Discreet and private, family offices have managed the wealth of the world’s richest for well over a century. Yet, despite the magnitude of wealth under management, family offices are subject to light regulatory oversight in most parts of the world, if any at all. This is because family offices are primarily regarded as extensions of private individuals, designed to manage personal wealth instead of external investors.
Whether family offices should be subject to greater scrutiny and regulation has been an intermittent topic of debate for years. Despite several reviews, family offices, by definition, have remained exempt from regulatory oversight. However, earlier this year, the collapse of Archegos Capital Management, a hedge fund structured as a family office, prompted U.S. policymakers to take legislative action to increase regulatory oversight. This decision may have international implications as other countries follow.
The Archegos saga simultaneously thrust family offices under the political spotlight at a time when wealth inequality, tax avoidance and the alleged unfair light taxation of the ultra-wealthy are hot topics. The recently published Pandora Papers exposed the hidden offshore accounts and dealings of 35 world leaders, including current and former presidents, prime ministers, and heads of state, as well as more than 100 billionaires, celebrities, and business leaders. Scrutiny is bound to intensify significantly.
While increasingly converging themes, should regulation and addressing the great divide be part of the same discussion? Here’s a look at arguments from both sides and the questions they leave in their wake.
The number of ultra-high net worth individuals and families is increasing, resulting in more family offices. Family offices bring all aspects of wealth management services in-house to preserve and grow ultra-high net worth families’ wealth for future generations.
Family offices are regarded as private wealth management entities and enjoy a “special status” outside of regulatory scrutiny in most parts of the world. Their unregulated nature is why many prominent hedge funds returned clients’ capital and converted to family office structures.
The Archegos collapse resulted in $10 billion in bank losses at Credit Suisse and Morgan Stanley and an estimated $33 billion in stock value losses. Those in favor of regulating family office operations argue that this reveals the extent to which family offices contribute to systemic risk because of their size, secrecy and growing interest in speculative investments. If left unchecked, it is believed that family offices that collectively hold trillions of dollars in anonymous, unregulated capital could be responsible for the next financial meltdown.
Another point of concern driving the call for regulation is the way family office investment is changing. There has been a notable shift from low-performing hedge funds and public equity markets to private equity, real estate, and cash. According to regulatory proponents, this creates a two-tier investment market – one for the masses and another for the ultra-wealthy. The former is subject to regulation and includes low-yield publicly traded equities and bonds. At the same time, the latter offers unregulated alternatives and speculative investments with higher returns, providing advantages to an already privileged group.
Regulatory proponents also contend that family offices are significant utilizers of wealth defense strategies and mechanisms, including dynasty trusts to sequester wealth and aggressively avoid estate taxes. In this way, it is believed that family offices serve to entrench multi-generational wealth inequality.
Not to regulate
In their truest form, family offices are not public investment advisors and do not fall under intense regulatory oversight in many parts of the world. Still, many pursue activities that are subject to regulation. Moreover, from a taxation point of view, recent years have seen increased scrutiny. As a result, even jurisdictions considered “tax havens” pose a far heavier compliance burden for family offices than ever before. As such, the complete opacity once enjoyed by these entities is fading. Still, with the Pandora Papers on everyone’s minds, could now be the time for family offices to consider the reputational risks of offshore structures? It’s a point worth pondering.
While the arguments and outrage based on the recent Archegos collapse are understandable, the systemic impact on the financial system was zero due to regulations already in place. Moreover, even the directly affected companies managed to weather the storm, with most posting record quarterly earnings. Only the Credit Suisse Group AG, which was simultaneously affected by the Greensill Capital implosion, was compelled to raise equity, which it did successfully.
According to Bill Woodson Head of Strategic Wealth Planning and Family Enterprise Services for Boston Private, an SVB company, “The concerns do not accurately depict family offices, their role in capital markets, the merits of the regulatory exemptions granted to them, or their importance to wealthy families and, by extension, society.” Woodson argues that “The culprits in this tragedy are the actors themselves, not the family office entity through which their actions were conducted.” He proposes that regulators should instead be asking how much risk private individuals should be allowed to take with their own money or what mechanisms exist (or should exist) to monitor these exposures within public companies.
Additionally, the role of leverage and the risk management policies of the prime brokers with which Archegos traded should be examined. These financial giants are already heavily regulated and extended considerable amounts of credit to Bill Hwang, believing that they had sufficient collateral, appropriate risk management policies and sufficiently liquid positions to sell shares, as required, to meet margin calls. Unfortunately, this was not the case.
Woodson explains that a select few families control the majority of the world’s wealth, and how their wealth is utilized and managed has significant implications for society. Therefore, the family offices representing these UHNWIs play a critical role and have a unique opportunity to determine how wealth is channeled for good.
More questions than answers
There is a great deal of sensationalism surrounding the regulation of family offices and what this can genuinely achieve. Unfortunately, many of the points raised pose more questions than answers.
Even if family offices become subject to regulation, there is no standardized version of the family office – so how will they be regulated? Some family offices are already registered with oversight bodies. However, this only means their reporting is subject to scrutiny and limitations, not what they invest in, so will regulation effectively curb repeat Archegos-like events?
The Pandora papers add fuel to the argument’s fire, indicating that while wealthy individuals choose to act within the letter of the law, many may not act within its spirit.
What’s more, reporting regulation alone does nothing to address wealth inequality or bridge the great divide. Instead of burdening family offices with red-tape, wouldn’t it be more powerful to get wealth owners involved in what they invest in when addressing these issues? This is a particularly relevant point of discussion given the next generation’s commitment to transparency and greater equality across various levels of society.
It is undeniable that the time has come for lawmakers and family offices to actively engage in open discussions to identify where the risks truly lie and address these effectively.