12/2005/#15. journal. journal of financial transformation. Wealth. Preservation Management Release

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1 journal the journal of financial transformation 12/2005/#15 Wealth Preservation Management Release Recipient of the APEX Awards for Publication Excellence

2 Our 200 mph laboratory. bmw williamsf1 team The BMW WilliamsF1 Team chose HP to provide the supercomputer used to design the car and to conduct thousands of race simulations. And before the car even hits the track, HP servers and notebooks are used to analyze research data that enables the team to make precise suspension and engine adjustments. It s mission-critical computing for fast-moving enterprises, and then some Hewlett-Packard Development Company, L.P.

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5 Editor Shahin Shojai, Director of Strategic Research, Capco Advisory Editors Dai Bedford, Partner, Capco Predrag Dizdarevic, Partner, Capco Bill Irving, President, Capco Pedro Matthynssens, Partner, Capco Editorial Board Franklin Allen, Nippon Life Professor of Finance, The Wharton School, University of Pennsylvania Joe Anastasio, CEO, Cross Border Exchange, and Partner, Capco Philippe d Arvisenet, Group Chief Economist, BNP Paribas Jacques Attali, Chairman, PlaNet Finance Rudi Bogni, Former Chief Executive Officer, UBS Private Banking Bruno Bonati, Strategic Consultant, Bruno Bonati Consulting David Clark, NED on the board of financial institutions and a former senior advisor to the FSA Géry Daeninck, former CEO, Robeco Stephen C. Daffron, Managing Director, Global Operations, Citigroup Private Bank Douglas W. Diamond, Merton H. Miller Distinguished Service Professor of Finance, Graduate School of Business, University of Chicago Elroy Dimson, Professor of Finance, London Business School Nicholas Economides, Professor of Economics, Leonard N. Stern School of Business, New York University Michael Enthoven, Chief Executive Officer, NIB Capital Bank N.V. José Luis Escrivá, Group Chief Economist, Grupo BBVA George Feiger, Executive Vice President and Head of Wealth Management, Zions Bancorporation Gregorio de Felice, Group Chief Economist, Banca Intesa Wilfried Hauck, Chief Executive Officer, Allianz Dresdner Asset Management International GmbH Thomas Kloet, Senior Executive Vice-President & Chief Operating Officer, Fimat USA, Inc. Herwig Langohr, Professor of Finance and Banking, INSEAD Mitchel Lenson, Global Head of Operations & Technology, Deutsche Bank Group David Lester, Chief Information Officer, The London Stock Exchange Donald A. Marchand, Professor of Strategy and Information Management, IMD and Chairman and President of enterpriseiq Colin Mayer, Peter Moores Professor of Management Studies, Saïd Business School, Oxford University Robert J. McGrail, Chairman of the Board, Omgeo Andrew McLaughlin, Group Chief Economist, The Royal Bank of Scotland John Owen, COO, Wholesale Banking, ING Derek Sach, Managing Director, Specialized Lending Services, The Royal Bank of Scotland Jos Schmitt, Partner, Capco John Taysom, Founder & Joint CEO, The Reuters Greenhouse Fund Graham Vickery, Head of Information Economy Unit, OECD Norbert Walter, Group Chief Economist, Deutsche Bank Group

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7 Table of contents Special Contributor 8 Adam Smith s relevance today Eamonn Butler, Director, Adam Smith Institute Nobel Laureate View 12 A perspective on the reliability of economic and financial predictive models. A discussion with Prof. Sir Clive W. J. Granger Prof. Sir Clive W. J. Granger, Professor Emeritus, University of California at San Diego, Joint Winner of The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel Helping to manage, if not eliminate, the nuclear threat facing our world Michael Christ, Executive Director, International Physicians for the Prevention of Nuclear War (Recipient of the Nobel Peace Prize in 1985) Preservation 18 Opinion: Switzerland and trusts Robert Danon, Tax Counsel, Baker & McKenzie Geneva Richard Gassmann, Partner, Baker & McKenzie Zurich Stephanie Jarrett, Partner, Baker & McKenzie Geneva Philip Marcovici, Partner, Baker & McKenzie Zurich 24 Opinion: From reform to crisis: Re-examining the pension system in Argentina Rafael Rofman, Senior Economist, The World Bank Fabio Bertranou, Senior Social Security Specialist. International Labour Office Carlos Grushka, Head of Statistics and Pension Research, Superintendency of Pension Funds, Argentina 31 Opinion: Financial terrorism in America Mark Faulk, Editor, The Faulking Truth 35 Opinion: Wealth and charity: Financial techniques and modern philanthropy David Clark, Chairman, Charity Bank, and Member of the Board of Editors, Journal of Financial Transformation 39 The effect of wealth and ownership on firm performance Kenneth R. Spong, Senior Policy Economist, Banking Studies and Structure, Federal Reserve Bank of Kansas City Richard J. Sullivan, Senior Economist, Payments System Research, Federal Reserve Bank of Kansas City 49 New guidance on structuring hedge fund investments within variable life and annuity contracts Deborah M. Beers, Esquire, Attorney, Buchanan Ingersoll, P.C. 59 The importance of wealth for subjective well-being Bruce Headey, Principal Fellow, Melbourne Institute of Applied Economic and Social Research, University of Melbourne Mark Wooden, Professorial Fellow and Deputy Director, Melbourne Institute of Applied Economic and Social Research, University of Melbourne Management 70 From regulation to over-regulation and back How to break the vicious circle Michel Y. Dérobert, Secretary General, Swiss Private Bankers Association (SPBA) 76 Opinion: The family office: Fleeting trend or lasting values? Myriam Burri, Head of Marketing and Communications, Pictet Family Office Olivier Reymond, CIO, Pictet Family Office 79 Opinion: Momentum and index investing: Implications for market efficiency Ron Bird, Emeritus Professor, Australian National University, and currently Associate Professor, University of Technology, Sydney Xue-Zhong (Tony) He, Senior Lecturer, University of Technology, Sydney Satish Thosar, Associate Professor, University of Technology, Sydney, and the University of Redlands Paul Woolley, Chairman of GMO (Europe) and Honorary Fellow at the University of York 87 Reporting value to the private equity fund investor Andreas Kemmerer, Chair of Banking, University of Frankfurt (Main) Tom Weidig, CEO, QuantExperts 97 The municipal bond market in South Africa Andrea Saayman, Associate Professor, School of Economics, Risk Management and International Trade, North-West University Adelia Horn, School of Economics, Risk Management and International Trade, North-West University 107 Private equity funds: Return characteristics, return drivers and consequences for investors Christoph Kaserer, Professor of the Department of Financial Management and Capital Markets, and Scientific Director of the Center for Entre preneurial and Financial Studies (CEFS) Technische Universität München Christian Diller, Research Assistant at the Department of Financial Management and Capital Market, and CEFS, Technische Universität München Release 120 Opinion: A new era for commodity investments Hugh R. Lamle, President, M.D. Sass Investors Services, Inc. Terrence F. Martell, Saxe Distinguished Professor of Finance, and Director, Weissman Center for International Business, Baruch College, City University of New York 126 Opinion: The growth of global wealth until 2020 Stefan Bergheim, Senior Economist, Deutsche Bank Research 132 Opinion: Residential property what role in individual wealth and investment? John Smullen, Greenwich Business School Keith MacDonald, Partner, Capco 137 The development of the reverse mortgage market Bill Irving, President, Capco Tom Roughan, Principal Consultant, Capco 147 Banks default risk and regulatory factors in emerging market economies Christophe J. Godlewski, Research Fellow, LaRGE, Université Robert Schuman 159 Saving and the effectiveness of financial education Annamaria Lusardi, Associate Professor of Economics, Dartmouth College and NBER

8 Today s wealth In an era which has seen the true advent of mass capitalism, widespread creation of personal fortunes and increasing affluence, devoting an issue of the Journal to wealth is a sensible step. In most of the Western world, the six decades since the end of World War II have been marked by an unprecedented abundance of capital, a high appetite for investment, and a remarkable rise in disposable income per capita. Reviving economies coupled with improving individual living conditions have for three generations in the first-world countries been the almost perfect remedy against waging war and averting human misery. This political model, first used by the Allies against former enemies Germany and Japan after 1945, has been in use in the former communist satellite states in Eastern Europe ever since the fall of the Berlin Wall. It is now the economic panacea for economically developing nations such as India, China, and Brazil. The numbers prove that there is incredible wealth in most Western countries: The United States is still the world s largest economy, with the economy of California alone the seventh largest in the world. A mediumsized European country like the Netherlands with seven million households has the incredible net asset value of 1,849 billion according to recent research, or an astonishing 264,000 per household (net of debt). The number of individuals with more than U.S.$1 million in investable assets rises each year, to 8.3 million in 2004, with the United States, Germany, and Britain leading the pack. Lottery drawings with jackpot winners receiving 7 million are hardly newsworthy these days. In short, wealth has become commonplace in firstworld countries, albeit spread quite unevenly among their populations. It is, therefore, no small wonder that the wealth management industry, which caters to the economic wellbeing of large fortunes, has exploded in the past two decades. Every self-respecting financial institution has a private banking venture looking after the needs of their most affluent clients, the definition of which includes individuals with liquid assets as low as U.S.$50,000. Family offices, once considered icons of an era gone by, sprout up and profile themselves prominently. Private equity and hedge funds accommodating individual investors are nothing new. All these service providers focus on a number of objectives for their clients: creation and preservation of wealth for future generations, management or growth of wealth with an acceptable risk profile and tax regime, and prudent release of wealth for a variety of reasons (inheritance, philanthropy, charity or other). This Journal highlights exactly these topics, using the contributions of acclaimed authors from the wealth management industry, economic policy institutions, the regulatory environment, and Capco s own wealth experts. The intellectual richness and readership numbers of our Journal grow with each new issue: you are holding the 15th edition of the Capco Journal, a rich fact in itself. Enjoy! Rob Heyvaert, Founder, Chairman and CEO, Capco

9 Nurturing and protecting human and financial capital in the 21 st century Almost 230 years after the publication of Adam Smith s most profound book on the wealth of nations, we see that human capital remains the most important factor input in stimulating economic development. However, there is no doubt that we still have a long way to go before we will have instituted all the wisdom that this great man has bestowed upon our world. It is for this reason that we are proud that the director of the Adam Smith Institute, Dr. Eamonn Butler, has kindly written a special contribution to this issue of the Journal, which is dedicated to the subject of wealth. Assessing how Adam Smith s wise words of all those years ago can be applied to our world today was a very interesting challenge, and one that Dr. Butler has met with tremendous success. This issue of the Journal aims to help our readers get a better understanding of how wealth, be it human or financial, can be preserved for future generations; how it can be managed to help its accumulation; and finally, and perhaps most importantly, how it can be released. We have a great number of wonderful articles covering these topics, representing some of the most well known experts in their respective fields. As in the previous issue of the Journal, two Nobel Prize recipients, one economist and one from another discipline, share with us their perspectives on major issues impacting our world. We are especially pleased that Prof. Sir Clive W. J. Granger, joint winner of the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel in 2003, has kindly shared with us his views on the reliability of financial and economic models in helping us improve our predictive capabilities. We are also very pleased to have a contribution from Michael Christ, Executive Director of the International Physicians for the Prevention of Nuclear War, Recipient of the Nobel Peace Prize in He shares with us his views on how we should use the lessons learned from the recent natural disasters to prevent similar catastrophes from taking place through man-made weapons, which threaten to eliminate the most valuable wealth the world possesses, its citizens. The papers presented in this issue predominantly focus on financial wealth, but we also have a number of articles that look at the more human aspects of wealth. We hope that you enjoy this issue of the Journal and that you continue to support us by sending us your best ideas. On behalf of the board of editors

10 SPECIAL CONTRIBUTOR Adam Smith s relevance today Eamonn Butler Director, Adam Smith Institute Adam Smith s world was, of course, very different from today s. The largest section of the population worked in agriculture. Different kinds of money coexisted within the same country. Weights and measures were not standardized. Commerce was regulated by the producer guilds, and competition was unwelcome regarded as destructive, indeed. Labor-saving innovations were outlawed at the behest of the guilds. Craftsmen from one town were not permitted to work in another; there were no trade unions to protect them. Monarchs granted lucrative monopolies to their favorites. Most businesses were small, family affairs: today s huge corporations did not exist. The state s role was small: today s massive central-government expenditures on health, education, welfare, or pensions were quite unknown. It would be easy to suggest, then, that nobody from this age had much to teach us, but Adam Smith was quite different. Not only did he develop an analytical system which explained how to get the best out of economic institutions, whatever they might be, but by tackling some of the most contentious issues of his time, he also gave us insights into how we should deal with the same issues that remain contentious today. Smith is now regarded as an economist, but he thought of himself as a student of the human mind and human society, what we would call psychology and sociology, with a large measure of moral philosophy thrown in. He took it upon himself to analyze our economic life in the most fundamental, and therefore the most enduring, terms. Wealth, from his perspective, should not be measured in the quantity of gold and silver in a country s vaults, but in terms of the energy, enterprise, skills, and productivity of its people. It is those things, not strongrooms full of dead metals, which create and spread prosperity. It followed that the best way to maximize prosperity was to give that productive energy as much freedom as possible to do its work. Smith challenged the prevailing idea that it made sense to place restrictions on how business was carried out at home, and attempts to protect the country against imports from abroad. After all, nobody is forced into trading. People will continue to do it only so long as each perceives a benefit. So why try to limit the free exchange of goods across borders? That sounds straightforward enough today, but in Smith s time it was a daring, almost impudent idea. Equally breathtaking was his insistence on exactly the same free market principles at home. He cites example after example of how government intervention and regulation in fact produces the opposite of the benefits claimed for it. And he goes on to show that, almost as if an invisible hand were guiding it, the result of people freely producing and exchanging is not chaos but a spontaneous order in which goods and labor are drawn systematically to their most productive uses through the simple guiding principle of the price system. Individuals may think only of their own self-interest in this process, but the benefit that it brings is general to all. Smith s wildly original and iconoclastic analysis had a huge impact on the politicians of the time, many of whom well understood that the protectionist, mercantilist system had its shortcomings. In time, that would lead to the abandonment of price-fixing on farm products and to the great nineteenthcentury era of free trade from which his native Britain, and so many other countries, would benefit. The message is just as relevant today. Certainly, world trade has advanced a great deal since Smith s time. And yet the mercantilism he fought against is still rife. By using glasshouses and hotbeds, wrote Smith, very good grapes can be raised in Scotland, and very good wine too can be made of them but at about thirty times the expense of buying them in from abroad. Would it be a reasonable law to prohibit the importation of all foreign wines, merely to encourage the making of claret and burgundy in Scotland? It is from such a clear example that one might have expected the lesson to have been learnt, over the last 250 years. And yet, today, the European Union is locked in a simmering dis The journal of financial transformation

11 pute with China over the number of garments that it is prepared to import from that source precisely in order to protect clothes manufacturers in Italy, France, and elsewhere. Since the cost of this domestic manufacture is in some cases quite literally thirty times the expense of Chinese imports, the policy does seem remarkable. But then Smith did tell us about the strange ways of that crafty and insidious animal, the politician and some of the bizarre outcomes that emerge from their (often) well-meaning policy efforts. Some people caricature Smith as promoting a model of the economic sphere based on universal self-interest, but it is through the political sphere that self-interest is at its most vicious. The guilds of earlier times, and the European producers of garments (and much else), use the power of politicians to try to protect their own industries from competition. That may be temporarily beneficial to them, but as Smith argues so cogently and with so many examples, in the longer term it benefits neither them nor the rest of society. Agriculture is another sector where Smith s analysis is both instructive and relevant. The plight of developing countries in Africa and elsewhere has captured the world s attention, and prompted modest rises in richer countries foreign aid budgets. And yet vitally important markets for their produce, like the European Union and to some extent the United States, remain closed to them, safe behind their high tariff barriers. Meanwhile, religious and other groups defend the rights of developing countries to raise their own barriers against the imports of global companies who are, they say, so efficient and low-cost that to allow their goods in would kill off their own production. Smith of course was in no doubt that free trade would help both sides. That when countries throw up trade barriers, others retaliate, until the whole world is denied the benefits of free trade. Certainly, trade requires people to adjust when they find that others can undercut them. But when that happens, their effort, and the world s resources, are drawn into more productive uses, to the benefit of themselves and of humankind. We should buy the cheap goods, and allow the developing world to prosper from the trade, but then they cannot expect to live by producing what we, in turn, can manufacture much more cheaply. This global economy that we are all trying to make sense of and to adjust to today brings us to another area where Smith has much to teach us. Many people resent the power of the large corporations, particularly the giant multinational players that today s global economy has enabled to prosper. And there are calls for their markets to be restricted in order to curb their dominance. Smith, of course, reminds us that monopoly is a great enemy to good management, and of its other evils: the high prices that monopolists can demand, and their manipulation of the markets to achieve that. But he also reminds us that if such price manipulation exists, whether by monopolies or cartels, there must be something wrong with the specific market. For if the market is free, an effective price-ring cannot be established but by the unanimous consent of every single trader, and it cannot last longer than every single trader continues of the same mind which means it is unlikely to last for long. Where we think we see monopolies or cartels, we should not be complaining against the monopolists themselves, but against the legal or regulatory framework that is impeding the free working of the market and so allows them that power. Smith was no apologist for business, and many anti-capitalists rejoice in his famous line that People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. What they forget, though, is that he goes on to explain what it is that makes these conspiratorial meetings more likely to occur. And in a word, it is regulation. Where professional people have to be registered, it becomes easier for each one to contact the others, and begin the conspiracy. When they are forced by law to practice in a particular way, or to take collective decisions about how the profession is managed, then these meetings are rendered not merely likely, but necessary. 11

12 Indeed, regulation is perhaps the most worrying issue of today. With the collapse of communism, market principles are spreading through the economies of the world. The debate is no longer whether enterprises should be in private or public ownership. The debate now is how private enterprises should be regulated. And there are many pressures to extend regulation which makes the public feel safer and which allows politicians to escape blame when things go wrong further and further. But much, perhaps all, regulation achieves the opposite of that intended, as Smith s contemporary Adam Ferguson noted, with his law of unintended consequences. Smith does not tell us how to solve the political problem of spiraling regulation, but he does at least give us a multitude of examples of its harmful effects, which should serve as a warning. Alongside regulation, the seemingly inexorable rise in taxation is another problem that troubles many people. And it always has. There is no art which one government sooner learns of another, says Smith, than that of draining money from the pockets of the people. But he helps us by spelling out some basic principles that the tax authorities ought to respect. Taxes should be proportionate; the amount that is due should be clear; paying it ought to be easy; and it should not require vast armies of officials to collect it. These same arguments have been used recently in a number of countries to explain why they have moved from complicated, progressive tax systems with lots of different rates and exemptions, to a flat tax system where everyone pays the same proportion of income and exemptions are minimized. In particular, the Baltic countries, Russia, Slovakia, and other East European countries have set the pace on this. Nor do they regret it: by following Smith s principles, they have been able to pull in more revenues on lower, flat rates. a very large sum of money which itself would generate more revenue than these state assets ever did on their own, widening the tax base in the process. Which was exactly what Mrs. Thatcher found and what other countries are now discovering. Once again, Smith reminds us that central, governmental control of things rarely produces a great outcome. It is all about incentives: Public services are never better performed than when their reward comes in consequence of their being performed, and is proportioned to the diligence employed in performing them. And in a properly free market economy, that is exactly how the incentives align. The profusion of government, thought Smith, was a powerful damper on progress. We can rely on ordinary people to husband their resources and to make their money work for them. Public expenditure, by contrast, is in most countries employed in maintaining unproductive hands. Governments, he observed, are themselves always, and without exception, the greatest spendthrifts in the society. Let them look well after their own expense, and they may safely trust private people with theirs. If their own extravagance does not ruin the state, that of their subjects never will. It is a sentiment that seems as true and as universal as when Adam Smith wrote it 250 years ago. These and other countries have, at the same time, been transferring their state enterprises to the private sector, a trend started in Britain under Mrs. Thatcher. Smith would have been pleased to see it. In every great monarchy of Europe, he wrote, the sale of the crown lands would produce 12 - The journal of financial transformation

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14 The Nobel Laureate view A perspective on the reliability of economic and financial predictive models A discussion with Prof. Sir Clive W. J. Granger Prof. Sir Clive W. J. Granger, Professor Emeritus, University of California at San Diego Joint Winner of The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel 2003 Sir Clive W. J. Granger is a leading authority in econometrics and is widely credited for developing methods for analyzing economic time series with common trends (cointegration) in order to test for causality. We are very honored that he has kindly taken the time to help us get a better understanding of the functioning of financial markets and the economy at large. Below, you will find the questions posed and the responses kindly provided by Prof. Sir Clive W. J. Granger. Markets Q: Investors place, or at least used to, a lot of emphasis of the reports that market analysts write about the companies and the markets they follow. Do you believe that the analyst community has the necessary tools for doing an adequate job? Prof. Granger: Prices follow a random walk or nearly so because of investor behavior. It has nothing to do with theoretical finance or econometrics. If an investment s outcome could be predicted with near certainty, all investors would use it (to buy or sell) and it would become a money-pump. This is clearly impossible. Actual studies show that prices are near to a random walk in most cases, most of the time, but occasionally they need not be for short periods if investors are not paying enough attention. Q: Many investors have increased their exposure to overseas markets. Do you believe that there is a real benefit to such diversification? Can the global participation of international investors help bring about more interdependence between stock prices and markets? Prof. Granger: The analyst community is very large and diverse; some are very well qualified and have excellent access to all the modern tools, while others do not. Prof. Granger: Diversification reduces some kinds of risk but not all types of down-side risk. This is particularly true if one invests in a situation that one does not understand very well. Q: Do analysts require more than an understanding of the companies they analyze, such as knowledge of macro-economic flows, etc.? If so, can anyone be truly capable of making reliable recommendations? Prof. Granger: Naturally, an analyst has to be able to judge the national and international economies within which the company of interest trades. By the use of appropriate news services and discussions with colleagues, this is certainly possible at most times. Q: Given the advances we have made in mathematical finance and econometrics, can we now say with certainty that prices follow a random walk? If not, what is preventing them from doing so? Economics Q: A large number of experts try to evaluate how economies will develop over time. Do the tools they use allow them to arrive at reliable predictions? Is the data available reliable enough? Prof. Granger: The ability to forecast economic variables varies across variables and across forecast horizons. Some variables are very difficult to forecast over short horizons (stock returns, for example), while some can be forecast over days or a few weeks perhaps (stock volume), while some for a few months (major macro variables). Very few can be well forecast beyond two years, except demographics. Q: Economists seem to have a great knack of coming up with 14 - The journal of financial transformation

15 very varied predictions of economic growth. It seems that even weather forecasters are getting better at their jobs at prediction than economists. At the very least, there is greater degree of agreement. Do you feel that this has to do with the fact that economic modeling is so dispersed? Or is it because we do not invest as much money in developing economic predictive tools as we do in weather forecasting? What would you attribute this to? Prof. Granger: Weather forecasters have information from satellites and so can see weather coming several days ahead. Economists do not have the equivalent. The problem is a lack of adequate data rather than good modeling, or handling of the data. Q: Predicting currency prices, an important component in economic development, relies on not only accurate predictions of GDP growth, but also on inflation, though the two are related. How good are the markets in predicting inflations and how can they improve the process they use? Prof. Granger: Inflation is a policy variable, and so is determined by the policy chosen and its success. Economists often find it is difficult to forecast policy. Q: Use of quantitative models has increased, as has their quality, in recent years. However, do you genuinely believe that these tools have increased our abilities to improve the management of the economy? If so, why do you feel some countries, such as those in Euro-zone, have so many problems getting the balance right? Prof. Granger: Again, this is politics. How much tax should be collected, what should it be spent on, do we care for the unemployed, the poor, or not? These are important social issues and they have economic impact. Q: If you had one piece of advice for your fellow economists, what would it be? Prof. Granger: Avoid the media. 15

16 The Nobel Laureate view Helping to manage, if not eliminate, the nuclear threat facing our world Michael Christ Executive Director, International Physicians for the Prevention of Nuclear War Recipient of the Nobel Peace Prize in 1985 The spate of recent natural disasters around the globe confirm what the International Physicians for the Prevention of Nuclear War (IPPNW) has warned for 25 years: that a nuclear disaster, whatever the scale, will overwhelm the emergency services of any country and that primary prevention is the only solution to dealing with this greatest threat to human health and welfare. While many national and local officials are scrambling to reassess disaster preparedness, governments around the world, most especially those that currently possess nuclear weapons the United States, Russia, Britain, France, China, Israel, India, and Pakistan are failing in their responsibility to protect their citizens from a devastating nuclear event. The deliberate or accidental use of even a single a nuclear weapon would dwarf the destructive force of the worst earthquake or hurricane. Even a relatively small radioactive dirty bomb used in a terrorist attack would cause severe social, economic, and political upheaval. With each passing day, the threat looms larger. Yet, after living with the Bomb for 60 years, a dangerous complacency has set in about both the magnitude and likelihood of the threat. We do so at our own peril. Recall that the atomic bombing of Hiroshima came without warning. About 140,000 people 40% of the city s population were killed instantly or died within a few months. The civil defense system was immediately obliterated. In milliseconds, temperatures at ground zero reached 4,000 C, resulting in fatal burns at least as far away as 2.5 kilometers. Firefighting was impossible. Wind speeds exceeded that of a Category 5 hurricane. Ninety percent of the city s buildings, including 42 of the 45 hospitals, were destroyed. Less than 30 doctors, and only 126 of the 1780 nurses, survived to treat the thousands of victims suffering from massive blast, burn, and radiation injuries. Today, the nuclear powers possess an estimated 30,000 nuclear weapons. The average modern nuclear weapon has an explosive force of 400 kilotons (equivalent to 400,000 tons of TNT) over 30 times more powerful than the Hiroshima bomb. The U.S. and Russia maintain 5,000 nuclear weapons armed on hair trigger alert, ready to be launched at a moment s notice. This fact, combined with troubles in Russia s command and control systems, has increased the risk of a nuclear attack by accident or miscalculation. The prospect of nuclear terrorism is also very real. There are more than 3,750 metric tons of plutonium and highly enriched uranium stockpiled around the globe (roughly 50% military and civilian stocks). Clearly, some non-state actors have the will to inflict maximum carnage on innocent populations and may seek to acquire nuclear materials. For example, Osama bin Laden reportedly stated that acquiring nuclear weapons is a religious duty. Testimony by Jamal Ahmad al-fadl, a former bin Laden associate, in the trial of those convicted in the 1993 World Trade Center bombing, recounted al-fadl s extensive but unsuccessful efforts to acquire enriched uranium for Al Qaeda. The acquisition of nuclear weapons by India and Pakistan, dangerous enough on its own terms because of the history of armed conflict between those two countries, marked the beginning of a new era of global proliferation that threatens to accelerate out of control. North Korea and Iran are the states of greatest immediate concern, but others are sure to follow. According to Dr. Mohamed ElBaradei, who shared this year s Nobel Peace Prize along with the International Atomic Energy Agency that he leads, Unless we are moving steadily toward nuclear disarmament, I'm afraid that the alternative is that we ll have scores of countries with nuclear weapons and that's an absolute recipe for self-destruction. Unfortunately, we are hurtling away from, not toward, that essential goal The journal of financial transformation

17 The 1970 Non-Proliferation Treaty (NPT), signed by 189 nations, stands at the center of global efforts to contain the spread of nuclear weapons and provides a framework for nuclear disarmament. It is a bargain that commits the declared nuclear powers to eliminating nuclear arms in exchange for a pledge by the non-nuclear weapon states not to acquire nuclear weapons. However, the NPT is in serious danger of unraveling. The single most important factor undermining the NPT is the nuclear double standard: the nuclear powers insist that they must retain nuclear weapons to ensure their national security, but that nuclear weapons must kept out of the hands of others. Such a view is dangerous and untenable. For its part, the Bush administration has distinguished itself as the most hostile of the nuclear powers to nuclear arms control and disarmament. In 2002, the U.S. completed a new Nuclear Posture Review that effectively repudiated its NPT commitments by enlarging the circumstances in which nuclear weapons could be used. It is even refusing to places tighter controls on nuclear materials a critical step to preventing plutonium or uranium from spreading to other counties or falling into the hands of would-be nuclear terrorist. Moreover, a recently disclosed draft policy document suggests that the U.S. is now formally planning the use of nuclear weapons against non-nuclear states as an integral part of its global military strategy. According to a document titled Doctrine for Joint Nuclear Operations, discovered last month on the web site of the Joint Chiefs of Staff (before it was quickly taken down), military procedures are being revised to provide commanders with instructions on how to request Presidential permission to use nuclear weapons preemptively. For many contingencies, said the document, existing and emerging conventional capabilities will meet anticipated requirements; however, some contingencies will remain where the most appropriate response may include the use of U.S. nuclear weapons. The document revises the discussion of nuclear weapons use across the range of military operations. Only five years ago, at the 2000 NPT Review Conference, the nuclear weapon states pledged themselves to an unequivocal undertaking to eliminate their arsenals and endorsed 13 practical steps toward that goal. All 189 NPT member states realized in 2000 that the surest way to prevent nuclear proliferation to other countries or even to terrorists was for the nuclear weapon states themselves to comply fully with their disarmament obligations. Tragically, the U.S. walked away from those commitments earlier this year at the 2005 NPT Review, and the rest of the NPT member states lacked the political will to demand that the world s largest nuclear power make good on its promises. By refusing to honor the NPT and asserting a central role for nuclear weapons well into the middle of this century, the U.S. and the other nuclear powers are creating a compelling incentive and excuse for other nations to go nuclear. Having made nuclear weapons the coin of the realm of international politics, and the Holy Grail of great power status, is it any wonder that other countries harbor nuclear ambitions? During the cold war, Washington advised citizens that in the event of a nuclear disaster they should Dig a hole, cover it with a couple of doors and then throw three feet of dirt on top It s the dirt that does it if there are enough shovels to go around, everybody s going to make it. Regrettably, today s leaders seem no less cynical or contemptuous of our health and safety. It is not certain when or where it will hit, or what form it will take, but a major nuclear disaster is only a matter of time unless the nuclear weapons states change course and take urgent and necessary steps to lock down nuclear materials worldwide and to abolish nuclear weapons. Indeed, it is precisely because of the multiple risk factors, and myriad 17

18 uncertainties in forecasting a nuclear disaster, that fundamental solutions are needed. Clearly, we face enormous dangers, perhaps greater than any other moment in the history of the nuclear age. We face a choice between two futures. One would have nuclear weapons as a permanent threat to the health and security of everyone on Earth, with the almost certain prospect that they will one day be used with catastrophic consequences. The other is where the development, testing production, stockpiling, transfer, use, and threat of use of nuclear weapons is proscribed by international treaty and enforced under strict and effective international controls. There are of course no clear pathways to reach a nuclear weapons free world. Yet, there is clear hope and possibility for achieving that essential goal. A growing groundswell of public outrage around the globe is being directed at the reckless polices of the nuclear weapons states and those nations who would seek to join the nuclear club. We must build this global coalition of citizens who are demanding protection from the nuclear threat. Much more pressure must be brought to bear not only on the handful of nuclear weapons states, but also on the rest of the world s non-nuclear governments. Their resolve, weakened in a world where they are either with the U.S., or against it, must be fortified. Only the combined efforts of citizens and supportive non-nuclear governments can persuade the nuclear powers to choose the better future. During the Cold War IPPNW brought a clear message to the U.S. and the former Soviet Union: a nuclear war cannot be won and, therefore, must never be fought. Today, with tens of thousands of doctors, students, health care workers, and concerned citizens in 58 countries, we are bringing a new message to anyone who harbors the illusion that ownership of nuclear weapons is a path to security: nuclear weapons in any hands whether those of terrorists, dictators, or the leaders of democratically elected governments are incompatible with human survival and must be eliminated.

19 Preservation Switzerland and trusts From reform to crisis: Re-examining the pension system in Argentina Financial terrorism in America Wealth and charity: Financial techniques and modern philanthropy The effect of wealth and ownership on firm performance New guidance on structuring hedge fund investments within variable life and annuity contracts The importance of wealth for subjective well-being

20 Switzerland and trusts Robert Danon Tax Counsel, Baker & McKenzie Geneva Richard Gassmann Partner, Baker & McKenzie Zurich Stephanie Jarrett Partner, Baker & McKenzie Geneva Philip Marcovici Partner, Baker & McKenzie Zurich Another recent development is that as the regulation of trust companies has tightened up in the offshore islands, companies are being registered in Switzerland and acting as trustees despite the uncertainties surrounding the use of trusts. Furthermore, individuals in Switzerland are acting as professional trustees with little or no understanding of trust law or the issues involved. This is a potentially dangerous situation. However, the Swiss authorities now seem to have become aware of this issue. Therefore, putting some order and certainty into matters by at least registering and licensing trustees (if not immediately insisting on full regulation) in the management and administration of foreign connected trusts in Switzerland would enhance the attractiveness of Switzerland as the wealth management centre of the future. What can be done? While the Hague Convention is not a perfect piece of legislation, Switzerland should ratify it. We would now expect ratification within the next two years. However, ratification of the Hague Convention alone will not address the current barriers facing financial institutions that are actively promoting the establishment and administration of trusts in Switzerland. This has been recognized by the Justice Department in its two rounds of proposals. More action, preferably simultaneous, will need to be taken on a step-by-step basis to introduce certain characteristics of the trust concept to Swiss domestic law. As an initial step and in conjunction with the ratification of the Convention, legislation would need to be introduced to deal with foreign connected trusts being those with non-swiss resident settlors and beneficiaries and only moveable assets in Switzerland. Legislation for Swiss connected trusts being those with Swiss resident settlors and/or beneficiaries and/or Swiss immovable assets can be introduced at a later date. We strongly advocate that the following items need urgent attention: recognition of the separation of legal and equitable ownership of property held in trust (i.e., protection of trust assets from creditors of the trust company and of other trusts assets), treatment of tracing rights for misappropriated trust assets located in Switzerland, licensing and registration of trust companies, licensing and authorization of their senior management, and clarification of the tax treatment of trusts (including underlying investment holding entities) managed and administered by such trust companies. We do not advocate, for example, that fiduciary transactions and their current tax treatment be affected. Similarly, the idea would be to avoid any change to the treatment of other existing civil law entities and concepts. In this way, it will be possible to introduce the eventual changes to the legal treatment of Swiss connected trusts based on experience in dealing with the issues arising from the treatment of foreign connected trusts. Most of these suggestions found their way into the Justice Department s first round of proposals with the major exception of tackling the issue of the taxation of trusts, which is now being addressed by a working group set up by the Finance Department. The licensing and registration of trustees has not been included in the second round of proposals from the Justice Department. Private banking in Switzerland Switzerland s position as a private banking centre is more than ever under significant threat. Reliance on bank secrecy as a means of addressing tax and other issues facing international families is just no longer feasible given the many global initiatives encouraging legitimate tax planning and the estab The journal of financial transformation 1 Thévenoz, L., 2001, Trusts in Switzerland: Ratification of the Hague Convention on Trusts and Codification of Fiduciary Transfers, Zurich

21 Although the trust concept is well known, even if not always fully appreciated, in private banking circles in Switzerland and other civil law jurisdictions, it is virtually unknown in Swiss law, and, as a result, continuing legal uncertainty exists where trusts have a Swiss connection. One of the most frequently suggested solutions to address these uncertainties has been the ratification of the 1985 Hague Convention on the law applicable to trusts and their recognition (the Hague Convention). However, it is drafted in such a way that the recognition of foreign trusts does not address the many Swiss legal and tax uncertainties associated with trusts that have a Swiss connection. The most recent development regarding ratification of the Hague Convention by the Swiss Government has been the issuance by the Justice Department in December 2003 of a first round of proposals and the consequent important amendments to Swiss law. These proposals were circulated to professional and industry bodies requesting comments by the end of March This first round of proposals was then followed by a second round of proposals from the Justice Department in October This second round of proposals has been circulated more widely than the first and a greater number of professional bodies, industry lobbying groups, law firms, private banks, and trustees are commenting on these proposals. It should be noted that the proposals from the Justice Department have not included any proposals on the taxation of trusts. In this area there has also been progress. A working group has been established by the Finance Department in Berne, which has held initial consultations with selected law firms, private banks, and professional bodies, such as STEP. A federal tax circular on the taxation of trusts is expected to be issued by the Finance Department as result of the consultations of this working group. The proposals of the Justice Department followed the parliamentary motion of Marc F. Suter on 8 May, 2003 in which he urged action by the Swiss Government recognizing and this was a very positive development the commercial importance of the trust industry to the Swiss private banking industry as a whole. Prior to that parliamentary motion there had been a number of colloquia and seminars to try to move things forward following the commissioning of a report by the Swiss Government on whether or not Switzerland should ratify the Hague Convention. This report was published at the beginning of Despite the uncertainties surrounding the treatment of trusts under Swiss law and, therefore, by some of the tax authorities in Switzerland, trusts have been offered and administered from Switzerland for several decades. However, during the past few years there has been a growing demand for transparency in investments. In this connection there have been a number of international efforts, for example, by the OECD, to harmonize taxes and combat money laundering, as well as domestic initiatives by various countries to improve the collection of taxes, such as the Qualified Intermediary regime introduced by the U.S. in 2001 and the forthcoming E.U. Savings Tax Directive and its related equivalent measures to be implemented between Switzerland and the E.U. In light of these developments, financial institutions and independent trust companies wishing to offer and administer trusts from Switzerland are increasingly keen to have certainty in the legal and tax treatment of trusts and their administration in Switzerland. This is, however, not possible under the present law. Indeed the cantonal and federal tax authorities are not even in agreement on the characterization of certain types of trusts for taxation purposes. As a consequence, well informed international families often direct their business in the trust area away from Switzerland. 21