Edited by Farah Ballands, Carlos de Serpa Pimentel and Brian Johnson
Welcome to this inaugural edition of our new Wealth Structuring 20:20 report, a feature publication that aims to tap into the issues facing high net worth individuals around the globe, and investigate the themes and challenges affecting this elite group.
INTRODUCTION
In this edition, we look at wealth management and structuring on an international scale, considering the impact of the Cyprus crash on Russia's wealthy; the unique challenges facing high net worth individuals on the West coast of the United States; and the different cultural issues that arise when embarking on cross-border wealth structuring.
We are also well aware of the significant changes within regulatory environments around the world and the impact of wealth regulations specifically, coupled with the complex geopolitical environments that push many high net worths towards structures focused on diversifying risk. And finally, we have looked at the smart investment in alternative assets, whether they be fine art or private jets.
We hope that this edition of Wealth Structuring 20:20 provides useful insight to our readers. Certainly it seems that, when we review information from the Capgemini World Wealth Report 2013i, the number and aggregate wealth of high net worth individuals in the world is growing and continues to reach record levels, increasing 9.2% to reach 12 million by the start of 2013. Aggregate investable wealth also increased during 2012 by 10%, reaching US$46.2 trillion, and so wealth structuring has never been more important or more complex.
Despite possible perceptions to the contrary, in 2012 the number of millionaires and other wealth individuals in North America grew by 11.5% to reach 3.73 million, and overtook Asia-Pacific, which grew 9.4% to reach 3.68 million. However, while a great number of the world's richest individuals now call America home, wealth growth was the strongest in Asia-Pacific at 12.2%, driven by strong fortunes in many of the region's countries, followed by North America at 11.7%. Tellingly, almost half of the global population of high net worth individuals is resident in just two countries - the United States and Japan.
When it comes to asset allocation, the Capgemini report tells us that the world's wealthiest people exhibited a clear bias towards wealth preservation in 2012, allocating nearly 30% of their funds and other assets into cash and deposits, with alternative investments making up only about 10% of allocations globally and that split evenly between structured products and private equity investments.
According to Boston Consulting Groupii, offshore wealth (defined as assets booked in a country where the investor has no legal residence or tax domicile) rose in 2012 to 16% of investable assets, with Western Europe the predominant source and Switzerland the most popular destination. It remains to be seen how the impact of FATCA and other regulatory initiatives will impact this capital flow, particularly as governments in Europe and North America push individuals to move money onshore.
It's clear to us that the world's wealthiest individuals cannot afford to stand still in the current climate, which sees macroeconomic uncertainty alongside rapid legislative and regulatory change. In the face of choppy stock markets, real estate has once again been the asset allocation of choice, with private investment in commercial property up to US$92bn in 2012, compared to US$47bn in 2009. New York, Hong Kong and London remain the primary beneficiaries of private investment into commercial real estate.
As 2014 progresses, however, we see confidence returning to the international capital markets as many governments move towards getting a grip on massive budget deficits, and financial institutions regain their footings. The aftermath of the global financial crisis will bring a new wave of challenges for the growing class of high net worth individuals seeking international exposure.
We hope that our articles on the following pages address some of the issues that are front of mind, and provide interesting food for thought. Please don't hesitate to get in touch with your usual Appleby contact should you wish to discuss anything further.
SOVIET WEALTH: TO CYPRUS & BEYOND
by Elizabeth Henson and Andrew Terry
A three-hour flight from Moscow, a double tax treaty and a generally very beneficial tax system have long made Cyprus the destination of choice for Russians looking to invest money overseas.
In 2012, statistics from the Central Bank of Cyprus showed Russian money dominating foreign direct investment into Cyprus, worth around €880m to the country.
But following the 2013 banking crisis in Cyprus and subsequent bailout, there were fears that Russian money would start heading elsewhere. Today, whilst there are some signs of a shift, the ties between the two countries remain strong.
Elizabeth Henson leads the Private Client and Private Business team at PricewaterhouseCoopers in London, and a significant number of her clients are ultra high net worth individuals from Russia. She says: "The banking industry in Cyprus has suffered in recent years. Some of the more sophisticated clients now don't want to use Cyprus for holding companies, and sometimes they are using UK companies instead. But some family offices have stayed in Cyprus because it remains a cheaper, professional place to run things from, particularly if you have employees on the ground." She adds: "Definitely amongst the very wealthy, with a greater level of sophistication, the use of Cyprus holding companies for new transactions is being questioned and greater consideration is being given to using the UK, the Netherlands and Luxembourg."
New generation of wealth
The political environment in Russia is such that many wealthy Russians continue to look for structures that allow them to get their money out of the country with maximum effectiveness. Andrew Terry, a senior tax partner at Withers and co-head of the firm's CIS practice group, says there is a new generation of rich Russians, following in the footsteps of the super-rich oligarchs who made their money in the privatisations of resource companies in the 1990s.
He says: "Now there is a group of very wealthy entrepreneurs coming from Russia who have made money in very difficult circumstances, often involved in less sensitive industries outside natural resources. This group of high net worths, once they have assets over about $500m, is looking to exit Russia and is providing quite a lot of business for offshore jurisdictions."
Because of fears about expropriation of assets, many of Russia's wealthy have relocated to London, often using offshore structures through the Isle of Man, Jersey and elsewhere to manage their wealth. Henson says: "Since the election of Vladimir Putin as President in 2012, there has been a high level of political uncertainty, and so people have been moving to the UK, including moving their families here. We have seen Switzerland becoming popular as a destination for Russia's wealthy, and we have also heard of Russians using Singapore as a base for a gateway into China, and choosing that as the start of a move eastwards."
There are also changes to the tax scenario in Russia that are pushing high net worth individuals to shift money overseas. The government, like elsewhere, is moving to increase sophistication in the domestic tax system as part of an economic drive to claw back revenues, such that the authorities are seeking more information and driving greater governance.
The new rules restrict how "politically exposed persons" hold their liquid assets and where they can bank. "There is greater emphasis on looking at where companies are managed and controlled," says Henson, "so if you have a BVI company and someone sitting in Russia is a shadow director taking all the decisions, that may be challenged."
President Putin is also pushing to have ownership of Russian companies held onshore rather than allowing the use of offshore or non-Russian holding company structures. Legislation introducing these changes has already passed on second reading in the Duma.
More transparency
A theme resulting from the new rules is a noticeable shift towards greater transparency and onshore structuring by Russian clients, Henson says.
Terry adds that post-Cyprus, "Many Russians have been looking to other jurisdictions, and particularly Luxembourg, the Netherlands, Sweden and Latvia, with some double-tier structures using a Luxembourg parent above a Russian company with a UK company above that."
He says his clients are increasingly interested in investor protection, as opposed to just tax. "With the Netherlands and Luxembourg there are bilateral investment treaties, which mean that if the Russian state were to seize the assets of the underlying subsidiary of the Luxembourg company, then the Luxembourg company would have rights to either get those assets back or seek compensation."
But whilst the super rich may, to some extent, have turned their back on Cyprus in favour of new structures, for Russia's wealthy middle classes the Mediterranean island remains a destination of choice. Terry says: "The number of clients moving money out has been significant, but not huge, and the shift is still ongoing. But it's expensive to move and any of these new structures are more expensive than Cyprus.
"The people who had deposits at the Bank of Cyprus wouldn't have enough money to interest the banks of Geneva or Zurich; if you want to put US$500,000 there, they aren't going to open an account for you. So those middle classes are not necessarily relocating."
Russia and Cyprus remain strong bedfellows, even if Russia's billionaires are starting to pursue other options.
IFCS: EAST VERSUS WEST
By Hubert Tse and Hélène Lewis
The global financial crisis brought with it a great focus on offshore finance in both the United States and Europe, as governments struggled to get a grip on massive budget deficits by cracking down on missing tax revenues.
Meanwhile in Asia the impact on international financial centres (IFCs) was entirely different, as instead of a clampdown on transparency and a raft of new regulations, the offshore centres of Hong Kong and Singapore thrived on the back of growing wealth in the region.
As the West pursued a campaign against IFCs and the distinction between tax avoidance and tax evasion blurred, so the East looked to IFCs to offer a familiar, comfortable and stable platform for high net worth individuals looking to keep money offshore.
Growth in the East
China is a classic case in point. GDP growth stood at 7.7% for 2013, and has, since 1978, averaged 10% a year, putting the country on track to be the world's largest economy by 2020. But currency exchange controls mean that the Chinese citizens who are benefitting from that growth in wealth cannot convert their money into foreign currency, so they cannot bring dollars into the country or convert their renminbi without getting approval.
Hubert Tse, senior partner at Chinese law firm Boss & Young in Shanghai, advises global, Asian and Chinese hedge funds, private equity funds, sovereign wealth funds, family offices, endowments, pension funds, insurers, financial institutions, asset managers and HNWIs in China. He says, "In terms of the numbers and the level of sophistication, Chinese high net worth individuals have changed dramatically in the last ten years since I arrived in Shanghai. You now find there are a large number of Chinese high net worth individuals having some of their assets outside of China, via immigration, outbound investments and overseas IPOs."
For the wealthy of China and many other parts of Asia, IFCs provide a well-regulated, simple, stable and well-run business environment, while China, for example, still suffers from often opaque regulation, long-standing bureaucracy, a less than open capital market and an almost non-existent wealth management platform. Moving money or consolidating wealth across a number of Asian countries is also complex given the different pace of regulatory development in each jurisdiction.
The result is that Hong Kong and Singapore have prospered, while the use of pure offshore IFCs in the Atlantic, Caribbean and Europe by Asian families has also increased. These would include Bermuda, the Cayman Islands, the British Virgin Islands, Jersey, Guernsey and the Isle of Man.
Hélène Lewis is a partner in the law firm SimonetteLewis, based in the British Virgin Islands, and is also the worldwide chairman of STEP, the Society of Trusts and Estates Practitioners. She says: "Asian families have long been attracted to the BVI, for many reasons including the stability of the dependent territories. They don't have to deal with aggressive governments, and offshore centres are deemed to be efficient and secure."
She notes that as Asian wealth is maturing, so too are the disputes that are arising amongst BVI companies: "We now have mature companies with mature problems, including family disputes about inheritance and estate planning issues, sometimes turning into dramatic court battles," she says.
Meanwhile new centres like the Seychelles and Mauritius are gaining favour also, thanks to lower costs and because they are increasingly seen as a gateway to continental Africa for investors. Mauritius continues to play a strong role for India, and both centres fall outside the umbrella of being British dependencies or British overseas territories.
Regulatory challenges in the West
But the boom in the use of IFCs by Asian clients is in marked contrast to what is going on with European and North American clients, who are being pushed by governments to move money onshore. Lewis says: "The popularity and importance of confidentiality, which has driven the growth and development of offshore centres, has been critically impacted by what was essentially meant to be a drive for tax revenues. The unique selling point of several financial centres has been severely eroded."
She points out that the majority of what people do in offshore financial centres is legitimate and prudent tax planning, but says the impact of the Foreign Account Tax Compliance Act (FATCA) from the US, along with efforts by the EU, the G8 and the G20 to drive tax harmonisation has impacted Western high net worth individuals.
"European clients are highly impacted," she says, "because the laws are changing so swiftly. The pressure of the media, which is focused on creating the division between the wealthy and the middle class, is creating a political environment that is leading to more aggressive legislation targeting individuals."
She points out that most IFCs are well accustomed to grappling with enhanced regulation, which has been tightening since the 1990s with anti-money laundering rules and "know your client" legislation. As such, she is optimistic about the long-term impact of the current regulatory crackdown on all IFCs: "The survival of IFCs will be assured," Lewis says, "because of the fact that prudent planning will continue to be a feature of high net worth and ultra high net worth decision making. The protection of wealth for future generations is not in itself abhorrent."
It is likely that, for those for whom cost is an issue, there may be some reshuffling between certain offshore centres. But Lewis concludes: "Shifting to centres where costs of compliance are less rigorous may, in the short term, appear to be a move people are making. But as long as international regulators like the OECD (Organisation for Economic Cooperation and Development) and the FATF (Financial Action Task Force) continue to impact on our business, I don't think that shifting centres is going to be productive in the long run. Indeed, with the recent introduction of global standards for the automatic exchange of information between tax authorities worldwide, few jurisdictions will be outside the wide net cast by the OECD."
There is currently a clear east-west divide for IFCs, but in the long run their important role in the efficient movement of capital, and aiding of high net worths in developing economies, looks assured.
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