The real risk for offshore jurisdiction

It is all too easy in the immediate aftermath of a big story to jump to conclusions and miss the bigger picture. I believe that there is a real risk for offshore jurisdictions doing this with regards to the current global media firestorm around tax havens and hidden assets. The real risk, in my view, is not the short term reputational damage, but rather that much of the business done today offshore will migrate back onshore over time and this onshoring will devastate those economies without plans for how to deal with the “post offshore” world we may find evolving in the next few years.

The past couple of weeks have seen the Panama Papers grab headlines around the world. Politicians of every hue line up to declare that “tax havens” must be “closed” and that Governments should “Act Now”. In the UK the members of the opposition Labour Party, including its leader Jeremy Corbyn, have even suggested that the UK Government should take over running of several jurisdictions, including the Crown Dependencies such as Guernsey where I live and work, despite the UK Government having no direct jurisdiction over our affairs. Needless to say, such arrogance and ignorance has not played well here in the Channel Islands.

However, it should be recognised that amongst all this bluster there are some home truths, even if there are some areas where reality is a million miles from the tabloid perceptions. It should be acknowledged that all “offshore” jurisdictions (which includes a number on the mainlands of Europe and the Americas) in the past functioned as a way for individuals, companies and Governments to hide assets and transactions. There is no point in denying this, but equally that is in the past. In my career I have seen first-hand the sea change in the workings of the finance industry. When I first joined the industry in the 1980s in the UK I heard stories of men turning up with shopping bags of cash to buy bearer shares, of politicians applying for privatisation shares in the names of their dogs and I heard foreign Government politicians thank UK companies for sanctions-busting. No one really did anything about it. There would be the odd exposé, the odd political scandal, but no real, effective and coordinated action.

Then, gradually, the world began to take notice. What began, after the formation of the intergovernmental body the Financial Action Task Force in 1989 as an international effort to prevent the laundering the proceeds of crime, through the introduction of more stringent Anti-Money Laundering (AML) regulations, was rapidly accelerated as Countering the Financing of Terrorism (CFT) became a priority for nations around the world in the 2000s and in the post financial crisis world was added the desire for Governments to collect tax revenue and for voters to feel the burden is being shared equally across individuals regardless of wealth and corporates regardless of size. All this has bifurcated offshore jurisdictions.

There are those such as Guernsey, that have sought to eliminate the racier elements of offshore business and where the finance sector is subject to far greater scrutiny than peers in “onshore” jurisdictions. However, there some others that choose to cling on to the notion that “offshore” should mean anonymity and absence of reporting requirements. For example, a recent Financial Times article showed how easy it is to set up dummy companies in some offshore jurisdictions. This is in stark contrast to the situation in jurisdictions such as Guermsey. I recently set up a new company here and to do so I had to use the services of a regulated fiduciary, and that fiduciary needed to see me personally to certify copies of the original documents I had to produce at the meeting to prove my identity, and it was necessary to have full details of the shareholders, Directors, the source of funds for the company’s capital and the source of wealth of each of the shareholders and Directors. All of the major shareholders and Directors would have to go through the same Client Due Diligence (CDD) as I did to prove they are who they claim to be. I also had to provide an explanation of the intentions of the business. If I was setting up the same company in the UK I would simply go onto the Companies House website, pay £15 and fill in an online form, giving the company name, the names and addresses of the Directors, and the details of the initial share capital. The initial shareholders need to be identified by name and address, but verification of this information is not done by passport or even utility bill, but by three pieces of information, which can be mother’s maiden name, eye colour and father’s first name (I kid you not). With CDD like that it is no wonder David Cameron is so confident that the UK is in the forefront of the fight against hiding assets.

So, the “good” offshore jurisdictions, that are jumping through hoops to ensure best in breed AML and CFT records are kept and systems in place, that already record the beneficial ownership of their companies and have agreed a range of information exchange agreements with onshore jurisdictions are feeling pretty relieved that the Panama Papers have left them relatively unscathed. I think this is a mistake, and if complacency creeps in it will be a very costly mistake. You see, the fact that better offshore jurisdictions are now applying extremely high standards might avoid being tripped over by revelations of misdeeds elsewhere, but it now means that offshore centres need to work that much harder to actually prove that they have any purpose at all.

At present, central to the rationale for why companies and individuals might continue to utilise an offshore jurisdiction is the notion of tax neutrality – you will still need to pay tax on the returns made in your home jurisdiction, but there are no “frictional” costs of holding the assets through an offshore structure. Thus wealth management for high net worth individuals and holding companies for corporates are a wash through – the assets are held in stable, safe jurisdictions, without any tax cost to holding the assets in those safe, stable jurisdictions. For companies working across multiple jurisdictions, multinational funds or for families spread across the world this makes perfect sense.

There is a big “but” and this, I believe, is the real threat to the offshore world from the Panama Papers and other similar revelations. If onshore jurisdictions were to decide that tax neutral structures could and should be available domestically then a large part of the offshore wealth management industry could be progressively eroded. Already the UK, for example, allows holding companies an exemption from tax, if they are simply holding companies for subsidiaries. Were this to be expanded to other corporate structures, individuals might find themselves able to accumulate wealth onshore free of tax. Rather than eliminate offshore centres, perhaps onshore Governments might decide that an easier and more effective path might be to simply eliminate the need for offshore centres. Given the higher requirements in terms of AML, CFT and CDD that better offshore centres require than their onshore counterparts, an onshore solution might start to look attractive to individuals, funds and corporates.

So how should such offshore centres react to such a threat? I think there are five key steps that the more forward-looking jurisdictions can and are taking.

Firstly, and most obviously, is to diversify away from a pure focus on financial services. Small nations require industries requiring small numbers of high value-add employees. Finance fits this, but so equally would technology businesses, in their very broadest sense. The most obvious area is in fintech, since this can draw on many of the skills and the expertise already in situ, but there are examples of some offshore jurisdictions that are becoming centres for excellence in life sciences, or as a test bed for broader new technologies, such as the deal recently announced in Guernsey for Hewlett Packard to work with the Guernsey Government.

Secondly, jurisdictions need to think of themselves as a place in which to store more than simply cash or investments. In today’s world intangible assets, such as data or intellectual property is more valuable that physical assets, and yet the principles behind protecting and securing those assets are the same.

Thirdly, jurisdictions need to think of themselves as offering more than a place that is free of tax. If that cost advantage of offshore centres is removed, jurisdictions need to sell themselves on the service provided. Fortunately for the offshore centres, customers are at the centre of most onshore financial companies’ Powerpoint presentations but are rarely actually at the centre of their business model. Customer focus, and a genuinely personal service still sell, and always will. In addition, many offshore jurisdictions benefit from a stability in the economy and politics that is not the case elsewhere. It may sometimes be a frustration to those of us living in a quiet, beautiful island, but change is viewed with scepticism and there will always be a healthy resistance. An island economy and environment will always be vulnerable and this militates against radical changes in direction. From an external perspective this is a tremendous advantage when choosing somewhere to base assets or a corporate entity – stability in a tumultuous world should not be underestimated.

Fourthly, jurisdictions need to ensure their regulatory and legal framework is not only as good as anywhere else, since they will be constantly under greater scrutiny and suspicion than onshore centres, but their regulation and laws should also be more adaptable than larger jurisdictions. As financial products and financial technology changes, regulators in larger markets struggle to adapt in a timely fashion. Smaller jurisdictions have the advantage that they can react faster to these new challenges and create an environment that can encourage emerging areas of financial services and technology to base themselves. It used to be the case that innovative financial services used to come to offshore jurisdictions to avoid regulation; now the need in a globalised and more heavily regulated industry is for an appropriate regulatory framework for these innovative businesses to allow them to provide services to the rest of the world from within an adequate regulatory regime.

Finally, jurisdictions need to convey these fundamental changes to the outside world. This will be a better way to combat the negative publicity that continually surrounds the offshore world than trying to say “we don’t do the things you think we do” because that is a message that is impossible to prove. It may be true that money laundering, financing of terrorism and tax evasion may be easier through some onshore jurisdictions these days than many offshore jurisdictions, but no one in the Western world is ever going to believe it, Better to focus on what offshore jurisdictions are doing other than its traditional business and maybe just maybe the world will see that these islands contribute positively to the global community as fiercely independent and proud nations.

Some offshore jurisdictions will be better able to adapt than others. Those that have positioned themselves as offering cheap and cheerful corporate services are most at risk from onshoring of tax neutral structures. These jurisdictions have built their industries around high volumes, commoditised services for larger financial centres, and could find their raison d’être disappear in coming years. More forward looking centres will be far better placed.

I see positive signs that Guernsey, and some other offshore centres, are heading in the right direction to have a sustainable and profitable future in a “post offshore” world. It will not be easy but I do see reasons for guarded optimism. Other centres that are perhaps feeling a little smug about the lack of blowback from the Panama Papers would be wise to start to think about whether they really have a sustainable long term strategy for the Brave New World.

Posted on April 16, 2016

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