Beneath the Surface

Legal Week
28 November 2002

The publication in August of the report Towards a Level Playing Field, prepared by the international law firm Stikeman Elliott, provides a timely opportunity to analyse more objectively some assumptions underpinning the initiatives of the Organisation for Economic Co-operation and Development (OECD) and the Financial Action Task Force (FATF).

The report gives substance to a view widely held in the offshore financial centres: that the OECD and FATF, both of which are agencies of the G7 countries, are simply applying double standards.

It makes clear that not only is corporate transparency in the offshore financial centres already at a far higher level than that applicable in most OECD jurisdictions, but there appears to be no pressure from the OECD jurisdictions to improve their own transparency to a similar level.
While the report focuses on the transparency of corporate vehicles, partnerships and trusts in the offshore financial centres, similar conclusions can be drawn on the standards of transparency, 'know your client', due diligence and anti-money laundering legislation across the board in each of the recognised offshore financial centres, notably the Cayman Islands, Bermuda and Jersey.

No doubt should exist that these new standards of transparency have resulted from the OECD campaign and from pressure applied by the FATF over money laundering. But given that those standards have now been introduced, why has no-one turned off the spigot controlling the negative public relations still flowing from these organisations? If this were an even-handed and objective debate, the offshore jurisdictions should now be anticipating a more mature recognition from the OECD of what has been achieved.

Double standard

It is increasingly difficult to understand why so little credit has been accorded to those offshore financial centres that have acceded to the OECD initiatives on tax transparency and which have applied the new FATF anti-money laundering regulatory regime. Certainly that regime as it now applies in the Cayman Islands, Bermuda and Jersey requires a higher standard of due diligence than exists under the Patriot Act in the US and in continental Europe and it applies across a broader band of financial service provider.

Further the 'know your client' and source of funds and due diligence must be applied in these offshore financial centres retroactively to every existing client, regardless of the date of inception. In which OECD countries are these rules in force?

The gap between the two standards sought by the OECD is now so wide that it can no longer be spanned by artifice alone. The offshore financial centre must now drill through corporate ownership until the identity of each ultimate 10% beneficial owner is obtained. No such similar obligation applies in most of continental Europe or in many other OECD jurisdictions.

The need for the G7 nations to apply a double standard is primarily driven by the need to prevent an outflow of mobile capital from the high tax European Union (EU) jurisdictions, where the fear of budgetary deficits, unfunded pensions and uncompetitive levels of social security spending make increased levels of taxation a foregone conclusion. No wonder the events of 11 September have been so swiftly hijacked by EU Treasury departments to maintain a political momentum against those offshore financial jurisdictions that, in their eyes, harbour the threat.

But as time passes, the negative implications suggested by these PR campaigns are becoming less and less credible. An impartial review of the evidence does not place the OECD jurisdictions in a good light. We are aware that the funding for the 11 September terrorists passed through routine banking channels in the US. We are aware that Mr Abacha transferred $4bn  (£2.5bn) from the Nigerian treasury through banks in the City of London to Switzerland and we are also aware that notwithstanding the transparency with regard to money laundering in the Cayman Islands which dates from the Mutual Legal Assistance Treaty with the United States in 1990, no similar case of money laundering, or anything like it, has yet been revealed.

Clearly the offshore financial centres remain the victims of the internecine warfare between the US regulatory agencies. Little or no credit was given to the offshore financial centres by any agency other than the Department of Justice, which is the federal department designated by the US government pursuant to the 1990 treaty as having exclusive access to the treaty with regard to money laundering offences in the Cayman Islands.
No favourable conclusion appears to have been drawn from the fact that in the Cayman Islands fewer than 200 applications have been made by the Department of Justice in a 12-year period pursuant to the 1990 treaty, which provides greater transparency on information sought than would exist in the US.

We should not forget that the EU is enmeshed in internecine warfare of its own making on the subject of the EU Savings Directive. While the predictable recalcitrance of the Swiss bankers is providing a possibly fleeting diversion, the fact of the matter is that whether it is immediate and spontaneous tax reporting required by the Directive or the application of a withholding tax, the potential for significant damage to the EU economy arises unless the mechanism of choice (or possibly a classically negotiated EU compromise) is adopted on a global basis.
Changed the rules Once again, the offshore jurisdictions simply represent the soft target and it is highly unlikely that full faith and credit - and indeed positive publicity from the relevant Treasury departments - will be accorded to any offshore jurisdiction with respect to its tax transparency or its anti-money laundering legislation while it has a more competitive tax rate and is not fully signed up to the European Union playbook.

Well-regulated and transparent offshore financial centres such as the Cayman Islands, Bermuda and Jersey have an important part to play in enabling onshore institutions to access the international capital markets, reducing reliance on bank and quasi-bank funding and therefore the cost of borrowing. And what of the point made by Alan Greenspan recently?

In his view, the reason why a current banking crisis may have been averted in the G7 countries has a great deal to do with the financial engineering and risk transference that is an essential part of the bankruptcy remote vehicles structured in the offshore financial centres for the benefit of onshore financial institutions.

As it stands there exist structured finance transactions involving billions of dollars based in well-regulated transparent offshore financial centres with excellent professional infrastructure to support them, all of which are inextricably linked to the financial position of financial institutions in OECD countries.

One possible outcome of the negative public relations campaign is the flow of these funds to infinitely less transparent centres where the writ of the OECD does not run, with costly dislocation to the current financial architecture.

If the financial condition of the G7 economies were robust, that would be a brave enough risk to take. In the current climate it seems ill considered, but would have the ancillary benefit of establishing beyond reasonable doubt the existence of the law of unintended consequences.
At the least, those responsible for the negativity should realise that their position, on any analysis, is becoming increasingly untenable, that by acceding to the OECD and FATF initiatives, a number of offshore jurisdictions have changed the rules of the game objectively and transparently so, and that as a result their standing has been necessarily enhanced in the eyes of the financial institutions who access the international capital markets.

That should be regarded by all as a positive outcome and should be described as such.