Are Offshore Banks off-limits

6 November 2001

Until the current U.S. administration stopped it in its tracks, the Organization for Economic Co-operation & Development (OECD) was relentless in its pursuit to reform the world's offshore banking centres. For over four years, the OECD has threatened fiscal sanctions against offshore financial centres (OFCs) that did not take adequate measures to comply with its guidelines. What was sought by the OECD were sweeping changes in the OFCs' regulatory framework and transparency. The Financial Task Force (FTF), a global agency housed in the Paris offices of the OECD also chipped in to push the OFCs to combat money laundering. Thus it was an orchestrated effort that also involved the Financial Stability Forum (FSF), the International Monetary Fund (IMF) and the European Union (EU), all wishing to see the world's financial system restructured robustly and ensuring that the OFCs do not become a law unto themselves.

The OECD had originally started off as a private club of the world's wealthy economies and soon acquired sufficient clout and leverage to call the shots with the rest of the world. It has been accused sometimes, of being picky and choosy in admitting new members. For instance, many of the wealthier Arab countries are not in OECD because their economies are said to be not sufficiently diversified or large enough in absolute size as compared to the existing OECD members. On the other hand, it excludes China, India, Brazil or Russia despite its economies being large but because their per capita income is much lower. Therefore "a level playing field" has not been a huge passion with the OECD. This is what the OFCs point out once again when they accuse the OECD and FTF of adopting a high-handed and arbitrary approach. For instance, the offshore banking centres were not amused that some of the OECD member states such as Switzerland or Luxembourg do nor comply with what was imposed as rules for the OFCs. Moreover the Clinton administration in the U.S. was supporting the OECD initiatives. The OFCs in any case are scattered and even collectively lack much clout and therefore had to eat humble pie and accept OECD's diktats.

Many of the proposed regulatory measures were intended to exchange information particularly for tax transparency and anti-money laundering purposes. Others were to modify excessive banking secrecy enshrined in the offshore structures.

In May 2001, there was a dramatic about turn when the new U.S. Treasury Secretary O'Neill turned the tables on the OECD agenda. While he encouraged the tax information exchange in his testimony before the Senate hearing, he cautioned the 'condemnatory tone' and the unfair treatment of the non-OECD countries. Quickly his clarion call had the desired effect. For instance the deadline for the OFCs to comply with OECD's measures was postponed to the 30th November 2001. OECD also began to ask all its member countries to adopt similar standards and timeliness that are atleast as 'rigorous' as those stipulated for the OFCs. Thirdly the non-core elements of the OECD's diktats were shelved so as to concentrate on tax-related information exchange. Most importantly, the so called 'co-ordinated defensive measures' by OECD (sanctions in common parlance) no longer had any 'bite'; as the U.S. was not going to back it up.

Off shore tax havens were how historically OFCs were called and perceived and over the years have always had a charmed existence. They found favour with the wealthy and discreet and those that sought to shelter their hard-earned and sometimes, their "fast bucks" from the preying eyes of the tax man. 'Private banking' as it has now come to be developed, became a helpful conduit through which millions of dollars were funnelled and from which the tax havens prospered. All that they assured in return was that customers' financial information would be protected and there would be, in some instances, multitudes of trusts and other corporate 'veil', through which it would be difficult to pierce to get to the underlying assets. Therefore the offshore centres mushroomed from the Cook to the Cayman to the Channel Islands and on to Mauritius, Malta, Cyprus and even closer home i.e. Bahrain. Of course the likes of Bermuda focused on insurance and the higher end of the market but it did not offer offshore banking facilities in the main whereas Bahrain was more of a offshore banking centre and did not have some of the other trappings associated with the tax havens for the wealthy. All of them had minimal or no tax.

The total value of the assets in the global OFCs is estimated to be over US$ 8 trillion. Although these started off as tax efficient mechanisms for clients, soon the banks followed suit for their own account and this is when offshore banking began to gallop forward. The banks were really looking at the greater flexibility that was available in OFCs and the lower regulatory burden, be it in the form of reserve or indeed reporting requirements and the whole raft of cumbersome inspection processes. In the U.S. for instance, there are multiple agencies (ranging from the Controller of Currencies to the U.S. Federal Reserve Bodies and the Office of the Treasury) that regulate the financial sector. Even in other jurisdictions (and particularly where the central banks were not the lenders of the last resort), there are a whole gamut of banking regulations that are intended to protect the customers but which some financial institutions and their wealthy risk taking clients find onerous. So a place like Cayman Islands or the Bahamas populated with fewer than a million people suddenly attracted more banks and financial institutions than many major Third World economies. These OFCs began to build up their book in these tax havens and soon invested in creating the level of treasury and wealth protection skills and expertise on par with what may be available in the major money centres.

As in most other matters (including centuries-old empires such as the Roman, the English and other colonial powers), the seeds of their downfall began to be sowed at the time of their almost invincible status and success. The OFCs began to attract the shady, the crooked and the drug traffickers i.e. the marginal users of the international financial systems including the tax evaders and money launderers.

Unfortunately the better OFCs began to be bracketed with the 'fly by night' dubious variety. The OECD dragnet treated them all alike initially but discrimination and scrutiny prevailed. Grudgingly the OECD now believes that there is a place for income-tax free systems in the world and that to be able to facilitate business with minimal regulation and the laisser-faire approach, is in itself, not such a bad thing. Many of the OFCs are well versed in establishing trusts, estate planning, creating special purpose vehicles that can support securitization and other capital market transactions, stock option plans, pension plans, insurance and reinsurance (as in Bermuda), shipping and aircraft financing structures. For instance, the Isle of Man (which recently promoted itself vigorously in the Gulf region last month with a golf tournament and Norman Wisdom to boot - pun unintended!) has an excellent IT infrastructure to support internet banking.

There will always be good and special reasons for the continued existence of the OFCs but they will have to reach a higher level of transparency. It is true that some OECD countries have own vested interests. To protect their own financial centres, they may seek to tarnish the OFCs as a bunch of money laundering mechanisms. The Financial Stability Forum (FSF) based in Basle is sensibly seeking superior standards for banking regulations so that the integrity of the financial system is intact and prudential norms are adhered to.

Of course many wealthy and freedom-seeking individuals dread the prospect of collection and sharing the information between the various financial regulators. They believe that the linkage of data base as it is now sought to be done, or the use of IT tools could invade their privacy and sensitivities. Such a centralized data base is currently being used by the French, Scandinavian and some Central European countries for control and collection purposes. The other concern is that sometimes such information may be sold by petty bureaucrats, down the line in certain countries, to criminal gangs who may then use it for kidnapping, ransom demands and other nefarious purposes. This is particularly so, because such information pool on computers, can be easily hacked into. Even otherwise, routinely and unwittingly and otherwise, some staff in tax collection departments may misuse personal data.

At the same time, there is need for co-existence and co-habitation between the well regulated onshore financial centres and the offshore centres. The OFCs cannot do without access to the major regulated financial markets. Ultimately, all their investment monies go into the latter. Similarly they would need to access for marketing their business to individuals and institutions who are onshore.

Even the likes of Switzerland and Luxembourg, both of whom are OECD members, did not agree with the stipulations specified on OFCs, possibly in their own interest, as they have no intention of complying or compromising. It is in this context that there was a classification of OFCs by OECD in terms of who had reached an agreement with OECD and who had been co-operative and represent high standards of financial regulation. The table thus produced some interesting results. Clearly the highest marks have been given to the likes of Dublin, Guernsey, Hongkong and the Isle of Man in addition to Singapore and Switzerland.

Ultimately, the OFCs will know that financial freedom cannot be abused and that they cannot have the cake and eat it too. If they wish to access onshore money centres for all their transactions on behalf of their clients, they will need to probe into the customers' credentials (know your customers – KYC). They should themselves be clean counterparties. Similarly the onshore regulators and agencies such as the OECD, need to be fair and equitable and cannot apply a harsher role than what their own members are able to copy and comply. In this unipolar world, ultimately it would appear that the U.S. is the arbitrator of the last resort and its weight will determine as to how much pressure and pull will be applied on and how long the OFCs are allowed to thrive and flourish as before.

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