By defying the worldwide destruction of private wealth, Asia's super-rich are flying in the face of a global trend. Jeremy Torr reports.
The ‘rich get richer’ premise still holds true in Asia, where private banks and high net worth individuals enjoy what is the only bright spot on a gloomy global market, according to new findings.
Despite tough economic times, the private banking industry in Hong Kong is expanding as more wealthy clients – those with at least US$1m to invest – seek extra financial help. The catalyst: the number of super-rich in Hong Kong is still rising.
About 1.7 million high net-worth individuals (HNWI) in Asia this year shared a total wealth of US$5.4tn, the Merrill Lynch / Cap Gemini World Wealth Report 2002 has found. Of these, about 77 are billionaires.
Accordingly, profitability for the private banks in the Asia Pacific region rose by 15%, says the latest Boston Consulting Group survey: Prospering in Uncertain Times.
Wealth managers elsewhere suffered a horror year, with profitability plunging 69% in the US and 14% in Europe.
The result is that all of the world’s major private bankers – UBS, Morgan Stanley, Credit Suisse, JP Morgan Chase, Goldman Sachs, Deutsche Bank, Citigroup, Merrill Lynch and BNP Paribas – are expanding operations in Hong Kong.
And this comes at a time when 10 of the world’s largest financial institutions announced global cuts of 26,000 jobs and $4bn in annual operating expenses in 2001. Merrill Lynch is closing 20 of its 28 branches in Japan.
Analysts are referring to it as the "worldwide destruction" of private wealth, as investors – from the mass affluent to the richest – saw the value of their equity holdings tumble.
But despite poor Japanese stock market and GDP performance, Asian HNWI rose 7.1% this year due to high savings rates and stock market strength in other Asian countries.
Among the trends was a shift by HNWIs to protect wealth and invest in fixed income, cash and deposit products and property. Some of the players also invested in alternative investments such as hedge funds, which tend to be non-correlated with stock market returns.
What the experts say
Private banking lawyer Michael Olesnicky, a partner with Baker & McKenzie, agrees it has been a tough time for the global private banking sector with many "under a lot of pressure".
"And some of these were previously seen as indestructible," says Olesnicky, "such as those private banks in the US and Europe."
"But all the latest figures seems to suggest private bankers in Asia are doing better," he adds.
"Maybe this has something to do with the type of investor. Mostly, investors are more aggressive in Asia, more hands-on and greater risk takers. In Europe, they tend to sit back and let the fund managers make the decisions."
One survey for an international private bank shows that the number of people in the SAR with more than US$100,000 in liquid assets has nearly doubled in recent years – rising from 96,000 in 1995 to 177,000 in 2000.
Olesnicky also believes Hong Kong’s vicinity to the economic powerhouse of China is a significant factor.
"China represents the last frontier for many private banks … a huge potential market and a huge potential client base," he says. "But there are client controls and residents are prohibited from sending money out of China.
"And they have been restricted from what they can do onshore. Private banks are not licensed to operate in China, and a Chinese person cannot invest in hedge funds – often the most sophisticated investment for a Chinese person is making a safety bank deposit.
"All the exchange controls have been made to make sure the money stays in China. The most important thing for private bankers is to know your customer and satisfy yourself that the money was not derived from illegal or corrupt means," Olesnicky adds.
Official figures on capital flight from China in recent years was not available, but a study by Beijing University put the amount of money leaking through the country’s supposedly closed – but infinitely porous – capital account at US$36.4bn in 1997, US$38.6bn in 1998 and US$23.8bn in 1999.
And one official says recent official estimates of capital flight in 2000 and 2001 show an alarming increase over these numbers.
All of China’s commercial banks have been ordered to set up systems to monitor suspected money laundering by January 2003, while the problem coincides with a recent focus in official circles on another vexed issue – rampant tax evasion and avoidance.
But the bright new world of tighter regulatory controls of money laundering and enhanced information exchange is nothing new to the global players in private banking.
Morgan Stanley, ranked second globally behind UBS Private Banking, has a large presence in the Asian region as does HSBC Republic, Credit Suisse and Citigroup (see table).
While unable to comment on the latest trends in information exchange, David Graham, managing director / general counsel for Morgan Stanley in the Asia Pacific region, says there is greater cooperation across borders between regulators.
"And certainly our customer documentation protects client confidentiality, but it does contain a ‘carve-out’ to allow us to provide information to regulators if required to do so," he says.
The major legal issues for the private wealth management business in the region mainly involves selling and marketing restrictions, adds Graham. "For example, our ability to sell and/or market particular products to particular individuals in specific jurisdictions. And secondly, suitability, such as the appropriateness of a particular product for a particular client."
HSBC Republic chief executive Monica Wong says suitability is a crucial aspect of the private banking business.
"The biggest part of our business when dealing with clients," she says, "is understanding what works and what does not … and then coming up with the best solution."
The best solution often involves working closely with a number of outside legal teams and international firms, particularly regarding tax issues. "We have our own tax advisory team," adds Wong, "but we also use outside firms to help come up with the most tax efficient structure."
The private banking arm of HSBC is big business. The latest annual results show that HSBC Republic contributed US$412m, or 4.7% of its total pre-tax profits, for 2001.
Some private banks have particular areas of expertise. The Bank of Bermuda specializes in establishing and managing trusts and other structures designed to protect and preserve family wealth.
Bernard Rennell, head of private client services at the Bank of Bermuda, says that the onshore market is growing faster than the offshore market, but that the offshore market continues to grow also and still totals some US$5tn.
"We act for wealthy families but we don’t force proprietary products," he says. "The trusts and structures we administer on behalf of the families we work with may invest with a wide range of other institutions and other investment managers.
"Our investment professionals sit on the same side of the fence as the family and help the family to evaluate the advice they are receiving from their third party investment managers. We often also help with evaluation of performance and consolidating reporting across the range of private bankers the family is dealing with. We can do this because we’re independent on the investment side. There is always plenty of hype surrounding what is new but when talking about investing for the longer term, there are standard asset allocation issues," he says. "We can help the family to look past the hype to the real issues.
Rennell adds: "There is a lot of talk about China, but it is not a material part of anyone’s business yet. It is going to become so, but it is going to take time and you have to be extra careful with due diligence and the restrictions on shifting capital.
"But business links in China are becoming more international, and it is going to continue. You can over-hype China, in terms of what is happening and how to make money. It is a long, hard slog and that is certainly true of private banking.
But, says Rennell, "it is also easy to underestimate China".
Revelations
All have welcomed a move towards greater transparency in the private banking sector.
Rennell says: "We put a lot of time and effort into developing structures that are tailored to a family’s own particular requirements. They are designed to address the family’s particular succession, tax and other issues. We also put a lot of effort into ensuring that structures are fully legal, and that they remain so notwithstanding changing regulatory requirements. They are always very private and although confidentiality is important, we like to be confident the trusts and other structures we are involved with will withstand regulatory scrutiny should that arise in any case.
"It is the people who sell a solution based on ‘no one will ever know’ or the ‘quick fix’ who will disappear. So we are going to see a decline in the marginal and fringe players.
"This is to our benefit."
Rennell cites a recent high profile UK case where a banker, accountant, lawyer and the client, all went to jail for non-disclosure of offshore accounts. "The chances of being caught out have increased substantially over the past three or four years," he says.
All of which is good news for lawyers.
There is a growing potential for legal business in the Asian private banking sector, with regulatory and legislative investigations focusing attention on the importance of truly independent research and advice.
With investor confidence yet to rebound from a series of corporate scandals in recent months, the case for separating investment advice from transactions has strengthened.
High earners bank on alternatives
Almost every major international bank doing business in the Hong Kong SAR operates private banking services and seeks to cater for high net worth individuals.
Monica Wong, chief executive of Private Banking Asia at HSBC Republic, says that private banking is not only about investment, it is a combination of wealth management and wealth protection: a bid to protect family wealth from generation to generation in a tax efficient manner.
This is one reason why HSBC Republic, the private banking division of the HSBC Group, has significantly expanded the range of services required by high net worth individuals in recent years.
Wealthy clients are being offered an exotic array of financial products ranging from offshore trusts and international mortgages to hedge funds and other structured products.
Wong says that with the global economic downturn, which is a tough time for traditional equity investments, high net worth individuals turn to alternative and structured products to preserve their wealth.
"Because the market has been so difficult," she says, "one of our best products has been hedge funds, where we can offer investments which are not correlated to the equity market."
HSBC Republic has a group of hedge fund experts in London and Geneva to monitor more than 700 hedge funds and invest in 400 funds, with client funds under management in excess of US$9bn worldwide.
Apart from alternative investments, some wealthy clients look into private equity. "We have a fund investing in the Russian market which has grown by more than 400% since its launch in 1996," says Wong.
One of the most senior female executives in the HSBC Group, Wong joined HSBC Investment Bank Asia Limited (formerly Wardley Limited) in November 1983 to establish the private banking business in Asia.
Wong initially set up the private banking business with a small team of 40 staff, which has now grown to more than 1,000 employees in Asia.
HSBC Republic is today positioned within the top three private banks in Asia, with combined assets under management exceeding US$40bn.
Wong says the success of HSBC Republic has been based on an ability to understand what works and what does not for different clients.
"It is very difficult to sell a broken fridge," she says, "but it is very easy to sell a top-notch product that you know works."
Wong offers some analytical insight into some of her strong performance products:
Structured Products
4-year Callable Daily Accrual Range Notes
In the current low interest rate environment, one structured product that can enhance the investor’s return is the four-year callable daily accrual range notes. In essence, investors can get a maximum annual coupon ranging from 4% in Year One to 8% in Year Four, depending on the number of days in which short-term interest rates such as the US$ 3-month LIBOR falls within a stipulated range. The callable feature allows the issuer of the note to call and cancel the note at some specific points during the life of the instrument. Customers are receptive to this structured product.
2-year Laggard Equities Linked Notes (ELNs) on a basket of stocks
Another interesting product related to equities is the 2-year Laggard Equities Linked Notes on a basket of stocks. While short-term market conditions are volatile and outlook is uncertain, longer-term fundamentals for stock investment are improving. Medium-term laggard ELNs are created to take advantage of the high-implied volatility and relatively cheap stock prices.
In this note, investors receive an annual coupon of around 7.5%. If all of the stocks in the basket close above the strike prices upon maturity, investors will get back 100% of the principal. If one or more of the stocks closes below the strike price, investors will not get cash upon maturity but will be delivered the stock that falls most from the strike price, i.e. the most laggard stock. On the other hand, if all the stocks in the basket close above the spot, an extra bonus, which is equal to the percentage of appreciation of the least performing stock in the basket, will be paid. Investors have found this instrument appealing especially when it is structured on the basket of local blue chips.
HSBC Republic Hermitage Fund
The HSBC Republic Hermitage Fund was created in April 1996 to invest in equity and equity-related securities of Russia and countries of the former Soviet Union. Hermitage Capital Management Limited, the leading international asset management firm specializing in Russian equities, manages this fund. With the acquisition of Republic National Bank of New York, it is now a member of the HSBC Group. The Fund has US$700m invested in Russia. The Hermitage Fund has increased in value by 416% compared to 156% for the CSFB ROS Index since its launch in 1996. It has been ranked the World’s Best Performing Emerging Markets Fund over a five-year period (please refer to Chart I for the fund’s performance).