Proud to be PRIVATE

Private banking has become a pet project at many international banks in the new capital-constrained environment.

It tends to be well capitalised, and the lending profiles of its customers, particularly among mass affluent clients with £100k-£500k in investable assets, are strong and offer good margins. The industry has fared well in recent years in profitability and performance terms, with leading industry figures often saying they “had a good financial crisis”.

But the industry is now dealing with a legacy of problems from the crisis period, particularly restoring client trust after declines in asset values, which will continue to shape the industry for years to come.

Capital has been one of the main talking points within banking in the past two months. Guidelines published by the Basel Committee in September mean banks will need to carry more capital than before, introducing a minimum Tier 1 capital level of 7 per cent, and imposing stricter rules on what can be included as core capital. The new rules are to be phased in between 2014 and 2019 and highlight the growing importance of managing capital tightly within banks.

Private banking within the large, universal banks has been a beneficiary of this move away from capital intensive projects. It is also seen as a good way of developing relationships with key clients. Barclays is one organisation which is investing heavily. In February, it announced plans to invest £350m in Barclays Wealth, its wealth management business. Two thirds of this is to be spent on product upgrades and technology and a third is to be spent on hiring bankers.

Favourable profile
Rick Denton, Head of Clients & Markets at Barclays Wealth Advisory, says universal banks are investing in private banking because of the favourable capital profile and also because of the return to traditional, relationship-based banking. Denton, who joined Barclays Wealth in July this year, was previously group commercial director at MeesPierson, a Fortis-owned private bank in the Channel Islands.

“The traditional banking business of taking deposits and lending at a satisfactory margin was turned into a much more aggressive environment [in the years leading up to the financial crisis], with people lending and leveraging on all number of assets to a larger segment of clients,” he said.

“It increased risk and undermined the banking industry and its capital value. Now the industry is in the process of rebuilding and there’s a flight to quality between institutions “Banks don’t want to be just post office or high street institutions. They want to be offering added value services that don’t have the same capital requirements.”

Although Barclays Wealth is in expansion mode, and remained profitable through the credit crisis, it faces a tough task to rebuild client confidence. The bank, along with a number of wealth managers across the world, received complaints and adverse media coverage after some of its clients were invested into AIG-linked bonds, which became illiquid after the US insurer was bailed out by the US government. AIG has promised investors in the bonds will receive at least 100 per cent of their money back, though not until July 2012.

Appropriate advice
Coutts is currently the subject of an FSA investigation into the matter, announced in August. Jo Thorne, a spokeswoman for Coutts, says the bank is co-operating with the FSA but remains confident the product was sold with appropriate advice that the investment was “low risk, not risk free”.

Stephen Fletcher, head of private banking for RBS’s wealth management division, which incorporates Coutts and Adam & Co, says the investigation is linked to a small number of clients and that overall confidence is high.

“There are two different aspects to trust at play here [after financial crisis],” he explains. “There are aspects of trust in the financial institution world and aspects of trust at a personal advisor level. What was damaged during the crisis was trust between the public and financial institutions. What we saw at Coutts and Adam & Co is that clients are very loyal to the bankers that run their personal affairs.

“We haven’t lost clients as a result of the financial crisis. Our client assets continue to grow strongly at both Coutts and Adam & Co.”

Some of the worst examples of the mis-selling of structured products occurred in Asia, through Lehman-linked mini-bonds sold by high street banks. Clients protested in the  streets of Singapore because products were sold in some cases to retail investors as risk-free investments. They were also sold to the elderly, those with learning disabilities and the poorly educated, according to an investigation by the Hong Kong monetary authority.

DBS, Singapore’s biggest bank, agreed to repay HK$651m ($84m/£52m) to Hong Kong clients with a low or medium risk profile who bought the notes. Bank of China Hong Kong was the biggest seller of Lehman mini-bonds. A trial of two of the banks’ employees, who plead not guilty to selling the products fraudulently, was due to start in early November.

Mis-selling of structured products impacted only a small percentage of private banking clients but has been damaging to the industry’s reputation. Private bankers’ jobs have been made even more difficult because all but a few asset classes outperformed cash during the crisis years. Client interest in complex products has declined in preference for vanilla offerings – although there are recent signs of renewed interest in hedge fund investments (see page 22).

Rebuilding trust among clients has led to an emphasis on closer relationships between private bankers and their clients. This has been driven by an increased demand for advisory rather than discretionary services. Clients want to be kept better informed on what investments they are holding and the value of them. This has meant discretionary mandates, where clients take a hands off approach and investment managers take decisions on behalf of the client, have become less popular.

Noticeable trend
Guy Tulloch, head of HSBC Private Bank Scotland, thinks the trend has been noticeable, but does not believe it represents a “sea change” in client preferences towards advisory services.

“Clients are looking at transparency and liquidity and those are relatively easy to achieve through our investment offerings,” he says. “The signs from the industry are that people are increasingly looking for advisory services to maintain more control.

“We’re still seeing a high demand for discretionary services because people don’t have the time to monitor investments on a day-to-day basis. They want a professional making those day-to-day decisions that need to be made within an agreed framework.”

Some in the industry see the shift from discretionary to advisory mandates as a good thing because it means contact between client and relationship manager is more frequent and helps build relationships. However, at a business level it means margins can be reduced because of the increased workload it places on relationship managers.

Overhauling prices
Swiss banks, which traditionally have a high emphasis on discretionary investment management, have been among the first to overhaul their pricing structures. Bank Sarasin, a pure-play Swiss private bank based in Zurich, has introduced a mid-tier pricing category called “active advisory” between its standard advisory and discretionary services.

In the UK, wealth managers are taking a wait-and-see approach. This is partly a result of the FSA’s Retail Distribution Review (RDR) initiative, which is aiming to bring more transparency and better training into the market for investment advice. It is fundamentally redesigning the fee-charging structure of most investment management firms.

They will be required to charge a clear, up-front advisory fee, in contrast to the current system where advisers may offer advice for nothing and generate revenue in less transparent ways, for example receiving retrocessions – more crudely known as ‘kick-backs’ – from asset management firms. The latter distorts and arguably misrepresents the market for independent advice, while the former, the FSA hopes, will foster consumer trust and confidence.

Described by the FSA as a consumer protection strategy, RDR’s three aims are to:
• improve the clarity with which firms describe their services to customers
• address the potential for adviser remuneration to distort consumer outcomes
• increase the professional standards of investment advisers through standard educational requirements.

Similar initiatives are being considered by regulators across the world. Australia’s Financial Planning Association is implementing fee-based remuneration by 2012 and India implemented RDRstyle regulation in 2009.

Philip Grant, Managing Director, UK Private Banking at Lloyds Banking Group, argues that the measures will force private banks to become more advice and service-oriented rather than product focused. Grant, who is also CIOBS president, adds that good quality private banking is as much about banking and savings solutions as it was about investments.

“RDR is only one part of a much wider position,” he insists.

“It’s a supporting framework but the need to become your clients’ trusted adviser is the main success factor in this market – there is a lot more to it than just regulation.

“It’s about openness and providing information through the advisory and product process. The ongoing relationship, conducting annual reviews, is also a key part of building that trust – a cyclical revisiting of the position to check it is best suited to the clients’ needs.”

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