LECTURE:   REGULATIONS

8th September, 2011.

 

 

On my desk I have my notary’s seal from the Turks & Caicos Islands with the words “Sambrook’s Folly” engraved on the handle.  It is a constant reminder of the truism that the road to hell is, indeed, paved with good intentions.  Many of you here today will be aware of both the past and present difficulties which exist in the Turks and Caicos Islands, a dependent but delinquent territory of the United Kingdom.  Twenty two years ago I was sent there by the British government as the first financial services regulator and my remit included recommendations concerning financial services legislation.  My three-year tenure brought both triumph and disaster and I did try, as suggested by Rudyard Kipling, to treat those two impostors just the same.  On the positive side I was able to form a joint committee comprising government and private sector members to address the multitude of issues which confronted us.  At the same time I was able to draft regulations for banking and captive insurance as well as a trust and captive insurance law. 


The Chief Minister at the time said he wanted the islands to become the Liechtenstein of the Caribbean but recent events have made them the Frankenstein of the Caribbean.  Sadly, the prevailing conditions in the 1980s have returned to haunt the islands in 2011:  a suspended constitution and a corrupt political system.  The constitution had been originally suspended in 1986 and after two reports by Sir Louis-Blom Cooper, QC, as well as a report prepared by the former Coopers & Lybrand accountancy firm, the stage was set for my appointment in 1989. 


Fast-track to Panamá this year and I am having lunch with Mike Gapes MP from the UK who is chairman of the Foreign Affairs Committee looking into the governance of the TCI.  A most interesting discussion ensued. But the question must be asked:  The Organisation for Economic Co-operation and Development is critical of offshore regulation, but where one of its members, in this case the UK, has the power and control to intervene it fails to do so effectively.  Why?  Not once, but twice.  To answer that question would take too long but it underlines a failure of communication, a common denominator in the offshore/onshore battle over regulation.


So my views on the subject have been shaped and influenced by personal experiences as both a poacher and a gamekeeper.  But having been now more than 30 years offshore I can remain objective and, in fact, those few brief years as a regulator have given me a clear insight into the difficulties which offshore centres encounter when their commercial endeavours collide with governmental bureaucracy.  It sometimes just boils down to a failure of either side to understand the priorities of the other and from which a level of hostility manifests itself – whether the players are a tiny island which is a dependency of a developed country or an independent country confronting the OECD. 


Others add fuel to the fire and quite often the agent provocateur in the mix is the press whose journalists are not even close-quarter participants but certainly are always on the lookout for a good story.  The publisher, William Randolph Hearst, famously said:  “You furnish the pictures and I’ll furnish the war”.  He sent that cable to his illustrator, Frederick Remington, and theirs was a major contribution to the start of the Spanish/American war which followed the sinking of an American naval vessel, The Maine, in 1898 in Havana Harbour.    Much more recently, some of you will have perhaps seen the published picture of Ugland House in the Cayman Islands home to a multitude of corporate registered offices singled out by US President Barack Obama as an outpost of massive tax evasion (can he really be unaware of Delaware?) Hasn’t he seen the Financial Action Task Force report that says that Delaware company agents promote the fact that the state offers greater secrecy than offshore tax havens?  One agent’s website states:  “The Delaware LLC provides the anonymity that most international jurisdictions do not offer”.  Fortunately, the only thing the Ugland photo has started is a war of words.  But it illustrates another difficulty which makes it hard to reconcile onshore and offshore:  hypocrisy.


Secrecy and confidentiality for some are one in the same, just as so many misguided souls have reached the conclusion that evasion and avoidance are inter-changeable for the purposes of taxation.  Part of the pincer movement employed by the leading economies is to throw the accusation of secrecy – a much more emotive word than confidential or private – at IFCs.  There again, as Humpty Dumpty would say, a word means what I want it to mean and it’s all a question of who is master.   More on that subject later.  Secrecy, of course, can denote something sinister, whereas privacy (an alternative meaning found in the dictionary) does not.  I understand that something that is confidential in business should remain private unless a legitimate cause arises for disclosure because harm has been done.  It is the definition of harm that becomes contentious and which often puts IFCs at odds with onshore regulators.  The US Judge Learned Hand suggested that words are chameleons, which reflect the colour of the environment.  I’m not sure what the colour of prejudice is.


And on the subject of words, so much has changed since the days when the word “offshore” was usually hyphenated.  Although the shortened version of International Financial Centres, IFC, is in common usage, I tend to use the terms “onshore” and “offshore” as shorthand, in broad terms seeing the former offering a benefit to a person or business that is not available in their own jurisdiction.  Benefit, of course, can be synonymous with competition which can cause resentment particularly now when governments are suffering economic stress.  This can lead to onshore regulators taking a dog in the manger attitude.  You can take your holidays, in other words, anywhere you want, except outside the country.


For the same reason that onshore and offshore jurisdictions should not have standardisation of their tax systems, so it should be with regulation.  The OECD approach supports Henry Ford’s quip that you can have your Model T in any colour you want provided that it’s black; eventually competition produced other cars in other colours and earned praise from consumers.


Many IFCs treat privacy and taxes as secondary, because they have specialised in particular fields such as hedge funds, insurance, banking, offshore companies, trusts, fund management, shipping and betting and gaming, offering a quality of service often better than found onshore.  The long-established centres offer the means to smooth the way for essential, but complex, wholesale finance transactions, such as reinsurance in Bermuda. Many IFCs offer lawful tax savings anyway, although one country’s tax haven will always be another country’s criminal haven.  But as the heat continues to be turned up by developed countries scrabbling for taxes, more and more of these centres are shifting from an emphasis on confidentiality and tax planning to just plain business and personal long-term financial planning with regulatory simplicity.


Simplicity is most certainly not the word that springs to mind when onshore regulation is considered and which, as events over the last few years has shown, is still found to be wanting.   A report published by the Small Business Administration, a US government agency, has estimated that red tape costs US companies US$1,750 billion a year.  In Europe, a think-tank called Open Europe, which is campaigning for easier trade rules in the EU, has calculated that between 1998 and 2008 the cumulative cost of regulation introduced in EU countries was almost two trillion US dollars


I have heard that when regulators see light at the end of the tunnel they order more tunnel.  No one disputes the need for regulation but it should be practical and not driven by prejudice; there has been too much onshore hostility in the case of the IFCs, most of which have built their legal framework from a common law base which their regulatory models reflect.  Being streamlined, however, hasn’t stopped them from being maligned.  Earlier in the year a fellow dinner guest in Panamá was the Permanent Secretary of a UK ministry and his views on the virtues of IFCs reminded me of an old car battery:  he was leaking acid.  In order for the offshore world to reconcile itself with developed countries, the latter have to eradicate a HIP problem:  hypocrisy, already mentioned, ignorance and prejudice.   What Goethe said in the 16th century is just as true this afternoon: “There is nothing more frightening than ignorance in action”. 


Of course offshore chicanery is to be found because wherever human beings congregate, whether under palm trees or not, man’s weaknesses will be present.  Somerset Maugham, writer, spy and socialite, once said that the “nature of men and women – their essential nature – is so vile and despicable that if you were to portray a person as he really is, no one would believe you”. I recognise how pure white sands can lull your senses and perhaps your judgment, particularly when bluebirds instead of grey beards are employed.  There will always be offshore scandals but think on this:  investors didn’t have to board a flight or ship to a Caribbean destination to lose their shirts to “the Jewish T-bill”.  This was the nickname given to New York’s Bernard L. Madoff whose fraudulent activities came to around US$50 billion, an amount which, in 2008, might have covered the US expenditure on the Iraq war for 4 months; or to put it another way, the US Federal Bureau of Investigation reckons that there were just under 10 million crimes against property in the US in 2007.  The total losses due to property crimes amounted to US$17.6 billion, which comes to perhaps 35% of what Mr. Madoff has apparently cost his victims.  It would seem to me that scandals originating in IFCs will always stand in the shadow of those created onshore.  If you remember the US investment banks and large corporations caught up in the 1990s boom you may also remember Enron, Worldcom, Xerox, Adelphia, Tyco, Imclone, Quest, Global Crossing, Healthsouth and Ahold.  Adam Smith was exactly right: “The directors of such companies, however, being the managers rather of other people’s money rather than their own, it cannot be well expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own.  Negligence and profusion, therefore, must always prevail”.    Whatever role IFCs played in those scandals, they were always just participants and not the perpetrators. 


Now just before you are convinced that my bias does not go further than the world’s blooper, sorry, superpower, let’s consider this country.  Being British I couldn’t ignore the French but I’ll save them for last.  Sir Arthur Conan Doyle called London “the great cesspool into which all the loungers and idlers of the Empire are irresistibly drained”.  That’s not all that’s to be found.  According to Transparency International £15 billion of dirty money is laundered through the UK each year, the vast majority through London.  The capital now languishes at 20th place on TI’s corruption perception index, below Qatar, Japan and Barbados;  two Latin American countries, Chile and Uruguay, rank above Spain, Portugal and Israel.  In March, Anthea Lawson, head of the transparency group Global Witness, was very harsh in her criticism:  “Any despot in the world can easily hide their identity behind the nominee shareholders and directors of a British-registered company.  The UK isn’t collecting information on the beneficial ownership of companies.  You can incorporate a company without anyone knowing who you are”.  As far as freezing Gaddafi’s funds goes, she had this to say:  “But it actually highlights a catastrophic failure of anti-money laundering laws that are supposed to ensure that corrupt politicians do not get easy access to finance”. 


Opening bank accounts or forming a company in the UK can be done in minutes over the internet, with worryingly few identity checks, according to Professor Jason Sharman, an Australian academic and tax expert familiar to many of you who looked into 22 countries in 2009 to measure how easy it was to set up anonymous companies in each.  In this country – the worst offender – he managed to create seven shell companies and two bank accounts without showing proof of his actual identity.  The professor concluded that the UK – and it must be said that he included the US in the comment – do a much worse job collecting information on the owners of shell companies than IFCs, where know your customer procedures are usually far more stringent.  He went on to say that the UK and US, and I quote:  “… collect little or no information on those behind shell companies, they provide financial anonymity that is widely held to facilitate money laundering, tax evasion, grand corruption and the financing of terrorism”.  A report back in 2007 by Camille Stoll-Davey of this University also found that in important areas (exchange of tax information and identifying the owners of entities) there were OECD members who fell short of the mark. 


Companies House, the UK agency set up to enforce company law in the UK, is overwhelmed by its workload, according to Richard Murphy, of Tax Research UK, who estimates that more than 500,000 UK companies “disappear” from registers each year.  How many IFCs can even boast that number of active companies?  About a third of these companies are struck off by Companies House before they have ever filed accounts, Murphy says, leaving regulators totally unaware of their trading history.  “As a result, UK companies can easily be used by those seeking to undertake tax and commercial fraud without risk of their activities being disclosed, even though the companies are meant to publish their accounts,” he says. 
And you don’t need to go offshore to see countries arguing over regulation in the context of quality and competition.  Timothy Geithner, the US treasury secretary, has criticised London’s, I quote:  “light touch approach to financial regulation” going on to say the motive was “to pull financial activity from New York and from Frankfurt and Paris to London”.  The head of the Financial Conduct Authority, the UK’s new financial products watchdog, said that Mr. Geithner was talking, I quote, “nonsense”.  The treasury secretary has also upset Asians and other Europeans by warning them not to take advantage of “a rise in regulatory standards in the US”. Should we consider their standard and pause, for thought?  (Sorry Mr. Geithner).  Mr. Geithner’s truculence highlights the issue of that acronym HIP and the problem it presents to IFCs.  The poet John Milton may have said that “neither man nor angel can discern hypocrisy, the only evil that walks invisible” but today its presence is palpable onshore.


Professor Gilbert Norris, the chief economist of the Caribbean Basin Review in Sao Paulo has written a book with the provocative title:  “Shifting Ground: The G20 Pogrom against International Financial Centres”.  He feels that IFCs do not have an organisation delivering a unified message and has argued that they need an international body, founded in law, to give it legal legitimacy.  This would be more than can be said of the OECD, which has extended any authority founded in law beyond its limits.  That’s helped me appreciate Henry Kissinger’s remark:  “The illegal we do immediately.  The unconstitutional takes a little longer”. 


Like integration in Latin America which I spoke about on Tuesday, the IFCs need to come together in order to strengthen their position.  However, I do agree with Rodney Gallagher, an ex-UK Foreign Office adviser (and a former colleague of mine) who said in the Financial Times back in November, 2009, that at the end of the day only those offshore jurisdictions with political clout or the support of large countries (such as China) are likely to survive as IFCs in the long run.  He identified Hong Kong, the Gulf States, Singapore and Panamá.  Professor Norris believes Brazil will target Panamá’s offshore facilities and India will concentrate on Mauritius.  He adds, “The UK will destroy their financial centres and then discover that they were the engines that kept things going”.  Perhaps a bit too extreme but I do remember also the words of Milton Friedman:  “If you put the federal government in charge of the Sahara Desert, in 5 years there’d be a shortage of sand”.   
I read that Montserrat, recovering from a volcano eruption a few years ago, is now apparently venturing back into the financial services sector.  Rising from the ashes, if you will, from the sea of ash which covered the island. I hope that the mistakes made in the Turks & Caicos are not repeated; I am not optimistic.  On 10th December, 2007, Edward Leigh, Chairman of the House of Commons Committee on Public Accounts, asked Sir Peter Ricketts, Permanent Secretary at the FCO:  “Tell us exactly what is happening in the Turks & Caicos and [give us] reassurance that you have got a grip there, please”.  We all know the answer to that from current events.


Returning to Professor Norris and his belief that the UK will one day discover the usefulness of its own financial centres.  Besides the services on offer, it is a fact that IFCs are an important conduit which helps domestic and foreign investors in developing countries access the institutions and their facilities which are not necessarily available locally.  Often, by passing investment through IFCs, these foreign and domestic investors can lower transaction costs.  China and India are perfect examples of the use of IFCs and in both cases until the specialised amenities offered are available in their own countries IFCs will remain very important.  Unquestionably, the dual targets of growth and reduction of poverty, are helped significantly by the cultivation of closer relations with IFCs.  I believe that this has been a key factor in China’s case since 1978 and in India’s since 1991.  And to reinforce my earlier point, despite the fact that most of the offshore tax incentives have been withdrawn by both countries, the flows of funds have not only continued, but have increased. 


Take Taiwan where accumulated capital is looking for overseas opportunities; there is ethnic comfort in directing it towards China and IFCs offer a tax-neutral low-cost intermediary service for Taiwanese capital to flow into the mainland, boosting China’s economic growth, contributing to poverty reduction and generating tax revenues.  The tax treaty between India and Mauritius, an India Ocean IFC, which came into force in 1983 has reaped similar benefits.  In this case a special type of Mauritius company, a Category 1 Global Business Company, has been employed.  Besides concessions on withholding tax, any shares held by it in an Indian company are exempt from Indian capital gains tax. 


Whilst the OECD would have us believe that IFCs are more repositories for proceeds of corruption and un-taxed money, the facts don’t bear this out.  Many IFCs could identify with this statement:  “The legal and regulatory requirements are strict and many requirements exceed those in place in industrial countries … the level of supervision dedicated to anti-money laundering is exceptional and under different circumstances disproportionate relative to the risk posed by money laundering”.  In this case that is an extract from an IMF report on Panamá.  Is the OECD taking a leaf out of Mark Twain’s book?  The American, after all, reminded us to first get your facts straight and then you can distort them as much as you like.


Last year I said that Panamá was not in favour of TIEAs and yet, since then, in pursuit of getting a free trade agreement, it has ratified one with the US.  I mentioned this during Tuesday’s lecture in relation to trade.  It is difficult to predict how effective the TIEA might be (the rules and procedures are not in place yet) and, of course, as many commentators have already pointed out, with no fishing expeditions allowed, the US Internal Revenue Service first has to know what it is looking for before it can ask for it.  Interestingly, Jersey, in the Channel Islands, which is well above Panamá’s ranking as an IFC had only 4 requests from the US in one recent year, and it was the first country that Jersey signed a TIEA with.  I suspect that this is not due to lack of trying on the part of the IRS. 


Rather surprisingly, non-government organisations have given support to IFCs.  They could be an important ally in countering the preponderance of negative reporting (not that NGOs have been natural allies in the past).  In line with my earlier observations about America and the UK, and my promise to include France, a 2009 report, Undue Diligence, was published by the NGO, Global Witness, which noted how receptive France has been in allowing vast sums of looted plunder into the country and acquired by Francophone African leaders.  The current Sarkozy administration has condoned extensive and luxurious real estate holdings and bank accounts owned by corrupt leaders from Angola, Burkina Faso, Congo-Brazzaville, Equatorial Guinea and Gabon.  As a postscript, the New York Times issue of 16th November, 2009, noted that in violation of its own laws and a presidential order, the US was allowing Teodoro Obiang of Equatorial Guinea to routinely travel to his US$35 million Malibu mansion while concluding that the mansion represented the fruits of corruption.  And importantly, NGOs have observed that financial under-legislation, facilitating corrupt practices, appears to be disproportionately a problem onshore.  Whilst accepting that there can be no meeting of the minds on taxes, both IFCs and NGOs could nonetheless combine to spread a powerful message.  Perhaps if Professor Norris gets his international IFC body in place it would be the perfect partnership.


It is sometimes overlooked how the seeds of some leading IFCs came to be planted.  There wasn’t a giant collective conspiracy to thwart the economic aims of developed countries.  When you think about the history of the development of IFCs, probably more than half of them are remnants from the British Empire which were encouraged by successive British governments to turn themselves into traditional tax havens and, of course, they would not only become self-supporting, or at least reduce the home governments burden, but at the same time – surprise, surprise – would serve as conduits for capital flows to London.  One NGO, Tax Justice Network, in the words of its London-based director, John Christensen, recognises this. “To be blunt”, he comments, “countries like the United Kingdom, USA and Luxembourg, are very heavily reliant upon inflows of capital from the South such as Latin America or Africa.  By and large, we turn a blind eye to the origins of that capital”.


In the 1960s professor Cain will know that young people from the Isle of Man were leaving the island until politicians began creating jobs for them by scrapping taxes and attracting financial institutions to do business with the self-governing crown dependency.  Perhaps without this they might have eventually suffered the fate of Scotland’s Western Isles.  Back before the 1960s Jersey and Guernsey were more famous for tomatoes, Alderney, in the Bailiwick of Guernsey, where I lived for a while, for its cows.  The Turks & Caicos provided salt for Bermuda (all that’s left are the disused salt pans that sometimes raise a smell, like succeeding administrations have) and Cayman’s major export was able hands for the merchant navy.  The British Government of the day saw financial services as a good thing for the Caribbean’s territorial dependencies (all 5 of them).  The trouble is a few – including the crown dependencies nearer home – got very good at it, which brings us up to the present.


And while the developed countries try to mould offshore regulation in their own image (heaven forbid) the acceleration in the global shift in power relationships in favour of the big emerging markets is causing changes to the international financial architecture which means that regulation at the national level is starting to be driven by international imperatives.  Could regulation turn into more of a circus than it already is?  Alfred Kahn, late academic and author of “The Economics of Regulation”, was responsible for the deregulation of America’s skies in the 1970s which created good, healthy competition.  He said that if the government couldn’t be useful, it should get the hell out of the way.  When he was accused of using the word “depression” too frequently in public, he replaced it with “banana” and announced that the country was heading for its worst banana in 45 years.  The head of United Fruit protested at its use, so he made it “kumquat”.  Mr. Kahn understood Humpty Dumpty well. 


Now we have an IMF report entitled “Bankers on the Beach”.  If I was writing a report about bankers on Wall Street and in the City I would call it “Bankers in Bunkers”.  But that’s another story.  The IMF with its proclivity for stating the obvious, observes that there are divided opinions on whether IFC activities are a source of growth and a legitimate area for economic diversification or a reflection of the problems of tax evasion and money laundering due to poor regulation and lack of transparency.  The authors mentioned 40 countries and territories hosting IFCs holding assets and liabilities of about $5 trillion at the end of 2009, with those in the Caribbean accounting for more than half of all IFC financial transactions. 


I am grateful for the IMF’s kind comments about Panamá’s money-laundering controls, but instead of visualising bankers in beach chairs, both the IMF and other agencies should pay attention to those bankers sitting, figuratively speaking, in deck chairs as the West’s banking model drifts towards an iceberg.  If it hits it, let’s hope that we don’t find out that two-thirds of our problems were actually below the surface.


What fate awaits IFCs in this century of profound upheaval?  J. K. Galbraith once said that economic forecasting made astrology look respectable.  Predictions,  like assumptions, as I have written before, can be dangerous, as Senator Morris Sheppard discovered during America’s prohibition when he said that re-legalisation of alcohol sales was as likely as a hummingbird flying to the planet Mars and, I quote, “with the Washington Monument tied to its tail”.  Three years later prohibition was repealed. 


In the mishmash that is regulation today, where standards onshore, let alone offshore, can be at odds with each other, one certainty, I believe, remains:  the offshore world has weathered several storms of adversity in the past few decades but has kept its instinct for survival in the same way that Zeno’s tortoise always kept ahead.  Zeno, the ancient Greek philosopher, devised a mathematical paradox in which a tortoise, which is given a head start, beats Achilles in a running race; even although the distance between the two narrows, Achilles cannot overtake the tortoise.  IFCs have hard shells too and I believe they will always stay ahead.  I appreciate your attention.  Thank you.

 

 

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