Emerging World Governance: What Does it Mean for International Financial Centres?

Political control of the global economic agenda has accelerated as governments collaborate following the recent financial crisis. The G8 and the G20 are the key fora for cooperation. France chairs both organisations in 2011.

Small international financial centres (IFCs) were on the agenda at the April 2009 G20 Summit, hosted in London by the UK as chair. Seeking domestic political advantage PM Gordon Brown, with firm support from France, proposed harsh action against ‘tax havens’. China kiboshed the Anglo-French plan at the 11th hour, providing a cliff-hanger reprieve for the offshore world.

In 2010 G20 summits were hosted by Canada and South Korea. Neither displayed much interest in challenging small IFCs. France is back. Will it renew and succeed with its call for tough action against IFCs?

This piece reviews the structures and tensions in the nascent world governance process, considers France's domestic agenda for world's IFCs and concludes by examining French leverage to secure support within these organisations for its agenda.

Both G8 and G20 had births catalysed by economic emergency. G8 had its origins in an informal meeting of US, Japanese and European leaders convened during the recession which followed the 1973 oil shock. The original group of six countries (France, Germany, Italy, Japan, the United Kingdom, and the United States) were joined by Canada (in 1976) and Russia (in 1998), forming the G8. The G8 heads of state meet at ‘summits’ held annually in June, while G-7 finance Ministers and central bank governors continue to meet without Russia three times a year. The presidency rotates annually. Canada held the G8 presidency in 2010. France is the 2011 chair, followed by the US in 2012.

G20 was formed at finance minister and bank governor level in September 1999 during the Asian financial crisis. G20 is comprised of 19 "systemically important" countries plus the EU. Spain and the Netherlands have attended as invitees, though the Netherlands was not invited to the Seoul summit (in November 2010) as Europe was perceived as overrepresented in the forum. The IMF Managing Director and the World Bank President also attend as ex-officio members.

Membership of G20 is fixed and exclusive without any organisational aspiration to universal membership. The G20 claim to legitimacy in making rules for which it seeks universal application rests on members’ representation of two thirds of the world's population and 90 per cent per cent of global GDP (75 per cent per cent if one excludes the countries represented indirectly through the EU). Small financial centres are not represented, despite controlling 8.5 per cent per cent of the world's cross-border assets (according to recent IMF figures). The G20 represents a laudably expanded membership, though it is careful to consult widely to limit perceptions that it has created a "new exclusion" for those unrepresented around the table.

G8’s claim to exclusive control over the global agenda diminished when G20 met (for the first time) at head of state level, in a summit convened in Washington in November 2008 during the recent financial crisis. A second G20 summit followed in London in April 2009 and a third was convened in Pittsburgh in September 2009. The Pittsburgh meeting concluded with a declaration from the heads of state proclaiming G20 "the premier forum for our international economic co-operation". With this assertion, control over the world economic agenda moved from G8 to G20.

G20 reflects a shift of growth and power from advanced to emerging economies. BRIC leaders had been invited to meet G8 heads of state informally on previous occasions after G8 sessions concluded. By 2008 their voice was central to global decision making; the four BRICs were on target to deliver 61 per cent per cent of world economic growth over the next eight years (as against a forecasted 13 per cent per cent from G-7).

G20 is much less homogeneous than G8. As the risk of the world economy capsizing recedes, so does the "fellowship of the lifeboat" within G20.  Tensions between mature dominant countries and energetic new entrants are manifest in many areas.  France finds itself steering organisations where members are increasingly conscious of disparate national interests and less inclined to engage in common enterprise without clear domestic benefit.

The leaders’ declaration following the November 2010 Seoul Summit was moderate on IFC issues. The communiqué did not link "non-cooperative jurisdictions and tax havens", a phrase which routinely popped up in previous summit declarations. Seoul spoke only of "non-cooperative" jurisdictions, reflecting IMF conclusions that the leading small tax neutral platforms in the world are highly regulated. The phrase "non-cooperative jurisdictions and tax havens" confuses lax standards with tax neutrality. These are two very different concepts, sensibly decoupled at Seoul.

President Sarkozy spoke at the press conference marking the start of the French year at the end of the Seoul summit. He included "the moralisation of capitalism, strict surveillance of trade profits, and stringent surveillance of tax havens" on his agenda.

France inherited a clear mandate from Seoul “to prevent non-cooperative jurisdictions from posing risks to the global financial system”. To this end, three tasks were given to France:

(i)         Review Financial Stability Board work identifying countries that have not cooperated or that “show insufficient progress in addressing weak compliance with internationally agreed information exchange and cooperation standards”.

(ii)        Monitor progress on OECD’s Global Forum peer review process, and place pressure on “jurisdictions identified as not having the elements in place to achieve an effective exchange of information”.

(iii)       Consider action against the Financial Action Task Force list of high-risk non-cooperative jurisdictions, due to be updated in February 2011.

French political pressures prompting pursuit of an anti-tax haven agenda includes the following:

• Budget deficit: forecasted at eight per cent of French GDP in 2010, with public debt at 84 per cent of GDP. The government has resisted growing pressure to spell out a fiscal austerity plan, perhaps due to given concerns over further downward pressure on popularity ratings.
• Wealth tax repeal: wealth taxes are due for repeal in spring 2011, with no compensating increase in general taxation.
• French banks assets in IFCs: French banks’ total assets in ‘tax havens’ amounted to US$532.6 billion at June 2008, representing a threefold increase over the prior five years. French banks are under pressure to reduce IFC operations, particularly in ‘non-cooperative’ jurisdictions.
• French leadership in G20: Consensus within G20 is fraying. Success on the issue of “tax havens” could boost perceptions of G20’s ability to deliver while it is under French leadership.
• NGO action: France’s determination to combat ‘tax havens’ will be cheered by NGOs. These organisations experienced frustration with the benign treatment of ‘tax havens’ at the Seoul Summit, prompting a reinvigorated campaign during France’s G20 chairmanship.

Despite considerable momentum in advance of the April 2009 G20 Summit, UK PM Gordon Brown did not succeed in his agenda to thrash tax havens. President Sarkozy will want to carefully weigh prospects within G20 for successful pursuit of an anti-tax haven agenda before expending significant political capital in a similar exercise, however appealing this may be from a domestic political perspective.

G20 hostility towards ‘tax havens’ has receded markedly since April 2009. Three key points are tempering G20 aggression on IFCs: increasing recognition of the high standards already extant in IFCs, tacit G20 recognition of the benefits for its member economies arising from the activities of IFCs, and a need to preserve credibility of G20 as a forum designing rules for universal application.

Extensive FATF and IMF reviews show regulatory standards for successful small IFCs at the top of the global league. Similarly, World Bank data shows top quartile governance standards in international financial centres. This is not surprising; financial intermediation business does not thrive in poorly controlled places.

Economists generally recognise competition (including tax competition) as having salutary effects. The larger countries have complex tax systems geared to domestic revenue collection. Interface with other countries is not a design priority, and is left to skimpy double tax treaties which address only the most egregious gaps. Small IFCs conduct mundane tasks lubricating the financial interface between the larger economies, facilitating trade, job creation and growth.  

As the immediate crisis recedes, the debate over the role of IFCs has become more reasoned and pragmatic, taking these views into account. A private sector group with broad-based professional backing, IFC Forum (www.ifcforum.org), is now active in producing and collating data and liaising with policy makers to ensure that the contribution of IFCs to the global economy is better understood. G20 is, understandably, increasingly cautious about rash moves to rip out the plumbing which connects their fragile member economies.

G20 credibility to make universally applicable rules would be fundamentally undermined by overt discrimination against small well-controlled states excluded from membership in the forum. Visibly harsher enforcement of standards on non-member jurisdictions embarrassed the OECD through the early part of its program on tax information exchange; G20 is sensibly avoiding this trap.

What are the individual interests of three key constituencies in G20 (beyond the EU) which France would need to have on side to pursue their agenda: China, the other BRICs and the US?

China rejected the attack on tax havens mounted by Brown and Sarkozy at the April 2009 G20. Beijing was no doubt motivated by pique that their territories (Hong Kong and Macau) would be named (and shamed) in the exercise. Pragmatic economic considerations no doubt also played a part.

China lifted 500 million residents out of poverty in the period from 1970 to 2000 as it emancipated economically. A recent paper by Australian academic, Jason Sharman, International Financial Centres and Developing Countries: Providing Institutions for Growth and Poverty Alleviation, shows that predictable and stable legal systems in small IFCs, like BVI and Cayman, played a crucial role in intermediating the international capital to China which facilitated this extraordinary reduction in poverty.

Despite a dirigiste communist domestic culture, China carefully avoided damaging the freewheeling capitalist centre it acquired in Hong Kong in 1998. (The UK sought guarantees for this at the time of the handover. Paradoxically, the UK is now damaging its own proximate financial centres, while China defends Hong Kong against threats organised by the UK!) China appears favourably disposed to international financial centres, but it is hard to predict how much political capital it would expend to defend them if France crafted a challenge narrowed to smaller centres.

Russia favours challenging non-cooperative jurisdictions but otherwise remains largely undeclared on the issue of ‘tax havens’. As to the other BRICs, Brazil and India engage in hostile public rhetoric towards tax havens, though their policies are tempered by pragmatism. A multipolar world suits the emerging countries, and they will not want to be confined to a global economic environment where regional finance centres doing similar work to that undertaken in New York and London are maligned simply because they are on the periphery of power. At the moment Brazil and India are awash with capital, but if flows decline they may relish the prospect of attracting global pension and other investment funds routed through offshore centres into their economies, particularly if that comes in the form of foreign direct investment or funding for small and medium enterprises.

As for United States’ support for an anti-tax haven agenda, the US may be pulling the rug out from under the OECD's efforts to build a bilateral (or multilateral) environment for tax information exchange by enacting their own rules (the Foreign Account Tax Compliance Act). This legislation will operate unilaterally by 2013 to give the US the tax information it wants without the inconvenience of reciprocating to the rest of the world. This progress is likely to reduce US interest in an OECD project premised on bilateral exchange. The US remains interested in ‘cooperation’ by IFCs of course, but high regulatory standards in those jurisdictions have substantially ameliorated US concerns on that issue.

G20, the new guardian of the world financial system, is the place to watch for action on IFCs. Global Forum’s peer review process has proceeded with admirable dispatch under OECD’s administration and G20 directions. France (and President Sarkozy in particular) has considerable domestic reason to pursue an anti-tax haven agenda, but the G20 mandate extends to dealing with non-cooperative jurisdictions, not to battles over tax neutrality (or tax competition) posed by IFCs.

G20 makes decisions by consensus and France will find it increasingly difficult to orchestrate concerted action in a world which is fragile but no longer leaning over the abyss. However, given the history, the offshore world should strap their seat belts on for a year where France holds the levers for emerging world governance. Will the empirical evidence of the IFCs’ contribution to world prosperity win the day?

Richard Hay
Richard Hay is a Stikeman Elliott London partner specializing in international tax law, and head of the London office's International Private Banking and Financial Regulation Group. Mr. Hay advises financial institutions and private clients on tax, regulatory and political risk aspects of cross-border estate planning structures for high net worth families, including those in Canada, Latin America, Asia and Europe. Mr. Hay also advises IFC Forum (www.ifcforum.org), banks and private clients on financial regulation and the information exchange initiatives conducted by the G-20, the OECD, the EU, FATF and the IMF. Mr. Hay is also Co-chairman of the London based International Committee of the Society of Trust and Estate Practitioners, a member of the International Bar Association and the International Tax Planning Association.