Friday, December 05, 2008On the Horizon

Susanna Henighan-PotterGlobal Pressures on the Financial Services Industry

The British Virgin Islands weathered the Organizaation for Economic Co-operation and Development’s Harmful Tax Initiative and the EU’s Taxation of Savings Directive. We have kept pace with regulatory requirements put forward by the Financial Action Task Force and others. And we have succeeded in protecting our reputation amid a period of bank failures and corporate corruption scandals.

Keeping the BVI’s financial services sector strong requires more than just staying in step with new products and legislative innovations. It requires more than keeping pace with our human resources and infrastructure. It also requires staying one step ahead of those who would like to see offshore financial centres shut down.

The global economy is constantly changing, and so are the political and regulatory threats to International Finance Centres (IFCs) like the BVI. Business BVI looks at three of the current trends which BVI must keep its eye on.
For the past eight years, the BVI and other IFCs have enjoyed a U.S. administration that espoused the benefits of tax competition and took a fundamentally hands-off approach to corporate regulation. Although some in Washington—especially the IRS and the Senate Finance Committee—have consistently pursued tax avoiders, President George W. Bush did not make it a high priority.

Early in his presidency, George Bush registered his disagreement with the OECD’s Harmful Tax Initiative. It was the death knell for an initiative that had already been damaged by the ‘level-playing field’ argument put forward by small countries like the BVI. Indeed, Bush embraced the view put forward by offshore finance centres and others that market competition – and therefore tax competition – is fundamentally good.

But that was then, and this is now. As Business BVI goes to press, the world is watching closely for the outcome of the U.S. Presidential election. IFCs like the BVI would be wise to do the same. Democratic candidate Barrack Obama has been a critic of tax loopholes and signed on as a sponsor to the “Incorporation Transparency and Law Enforcement Assistance Act” better known as the Stop Tax Haven Abuse Act. The law would require U.S. states to obtain beneficial ownership information on corporations formed under their laws, and to provide access to this information to law enforcement upon receipt of a subpoena or summons. The material impact of the proposed law on the BVI is not clear. It depends largely on how much business the Territory does with U.S. companies, and how those companies respond to the legislative changes. But the bigger point is that should Obama become president, and if the Democrats succeed in holding on to the House of Representatives and increases its majority in the Senate as well, the attitude in Washington could become more sceptical of offshore finance in general. IFCs could find themselves on the defensive.

Control by the Executive and Legislative branches of the US Government by the Democrats could also give the OECD strong United States support for its financial centres initiatives which it has lacked for the last eight years. This could essentially create an emboldened OECD to advance these initiatives.

During the summer of 2008, a taste of this new atmosphere was observed in two back-to-back Senate hearings. The first was about tax avoidance by wealthy Americans and the second was about the use of Cayman Islands companies by U.S. taxpayers. In both cases, the hearings resulted in headline news stories on major television networks and in newspapers, in which, almost without exception, international finance centres were the losers.

It’s yet to be seen, of course, if Obama or McCain will win the November election. And if Obama does, it is far from certain that he will succeed in his promised change agenda. Governing is, after all, not the same thing as campaigning. But clearly, the battle over policy begins in the debate and the voice of the international finance centres needs to be heard. Equally, wise governments and practitioners would keep a close watch on the U.S. horizon, and reach out quickly to whom ever takes over in November.

Across the Atlantic too, there is murmuring about the offshore world. As the pendulum swings from the business-friendly, boom years of the 1990s, to the lean anti-corporate era of today, there is a growing chorus which seeks to blame present economic woes on tax havens. Scandals such as the failure of the bank Northern Rock and the discovery that a special advisor to Gordon Brown profited from an offshore mortgage have caused the UK and European publics to become more suspicious of the offshore world. And tax authorities in the UK and other European nations are following the lead set by Germany in aggressively prosecuting citizens who stow funds in Liechtenstein, a well-known international finance centre.

In April, the UK Parliament announced a Treasury Committee inquiry into offshore finance and financial stability. A few months later, Rathbone Brothers, which does business in the BVI under the name Rathbones, announced it would seek a management buy-out of its offshore businesses “because of increasing political hostility to offshore tax planning.” In July the left-leaning Guardian newspaper summed it up with a headline: “Spotlight Falls on the Dark Dealings of Tax Havens”.

Clearly, the pendulum is swinging, and it is not in the direction that turns a blind eye to the offshore world. But there is a long distance between public comment and serious changes to the world’s financial and economic system. And as a number of observers have pointed out, while the UK may treat its own IFCs as a source of embarrassment, it has yet to signal a change in its traditional hands-off policy. As the Guardian article cited above observed: “The secret world of offshore financing, it seems, is the shadow bank system the UK government wants to ignore.”

There is some truth in this statement. The City of London itself might well be the largest IFC in the world, and any effort to truly curtail the so-called offshore world would have to address this fact. At the same time, the UK Government encouraged, or at the very least ignored, the development of IFCs in its own crown dependencies and overseas territories in the interest of getting them to be self-funding. Some would even go so far as to say that the UK encouraged IFC development in order to spur the growth of its own financial centre. When the view is broadened to include all of Europe, the situation becomes even more complex. This is because some of the world’s oldest and most successful IFCs—including Switzerland—are in the heart of Europe and rarely face the same negative press as IFCs in other parts of the world (the recent focus on Liechtenstein is a notable exception).

The difficulty for finance centres like the BVI is that the UK government has yet to demonstrate a willingness to make serious changes that would impact its own financial centre. But at the same time, it is willing to – in a sideways fashion at least – cast doubt on its own overseas territories. In November 2007, the National Audit Office published a risk assessment of the UK overseas territories, which identified perceived weaknesses in some territories’ regulatory and investigative infrastructure. In May 2008 a Public Accounts Committee report of the House of Commons also cast doubt on the ability of territories, including the BVI, to adequately regulate and investigate financial fraud. What is perhaps most frustrating about these reports is that tendency to, as one observer put it, “tar all overseas territories with the same brush” by insisting on grouping highly developed IFCs like Bermuda, the BVI, and Cayman Islands with undeveloped IFCs like Montserrat and Turks and Caicos Islands. It is an approach which is inconsistent and unfair.

In May 2008, the UK government published a preliminary draft of the European Union’s “white list” of jurisdictions said to have anti-money laundering regulations equal to that of the EU. An evolution of the “blacklist” that named and shamed, the innocent-sounding white list is actually more insidious. (It is, after all, more difficult to prove one’s innocence than to disprove one’s guilt.) The BVI, along with other UK overseas territories, were not on the EU’s white list, while Russia was. China and India were also excluded, and the UK Crown Dependencies were given marginal status. The EU insisted that it was only a preliminary draft, but that did not halt the criticism. The BVI’s International Finance Centre, the Society of Estate Planners, and some unnamed UK Treasury officials quickly rushed to criticise the list as ill-founded, poorly devised, and discriminatory. For the BVI, the lesson to draw from this event is that Europe is pressuring the UK to close down the IFCs in its territories and dependencies, and that some in Her Majesty’s Government may be listening.

The fundamental truth is that the UK government is being pulled in more than one direction when it comes to its treatment of territories and dependencies which are also major financial centres. There are forces lobbying for drastic action against IFCs. There are other forces working to preserve the UK’s own financial centre. And the public is looking for signs that the government will stop tax avoidance. It is easy to see that the viewpoint of the territories themselves and the BVI in particular, does not rank high on the agenda. Therefore, it is important for the BVI to be heard. It is also essential that local officials watch carefully and act quickly if the line between talk and action is crossed.

t is no secret that it has been a tumultuous ride for the world’s economy over the past 18 months. Bank failures in the US and UK, the spiralling cost of fuel, food shortages, mortgage melt-downs, and lagging growth in major economies has put everyone on edge. Add to that instability in the Middle East, fears over climate change, and the political uncertainty caused by the upcoming U.S. elections, and the world’s financial markets are jittery at best.

As much as politicians, business leaders, and regulators are looking for solutions to the present situation, they are also looking for someone to blame. And some fingers are pointing to offshore finance centres like the BVI.

The argument goes like this: international finance centres create financial instability because they create so-called “secrecy space” in the free market, which traditionally depends on transparency and equal access to information to function properly. Equally, it is argued, IFCs allow and even encourage regulatory avoidance, which by definition undermines safeguards put in place to serve the greater financial good.

Professor Ronen Palan and Dr Anastasia Nesvetailova of the University of Birmingham wrote in June that in the current mortgage crisis, secrecy afforded by so-called offshore finance centres allowed corporations to disguise debts, thereby creating a false illusion of liquidity. While Palan and Nesvetailova concede that regulators in the onshore economies failed to do their jobs, they conclude (rather feebly) that “OFCs are not making the task [of regulation] easier.”

Discussion such as this allows actual links—however tenuous—between offshore finance centres and failed corporations like Enron in the US and Northern Rock in the UK to be hijacked by the media and others, who are eager to apportion blame for financial failures which have caused real pain to investors, employees, and the economy on the whole.

So what is the right response from IFCs like the BVI, to the allegation that they lead to financial instability?
First, we must remind the world that time and time again, assessments have failed to find IFCs guilty as charged. In 2001 the Financial Stability Forum found that “IFCs, to date, do not appear to have been a major causal factor in the creating of systemic financial problems.” An Economist review published in 2007 concluded that IFCs, on balance, contribute positively to the global economy. Other reviews by multilateral agencies have also found evidence that IFCs are no worse (and are sometimes better) than onshore jurisdictions. (Even the US and UK themselves are only “partially compliant” with the Financial Action Task Force’s customer identification standards)

Second, we must argue that IFCs themselves have an interest in financial stability, since stability is necessary in order to achieve economic growth and development.

But the most important argument which IFCs, and in particular the BVI, have turned to increasingly hinges on competition. It is an argument which says that “financial instability” is a new name for an old fight – and that is the fight for business. In other words, “financial instability” is the new “harmful taxation”, a buzz-word that takes advantage of current fears.

In its own report to the UK Treasury Committee submitted in June, the BVI’s Financial Services Commission argued that concerns about “financial stability” and “transparency” are really about taxation and competition. The anti-offshore lobby is always led by “countries or associations of countries with which [IFCs] are in material competition in the field of financial services,” the FSC points out.

In other words, it is a bit like playing a game of football, where the referee is a member of the opposing team, and he makes up the rules as he goes along. In fact, the argument of a level playing field is one which the BVI has used to its advantage for many years and in many contexts. The longevity and effectiveness of the argument is evidence that what the FSC says is right: despite the evolving terms and cast of characters, attacks on IFCs are fundamentally about one thing – keeping back the competition.

So how does the BVI move forward in this climate of uncertainty, trigger-happy politicians, and fear? First and foremost, the BVI must remain vigilante to prevent the Territory from being used by criminals, terrorists or money launderers. It would take only one major scandal to seriously damage the reputation which BVI spent more than 25 years cultivating. The public and private sectors have long recognized this fact, and have worked together always to ensure it does not happen. Whenever possible, the BVI should be a step ahead of onshore counterparts in terms of regulation and information exchange.

But at the same time, it is not just about keeping your nose clean. The BVI needs to be canny. And it needs to be on the offensive. The David and Goliath argument that did serious damage to the OECD’s Harmful Tax Initiative back in the late 1990s and early 2000s still has currency. Today, there is a growing awareness that the old economic guard of Europe and America is ageing, while the economies of the so-called second such as the BRIC countries and even third worlds are rising. International finance centres like the BVI should be a part of this narrative.

The Territory must pay close attention to policy statements emanating from the US and the UK. A President Obama may bring a new approach to tax and financial oversight in the United States. Ears in the BVI need to listen very closely to the UK and Europe to determine if there is intent to shift away from the traditional hands-off approach as it relates to financial services.

The fight over the world of international finance is in many respects a battle of words and perceptions. And it matters where you stand, because experience has shown that this is a world where everyone fights for her piece of the pie.

The BVI must be forever watchful and always vigilant.

Beyond Offshore

In July, the International Monetary Fund announced that it would drop the distinction between “onshore” and “offshore” financial jurisdictions. In a statement, the IMF said that the distinction between offshore financial centres and other financially active jurisdictions has been blurred by globalization. The IMF decided that there should not be a separate assessment programme for so-called offshore jurisdictions.

The news was welcomed by many in the BVI, including Executive Director of the BVI International Finance Centre Mrs. Lorna Smith, who said, “We have long made the point that it is not a question of onshore or offshore, it is a question of sound or weak regulation and we are delighted that the IMF has recognised this.” She credited the work of the BVI Financial Services Commission as having contributed to the shift.

Indeed, the question of what to call financial centres like the BVI has vexed just about everyone who’s put their mind to it. Muddled definitions—and therefore double-standards—have been the Achilles heel of those who have sought to regulate or crack down on the thriving world of offshore finance.

The truth is that today, New York, Hong Kong and London carry out more “offshore” business than places like the Cayman Islands, the BVI, and Bermuda, and yet they are thought of very differently. Luxembourg, Switzerland, and Liechtenstein operate enormous financial services centres, yet they are not offshore at all -- they are in the heart of Europe.

In a recent report, the BVI Financial Services Commission suggested that the terms onshore and offshore have become (rightly or wrongly) stand-ins for distinctions between the developed and the developing world. “This characterization [offshore] does not affect institutions that belong to the developed world, generally referred to as ‘onshore’ and which in the main do not suffer from the negatives associated with the characterization of ‘offshore’, even though in reality they engage in the same types of business administered by the so-called offshore centres,” the FSC states.

The Tax Justice Network, a left-leaning group that seeks to stamp out tax avoidance and evasion, has its own definition of the term ‘offshore finance centre’. The Network says that OFCs are “the accountants, lawyers, bankers, plus their associated trust companies and financial intermediaries who sell services to those who wish to exploit the mechanisms the tax haven has created.” It’s a messy definition, but one which is honest about the links that exist between the “offshore” and “onshore” worlds.

For sure the terms “offshore” and “tax haven” are still heavily used. But there is no doubt that there is a trend away from their use. It can be counted as a major victory for the BVI.

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