Geneva police are hunting a vindictive attacker of Swiss private bankers in a bizarre footnote to recent pressures on Swiss banking. The frenzied search was triggered after envelopes concealing blue canisters of a corrosive liquid akin to sulphuric acid were mailed to the homes of nine private bankers. An eight-year-old child whose face was seriously burned was among three people injured, while the targeted victims are understood to be high profile figures in the banking community.
It was a nasty twist for Swiss bankers besieged by proliferating fissures in famed Swiss banking secrecy laws dating back to 1934. The roots of Swiss private banking may be buried deep in the Swiss psyche but it is Swiss banking secrecy coupled with the anomaly that tax evasion is not a crime in Switzerland which have long been twin pillars for a big part of Swiss banking.
There is a lot at stake. A UBS report based on figures from the Swiss National Bank estimates assets under management in Switzerland at around CHF 4 trillion, a figure equivalent to almost one third of U.S. GDP. About CHF 2.2 trillion of this amount is offshore money and if KPMG’s calculations on the European component apply to the entire offshore tranche, CHF 1.7 trillion could be undeclared. Up to 130,000 jobs could be at risk.
Swiss private banking in the 1980s morphed from an ultra discreet business where clients preferred to visit their bankers in Zurich or Geneva to one where bankers began to actively travel abroad to solicit new business. That might be fine in unstable countries where the commercial class needs somewhere safe to secure the family nest egg, but continental Europe is no longer haunted by Baader-Meinhof terrorists. Worse, sometime in the 1990s, some Swiss banks began pedalling seamy offshore product directly into the U.S.. No country appreciates its tax base being undermined, and most particularly not the world’s superpower. The U.S. reacted with a civil suit against UBS, which they will finally drop only after the IRS receives a further 2,450 names of American account holders by the northern Autumn. This compromise turned out better than surrendering to the initial US clamour for details on 52,000 accounts, but that handover was the first major breach in famed Swiss banking secrecy.
Renewed U.S and European pressure forced the Swiss to fold in March 2009 and agree to adopt Article 26 of the OECD Model Tax Convention. Switzerland has so far re-negotiated 25 double tax treaties. The wording of the new treaties does not suggest it will be particularly difficult for foreign tax authorities to obtain information on defaulting taxpayers, although the administrative procedures remain vague. Fishing expeditions for information are not permitted and since almost three quarters of Swiss voters support banking secrecy, it might not be so easy to get data on undeclared accounts, unless of course you steal it.
As a result the German government has paid millions of Euros to purchase stolen data from disloyal employees of Swiss and Leichtenstein banks. About 15,000 names from HSBC
Switzerland are in the hands of the French government courtesy of an IT technician who seems intent on remaining outside Switzerland. There are rumours that this number is more like 100,000 and Swiss bankers worry that foreign spies continue to sniff for more greedy employees willing to sell stolen CDs. Elsewhere, Credit Suisse offices have been raided in Germany in an attempt to prove that the second biggest Swiss bank provided tax evasion assistance.
But this is not the first time Switzerland has worried about its place in the world. Wegelin & Co, founded in 1741, carries on its web-site an article from 1965 entitled “Is Switzerland losing its significance as an international financial centre?” So nothing is new. The answer to Wegelin’s question is a mix of yes and no. It will be a question of timing.
A substantial slice of that CHF 1.7 trillion of estimated offshore money will head home where it comes from countries which have signed new treaties. Certainly, Swiss private bankers without a licence to operate outside Switzerland now view travel as a frightening prospect when visiting offshore clients. Will Swiss banks become less profitable ? Yes, since they are all trying to offset the loss of sleepy offshore business by the same strategies :
- opening onshore to retain or win new business despite the fact that onshore pre-tax margins run around 0.10-0.20% on assets versus up to 0.50% for offshore accounts;
- expanding into Asia where Cap Gemini says wealth grew 31% in 2009 while the number of high net worth individuals (liquid millionaires) rose almost 26% surpassing Europe for the first time;
- recruiting traditional offshore bankers in Geneva and Zurich; a game of musical chairs in a shrinking market; and
- vertically integrating by building mutual fund and institutional business, ignoring the historical lesson that funds under management and the number of funds always nose- dive after secular stock market highs as in 1929 and the late 1960s when investors opted for liquidity over paying for expensive investment advice
This translates, according to a report from Barclays Capital, into the possibility that Swiss bank profits might slump by 20% due to the offshore/onshore switch, or even 45% under a pessimistic scenario. Classic offshore business they say is characterised by little client contact, a preponderance of discretionary-managed accounts (averaging 1.5% in Return On Assets for the banks) and a small number of efficient Swiss offices. That high revenue coupled with low overhead has been a very profitable model. Onshore business means lower ROA and more costs such as a branch network. The last figures from the UBS onshore business indicated it was breakeven at best and that was before the 2007 crisis. Therefore, offshore clients might represent only 25% of assets for Swiss banks but perhaps more than 50% of profits in some cases. The chart from Barclays Capital below illustrates this point.
The move away from offshore driven by tax treaty changes is far more significant that the impact of the Global Financial Crisis since there was no credit bubble in Switzerland. Of course, UBS took a hit internationally in its capital, profits and client assets while its credit default swaps spiralled into emerging market territory as Keefe, Bruyette & Woods’ charts demonstrate.
However, apart from UBS, where in any case the Swiss government has sold its “rescue” equity stake for a profit, Swiss banks generally sailed through the storm afflicting the rest of Europe and North America. Their pain came in the form of a lower return on client assets as customers moved from lucrative structured derivative products, hedge funds and house equity funds into cash and direct bonds. For many banks, the change in “product mix” cut revenues by 20-30% compounded by a Swiss Franc on steroids which continues to soar. These changes are driving an upsurge in M&A activity driven by weakened foreign banks exiting Switzerland due to their need to raise equity capital to bolster their battered balance sheets. Deals are being struck well below the historical 4.8% average Price /Assets under Management, based on figures from Zurich-based Vontobel, with Swiss assets recently selling around 3.5%, far below coveted Asian private banking businesses.
On the positive side, the Swiss are seeing substantial capital inflows from rich foreigners fleeing rising tax rates taking up residence in the alpine haven with Geneva and Zurich real estate enjoying solid demand. These HNWIs drive a tougher bargain than the illusive Belgian dentist, but it’s still quite profitable. Longer term, there’s a little thing called sovereign risk. Do you really want to keep your Euros in Athens or Dublin when you could simply open a declared account in Zurich, pay your taxes, and perhaps watch the nightmare of the European political elites unfold in front of you; the Euro coming apart at the seams due to its inherent inconsistencies, Greece abandoning Depression-style austerity and exiting the Euro, returning to the Drachma, imposing capital controls and devaluing its way back into competitiveness. You’ll never know if that will happen until it is far too late.
Of course, to worry about sovereign risk in the U.S. is ridiculous so why are Swiss banks now rushing for SEC registration. Only recently American clients were considered akin to Typhoid Mary amongst Swiss private bankers, but suddenly the canny Swiss see opportunity: Pictet, Vontobel, Franck Galland and wealth manager Maseco all have moved to set up specially SEC-registered companies to serve U.S. clients, guaranteeing transparency for the IRS.
The reason why ? A little statistic from history : In 1901 there were 5.2 Swiss Francs to the greenback. By 1933 after the Great Depression, it fell as low as 3.1 by 1935, before settling around 4.45. After Nixon went off the gold standard in 1972, the dollar fell off a cliff down to 1.8 Swissies by 1979 which it briefly hit again at the top of the Internet boom. Today, with the GFC and Ben Benanke putting the Fed’s printing press into action, the dollar has slipped well under one Swiss Franc.
Coincidentally, those big falls in the dollar versus Swissie always come after the Dow Jones / Gold Ratio peaks, as David Rosenberg recently illustrated.
You might ask, why measure the stockmarket in terms of a “useless relic” as Keynes referred to it, but, buddy, if you can’t out-pace a “useless relic,” exactly what can you out run ? A runaway pram in Central Park ?
And really, was all that American economic growth since 1995 just a credit-driven bubble now melting away with the Dollar-Swissie exchange rate ? Everyone loves to talk about the “Lost Decade” of Japan, but, go figure, US GDP re-calculated in Yen, was barely a more volatile version of the pathetic Japanese economic performance since the early 1990s.
What may also be worrying Americans opening accounts with newly SEC-registered Swiss banks is not just memories of FDR criminalizing ownership of gold in the 1930s, but the fact that US government policies, like those of the UK, are all about sustaining high real estate prices to protect the banking system by a cocktail of zero interest rates, quantitative easing and big government spending deficits. For the average investor that means that over-valued real estate and excess capacity in the economy, propped up by life support from Washington, may only be washed away by a decade or more of feeble business investment, leaving aside concerns about government debt piling up making inflation a tempting option for indebted Washington, Japan has actually experienced years of exactly that.
That weak business investment didn’t do much for Japanese equity returns. The Nikkei is still down more than 75% from its 1990 peak.
So, somehow, Americans looking for a hard currency and a global portfolio manager might find solace in the newly SEC-registered Swiss banks. Countries with low government debt and low primary deficits may be a place to hide from the current turmoil and Switzerland, shown as “CH” on this JP Morgan chart, may be a decent haven after all.
Richard H. Schweizer is the pseudonym of a Swiss banker with more than 25 years of experience managing money and trading markets.