In a globalised world, cross-border finance and investment, routed via 'Offshore', has generated tremendous press coverage over the last two decades. Nevertheless, what is Offshore? What are its origins? Moreover, given the controversial nature of some of the commentary, how might Offshore reimagine itself over the coming decades?
The name Offshore is problematic, as there needs to be a clear and accepted definition. The IMF attempted this in their Monetary and Exchange Affairs Department paper dated 23 June, 2000:
"Offshore finance is, at its simplest, the provision of financial services by banks and other agents to non-residents. These services include the borrowing of money from non-residents and lending to non-residents."
They went on to attempt to define Offshore Financial Centres (OFCs):
"The definition of an OFC is far less straightforward. At its broadest, an OFC can be defined as any financial center where offshore activity takes place. This definition would include all the major financial centers in the world"
The Wikipedia commentary on the same subject is helpful:
“An offshore financial centre (OFC) is defined as a country or jurisdiction that provides financial services to non-residents on a scale that is incommensurate with the size and the financing of its domestic economy.”
Pros And Cons
Of course, critics and proponents of 'Offshore' tend to be influenced definitionally by their own particular 'confirmation bias’. Journalist Nicholas Shaxson[i] describes 'Offshore' in his book Treasure Islands, (subtitle: Tax Havens and the men who stole the world) as:
"A place that seeks to attract business by offering politically stable facilities to help people or entities get around the rules, laws and regulation of jurisdictions elsewhere."
Whilst proponent, economist and author Dan Mitchell, in a speech to Capitol Hill, advocated for 'Tax Havens' as being the most powerful of instruments in aiding tax competition:
"In other words, tax havens not only stimulate economic reforms to lower taxes around the world, but also play an important role in reducing the double taxation of savings and investment."
Origins And History
Tax concessions designed to lower headline rates have been a tool of economic competition for centuries. Greek Islands with special tax status incentivised the landing of goods to avoid Athenian import duties. In the 1800s, New Jersey and Delaware developed early preferential regimes for Corporates and in the 1920s and 30s, havens in Europe developed in response to political instability. In the 1960s and 1970s, the British International Finance Centres took off, providing a secure financial and physical home for post-colonial workers.
Of course, tax has always been one of the many and sufficient hallmarks for centres to flourish. The leading and most cited academics in the field, Professor James Hines and Professor Dhammika Dharmapala, observe that:
“Roughly 15% of countries are tax havens; as has been widely observed, these countries tend to be small and affluent. This paper documents another robust empirical regularity: better-governed countries are much more likely than others to become tax havens. Controlling for other relevant factors, governance quality has a statistically significant and quantitatively large association with the probability of being a tax haven.”
Before modern transparency initiatives, all financial centres were prone to the placement of corrupt funds disguised as legitimate investments, whether dodging taxes or laundering the proceeds of criminal activity. Transparency NGOs such as Transparency International and Action Aid deserve credit for lobbying, contributing to the impetus for change and greater openness. That said, the narrative of similar organisations has failed to adjust to the considerable efforts made in IFCs to fight financial crime and the significantly increased measures and penalties applied to criminal activity.
As far back as the late 1980s and 1990s, many British centres introduced tax evasion legislation, frequently ahead of major onshore centres, and created company registries of ultimate beneficial ownership. These actions ensured that the owners of value could be traced and pursued in the event of wrongdoing. Further measures followed in the early years of the new millennia, with tax information exchange agreements and IMF Financial Sector Assessment Program (FSAP) reviews. Both evidenced high compliance with international standards and proved to be class-leading, with white-listed status as an outcome of the 2009 G20 in London.
After the Global Financial Crisis of 2008-2010, many IFCs proved more stable than their larger onshore counterparts. Moreover, they embraced the opportunity to join the fight against financial crime; by signing up for FATCA, adopting the Common Reporting Standard (CRS) and supporting the OECD Global Forum in adopting BEPs measures. All of this was followed by entry into mandatory disclosure regimes, economic substance laws, and demonstrating equivalence with the EU in the fight against financial crime.
The Good And The Bad
There have always been good and bad reasons to hold value in IFCs, and no system can be regarded as 100 per cent failsafe. Independent researcher and sustainability expert Maya Forstater identified a continuum of activity in IFCs. At one end was the potential for criminal enterprise; in the middle were actions that could be the subject of debate, and at the opposite end, clearly non-controversial, value-enhancing activity.
Actions to conceal ownership, corruption, laundering the proceeds of crime, terrorist financing, tax evasion, and such were rated red on a traffic light system.
Forstater graded asset protection, capital gains tax planning, profit shifting, and treaty shopping as amber, where a debate could be held as to the reasonableness and propriety of such actions.
Simply holding property in a different country due to the rule of law benefits, tax neutrality to combine capital from various sources, and security and stability were featured as 'green light' activities.
Finding The Greenlight
Having experience representing the financial services industry in the Crown Dependency of Jersey for more than a decade, we found that 'green light' qualities were substantially more important than any theoretical tax savings in attracting business.
We aimed to provide a well-regulated platform for global financial services based on transparent laws consistently applied, moreover, with solid regulation in line with international standards, a competitive environment for both companies and individuals, and supporting reliable infrastructure in the form of accounting firms, law firms, digital capability, and a professional and highly qualified workforce.
The Hines research concluded that Offshore Financial Centres play a vital role in the international financial system, improving the availability of credit and encouraging competition in domestic banking systems. The result is a boost in investment in the major economies, which ultimately supports job creation and growth.
In a later study compiled for the Society of Trustee and Estate practitioners in 2009, Professor Hines concluded that contrary to the widespread impression, IFCs are not the locations of choice for anonymous accounts and other vehicles for international tax evasion. Evidence indicates that larger countries such as the United States and the United Kingdom were much more prone to serving this function.
“Modern tax competition theories indicate that the low tax rates available in IFCs contribute to a form of tax competition that is likely to contribute to the efficiency of tax policies elsewhere. By distinguishing between highly mobile international investments responsive to tax rate differences and less mobile, more commonly domestic, investments that large countries can tax at high rates.
“By fostering this competition and not taxing income that is therefore available for others to tax, IFCs will likely enhance other countries' ability to operate their tax systems efficiently.”
British IFCs, in their 60-year history, will undoubtedly have been used for nefarious purposes in their early years. However, they have transformed into highly regulated international financial centres that combine capital, creating jobs and prosperity while benefitting the investment source and destination countries with whom they work.
A report[ii] by CEBR commissioned by Jersey Finance in 2021 demonstrates the contribution of the Jersey IFC to global value chains and the positive real-world impacts.
In their research, CEBR recognised the economic concepts of agglomeration and spillovers. An agglomeration economy is a localised economy in which many companies, services, and industries exist close to one another and benefit from the cost reductions and gains in efficiency that result from this proximity (Merriam-Webster, 2021).
IFCs enjoy these often-large productivity gains because a wide range of firms and workers involved in similar sectors are closely located to one another. Spillovers, or 'learning by imitation', are maximised within clusters. Agglomeration economies tend to be knowledge-intensive and highly concentrated locations that can attract and retain a talented and specialised labour force.
The industrial policies enable domestic producers to adapt and adopt learning and knowledge spillovers from foreign investment (Morrissey, 2011).
Remarkably the researchers identified that every IFC job supported 380 jobs globally.
Pivoting To Private Capital
The rise and rise of private capital has been a striking phenomenon over the last two decades, and IFCs have played a key role in its success. The packaging and deployment of institutional investment gradually replaced the pool of private wealth businesses on which many IFCs were founded.
Private capital has become synonymous with a broad range of interrelated sectors, including private equity, private credit, real estate, infrastructure and venture capital. These sectors and asset classes have become the cornerstone of the IFC business. The finely honed skills developed by private capital players have seen a resilient response to the pandemic and an agile, fleet-footed grasp of the recovery opportunities that have emerged.
The private capital industry encountered new headwinds in 2022; the return of inflation, less accommodative central bank policy, rising interest rates, the prospect of market corrections, and increased geopolitical tensions, to name just a few.
However, investor confidence remains high - private capital has delivered exceptional returns in times both good and bad for more than two decades since the Great Financial Crisis. In the future, the search for return will likely see an even more significant share of the available investor funds attracted to private capital and administered by IFCs.
Few would have imagined the growth and success of the developing IFC world in the formative years of the 1960s and 1970s. Current estimates of transaction volumes intermediated vary enormously. Still, there can be little doubt that they run into many trillions of dollars and make a substantial contribution to the efficiency of global value chains, cross-border investment, job creation and growth.
From early beginnings as OFC tax shelters, IFCs have transformed into modern progressive investment facilitation centres, winning business on the back of stable legal and political environments, sound financial infrastructures, and class-leading professional ecosystems. Highly regulated and trusted by institutional investors worldwide, IFCs have reinvented themselves and continue flourishing as world-class investment hubs.
Looking to the future, the private capital pools that are an essential source of the investment required to solve the world's challenges will see IFCs making a vital and growing contribution.
Whilst the core role of efficient capital allocation will endure, the hallmarks of successful IFCs will develop. They will be characterised by further innovation in digitisation, sustainability and inclusiveness.
Geoff Cook is an experienced Chair and non-executive director. He has led significant business enterprises for more than three decades and helped major international groups to grow and prosper. As a Chartered Director, Geoff has deep knowledge of corporate governance, global regulation, and risk management. He has authored numerous articles and papers on cross border investment and the role of International Finance Centres (IFCs) in the global financial system. Geoff is a non-executive director to a select number of Family Office, Private Capital, Banking and Advisory boards. He was appointed Chair of Mourant Regulatory Consulting in 2021 and Chair of Quilter Cheviot International in 2019 to lead and develop the firm's international strategy. Geoff is also a Board member of Apex FS (Jersey) Ltd, a leading fiduciary and is presently Chair of the Society of Trustee and Estate Practitioners (STEP) Global Public Policy Committee. He was formerly the CEO of Jersey Finance and Head of Wealth Management HSBC with extensive international cross border experience across various sectors.