Bob Reynolds is consultant editor of Offshore Red magazine.
One third of all money placed offshore is managed by the Swiss financial sector. No other jurisdiction comes close to matching or challenging the dominance of Switzerland. Bob Reynolds reports
According to a report released by Gemini Consulting, the amount of money deposited in the world's 4,000 private institutions has increased steadily over the past decade.
In 1986 the amount was said to be $4.3 trillion. A decade later, the figure has more than doubled to $10 trillion. In year 2000 alone, the figure hit $13.6 trillion, and is still growing at a rate of 30% a year.
Hans Geiger, professor of banking of the Swiss Banking Institute at the University of Zurich says, "Private banking is a highly personalised business and it is and will remain a fragmented industry. UBS as the global market leader has an estimated 2–3% share of the world market and the ten largest private banking institutions of the world hold a cumulative market share of less than 12 %.
"The concept of Swiss private banking is much more than just banking. It is a representation of a rich cluster of economic and cultural institutions and activities. Swiss private banking starts at the three international airports of Zurich, Geneva and Basel and continues via the railway stations and luxury hotels of our country right up to the doors of Sprüngli's cake shop. Swiss private banking encompasses our hospitals, cultural institutions, media, lawyers, shops, schools, universities and our banks and asset managers."
Since 1990, the Swiss banking system has undergone a radical transformation. The total number of banks decreased from 625 to 356, the regional banks suffered the largest loss of 116 institutions. The number of large banks was halved from four to two due to one merger and one acquisition and the total number of bank employees in Switzerland declined by 13%.
Contrary to this general trend, those institutions which focus on private banking (exchange and asset management banks and the 'banquiers privés') increased their domestic staff by 70%, and the number of respective banks rose from 74 to 77. On average, these banks were more profitable and efficient than most other Swiss banks, although they suffered a sharp set back in earnings, profits and assets under management since the record year of 2000.
Since the beginning of 2002 there have been ten acquisitions, two mergers and one alliance affecting the Swiss private banking sector. The most significant being the merger of the two Geneva banquiers privés, Lombard Odier and Darier Hentsch, the acquisition of the Discount Bank & Trust by Union Bancaire Privée (UBP), and the alliance between the Dutch Rabobank and Bank Sarasin.
In a report on private banking in Switzerland, Professor Geiger and his colleague Harry Hürzeler, managing director of the Swiss Banking School, described the change in client base. "In the 1980s the central service demanded from private banking was the managing or advising on a portfolio of bonds and stocks. Clients were on average over 60 years old, and were often more focused on wealth preservation through low-risk bond and money market investments. At times some specialist advice for tax and inheritance issues was requested, such as the setting up and administering of wills.
"The 1990s brought a spectacular increase in wealth, which affected a number of these basic tenets. For the first time in a century there were more self-made as opposed to old money billionaires in the US with the wealth effect of the dot.coms making a significant impact. At the same time the remuneration schemes of executives changed in Europe to a more Anglo-Saxon style, with stock grants and stock options becoming prevalent, again leading to a dramatic increase in wealth. And then the general stock market boom increased wealth for all shareholders.
"This created the term 'newly wealthy' – younger clients who have made their own wealth in a short period of time and who are more aggressive in their expectations and willingness to take risks. Their success induced other investors to participate in this wealth creation process, even if they were not executives or entrepreneurs themselves. As a result the demand in alternative investments, such as private equity, hedge funds and venture financing has increased significantly."
The impeccable reputation of Swiss banks, especially the private banking industry, for sound management and client discretion is unequalled. In the present environment many may argue that the Swiss are trading on past glories. But despite any professional reassessment, clients vote with their money. Swiss bankers remain true to their commitment to banking secrecy – probably the single most potent force in attracting investors to the alpine federation. Switzerland's last president, Pascal Couchepin, said that banking secrecy was an indissoluble part of the Swiss constitution.
The largest bank in Switzerland is UBS. Of the SFr9.4 billion ($6.9 billion) that flowed into the bank last quarter, almost a third was from Europe, but only SFr400m came from clients in Switzerland. In its move to countries with more potential for growth, the bank bought Merrill Lynch's private banking business in Germany in October 2003 and one in France from Lloyds TSB in May 2003.
Under chairman Marcel Ospel, it has become the leading operator in wealth management with $2.4 trillion of invested assets. He is unrepentant about his countrymen's attitude to banking secrecy, stating that Swiss banks should not have to determine whether foreign customers are complying with their own domestic tax laws. "We cannot and do not care whether income or assets are taxed or declared in the client's home country," he says. Ospel adds that Switzerland's stringent anti-money laundering laws combined with his industry's obsession with secrecy gives the client the greatest protection.
The EU has offered Switzerland a six-year amnesty before automatic exchange of information be required. Under the European savings tax directive, 12 EU member states voted for information exchange while the remaining three ( Luxembourg, Belgium and Austria) agreed to a withholding tax. To encourage the Swiss (who have been side-stepping the issue for the last couple of years) to sign up, the EU has offered a package of concessions plus delayed entry to automatic exchange of information.
The Swiss private banking industry is sceptical about the withholding tax being adopted. Christian Rahn, partner at Rahn & Bodmer, explains. "Political decisions have taken too long and the administrative authorities and the banks have still an enormous amount of work to complete."
Swiss bankers have in the past complained bitterly that they should not be forced to apply tax withholding rules when rival offshore banking centres such as Liechtenstein, Monaco and the Cayman Islands have yet to commit.
Phil Austin, chief executive of Jersey Finance, says: "In the end there will be a fudge. Both sides want a deal but Switzerland cannot agree to the present EU terms and Brussels cannot back banking secrecy."
Jersey, which is one of the best managed offshore finance centres, regards Switzerland as one of its principal competitors. Any advantage, actual or perceived, would be scrutinised very carefully.
During the high points in the initiatives by the Organisation for Economic Cooperation and Development on harmful tax practices and the Financial Action Task Force on money laundering, the offshore centres were concerned about the operation of a level playing field.
The Society of Trust and Estate Practitioners (STEP) and the International Trade and Investment Organisation (ITIO) engaged international lawyers Stikeman Elliott to investigate the issues of parity and equity for offshore jurisdictions in projected deals with international agencies.
They were concerned that the Swiss, along with some other members of OECD, would be allowed to escape the sanctions of OECD mandates but that the OFCs would need to honour them to the letter. "It would be like operating with one hand tied behind our back," says Phil Austin.
To lessen Switzerland's evident commercial advantage, neighbouring territories have imposed tax amnesties. Citizens who have avoided domestic taxes (often in Switzerland) will not be prosecuted if they fall into line with a tax amnesty. Recent Italian amnesties took in $58 billion with Belgium and Germany hoping to launch their own.
The impact of EU pressure, tax amnesties and a greater regulatory burden will affect the largest institutions but they will survive. It is the mid-tier where the most significant impact will fall. Profits at Julius Baer, one prominent private bank, dropped by 19% in 2002.
Credit Suisse, Switzerland's second-biggest bank, and Citigroup, the world's biggest, have pockets deep enough to finance international expansion. But even the best known private banks, such as Pictet and Julius Baer, will struggle to find the capital to fund rapid growth and keep pace with larger rivals.
Then there are the costs of complying with new regulations, from increased disclosure to new rules for international bank capital (Basel 2), which bigger banks can spread across a wider base. Consolidation is one answer. Ray Soudah of Millenium Associates, an adviser to private banks, expects the number of attempted mergers or acquisitions to rise from below ten this year to around 50 in 2004.
But the economics of mergers are not as compelling as they are elsewhere in fund management. Wealthy investors expect a personal service so staff account for half of total costs at most private banks, according to BCG. Many smaller banks are opting for an open architecture business model, mixing their products with those of others.
Contingency plans are also in place to channel money out of Switzerland if the environment becomes too hot. The favoured destination is Singapore. A leading baking analyst says, "All the international banks see Singapore as a back door retreat for Swiss–domiciled funds. Each of them has set up Singapore-based operations for a quick but ordered retreat but as yet none have adopted any of these contingency plans.