One of the big challenges of international financial regulation is the existence of offshore financial centres. Concerns focus on money laundering, financing of terrorism and the hiding of fortunes of kleptocratic rulers. A recent study for the Tax Justice Network, an anti-tax haven pressure group, drew the attention to the enormous wealth hidden from the world’s tax authorities in these places and related consequences.
Generally spoken offshore centres offer preferential treatment such as low or zero taxation and high financial privacy to foreigners helping them attract financial business and high-quality professionals and support personnel. As I wrote elsewhere:
Financial activities undertaken in offshore centres include
– international banking. Most banks located in offshore centres are branches or subsidiaries of international banks. Many are specialised in private banking, offering services such as asset management, estate planning, foreign exchange trading and pension arrangements for wealthy clients.
– collective investment schemes such as mutual funds and hedge funds. Related activities are asset allocation and management, fund distribution and administration, custodian services and back-office work.
– There are many special purpose vehicles (SPVs) registered in offshore centres which are established by both financial and nonfinancial corporations. While the former use the SPVs mainly for securitisation purposes, for nonfinancial corporations they have the advantage of lowering the cost of raising capital.
– Insurance business is another niche exploited by offshore centres. In particular, as a consequence of innovative regulatory and legal environments, some have attracted a large share of the world’s reinsurance market.
– Still another service offered by offshore centres is asset protection, including trusts. Among the reasons why assets are managed in these centres are protection from weak domestic banks or currencies, tax avoidance and protection from lawsuits in the home jurisdictions.
– Loose financial regulation and supervision provides incentives for a whole range of criminal financial activities of which money laundering and the financing of terrorism attracted a growing international attention in recent years.
Some jurisdictions “specialize” in different types of taxes or different categories of clienteles, but there is also regulatory and tax competition between centres.
In 1998, the OECD launched a global initiative to improve financial transparency. Its report lists four criteria for identifying a preferential regime:
– The regime imposes low or no taxes on the relevant income from geographically mobile financial and other services activities;
– it is ring-fenced from the domestic economy;
– it lacks transparency and regulatory supervision or financial disclosure are inadequate;
– there is no effective exchange of information with respect to the regime.
After a rather modest start, the initiative gained momentum with the establishment of the Global Forum on Transparency and Exchange of Information for Tax Purposes after the G20 Summit in London in 2008. The task of the Global Forum is to promote the effective implementation of an internationally agreed standard on transparency and information exchange. It is served by a self-standing, dedicated Secretariat based within the OECD.
The Global Forum has developed a peer-review mechanism based on the following Terms of Reference.
Source: Global Forum.
While the initial OECD report identified 47 countries as tax havens, the current list is much longer. So far the Global Forum has completed 59 peer reviews, 17 of which examined both the legal and regulatory framework (Phase 1) and practical implementation (Phase 2). More than 40 additional reviews are expected to be completed by the end of 2012 and approximately another 40 Phase 2 reviews by the end of 2013.
Efforts concentrate on jurisdictions rather than countries. To cite the Tax Justice Network:
The term jurisdiction is used … generally in this context … to describe any territory with its own legal system, regardless of whether it is an independent or sovereign state; it may be a component of a federal or confederal state (e.g. Dubai), a dependent, associated or overseas territory (e.g. Cayman Islands, Isle of Man); or an internal zone to which a special legal regime has been applied (e.g. Labuan).
Beside the usual suspects such as the Bahamas or the Cayman Islands lists of tax havens and offshore financial centres include many places lesser known in this function some of which have few sources of income outside financial services. Some of them are not far as this map of European offshore centres illustrates:
1 Isle of Man, 2 Dublin, 3 Guernsey, 4 Jersey, 5 Luxembourg, 6 Switzerland, 7 Liechtenstein, 8 Monaco, 9 Andorra, 10 Gibraltar, 11 Malta, 12 Cyprus.
Source: Reszat 2005.
Not included in the map are countries such as Finland, Germany, Sweden and others which were identified for one reason or another as potentially harmful preferential tax regimes by the OECD 2000. Another European offshore centre which is missing in the map is the City of London. In a recent article in the New Statesman, Nicholas Shaxson described vividly how over centuries “sovereigns and governments have sought City loans, and in exchange the City has extracted privileges and freedoms from rules and laws to which the rest of Britain must submit.” (See for the historic roots of the privileges also Inwood 1998.)
Shaxson sees the City as “the centre of a big part of the modern global offshore system …, of a great, secretive financial web cast across the globe,” each of whose sections – the individual havens – is trapping passing money and business from nearby jurisdictions and channeling them to the City. The following figure illustrates his idea:
There is an inner ring around the City of London which is formed by the Crown dependencies of Jersey, Guernsey and the Isle of Man with their focus on European business. A second ring of the web contains the British overseas territories such as the Cayman Islands and Bermuda. To cite Shaxson again: “Like the Crown dependencies, they have governors appointed by the Queen and are controlled by Britain in myriad ways, but with enough distance to allow Britain to say ‘There is nothing we can do’ when it suits.” The outer ring of the web includes financial centres such as Hong Kong, Mauritius and the Bahamas which are not controlled by Britain but strongly linked to the City otherwise.
All in all, the list of achievements of the Global Forum is impressive. But many observers consider the factual progress made so far in the taxation of offshore wealth as insufficient as the above-mentioned study for the Tax Justice Network indicates:
The Network suspects that trillions of US dollars in assets hidden in these places are not taxed. Its estimates of the amount of assets range from $21 trillion to $32 trillion. Heather Stewart from the Guardian summarized how these estimates were derived. Figures for offshore deposits from BIS statistics were “scaled up” according to the share of cash “usually” held in large investors’ portfolios. The results then were “corroborated” by estimating cumulative capital flight from national accounts of more than 130 countries over 40 years and the resulting “likely” returns.
The quotation marks indicate my reservations. Given the underlying assumptions, and the way the results are derived, the reliability of the findings is hard to judge. As James S. Henry, the author of the TJN study admits: “… the estimates are subject to maddening, irreducible uncertainty.” One critic hints to a conceptual weakness: Just because money is in a place known as tax haven does not allow to conclude that tax has been evaded. As mentioned above, offshore financial centres undertake many different activities and the reasons why individuals and companies put their money there differ, too. Another author refers to the danger of sloppy miscategorisation which fails to make a distiction between transparent low tax jurisdictions and others that hide behind secrecy.
Having said this, there are few doubts that the numbers involved are huge. Getting a grip on the problem of tax evasion is a matter of utmost urgency in times of empty coffers and high public indebtedness. Furthermore, as Heather Stewart convincingly argues, many of the world’s poorest countries could probably have avoided indebtedness had they been able to tax their richest citizens.
What can be done? Firms in offshore centres are not out of reach. Many of them are part of the worldwide networks Andrew Haldane described in his super-spreader analogy. As Nicholas Shaxson writes: “Nearly every multinational corporation has offshore subsidiaries … – and the biggest users of offshore finance are banks. Financial Mail recently counted over 550 offshore subsidiaries just for Barclays, RBS and Lloyds … So, offshore is a big part of the Too Big To Fail story”.
A recent study by Dafna Avraham, Patricia Selvaggi and James Vickery from the Federal Reserve Bank of New York on bank holding companies (BHCs) in the United States gives an idea of the dimension of interwovenness: These days, parent holding companies control up to several thousand separate subsidiaries. There is a hierarchy of controlled entities. To cite a related FRBNY article:
This hierarchy … generally includes domestic commercial banks primarily focused on lending and deposit-taking as well as a range of nonbanking and foreign firms engaged in a diverse set of business activities, such as securities dealing and underwriting, insurance, real estate, private equity, leasing and trust services, asset management, and so on.”
The geographic reach of these constructs is breathtaking: Each of the seven most internationally active banks in the US controls subsidiaries “in at least forty countries” (Avraham et al., p. 66).
Banks are thus an important lever to lift the veil of secrecy. The three largest tax haven players are said to be UBS, Credit Suisse, and Goldman Sachs (Josh Harkinson, Mother Jones). But think of the UK example: What if the nations with the world’s biggest financial places are part of the game? Observers worry increasingly about the growth of “onshore-offshore” markets, in particular in the United States. The TBTF story of offshore centres is not complete without mentioning Wilmington, Delaware.
Wilmington is the largest city in the US state of Delaware with a population of about 70,000. Wilmington is a tax haven and, among others, home of Taunus Corporation, which up to 2011 was the eightth-largest bank holding company in the United States with assets of just over $380 billion (Simon Johnson). Taunus is a subsidiary of Deutsche Bank which in turn has about 2,000 subsidiaries and special purpose vehicles – 430 of which are registered in Wilmington.
End of 2011, Deutsche Bank caught the headlines with a restructuring of its US business in an attempt to declassify Taunus as a bank holding company in order to circumvent financial regulation and capital requirements. Those parts of the group which unavoidably require a banking licence were shifted into a banking group with modest $58 billion of assets, while the much larger part was transformed to an unregulated securities firm – a shadow bank.
(The German TV report on that matter (in German language), including a visit to the domicile of the 430 Deutsche Bank subsidiaries at 1209 Orange Street in Wilmington, can be watched here. Urs P. Gasche of the Swiss blog Infosperber provides a written summary.)
The irony is that at the time of business restructuring the then head of Deutsche Bank, Josef Ackermann, in his role as president of the Institute of International Finance (IFF) participated in international talks and summits on how to improve bank regulation.
Do not expect much progress on this front soon.