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Follow the Money

“If you can’t trust a Swiss banker, then what’s the world come to?”
— James Bond, The World Is Not Enough

Swiss banking has been through a major strategic refit over the past ten years. It initially grew beyond its borders by exploiting several advantages its home base had to offer – secrecy and stability. The problem is that since the 1990s, political stability has ceased being a differentiating factor, as the world has generally become more stable; and since the 2000s, bank secrecy has come under sustained pressure from countries looking to shore up their tax receipts. 

As a result, Swiss banks have lost share in the market for global wealth management. Over the past ten years, world wealth is up 86%, yet foreign assets managed by Swiss banks are up only 28%. 

But Swiss banking may now be back on track and its recovery is a lesson in how to redesign a customer proposition. This week, UBS – the largest Swiss bank – reported earnings for 2021. It remains the world’s largest wealth manager, with $3.3 trillion of assets under management. It banks half the world’s billionaires and holds a significant share among the rest of the 1%. Last year, its wealth management revenues returned to their highest level since 2007. 

Its secret is the same as it always was: follow the money.

Europe: For Your Eyes Only

Switzerland emerged as a centre for wealth management at the beginning of the twentieth century. As a small country, sandwiched between empires, it struggled to compete with London, Paris and Berlin on the global financial stage. But local bankers realised they had an edge – two, in fact: they had secrecy and they had neutrality.

Secrecy had been enshrined in Swiss banking culture for some time. In 1713, long before Switzerland even existed as a sovereign state, lawmakers in Geneva had introduced regulations to prohibit bankers from revealing details about their clients. For the French Catholic elite, nervous about being seen dealing with Swiss Protestant bankers, this was a boon. By itself, a commitment to client confidentiality wasn’t unusual, but combined with international neutrality – formalised at the Congress of Vienna in 1815 – it was a powerful combination. Switzerland developed a reputation as a safe haven for foreign wealth. 

Demand for Swiss banking began to ramp up at the turn of the twentieth century, when several European countries started to levy higher taxes on the wealthy. The French government increased inheritance tax in 1901 and signalled that it would introduce income tax on high revenues. Sensing an opportunity, Swiss bankers launched marketing campaigns targeting the wealthy of these countries. In a circular distributed in France in 1910, one Swiss bank proclaimed that the situation in Switzerland “enables us to manage with the utmost discretion securities entrusted to our care by customers from abroad.”

The turmoil of the First World War and the hike in taxes levied to finance the war effort led to increased demand for Swiss banking. Depositors were attracted by the political stability of the country and its currency, by its neutrality, by its mild tax laws and by its secrecy. Foreign capital, especially from France, Germany, Italy and Austria, poured in. For the French, Geneva became a convenient offshore banking location; for the Germans, it was Zurich; and for the Italians, Lugano. At the same time, Switzerland provided a place for commerce to continue between warring countries in secret. 

After the War, lawmakers in neighbouring countries did not sit idly by; they lobbied the Swiss authorities for information on the source of the capital flows. But the Swiss authorities obfuscated, by now appreciating that “the importance of banking activity to the Swiss economy calls for the greatest prudence as far as measures against tax evasion are concerned.” Indeed, in 1934, they doubled down, formulating a new banking law that made the violation of banking secrecy subject to criminal law, rather than just civil law, subject to heavy fines and up to six months imprisonment. 

The Second World War led to another step-change in the growth of Swiss banking. Controversy erupted over Swiss banks’ role in the War and in their refusal to allow descendents of Holocaust victims to withdraw deposits. But the Cold War kept Swiss bankers busy. By the early 1970s, around 5% of Europe’s household wealth was deposited in Switzerland. 

Over time, pressure built on Switzerland to relax its bank secrecy regime. Various European countries launched tax amnesties to encourage citizens to repatriate assets back home. Later, they joined together in an effort to create a new mechanism of automatic information exchange. Swiss authorities responded by playing countries off against each other, for example by offering special bilateral tax deals with Germany, the UK and Austria. 

One case continues to hang over UBS. The bank is currently appealing a verdict that it helped wealthy French clients stash undeclared funds in Swiss accounts between 2004 and 2012. According to the prosecution, Swiss bankers snuck across the border with encrypted laptops to recruit French clients, in contravention of French law at the time. Pending the appeal, UBS has been ordered to pay €1.8 billion in penalties. Although the fine was cut by more than half from an earlier ruling, the bank is reluctant to accept a guilty decision that would cast a pall over its reputation.

Anticipating the mounting threat to their business, Swiss banks did two things. They turned their attention to new markets outside Europe; and they established an onshore presence in European countries in an attempt to replicate their core business without the secrecy part.

In early 2001, UBS launched its ‘European Wealth Management Initiative’ (EWMI) in the five large European onshore wealth markets. By the end of 2006, when it stopped separately disclosing financial information for the effort, the bank had 870 client advisors working inside these five countries (18% of the total) with SFr144 billion of assets having been brought in (13% of the total). But the bigger prize was in Asia. 

Asia: Casino Royale

As scrutiny increased from neighbouring countries within Europe, Swiss banks looked towards Asia for growth. As well as the advantages offered to European clients for decades, Swiss banks were also able to offer Asian clients the prestige of dealing with a centuries-old wealth management business. 

Wealth in Asia has been growing rapidly. Over the past ten years, the wealth amassed by high net worth individuals (those with investable assets in excess of $1 million) has grown by 122%, according to Capgemini. UBS currently has 852 advisors working in the region and 16% of its client invested assets there. It has a particularly strong franchise among Chinese billionaires, many of whom are UBS clients. 

Yet in their rush to build up businesses in Asia, several Swiss banks were less than diligent in verifying the legitimacy of some of the customers they picked up. In their book, Billion Dollar Whale, Tom Wright and Bradley Hope tell the story of Jho Low and how he syphoned off $4.5 billion of assets from the Malaysian 1MDB sovereign wealth fund. Low used BSI, a Lugano-based bank with an outpost in Singapore, to channel funds. His banker there was Yak Yew Chee.

Yak began to take home around $5 million a year in salary and bonuses, more than five times his previous earnings, binding him to Low, the money and adulation too alluring to turn down. The bosses, too, began to reap the benefits of the relationship, as BSI became a force to be reckoned with in Singapore and globally.

After the scandal came to light, the Swiss regulator deemed BSI to have been in serious breach of money laundering rules and recommended it be legally dissolved.

Growth is still strong in Asia. Boston Consulting Group estimates that Asian wealth will grow by 6.8% a year over the next five years. But as quickly as it grows, it struggles to catch up with North America, where wealth continues to grow unabated.

United States: Diamonds Are Forever

The US has always been a trickier market for Swiss banks to crack. The allure of political and economic stability was less of an advantage to Americans than it was to Europeans. UBS acquired PaineWebber in 2000 as a vehicle to attack the affluent yet not-high-net-worth segment but the business models were different and the firms didn’t integrate well. 

But nobody likes paying tax wherever they live, and so that was a useful wedge into the US market. Bradley Birkenfeld is a whistleblower who spilled the beans on UBS practises in 2007. “What I can do for you is zero,” he’d tell prospective clients, before hitting them with his punchline: “zero income tax, zero capital gains, and zero inheritance tax.”

Based in Geneva, Birkenfeld dealt with US-based clients he’d pick up at events like Art Basel in Miami. In order to get access to their funds, clients could ask Birkenfeld to bring them back into the US for them, say, as diamonds, which he once hid in a toothpaste tube (“It was just a way of carrying them, so I wouldn’t lose them. Where would you put your diamonds?”) Or they could take out a loan against their Swiss deposits. 

In total, Birkenfeld told US lawyers that UBS harboured funds in Switzerland for 19,000 US-based clients, in an amount of SFr19 billion ($20 billion). “I’d perfected my game, flying first-class all over the word, staying in five-star resort hotels, and seducing scores of one-percenters into stashing their fortunes in Swiss numbered accounts, no questions asked,” Birkenfeld wrote in his memoir. 

In theory, UBS should have declared these accounts. In 2001, the bank agreed with the US authorities either that its American clients would declare income from their Swiss accounts or that the bank would withhold tax from the income and pay it directly to the US Treasury. It didn’t do so. A Senate report into the matter makes plain the reason why: “Undeclared accounts held more assets, brought in more new money, and were more profitable for the bank than the declared accounts.” American customers weren’t flocking to UBS for the reputation of its wealth management platform nor for the charisma of Bradley Birkenfeld; they were flocking to the bank to avoid paying tax. 

Birkenfeld’s evidence led US authorities to come down heavily on UBS and other Swiss banks. In 2009, UBS was fined $780 million; five years later Credit Suisse was fined a larger amount for similar offences. Congress passed a Foreign Account Tax Compliance Act which largely neutered the opportunity for Americans to use offshore accounts to evade tax.

The World Is Not Enough

The elimination of secrecy from the Swiss bank proposition had a material impact on UBS’s business, over and above the fines it incurred at the same time. A few years ago, the CFO of UBS paraphrased the reaction of some customers: “Sorry, we’re going to move elsewhere because that’s not what we signed up with you.” He went on to highlight the impact that had on the bank: “So we lost a couple of billion in revenue, and that cost is substantially in terms of our growth trajectory.”

Greater transparency also had an impact on the margins Swiss banks were able to charge. Swiss banks were required to open themselves up not only to tax authorities and to regulators but to customers as well. Opacity is a tried-and-tested way to extract fees in financial services, and its elimination hits profit. Gross margins in UBS’s wealth management business have come down from 0.93% in 2007 to 0.62% in 2021. 

But the super wealthy need someone to talk to, and UBS bankers have a track record of offering an ear. Importantly, that requires a human touch, which technology is less equipped to disrupt. Swiss private bankers may have stopped providing “tax advice” but they continue to provide support around inheritance, philanthropy, art; and they help clients to network and connect with other wealthy individuals. In some respects, the job is akin to a high-end concierge service. 

It’s also a global job, as clients typically have assets spread around the world and exposure to multiple currencies. Global financial services firms have a tendency to flip-flop between regional organisational structures and global structures. Credit Suisse is currently on a regional structure; UBS’s is more global. 

On his recent earnings call, UBS’s CEO outlined where he’ll be following the money next:

“Regionally, most of the wealth will be created in the US and in Asia Pacific and most of the industry revenue growth is expected to come from affluent clients and entrepreneurs. Also a big trend is that women are increasingly gathering wealth, and they tend to be underserved in the industry. And we see a shift in needs and priorities as wealth is passing down through the generations.”

All of this reflects UBS’s core challenge, which is that its customers are ageing. The average age of its clients is well into the sixties “because those are the individuals that have all the money.” To sustain its business, UBS needs to replace them, which means targeting the prospective super-rich further up the funnel. There are two sources: affluent people who haven’t yet broken into the high net worth bracket; and existing clients’ children.

Technology lowers the cost of serving affluent customers with less than $1 million in investable assets and the recent acquisition of Wealthfront for $1.4 billion can be seen in that context; if it captures a few potential billionaires, while washing its face, it will have been a worthwhile deal. Acquiring existing clients’ children is harder, but the bank mobilises its concierge services to keep them engaged. The advantage it has: Geneva, Zurich and Lugano may no longer offer the benefits of secrecy, but they remain wonderful places to visit.