The façades of risk

It is no secret that the family office (FO) world is growing. This growth is shown both in terms of the number of new FOs being established and in FOs aggregately growing assets under management across the board and the world.

With the prolonged growth of FOs since the early 2000s has come increased sophistication, with specific investment experts and professional services individuals of the highest calibre being brought in to run FOs valued at billions of pounds in the past five years. Staff costs now account for approximately 70 per cent of FO total costs and 60 per cent expect this to increase in 2023.[1]

In these times of economic and political uncertainty, a key role of the FO executive is to react to changes happening around them in the best interests of the principals they represent. This can include changes in the need for and type of governance and compliance; investment approach and policy; liquidity planning and overall structures for the principals.

With the above in mind, and the age-old fact that no one wants to make a decision blindfolded, there has become a growing desire for information and the need to have it all to hand to manipulate, extrapolate, analyse and scrutinise.

To compound the above, we live in a world where governments and tax authorities communicate more than ever. In times of recession, tax authorities around the world are under pressure from governments to collect more tax and reduce the leakage from deliberately and inadvertently incorrect taxpayer reporting. Therefore, we are seeing not only more information exchange but also tax authorities (not only in the UK) acting on that information.

Finally, to add to the mix of the above, information is often easy to get hold of in the world of social media and instant reporting. It is no wonder then that more information is finding its way into the wrong hands more often.

These elements circulate to form a perfect storm of data exchange for FOs, with many façades of risk relating to data and information exchange. Is this a good, bad or necessary thing? And can we do anything about it? Perhaps the best way to answer those questions is to look at each type of information exchange separately.

Information within one’s control

Compounding the risk versus information at one’s fingertips

The author refers to ‘information within one’s control’ to mean information that an FO choicely harnesses. This is usually performance and reporting data that is put together by the FO itself or its professional advisors.

The growth in this type of data creation has been exponential for two reasons. First, FOs are being run by younger generations who want information at their fingertips. They want to be responsible for the FO and the investments and decisions they make. To do that, they need data.

Technology is playing a part in accessing that data. Advisors spend much of their time working with FOs to build information platforms to allow FO executives, advisors and family members to access information on tablets and smartphones. This type of information can be manipulated in a way that is suitable to make crucial decisions for the family.

For example, upon the Russian invasion of Ukraine, one could ascertain what investment exposure the FO had to Russia. It might be clear what the value of Russia-based assets is from looking at public market portfolios and bank accounts. But, in the context of the worldwide estate, can it be confirmed what percentage the Russian assets make up? Having a holistic technology platform to provide up-to-date values for residential and commercial real estate, art, currencies, public and private equity markets, as well as other luxury assets, means an FO can understand its exposure within 24 hours and act with full knowledge.

The above example is perhaps a little severe, but serves to prove a point that, particularly with the influx of the ‘next generation’ of FOs, this type of information exchange is pivotal for business.

The risks associated with this type of data are reasonably clear: relying on security of third-party platforms, human error, additional people in the chain leading to higher exposure to the risk of data theft, as well as incorrect data being used. However, it is also clear to see the progress the FO can make with such sophisticated tools at its disposal. It is therefore arguable that the additional information exchange risk is worth taking.

Information outside of one’s control

The known factors

Separate from known and purposeful information exchange, there is another façade of data risk that comes from the increase in tax authorities prying into taxpayer information. Reporting obligations for people and entities across the globe have become more complex, comprehensive and intrusive. In the UK alone there are trust registers; the Register of Overseas Entities; personal, company and trust tax returns; company accounts; company confirmation statements and ‘people with significant control’ registers; property registers; and countless other forms of submissions that must be made to the government. Further, the penalties for misreporting or failing to report have been increasing with the introduction of His Majesty’s Revenue and Customs’ (HMRC’s) Failure to Correct regime for ‘offshore [outside the UK] matters’ from 2016;[2] the announcements for HMRC ‘tax crackdown’ resources in successive recent budget announcements;[3] and GBP30.8 billion being collected through compliance activities in 2021–2022 (up 1.1 per cent compared with 2020–2021).[4]^,[5]

This data gives another façade of risk relating to the possibility of incorrect reporting, giving rise to the FO executives losing time, professional fees and lost funds through tax, interest and penalties.

In the UK, we see what HMRC refers to as ‘one-to-many’ letters (what most tax practitioners refer to as nudge letters) by their droves sent to taxpayers and advisors across the UK. The letters typically allege that HMRC has information about non-UK income that has not been reported correctly on their tax returns. This is usually incorrect, but such letters require the taxpayer to take care in their replies. Ensuring their responses to these letters are accurate, clear, complete and factual will prevent the taxpayer from inadvertently entering into a time-consuming and costly process of back-and-forth with HMRC.

This form of data exchange is not an option, so there is no need to appraise whether it is worth it or has value for money, but it is worth noting that it can give rise to some severe consequences if not taken seriously, with FOs spending more time and resources than ever on making sure administration and reporting are done correctly, particularly internationally.

Information outside of one’s control and knowledge

The last façade of information exchange is that of information exchanged without the knowledge or intention of the FO itself.

This tends to come from data breaches and hacks, such as disgruntled employees acting out or important paper documents being left in public. However, there is also an element of risk from information being exchanged between well-intentioned tax authorities without the knowledge of the FO and often with incomplete or wrong information.

These information losses cannot, to an extent, be helped (other than by meticulous data security measures). However, the 360-degree exchange of information between tax authorities and governments may lead to unwanted attention from tax authorities, which can be helped. Although it is not always clear what information is, or may be, exchanged, it is vital that the information produced is correct and complete so that the risk of the wrong information falling into the hands of tax authorities from one country to another can be minimised.

The reality is that, as we move into a new information age with machine learning and artificial intelligence, the data that is transferred between machines and humans will only increase. The best advice would be to embrace it, ensure that it can be controlled and be meticulous with what information is fed into the machines to start with.