Swiss Bankers, Chinese Billionaires, and the CEO Betting It All

Illustrations by Raymond Biesinger

Illustrations by Raymond Biesinger

Inside the fraught race to manage China’s money.

For Western wealth managers eager to feast on the China market, Wan Long qualifies as prime red meat. Known as China’s “No. 1 butcher,” Wan is the billionaire chairman and chief executive of WH Group, the world’s largest pig slaughterer and pork processor. And nearing 80, Wan is surely weighing how to preserve his vast wealth for family and favorite causes.

But a web of regulations in Chinese financial services keeps potential clients like Wan largely, tantalizingly, out of reach of foreign wealth managers. The rules make it almost impossible to deal directly with customers on China’s mainland, forcing foreign firms to lure smaller amounts of Chinese money offshore instead. And even if protectionist obstacles fell away, Western wealth managers would need to sink vast resources into competing against the big Chinese financial firms on their own turf.

Sergio Ermotti is willing to make that bet.

“We are focused on the longer trend,” says Ermotti, chief executive officer of Swiss banking giant UBS Group, the largest wealth manager in Asia and the world, in an interview with Institutional Investor.

Ermotti concedes that UBS won’t make any significant profits from onshore Chinese business over the next three to five years. And that’s bad news for other foreign wealth managers who lag well behind UBS. It is increasingly clear to them just how difficult it will be to gain onshore stakes in the world’s second-largest wealth management market.

Nowhere is private wealth being generated faster than in China. That’s especially true for ultra-high-net-worth (UHNW) individuals, who are the most coveted clientele. As financial advisers never tire of pointing out, China mints two new billionaires every week.

Chinese wealth management is also alluring because it offers lucrative fees in a world where charges across the whole range of financial services are contracting. Elsewhere, wealth and asset managers complain their gross margins are under pressure. Mutual-fund, index-fund, and trading fees are miniscule, and passive investing is widespread. Traditional investment advisers in the U.S. and Europe are starting to trim their prices, and Wall Street firms are launching ever-cheaper robo advisers.

But entry into the China market — on- or offshore — takes deep pockets. Only large Western financial players have the combination of investment banking and wealth management prowess to service Chinese and other Asian UHNW clients. Besides UBS, the A-list includes its Swiss rival Credit Suisse Group, now the second-leading wealth manager in Asia. A few U.S. banks qualify: Citigroup, JPMorgan Chase, and Morgan Stanley. Goldman Sachs Group, a rising force in Asian wealth management, may be slowed by criminal charges and possibly huge fines linked to its involvement in the multibillion-dollar 1Malaysia Development Berhad (1MDB) scandal in Malaysia. Goldman did not respond to multiple requests for comment.

No foreign wealth manager has shown more determination than UBS to crack the China market. In 2016, the bank announced a doubling of its personnel in China by 2021 — and then reached that target in 2018. It became the first foreign bank given approval to hold a majority stake in a securities joint venture in China that same year.

But UBS isn’t ready for a victory lap. Ermotti and his senior executives kept mention of their onshore China business to a minimum at their annual investor conference last year. “It’s true that the onshore China market is huge,” says Martin Blessing, UBS’s co-head of global wealth management. “But you have to be very patient.”

In the meantime, Western banks have been forced to nibble on China’s periphery with offshore booking centers in Hong Kong and Singapore. Profits are rising on offshore Chinese assets — and at a faster clip than in any other wealth management market. But $4 out of every $5 invested by wealthy Chinese remains on the mainland, either in companies owned by their founders or in financial products peddled by local wealth managers.

Switzerland’s two big banks lead in offshore Asian wealth management partly because of their past troubles elsewhere. UBS and Credit Suisse almost forfeited their operating licenses in the U.S. and several EU countries for abetting tax evaders on both sides of the Atlantic with secret bank accounts in Switzerland.

Of the two banks, UBS had more dire financial straits. Not content with its sterling reputation for wealth management, UBS longed to be an investment bank on the scale of Goldman Sachs. In 2008, it ran up Sf21.3 billion ($24 billion at the time) in losses on U.S. subprime securities and needed a Sf43 billion Swiss taxpayer bailout.

When Ermotti, now 58, was named UBS chief executive in 2011, analysts and investors initially viewed him as just an interim appointment — the best the board could get given UBS’s battered reputation. Ermotti was known as a skilled investment banker (a post he last held at Italy’s UniCredit) who knew little about wealth management.

Following U.S. and EU attacks on Swiss banking secrecy, the wealth management division struggled to keep American and Western European clients. But on Ermotti’s watch, UBS wealth management has reached the No. 1 spot in Asia, Europe, and emerging markets — and a respectable fourth in the U.S. In all, it manages a whopping $2.26 trillion worldwide.

“Sergio has done a terrific job in turning around UBS,” says Davide Serra, London-based head of Algebris Investments, a hedge fund focused on the financial sector.

The key to UBS’s turnaround was Ermotti’s decision, within months of becoming CEO, to shrink the investment bank and use it to support wealth management operations. The investment bank isn’t allowed to exceed one-third of UBS’s risk-weighted assets.

Last year, investment banking accounted for less than 30 percent of UBS’s pretax profits, while wealth management generated more than 60 percent.

But client capital seems to rise and fall like ocean tides. In the third quarter of 2018, net inflows hit an impressive $13.5 billion. Then in the last quarter, flows reversed. Clients pulled out nearly $8 billion net.

“We don’t need a bigger investment bank to create value for shareholders and clients,” Ermotti says. “We just have to keep working more closely to deliver the entire bank to our clients.”

Especially the ultra-wealthy ones, he might add.


Ermotti seized on a formula in Asian wealth management: Woo entrepreneurs with early-stage financing for their startups, help them to IPOs, and then manage those personal fortunes, including via family offices.

This playbook isn’t exclusive to UBS. “Today, all major Western banks operating in Asia are much more focused on UHNW clients,” says Kinner Lakhani, London-based head of research for Deutsche Bank. Wealth management is one of the most fragmented financial services, with some 35 banks holding a combined 50 percent global market share. It makes sense to focus on the top end of the wealth pyramid, where certain banks hold an advantage. Only a sizeable investment bank can lure UHNW clients through loans and a variety of financial products unavailable to mere HNW wealth management customers.

JPMorgan Chase uses its investment bank to target the $100-million-plus Asian client. Citigroup has a “mega-wealth” team aimed at customers with financial assets above $250 million. Goldman Sachs has the most productive Asia-based private bankers, with each relationship manager overseeing almost $1 billion in HNW client assets, on average, according to Asian Private Banker’s 2017 figures. Their counterparts at UBS averaged just $369 million. But the Swiss bank’s $383 billion in Asian assets under management was more than four times the Goldman Sachs total.

In the months or years ahead, Goldman must cope with fallout from its involvement in the misappropriation of billions of dollars from 1MDB, the Malaysian development fund. In 2012 and 2013, Goldman arranged $6.5 billion in bonds for 1MDB, of which $2.7 billion was allegedly stolen by cronies of then-Malaysian prime minister Najib Razak. Goldman collected $600 million in fees, according to The New York Times.

The Malaysian government has filed criminal charges against Goldman. And the U.S. Justice Department and various Asian and European authorities have launched investigations into 1MDB. In August, Tim Leissner, Goldman’s former chairman of Southeast Asia, pleaded guilty to bribery and money laundering charges in connection with the 1MDB bond deals.

The fiasco could end up costing Goldman billions of dollars in penalties. The Malaysian government is seeking $7.5 billion in damages from the bank, which recently set aside $516 million to cover potential damages, including those related to 1MDB. According to some bank analysts, the scandal threatens to damage Goldman’s reputation and could slow its growth in the region.

For now, UBS has less to fear from the big American banks than from its crosstown rival in Zurich. Credit Suisse has emerged recently as UBS’s staunchest competitor in Asia. The smaller Swiss lender has racked up more than $200 billion in managed assets across the region.

Credit Suisse successfully combined investment banking and wealth management services to snare the largest Chinese client of them all: e-commerce giant Alibaba. In 2012, it helped the company raise $8 billion in private financing, and bought a $50 million convertible bond as part of the deal. Alibaba picked Credit Suisse as one of six banks to manage its record-setting $25 billion IPO in 2014.

The convertible bond turned out to be much more valuable than $50 million in IPO fees. Purchased when Alibaba was valued at $45 billion, the bond converted to an equity stake after Alibaba went public. Credit Suisse declined to say if it has held on to all or part of that stake, now worth more than $450 million.

The investment bank’s relationship with Alibaba became a windfall for Credit Suisse wealth management. Scores of Alibaba’s so-called “gold-collar” executives — each owning multimillion-dollar stakes in their employer — have signed up with foreign wealth managers, among them Credit Suisse.

UBS can’t point to such a high-profile relationship of its own. But it runs the most streamlined and effective offshore wealth management operations in Asia. In 2018, Asia generated more than two-thirds of the total $24.7 billion in net new money inflows into UBS wealth management. And offshore Chinese clients alone accounted for an estimated $11 billion of those inflows.

The region’s business is almost equally divided between Hong Kong and Singapore. “Hong Kong is more a magnet for capital markets,” says Edmund Koh, president of UBS Asia Pacific. “And asset management is clearly stronger in Singapore.” Wealthy mainland clients funnel assets into both places. They increasingly send their children to schools in Mandarin-speaking Singapore, which is considered more international than Cantonese-speaking Hong Kong. Singapore is also viewed as more politically reliable than Hong Kong, where pressure to conform to Beijing’s authority is mounting.

UBS and other Western wealth managers are nowhere near achieving the critical mass needed to compete against the Industrial and Commercial Bank of China and other mammoth domestic banks, which dominate wealth management. And with only a handful of pure-play Chinese wealth managers around, foreign firms can’t acquire their way to critical mass.

“Foreign wealth managers are scratching their heads on the onshore China opportunity, which requires significant investment to break into without any certainty of a payback,” says Deutsche Bank’s Lakhani.

Few foreign firms would be willing to match the most popular Chinese wealth management products, which typically offer a fixed rate of return, a set maturity date, and guarantees on principal. Beijing recently moved to cut back these products, which have already reached $4.35 trillion outstanding.

But the biggest complaint from foreign wealth managers remains the bureaucratic maze of onshore China operations. Receiving a license for one business activity is only a step to seeking approval for the next license, and so on. Koh, UBS’s Asia head, finds solace in the fact that his native Singapore took years to open up its financial system to foreign competition. “China is moving in the same direction,” he says. “But such a big country must have its own financial institutions ready to go regional and global before allowing foreign players into the market.”

In the meantime, UBS’s presence in China is confined to asset management and securities. Onshore China is expected to contribute little, if anything, to its bottom line.

Offshore, UBS and its peers offer UHNW Chinese investors opportunities they cannot readily access with their mainland wealth managers, such as hedge funds, private equity funds, bespoke products from BlackRock and Goldman Sachs, and more. “We can even ask firms to create mutual funds that can only be purchased by UBS clients,” says Blessing, the co-head of wealth management. “We promise them enough volume if they lower their management fees for our clients.”

Family offices have become an essential part of the UBS wealth management strategy. According to the bank’s surveys, Europe and the U.S. each have twice the number of family offices as Asia does, where they are a more recent phenomenon. Most Asian family offices still belong to the family patriarch — usually an entrepreneur who commingles his personal wealth management with corporate financial operations. As a result, the company’s chief financial officer often runs it instead of a professional wealth manager. “That will change as wealth shifts from the first to the second generation,” Koh predicts.

Will a more sophisticated generation of super-rich Chinese continue to favor Swiss wealth managers over their larger, flusher U.S. rivals?

American banks benefit from their enormous base of retail clients, who bring down funding costs and help improve operating leverage. But with a tiny home market of 8.5 million Swiss, neither UBS nor Credit Suisse will ever generate the retail banking revenue to offset the higher costs of their investment banking and wealth management operations. Little wonder that the cost-income ratio last year at both Swiss banks was above 78 percent, compared to JPMorgan’s 58 percent.

During buoyant markets, revenue growth and costs remained relatively flat at UBS. “Investors have to ask themselves: If UBS isn’t improving its operating leverage when markets go up, what can we expect when markets come down?” says Andreas Venditti, Zurich-based head of banks research for Swiss investment bank Vontobel.

Ermotti delivered his response to doubters at the October investors’ conference. “It is true that our geographic and business diversity comes at a cost, which — when measured on a cost-income ratio basis — is structurally higher than our peers’,” he said. “But we are happy to make that choice, because the model offers stability and superior returns on capital.”

It may be a lot to ask investors to set aside their usual yardsticks for bank performance. But Ermotti and his team tout their UBS wealth management model as unique. “If you look at our competitors, you find two kinds: other Europeans who are strong in Europe and Asia but have no real presence in the U.S.,” says Blessing. “Or you have our American rivals, who are bigger in the U.S. but are hardly present in Europe and Asia. So if you want a wealth manager with a significant presence in all the main markets of the world, we are the only one.”

But Blessing missed one main world market: onshore China.