Cablegate: Frankfurt Stock Exchange: Meeting Global Capital

DE RUEHFT #5173/01 3411025
R 071025Z DEC 07





E.O. 12958: N/A
SUBJECT: Frankfurt Stock Exchange: Meeting Global Capital

FRANKFURT 00005173 001.2 OF 002

1. SUMMARY: The Frankfurt Stock Exchange (FSE) is the world's third
largest and the sixth by market capitalization. Known for its
high-tech trading technology, it has played a lead role in cementing
Germany's reputation as a financial and economic power. However in
an increasingly securitized world, German companies and investors
have kept their distance from the equity market and Germany has low
rates of market capitalization and stock ownership for an economy of
its size. Not only has Frankfurt failed to keep pace with other
more globalized financial centers, but the Germany economy also
remains more self-contained and at a distance from global capital.

Germany's Underdeveloped Equity Market

2. Despite having one of the world's largest and most dynamic
economies, Germany's overall stock market capitalization remains
only 57% of GDP. Compared with ratios of 300% in Switzerland, 150%
in the U.S. and 92% in India, a larger part of the German economy
still lies outside the stock market. Financial experts have
criticized the lack of capitalization, saying that capital remains
inefficiently allocated and firms lack sources of funding for
expansion. In a November 19 speech at the Euro Finance Week
conference in Frankfurt, Deutsche Bank CEO Josef Ackermann pointed
out this weakness in the German economy, saying that "a high market
capitalization is a central factor in the quality of a financial
center and a national economy."

3. Low-level market capitalization in Germany is primarily a result
of the business model of the "Mittelstand," Germany's small and
medium-sized enterprises (SMEs). Loans from German banks are still
the most important debt instrument for SMEs, which make up 99% of
Germany's 3.3 million companies and provide 70% of its jobs. German
banks and SMEs have had a historically close, relationship-based
lending system. Most loans from regional banks (Landesbanken)
enjoyed state backing as recently as 2005. Germany's state
development bank, Kreditbank fuer Wiederaufbau (KfW), lends and
provides advice to SMEs and made 15.8 billion euros in commitments
in 2007.

4. German SMEs have shown a hesitancy to go public in recent years.
In 2006, around 3 billion euros were raised in initial public
offerings (IPOs) in Germany, compared with 17 billion euros in Great
Britain and 30 billion euros in the U.S. A November 2007 German
Stock Institute survey revealed that only 24% of German SMEs were
considering an IPO in the future. A full 60% of the firms surveyed
said other forms of financing sufficed, and 30% feared that going
public would bring costly regulatory burdens that they cannot
afford. Shareholder rights are also strong in Germany meaning that
once a company goes public it must maintain high, and often costly,
transparency requirements.

5. Staying private means SMEs face greater challenges in
strengthening their equity ratio and improving their credit standing
in the eyes of global investors. Ackermann argued in his speech
that "they (equity markets) are indispensable for efficient capital
allocation and cost-effective enterprise financing." In relying on
German bank loans, SMEs remain a step removed for global

Why Germans Don't Own Stock

6. Germany also lags behind other large economies in stock ownership
with only 7% of Germans directly invested in stocks as compared with
over 20% in Great Britain, the U.S. and Switzerland. German pension
funds are also less invested in stocks as their foreign equivalents
and only 15% of Germans participate in private pension plans. A
Deutsche Bank researcher told Econ Specialist November 29 that while
Germans had a high savings rate of around 11%, the state covers
large expenses such as higher education and retirement, meaning that
potential investors do not see the need to "grow money quickly,"
unlike in other countries.

7. Starting in 2009, private German shareholders will pay a capital
gains tax of 50% when they own less than 1% of a company, a move
which is unlikely to foster a shareholding culture in Germany. Such
a tax already applies for private shareholders who own more than 1%,
while corporate capital gains are taxed at 25%. Both the burst of
the dot-com bubble in 2000-2001 and a similar bust in over-valued
shares of Deutsche Telekom in 2002 have only cemented the popular
view in Germany that stocks are a risky venture.

Deutsche Boerse: A Regional Player

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8. Deutsche Boerse AG, which manages the Frankfurt Stock Exchange,
has attempted to remain competitive with mixed results. In 1999,
Deutsche Boerse unveiled the Neuer Markt (New Market), a small
exchange for start-up and high-tech companies that followed the
model of the NASDAQ. Despite initial success, the Neuer Markt
closed in 2003, a victim of the global dot-com bust. The Deutsche
Boerse also failed in its bid to expand by taking over the London
Stock Exchange in 2004, when its shareholders failed to back the

9. A notable success for Deutsche Boerse was the launching of the
high-tech Xetra electronic trading system in 1997, which opened the
market to more European investors. Deutsche Boerse introduced the
Entry Standard in October 2005, whereby smaller companies can list
themselves while meeting fewer formal requirements. The FSE has
cemented itself as a leading exchange market for the Euro zone, but
clearly does not compete with counterparts such as London, which
liberalized its equity market as early as the 1980s and took on a
global role. A senior AmCham representative told Econ Off November
1 that Deutsche Boerse retained a focus on the German and European
economies but "faces a real challenge in that it wants to grow, but
can find no partners."

10. COMMENT: The German economy looks to remain the outlier among
the world's large economies in market capitalization and stock
market participation. During the current period of economic upswing
in Germany and global financial unrest, there is little public
debate about the need to change traditional financing practices.
While the FSE is certainly not in decline, it remains a regional
player, leaving global capital investment to other centers. END

11. This cable was coordinated with Embassy Berlin.


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