TAX NEWS - June 2010
London's tax flight
Beneath a crystal chandelier at London's Mandarin Oriental hotel, across the street from Harrods department store, more than 100 bankers, hedge fund managers and wealthy retirees are gathered on a cold March night to plot their escape from Britain. Swiss government officials and Geneva-based financial advisers have come to London to lure rich residents with glowing descriptions of the country's low taxes, safe streets, private-banking options and convenient ski weekends.
"We are here to make it easier for you to come to Switzerland," says Martin Meyer, head of economic development for the Swiss canton of Valais, which borders Lake Geneva, Bloomberg Markets reports in its June issue.
Next door, an overflow crowd of 50 more attendees enjoys wine and canapés as they watch the presentation on closed-circuit televisions in a mahogany-lined library, which includes a chart showing the prevalence of English as a language for doing business in Switzerland. A JPMorgan Chase & Co. banker who declined to be identified confides he's planning to relocate next year. His main complaint: higher UK taxes, a theme the Swiss delegation has pounced upon.
"Some people think it's morally wrong to be working for the government for more than half the year," says Jonathan Ivinson, a Geneva-based tax partner at international law firm Hogan & Hartson LLP, as he works the room, passing by a painting of Horatio Nelson's HMS Victory.
Fed-up financial professionals say they're ready to quit the UK because of a lethal combination of high taxes, looming European regulation and public anger toward bankers following taxpayer rescues of some of Britain's biggest lenders. London's highest earners must now pay a 50-percent tax on incomes above £150,000 ($227,200) that came into force on April 6, replacing a 40-percent top rate.
The new levy follows a temporary 50-percent tax on banker bonuses that the Labour government imposed on awards over £25,000 issued from December 2009 to April 2010. The bonus tax raised £2 billion in revenue.
Terry Smith, chief executive officer of interdealer broker Tullett Prebon Plc, says the City of London, the financial district that has long been a magnet for the world's bankers, will inevitably lose some of its expatriate talent.
"There's absolutely no doubt some people will move," Smith says. "Some people say they won't sever their ties to the UK because they won't be able to come and see their mothers at the weekend. Well, if they're Irish or American or French, that won't apply."
As bankers contemplated flight, Britons of all sorts headed to the polls to decide who will lead the next UK government. But whoever occupies No. 10 Downing St. won't be likely to provide tax relief for wealthy financiers. The new government will have to grapple with a record budget deficit of £167 billion, a currency that slumped about 25 percent from the start of 2007 to April on a trade-weighted basis and an economy that grew just 0.2 percent in the first quarter of 2010.
The new prime minister, David Cameron, must also address a growing dissatisfaction with — and among — the financial executives who did so much to fuel the UK's growth before they helped trigger an economic collapse. Bank bailouts have saddled UK taxpayers with £846 billion in long-term financial commitments, according to the UK Office for National Statistics. That bill includes the £45.5-billion rescue of Royal Bank of Scotland Group Plc, which is now majority owned by the state.
Britain emerged from six consecutive quarters of economic contraction last year, and the International Monetary Fund says gross domestic product will expand 1.3 percent this year. Since the beginning of the global economic crisis in 2007, bank rescues and an injection of £200 billion of stimulus cash by the Bank of England drove the UK budget deficit to a record level of 11.8 percent of GDP.
The UK may have to consider devaluing the pound, says George Soros, the hedge fund manager who made $1 billion betting against the British currency in 1992.
"Britain, by having kept out of the euro, has the option of allowing the exchange rate to adjust," Soros says. "It has had a really serious jump in its indebtedness because it had to take over the debt of the banks that are in trouble and also the financial industry's a very large part of the economy."
During the campaign, both Brown and Cameron said they backed additional curbs on the UK financial industry — including a bank transaction levy — and agreed that Britain's dire financial state would lock in higher tax rates for the foreseeable future: The UK Treasury forecasts that the country's net debt will reach £1.41 trillion by 2015, up from £777 billion in April.
Cameron said he expects the financial industry to do its part to help pull the country out of its fiscal bind.
"This is no time to shy away from confronting some of the biggest vested interests in our country: the banks," he said during a speech in London on March 20. "We can't carry on as if nothing happened."
Former prime minister Gordon Brown said that allegations of mortgage-securities fraud by US regulators against Goldman Sachs Group Inc. showed the need for more regulation.
"There has been reckless and irresponsible behavior by some people," he said on April 19 in London.
The UK Financial Services Authority announced a day later that it was opening a formal investigation of Goldman's London units.
The relationship between British bankers and politicians resembles a decade-long love affair that abruptly went sour. Financial services helped drive the Labour government's record 43 consecutive quarters of economic growth — a golden era that came to a crashing halt two years ago. The financial industry accounted for 10.1 percent of British GDP and 27.5 percent of the corporate tax take in 2007, according to statistics from the government and PricewaterhouseCoopers.
"These businesses are as vital to the UK as wine is to the French and autos are to the Germans," says Syed Kamall, a Conservative member of the European Parliament.
As the taxman's take grows larger, Switzerland is shaping up as the most-welcoming alternative for British exiles. Light-touch regulation and the willingness of cantons, as regional governments are called, to negotiate special tax rates for both individuals and businesses have prompted at least 30 London hedge fund managers to consider moving to Geneva in the past year, says Shelby du Pasquier, a Geneva-based partner at Lenz & Staehelin, a Swiss law firm.
Investment management and advisory services aren't regulated in Switzerland, apart from anti-money laundering rules, and the federal government and several cantons last year reduced taxes on dividend payments for entrepreneurs, including owners of hedge fund firms, he says.
"Until two years ago, we were dealing with small fish," du Pasquier says. "Now, large hedge funds are looking at relocating large parts, if not all, of their operations to Switzerland. It's a way to arbitrage their position to have the ability to move out of the UK completely."
Geneva has already attracted some of London's top talent. Alan Howard, cofounder of Brevan Howard Asset Management LLP, Europe's largest hedge fund firm, has rented office space in Geneva for 60 traders relocating from London. Howard himself is considering joining them, according to investors in the firm's funds who have been briefed on the matter.
BlueCrest Capital Management Ltd., Europe's third-largest hedge fund firm, has opened a Geneva office for as many as 70 traders and analysts who have worked in London on its two biggest funds. They're being joined by BlueCrest cofounder Michael Platt and Leda Braga, manager of the $9-billion BlueTrend fund, according to people familiar with the firm's transitional plans. During the winter, BlueCrest employees and spouses took evening French lessons in the firm's London offices near Buckingham Palace to prepare for the move.
The departures of those principals prove that the threat to London's prominence as a financial center is real, says Stuart Fraser, head of policy at the City of London Corp., which runs the financial district.
"We have to be careful we don't end up as the back office of Europe and all the front-end rainmakers have gone elsewhere," Fraser says. "It's the superstars who make the difference."
Under the 50-percent top tax rate, a London banker earning a £5-million bonus on top of a £150,000 base salary will pay an extra £500,000 annually, or about £10,000 more a week, once a 2011 increase in Britain's National Insurance payments is taken into account. Over five years, that equates to losing about £2.5 million extra to the UK Treasury, according to PricewaterhouseCoopers.
"There's an emotional response to being asked to pay an extra £10,000 a week," says Alex Henderson, a London-based tax partner at PricewaterhouseCoopers.
UK top tax rates will exceed those in Germany and France for the first time since 1989, according to a study by accounting firm KPMG. A banker earning £1 million a year in London will now take home less than his counterparts in Frankfurt, Hong Kong, New York, Paris, Singapore and Zurich, KPMG says.
"The UK has abandoned one of its key principles when it comes to tax, which is predictability," says Bertrand des Pallieres, founder of SPQR Capital LLP, a London-based hedge fund firm with about $700 million in assets as of April. He left the UK last year and opened an office in Geneva after the new tax rate was announced.
It's not only funds looking at leaving. Broker Tullett Prebon said in December it would allow its 700 employees in London to move to "more certain tax regimes." Several of Tullett Prebon's major desks are now planning to move key personnel, the company says. The firm has offices in Hong Kong, New York, Singapore and Tokyo.
In the weeks leading to the election, few Britons were showing much sympathy for the tax concerns of financial executives whom they hold responsible for the recession. Fifty-eight percent of voters said that the economy would be the most important factor in determining whom they would support, according to an April 6 poll for the Sun newspaper by London-based YouGov Plc. An earlier YouGov survey in February found that 76 percent of Britons supported a cap on banker bonuses.
"It's the end of a recession, and everyone is a bit fed up," says Anthony Wells, a YouGov polling analyst. "People will pick the most angry response in any poll about bankers."
The optimism that helped turn the UK into Cool Britannia seems a distant memory. In May 1997, Tony Blair ended 18 years of Conservative Party rule partly by promising to promote business and not to raise the top tax rate above 40 percent; his government slashed corporate levies to 31 percent from 33 percent two months later. Peter Mandelson, part of the Labour brain trust, boasted at the time that his party welcomed the benefits of capitalism.
"We are intensely relaxed about people getting filthy rich — as long as they pay their taxes," he told a group of Hewlett-Packard Co. executives in Silicon Valley in 1998.
In the wake of the bank bailouts, Mandelson, Brown's business secretary, changed his tune. He used an April 3 interview with the Times of London to criticize the reported compensation paid to Robert Diamond, the American-born president of Barclays Plc.
"That to me is the unacceptable face of banking," Mandelson, 56, said. "He hasn't earned that money. He's taken £63 million not by building a business or adding value or creating long-term economic strength. He has done so by deal making and shuffling paper around."
According to Barclays financial statements, Diamond, 58, realized a £26.8-million gain on the sale of his shares in the Barclays Global Investors unit after it was purchased by BlackRock Inc. last year, even as he took home his £250,000 salary and passed up an annual bonus.
"The £63-million figure is total fiction," says Alistair Smith, a London-based spokesman for Barclays. "The sum has been innocently picked up as the truth."
Such banker bashing — at the electoral hustings, on the opinion pages of newspapers and even in the classroom — will drive talent away from London, says Angela Knight, CEO of the British Bankers' Association.
"The overwhelming majority of individuals haven't had anything to do with the crisis, and you can't blame them for feeling that they are being demonized," she says. "The atmosphere is uncomfortable. If Daddy is a banker, even the teacher may have a go."
London Mayor Boris Johnson estimates that up to 9,000 bankers, hedge fund managers and private-equity executives could leave the city, according to a letter he sent to the Labour government in January.
"No matter how much you may dislike the masters of the universe, my friends, there are plenty of other parts of the universe that would welcome them," Johnson said in a September speech in Birmingham, England.
Top hedge fund managers and private-equity executives, such as Nagi Kawkabani, Brevan Howard's co-CEO, say that proposed European Union regulations on financial firms would help turn London into hostile territory for their businesses.
EU Financial Services Commissioner Michel Barnier says those rules are needed to curtail risk taking and help prevent a second global credit crisis. He wants the trade bloc's 27 governments to adopt the Alternative Investment Fund Managers Directive drafted by EU lawmakers that would require hedge funds with more than €250 million ($328 million) in assets to limit the amount of leverage they use.
Additional measures would defer compensation for up to three years and require firms to pay a greater proportion of bonuses in shares—a requirement that hedge fund executives say is impossible because their firms are usually partnerships. Firms that don't comply with the rules may be barred from accepting funds from EU-based investors.
In early March, a dozen of London's top hedge fund managers and private-equity executives gathered at the European Commission's office near the Houses of Parliament to confront Barnier about the new rules. Kawkabani told Barnier that his firm's decision to open a Geneva office was simply a matter of preparing for an inevitable political and economic catastrophe.
"We're there for disaster recovery," he said, according to two people who attended the meeting.
Barnier replied that new restrictions were inevitable. Not everyone agrees with Kawkabani's pessimistic take on London's future. The UK capital is still home to more than 80 percent of Europe's estimated $400 billion in hedge fund assets and about 60 percent of its private-equity firms, according to the FSA.
"London is where the brain is," says Georges Gedeon, chief investment officer of Mereor Investment Management, a hedge fund firm he started in February with $50 million. Mereor, which is now operating out of a Parisian town house near the Eiffel Tower, plans to open a London office later this year.
London survived a similar challenge to its primacy as a financial services center in the late 1990s, when Britain didn't adopt the euro as its currency and the bund futures contract moved to the Deutsche Boerse from the London International Financial Futures and Options Exchange, says Douglas Shaw, who manages alternative investments in London at BlackRock, the world's largest asset manager.
"This is perhaps something we agonize about every six years or so," Shaw says. "It's an exercise in self-contemplation, and it's always been overly pessimistic."
Marcel Jouault is working to make sure that agitated Britons wind up in Pfaeffikon, a village on the shore of Lake Zurich. Pfaeffikon's 11.8 percent corporate tax rate and 19 percent personal income levy are both Switzerland's lowest, helping the village lure funds that handle about $100 billion in investments, according to hedge fund research firm Opalesque Ltd. Jouault, who used to work for a hedge fund, spends most of his time in London extolling the charms of Pfaeffikon, handing out Swiss chocolates to potential clients in his job as head of business development for the town.
Londoners who move to Switzerland may find it harder to educate their children. In Geneva, international schools say they've witnessed a surge in calls and applications from families relocating from the UK. The Institut International de Lancy, a private Anglo-French school in Geneva that charges as much as 21,400 Swiss francs ($20,000) in annual tuition, received 30 applications from children of hedge fund managers in January and February alone, headmaster Norbert Foerster says.
Not everyone is thrilled that the British are coming. Scottish-born Christopher Cruden, who set up his investment firm, Insch Capital Management SA, in Lugano, Switzerland, four years ago, shudders at the prospect of more Britons as neighbors.
"The last thing I want is to see more people like me walking the streets and cluttering up the cafes," says Cruden, who manages about $200 million in currency and gold funds.
If the movements of hedge fund firms such as Brevan Howard and BlueCrest presage a greater exodus from the UK capital, Cruden may find it harder to find an empty table at his favorite spots.