Private banking in a changed world

What has changed since September 11? Private bankers give their expert assessment.

Participants:
Kurt Schenk, Regional Coordinator, Dresdner Private Banking
Daniel Truchi, CEO, Asia Pacific, SG Private Banking
Kees Stoute, head of North Asian private banking, MeesPierson
Thomas Meier, CEO North Asia, CSPB
Bernard Rennell, managing director, Bermuda Trust, Bank of Bermuda
Sabrina Chan, LGT Bank in Liechtenstein

Given that we are moving into an uncertain new world, how will the private banking market be affected?

Kurt Schenk: We will start to distinguish between wealth management and the brokerage business, which has been quite popular in the last two or three years. I am convinced that asset flows to the private banks and wealth managers will be bigger than they were before, due to the uncertainties in the market.

Thomas Meier: In times of uncertainty, you focus on the basics. People will look again at trust, at institutional strength and asset preservation. Private banking is going to shift back to its main principles. And only the players with the commitment and quality to help preserve assets will survive.

Daniel Truchi: Back to basics is a trend we have noticed since the Asian crisis. We have already seen a number of competitors fading out because they were only focusing on leverage and brokerage, which are not private banking. We are going to see a strong consolidation in the market and that's good for customers. Only the banks that can offer wealth preservation, wealth transmission, structured deals and transactions that preserve the principal will remain. Private Banks will move into more financial engineering, offering capital protection and performance through a variety of schemes.

Has anyone seen any marked capital inflows as a result of the uncertainty in the market in the last two or three weeks?

Truchi: We have seen some flows in, coming from investment banks and smaller banks as a sign of flight-to-quality.

Meier: In flows are seen quite clearly. People are rethinking their risk profiles, in terms of assets and institutional risks.

Sabrina Chan: I think credit rating and financial strength of the private bank are crucial at this point. Clients also look for added value today, much more than before. It is not just about how much they can make from an individual transaction, but how an institution can handle their need for asset protection within a risk management framework. That requires more custom- made attention. I will not say there is a lot of inflow at this point, because it's still early. But the interest is there in banks that can protect clients' assets from the volatilities that happened in the last five years.

One of the most basic forms of risk management is diversification, and if the terrorist attacks show anything it is the risk of having a concentration of assets.

Kees Stoute: If you look at what has happened before the terrorist attacksá- with the Nasdaq down 70% in the last yeará- the situation had already changed tremendously. The problems facing the private banking industry have become more manifest since September 11, but the issues were already there.

Bernard Rennell: The US and global economy was already teetering on the edge, and the attacks will probably push them over into recession. Most of our clients are families and they want long-term preservation of capital. We think it brings the focus back to traditional concepts such as the importance of allocation of capital. While the events of September will have changed America's perceptions of its own internal security, provided there is nothing more sinister around the corner, I don't see it changing the global capitalist economy in any permanent sense. In other words, wealth will still be generated and there will be demand for wealth management services but there will be a move towards quality.

Stoute: We were talking about more assets coming to the private banks, but we are still seeing capital destruction with $1.2 trillion wiped off US equities since the attacks. So where are we seeing the new assets coming from? They must already be somewhere.

Meier: What we are seeing is that clients are now showing us the entire portfolio that they have with other banks. This is a sign of trust in us as an institution.á So we can now do the asset allocation for the entire wealth the client has. That is something clients were reluctant to show you before.

In terms of asset allocation, where are your clients parking their wealth?

Rennell: Our core business has for a long time been the provision of trust and fiduciary services.á In that role, we have been privy to our clients' total wealth picture in most instances.á The assets are held by us as trustee or custodian or in some other type of structure, even if they're not all managed by us.á Therefore we've long had this broader view.á What we're seeing is an increasing focus on traditional investment theory. A lot of clients have already reduced their equity allocation. But some clients might now be looking to increase their equity exposure in order to bring their portfolios back closer to traditional allocations. Alternative investments such as long/short and arbitrage funds are also an increasingly important consideration in reviewing overall asset allocation within the total portfolio.á Obviously it is an uncertain environment. You can compare it to previous shocks but there are additional geopolitical uncertainties around at the moment.

Chan: A lot of clients are reviewing their past experience of buying and holding stocks and bonds. They are now questioning the conventional approach and want to reassess risks in totality. Recently they are including less liquid assets in their allocations such as buildings and international businesses. So we have been concentrating on how to structure a client's entire asset base, not just financial assets, in balanced proportions yet in line with their life cycle needs. Some may just decide toá be very liquid for the moment.

Meier: This event has forced clients to rethink their risk profile and then to restructure their portfolios accordingly. Many clients think they are balanced investors, but a lot them had got into position where their portfolios were 80%-90% equity, because they got dragged into it. They have compromised their investment principles and discipline and now we have to bring these back into line to achieve our clients' financial objectives

Truchi: Trust structuring is an area that is becoming very important. Trusts serve many purposes: wealth transmission, tax mitigation, confidentiality. But they also meet individual and corporate requirements at the same time. In Asia, most high net worth individuals are entrepreneurs and shareholders, so Trusts services help them to meet their specific requirements.

Schenk: In fiduciary services, the client is willing to show the entire portfolio. Nevertheless, they can diversify through other banks after that, but the client only has one partner to talk about the whole strategy. That is crucial.

Rennell: We accept that all clients are not necessarily going to want all their eggs in one basket in terms of service providers such as asset managers. And that is fine. Butá as a substantial provider of fiduciary and structuring services, we will generally looká to assist the client in managing those various relationships - essentially acting as the hub in the wheel.

In terms of products, we have seen a large interest in hedge funds as well as principal guaranteed products. This seems to suggest that clients want a definable, absolute performance.

Stoute: This just shows that when the market is down the clients want absolute performance, but when it goes up they want a relative performance. This is not new. But at the moment we are seeing a big appetite for hedge funds. At the same time it is a big risk, because there are so many unqualified hedge fund managers in the market. So as a private banker, we have to be sure that if we help a client go into alternative investments, that we find the right ones.

Chan: Clients are looking for transparency when it comes to hedge funds: how is it being managed; what kind of inherent corporate governance; the consistency in track record .á Clients are looking at how to protect their life savings and how to ring-fence themselves from creditors claims. In this regard, clients are looking seriously at trust structures as well.

Truchi : Alternative Investments cover a wide range of financial schemes and techniques such as event driven, long/short equities and bonds, as well as arbitrage. They serve as underlying assets for structured products that offer to the investors the opportunity to achieve absolute performance with no correlation to the financial markets, low volatility and enjoying also a capital protection feature.

So why are trusts becoming more important? Is it because the wealth is being transferred? Is it because the tax situation in Asia is becoming less benign?

Meier: The old generation is now passing on the wealth to the new generation and that has helped to re-emphasize the issue of inheritance planning. But we also see trusts as an indispensable tool for overall wealth planning. Tax issues are not that hot of an issue in Asia, but you still try to optimize the tax situation as best you can.

Schenk: The Asian crisis has helped a lot, coming away from unsophisticated private banking to wealth management. With the new generation we are moving in a more sophisticated way and trusts are part of that.

Rennell: It is a growing understanding and acceptance of structuring as an important part of wealth planning. In Hong Kong, trusts have long been used as a vehicle to address succession planning and estate duty issues.á For instance, if your assets are over the estate duty threshold, 15% of your assets may pass to the revenue in inheritance duty. And there is absolutely no need to pay that duty. There are quite legitimate ways of structuring your assets via a trust and one of a number of benefits will be that that duty may be avoided. Added to that, many wealthy Asian families have connections with many countries - for instance many have obtained citizenship in other countries such as the USA, Canada or the UK - and as a result there is a terrible tangle of different taxation and succession implications. So structuringá- through trusts or other vehiclesá- is increasingly important for people. That is where we specialise.

Chan: Some Asian clients prefer Foundations. It is a very receptive product due to its flexibility. It builds a roof as a holding vehicle over all other companies within the corporate structure. The fees are reasonable and it provides control to the founder.

Schenk: Most of our clients have a certain appetite for fiduciary services. But it depends on your wealth for what structure you should have.

One area we haven't discussed, which will be affected by the terrorist attacks on the US, is the area of banking secrecy. It has been under attack for a while and recent events suggest that it will come under even greater attack. What is the view from the table on this situation?

Truchi: This is a trend we have been feeling for some time. There are strong impulses from the monetary authorities in various placesá- Hong Kong, Singapore and Japan. We are again going back to Ethics. "Know your customer" is something that's fundamental for every bank, more particularly in Private Banking. But there will probably be another layer of compliance in the future.

Rennel: Banking secrecy, for most reputable institutions, is probably a misnomer anyway. What we are talking about is confidentiality and I don't see that changing materially. People have a right to have their affairs kept confidential within the bank. But that does not remove the obligation from the bank or institution to know the customer and to know the source of funds. Certainly the bar has been raised on that issue over the last couple of years and recent events will just go to further accelerate that process. It may lead to increased information sharing among authorities. I don't think any of that undermines a person's basic right to confidentiality. But banks will no longer be opening accounts for people where they are not sure what are the underlying activities or source of funds.

Meier: I agree. Nothing will change from the Swiss banking side. Swiss banking secrecy has never protected terrorists. There is a wrong perception about this. It is the legitimate interest of any client to protect their privacy. And Switzerland has the proper systems and rules in place to ensure that. The crucial issue is that you deal with it in a professional and speedy manner. It goes back to knowing your client rules. In Switzerland we have done a lot of work to ensure that we know our clients. We see exactly the same process here in Hong Kong.

Schenk: There are world leaders who continually suggest that the Swiss banking system is there to protect criminal money. The Swiss government has to make it clear that the banking laws are not there to protect criminal money.

Truchi: All International banks are bound by strict ethics rules. The level of ethics might be the same across the board since some banks are not subject to the same rules. The whole banking system is suffering as a result of that. However, another compliance layer will not affect, in any way, the high level of confidentiality that SG has maintained with Private banking clients.

Chan: Due diligence on background search is a must. The development of new relationships for LGT usually comes from established sources of referral with whom we have been working together for a long time. As LGT does not directly handle corporate or retail banking, the basis of our clients' funds are defined purely for investment management.á

Schenk: No bank would want to be associated with terrorists and so would do all they can do identify those accounts that are suspect.

Is there a danger that in pursuing 'know your clients' rules to the degree they are today, private banks are getting away from their core competencies? A bank's job is not to decide if a clients' assets are good or bad, clean or dirty but rather it is to manage those assets. Surely it is someone else's job to decide if they are politically acceptable, not the banker's?

Meier: Well, we have to do it. There is a huge reputational risk attached to it. We have established procedures for dealing with politically exposed persons. We have to watch these accounts very carefully because they can damage the reputation of your bank considerably.