Switzerland learns to adapt to increased regulation

There is nothing new about countries, city states and financial capitals trying to re-invent themselves. Ireland’s transformation from rural backwater to Dublin-led financial services powerhouse is a case in point. It was briefly derailed only because the whole country forgot about its 40-year masterplan for European integration, when a scramble for property fuelled an unsustainable bubble.

Poland’s plot to become a back office service centre has also paid dividends, and the recent EU entrant remains one of Europe’s few current success stories.

The next country at Europe’s heart which must re-define its role in the financial and wealth management world is Switzerland. This is not a new challenge for the landlocked territory, blessed with some of the world’s most attractive vistas, yet lacking natural resources.

The current recession-driven obsession with global regulation, much of it emanating from an increasingly aggressive US audit and revenue collection service, is taking its toll on a nation fast-losing its raison d’être, now that the once cast-iron certainty of banking secrecy has lost its allure.

As the reporting season for Swiss banks gets into full swing, answers to some of the questions being asked about the country’s future as a finance centre can be found in the results. The core wealth management division at Credit Suisse reported pre-tax profits of SFr284m (€234m) for 2011, down from more than SFr600m in 2010. Net new money of SFr4bn in the fourth quarter of last year was ahead of UBS, but below expectations.

So what has lead to such a big fall? Aside from anecdotal evidence of assets diverted to banks in Singapore, the biggest dent came from SFr295m set aside for a possible settlement with US authorities. Credit Suisse is one of 11 Swiss banks being investigated by the US for allegedly helping wealthy Americans avoid tax. This follows a €150m settlement paid to German authorities last year.

Wegelin, another bank on the US blacklist, was formally indicted at the beginning of February. This indictment, preceded by a rapid sale to Raiffeisen and a renaming of the bank to Notenstein, sent a further shudder through the close-knit Swiss banking fraternity.

This is something many Swiss banks have been expecting for several years, with M&A valuations increasingly determined by the percentage of offshore Swiss accounts for US taxpayers which comprise a bank’s client assets.

Stepping in

Needless to say, these accounts, which may have lead to the bank’s downfall, were not included in the Wegelin sale. After UBS pulled back from the US following accusations that it was helping US citizens evade tax, smaller Swiss banks seem to have stepped into the vacuum. Zurich-based M&A consultant Ray Soudah of Millenium Associates says further sell-offs are inevitable, with the expected disposal of smaller players and foreign bank-owned subsidiaries.

He believes these high profile actions are all good news for the Swiss banking sector, which is co-operating to clear its name and start work again on a fully compliant basis, focusing on a revised set of core competencies.

While competition between US and European financial centres is clearly intensifying, this move appears to be more about boosting coffers and gaining the confidence of the electorate than the European-bashing which Americans are often accused of.

“It’s not that the US want to put the Swiss out of business,” says Sebastian Dovey, of Scorpio Partnership. “They just want to put non-compliant US tax evasion out of business. Any financial institution in Switzerland that thinks it is going to escape this by either being too small to be noticed or too large to be challenged is clearly on the wrong side of history.”

This does not mean business with Americans is no longer possible. But it does mean Swiss banks will increasingly concentrate on improving portfolio management and asset allocation, rather than attracting foreign nationals with a promise to reduce tax.

Most Swiss banks have been quietly reshaping business models for the last three years, when tax evasion issues first became prominent, according to Adrian Darley, head of European equities at Ignis. Indeed, this is part of the reason for their re-orientation to target emerging markets for new clients.

At Basel-based Bank Sarasin, the issue of a strategy for avoiding non tax-compliant assets has been on the agenda since spring 2009, with the aim of purging the bank of such business by 2012. “This objective has been confirmed,” says the bank.

The decision to pull out of this business is motivated not just by a wish to comply with global norms, but to be “in harmony with Bank Sarasin’s holistic commitment to sustainability”.

The bank is making the link with the way assets are now managed for clients, invested through an environmentally and socially responsible screen. This is a key differentiation point in a cut-throat market where most offer a highly commoditised service.

Exit strategy

There are voices within Switzerland who believe Swiss banks will pull out of US business altogether, particularly as we approach the implementation of draconian legislation, which will require every financial institution in the world to make sure it is not aiding US tax-dodgers.

Julius Baer, which has also been targeted by the US alongside Wegelin and Credit Suisse, has exited the US offshore business since beginning discussions with US authorities in 2009, after terminating its US onshore business in 2004. “The exit of US clients is completed,” says the bank, which has taken measures to prevent inflow of undeclared assets and encourages clients to appoint external tax advisers, while it concentrates on managing portfolios.

“As a result of this increasingly assertive approach and in anticipation of the FATCA implementation, a majority of the Swiss banks have started moving away from the US clientele, regardless of whether it is tax-compliant or not,” says Shelby du Pasquier, a Geneva-based banking lawyer with Lenz & Staehelin.

He foresees a significant risk that following the Wegelin case, other Swiss banks or their employees will be threatened with indictments. For the time being, those with most to fear appear to be the institutions and individuals that have actively participated in the acquisition of US clients of UBS.

But the current investigation being conducted by the US Department of Justice, claims Mr du Pasquier, will not be limited to Switzerland and is also targeting centres such as Hong Kong and Monaco. Similar moves against other offshore financial centres, can be expected. Could Singapore be next on the US hitlist?