Why Switzerland Is In A Hurry To End Its Tax-Haven Standoff With The U.S.

Last week, Switzerland’s lower house in the parliament blocked a law which would have provided the 14 Swiss banks locked in legal tussle with the U.S Department of Justice (DoJ) over tax evasion charges, a way to work around the country’s banking secrecy laws to share client information. ^[1] Since then, Swiss lawmakers have been trying to find an alternative to the rejected tax law, dubbed Lex USA. Meanwhile, the uncertainty created by the situation has triggered sell-offs in several Swiss bank shares, including the two largest among them – UBS (NYSE:UBS) and Credit Suisse (NYSE:CS).

At this point, a likely question that pops in the mind is, “Why exactly are Swiss lawmakers so anxious to find a way around their own, highly-coveted secrecy norms for the banks?” The answer stems from the dilemma which the Swiss government is facing in view of the pressure from the U.S. – it can either bend its own secrecy norms now, or it can watch as the DoJ escalates the ongoing formal investigations into criminal lawsuits and wrest that information out from the Swiss banks. Such a scenario will completely erode confidence in the Swiss banking system, and could end up with the smaller banks being forced to shut shop – similar to what was witnessed earlier this year when the oldest Swiss bank Wegelin ceased all operations after pleading guilty to U.S. tax evasion charges. ^[2]

See our complete analysis of Credit Suisse | UBS

The Swiss banking system has thrived for decades on the back of the secrecy privilege it provides account holders, allowing it to amass the $2 trillion in offshore assets it boasts of today. While the country’s biggest banks, UBS and Credit Suisse, have a sizable international wealth management operation, many of their high net worth offshore clients maintain accounts in Switzerland to benefit from privacy that comes with such an account. And while the Swiss government’s unyielding support of privacy in its banking system has been the target of scorn from governments across the globe for decades, extreme pressure from the likes of the U.S., the U.K., Germany and France since the 2008 recession, has forced the Swiss government to relent and agree to various tax agreements with some of these countries (see UBS and Credit Suisse Will Take Lumps from Swiss-British Tax Agreement)

The U.S. DoJ in particular has been rather stubborn in pursuing the Swiss banks over assisting U.S. citizens, starting with the crackdown of UBS in 2009. UBS ended up paying a $780 million fine and also handed over details of nearly 4,500 secret accounts to the U.S. The DoJ then shifted its focus on other Swiss banks and demanded that they furnish information about all U.S. clients holding accounts worth at least $50,000 over the last 10 years (see Swiss Bankers and US Gov’t Square off Over Credit Suisse). But the stand-off dragged on for well over two years before the DoJ turned the heat up by threatening to initiate full criminal proceedings against all the banks.

Now this would be a big problem for the Swiss banking system on several fronts. Firstly, some of the banks – notably Credit Suisse – have a strong presence in the U.S., and the criminal proceedings could end up with the banks forfeiting all their U.S. assets and in a worst case scenario even losing their operating license in the country. The partial impact of such a scenario on Credit Suisse’s value can be understood by setting American client assets for the banks in the future to zero in the chart below.

Secondly, two of the banks named by the DoJ are government-run cantonal (or regional) banks. So any fines adjudged on them would necessarily be a liability to Swiss taxpayers. And finally, any delay in resolving this issue would introduce further uncertainty in the minds of offshore bank clients – likely leading to mass withdrawals from Swiss banks. Not to mention it will devalue Swiss bank stocks in the process.

What remains to be seen is how quickly and effectively Swiss lawmakers find a way to resolve the impasse.

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1. Switzerland buries U.S. tax law, banks seen at risk, Reuters, Jun 19 2013 [↩]
2. Wegelin’s Fall to Tax-Haven Poster Child, The Wall Street Journal, Mar 3 2013 [↩]