Traditionally, whether acknowledged or not, a focus of international wealth management has been to use bank secrecy laws for tax avoidance. An unstoppable trend toward greater global transparency, however, is rendering this model obsolete. Wealth managers who fail to adapt will not survive.
The wealth management industry produces about twice the profits for financial institutions as investment banking. Nonetheless, in all too many cases, financial institutions fail miserably to meet the needs of the wealth owners they seek to serve. Families around the world are affected by legal, tax and other developments combining to create a mismatch between what the wealth management industry offers and what the families themselves really need. One major area is the unstoppable trend toward global transparency and the fast decline of offshore private banking.
For years, the unspoken focus of wealth management has been to take advantage of bank secrecy rules and the lack of information-exchange agreements to help wealthy owners “hide money,” despite the tax rules of their home countries. It’s hard to estimate how much undeclared money is in onshore and offshore centres but some figures suggest close to $6 trillion, with about one-third in Switzerland.
Bank secrecy is alive and well in some countries but even those with strong bank secrecy rules, such as Switzerland, face growing international pressure and the reality that transparency is a key objective of many of the world’s main economies.
The days of a client arriving at a bank in a bank secrecy country and being told, “We can handle your affairs here without having to worry about the rules of your home country — we have bank secrecy” are over. Let me suggest some reasons why.
In 2000, the US began implementing its Qualified Intermediary (QI) system, requiring non-US banks to provide full disclosure of both US and non-US clients investing in US securities.
This means, for example, if a German citizen has a bank account in Liechtenstein with a non-QI bank and within that account US securities are purchased, their name could be provided to the US. In turn, the US could provide that information to the German tax authorities. Every serious bank around the world entered into this agreement because as QIs, they can keep certain clients confidential, such as direct non-US clients of the bank. The fact that banks around the world have signed an agreement of this kind with a foreign tax authority is a good indication of the weakening of bank secrecy and the declining ability of players in the wealth management industry to offer clients a way to ignore tax and legal requirements in their home countries.
The QI system in the US is only one of many examples of the growing irrelevance of bank secrecy to families and their increasing need for a real understanding of their home country as well as other country issues.
The increasing global use of credit cards and other cashless payment systems also results in an exchange of information that a family may be surprised to know exists. A number of countries have followed the US example of obtaining information on the use of credit cards, including Brazil, the UK and Australia. Surprisingly, the US estate tax can be a particularly important issue for both US and non-US families.
Although the US estate tax is well known for its worldwide impact on US citizens and domiciliaries, it is less understood that non-US individuals are also subject to this tax in relation to transfers of “US situs” assets, such as real estate and movable property located in the US. But a US situs asset for estate tax purposes also includes portfolio holdings in US companies.
Another trend discouraging wealth owners from needing secrecy-based wealth management is the growing understanding that greater tax compliance can be achieved through lower tax rates and a simpler tax system. Many of the world’s growth markets, which new wealth owners often spring from, are countries that understand this dynamic and make it part of their economic system. Russia is an example with its low tax rates.
When the cost of complying with the law reaches such low levels, the idea of hiding money becomes almost obsolete. For countries such as Singapore and Switzerland, a broad network of tax treaties is something required by the many multinationals with a presence in these countries. It is important to understand that tax treaties often include far-reaching provisions for the exchange of information that can compromise the ability of a country to keep information secret.
Industry, in contrast, encourages countries to maintain a wide network of tax treaties and to be generally cooperative when treaty partners request access to greater information. Although the financial services industry may lobby hard against expanding the provisions, at the end of the day, it is difficult for a country to avoid broadening the exchange of information it grants and increasing the number of treaties in which it provides such information.
The European Union Savings Directive (EUSD) and international money-laundering rules are other areas where information comes to light in relation to undisclosed funds. Although money-laundering rules around the world originally focused on tracking down money generated by drug dealers and terrorist organisations, laws are increasingly moving toward what are known as “all-crimes” money-laundering rules. Today in the UK, money-laundering rules require the reporting of suspicious activity if the money at issue is tainted by any crime, even one associated with the tax laws of another country.
There will continue to be, for technical reasons, exceptions in such countries as Liechtenstein, but the questions that families will begin to ask are: “How long will these exceptions continue to exist?”; and “How long will the global community allow certain centers to attract undeclared money and shelter families from having to comply with the laws of their home countries?”
The more important question for family offices is whether helping families break the laws of their home countries, either tax or other laws, is actually in the interest of the family involved. Few financial institutions really understand the risks they take when the structures they offer help hide assets and earnings from tax authorities. Recent events in the banking world in Germany and Lichtenstein, and also the US and Switzerland serve as grim reminders of just how far governments can go to track down their citizens’ assets.
Families require advisors who can identify their real needs. These needs are not restricted to the tax area but, rather, extend to many issues that in the current environment are simply being ignored.
Traditional private bank product structures sometimes work but often rely, more than anything else, on never being looked at by taxing authorities. Most importantly, the current “product” culture has meant advisors are ignoring many other issues. The structures established for them neglect to take these needs into account.
Some families need to simply plan for business and investment succession and to address how a wealth owner wishes assets pass to the younger generation. Is the younger generation meant to be the owner of the assets involved, or is the intention that they merely be custodians for further generations? Other needs can be driven by the specifics of the tax and legal rules of a family’s home countries. The political situation of the home country can also be a driver of wealth-planning needs.
Aside from tax, there are numerous legal issues also driven by the home country, including those associated with wealth owners who may be connected to countries with high political risks. Structures adopted for these families should be designed to provide protection of assets in the event that one of these political risks materialises. This type of planning is what families need — not a wealth manager who says, “We have bank secrecy, no one will ever find out what we are doing, so we do not need to pay attention to the rules of your country.” Such statements are simply not true.
For financial institutions and family offices, a wake-up call is around the corner. It is the global financial institutions that will be the targets of tax authorities equipped with full information seeking redress for encouraging taxpayers to hide their money. It is the global financial institutions that are losing revenue as manufacturing moves out of the banks. It is the global financial institutions that risk becoming nothing more than custodians as relationships walk out the door because relationship managers are not provided with the support and training they need.
The failings of the banks and the new needs of families are creating new opportunities for the niche players in the industry. Asset managers, multifamily offices and others have a chance to step into relationships abandoned by private banks run by investment bankers who understand more about the rewards of buying and selling a business than about nurturing a relationship and meeting the long-term needs of wealth-owning families.