Addressing the morality attack on the offshore world

Arguments against offshore financial centres (OFCs) have been around for about 2 decades but they have evolved with increasing effect recently. Historically, the attacks against OFCs began largely as a straight forward accusation that these financial services centres were encouraging or harbouring tax evaders. OFCs pretty much ignored this argument until about the early to mid 1990s when they responded in a number of ways. In addition to denying the tax evasion charge, they raised the issue of their right of tax sovereignty, the benefits of tax competition and finally that there was no level playing field between OFCs and the main OECD members countries.

In the mid to late 1990s the accusation that such centres were a key channel through which the world’s illegal funds were laundered entered the fray, not that long after the US criminalised the proceeds of crime in 1986. This accusation was further fueled by the FATF’s blacklisting of many OFCs after a round of reviews. OFCs, including the Cayman Islands, responded by making major changes to their anti money laundering frameworks. In all of the main OFCs these changes were so extreme that they stand today as being light years ahead of every OECD based financial centre in terms of the due diligence requirements in place.

The pressures continued from the OECD side around 2002 when a new and substantial argument was put forward; namely that such centres had very poor systems of financial regulation and were therefore a threat to global financial stability. This resulted in a round of reviews by the IMF against the main international regulatory standards such as the Basel Principles for Effective Banking Supervision, and again many OFCs made enhancements to their regulatory frameworks.

All along the basic tax evasion accusation has remained at the forefront as this is not an issue that can be easily resolved by passage of domestic legislation. And anything falling short of a global regime where all tax systems are aligned will ensure that this issue remains unresolved for years to come.

Up until recently the OFCs’ standard response to the tax charge is that there is a distinction between “tax evasion” (clearly illegal activity) which they do not condone, and “tax avoidance” (use of legal structures and law abiding activity to minimise one’s tax burden) which is a part of the services they have on offer. For the most part, this approach seemed to be working; at least until a series of “morality arguments” surfaced in recent years.

First there was the “scrutiny” of social corporate responsibility by OECD based firms, an argument pushed by American politicians some years ago, where companies which utilised OFCs were labeled “unpatriotic”.

Then there was the argument that tax rates in OECD based countries were unnecessarily high because of the billions of tax revenues lost as a result of OFCs. It is easy to see why these two arguments might resonate with the common OECD resident (even if incorrect) and why they were used primarily around election time.

This “morality movement” continued without much impact until it was tweaked to have a more conscientious effect very recently. The argument was put forward that OFCs somehow played a role in the demise of the very poor around the world by depriving these people of the necessary aid due to this tax avoidance activity.

Evidence of this new morality approach can be seen from a report earlier this year by the group Christian Aid which essentially lays the blame for poverty (and death) in developing countries at the feet of offshore financial centres. The Christian Aid argument is not only a ludicrous attempt to link OFCs to the demise of developing countries, but it also fails to apportion any blame on the policies of the World Bank, IMF or widespread corruption by international charities and local governments for the plight of these developing countries. Not surprisingly, in its 33 page report, Christian Aid manages to avoid highlighting a single example of how OFCs have actually helped the poor, for example by facilitating the financing of major infrastructure projects such as roads or water facilities via securitisations.

The Vatican offered its own assistance recently to the morality efforts against OFCs, when the Pope argued that OFCs are to blame, not only for the world’s global financial crisis but for the abject poverty witnessed around the world. More important than the inaccuracy of the Pope’s arguments is the possibility that advocates of this new morality approach have been able to influence the Vatican’s public statements through his advisors. It shows that this new strategy should be taken seriously by OFCs.

To the advocates of this new morality criticism of OFCs, it does not matter whether funds are missing from the coffers of OECD governments due to “tax evasion” or tax avoidance” as the core of this argument is simply the loss of such revenues. Therefore no future OFC strategy which relies on the distinction between avoidance and evasion works in this new scenario, certainly not in the long term.

Policymakers and industry alike in OFCs need to understand that what they are up against with this new strategy cannot be dealt with by technocrats or new financial regulations, but that the commercial survival of offshore centres requires advocating the true benefits of the offshore world like never before. In the same way that the advocates of the morality arguments against OFCs have taken up their campaign, OFCs need to come together and formulate an effective response.

If they fail to do so, the new morality propaganda will not only strengthen the existing perception of OFCs as the bad guys, but through OECD protectionist policies backed by a “new conscience”, it could eventually result in the type of isolation in the global financial markets that no amount of marketing, lobbying or legislation will be able to correct. And in 10 to 15 years, the basis of economic development in many OFC economies around the globe may all but disappear. Ironically, this would also be a loss to both the wealthy and the poor in the world economy.

Paul Byles is Managing Director of Focus Corporate Services & Consulting. He is a former regulator who has worked in the offshore sector for over 18 years and as an economist and international consultant on offshore services and its regulation. He is author of the book Inside Offshore.