Offshore

Analysis: As Bank Secrecy Erodes, Firms Must Reinvent To Protect Margins

Tom Burroughes , Group Editor, London, 10 November 2011

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As bank secrecy erodes, the old easy days of hiding funds and only seeing clients rarely are fast departing, which means banks must work harder to protect margins.

That the walls of financial secrecy are continuing to crumble means banks that once made fat margins in Switzerland and other locations must reinvent themselves or die, industry figures say.

The assault on Swiss bank secrecy laws has been the most dramatic example of how the landscape is evolving. A number of wealth managers, such as UBS, Julius Baer and Wegelin no longer provide offshore banking to US citizens, for example. In the case of Credit Suisse, Switzerland’s second-largest bank, it has started to notify some US clients that it intends to hand their names to the Internal Revenue Service, with the help of Swiss tax authorities. Switzerland is trying to agree a disclosure and information exchange deal with the US that would include its entire banking industry. Meanwhile, Germany and the UK have recently signed tax disclosure pacts with the Alpine state. Other states, such as tiny Liechtenstein, have moved to break down bank secrecy.

The days when a bank could take the lazy route of storing secret cash and only see a client maybe no more than once a year, and devote little time to maximising returns, are numbered, analysts say. As a result, margins will continue to narrow unless banks adapt. In the summer of this year, Scorpio, the consultants, said average cost-income ratios in the global wealth management industry had risen to an average of almost 80 per cent - a record level. Regulatory costs were cited as a key factor behind the cost squeeze. They are unlikely to abate.

"This [assault on bank secrecy] is going to have a huge effect and many in the industry have still not come to grips with this healthy move to tax transparency and compliance,” Philip Marcovici, a recently retired lawyer who played a central role in crafting the recent Liechtenstein Disclosure Facility with the UK, told this publication. His efforts on the LDF recently won him the Spear’s Wealth Management Innovator Of The Year Award.

“I am not 100 per cent convinced that all players have embraced the changes that are happening,” Marcovici said. "People are still thinking that in Asia and Latin America, for example, that you can stick to the same old procedures as in the past, ignoring the real needs of wealth-owning families, whose needs include navigating ever changing tax systems and many other legal and family issues.”

"The effect of the move to transparency is profound and it is going to be challenging for some banks to survive in this environment,” he said.

And it is not just the slow but remorseless erosion of banking secrecy that is forcing banks to work harder. In Switzerland, the nation’s banks’ revenues have been blunted by a high Swiss franc exchange rate. The Swiss National Bank has sought to curb the currency’s strength – but that may prove fruitless if the eurozone implodes under the weight of sovereign debt.

A broad trend

Other offshore centres are under pressure to open up their affairs, with implications for profit margins. While they have been criticised in some quarters for not going far enough, hundreds of tax information exchange agreements have been signed between jurisdictions such as the Cayman Islands, Jersey and Guernsey under OECD standards. And even before the 9/11 attacks, anti-money laundering rules and crackdowns on financing for terror groups also made life less comfortable for illicit funds.

The changes have been slowly gathering pace, industry figures say.

“It's simple - running offshore undeclared money is illegal. That's the way of the world. Evidently some banks/bankers will want it to continue and will point to markets where it still does (Indonesia, Nigeria, Nicaragua, Greece etc.) but there is only one way the story is going to end,” said Sebastian Dovey, managing partner at Scorpio.

Steffen Binder, co-founder and managing director at MyPrivateBanking, an organisation that pushes for improved client service in the sector, agrees that in a world where customers must pay tax, they will demand more effort from banks to maximise returns than in the old days.

Margins, Binder said, are squeezed by two forces: legalisation of assets and client fear about markets and refusal to buy high-margin structured products.

“Clients care a lot more about cost and performance when they have to pay taxes on their assets. In addition, 'discretion' was a big unique selling point but once it is gone people start questioning investment strategies, or can threaten their Swiss bankers with re-patriation of their assets to get a better deal,” Binder said.

“The financial crisis has left many investors scared. Performance has been bad so they put pressure on fees. Moreover, they have become skeptical about structured products, hedge funds and other black-box products that usually come with hefty margins. Clients nowadays prefer more and more clear-cut and cheap products: ETFs, for instance, have been a big thing in the last two years. Yet, there are no kick-backs with ETFs,” he said. Binder added that rising regulatory pressures in Switzerland were also a pressure on margins.

A tougher environment

Regardless of whether so-called tax havens fade into history or not – this publication has argued it is unlikely and not even desirable – banks must adapt to a different landscape, said Marcovici.

"Many banks have survived by saying to clients, 'Trust us, you don't have to do anything – bank secrecy is all you need',” he continued.

“Undeclared clients have only contacted their banks infrequently. In a transparent world, clients are in much more frequent contact with their banks, meaning that the number of clients that a client relationship manager can handle is much reduced, which adds costs, as does developing a real understanding of the holistic needs of clients and their regulatory environments,” Marcovici said.

Banks, he said, need to show a value proposition to clients that goes beyond bank secrecy but which includes clear use of bank secrecy to afford privacy and asset protection in a legal way that does not confuse bank secrecy with its misuse in the tax area.

"Some of these pressures are pressures that banks have brought upon themselves. Banks haven't been proactive in how the world is changing. Secrecy misused to enable tax evasion has, in fact, been a distraction and it has, for example, cost Switzerland severely,” he said.

A large number of banks have also failed to retain ownership of clients, hit by the impact of high turnover in relationship managers, for example. This explains why a number of high and ultra high net worth clients have defected to independent asset managers, or multi-family or single family offices. In serving such businesses, banks, which used to earn, say, 80 basis points in fees from a client are now earning in the low teens in providing just custodial services, he said.

Marcovici’s work on the LDF between Liechtenstein and the UK, working with Kaiser Partner, gave him an insight on how firms can prosper in a transparent world.

“There is hard work involved, but it is rewarding given that it means being on the right side of change,” he added.

 

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