The State of the International Financial Services and Wealth Management Industry

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Prof.  William H. Byrnes, IV

Walter H. & Dorothy B. Diamond Graduate Program Int'l Tax & Financial Services

Asst. Dean, Thomas Jefferson School of Law

2121 San Diego Avenue, San Diego, Ca. 92110

T (619) 297-9700 ext. 6955 F (619) 374-6957 E 

I www.llmprogram.org  www.tjsl.edu

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Interview Notes Written by Professor William H. Byrnes, IV

The State of the International Financial Services and Wealth Management Industry

In my 900-page economic report on the offshore financial services industry, I examined and calculated the economic size and impact of the sector on local jurisdictions.[1]  But for periods of global financial crisis, the sector had experienced double-digit annual growth and contributed robustly to the local economy and society.  Since 1998, the international financial services sector client base has expanded nearly 10% on average.  During this period, the number of HNWI clients OI’s readers serve have more than doubled, to just over 10 million, as have their assets, from $17.4 trillion to $40.7 trillion.[2]   

In just four years, the pool of HNWI clients assets will grow another 50% to nearly $60 trillion.  The average HNWI, excluding the value of primary residences and collectables, is worth more than $4 million!  HNWI’s continue to leverage offshore skill sets, growing their assets from $5.8 trillion from 1998 to $11 trillion today.[3]    That $11 trillion under management represents, at combined fees of just 1%, at least $100 billion to OI firms.  The international-offshore financial service industry’s direct professional level employment now surpasses 50,000.

High Net Wealth Individuals (HNWIs) are showing lack of fidelity to older institutions and are migrating a portion of their portfolios to boutique investment firms and family office operations.  By example, HNWI clients have already diversified their portfolios to 20% alternative investment, up from just 3% in 2000.[4]     According to polling by Cap Gemini, several factors are driving this re-allocation.  HNWIs, and in particular the new generation of HNWIs, are increasingly globally informed about investment opportunities and risks.  Thus, HNWIs are undertaking their own research of information.  HNWI’s are demanding firm’s investment teams develop and use global strategies and products to hedge local risks. 

The OECD members are not experiencing HNWI high growth.  Instead, the BRIC countries of Brazil, Russia, India and China are the clear winners.  The BRIC countries, in particular Brazil because of its vast natural commodities base, will continue to lead the world in both economic and HNWI growth.  Thus, winning OI firms will provide services reflective of the needs of BRIC clients, as well as speak their languages.

Trends within International Financial Servicesand Wealth Management Industry

My forecast for an expanding and robust sector the past years has not been drawn from the conclusion of “what doesn’t kill you makes you stronger”, though I often lecture that “the survivors shall inherit the spoils”.  Rather, I have examined the upward trend in expenditures by firms, and the sector as a whole, that allows them to the flexibility to adapt to changing climates and to evolve distinguishing services, such as well rounded, trusted advisors.

By example, for ten years I have measured that growing firms increase investment in education and information, and an increase in these two areas support that firm’s growth.  On the other hand, firms' declining revenues, by example through loss of clients and key staff, correlate to a reduction in education and information spending.  In the 2008 poll by Robert Half's Accountemps of 1,000 top companies, 94% offered tuition benefits to their key employees.  Naturally, this correlation begs the causation question of whether the decline in spending caused decline of revenues, the other way around, or some other factor caused both.

In support of the winners investing in education, this year Cap Gemeni reports that “While most HNWIs and UHNWIs have relationships with multiple wealth management firms, many clients seek long-term “trusted advisors” who can help them navigate complex topics and strategies.”  The trusted advisor must understand the HNWI “in the context of a larger relationship that encompasses personal and family finances as well as business partnerships or estate planning.” 

Moreover, Cap Gemeni reported that employing qualified talent will sharply increase because of the retirement of the baby boomer wealth manager generation.  “Bidding wars among firms for top advisors are not uncommon” and that packages will include “bonuses equaling two or three times the payouts from just a few years ago.”  More directly supporting investment in education, the industry career newsletter, Jobs in the Money, reports that credentialed professionals with certifications earn over 30% more than their colleagues.[5]

Because the financial services sector continues to out or evenly pace other sectors in terms of firms’ and employees’ earnings, the sector has grown more competitive with new boutique firms entering monthly.  Three types of boutiques have shown significant growth in the past five years.  First, investment team boutiques that create and manage internationally oriented investment funds focusing on alternative investments, such as cross-border arbitrage strategies.  These boutiques appeal to both HNWI’s directly, competing with larger institutions, and to the institutions themselves, in collaborative arrangements.  Secondly, family office firms employing holistic family business and tax management and lifestyle solutions, sometimes in combination with investment management services.  Thirdly, compliance advisory service firms have been established to serve financial service providers.

Besides the army of lawyers advising regulated firms and the chartered accountants undertaking compliance, anti-fraud, AML, terrorist activity, and qualified intermediary (QI) audits, the publications market employment will grow.  Because compliance regulations, costs, and penalties are growing more onerous, all regulated financial service providers and their advisors must purchase some information resource to address the variety of compliance issues encountered regularly.  Moreover, to undertake the role of the ‘trusted advisor’, a sophisticated wealth manager must have a bundle of reliable resources enabling the holistic, international, business partner approach that modern HNWIs and UHNWIs now demand. 

Indication of this trend is that the legal, tax and regulatory publishing market has been and is growing consistently.    L  egal publishing is the largest segment in professional publishing, accounting for approximately 36% of the total market. In 2007, legal publishing revenue was about $10 billion, up 7.5% from $9.3 billion in 2006 and 14.9% from $8.7 billion in 2005. [6]  Legal publishers are sparking growth by developing digital tools and software out of their reference book and journal content designed to make it easier for legal professionals to find information and automate mundane tasks.  New online publishing will use mind-mapping technology to educate users about holistic connections amongst ideas, issues, and strategies.  Growth in publishing for an industry tends to indicate growth in that industry.

Looking at the Compliance Career Market

Resulting from the impetus of the Al Qaeda’s terrorist attacks of 9/11, the US financial institution regulators became an enforcement hawk of the money laundering provisions of the Bank Secrecy Act (“BSA”).  In turn, hawkish enforcement has led to a drastic increase in the number of BSA filings.  In 2005, the approximate two hundred thousand US financial institutions filed over sixteen million BSA reports, e.g. Suspicious Activity Reports (“SAR”s), as recently reported by the US Government Accountability Office (“GAO”).  FINCEN reported most recently that in the last half of 2007, it received 5.4 million SARs of which 2.8 million resulted from depository institutions.[7]   It should come as no surprise that FINCEN reported that mortgage fraud, consumer loan fraud, and identity theft SARs dramatically increased, 40%, 19% and 59% respectively.

By contrast to some other jurisdictions with which the US has substantial transnational financial activity, in the UK just two hundred thousand SARs were filed in 2006.[8]    Complinet reported that Brazil  's financial intelligence unit (FIU) received approximately 368,000 SARs the first half of 2008 while Mexico’s FIU and Tax office is working on just 84 suspected cases of money of 100 referred.

Notwithstanding the level of apparent US compliance, the GAO noted that the federal regulatory authorities cited well over 7,000 BSA violations, leading to over 2,000 various actions against banking institutions.  Interestingly, a majority of 2005 actions were issued against the traditionally smaller credit unions that at first glance may be considered to carry less risk for money laundering.[9]    Further, these enforcement figures did not include the actions taken against casinos, jewelry stores, and money service businesses, such as check-cashing, whose anti money-laundering (“AML”) program compliance is audited by the IRS.  Reviewing a few of the high dollar value civil penalty actions issued by the US regulators in the last two years illustrates that a lack of money laundering expertise at the management level and a lack of firm wide education and training at the staff level cuts across both large and small banking firms. 

Since the high profile Bank of New York, Riggs, and AmSouth enforcement actions, the federal regulators have been strictly applying the AML and compliance statutes and time line for procedures, issuing fines and cease and desist orders (which usually lead to job firings and even changes in management).  Last year’s high profile action occurred against American Express Bank International (“AMEX”).  producing originally a twenty-five million dollar penalty and corresponding fifty-five million dollar forfeiture that has since grown.  The action resulted partly from the gross amount of errors in just one year in its SAR filings regarding its private banking services to its high net-worth individuals (HNWI) and the individuals’ respective businesses throughout Latin America.  In the 12 month period from May 2006, over 2,000 filing error were found for only 1,639 SARs, not including over 1,000 late SAR filings.  Other recent large penalties citing the lack of staff training include ABN-AMRO’s (forty million dollars) and fines of ten million dollars each for Bank Atlantic and AmSouth. 

Medium size Foster Bank suffered a two million dollar penalty because “management failed to implement adequate training for appropriate personnel to ensure compliance with the suspicious activity reporting requirements”.  The regulator found that Foster Bank staff was inadequately trained in suspicious activity identification and monitoring, detection of structured transactions, and identification of possible money laundering.  Israel Discount Bank, with branches in a few states, paid a twelve million dollar file for inadequately training its staff regarding the heightened risks associated with its transaction involving Delaware LLC shell companies.  On the opposite size spectrum from AMEX, a one branch bank, Beach Bank of Miami, with less than $150 million in assets, suffered an eight hundred thousand dollar fine for its lack of monitoring of high risk accounts, including six foreign correspondent accounts. 

Indications of Market Expenditure on AML Compliance

The Regulatory Environment[10]

For the past several years, the US banking industry has focused on regulatory issues, such as the corporate governance provisions of the Sarbanes-Oxley Act (enacted in 2002) and the banking-related parts of the USA Patriot Act (enacted in 2001). These provisions are now beginning to have an impact.  Smaller community banks have contended that it is difficult for them to comply with certain Sarbanes-Oxley provisions, such as the requirement that audit committees be composed entirely of independent directors and that companies have a “financial expert” on the board of directors. The provisions of the USA Patriot Act require increased investments in technology (though many in the industry have questioned the effectiveness of these investments in preventing the funding of terrorist groups or activities).

Senior banking management perceives rising and unpredictable compliance costs that undermine global competitiveness as the most significant threats to the future growth of banking.[11]    The cost of AML compliance increased around 58% globally and 71% in North America between 2004 and 2007.[12]

A 2005 survey of Florida banks engaged in international banking estimated the staffing cost of AML compliance at nearly $25 million. The study concluded that compliance costs are not uniform across institutions, even after making adjustment for size.[13] Banks estimate that training costs and transaction monitoring will require the largest investment of all AML activities. All North American banks provide AML training for nearly all of their employees.

Larger institutions (measured in terms of deposits) typically devote more resources and spend more on compliance than smaller ones, of course, but the compliance burden does not rise proportionately with size.  That is, survey data indicates that economies of scale in compliance are present, and that compliance costs per dollar of deposits is greater for smaller institutions than for larger ones.[14] Even after the dramatic increases in compliance costs and regulatory complexity since 2001, the regulatory environment is likely to become increasingly challenging in coming years.

In a 2006 Economist Intelligence Unit survey, international senior bank executives were asked about the costs of compliance with government regulation. When asked what changes they expected in the regulatory environment over the coming three to five year, over 91% stated that they expected regulations affecting their institution to grow in complexity and breadth, 88% stated that compliance with industry regulations will become more onerous, and 81% reported that they expect penalties for non-compliance to increase in severity.[15]

US Financial Services Market Compliance Employment Trend

The US financial service institutional market subject to the Patriot Act related AML provisions is comprised of over 50,000 firms with three million employees and agents, including deposit taking institutions, life insurance and annuity companies, and investment companies.[16]     The USA Patriot Act also applies to Money Service Businesses, NASD licensed professionals, real estate brokers, casino operations, jewelry stores, amongst other businesses that money launderers target

The USA employs over 150,000 compliance officers addressing all compliance issues, from the privacy of information to Patriot Act compliance.  Specific to these publications, Miami has over 150 full time AML officers addressing just international banking issues.[17]

USBanking Center AML  Compliance Costs: Miami

The international banking industry in Florida has been characterized by consolidation and contraction since 2000.  The number of foreign bank agencies operating in Florida fell from 38 in 2000 to 31 in 2005.[18]    There were 10 Edge Act banks operating in Florida in 2000, but only 7 in 2005.  The number of international banking employees (in foreign agencies, Edge Acts and the international divisions of domestic banks chartered in Florida) declined from 4,660 in 2000 to 3,027 in 2005.

Based on a survey of banks significantly engaged in international banking Florida International Bankers Association (FIBA) was able to estimate the Florida international bankers staffing cost for 271 full-time employees of anti-terrorism/anti-money laundering compliance at nearly $25 million in 2005. [19]    The average survey respondents indicated that it devoted 2.9 FTE employment positions to BSA/AML compliance in 2002 versus 6.8 FTE positions in 2005. The number of full-time employees devoted to compliance represented 9% of the workforce in 2005.  Staff resources devoted to compliance increased by 160% between 2002 and 2005.

39% of banks surveyed reported that private banking accounted for more than 50% of their operating revenues.  Florida’s international private banking and wealth management customers predominantly reside, as one would expect, in Latin America and the Caribbean, with 1/3 residing in Europe.  South American residents account for 44% of private banking and wealth management customers of Florida’s international banks.  Approximately 19% of international private wealth management clients reside in Mexico or Central America, while 4% reside in the Caribbean.

Conclusion 

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