Risk To Wealth Is Not the Problem- Not Understanding the Risk Is the Issue
The contents of this Insight are generalised, and readers are urged to seek specific advice on matters and not rely solely on this text. © Vibha Vallabh, Ellora Private Office, November 2023
In my article “Isn’t It Too Bad that Your Grandfather Only Left you Money,” I looked at some well-known families in history whose wealth has successfully survived beyond three generations, and why this has most likely occurred.
A consistent theme found, was that the initial wealth creator of any old wealth family, possessed extraordinary entrepreneurial talent; and had the ability to master opportunism, possessing an ability to use their external environment to their advantage. This combination of both talent and opportunism is rare and comes along occasionally, accelerating the wealth creation phase for an individual and their family.
Once created, to sustain such wealth across successive generations, one must have the talent of not only building upon what has been created, albeit incrementally compared to the high acceleration phase, but also of preserving it.
Unfortunately, far too often this newly created or inherited wealth is lost within one or two generations due to management management. Thus, never giving it an opportunity of maturing into old wealth. Preservation is often viewed as being too tedious and laborious compared to the excitement of building or spending. Both creation and preservation are required to sustain and accumulate further wealth, not only over one’s own lifetime, but over successive generations. Success has been achieved by old wealth because they have skin in the game for the long term, beyond their own lifetimes’. Requiring strategic thinking and planning; as well as the ability of navigating the risks to wealth, which are ever present so long as it exists.
The Nature of Risk to Wealth
Currently we live in a time where both internal and external forces threatening family wealth are not only prevalent but also mercurial. Some potential risks are easily identifiable and can be dealt with well in advance, such as divorce, death, incapacity, taxes, family conflict, and succession. Whereas others, are predicably unpredictable such as geopolitical, financial, legal, and regulatory. Both categories now requiring constant vigilance and the ability to act upon in a timely manner.
Risks affecting source of wealth/operating business or personal wealth/family office, can be different but are often the same (see Table 1). If they cause a negative impact on one side, invariably there will be a knock- on effect to the other. In our current globalised world context, it’s therefore important to have an integrated view of wealth creation and preservation rather than siloed, recognising the interdependence and the commonalities of risks affecting both sides.
Unpredictable Risks Becoming Unpredictable
In recent years, unpredictable risks are now becoming reliable predicable and far reaching in so far as they initially appeared benign to begin with, but with time have morphed bigger both in breadth and depth, which will continue to grow in my humble opinion. Risks such as climate, privacy & confidentiality, and political will require constant close attention.
Climate risk
Climate change is perhaps a risk that is currently not being critically considered enough. There are the obvious changes that we’ll all have to contend with within our physical environment caused by adverse weather effects and pollution. But have we considered climate litigation, increase in costs such as taxes, directors’ and trustee liability and insurance, as well as those associated with changing production and consumption patterns. All are constantly evolving in these uncertain times, the burden of which will ultimately be passed onto everyone including wealth creators and their ability to create and preserve wealth.
The 2015 Paris Agreement saw countries make a commitment to transition to net zero greenhouse emissions by 2050 or even earlier in some cases, with the aim of cutting global carbon dioxide and other greenhouse gases at a rate consistent with climate stabilisation targets of limiting further global warming to 1.5-2°C. It appears that those commitments made, have been slow to come to realisation, resulting in further prompting by the OECD, World Bank and UN. Even the London Financial Times has its own section on Climate alongside its traditional subject matter.
In 2021 the IMF/OECD provided guidelines in its report to countries in how it can meet these commitments.[1] What could this look like going ahead? Carbon taxes, emissions trading systems, fuel excise taxes and carbon pricing, some of which have already been implemented by countries. Whatever system is currently or will be adopted, doing business that is not carbon friendly will now become expensive be it as another layer of costs and/or indirect and direct taxes.
Changes are coming
The OECD, in their report, have said carbon pricing[2] should apply to all greenhouse gas emissions and not just carbon, and be reflective of the most harm caused, incentivising businesses and households to make production and consumption decisions that support lower emissions. Pricing should apply to cheap fossil fuel and process emissions across the power, industry, transport and building sectors, as well as including fugitive emissions from extractives, net emissions from land use change, and agriculture (this classification is becoming wider, so too are target rates and timelines) [3]. Further, fossil fuel subsidies should be phased out, and forms of emissions monitoring be developed or be based on outputs and default emission rates. Therefore rising carbon pricing should incentivise private financing into the innovation of low carbon alternative energy sources and processes as well as providing a source of revenue.
Governments therefore are being encouraged to widen the class of carbon emitters as well as increase carbon pricing to meet targets. Carbon pricing revenues can be used in the meantime during the transition phase.
They’ve said that currently carbon prices do not match policy ambitions; they are too low [4], at the same time acknowledging that such policies will only work if there is energy affordability to lower income households and if carbon leakage and competitiveness in countries can be managed.
To prevent carbon leakage where competitors in countries pursue less ambitious carbon pricing thus encouraging production moving to their countries, the OECD recommend having border carbon adjustments (BCA). An international coordination effort where a measure will be applied to traded products, making their prices in destination markets reflect the costs they would have incurred under that destination country’s greenhouse gas emission regime. Sound familiar? Like a double tax regime perhaps? An alternative mechanism is the international carbon price floor (ICPF) that would cover all emissions of participating countries (currently 195) rather than only those involved in trade flow. There are pros and cons to both which can be found in the Report.
Measures undertaken by countries
Bloomberg NEF[5] have provided an analysis of practices adopted by countries and how they’ve been working. They include carbon taxes; market-based mechanism: cap and trade scheme and baseline; and credit scheme [6]. Interestingly, the USA like its tax system, have adopted a state scheme so there is no universal practice for the entire country.
Directors’ obligations
The Commonwealth Climate Law Initiative Primer on Climate Change: Directors’ Duties and Obligations [7] provides a jurisdictional review of legal opinions from around the world on how climate change will affect director’s duties and corporations.
According to the report, as at the end of 2020 there were globally, at least 1,550 litigation cases involving climate change brought about in 38 countries with a warning that “while only a few of these cases to date involve fiduciary duty or securities claims, this is likely to change as this field of litigation expands. Those fiduciary duty and securities claims that have been brought clearly show the risks to companies, and their directors, officers, from failing to incorporate climate change into strategy, oversight, risk management and disclosure.” [8]
The report should be read in full by the reader to see what jurisdictional requirements will be applicable to them. Japan, Malaysia, Singapore, and the USA have adopted more of a detailed approach in their laws and regulations, whereas the EU (in conjunction with additional measures adopted by each Member State) as well as Switzerland, only require disclosure obligations on the impact of corporate activity on environmental matters, if any, from large organisations. Whereas common law countries consider the expansion of director’s duty of care liability and case law. Brazil has voluntary initiatives and there is no current legal framework requiring directors to consider climate change matters.
However, consistent themes acknowledged were that climate change is a systemic risk that could have a major impact on the future financial performance or prospect of an entity; that this risk is foreseeable therefore relevant to directors and companies taking positive action; and that regulators have increasingly become empathic regarding companies and directors needing to adopt climate resilience in governance and disclosure. Recommendations for each jurisdiction are provided further in the report.
Dealing with Climate Risk
There should be an expectation of not if, but when?[9] Whatever measures have been or will be adopted, consider them as the opposite of royalties, user pays to their detriment.
The direction of policy adopted by a country will be dependent upon what is the intended role of carbon pricing. Is it to drive emission reduction; to drive the permanent deployment of low carbon technologies; or a national carbon market?[10]
Expect that carbon pricing will not be enough and that most jurisdictions will also implement a range of other policies designed to promote decarbonisation.[11] This will be an evolving and dynamic area, so too will be the effects on wealth creators, companies, employers, employees, and consumers.
Insurance prices are surging or may no longer be available for some assets as the global insurance sector incur losses. [12] This will be the new norm.
How will businesses, assets or investments be impacted physically and financially by climate change as well as laws and regulations. Is it time to make changes?
Consider the duties of directors and trustees in managing climate risk. How will it affect the governance of companies and trusts, and decisions being made by boards and trustees on asset management? [13]
How can directors and trustees discharge their duties adequately? Consider jurisdictionally both situs of the company as well as assets. Do they have a climate change investment strategy for its portfolio of assets?
Climate change litigation is now a real risk. Be prepared for retrospective liability.
ESG is being legislated and regularised for much faster in some parts of the world such as Europe compared to others. It will be a governance matter for boards to consider especially in relation to cross boarder business. Take care of what commitments are being made and if they can be met. Green washing and blue washing are litigation risks.
A variety of commitments and measures are being undertaken by countries. The extent and enforcement will be country dependent. Will climate efficiency become the next tax efficiency.
How far-reaching measures will be undertaken to meet that climate target? Will a universal practice be adopted like the OECD Global Anti Base Erosion Model Rules establishing a global minimum effective corporate tax rate of 15% to MNE; or will non compliant countries be blacklisted to prevent carbon leakage?
Finally, it would be prudent to add climate risk to your due diligence before making any decisions or commitments in relation to asset management and acquisition.
Privacy and confidentiality
There are other risks worth considering that previously were not an issue.
Privacy and confidentiality in financial affairs no longer exist. The abuse of bank secrecy and tax avoidance by a few now require tax transparency from all.
At first it started with the USA requiring overseas banks to report on US persons acquiring international credit cards, then moved on to Foreign Account Tax Compliance Act (FATCA). Thereafter similarly, Common Reporting Standard (CRS) was adopted by the rest of the world. Initially both FATCA and CRS required the reporting of financial accounts held in countries other than the person’s country of residence. However, the OECD are now looking at extending CRS to apply to cryptocurrency and real property. The EU have various Directives on Administration Cooperation (DAC) which are constantly being expanded; as well as beneficial ownership registers applicable to trusts and companies. Some countries require this information to be available publicly where journalist and ‘interested parties’ have unfettered access to this information, or only by a country’s tax authority. Gone are the days when any interested party including the police, were required to make an application to the courts to get access to such private information.
Since its inception, there has been a data breach of gathered CRS information.[14] It’s likely that information gathering will get wider and could get into the wrong hands if not managed properly by the government collecting it. It would therefore be prudent to consider, which countries have governments that can be trusted to keep the information safe and not to misuse it when considering situs of assets and residence of family members. Also consider your family’s use of social media. How much of such information do you want in the ether permanently? Old money has traditionally always kept a low profile.
Political risk and the rule of the law
Ownership of assets globally comes with inherent risk. Is the private ownership of assets protected both under domestic and international law? How strong is the rule of law of that country? Is a country legally able to expropriate assets within its borders? To what extent does a country have independent sovereignty to determine its own future? To what extent can international treaties be relied upon? To what extent could the long arm of a jurisdiction apply in another jurisdiction?[15] The USA and increasingly the EU, exercises extraterritorial jurisdiction over anyone who may do business intentionally or unwittingly with a country or person on a sanctions list. Foreign banks, institutions, businesses, and people can now be blacklisted and deprived of their property without due process.
Always have the expectation that a friendly jurisdiction can become unfriendly at any time, and the laws and regulations applicable when first making an investment or doing business can also change. The same also applies to legal claims and lack of due process. The riskier the country is, the more pertinent it is to have an exit plan, particularly when it comes to structuring. Try minimising risks attached to situs of assets particularly if they cannot be moved so easily when located in at risk countries. This applies not only in the home country but also to other jurisdictions. Therefore, choose your jurisdictions wisely.
There is no such thing as having too much information
A risk that can often be overlooked is not having the right information at the right time and acting upon it in a timely manner. Being well informed is being forewarned and/or provides opportunity.
For the Rothschild family, Mayer Amschel Rothschild and his five sons started what is now a 200-year-old wealth legacy. An example of extraordinary talent in creating wealth and preserving it across generations. Their success has been attributed to several things by several authors. However, what is notable is that they’ve always kept a low profile, are practical and self-aware and have always been well informed. “They love to glisten by only in camera for and among their own kind. Today the family grooms the inaudibility and invisibility of its presence, so little is left except a great legend be their public relations.”[16]
Staying ahead of the game
Back in the day, Mayer Rothschild and his family operated a rather clever courier messaging system by horseback across the European Continent, relaying vital and important information about opportunities and risks to other family members, giving them an advantage that others lacked. The world of course is different now as things occur at a much faster pace. Information overload coupled with attention diversion can lead to inefficiency in asset management, making it difficult to stay ahead with what’s impacting wealth.
Thomas McCullough, Chairman and CEO of Northwood Family Office[17], identified a common family scenario “significant wealth, an active business, liquid and illiquid assets, a complex structure, multiple unrelated advisors, significant administration, growing complexity, no clear strategy, no clear leader, multiple family issues (including older and younger generations) health concerns, a desire for freedom and frustration with all the oversight required.”[18]
McCullough says that over the past several decades there has been a need to address the complex needs of a family if there is no one within it allocated with this role. The traditional service models are more siloed and product orientated, lacking central strategy and the recognition of the dynamism of a family, leading to the rise of an integrated adviser. The USA has seen a surge in such advisors. These advisors provide professional management and oversight. Developing a plan, coordinating the project, and ensuring the family’s goals are met. They have skills and experience in a wide range of disciplines that are important to families of wealth. More importantly, they are impartial and objective, focusing on the family and not on a particular product or service they sell and “they must be able and willing to evolve and stay current on a wide range of topics, most of which are constantly changing geopolitics, the economy, capital markets, personal tax, estate law, philanthropic trends, succession planning strategies, the health of the family system, individual family member needs, family engagement practices, and more.”19 He says they won’t be an expert in all of them, but there must be some basic awareness and fluency in the topics and the ability to spot issues of concern and find help and integrate them into the overall client strategy.
Families and family offices should consider how they can be more efficient in their asset management; and how they can stay ahead of what’s impacting their wealth, including climate, political and privacy risk which is unpredictably predictable right now. Whatever methods are adopted, stay well informed of all potential risks to wealth and have the ability to make changes when required and in a timely manner. Risks to wealth and regular due diligence in an ever-changing landscape that should never be underestimated.
What next? It all starts with a conversation to explore possibilities and cover some questions you may have, and from there, together we build a plan info@elloraprivateoffice.com.
[1] IMF/OECD (2021), Tax Policy and Climate Change: IMF/OECD Report for the G20 Finance Ministers and Central Bank Governors, April 2021, Italy, www.oecd.org/tax/tax-policy/imf-oecd-g20-report-tax-policy-and-climate-change.htm
[2] According to the UN carbon pricing works by capturing the external costs of emitting carbon - i.e. the costs that the public pays, such as loss of property due to rising sea levels, the damage to crops caused by changing rainfall patterns, or the health care costs associated with heat waves and droughts - and placing that cost back at its source.”
“Carbon Pricing effectively shifts the responsibility of paying for the damages of climate change from the public to the GHG emission producers. This gives producers the option of either reducing their emissions to avoid paying a high price or continue emitting but having to pay for their emissions”. https://unfccc.int/about-us/regional-collaboration-centres/the-ciaca/about-carbon-pricing#How-does-carbon-pricing-work?
[4] “More stringent carbon pricing policies or equivalent policies will be needed for countries to reach their nationally determined targets,” Page 24 IMF/OECD (2021), Tax Policy and Climate Change: IMF/OECD Report for the G20 Finance Ministers and Central Bank Governors, April 2021, Italy,
[5] Bloomberg NEF Carbon Pricing Demystified Key Trends and Lessons Learned by Victoria Cumming, September 20, 2021
[6] Ibid Page 7 “Looking at major emitters, nine of the 19 individual member countries of the G-20 have implemented at least one carbon-pricing program (France and Germany have two), while the U.S. has state level schemes in California and Northeast/Mid Atlantic. These schemes vary considerably in scope, meaning they share of national emissions covered ranges from 8% (the U.S.) to 85% (Germany). Overall, a third of G-20 countries’ greenhouse-gas output are subject to a carbon price.”
[7] The Commonwealth Climate Law Initiative, Climate Governance Initiative, Primer on Climate Change: Directors’ Duties and Obligations, In Support of the Principles for Effective Climate Governance, June 2021
[8] Ibid page 23
[9] Ibid page 9 “carbon taxes are likely to apply to more sectors than market-based mechanisms. Of the carbon pricing policies in force today, taxes cover an average of four of sectors (electricity/heat, industry, transport, agriculture) compared with two emission trading schemes. This could be because fixed price systems tend to be simpler from the perspective of administration and compliance. In contrast, governments often launch emission trading in a few sectors then extend the scheme to other areas. Power and industry are the most common starters: these tend to be the biggest emitters and comprise fewer compliance entities compared with transport or buildings for example. This is one reason why new Zealand’s program has yet to be extended to its biggest emitter- agriculture. Transport is increasing its share of emissions as the power sector is decarbonised through renewables. This has spurred governments to look at how to put a price on the sector -which like agriculture- comprises many point sources. In the case of transport and indeed, building heat, the program typically applies to the fuel retailers or suppliers.
[10] Ibid page 13
[11] Ibid page 14 “only 4% of global emissions are covered by carbon price high enough to limit global warming to 2 degrees. An explicit carbon price of $40-80 per metric ton is needed by 2020 and $50-100 by 2031 in order to limit global warming to 2 degrees above pre-industrial levels by the end of the century, according to the World Bank’s High-Level Commission on Carbon Prices 2017 report. Even at these levels, carbon pricing alone would not be enough to achieve this target of the Paris Agreement: other policy support will be required such as measures to promote the development of new technologies, provides revenue stability so projects can secure cost-effective financing, and ensure that the required infrastructure is in place.
[12] Financial Times: Lloyd’s of London Warns Insurers Climate Change- Related Pain is Still to Come, Ian Smith October 22 2023, https://www.ft.com/content/44cc0731-e863-468a-a6b7-f55e4d28e90d
Bloomberg: Florida’s ‘Last Resort’ Property Insurer Is Now State’s Biggest, Saijel Kishan, August 11, 2023. https://www.bloomberg.com/news/articles/2023-08-10/hurricane-season-2023-florida-s-biggest-property-insurer-is-nonprofit-citizens?sref=vllWFA1z
[13] Commonwealth Climate and Law Initiative, Climate Governance Initiative. Primer on Climate Change: Directors’s Duties and Disclosure Obligations. In Support of the Principles for Effective Climate Governance, June 2021.
[14] Data breach was reported on the Bulgarian National Revenue Agency holding this CRS information. This breach compromised the personal, tax and social security information of four million Bulgarian citizens.
[15]This net capture is increasingly becoming wider as can be seen by litigation case outcomes. England and Wales, and USA being the most notable.
[16] Pg 27 The Rothschild A Family Portrait by Frederic Morton.
[17] The Rise of the Integrated Advisor, The Journal of Wealth Management Volume 26|Number 1 Summer 2023.
[18] Page 2 ibid