Melanie Stern is Section Editor of Families in Business magazine.
The European private banking industry is now split between enterprising corporates and smaller, traditional players; lack of dynamism has retarded competitive spirit in the latter while the former established its domination. Time to get busy, says Melanie Stern
During the wintertime, an ant was living off the grain that he had stored up for himself during the summer. The cricket came to the ant and asked him to share some of his grain. The ant said to the cricket, "And what were you doing all summer long, since you weren't gathering grain to eat?" The cricket replied, "Because I was busy singing I didn't have time for the harvest." The ant laughed at the cricket's reply, and hid his heaps of grain deeper in the ground. "Since you sang like a fool in the summer," said the ant, "you better be prepared to dance the winter away!"
(Source: Aesop's Fables – The Ant and The Cricket. Translated by Laura Gibbs. Oxford University Press, 2002)
The third millennium has so far been pivotal for the European private banking industry. After generations of quiet prosperity, many incumbents now realise that while their business model has stayed the same, private clients have changed. This has created a fissure between the two, now increasingly filled by powerful corporate financial institutions marketing many of their institutional offerings under private client, wealth management or family office labels.
Having spied a lucrative but unfulfilled market, and with the recent losses in the investment banking industry, the top three or four corporates have spent the past decade buying up smaller, ailing independent private banks. Their plan has been to realise earning potential from private clients through an established player with a familiar face. UBS and Credit Suisse are two such contenders who have done this and now take the lion's share of Europe's market segment; a cycle of consolidation, strategic alliances and more corporates vying for their share is mid-flow, further threatening the market's oldest players in their weakened state.
Smaller private banks have relied too heavily on procuring new business by hiring managers with ready-made client relationships to import. Research conducted by UK-based private banking think-tank Scorpio Partnership in 1998 revealed that the best-case scenario for book transfer was only 50%, while average transfer fell at 30% and worst-case was just 5%. Some say that best-case transfer in 2003 is just 15%, and as current private banking advisory staff hiring activity is in keeping with the slowdown in other financial markets, this passive growth strategy has been rendered redundant. In a recent trend, some clients have decided to stay with an outgoing manager's former institution but give the manager a portion of their assets under their new employer, taking advantage of whatever products or services the latter has to offer and wisely spreading their risk.
However, it is hard to feel sympathy for these older players. The bull market of the 1980's saw many private banks take a relaxed attitude to splashing out on their asset management businesses and buying up star investment bankers. As the bear market took hold, this model became cost-ineffective. "The current private banking business model is a hugely expensive one, and what has been shown in the past two years is how people thought it was a counter-cyclical industry that worked in good and bad markets – even better in bad because clients would come to them in a kind of flight to quality," says Seb Dovey, the director of Scorpio Partnership. "That is not happening as effectively as it used to now." Additionally, independents are still slow to react to increased competition, perhaps continuing to rest of their laurels; much like Aesop's cricket. With European wealth set to balloon 15% from US$8.4 trillion in 2001 to US$12.8 trillion in 2004, according to Moody's Investor Services, they do so at their peril.
European private banking: key players serving family businesses
For European business families – many of whom employ private banks to manage their assets and increase their wealth – the corporate's ability to offer private wealth and family business services across all geographical jurisdictions, under the implied safety of a global brand, is seductive. Some still value the traditional institutions, but most are no longer content to stay with a bank if it does not produce satisfactory financial and investment performance, a sticking point for the less dynamic, older players. Families also want to take a more active role in their finances. "High net worth investors now look for advisors who take a 'manage it with me' approach, characterised by collaboration, transparency, reliability and high service levels," vice president of securities consulting at Cap Gemini Ernst & Young, Alvi Abuaf, says. "We are now in the era of 'collaborative counsel'."
With this new mindset, families are increasingly breaking up their assets among multiple players to minimise the risk of losses. This signals the end of assumed client loyalty to any one institution, although many players have not realised that this heats up competition even more. "Some banks have assumed families are unsophisticated when in fact, the reason they began to offer more products and services is because the families had been demanding more of them – they had realised that they could demand more, and for less," Dovey concurs. "These clients realised that they were being overcharged and under-serviced. Now it is clear they consistently re-assess the results they get from private banks, and some are becoming increasingly irritated with poor results to the extent that they may decide to change institutions." His comments are supported by the 2003 World Wealth Report, conducted by Merrill Lynch and Cap Gemini Ernst & Young; of the top four requirements private clients have when looking for a wealth advisor, the top three are service quality, personal service and the relationship with the advisor, and valued advice. Investment performance came fourth.
This fissure between families and private banks has been further widened by the advent of family business education, offered through a wealth of universities and specialist institutes across the world. Aware of what products and services are out there, and the proliferation of providers, families increasingly expect the level of service afforded investment banking clients. Many observers believe that families now know more about how best to manage their portfolios, and activity in their market, than their private bank relationship manager.
As traditional European private banks have slowly fallen into decline over the past decade, many have been bought up by powerful corporates as a direct line to the private wealth market. As an example, UBS spent a decade buying up five of the oldest Swiss private banks including Ferrier Lullin & Cie and Banco di Lugano, consolidating them into a holding company with asset manager GAM in February this year. This arrangement allows an institution to draw in clients who like a boutique service, but affords clients a wider product range underpinned by the financial strength of a corporate bank – often called the 'gatekeeper solution.' "Many families have a relationship with the two and they like that," says Dovey. "They prefer to be with the boutique but at the same time to know their assets are safely held at a larger institution." Credit Suisse offers a similar organisation through a small consortium of private banks including Bank Leu and Clariden Bank.
For smaller banks that do not have the resources to purchase their rivals, outsourcing has recently gained popularity, commonly labelled 'open architecture'. This solution allows these players to widen their product palette through prestigious partners, without needing to invest in specialised staff. "For most banks, it is no longer economical to either depend on one product or to be 'everything to all people' – because clients' needs are broader, complex and shifting," Moody's analysts Alexandra Sleator and Samuel Theodore explain. "Through open architecture, private bankers can offer a range of investments larger than those they could reasonably manufacture in-house as long as they are able to offer valuable advice on these products." Additionally for clients, this further opens up the market.
With the dominance of large players has come the issue of service as a priority for private and family clients. The traditional private bank touted personal service as its unique competitive edge, along with secrecy and trust; this led to managers who would do everything from looking after a family's wealth to organising dog-walkers. In turn, private clients seemed to like this. The UBS' and Merrill Lynch's of the market are unlikely to see dog-walking as part of their remit – the quarterly and annual target-driven structure behind them means their client relationship managers have vastly different pressures. The assumption is that smaller banks will still offer their personalised service and corporate banks will concentrate on portfolio performance, but strangely, many think not. "These institutions are no longer client-centric and families know that. Clients see a negative impact on their asset base because of poor performance and low levels of engagement between the client and the banker," says Dovey. "The criticism of the big banks, is that they too are not client focused."
Does the increasing dominance of the corporate players signal the demise of time-honoured personal service? "For family business clients, the choice between a larger corporate or a smaller partner is available and should be linked to each client's requirements," says Thierry Lombard, Senior Partner and owner of mid-sized Swiss private bank, Lombard Odier Darier Hentsch & Cie.
"We believe that a mid-sized private banker can be a better solution for the private assets of a family – in this type of relationship the client will attach a higher value to confidentiality and the banker is ideally positioned to respect the clients' private sphere. This is easier to achieve in a mid-sized structure with a longstanding private banker culture. Larger corporate banks tend to be more structured, pushing the client to deal with a number of specialists."
Some observers note that attempts by some smaller players to professionalise their offerings in the likeness of some corporate offerings could see the private banking sphere turn into investment banking mark two. Thierry disagrees. "The owner of a family business will continue to look for partners able to offer a combination of financial advice with a strong understanding of softer factors surrounding the situation of the family, the history of its business or the expectations of its members. We believe that the specific expertise of the smaller, independent players will remain attractive to a wide number of private clients who expect more than pure financial services."
Time to act
It may initially look rosy for the corporates and not so rosy for the independents, but historic market reform provides opportunities for whoever is able to act in the current challenging climate.
The family office structure has made some impact on the European family business sector, and gains a lot of trust from being run by families themselves. Not only are family offices – like the Fleming family's SandAire and Germany's Feri, part-owned by Germany's Quandt family – drawing more affluent families, but they are also forging important relationships with the private banking industry. Some believe it would be a wise move for private banks of all sizes to take the 'gatekeeper' route using those relationships.
Many families still strongly believe that it is too great a risk to place their assets with a listed institution, because their pressures – shareholder value, and all the drivers of it – are not well aligned with the families'. For this reason, independent and often family-owned private banks have a strong advantage with those clients.
Additionally for independents, having a distinguished culture, while being an intangible, is still clearly attractive to family and private clients who find it easier to identify with an institution that can boast hundreds of years in documented history and ingrained beliefs. Perhaps this is why Swiss private banking remains at the top of the market. "Private banking is agonising over its identity at the moment. Aside from in Switzerland, there is no clarity as to what 'private banking' means, and that needs to change. The reason Switzerland has such a distinct place in the private banking market is that it has a culture – and this will survive." Observers also note the lack of definition for the term 'family business advisor' within private banking.
Thierry Lombard, recalling his own bank's recent merger with Darier Hentsch & Cie in order to compete with the corporate onslaught, is upbeat about the future for his remaining contemporaries – if they get to work on defining their individual strengths. "We believe the specific expertise of mid-sized, independent players will remain attractive to a wide number of private clients who expect more than pure financial services. The diversity of cultures and styles in Europe will continue to foster the more flexible and human approach of private bankers. There is room for everyone, as long as each player concentrates on its area of competence."