This is the first part of a two-part feature exploring the future of Switzerland's wealth management sector as it wrestles with challenges, such as from Asia.

Editor’s choice: This article is by Options Group and is republished, with permission, by this publication. To view a link with full tables, footnotes and statistics, click on this link. As always, the views here are not necessarily shared by this publication. This is the first half of the article. The second segment can be read here. 

In this issue we bring perspectives on the changing face of Swiss offshore wealth management, the rise of the Asian offshore wealth management industry and the challenges facing all banks within this industry. Finally, we address the ways banks need to adapt in terms of relationship management expertise and how this can be addressed from a human capital perspective.

Switzerland has been synonymous with wealth management and offshore tax shelters since the country opened is first private bank in 1741. Despite significant changes in the global economy since that time, Switzerland has retained its prestigious reputation, and continues to hold the largest share of high net worth assets globally. But in recent years, and accelerated by the most recent market downturn, the historic heart of private banking - lack of full disclosure and consequent underpayment of taxes - has been subject to regulatory reforms which threaten Switzerland’s leading position.

Historically Swiss law took a somewhat liberal view towards tax evasion - it was not truly perceived as a crime. This, coupled with high-end client services, attracted some of the world's wealthiest and most discerning clients. They preferred that their assets not be heavily scrutinised by regulatory authorities, a situation which was afforded to them by the Swiss “numbered account” banking model. It also meant that Swiss banks were unable to assist authorities in any investigation. This is no longer the case. 2009 saw the beginning of legal action being taken against banks suspected of helping clients to hide money in Swiss accounts. The US Department of Justice led the charge, levying a $780 million fine against a Swiss bank, in exchange for a deferred prosecution agreement and the provision of client details to the IRS.

The domino effect of the US agreement meant that the UK, Italy, France, Germany, India and Australia all followed suit - attempting to persuade their wealthy citizens to report their offshore accounts in return for waived or lowered penalties, tax amnesties and immunity from prosecution. Some reports indicated that these attempts delivered billions of dollars in “lost” taxes.

Since 2009, there has been a significant increase in the number of Tax Information Exchange Agreements (TIEAs) being signed. The TIEA was conceived as an agreement to promote international cooperation in tax matters through exchange of information, to address "harmful tax practices".  Between 2000 and 2004 only thirteen TIEAs were signed, but as a consequence of the economic downturn and ongoing repercussions, almost 500 have been signed in the last three years. Within these were a large number of so-called black and grey “tax havens”, including Bermuda, Bahamas and the British Virgin Islands, as well as Switzerland and Liechtenstein. 

The hidden billions

Beginning with the collapse of Lehman Brothers in 2008 and the subsequent global market decline, governments have been more aggressively seeking ways to offset their growing deficits, including investigating any existing sources which may have been overlooked during better economic times. With good reason – debt is at an all-time high.

Even the largest global economies have had to focus their efforts on identifying overlooked sources of revenue - and garnering the attendant, politically-positive headlines - which could help them offset rising deficit.

So why is there the focused attack on wealth management? As a comparatively small segment of the banking industry, it has come under intense scrutiny. One could perceive that it has been driven in large part by a media-peddled image: that of the super-rich who have, for generation upon generation, escaped paying their taxes and dues. So is this a fair illustration?

Looking objectively at the figures, it is possible to see that there is some substance to the media's focus.  According to a 2011 Booz & Company survey, deposits by Western high and ultra high net worth individuals totalled SFr850 billion, of which an average of 61.5 per cent was undeclared. Broken down further, German deposits of SFr210 billon included SFr126 billion undeclared, and from the UK's deposits of SFr60 billion, SFr38 billion is assumed to be undeclared.

Media perception was in fact reality - there were large sums of under-taxed assets which, though clearly not capable of bringing about the end to financial deficits and political woes, would address some of the general public's backlash against the wealthy, while adding some much-needed money to the shrinking coffers. For example, as a result of the Italian tax amnesty in 2009, €80 billion was raised from an estimated €500 billion undeclared offshore assets. 

A swathe of regulations quickly passed in a number of jurisdictions, all addressing the tax evasion that was seen to be rife in the Swiss wealth management industry. France led the way; the government reached a revised tax treaty with Switzerland in August 2007, making it clear it would actively pursue Swiss bank account holders who did not regulate their tax affairs within a prescribed period of time. In the UK, Schedule 10 was appended to the Finance Act (2007), dealing specifically with penalties for non-declaration or deliberate concealment of offshore income. The UK tax disclosure pact was signed with Switzerland in October 2011. This required UK citizens with offshore accounts in Switzerland to settle their outstanding tax bills in lump sum payments of between 19-34 per cent of funds held. 

Germany passed a similar pact in September 2011 which was later amended in April 2012. The amendment offered those with significant tax amounts outstanding the opportunity to put their affairs in order by means of voluntary disclosure or by making an anonymous single payment. 

By 2012, the effects of the additional pacts and regulations have forced the Swiss wealth management industry to make significant revisions to key tenets of its culture. These revisions have raised questions as to whether Switzerland can remain the global wealth management capital as a white money haven, particularly when it must now compete with the emerging East: Hong Kong, Singapore and Indonesia.

Switzerland

Historically the epicentre of wealth management, Switzerland has come under sustained scrutiny in the past few years, moving from being a haven for the wealthy to being tarred as a repository for billions in undeclared assets. Because of this shifting landscape, both Swiss and international banks have been forced to re-evaluate their business models, placing the emphasis on value-added services and investment management. 

James Persse, managing director at the Geneva office of Barclays Suisse, comments: "Swiss banks, and particularly those that focus on traditional European markets, have had to drastically change their business models to one of service orientation, execution excellence and asset management performance.” This requires a shift in mentality from the inherent historic view of automatic Swiss banking superiority to one of competition with new wealth management jurisdictions.

Persse's comments are echoed by Alexander Friedmann, CIO of UBS. In a recent interview, he stated that the emphasis going forward for his firm will be on investment management. Friedman said: "The core of this place is wealth management. So unless we outperform as investment managers, the business model has to come up with something new."

Where UBS goes, others tend to follow. The importance of increased service for clients is similarly reinforced by Philip Harris, Royal Bank of Canada's head of UK Wealth Management, who said that the three tiers of focus for the bank are "Wealth Appreciation, Wealth Preservation and Wealth Distribution".  Emphasising the "brave new world" of full tax disclosure and transparent wealth management Harris commented that "business models are not predicated on tax avoidance. The focus will be compliant confidentiality - the setting up of legitimate structures rather than the cloak of secrecy used by other jurisdictions”. When asked whether he thought that Switzerland would remain competitive Harris said: "Yes, it will have to be. Banking is one of its principal exports which Switzerland cannot turn its back on. A new order is being developed; Switzerland will not be foolish enough to stand in the way." 

According to the State Secretariat for Economic Affairs (SECO) we can see that the Swiss banking industry contributed 10.3 per cent of gross domestic product in 2011. The significance of this contribution underpins Harris's sentiments. There are SFr5.3 trillion of foreign and domestic assets under management; the industry employs 195,834 people (Source: Swiss Banking Association).

Retaining the platinum edge

Switzerland's private wealth management legacy and prestige is one of its greatest assets in the fight to retain dominance. Heiner Weber, head of Geneva for Falcon Private Bank, said: "Switzerland has unique strengths in operations, human capital, legal and economic environment.  On the operational side I would like to highlight the quality of the IT systems and the SIX clearing system; the professionals adhere to a high standard, are service minded, multilingual, have a risk management culture and are used to working in different markets and booking centres."

The paths that banks are following are twofold. First, an increased emphasis on onshore banking and secondly, carefully navigating the regulatory line in terms of what can be offered to clients based on their jurisdictions. Between the demands of infrastructure, compliance and risk management, and staff retraining, operating costs have been on the rise and are expected to continue for the foreseeable future. To add further pressure on industry revenues, this increased emphasis on onshore banking has reduced its ability to offer offshore banking to US citizens. For example, as a consequence of the actions in 2009 of the US Department of Justice, a number of Swiss banks no longer provide any offshore facilities to US citizens. 

Christian Bouille, executive director at Banco Itaú on this topic, said: "The best available solution [for banks] is to think locally, establishing an onshore presence where they can get closer to clients [and] can provide services and financial solutions which are 100 per cent compliant with local regulations. Indeed we are already seeing banks doing this." When asked whether there would continue to be a rise in offshore banking for emerging economies, his view was in the affirmative but "in a completely different way. Offshore banking has the importance of the diversification of risk and will be more connected to client's business needs...this is where offshore banking has the potential to grow".