After a tumultuous period of plummeting asset prices and downward-spiraling revenue, and the near collapse of some of the world’s leading firms during the financial crisis, the global wealth management industry is regaining some of the ground it lost. More specifically, assets under management (AUM) are now rising in markets around the world. In North America, for example, AUM have passed their pre-crisis levels after four years of steady growth. In China, Latin America, and other emerging markets, they have risen far beyond their mid-2000s levels. Only Europe is lagging, and even there, AUM have increased significantly since the nadir of 2008. Yet the industry is still struggling, because the gains in assets have not translated into healthy top- and bottom-line growth.
According to a global study conducted by Booz & Company using quantitative market analysis and in-depth interviews with more than 150 wealth management executives, senior financial advisors, and regulators, AUM are rising for three distinct reasons. First, emerging-market economies have been expanding. Second, equity markets worldwide have rebounded, drawing greater inflows of assets from investors. Finally, the number of high-net-worth individuals (HNWIs)—those with more than US$1 million in investable assets—continues to grow two to three times faster than the gross domestic product in most markets.
Despite these gains, however, pretax profit margins for wealth managers fell in all regions of the world from 2007 through 2012: from 37 percent to 16 percent in Europe, from 29 percent to 21 percent in North America, and from 30 percent to 12 percent in Asia. The explanation? New global regulations (including greater scrutiny of undeclared offshore assets), changing customer behavior, the rapid advance of digitization, and a fluid competitive landscape have permanently altered the rules of the game and raised the cost of doing business. Few wealth managers have adapted to this new reality, but they must do so quickly if they are to survive, let alone capitalize on the continued economic recovery expected in 2014 and 2015. Before delving into the solutions, it’s helpful to look at each of these issues in more detail.
New rules, changing customer behavior, and digitization have altered the rules of the game.
An Industry in Transition
The financial industry currently faces an unprecedented degree of regulation, covering a wide range of issues: capital, liquidity, proprietary trading, derivatives, corporate governance, and the transparency of offshore assets and income. If there is any good news on the regulatory front, it’s that predicted new global rules are finally taking shape, ending years of uncertainty about how to prepare. Also, these regulations will likely raise the industry’s barriers to entry, which may ultimately help wealth managers preserve margins. We see the major regulatory challenges for wealth managers falling into two main categories: taxation and transparency, and client protection and suitability.
More specifically, new rules on international compliance and transparency have radically changed the climate for tax havens. One of the most significant changes so far is the U.S. government’s new Foreign Account Tax Compliance Act, which requires banks in other countries to disclose the accounts of U.S. citizens. Similarly, most interviewees in the recent Booz & Company study assume that the Organisation for Economic Co-operation and Development will ultimately push for full tax transparency among its member states. In light of these developments, players will need to reevaluate their offshore strategies, withdrawing from some markets and focusing only where they have a clear value proposition, growth prospects, and proper compliance capabilities.
Besides taxation and transparency issues, new regulations designed to reduce conflicts of interest and improve customer “suitability” are changing traditional distribution, compensation, and pricing models across the wealth management industry. In the past, financial players paid banks handsome distribution fees known as retrocessions for distributing their products to clients. But recent laws aimed at eliminating conflicts of interest spell the end of these business practices. Most of those surveyed expect that these bans will reduce costs for clients—and profits for banks. That effect has already become apparent in the U.K., where retrocessions were banned in 2013.