Old game, new rules

Thursday, 01 October 2009
An outline of the challenges facing the future of Switzerland's financial centre.

Since the outbreak of the financial crisis, Swiss bank secrecy has been under fire from many quarters, most notably the USA. In particular, the much publicised case over whether UBS could be forced to reveal the identities of up to 52,000 American clients with accounts in Switzerland, led many to predict that banking secrecy was facing its final hour. Immediate tensions reduced as the case settled out of court on 11 August, but the broader, long-term implications remain. What do the recent developments in bank secrecy and information exchange mean for Swiss banks and the future of Switzerland’s financial centre?

Switzerland and the USA resolved their differences over the UBS case by agreeing, in principle, to settle the matter through a double-taxation agreement. Hence, the widely expected blow to Switzerland’s bank secrecy did not occur. More importantly, the disclosure of a relatively small number of UBS client names to the IRS does not create a precedent for other foreign tax authorities that will breach Swiss bank secrecy in the future. Switzerland’s image as a stronghold in matters of client confidentiality has been preserved – once again.

Nevertheless, it is to be expected that the fallout of the UBS case will, to a certain extent, hamper the development of cross-border private banking business in Switzerland. Swiss banks will most likely establish stricter internal guidelines for providing services to international clients, in order to reduce the risk of being considered to have assisted actions deemed unlawful by foreign jurisdictions. As costly for the Swiss banks and Switzerland as this may be, the real challenge is much greater. It is essential for Switzerland – as an international financial centre for the management of private and institutional assets – to get in shape for the old game, but with new rules. If Switzerland and its banks are to pass the fitness test, they must deal swiftly and appropriately with the three issues discussed below.

How can Switzerland continue to protect the privacy of clients’ data without being labelled a ‘tax haven’?

Negative economic developments have the unfortunate tendency to foster capital protectionism, whereby political systems introduce controls over funds and associated transactions in their claimed area of influence. The USA, for example, is trying to expand this area of influence very significantly based on their imperative of taxing US persons globally. Cross-border wealth management is diametrically opposed to capital protectionism. One of its fundamental characteristics is that both capital and transactions are located outside the control of the countries of domicile, i.e. partially or wholly out of reach of the exchequer of the country of origin. Given the tightening national budgets and escalating debt burdens, it is no wonder that several political leaders want to tighten the grip on international financial centres.

Governments around the world are targeting the so-called ‘offshore centres’, in a campaign to expose wealthy tax evaders. This, however, is a pretext for achieving their true final goal, i.e. to capture the assets managed by bankers in other countries in order to feed their treasuries. Since Switzerland is the financial centre for 27 per cent of the world’s offshore wealth, it is naturally the top target. Switzerland is small, and the big countries want to capture market share. Switzerland is in an economic war. In its recent European Private Banking Survey 2009, McKinsey & Company tried to value the risk of Switzerland losing such a war. Even when assuming a high share of undeclared money in offshore locations, significant repatriation of the same and high taxation of the remainder, it is still unlikely, the report concludes, that offshore locations would lose more than a third of their asset base. One fact supporting this view is that an estimated one-third of offshore funds in Switzerland originate from countries where the wealthy are not subject to high taxation. The inflow of funds from these regions into banks in Geneva and Zürich has accelerated in the past five years. Thus clients in low-tax countries, such as Russia and the United Arab Emirates, are not aiming to avoid taxes at home, rather, they appreciate Switzerland’s strong currency and political stability. Many clients are attracted to Switzerland as a safe haven – not a tax haven. Moreover, the significance of the taxation implications of banking secrecy has long been in decline, but Switzerland’s tradition of protecting the sphere of privacy is still very attractive to wealthy persons.

Given that there is no ethical conflict between the right of the state to enforce taxation laws and the respect for financial privacy, there must be a solution to preserve Switzerland’s attractiveness as an international financial centre. One potential way of resolving the current tensions with foreign governments would be to separate the fiscal component from the fundamental component of banking secrecy. The introduction of a well-structured withholding tax – equivalent to the rate in the country of domicile – that would provide definitive compensation for potentially forgone taxes could be an acceptable solution for all parties involved. Foreign clients of Swiss banks would have to give up the possibility of protection from taxation in their county of domicile, but at the same time it would guarantee the non-criminalisation of funds held abroad and completely maintain investor anonymity. At the same time, if negotiations with foreign states were conducted on a reasonable basis, Switzerland should, in all fairness, be granted complete freedom to provide services in the countries with which it has reached such agreements. This, in turn, would support the objectives of a globalised liberal economy, and the maintenance of a free market for capital, uncontrolled by any state authority.

How will Swiss banks be able – and authorised – to deliver cross-border financial services to private individuals?

Whatever the outcome of the economic war, wealthy individuals will continue to seek to diversify their liquid assets in various international financial centres that have the discretion and expertise to manage their funds.

McKinsey & Co indicates in its European Private Banking Survey 2009 that Switzerland, with more than EUR1,700 billion in assets under management, is not only one of the largest markets, but also the private banking market with the longest tradition and highest reputation. Swiss private banks have been able to keep their margins at high levels due to the lower price sensitivity of international clients and their expertise to recommend the right products and asset allocation mix.

However, in order to successfully serve international clients in their home countries as if they banked at home (while keeping their money deposited in Switzerland) these two unique peculiarities may vanish over time. The key to succeed, given that free access to markets is granted, is the right service and product offering, seamless delivery, and tighter compliance standards that guarantee adherence to the rules in foreign jurisdictions.

The investments to achieve a level of client satisfaction that allows a Swiss bank to successfully compete against local banks abroad may be substantial. However, given the passion of Swiss bankers for their business, their exceptional know-how, and their understanding and experience in catering to the needs of wealthy clients, one should not be surprised if a number of Swiss banks will be able to capture market share from local competitors abroad.

How must Switzerland and its banks frame the political and business environment to retain and attract foreign clients?

Switzerland must remain politically and economically stable, with a good legal system and well-run banks. Moreover, Switzerland must maintain a strategy of non-confrontation with big economies on tax, but without relinquishing financial privacy laws that are a foundation of individual dignity and basic property rights. In addition, the Swiss government and regulators must continue to develop and implement clear, long-term and transparent financial industry strategies that foster confidence in the Swiss financial centre.

The financial service industry in Switzerland must also learn its lessons from the recent past. Unfortunately, as stated in McKinsey & Co’s European Private Banking Survey 2009, some banks charged fully but delivered too little personalised advice. Clients were profiled into standard risk categories and the asset allocation and selection of investment products were, to a large extent, well aligned. However, only a few banks managed the assets according to the clients’ changing risk appetites. In addition, many clients have realised that the interests of their relationship manager were not always fully aligned with their own investment needs and concerns. In the future, risk management will play an increased role in all parts of the investment advisory process. Only banks which are able to ensure that its staff acts in the clients’ interests will survive. Clients will not stay if their wealth is not preserved and grown. Banks will therefore have to ensure excellence in understanding client needs, advising on asset allocation, product and manager selection, risk management, and transparent client information and reporting.

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Christian W Hafner

Christian W Hafner is Managing Partner at Wegelin & Co Private Bankers, the oldest bank in Switzerland.

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