Taxing times: opportunities and challenges in wealth management

A PwC seminar on opportunities in wealth management, held in London in February, discussed the role of tax at the heart of the shifting regulatory environment and product landscape – in particular, the extent to which wealth managers need to engage with the tax profile of their client base.

As Governments seek to protect and augment the tax base whilst reducing tax authority resources, they are increasingly outsourcing compliance responsibilities to, amongst others,  the wealth management industry (“the industry”).  At the same time the industry has recently been branded by the EU Parliament PANA Committee as “facilitators of tax avoidance and evasion”. The industry now need to do more to combat such practices.

The rising compliance stakes ...

Wealth managers have always had compliance responsibilities, of course. Authorities in leading economies have been imposing additional regulation in areas such as know-your-customer (“KYC”) and anti-money laundering (“AML”) for decades. FATCA-type legislation in the US, UK as well as the OECD’s Common Reporting Standard (CRS) has leveraged AML/KYC identification documentation for tax compliance purposes, while introducing new obligations to monitor for changes in customer circumstances.

This year, however, the stakes will rise once again. From September, new UK legislation will include the criminal corporate offence of failure to prevent the facilitation of tax evasion. Wealth managers that lack the systems and processes to combat evasion could be held criminally responsible for offences committed by their clients with the involvement of their staff.

The challenge, as one panel member put it, is to move from “knowing who your customers are to knowing what your customers are doing”. That may sound simple in theory, but the practice will be difficult for most wealth managers.

For one thing, the KYC burden falls heavily on the front office, where it’s easy to see how relationship managers may have more pressing priorities – both at the onboarding stage and on an ongoing basis. Moreover, many wealth management organisations remain siloed, for example; operating through separate onboarding, tax and compliance teams, this makes joining the dots very tricky. Legacy IT issues represent a third problem – evolving regulation over an extended period has seen systems layered on top of one another, but they are often poorly connected.

However, the head-in-the-sand approach is not an option. Wealth managers are required to collect more client data than ever before under regulation such as Mifid II, and regulators intend to share this information – with one another but also with the tax authorities. HMRC and its international counterparts, moreover, have sufficiently advanced IT systems to put that data to good use.

Wealth managers that do not have connected tax and compliance systems can expect to find themselves under the spotlight. Those that fail to shift the culture in the front office, so that relationship managers instinctively seek to understand client behaviours and motivations in relation to tax, will be more vulnerable than ever.

Still, it’s not all bad news. In this information age, better data and more advanced analytics tools represent an opportunity for wealth managers to do far more than just prevent tax evasion – they promise to unlock a far richer understanding of the client’s needs, help wealth managers address the suitability agenda and create new avenues for boosting revenues through additional targeted products and services.

The changing landscape ...

In the crowded wealth management sector, such advances represent a crucial potential source of competitive advantage. For this is an industry at an inflexion point, facing challenges such as the emergence of a millennial generation that has no intention of using its services, the demise of lucrative revenue streams courtesy of reforms such as the retail distribution review, and the threat of competition on all fronts.

In this context, wealth managers will look to achieve scale through M&A and consolidation, or focus on small and specialist niches of the market. And the regulatory imperative can be a helpful facilitator of this process, forcing wealth managers to re-examine the commercial realities of every area of their business as they seek to comply with regulators’ demands.

Generating (Tax) Alpha ...

In addition, as tax becomes a mainstream consideration across the business, wealth managers will identify new possibilities. To take just one operational example, the cost of running a simple passive fund through a traded ETF structure could be as much as 50 basis points lower than the same product provided through a unit trust, simply because of lower transfer taxes. Such savings may bolster the bottom line or be passed on to customers as more competitive fees.

Tax, in other words, offers opportunities as well as challenges. This will be the year in which wealth managers that fail to address their regulatory responsibilities will risk, for the first time, criminal charges in relation to tax. But tax and the broader compliance effort may also hold the key to unlocking customer value in this fast-moving and consolidating marketplace – and even a new source of (tax) alpha.

To read about some of the digital challenges that wealth managers are facing download our Sink or Swim report.

View Robert Mellor’s profile on LinkedIn