After decades of luxuriating in low-profile affluence, Liechtenstein's banking industry faces a shake-up that raises doubts about its future as a haven for the wealthy. The tiny Alpine principality sent out the first signals that it was on the verge of a new era after a referendum in December 1992. Its 30,000 inhabitants confounded pollsters by voting to join Iceland, Norway and the EU as a member of the the European Economic Area (EEA), thus ending a cherished tradition of independence from foreign regulators.
The result of the referendum raised eyebrows in Europe's financial community, since it came only two weeks after Switzerland, with which Liechtenstein maintains customs and currency treaties, had voted to remain outside the EEA. Because of Liechtenstein's formal ties with Switzerland, the referendum raised legal complications that required months of debate and compromise to resolve before Liechtenstein could go it alone. It also meant that Liechtensteiners would once more have to ratify their decision under the new arrangements by going to the polls. This they did in March last year, once again stubbornly voting yes to EEA membership.
The driving force behind Liechtenstein's move toward greater integration with the rest of Europe is the principality's ruler, His Serene Highness Prince Hans-Adam II von und zu Liechtenstein. The 50-year-old prince, who rules from a fairy-tale hilltop castle above the capital, Vaduz, had threatened to abdicate in 1992 if EEA membership was rejected.
Only three months ago, in a speech to the legislature, Prince Hans-Adam once again held out the threat that he would step down if his subjects were unhappy with his reformist policies. He suggested that if that happened Liechtenstein could formally join one of its neighbours, Switzerland or Austria, as an alternative to declaring a republic. But the prince, whose approval is required to validate any law, made it clear he had no intention of being a "ribbon-cutting figurehead or a plaything of the mass media".
The country's 25 legislators were suitably impressed and no more has been heard about slowing the advance toward European integration. Indeed, reformist zeal has even penetrated the country's social-security provisions. This month the government is debating a proposal to set the retirement age for both sexes at 65. It is now 64 for men and 62 for women. "We will offer women some incentives to accept the later retirement age," says Liechtenstein's prime minister, Mario Frick. "We also plan to introduce a fairer system for acquiring Liechtenstein citizenship. This will be dealt with after next year's elections, as we do not want this to become a political issue."
At present a Liechtenstein man married to a foreigner can automatically pass on his citizenship to his children, but this does not apply to women born in the principality with foreign husbands. Foreigners resident in Liechtenstein for 20 years may apply for citizenship. However, this has to be approved by referendum in the person's local community. "I have seen cases where an applicant has lost a referendum and spends the rest of his life wondering which of his neighbours voted against him," says Frick. "All these laws need to be changed and will be."
Since the first EEA referendum Liechtenstein has passed liberalized banking legislation as well as new insurance and investment codes. Attention is now focused on crucial and controversial legislation that comes into force on January 1. This lays down stringent EU-friendly due-diligence requirements for accepting trust or foundation money from wealthy individuals, the lifeblood of Liechtenstein's financial success.
Disclosure is the buzzword these days in Vaduz banking circles. Only last month the government published its first official figures on trusts and foundations. The total came to 73,000 - nearly 2.5 registered companies per inhabitant. The trust/foundation system is what sets Liechtenstein apart from other private-banking centres such as Switzerland and Luxembourg.
The trust, or Anstalt, can be a commercial or non-commercial arrangement set up between one of Liechtenstein's 300 or so trustee lawyers and a corporate person for trading with a structure like a limited company. Instead of shareholders the Anstalt's owners are the beneficiaries. The foundation, on the other hand, is a registered company generally holding the assets of a wealthy family. It is required to submit accounts and is a vehicle for investment rather than trading.
"The new Banking Act was a step in the right direction, since it simplifies the rules for obtaining a banking licence," says Rolf Ehlers, head of private banking at Verwaltungs- und Privat-Bank (VP Bank), the third-largest of the five domestic banks operating in Liechtenstein. "In the past you had to make a convincing case that another bank was justified. Now all you need is Swfr10 million ($7.9 million) in capital and an approved board of directors."
Ehlers says the insurance law which came into force last year provides the legal framework for a captive insurance industry, while the investment fund law, which replaces an informal three-paragraph 1960 ruling, conforms to EU regulations. Both are perceived as being beneficial to Liechtenstein's financial services industry since they will enable the principality to compete more efficiently with other offshore centres such as Dublin and Luxembourg.
Competitive edge
A clear attraction of Liechtenstein as a haven for serious wealth is the absence of a withholding tax, compared, for example, with the 35% rate levied by Switzerland. The principality's tax structure has been left unaffected by EEA membership, but Liechtenstein's trustee lawyers and bankers consider that their competitive edge springs as much from a level of secrecy that no other banking centre, not even Switzerland, can offer. Tightening up procedures on Anstalts and foundations will, they argue, be a potentially disastrous consequence of EEA membership.
As things stand, once the money behind an Anstalt or foundation is deemed to be clean and above-board by a trustee lawyer, he refers his client to one of the principality's five banks. The Liechtenstein banker is not required to know the identity of the account's ultimate beneficiary, as he would have to under Swiss or EU legislation.
However, the new due-diligence agreement which becomes law next year stipulates that if a lawyer has any suspicions about the source of money he is handling on behalf of a client, he is required to report this to the Banking Commission, at which point all operations are immediately frozen. Current regulations only state that in such cases the lawyer has the right, not the obligation, to take action against his client. Companies formed under the new law will also be obliged to undergo an annual independent audit.
"The new legislation poses a direct threat to Liechtenstein's basic competitiveness," says a banker in Vaduz. "What it means, in effect, is that all Anstalts and foundations will be scrutinized by an extra pair of eyes. In theory the client's anonymity is preserved, since the auditor is required to file only the name of the company and not the beneficiary, but it is obvious that this creates a greater scope for leaks. All it requires is one office boy passing by a desk, intentionally or not, where an auditor has left his books open and you can imagine the potential risks."
Bankers say they have not yet detected any loss of business because of concern over the new system, which becomes effective next year. "It could have an impact, but in the end it should be positive as it helps us to achieve our target of transparency and to preserve our clean reputation," says VP Bank's Ehlers. "Most people would admit they haven't yet felt any disadvantages from EEA membership, but it is too early to say that we have benefited from the advantages."
A Swiss banking analyst in Zurich says some requirements, such as the adoption of international accounting standards and the filing of fully consolidated accounts, will significantly change Liechtenstein's banking industry. "They've got to break down their top-line income; items such as staff expenses need to be explained; and we still don't know what unrealized gains they are holding in the form of hidden reserves, which are treated as other liabilities," he says. "Under the EEA agreement European banks can now set up representative offices in Liechtenstein. This is bound to have an impact on their business."
Liechtenstein bankers are taking a typically sanguine view of the threat of foreign encroachment. "There is a possibility that some foreign banks might want to come in, but I don't envisage this as a threat," says Josef Fehr, head of the dealing division at Liechtensteinische Landesbank (LLB), the principality's oldest bank. "On the one hand they would need qualified staff and there is a shortage of people as well as premises. There is also the question of how many foreigners we are prepared to allow into the country. More than a third of our people are now foreign residents and under the terms of our EEA agreement we have the right to limit these numbers. If it were to go above 50% the question would arise of what is a Liechtensteiner."
Diversification
Fehr says a much more likely prospect would be the formation of joint ventures or partnerships, such as the investment fund partnership LLB has with Union Bank of Switzerland (UBS). "We might consider setting up another one with a German or EEA bank, for instance," he says. "For me this is the way to participate in the EEA market. In any case, if a German bank sets up an office in Vaduz, it is still restricted by German law. So it wouldn't make sense for anybody to go to a German bank in Liechtenstein."
In order to continue to prosper in the new environment, analysts believe Liechtenstein's banks will have to diversify from their traditional business of taking deposits and placing them in the interbank market. "In the past Liechtenstein banks could go into the Lombard market and squeeze 200 basis points out of their deposit funds," says this Swiss analyst. "This is no longer the case, so now they need to diversify and become full-service private banks in the true sense of the term."
Fehr agrees on the need for LLB, which is also the principality's leading domestic retail bank, to diversify. "It is true that the returns offered by the interbank market are not as high as in the past, but they will come back," he says. "One thing is certain: we will not engage in higher-risk business only for the sake of enhanced returns. We always deal with AAA minus or AA rated banks, and not with single-A banks we hardly know anything about. We are contemplating expansion abroad, but so far it does not go beyond the contemplation stage."
Centrum Bank, the youngest of the principality's five banks, ruled out retail activities when it started operations in 1993 under the new Banking Act. It restricts itself to the traditional Liechtenstein business of private banking, and portfolio and asset management.
"Our target is the high-net-worth individual with at least a million Swiss francs to invest," says deputy manager portfolio management Aribert Schurte. But he recognizes the need to cater for a new breed of investor who is more demanding than the traditional client, who tends to be Swiss, German or Austrian "old money" seeking little more than a safe haven for his millions.
"Clients today tend to be better informed about the market and want to get more out of their money," says Matthias Trösch, Centrum's deputy manager, trading. "We've got to support this client and we can cope with the demand for risk. But we do not offer a standard menu nor are we selling anything. Our goal remains that of a private bank seeking a long-term relationship."
The bank that has set the benchmark for international expansion and diversification is LGT Bank in Liechtenstein, part of the Liechtenstein Global Trust (LGT), which is controlled by Prince Hans-Adam's family. Since its £91.5 million ($140 million) acquisition in 1989 of Britain's GT Management, the bank has built up a portfolio of Swfr55 billion under management in 18 countries.
Positive attitude
"Our target is to grow to Swfr100 billion by 1998 and I am confident we shall achieve this," says the bank's chief executive, Heinz Nipp. He says an acquisition will be needed to reach that goal, and LGT is looking for a private bank or asset-management firm, possibly in the US domestic market or in continental Europe.
Nipp thinks there is nothing to fear in Liechtenstein's move toward closer European integration, although he echoes the sentiment of other bankers and the government in ruling out EU membership. "This is as far as it should go," he says. "It would be impossible to retain our present structure if we were a one-vote member of the EU, and we would have nothing to contribute. On the other hand, EEA membership is positive because, as a little country, it helps us to make our presence felt."
Nipp considers the spate of new legislation as positive for Liechtenstein's banking industry. "This opens the possibility of competing in the offshore funds market," he says. "We've been very successful in structuring funds and this will diversify our product mix. The due-diligence law clears up a lot of uncertainty, and it will also help us to shake off the old clichés about money laundering."
Confidentiality and competition Mario Frick, Liechtenstein's prime minister, talks about the implications of membership of the European Economic Area for his country's financial services industry.
It is now a year since Liechtenstein took its first major step toward integration with Europe by joining the European Economic Area (EEA). What impact has this had on your country?
On balance I would say it was a positive move for Liechtenstein. True, it has brought some pressure on us to bring our banking system and other aspects of our economy in line with European Union standards. It is important to ensure this is not taken too far, certainly not to the point where it might jeopardize our unique system. For now, EEA membership has been advantageous in that it gives us entry into the European market.
Are there any concerns about the regulatory implications EEA membership will have for your banking system, which is the heart of Liechtenstein's prosperity?
The EEA does not require any changes in banking confidentiality, although our banks have to comply with international accounting standards in the next two years. It should be noted that we have already taken the initiative in tightening up the regulatory environment. Parliament has just passed a law, which takes effect on January 1, on supervising the origin of funds used to open trusts. Basically we have enshrined in written law traditional safeguards against money laundering that have always been in practice in Liechtenstein. The rules governing trustee lawyers have been clearly defined. They now have a legal obligation to inform the authorities if there are any doubts about the source of the funds they are handling for a client.
Doesn't this pose the risk of deterring people who do business with your banks precisely because of the high level of confidentiality they offer?
If it acts as a deterrent to money launderers then we have accomplished our purpose. We spent two years working on this law, which is a very long time for our legislature. I am confident that we have come up with a compromise solution that gives us a reliable framework of control and at the same time safeguards our banks' competitive edge.
EEA membership requires you to open your banking system to foreign competitors. Do you think many banks will take advantage of this to set up operations in Liechtenstein?
We are currently reviewing this issue to see if it could pose a significant problem. Personally, I don't see a lot of foreign banks opening up offices in Liechtenstein. On the one hand, the domestic market is too small to make it a lucrative proposition. If they want to come in to use Liechtenstein as a base of operations, they will encounter several problems. One is finding premises and qualified staff, as both are in short supply. We are also very restrictive about allowing foreigners into our country. Nearly 40% of the residents of Liechtenstein are foreigners; this is not seen as a problem now, but our people don't want to become a minority in their own country. Liechtenstein is not a cheap place to do business and start-up costs could be seen as prohibitive. On the other hand, I do see the possibility of foreign banks setting up partnerships with Liechtenstein banks or trust companies. We have very low taxes and very little red tape; we know the local business and have the contacts. So it makes sense for a bank looking to broaden its European investment base to use Liechtenstein as a springboard.
The question of Liechtenstein's future sovereignty arose last March when Prince Hans-Adam mooted the possibility of a referendum on becoming part of Switzerland or Austria. Do you see any advantages in Liechtenstein giving up its independence?
The prince is a firm believer in public debate on all issues. I personally do not believe it is a good idea even to consider the possibility of becoming a Swiss canton or Austrian bundesland. Liechtenstein owes its prosperity to its status as an independent country. We enjoy a unique position in that as a member state of both the EEA and World Trade Organization (WTO) we have access to the European and international markets. So why should we give this up to become part of another country? If we look at our financial situation, Liechtenstein has always had a budget surplus. The system works well and I do not foresee any economic problems now or in the near future.
There has been speculation that Liechtenstein may have to raise taxes to meet the country's revenue requirements. Is this under consideration?
Perhaps I shouldn't say this, but at the moment we have more money than we need. We have introduced a 6.5% value-added tax, along with Switzerland, and this gives us an added source of independent income. Previously we received a proportion of Switzerland's Wust tax on services. Barring unforeseen events, I could not imagine any increase in the tax burden for the next 10 years or more. As a small country we always have to rely to an extent on more powerful partners for some areas of activity. But in terms of public finances, smallness is our key advantage as we can keep a tight control on items such as government spending.
In the past two years the financial services sector has overtaken manufacturing as the country's main source of income. Are you happy with this?
I am not unduly concerned about the current diversity. It is more or less in line with the trend in other countries, where in some cases financial services play an even greater role in the economy. I would like to keep the ratio more or less at its present level as I believe that balanced diversification provides a cushion against future economic downturns.
Compiled and written by Katharine Morton |