In the face of ever-increasing regulation and international scrutiny, offshore financial centres face a stark choice – adapt or die. Paul Golden delves deeper.
Much has changed in the offshore financial centre (OFC) universe since the G20 started to crank up the pressure on so-called tax havens in 2009. Double taxation agreements and tax information exchange agreementsare increasingly commonplace and the findings of thelatest Global Financial Centres Index (covering the first half of 2013) suggest that this scrutiny is taking its toll.
The surveyreported a higher disparity in con?dence among the 80 surveyed locationsduring the second half of 2012 and the first six months of last year compared to the previous 18 months.
Looking for alternativesA number of jurisdictions are looking beyond finance for the next profitable service. Mauritius has aspirations to become an international arbitration centre for commercial disputes, while the soon-to-open Health City Cayman Islands facility will eventually bring a 2000 bed medical tourism hospital to the islands.
Professor Jason Sharman, an Australian academic whose research focuses on money laundering and tax havens, says OFCs in Europe and the US have suffered from an erosion of secrecy. "For US customers of almost any OFC there is less secrecy thanks to unilateral measures such as the Patriot Act and Fatca, as well as bilateral deals and high profile enforcement actions against foreign firms assisting US taxpayers to evade taxes at home. For EU citizens, centres within the EU, dependent territories (Channel Islands, Caymans) and Switzerland and Liechtenstein are much less secret than they used to be on account of the Savings Tax Directive and OECD bilateral tax exchange information agreements."
According to Professor Sharman, European – and to a lesser extent US – clients could still maintain secrecy by using shell companies or other legal arrangements to obscure their ownership of a particular asset or income stream."With only a few exceptions, European and US OFCs also still provide pretty tight secrecy for citizens of countries outside the OECD. The efforts of clubs like the OECD have been directed much more at protecting their own members’ tax bases than stopping tax evasion per se."But he describes the decision by the Financial Action Task Force (FATF) to make tax evasion a predicate crime for money laundering as a blow against secrecy. "This means that the whole anti-money laundering apparatus is potentially available for pursuing tax crimes and it seems likely that this will increasingly be exploited by US and European authorities in the future."
Regulatory restrictionsAdditional regulation is inevitable for all jurisdictions according to Cindy Scotland, managing director of the Cayman Islands Monetary Authority (CIMA)."Financial regulation is in a constant state of change, driven largely by international standards setters. Jurisdictions with well-established financial sectors that are highly compliant with international standards are likely to continue to thrive, while those that already find the international regulatory environment burdensome will likely see some fallout from increased regulation."
The right amount of regulation would enhance the reputation of the offshore industry, for example by creating a uniform approach to creating public registers of beneficial ownership. But this will be very difficult to achieve, admits Jonathon Clifton, managing director Offshore Incorporations Asia, not least because sovereign nations have the right to determine what is best for their own national interest.
Instead of trying to ‘stem the tide’ of regulatory change, he advises offshore jurisdictions to work together to influence the future direction of regulatory reform.
"Our research has been pointing to the future lying in ‘mid-shore’ jurisdictions such as Hong Kong, Singapore, Cyprus and Malta that display characteristics of both offshore and onshore jurisdictions. That said, I don’t think it is a zero sum game and any increase in usage or popularity doesn’t necessarily equate to a decline in the traditional offshore jurisdictions. We see many structures involving combinations of Hong Kong, British Virgin Islands and Cayman, for example."
Timothy Ridley, who has practised as a Cayman attorney-at-law for over 30 years and is aformer chairman of CIMA, claims additional regulation will lead to increased costs and bureaucracy for clients and OFCs alike, leading to consolidation among service providers "and the elimination of low end business that will seriously impact the smaller centres."
He says it is ironic that those who heavily criticise bank secrecy are the same people who clamour for enhanced data privacy laws. "People are entitled to privacy rights that extend to cover medical, financial and other personal information. Such rights are and should be subject to limitations in the case of legitimate law enforcement, extending to cross border assistance using appropriate and controlled gateways."
In each jurisdiction, the motivation to change will depend on the size of the financial services sector relative to the rest of the economy, says Scotland. "Traditionally, institutions (banks, insurance companies, investment houses) have been licensed, while instruments and individuals have been given other forms of recognition, such as registration. Given the global nature of financial services, consensus will eventually develop with respect to the institutions, instruments and individuals to be licensed or to be otherwise authorised."
She rejects the view that offshore service providers have helped to create a negative perception of offshore financial centres by implementing complex structures for their clients.
According to Josh Simmons, policy counsel at Global Financial Integrity, the negative perception of offshore financial centres is not necessarily the result of the complex ownership and financial structures employed there, but rather a consequence of the indiscriminate use of those structures for both licit and illicit purposes. "Many service providers in offshore centres fail to do any reasonable amount of due diligence on their clients and many deliberately look the other way while accepting laundered money."
He adds that the private banking industry is undergoing changes due to global policy shifts on issues such as automatic exchange of tax information and beneficial ownership transparency. "We have seen anecdotal evidence that a lot of money has been moving to Singapore, Hong Kong and other Asian financial centres from Europe as a result of the perceived weakening in the bank secrecy regimes of established tax havens, as well asthe emergence of Asian economic giants like China and India."
While Switzerland is often mentioned as the European jurisdiction that has lost most from the move towards Asian OFCs, a spokesperson for the Swiss Bankers Association says assets under management have not changed significantly in recent years.Ridley believes there are opportunities for smaller OFCs that can quickly take advantage of opportunities, while Scotland reckons international financial centres in Asia will benefit directly as more of the world’s wealth is concentrated in the region. "The growing economic power of emerging economies is creating opportunities for the export of financial services generally," she says.
Simmons observes that private bankers who fulfil their due diligence obligations, ensure that the money they handle does not have illicit origins and comply with all applicable laws have no reason to feel threatened or impinged upon.
But he also states that the value of banking secrecy is often conflated with the value of banking privacy and warns that the financial crisis demonstrated just how low the value to a host country of operating an offshore financial centre really is.
"When tax havens adopt policies to attract foreign money as a way of growing their economy, they are actually making a huge gamble. When the global financial system faces a sudden liquidity freeze like the one that kicked off the financial crisis, those financial flows quickly halt and tax havens are left with nothing."
Emerging offshore opportunitiesThe Jamaica International Financial Services Authority (JIFSA) is convinced that there is room for another offshore financial centre in the Caribbean. Speaking at an event in January, JIFSA chairman Eric Crawford referred to research suggesting that international financial services could generate annual revenue of up to $300m and create as many as 15,000 jobs on the island.
Significantly, he also acknowledged that the era of secrecy was over as the importance and influence of the OECD’s Global Forum (of which Jamaica is a member) continues to grow.
John Spellman, head of finance at the Isle of Man Department of Economic Development explains that the clear direction coming from the EU and G8 is that further rules to address sham structures are on the way. But he says it is an "unfortunate misconception" that offshore financial centres have created complex structures and that they are often created at the instruction of tax advisors and those who architect tax shelters to benefit from permitted activities.
When asked whether it is inevitable that the activities of offshore service providers will eventually be licensed, he points out that the main offshore jurisdictions regulated their service providers many years ago (1985 in the case of the Isle of Man). "Frankly, it is the onshore and often major jurisdictions that are years behind the pace but are loathe to accept that fact."
Spellman sayscomplexity and compliance costs are driving down the number of potential OFCs ("Those who will be successful need to implement consumer protection, appropriate legislation, international standards of regulation, a choice of professional advisers and political and fiscal stability") and warns that those who move eastin an attempt to avoid reporting will be sorely disappointed.
"The world is shrinking and the same levels of compliance and transparency will ultimately be implemented in all reputable centres," he concludes.