Family value: how private client filled the corp gap
23 May 2011 | By Catrin Griffiths
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Family constitutions, governance, succession planning and plain old hard work are in the spotlight, writes Catrin Griffiths from Monaco
Long associated with crumbling stately homes, errant marquises and Uncle Matthews, private client work has now stepped decisively into the City mainstream.
With corporate funds evacuating the market as the recession took hold, international private investors filled the gap. The result was that mid-tier firms such as Berwin Leighton Paisner, Macfarlanes and Taylor Wessing, to name but three, were able to shore up their conventional corporate practices during the downturn.
And the opportunities are ample: Credit Suisse Research Institute, in its Global Wealth Report published in October 2010, calculated that at the top of the wealth pyramid there are more than 1,000 billionaires globally, of whom 245 are in the Asia-Pacific region, 230 are in Europe and 500 are in North America. Further down, there are 80,000 ultra-high-net-worth individuals, which Credit Suisse defines as average wealth per adult of more than $50m (£30.8m).
Of the 24 million other high-net-worth individuals (defined as wealth per adult of between $1m and $50m), more than 800,000 are in China, around 170,000 are in India and more than four million are in the rest of the Asia-Pacific.
It is not surprising, then, that the classic business issue of succession planning for these families has become a major preoccupation for advisers. But in a world of increased regulation the concept of governance has also come to the fore.
And sure enough, when advisers gather - as at The Lawyer Family Office and Private Client Summit in Monaco on 11-13 May - there is widespread agreement in the sessions and debates that succession planning and governance are the twin priorities for private client lawyers. Both themes dominate the discussion over the two days.
With only six out of 100 family businesses surviving into the third generation (a dramatic statistic proffered by Barbara Hauser, principal of business consultancy Barbara Hauser Associates), the issue of the work ethic still looms large.
“Some families fail to realise that the driver for the preservation of family wealth over time is hard work,” Farrer & Co co-senior partner Jim Edmondson observes drily. “All family businesses face the cycle of creation, stability and dissipation.”
The overlay of a family drama on a business structure is an inherently destabilising dynamic, but a top-down approach to control from the family patriarch is not necessarily the right answer either. To this end, very wealthy families benefit enormously from a constitution, argues Hauser.
“Why? To avoid family conflict, to keep the family business intact and to promote loyalty,” she elaborates. “Participation moderates extremism. That happens with families too, and they’re much more likely to see a constitution as part of their lives. When a family creates a constitution, the very process of creation is the learning of valuable self-governance.”
For LG partner Caroline Garnham, the disadvantages of not putting proper governance in place for wealthy families are clear - reputation exposure, wealth entropy, family division and legal costs. Withers partner Sarah Cormack highlights the key role of the trustee, where the key governance issue is who has power to appoint, remove and replace trustees.
“Many onshore families still appoint non-family trustees to provide for checks and balances and separate ownership from management,” she explains. “International families increasingly use the private trust company model to allow greater input into trustee decision-making.”
However, adds Cormack, there is a number of variations.
“The protector model’s a common buffer between family input and trustee deliberation,” she says.
There are other dimensions, however. Manches matrimonial partner James Stewart argues that the growing trend for prenuptial agreements and the move towards increased enforceability following Radmacher v Granatino (2010) should not be overlooked by family office advisers.
“Partly due to historic uncertainty, family office advisers have often not given due weight to matrimonial issues,” says Stewart. “In particular, the use of prenups should be considered as an important part of more holistic wealth planning.”
If anything, Stewart adds, it is the adviser community that is sitting up and taking notice of this trend.
“Lawyers see the majority of prenup referrals coming not from the future spouses themselves, but from family advisers and business associates,” he stresses.
But how do you integrate matrimonial aspects with the family constitution? Stewart recommends that they should be incorporated in governance documentation and that a statement of core values should require family members to ensure that business or trust assets are defined as separate property.
“International families could seek to agree the law applicable in any divorce,” he suggests. “It’s not binding in England, but following Rome III [the regulation implementing cooperation in the area of the law applicable to divorce and separation], it may have force in other EU jurisdictions.”
Different jurisdictions have different approaches to wealth preservation and planning. The vast majority of Indian businesses are family-run, and there has recently been an emergence of family offices and a growing awareness of the need for, and importance of, tax planning, says Nishith Desai Associates partner Bijal Ajinkya.
Meanwhile, Maxim Alekseyev, senior partner at Alrud, notes that old structures created by Russian individuals in the early part of the last decade “often require restructuring due to their initial purposes and architecture”.
Furthermore, in terms of recognition of the trust concept, there are difficulties in declaration of the dividends from the trust for tax purposes, which means that medium-term solutions via corporate legal entities should be applied.
Middle Eastern clients, with their vast wealth built on a Western model, pose particular issues for both lawyers and family office advisers, particularly in light of the so-called Arab Spring, when all politico-legal structures are being scrutinised.
It is estimated that $1tr of private wealth will be transferred in the Middle East in the next 10 years.
“We can’t forecast where the current upheaval in Arab countries is going to lead,” says Andrew De La Rosa of ICT Chambers.
However, traditions underpin wealth protection strategies and so need to be incorporated in the way lawyers advise clients.
“These are things that you need to incorporate in the way you draft your agreements, the way you draft your governance rules and the way you draft your family constitutions when dealing with families from the Gulf,” declares Walid Chiniara, co-founder and managing director of the Family Business Advisory Group. “We’re still living in a tribal world. There are four generations living under the same roof, but the youngest is born with an iPad in his hands and the patriarch holds the chequebook.”
Wealthy Middle Eastern clients still habitually turn to Swiss banks and offshore jurisdictions, but advisers also have to negotiate their way through layers of legal systems, whether they be sharia or local laws based largely on the French model. Added to that are Egyptian law and common law, plus the competing trust laws of the Dubai International Financial Centre and the Qatar Financial Centre (both of which are considered by some lawyers to be more user-friendly than the Bahraini equivalent).
“In a sense sharia-compliance is a misnomer because there’s no such thing as a fully sharia-compliant trust, and the views of Muslim scholars about trusts vary,” explains De La Rosa. “There’s a relatively unrestricted rule in sharia law to make lifetime gifts. However, I think that in the fullness of time people will realise that trusts set up for the benefit of families over a long period of time are valid under sharia.”
Who’s in charge?
Who should be managing the affairs of wealth clients? The Monaco conference teems with discussions on how the family office is evolving and how lawyers work with those advisers.
The family office - a private company that manages investments and trusts for a single wealthy family - is often dated back to US Judge Thomas Mellon in Pittsburgh in 1868 and John D Rockefeller in 1882, although KPMG head of private client advisory David Kilshaw traces its roots all the way back to the great European banking families such as the Medici and the Rothschilds.
Since the 19th century the family office has evolved into a variety of services, including financial planning, portfolio management, back-office and consolidated reporting, tax planning, trustee management, estate and wealth management, and philanthropy.
There are now some 5,000 single family offices in the US, but a more recent trend is the growth of the multi-family office, of which there are now more than a hundred in the US.
“It’s a trophy asset for our times,” quips Kilshaw at KPMG.
However, he adds that there is an “innate tension when advisers don’t know the family - it’s service versus sale”.
Maitland Group head of clients Andrew Dixon notes that choice in the market has exploded.
“There’s always been a huge variety of wealth management services, but it’s now become considerably more institutionalised,” he says.
Developing this theme, Jean-François de Clermont-Tonnerre, managing partner at Swiss private bank Hottinger & Partners, says his company’s main challenge - apart from to continue to offer good custody and asset management services - is to integrate itself into a global group of service providers, whether tax advisers, family offices or lawyers.
“We want exclusively to work in a compliant world because we want to be able to travel,” he says. “And we need to work a lot with legal advisers to make the business compliant.”
William Drake of private investment office Lord North Street observes that “an outsourced investment department for families or charities can suit families that don’t want to build a team from scratch or hire their own dedicated chief investment officer”.
And Mercator Partnership managing partner Edward Nicholson believes “it’s important as advisers that you’re aware that illiquid assets are looked after, as they’re the engine of wealth generation for many of these families. You have to put architecture in place, such as a holding company structure that deals with succession planning and immunisation against political risk.”
Private client work is officially big business.
firstname.lastname@example.org. Additional reporting by Joanne Harris