Life after the clean-up
The crackdown on tax evasion in western economies is causing nervousness about the future of private banking in Switzerland. The received wisdom is that without total secrecy Swiss private banking would lose its appeal. Anecdotally, though, the anticipated capital flight has not been that great and, more to the point, trying to appease such flight is chasing a rapidly shrinking and high-risk segment of the private wealth market.
Swiss private banks that have read ahead and adapted to operating in a tax-transparent world appear to be retaining and, indeed, in some cases growing their business after suffering the initial pain of the transition. However, well-known private banks that remain rooted in the past are either being sold or are disappearing entirely. Those proclaiming shock or surprise at the fate of Wegelin & Cie need a better grasp of what is going on in the world and the way the tectonic plates of international tax cooperation have moved.
Whether or not you agree with the US and other western governments’ drives to obtain further information and prosecute both tax evaders and the organisations that assist them, the reality is that those governments have viewed the undermining of their tax base as tantamount to an act of economic warfare and have responded accordingly.
There is a large disparity in the power of the armouries of each side. Western governments have managed to galvanise public opinion and journalists behind what was previously quite an esoteric subject by linking it to funding their way out of the present economic crisis and limiting austerity measures. Running and hiding has one inevitable conclusion when faced with such inequality of economic firepower.
However, many banks realised the way the world was changing and reacted accordingly. A number of factors have therefore made predictions of the demise of the Swiss private banking industry somewhat premature. The unexpected trend has been the extent to and speed at which holders of undeclared Swiss accounts are choosing to disclose and pay outstanding tax due in their home countries. Of course, some have chosen to move their money to jurisdictions not yet under the spotlight of Organisation for Economic Cooperation and Development (OECD) governments in an effort to buy more time, believing (wrongly) that the drive to catch tax evaders will go away if they just keep their heads down.
Many, though, have understood that, in an age of electronic banking data and analytics, buying more time isn’t an option: the gaze of the OECD is turning eastwards. Singapore has criminalised tax evasion and Hong Kong has signed up to many more tax information exchange agreements and tax treaties with OECD governments. The few places left for tax evaders to hide the loot tend not to have strong economies or sophisticated private banking industries: they are not desirable places to put your money. Delaying the inevitable will increase the tax and penalties payable in the future.
The carrot and stick approach of certain countries has made now an ideal time to disclose untaxed accounts and retain a good proportion of the balances. The recent agreements with Germany and the UK using the ‘Rubik’ formula – under which Swiss accounts that have never been declared to the German or UK tax authorities are to suffer a sizeable one-off withholding payment – have forced many account holders into disclosure. Generous amnesties such as the UK’s Liechtenstein Disclosure Facility have been key in persuading many to go down the disclosure route. Even though the EU may have put these agreements in doubt, they still seem to have had the desired effect of bringing the tax evaders to the table.
Governments have viewed the undermining of their tax base as tantamount to economic warfare
Having disclosed, the key question is why the clients should stay with Swiss banks if traditional secrecy is gone. In practice, many are, for now, choosing to stay. Swiss private banking, at its best, offers some attractive features that few equal. Even with tax secrecy gone, Swiss banking remains highly valued for its protection against many other undesirable intrusions into privacy. The personal customer service provided by Swiss private banks remains attractive compared with other major private banking centres. Perhaps most importantly at this time, the Swiss private banking system has seen recent net inflows of assets under management as it is perceived as a safe haven in the current financial crisis because of the financial stability of Switzerland, its currency and its banking system.
These core attractions of Swiss private banking are being rigorously defended and promoted by banks that have been willing to adapt to the new disclosed world, but it will undoubtedly be imperative for Swiss banks to retain funds when the present financial situation is resolved. This has required certain other key concerns to be addressed by these banks.
Fees are an area of concern as the global private banking market is becoming more competitive. Swiss private banking is expensive but is also a premium brand that must not be devalued, as Switzerland cannot realistically compete on price alone. With a strong Swiss franc, either fees are high or margins are squeezed. Banks could be leaner, but too aggressive cost-cutting will risk the premium brand, so there is a difficult balance to strike. Delivery of a premium product will be the key to Swiss private banks’ survival and growth.
Investment performance is another area where Swiss private banks are going to come under greater scrutiny. In the past, tax evaders were only concerned, at best, by capital preservation. The process of disclosure has caused many to review their financial performance, as historically they have deliberately chosen to receive little or no information from their bank to escape detection by the tax authorities.
In reality, the best Swiss banks may have delivered relatively modest returns, but their conservative strategies tended to come good in recent times, and this continues to make them popular. However, some banks delivered poor returns for high fees. The joy of a low tax bill on disclosure frequently gives way to shock and then anger as clients realise that 40 per cent of nothing is still nothing. Such clients are likely to leave. Even the good conservative performers are now looking to deliver more exciting and varied investment products so they can compete in a transparent, disclosed world.
In the world of tax evasion, tax-efficient investment was given little thought. Some banks put clients into collective investments and wrappers, such as life insurance or foundations, for perceived advantages. When the clients came to disclose, many of these had not been designed for their home markets and they often paid significant additional tax as a result. For example, UK clients who invested through life insurance contracts that were ‘personalised portfolio bonds’ were charged income tax on an annual deemed gain of 15 per cent of value, irrespective of actual performance.
Delivery of a premium product will be the key to Swiss private banks’ survival and growth
In the fully disclosed environment, this has had to change. The response by banks willing to embrace change has been to offer country-specific tax-optimised investments, products and reporting, and to assign clients to country or region-specific desks for which the relationship managers are appropriately trained. Those unable or unwilling to deliver such a proposition have had to focus on markets where tax is less of an issue, such as the Gulf or the Far East, or risk going out of business.
Perhaps the biggest issue for Swiss banks to address in the disclosed environment has been having to engage with the high level of financial services regulation in western markets. Swiss private banks can no longer assume that business will come to them; bankers now have to travel to generate business. In highly regulated markets, there is potential for prosecution or liabilities for the bank if activities are conducted without appropriate authorisation. Are the banks only marketing financial services and products or do they wish also to give financial advice? Do they want to lend into the jurisdiction and take security over real estate? Solutions to these issues range from banks obtaining the minimum authorisation to market, opening a representative office or branch with authorisation to give financial advice, right through to opening a full subsidiary with credit and deposit-taking licences in the local market. The appropriate solution will depend on the size and importance of the local market to the particular bank.
Many of the best private banks in Switzerland are addressing these issues and look likely to continue to compete in their new tax-disclosed world. Those banks with no appetite or ability to change are under serious threat. Consolidation of the larger institutions will probably continue, but a stronger brand is likely to emerge.
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