British Offshore Financial Centres: Prospects in a Changing World

In the modern world grand ideologies tend to move in 30 year cycles. Investor confidence ultimately overshoots and crashes, just as it does in stock markets.

Western thinking from the middle of the last century was dominated by the Cold War. Communist containment was the central organising principle. A new era launched in the 1970s, characterised by exuberant confidence in the private sector. The global economy experienced dazzling growth, unprecedented in world history.

The extraordinary growth fuelled unsustainable bubbles, triggering a financial crash in 2007-2009 and signalling another radical shift in Western thought. Freewheeling capitalism and the financial services industry which serves it are now in the dock. Governments are back in the ascendant.

The British offshore centres are the best of their breed and they were remarkably successful in the last era. They are now under unremitting scrutiny. What are the implications of the new grand narrative for such centres?

This article reviews three key developments by way of response:

1. The remarkable rise of ‘civil society’ (non-governmental organisation) influence in global financial services policy.

2. The recent United Kingdom review of its Overseas Territories.

3. The advent of the US Foreign Account Tax Compliance Act (FATCA), the world’s most ambitious tax compliance program.

The Rise of Civil Society

Non-governmental organisations (NGOs) campaign on ‘tax fairness’. Their agenda items include close scrutiny of the small financial centres. The NGOs are networked, ideologically committed and integrated into G20 - the principal forum for coordination of global economic policy.   Civil society was invited inside the cordon at the 2011 Cannes Heads of State Summit during the French Presidency. NGOs continued their prominent role at the Los Cabos Heads of State summit meeting in Mexico in June 2012. They are active again in their preparations for G20 under the 2013 Russian Presidency.

All voters want more public spending than they are prepared to pay for in taxes. Darwinian survival for politicians requires them to deliver on this voter demand, however fiscally reckless.   Politicians seek reasons to delay spending reform, ideally to the time that the next lot are in power.   A fictional NGO narrative that the spending gap can be closed by more and particularly better enforced taxation has appeal. NGOs offer an (imagined) alternative to the gloomy reality that Western government spending is unsustainable.

In the UK, HMRC has suggested that estimates of tax evasion advanced by NGO ‘experts’ to support their narrative are a multiple of the correct number[1]. The Tax Justice Network estimates tax evasion at £120bn; UK HMRC’s calculations, provided in evidence in a direct response at the Public Accounts Committee for this, are £4bn. Despite such authoritative challenges to NGO facts and conclusions, their work is routinely profiled in the mainstream press with little critical analysis.

The rising influence of NGOs has been largely ignored by the British offshore centres - at their peril. What should they be saying in response?

British offshore centres have adopted financial services regulation at the leading edge of global standards, routinely assessed and confirmed in peer reviews organised by the OECD, The Financial Action Task Force (FATF) and the IMF. A recent empirical study by three independent academics, including Professor Jason Sharman from Griffith University, tested compliance with anti-money laundering regulatory standards in 182 countries and concluded as follows:

“The overwhelming policy consensus, strongly articulated in G20 communiqués and by many NGOs, is that tax havens provide strict secrecy and lax regulation, especially when it comes to shell companies. This consensus is wrong. Some of the top-ranked countries in the world [showing compliance with international standards] are tax havens such as Jersey, the Cayman Islands and the Bahamas, while some developed countries like the United Kingdom, Australia and Canada and the United States rank near the bottom of the list.”[2]

Most of the work in financial centres -large and small - is mundane support for the transaction ease, stability and neutrality that business requires in capital raising and commercial dealings.   Such services play a crucial role in easing the jagged interfaces between the complex and inflexible tax systems of the large economies they serve. Financial intermediation facilitates trade, economic growth and jobs.

An offshore rock needs much more than secrecy and a teller’s window to succeed in the ultra-competitive world of offshore finance. British offshore centres are successful because clients value their stability, probity and world class professional services.

UK Views on its Overseas Territories

A recent White Paper on the future of the United Kingdom’s Overseas Territories[3], published by the Foreign and Commonwealth Office, provides encouraging UK government support for the financial services industries in its Overseas Territories. On its terms the Paper is confined to the Overseas Territories - essentially the Caribbean territories and Bermuda - but it might also be seen as an indication of attitudes towards the UK Crown Dependencies (Jersey, Guernsey and the Isle of Man).

The report describes the financial services industry of Bermuda, the British Virgin Islands and Cayman as “key contributors to local economies” and “success stories [with] important niche positions in international financial markets”. Self-interest is always a good companion in taking any supporter along, so it is particularly promising that the report recognises the international business centres in the Overseas Territories are positioned to “play a complementary role to the UK-based financial services industry”.

The White Paper records a UK commitment to “work in the international area to ensure no discrimination against such centres”. Encouragingly, the report also acknowledges that “UK government respects the right of Overseas Territory governments to compete on tax”, acknowledging the importance and legitimacy of tax neutrality in their financial centre offerings.

The UK government is the key spokesman (and, when minded, protector) for the British offshore centres in the intergovernmental dialogues over financial services regulation.   More concrete UK action supporting Overseas Territories’ involvement in international rulemaking and standard setting processes is still required. However, the report is a welcome expression of support for such centres, signalling a recognition of UK government interest in the success of its offshore symbiots.

Global Information Exchange – FATCA

The main work stream affecting small financial centres pertains to information gathering and exchange for tax enforcement purposes. The US FATCA juggernaut signals a massive acceleration in information collection and exchange with eye watering costs.

In 1998 OECD launched a program to promote financial transparency and information exchange. The US often leads world innovation, including in its regulatory environment. Yet lax US incorporation requirements have undermined a central pillar of the OECD project, globally comprehensive identification of beneficial owners of companies.

As the OECD's peer review process was gathering momentum in 2008, the US announced a change of tack, unveiling unilateral measures in FATCA for collection and provision of financial information to the US. Draconian consequences loom for those who decline to participate. Compliance costs borne by foreign financial institutions and governments (and so ultimately their clientele and taxpayers) will likely exceed US taxes collected. Costs borne by the small financial centres may be eased marginally if they conclude inter-governmental information exchange agreements with the US along the lines of those negotiated by the so-called G5 countries in Europe.

The most striking feature of the FATCA story is that the world environment has changed so much that a system like it can be operationalised. Had the United States proposed FATCA a few years earlier, the goals would not have been unachievable. Global information on beneficial ownership was simply not available and the US could not have insisted on access to a massive reservoir of information which did not exist. OECD built out transparency to support a moderate system of information exchange on request. Now any country with leverage can oblige others to provide wholesale supply of data on the financial affairs of its citizens and residents.

Concerns posed by government intrusion into private affairs are largely ignored by a public still in the grip of hysteria over terrorism. The wider implications of systematising comprehensive government collection of financial data may come to be seen as disconcerting in due course. Those readers born closer to 1945 than 2012 need no further elaboration on the potential dangers.

Despite their travails the British offshore centres are hardly properly regarded as victims of the world order. They have transformed in a generation from small rocks, with barely viable economies, to the commanding heights of the global economy. The remarkable success of those centres crucially turns on a shortened distance from the countries which surround them. Vexing it may be for those who long for a quiet life, but scrutiny by the countries which supply those financial centres with their clients and markets comes with the territory.

Governments, institutions and professional firms in small financial centres have collective responsibility to foster informed international policy on their operations. The small British offshore centres now regulate at the leading edge of global standards, yet this is not enough. Broader public support for their activities will follow only if they can also effectively articulate their constructive contribution to the larger economies they serve. On this task, the work has only just begun.

[1] Closing the tax gap: HMRC’s record at ensuring tax compliance: Government Response to the Committee's Twenty-ninth Report of Session 2010–12, House of Commons, Treasury Committee, 15^th May 2012

[2] Michael Findley, Daniel Nielson and Jason Sharman, “Global Shell Games: Testing Money Launderers’ and Terrorist Financiers’ Access to Shell Companies”, Centre for Governance and Public Policy, September 2012

[3] The Overseas Territories Security, Success and Sustainability, Foreign Commonwealth Office, June 2012

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.