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As local market infrastructure strengthens in EMEA countries, private banking is increasingly going onshore. So will western offshore centres lose out?  14.10.2008

EMEA Finance magazine
As local market infrastructure strengthens in EMEA countries, private banking is increasingly going onshore. So will western offshore centres lose out?
Private banking is booming, and nowhere more so than in emerging markets. Catherine Tillotson, head of research at Scorpio Partnership, which is a private banking consultancy firm, says: “Our evidence suggests last year was an excellent year for private banks, and that most of the growth came from emerging markets.”

That’s not surprising. As Gregg Robins, regional head of Union Bancaire Privé (UBP) for Russia and Eastern Europe says: “If you look at the world today, one half is in debt and struggling, and the other half is growing like crazy. There’s an unprecedented transfer of wealth to emerging markets because of commodities prices, so clearly that’s where the new clients are.”

Private banking is not an entirely new product for the EMEA region. The very wealthy in the Gulf and Russia, in particular, have been using private banks in Switzerland and London for some years.

But things are changing now, in two ways. First, capital that used to leave emerging markets and head to offshore centres like London and Geneva is coming home, and coming onshore. And second, as a result, new local players are rising in the CIS and Middle East, and are competing with traditional western private banks.

New players in Russia

In Russia and the CIS, the top tier of extremely wealthy individuals, or the so-called ‘oligarchs’, are of course no strangers to private banking. They have been putting their money into accounts and assets in western markets ever since they first got their hands on it, over a decade ago. They buy western houses, educate their children in western schools, and put their money in western private banks.

However, there has been a change in emphasis in this tier. Steve Sokic, head of business development at RBC Trust Company in Jersey, says: “In the 1990s, there was a big emphasis on secrecy and confidentiality among the oligarchs. Now, they’re much more global and transparent.”

That’s partly because everyone in Russia has seen what happens to oligarchs who try to hide their money from the Russian state. Mikhail Khodorkovsky, once one of the richest men in Europe, is now kicking his heels in a Siberian prison, after president Putin went after him for fraud and tax evasion. The Kremlin also went after the offshore accounts where Yukos hid its money.

The case obviously emphasised the need for transparent and clean book-keeping among the super-rich. Gregg Robins of UBP says: “One clear trend is declared money. More and more clients are becoming vigilant about making sure their taxes are declared properly. It causes banks a lot of headaches simply because of the paperwork involved.”

But oligarchs are also becoming more transparent because they are listing their companies on domestic and foreign resources. Russian company owners raised over US$30bn in equity markets last year, which obviously creates huge piles of cash that need to be managed efficiently. It also involves becoming much more open about their personal wealth. Robins says: “If you IPO your company for a billion dollars, it’s hard to hide that money.”

Many Russian owners have been using wealth managers to list their companies abroad in offshore trusts. RBC’s Sokic says: “There’s still a fear of political and economic instability among the wealthy in Russia. Many of them are using offshore trusts in places like Jersey to secure their wealth on a tax-compliant basis, because Russian laws pertaining to trusts are still in their infancy.”

The patriotic mass affluent

But while the oligarchs may still be putting a lot of their money offshore, a new tier of wealthy is appearing in Russia and the CIS – the mass affluent. Incomes have been rising by around 10% per year for the last eight years, so more and more entrepreneurial Russians, Ukrainians and Kazakhs are building up piles of cash, and the demand for private banking products is growing.

New businessmen and women are joining the ranks of the mass affluent all the time, which means the potential pool for onshore private banking services is getting bigger. Robins says: “It’s not like France where everyone is fighting over the same handful of multimillionaires. In the CIS, new millionaires are appearing every day.”

According to a survey by Merrill Lynch and Cap Gemini, Russia had 80,000 millionaires in 2004. This figure had grown to 100,000 by the end of 2005, and is now at 140,000. And yet the amount of money in the onshore private banking system is quite small, at just US$15bn. But private banks say annual growth rates are at around 70%, and the market could grow to US$400bn over the next 10 years, according to estimates of Credit Suisse.

Irina Rapoport, managing director of Renaissance Investment Management, a leading Russian wealth manager, says: “When you have bought a new apartment, a new dacha, three new cars and two new plasma screens, after a while you have bought all the gadgets you need. So you start to invest more of your money with professional wealth managers.”

Catherine Tillotson of Scorpio Partnership says: “The mass affluent and high net-worth individuals in Russia are more likely to invest in Russia, because they’re patriotic. So it’s among the mass affluent that we see the primary growth for onshore private banking.”

Western private banks are now piling into Russia and setting up onshore private banking divisions. One private banker says: “Moscow is swarming with private bankers right now. You look in hotel lobbies, all you see is private bankers.”

Deutsche Bank was the first western bank to set up onshore private banking in 2003, followed by Credit Suisse in late 2006. Glitnir Bank, the recently-nationalised Icelandic bank, also set up operations there, as has Citigroup. Dresdner Kleinwort set up private banking operations in December 2007. RBC says it plans to open a Moscow office soon, as does UBP.

Unicredit is also holding a tender for a technology provider at the moment, with a view to rolling out its private banking services across Eastern Europe and Russia in the near future.

HSBC has a small private banking operation in Russia, but it also plans to expand aggressively over the next 12 months. Stuart Lawson, CEO of HSBC Russia, says: “HSBC asked me when I became CEO here in April 2008 if I thought it was too late to go into private banking here. I said absolutely not. Significant pools of onshore wealth have only really developed in the last three years, because of the growing political stability here. Before, there was a lot of capital flight, and as a result the largest investor into Russia was Cyprus. But now that’s changing and it’s seen to be more transparent to have your wealth onshore.”

Western or local?

But western wealth managers are not having the CIS private banking market all to themselves. Local players are also aggressively competing for market share. So far, a handful of private banks have set up operations, such as Renaissance Investment Management, Troika Dialog Asset Management, Uralsib, Ansher Holding and Alfa Bank. Other local players are setting up private banking operations. Mikhail Prokhorov, the billionaire who in September bought a 50% stake in Renaissance Capital for US$500mn, announced at the same time that he was putting US$500mn into resurrecting MFK Bank, a bank he owned in the 1990s before it went bankrupt. The new MFK would target private banking, a statement said. Prokhorov has also established a social networking site for wealthy Russians, called Snob.

Until recently, the big state banks which control 70% of the bank sector – Sberbank, VTB and Gazprombank – had avoided the private banking market. However, in August, VTB, which is the second biggest bank in Russia, announced it intended to hire around 20 bankers from foreign wealth managers to expand into the private banking sector.

A source at VTB says: “The VIP market is not very developed in Russia yet. We’ve never done this before, and there are a limited number of Russian companies which specialise in private banking. This gives us a good opportunity to attract lots more wealthy clients with the offering.”

With rich local players like VTB and MFK using their deep pockets to lure private bankers away from foreign banks, the competition for experienced private bankers is likely to be intense. Local banks are also spending big on getting the best private banking technology.

Didier Pitton, vice-president of marketing at Odyssey, which designs technology for private banking solutions, says: “We’re working with two local institutions in Russia that are targeting onshore high-net-worth individuals. We’re seeing a trend where money is coming back onshore and people are trusting investment managers in these countries.”

Still, more established western banks say their experience gives them an advantage over local competitors. Gregg Robins of UBP says: “Some local companies are offering clients funds-of-funds with returns of 20% a year. I tell clients that the only way they can get that is by either having a very undiversified portfolio or by leveraging the hell out of the money.”

In fact, after several years of relative stability, the Russian financial system was plunged into turbulence in August and September, with banks having to be bailed out by state-owned banks and private banks. One of those bought out was Renaissance Investment Management. Antanta-PIO Global, another local asset manager, was also bought out by a Russian investor. And Kazakh banks have also been looking to sell assets to cope with the global financial crisis.

The turbulence in CIS banking markets may have helped more established foreign players. Robbins says: “The turbulence in the market and the failure of local banking systems is affecting us positively, because we’re in good shape. Clients want to know their money is safe.”

Some analysts also suggest that local banks are not really offering private banking services but “retail banking but without the queue”, in the words of Scorpio Partnership’s Tillotson. “There is not the real spread of products there, partly because of the clunkiness of Russian investment laws,” she says.

But local players say only they have the proximity to the market and the local market knowledge to compete. Rapoport of Renaissance Investment Management says: “Clients can come to us, speak Russian, and have access to the fast-growing CIS market that they know best. Or they can go to Geneva, speak English, and trust UBS…”

Middle East onshore boom

The Middle East’s ultra-wealthy have a long tradition of investing offshore in Geneva and London, and that’s still taking place. But some of the most high-profile recent Arab investments into western assets, including into the equity of western asset managers like UBS or Citi, have been expensive failures. Meanwhile, local investments have done very well. Tillotson says: “Why would a Middle East investor have money anywhere other than the Middle East – you can get returns on local projects of 15-20%, rather than 5-7% for an offshore project.”

Arabs have of course traditionally come to western centres like London and Geneva to holiday and go shopping. But this is changing too. Fadi El-Khoury, head of Samba Capital’s London office, says: “For Saudi investors, places closer to home are becoming increasingly popular, such as Lebanon. They speak the same language, so our families don’t get lost on the Tube. And there are good investments to be had there too.”

This return of private capital back to the Gulf has been a boost for onshore local banks. Tillotson says: “Like in Russia, there has been a surge in patriotism in the Gulf region, and wealthy individuals are keen to work with local players. We’ve seen a number of local players emerge very quickly, such as Ahli United Bank, Faisal Bank, Emirates NBD and National Bank of Abu Dhabi.”

In fact, some of these local players are trying to get the best of both worlds, by offering both onshore banking in the Gulf, and offshore banking in Switzerland. One pioneer in this regard is National Bank of Abu Dhabi (NABD), which set up its private banking headquarters in Geneva in May 2007.

Khaled Suleiman, CEO for NBAD private bank, says: “NBAD has an onshore platform in the UAE, an independent offshore platform in Geneva, and a trust offering in Jersey.”

The Swiss bank is, Suleiman says, an important part of NBAD’s offering: “Middle East clients have a strong preference for ‘Swiss private banking’ due to the renowned Swiss service and banking culture, long history of stability, highly qualified bankers, and attractive range of investment products.”

Other local banks in the EMEA region are also setting up private banking offices in Switzerland. Ansher Holding is a leading investment banking and fund management holding in Central Asia. Having gained strong positions in Central Asian countries, the company is actively expanding its activities in East Asia, Middle East and Europe. Two Two years ago, it set up its operations in Zurich, where its chairman, Anvar Rasulev, is now based full-time. Among its traditional services, Ansher provides full -fledged private banking services for its Central Asian clients.

media5 Rasulev says: “Our clients like the fact we are a Swiss company, in full compliance with Swiss regulations. It gives them a lot of comfort. We offer the best of both worlds – access to the dynamic markets of Central Asia and the Caucasus, but with the security and strong regulatory framework of western banking.”

Ansher’s fund management arm has over US$40 mn under management in two regional funds as well as in managed accounts. Those regional funds are the Ansher Regional Property Fund, which invests in real estate, and the Ansher Regional Equity Fund, which is a long-short equity fund that invests in public securities and fixed income instruments across Central Asian and the Caucasus markets. Rasulev says: “Our funds are well-positioned to take advantage of the local presence and experience of the investment team in locating most undervalued assets in the region. As a result, this contributes to the positive performance of the funds despite present volatility in global capital markets”.

Meanwhile, many western private banks are also setting up shop in the Gulf. One example is Mirabaud, the Swiss wealth manager, which set up a Dubai office last year, managed by Gilles Rollet.

Rollet says: “Private banking has been active in the Gulf for some time, but a great number of players have decided to set up in the last two or three years, so there is the phenomenon of being over-crowded. The talent pool is thin.”

Mirabaud has tried to distinguish itself by offering clients a range of custodians, in several jurisdictions, in effect offering both onshore and offshore banking. Rollet says: “No one was doing this in the Middle East. Many of the banks offering private banking here are really just offering super-retail products, rather than a real customised offer.”

Finding the right partner

Some local players are trying to combine local knowledge with western experience by teaming up with western partners. Emirates NBD, for example, has its offshore trust division administered by RBC in Jersey. Sokic from RBC says VTB and Alfa Bank from Russia are also looking for western partners.

Western wealth managers, and technology providers, are also looking for local partners. Scottish Widows recently set up a joint venture with an unnamed Saudi investor, while Prudential set up a JV with Bank Al-Jazira.

Technology providers for wealth management are also looking for partners, but say the relative inexperience of local players should make western players wary before signing agreements.

Didier Pitton of Odyssey says: “The main challenge in finding a partner is finding people who understand what private banking means, and who will work to take a project forward. We tried to establish a Middle East business with a local partner but it didn’t work out.”

Weak regulatory framework, but improving

The legal framework for private banking in both the CIS and Middle East is weak, but it is improving, which is also helping to bring the business back onshore.

Sokic of RBC says: “In the Middle East, sharia law restricts how people pass on their estate, up to a point. It’s not as simple as ‘boys get double the girls’. Still, people aren’t free to dispose of their assets as they want, so some turn to trust funds in Jersey.”

However, Sokic says that Middle East clients can use the waqf structure, which is centuries-old, sharia-compliant, and similar to the western trust structure. Several Middle East jurisdictions have also recently introduced trust legislation, including DIFC, Bahrain and Qatar.

Sokic raises the question of Islamic private banking, which hasn’t yet fully taken off, but is very likely to do so over the next few years.

Mark Gunning, head of group strategy at Temenos, says: “Islamic banks are turning their thoughts to private banking. Yet, while many feel they should be offering Islamic private wealth management services, few are entirely sure what form it should take and what their activities will entail. In the absence of any concrete industry vision, there is an opportunity for entrepreneurial banks to carve a niche by defining the market.”

Story is also available here.

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