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Investment bankingApril 1 2014

Is private banking a global or local game?

Recent years have seen private banks hit by heavy regulation, fines and spiralling compliance costs, all of which have taken their toll on profits and brand value. As banking groups redefine their exposure to wealth management across the world, will private banking become a game better played by local and specialised names?
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Is private banking a global or local game?

The retreat of US giant Merrill Lynch from international wealth management two years ago is a high-profile example of the challenges that private banks have been facing since the financial crisis. New regulation from the US to the EU and other jurisdictions have made wealth managers’ offshore models crumble.

Private banks need to ensure international clients’ investments comply with the rules on taxation and consumer protection in the jurisdictions where products are sold. New rules have also hit wealth managers who are having to correct past behaviour and, in some cases, pay heavy fines.

Banks active outside their domestic markets have been faced with the choice of either significantly ramping up compliance efforts, including new reporting systems and procedures, or exiting the market. For some, the additional costs, coupled with the challenges of establishing a successful brand abroad, have just proved too much

Closing down

Dieter Enkelmann, chief financial officer of Julius Baer, the Swiss pure-play private bank that took over Merrill Lynch’s international business, says: “You could argue that for all banks, wealth management is a good business because it’s low capital intensive. But due to increased regulation, due to clients’ demands that require more resources than before, a lot of businesses have become not profitable and therefore [banks], either global organisations such as Merrill Lynch, or, if you look at Switzerland, a lot of small and medium-sized players, are giving up and are closing down or selling the business.” Merrill Lynch declined to comment.

After Merrill Lynch’s retreat, Morgan Stanley also disposed of its wealth management arm in Europe, the Middle East and Africa last year, while HSBC is seeking to sell some of its international operations. In Switzerland, Wegelin & Co, the country’s oldest bank, announced last year that it would cease to operate as a bank after it pleaded guilty in a New York court to allowing US citizens to evade tax and agreed to pay $57.8m in fines to US authorities.

Further, in 2009, UBS agreed to pay an eye-watering $780m fine to US authorities related to tax evasion charges. Other Swiss banks are being investigated for allegedly helping Americans evade taxes.

Even for banks that can absorb heavy fines, damage is inevitably done to the brand. Some established names are able to sustain both financial and brand damage. UBS, for example, has recovered from past hits in terms of brand value in 2014, according to consultancy BrandFinance. It is now comfortably the highest valued private banking brand in the world (see table). Others, however, are struggling to grow the business, particularly outside of domestic borders.

Regulation and reputation

International expansion is challenging at the best of times in a market such as wealth management, where the brand means more than in other banking areas. “Client franchise is quite sticky; clients don’t change private banks from one day to the next,” says Karsten Le Blanc, managing director in the key client partners unit, Europe, the Middle East and Africa, at Deutsche Asset and Wealth Management. Deutsche Bank’s brand value places it just below UBS in the ranking.

Catherine Tillotson, managing partner at London-based consultancy Scorpio Partnership, says: “It is quite hard for an international bank brand to establish itself in a foreign market. We take it for granted in financial services that we operate in a global business, but actually it takes a long time for a new brand to become relevant.”

Mr Enkelmann notes the case of Bank of China’s Swiss business, which Julius Baer took over in 2012. “[Bank of China was] not successful because it was targeting European clients and had difficulties with the [brand],” he says.

Focusing on other emerging market names looking outside their national borders, Mr Enkelmann says: “If you look at banks such as Itaú or Safra [in Brazil], these are outstanding banks and that’s the reason why they want to expand internationally. But serving clients in Europe is different from serving clients in Brazil or China, therefore it’s very hard for emerging market banks to internationalise the business.” Itaú is the highest scoring emerging market brand, according to BrandFinance, with a brand value of just under $1bn.

Different market, different rules

Expansion in developed markets is also difficult. Another banker privately names a wealth manager that, in spite of its well-known brand, could not make a profit in its non-domestic, European operations because of limited brand traction abroad and increased regulatory burden.

“If you book in other jurisdictions, you need to make sure a product complies with rules in each of those jurisdictions,” says the banker. “You have to issue an almost identical product to [the original you could have previously booked offshore] to accommodate for other countries’ specifications. Instead of one product you may need seven products; instead of making $1m on that product, you make $1m across seven products. You also have to invest in [client] acquisition. It takes time.”

With regulators around the world clamping down on the offshore model to protect local consumers and make sure local tax is paid, international banks have to make sure their products comply with the rules of all countries where they are sold.

The US Foreign Account Tax Compliance Act, which affects any bank dealing with US clients, has been the most disruptive new piece of regulation, say bankers, but other legislators have also been prolific in this space. Just to mention a few, in Europe, the Markets in Financial Instruments Directive imposes greater transparency to protect investors and avoid possible conflicts of interest. The UK added the Retail Distribution Review to the mix, imposing new checks and training for bankers. And Switzerland’s Rubik bilateral tax agreement has been signed by a number of national governments, requiring increased information exchange between Swiss banks and other jurisdictions.

Scorpio’s Ms Tillotson says: “[These regulations] are all driving towards the same thing, which is making financial institutions more accountable to their clients. But there are enormous documentary requirements to [comply with new rules], and they’re different in different markets.”

Hidden costs of compliance

In the UK, consultancy ComPeer surveyed the local operations of 147 wealth managers, including 27 private banks, and found that private banks had to increase compliance staff numbers by 20% between 2007 and 2012, with a sharp rise since 2009. It estimates that the total compliance cost for UK wealth managers was $420m last year and expects this to rise to $500m by 2015. Half of this total cost is represented by hidden costs outside of the compliance department and related to front office and senior management, which account for just under one-fifth of profits.

This data is similar to that of private banks elsewhere in the world. Julius Baer’s Mr Enkelmann, for example, says that compliance costs have suffered a “low double-digit” percentage increase over the past five years.

To make things worse, not all are convinced that the new rules will provide the intended transparency. Mr Enkelmann says: “I think we served our clients [well] before all these regulatory changes. All in all, I don’t think clients feel the change in regulation other than they have to sign more forms.”

Top 50 Most Valuable Private Banking Brands

Which model is best?

So what should international private banks do to cope with heavier regulation that erodes profitability but may not result in a better service to clients? Should a more territorially defined strategy be preferred to global outreach?

Banks need to choose carefully what foreign markets they can compete in, and where they can offer better products than local banks with reasonable returns, say many bankers. They also need to tune their compliance effort with their size.

Credit Suisse’s head of private banking in western Europe, Romeo Lacher, defends the global model. “Many of our clients seek geographical risk diversification, access to global execution services and a wide range of products. Large and global players are at an advantage when it comes to fulfilling these needs. I see more challenges for small or mid-sized international players,” he says.

Deutsche Bank’s Mr Le Blanc points out that size and relevance to the overall banking group will separate the leaders from the quitters. “Smaller players, whether small banks or smaller divisions of the bigger players, will at some stage ask themselves ‘Is this still worth it? Is this going to be a durably profitable business?’ Some people [have already] decided the answer is no.”

Smaller, more agile

A smaller bank, Pictet, has a different approach to size. Dina de Angelo, in charge of handling international client relationships for the Geneva-based institution, argues that smaller banks are in fact better at dealing with compliance because their size allows them to be more agile and responsive.

“In this environment you need to be nimble,” says Ms de Angelo. “In larger institutions I don’t think you have that close-enough relationship between compliance and front-line staff. In our business, our compliance officer sits with us and for smaller banks that is the way forward. Compliance can’t be a separate entity that you e-mail or call on the phone. They need to be in your business.”

Furthermore, pure-play wealth managers, typically smaller than international brands that are part of universal banks, claim a competitive advantage over their bigger competitors. “When you hire relationship managers, it is clearly an advantage to say that there is no conflict of interest between the investment bank and the private bank. We’re not a product-push organisation,” says Julius Baer’s Mr Enkelmann. “That is clearly an advantage over big organisations.”

Mr Enkelmann also says that because of his bank’s sole interest in wealth management, digesting and complying with new regulation is a necessity that is felt by the compliance department as much as it is by the chief executive, allowing the bank to adapt faster to the new environment.

Changing sentiment

But there is an additional, and crucial, complication. No matter how efficient or focused a bank may be when it comes to compliance, changing client sentiment still plays a part. If the financial crisis sent high-net-worth individuals searching for multiple wealth managers to reduce risk, the mood now seems to be shifting and a single provider seems more appealing. “You’re seeing client behaviour changing again,” says Ms Tillotson. “After the crisis, clients [wanted] multiple private banks because they saw Lehman collapse. They appointed big names as well as small names. The trend now is back to consolidation. They would much rather be with one firm that can do a lot for them.”

In the short term, more banks will probably reduce their international presence and a number of universal banks will re-evaluate their commitment to wealth management. Despite the challenges, however, this business has much to offer to large banking groups.

“Private banking provides steady revenues and income, which shareholders prefer to volatility of earnings,” says Mr Le Blanc. “But the business model is adjusting to the new world. Some players have sold part of their businesses, others are merging or shutting down. For big universal banks that invest in the right manner, with the right systems, training and product offering, this can be a very appealing business.”

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Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
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