by
Philip Morris *
and
Kevin Campbell**
Background
The development of the Offshore Finance Centre (OFC) is a phenomenon
of the last forty years. The postwar expansion of international trade,
the rapid growth of the multinational corporation, the emergence of offshore
currency markets, and the creation of new financial instruments and markets
have all combined to fuel the growth of OFCs. Demand for the services
they provide has also been assisted by high tax levels, overly complex
laws and excessive regulations in many industrialised countries, and also
by political turbulence and economic uncertainty in developing countries.
The proliferation of OFCs around the world has been unprecedented.
Some focus on the provision of traditional trust and company administration,
whereas others offer more specialised services, involving banking, corporate
consultancy, structured financial transactions, and insurance and mutual
fund administration. The essential features of an OFC may be summarised
as follows:
? Geographic Location - convenient to the centre of an individual’s
or corporation’s operations;
? Political and Economic Stability - long-term stability of the OFC
and environs through the absence of any threat of political conflict;
? Reduced Tax - either exemption from local taxes, extensively reduced
levels of local taxation, or, in some cases, meaningful guarantees against
future imposition of taxes for lengthy periods;
? Absence of Exchange Controls - within the major OFCs there is no
longer exchange control legislation or regulations and thus there is the
complete free flow of financial transactions;
? Codification of Banking, Insurance, Trust and Company Laws - a clear
and flexible legal and regulatory framework within which the incorporation
and business of the OFC entity is facilitated, enhanced and controlled;
? Confidentiality Practices - the OFC should provide for strict confidentiality
of client information except where evidence of criminal activity is found;
? Tax Treaty Network - OFC entities may benefit from the use of a double
taxation treaty network;
? Cost Effectiveness - the pricing of license fees, cost and quality
of labour, the ability to secure professional staff and work permits for
foreign nationals;
? Reputation - above all, the OFC must maintain an excellent record
for business propriety and due diligence in its practices.
In the British Isles, Jersey, Guernsey and the Isle of Man have grown
rapidly as OFCs since the abolition of exchange controls in 1979.
Their ability to offer low tax rates has attracted large numbers of international
companies to their shores. About 90,000 companies are incorporated
in the Islands - most in the Isle of Man. Table 1 provides some information
on the key features of Britain’s three OFCs.
TABLE 1
Key Facts About British Offshore Financial Centres
Jersey
Guernsey Isle of Man
Population 85.2
61.4
71.7
GDP per head
(£)
15,854 15,615
8,931
Proportion of
GDP arising
from financial
services (%) 55
59
36
Bank deposits
(£ bn)
99.8
49.8
20.0
Funds under
management
(£ bn)
37.8
16.7
7.5
Companies
locally
incorporated 32,000
16,000
42,000
Companies
entitled to
special tax
or no tax 16,000
8,000
22,000
Source: Home Office, Review of Financial Regulation
in the Crown Dependencies, A Report, Part I Cm 4109-1 p10.
The table reveals that the Islands generate a substantial amount
of economic activity from and are heavily reliant on their OFC status.
They are described in the Edwards Report as being in the “top division”
of OFCs. Total assets and liabilities of Island institutions and
trusts are now some £300-350 billion. At the same time, however,
concern has grown over the use of the Islands as a means of tax avoidance
and also about the adequacy of financial regulation following a number
of scandals. Given the economic benefits accruing from their OFC
status, any attempt to tighten regulation in the Islands needs to be balanced
against the potential loss of clients to other centres. It was against
this background that the Edwards Report into financial regulation in Jersey,
Guernsey and the Isle of Man was published in November 1998 following a
10-month review of the British Offshore Financial Centres.
At the outset it should be stated that the Report leaves unscathed
the twin pillars’ upon which OFCs have built their growth. First,
tax advantages, which were not within the remit of Edwards.
Secondly, secrecy: the Report stops short of requiring public disclosure
of the beneficial ownership of offshore companies and the individuals lurking
behind offshore trusts.
Despite the fact that the Islands’ status as tax havens was outside
the scope of the Report, the public spotlight on this contentious issue
is bound to intensify. Pressure on the Islands is mounting from the
European Union, where Mario Monti, the single market Commissioner, is pushing
for tax harmonisation. Furthermore, the Organisation for Economic
Co-operation and Development has also launched a drive to stamp out havens
which it views as offering unfair tax competition. This broader issue
seems destined to resurface in the not too distant future.
The Constitutional Status of the Islands
Neither the Channel Islands nor the Isle of Man is part of the United
Kingdom. Rather they are Crown Dependencies that have historically enjoyed
sweeping powers of self-government including the right to determine
levels of domestic taxation and develop innovative legal vehicles for the
conduct of offshore business. This substantial internal autonomy
is bolstered by a firm constitutional convention that prohibits Westminster
from legislating for the Islands in relation to matters of purely insular
concern. Acts of Parliament do not extend to the Islands automatically.
They only do so if expressly stated to or by necessary implication. In
fact it is fairly rare for Westminster to legislate directly for the Islands.
Instead the more common technique is for Westminster to include in United
Kingdom legislation a section providing for its extension to the Islands
by subsequent Order in Council with such exemptions, modifications and
adaptations as are appropriate. This permits the legislation to be “customised”
to the needs of the insular administrations.
In terms of internal administration, Jersey and Guernsey at least
operate very much along the same lines as United Kingdom local authorities,
namely with functional committees working in tandem with the insular civil
service. The Isle of Man in contrast has shifted toward a ministerial system
of government with a Manx Cabinet headed by a Chief Minister accountable
to Tynwald, the Island’s legislature. All three Islands have introduced
self-standing financial services regulatory agencies intended to have an
arm's length relationship with the rest of the insular administration,
and Edwards includes several key recommendations designed to bolster their
independence and effectiveness in regulating offshore financial business.
So far as the Islands’ legal systems are concerned, they enjoy
distinct legal professions, judiciaries and court systems with ultimate
rights of appeal to the Privy Council. The development of common law on
the Islands is heavily influenced by English Law though, in common with
many small jurisdictions, there are concerns that this influence may become
so powerful and pervasive that the laws of Jersey, Guernsey and Manx will
lose their discrete jurisprudential identities. In an effort to avert this
threat, considerable efforts and resources have been expended in recent
years in developing law reports, journals, bulletins and treatise's etc
with the objective of preserving each Island’s distinctive legal tradition.
Finally, it is worthwhile briefly noting the Islands relationship
with the European Union. Essentially the Islands are, by virtue of Protocol
3 of the Act of Accession , subject to European Community Law in regard
to free movement of goods and agricultural produce but otherwise insulated
from most of the EC Treat. The main practical consequence is that the Islands
are not exposed to the Union’s tax harmonisation programme and thus have
been able to survive and indeed thrive as offshore jurisdictions offering
a fiscal structure that is extremely attractive to multinational corporations
and high net worth individuals.
The Edwards Report : Selected Key Recommendations
At the outset it is vital to stress the status of the Edwards Report:
it is a report compiled by a civil servant that does not disclose the evidence
submitted to it and which was concluded evidently without any public hearings.
Accordingly, it lacks the stature, perceived independence and methodological
rigour one would associate with a Royal Commission or Law Commission inquiry.
Nevertheless the government is taking its proposals seriously. Meetings
have been held in January between the insular authorities on the three
Islands and Lord Williams, Minister of State at the Home Office, in order
to develop an action plan to implement the proposals. Throughout the Report,
Edwards’ tone is conciliatory and, in general, positive about the Islands’
systems of financial regulation. In response senior insular officials have
broadly welcomed Edwards raft of recommendations while reserving the right
to reject those which may undermine their attractiveness as magnets for
offshore business .
Reform of financial regulation in any offshore finance centre
requires recognition of the inherent tension between on the one hand the
need to attract business (critical for the Islands given their economic
dependence, as Table 1 above highlights on the financial services sector)
and at the same time the need for proper standards of investor protection.
Edwards does not duck this dilemma and concludes that on balance “good
regulation is likely to attract more business than it drives away” and
that the business it attracts is more likely to be reputable than that
which seeks out jurisdictions having lax regulatory standards (para 17.2.4
and see paras 17.2.1-17.2.6 for discussion of the issue).
Space does not permit a detailed account of the entire raft of
proposed reforms contained in Edwards. Instead we focus on the four
areas identified below on the bases that (i) they will require the
most far reaching changes in the Islands’ regulatory regimes; and (ii)
are likely to be of the greatest interest to financial institutions that
have business relationships with the Islands.
(a) Institutional Structures, Objectives and Policies
Edwards accepts the principle of independent financial regulation because
regulation is:
“better performed by suitably qualified independent professional people
than by politicians or government officials with other axes to grind”(para
6.2.6).
Moreover, a measure of independence permits the regulatory agency to
pay the competitive salaries, free of traditional public sector constraints,
necessary to recruit high calibre individuals (supra). In terms of specific
details the Report suggests(paras 6.3.1-6.10.5):
? Single unified regulatory bodies on the Islands (currently the Isle
of Man has a separate Insurance and Pensions Authority, and on both Jersey
and Guernsey the task of company registration is not entrusted to the financial
services regulatory commissions) as likely to prove more cost-effective,
flexible and facilitate better supervision of financial conglomerates and
the company sector;
? Political participation on financial services regulatory commissions
should be precluded in order to bolster their professionalism and perceived
independence, though channels of accountability to the Islands’ legislatures
ought to be created;
? The Jersey and Guernsey commissions should consider the creation
of dedicated enforcement units (modelled closely on that operating on the
Isle of Man) with proactive powers and locus in civil proceedings;
? Financial services regulatory commissions on the Islands should be
furnished with statutory “mission statements” articulating their key objectives
and duties including, inter alia, protection of investors via stringent
supervision, combating financial crime, co-operation with overseas authorities
but not engaging in promotional activity (as currently occurs) because
this would create the “wrong impression” given that promotion is not a
proper task for regulators.
Two further specific reforms are suggested to enhance levels
of investor protection on the Islands. First, the introduction of depositor
protection schemes to mitigate investor losses hould a financial
institution collapse (paras 6.15.1-6.15.11). Secondly, the creation of
separate (or possibly for Jersey and Guernsey a common) Financial
Services Ombudsman scheme(s) to resolve customer disputes (para 6.6.17).
For Edwards these schemes are an invaluable technique of investor protection
given that legal processes on the Islands are regarded as “too long and
too expensive, the likely outcomes …too uncertain” (para 6.16.6).In addition
such schemes have the advantages that: disputes are resolved by means of
independent adjudication; speedy resolution of disputes is attained; the
financial services regulatory commissions do not become embroiled in dispute
resolution; and Ombudsmen, unlike the courts, can go beyond strict legal
standards in resolving cases.
In order to underline the seriousness of this proposal Edwards
specifies a “blueprint” for his postulated Ombudsman schemes: membership
should be compulsory and extend to all financial services providers; eligible
complainants should include private individuals, unincorporated bodies,
partnerships, and small companies who have been customers of the firm complained
about; there should be no inflexible maximum limit on the amount claimed;
customer complaints should go direct to the Ombudsman; cases should be
resolved in the first instance by means of conciliation, with the next
stage being an informal or recommended award; awards should be binding,
either at the behest of the Ombudsman or via the court system if
the recommended award is considered fair and reasonable; the Ombudsman
should be accountable to the Islands’ Parliaments and submit published
annual reports to them; and links should exist between the Ombudsman
and regulatory agencies, with the latter being consulted by the Ombudsman
on standards of business to be expected of authorised bodies and
the Ombudsman feeding back information to the regulatory agency so that
regulatory standards generally may be improved (para 6.16.13). These
arrangements clearly envisage a dual “grievance man” and quality control
mission for the Ombudsmen, which is broadly comparable to that already
performed by the sectoral Ombudsmen operating in the United Kingdom financial
services industry. If implemented they will, as Edwards acknowledges
(para 6.16.14), not come cheap but will deliver the benefits of a quick,
informal and free mode of extra-judicial redress for investors, which in
turn may bolster investor confidence in the Islands as well regulated,
safe OFC’s.
(b) Company Registration and Vetting
Edwards supports the principle of careful vetting of company registration
applications as practised in Jersey and Guernsey and hopes it will be extended
to the Isle of Man on the basis that when properly conducted it can “nip
potential problems in the bud” (para 19.7.2 and see generally: paras 10.6.1-10.7.3).
On the specific issue of beneficial ownership, Edwards supports full disclosure
in principle albeit subject to preservation of confidentiality (para 10.8.3).
For Edwards disclosure of beneficial owners (and shadow directors) is a
vital weapon in the fight against financial crime and money laundering
(para 10.8.7 and see generally paras 10.8.1-10.8.12).
Moving on to the controversial topic of disclosure of accounts
and requirements for audit, Edwards starts from the premise that:
“all limited companies … be required to keep audited accounts and to
file them publicly, with much abbreviated requirements for small companies”(para
10.10.7).
Edwards is unflinching in applying this principle to asset holding
companies, especially given the high risk that such companies could be
exploited as vehicles for money laundering by non-residents (paras 10.10.10
-10.10.11). This will necessitate a radical transformation of the Islands’
company legislation which at the moment falls considerably short of universally
requiring the maintenance and filing of audited accounts (see the summary
at para 10.10.5). It is this proposal which is like to encounter the stiffest
opposition from the insular authorities who regard the privilege of no
requirement for the filing of audited accounts as a key magnet in attracting
footloose international capital, and are concerned that loss of the
privilege may simply divert that capital to more lightly regulated offshore
jurisdictions in the Caribbean and Pacific that have no qualms in continuing
to offer it. These fears could perhaps be assuaged and an effective campaign
against money laundering maintained by adopting Edwards fall back solution
that private, non-trading asset holding companies could disclose information
to regulators on the Islands in confidence rather than the public, and
permitting small companies generally the facility to file much abbreviated
accounts, possibly limited to a single page (para 10.10.12).
(c) Directors and Partnerships
Here the Report identifies the so-called “Sark Lark” as a flagrant abuse,
that is to say the use of nominee directors drawn from the population of
the Island of Sark (which is part of the Bailiwick of Guernsey) in respect
of companies incorporated elsewhere, typically the Isle of Man. The end
result is to achieve secrecy, by virtue of the emaciated disclosure requirements
for non-resident companies on the Isle of Man, and tax avoidance, stemming
from the total absence of corporation tax on Sark (for full discussion
of this abuse see paras 11.2.1-11.2.16 ). Some mind-boggling statistics
are revealed concerning this sham practice: out of a total population of
575 on Sark, residents evidently hold a total of around 15,000 Directorships,
with 3 residents holding between 1600 and 3,000 Directorships each! (para
11.2.3).
On this issue at least Edwards adopts a robust stance involving
a three pronged attack on the abuse. First, a regime of licensing and supervision
performed by the Guernsey Financial Services Commission applying the criterion
that only “fit and proper” persons in terms of integrity, solvency, competence,
track record and technical support on those Islands - including Sark -
comprising the Bailiwick of Guernsey would be permitted to act as Directors.
Secondly, a Code of Conduct for Directors which would, inter alia, require
them to be aware of who owns the company, the nature of its business, its
financial position, to have full and up to date information and ensure
that the company is not being used for illegal purposes. Thirdly, as a
general principle Directors would be obliged to refrain from holding an
unreasonable number of Directorships though no specific ceiling should
be set. Annual returns would be required from those providing Directors’
services specifying the ownership, place of incorporation and principal
activities of the companies they serve as Directors (para 11.2.19).
Edwards confidently predicts that this stringent regime would kill the
Sark Lark “once and for all” (para 11.2.20).This may well be true in the
context of the British Isles, but is there not a real risk that highly
mobile international capital will simply relocate and replicate the practice
in other under-regulated offshore jurisdictions, with the result that the
abuse is simply displaced rather than eradicated?. Effective and permanent
solutions to the Sark Lark and allied egregious abuses surely requires
multi-lateral international treaties with the background threat of imposition
of sanctions on “rogue” offshore jurisdictions that refuse to become contracting
parties.
Turning to partnerships, Edwards notes the controversial Jersey
Limited Liability Partnership legislation (paras 11.4.1-11.4.5) and suggests
changes including audit and disclosure of annual accounts (para 11.4.5).
Remarkably however no mention is made of the influential role played in
its conception and drafting by two international accountancy firms and
the furore this caused both on the Island and in the United Kingdom.
(d) Financial Crime and Money Laundering
Perhaps the most innovative and potentially far reaching of Edwards
proposals lie in the fields of financial crime and money laundering ; areas
in which Jersey, Guernsey and the Isle of Man have attracted considerable
criticism in recent years based on allegations of acting as havens for
funds which are the proceeds of crime and inadequate co-operation with
overseas’ enforcement authorities investigating criminal activity. Edwards
sees effective policies in these fields as “clearly essential in any international
finance centre of repute” but observes that for such policies to have real
impact there must be (i) good co-operation with regulatory agencies in
other jurisdictions; and (ii) strong legislation and proper resources for
implementation (para 14.1.2).
In relation to money laundering Edwards frankly acknowledges
that it occurs in the Islands but that the extent of it is hard to quantify.
Striking a note of realism, Edwards comments that all offshore finance
centres;
“are likely to receive substantial amounts of laundered funds as criminals
seek to conceal their tracks by moving the proceeds of crime through a
number of separate jurisdictions” (para 14.3.4).
It seems judging from Edwards consultations that most money laundering
takes the form of using the Islands as “staging posts” in a trail whereby
money is passed from one jurisdiction to another in order to conceal its
origin (paras 14.3.5-14.3.6). Nevertheless Edwards argues that the problem
needs to be “kept in perspective”: some money laundering in OFC’s is inevitable
and that the evidence suggests most offshore business on the Islands is
legal (para 14.3.13).
On the whole Edwards is impressed with the insular authorities
existing armoury of legislation designed to combat money laundering and
the vetting of new business (supra). Detailed proposals from Edwards therefore
are geared toward filling lacunae, refining existing insular legislation
(such as the need for a general law on cooperation between law enforcement
authorities in different jurisdictions (paras 14.7.6-14.7.7)), sharing
of information between the United Kingdom and Island authorities (para
14.7.14), more extensive use of the civil law to take the profits
out of money laundering via reversing the burden of proof where an individual
has an unexplained lifestyle, heavier financial penalties and conferring
powers on enforcement authorities to use civil proceedings to gain Mareva
injunctions and forfeiture orders (paras 14.9.1-14..16) and a disqualification
regime for professional services providers such as lawyers and accountants
who may facilitate money laundering.
The most radical part of the entire Report is that which commends
for consideration by the insular authorities self-standing Financial Crime
Units with the following substantive features (para 16.4.5):
? The units should be unified agencies entrusted with responsibility
for the investigation of financial crime;
? The principal responsibility of a unit would be policing the Islands
financial sector and supporting the insular Attorney- General in his role
as public prosecutor;
? Specific tasks of the unit should encompass intelligence, handling
of suspicion reports, maintenance of a comprehensive database, investigation
of financial crimes including money laundering and tax evasion, obtaining
of evidence, seizures, restraints and confiscations, relations with the
finance, company and professional sectors and assistance to other jurisdictions;
? Staffing of the new units should be multi-disciplinary, including
Customs and direct tax staff, police officers and specialist accountancy
and information technology support. Other professional assistance would
be bought in as and when required;
? Directors of the units should be full time with no other responsibilities;
? Units would report direct to the Attorney-General but remain separate
from the police, customs and the Attorney-General’s Office;
? Despite its independence the unit would work closely with other law
enforcement agencies and regulators;
? Units should receive dedicated financing with the Attorney-General
responsible for ensuring budgets and staffing are adequate;
? Staff in each unit ought to be encouraged to forge a career within
the unit without moving from the unit to other types of policing work.
Units along these lines would represent a quantum leap forward
in the detection and prosecution of financial crime. The mere fact of their
creation would itself bolster confidence in the Islands as clean and effectively
regulated OFCs. The ball is now in the insular authorities’ court: a bold
decision is required to provide the necessary substantial funding
and in doing so demonstrate that on the Islands finance centre policing
is just as important as physical crime and neighbourhood policing (para
16.4.6).
Conclusions
The generally warm welcome given to Edwards by senior Island officials and politicians is scarcely surprising given the Report’s conciliatory tone and fairly moderate substantive recommendations. Doubtless Edwards was mindful of both the heavy reliance of the Islands’ economies on offshore finance business and the “constitutional” sensitivities of the review given the hostile reaction by the insular authorities to its creation without, evidently, prior consultation with them. The net result is a Report which is tentative and apart from a few initiatives (such as the proposed new Financial Crime Units) will not require a major programme of unexpected legislation in view of the fact that many of the suggested reforms were planned anyway or merely require the “fine tuning” of existing legislation.
There are a couple of more disturbing points about the Report.
First, its tentative nature at times comes perilously close to a whitewash:
recent scandals on the Islands such as Bank Cantrade in Jersey, Barings
in Guernsey and BCCI in the Isle of Man are covered in just over three
pages. Admittedly some suggestions for better banking supervision
and licensing are made but Edwards glosses over the fact that large numbers
of investors lost substantial sums of money in these scandals and that
many are still uncompensated (see generally Chap 7). Likewise, the alleged
“purchase” of limited liability partnership legislation from the States
of Jersey by two “Big Five” accountancy firms as part of a campaign to
pressurise the United Kingdom government to introduce auditor liability
reforms is not mentioned at all. This is in spite of the fact that such
incidents and the attendant adverse publicity inevitably have a very real
bearing on investor perceptions of the integrity and professionalism of
legislators and regulatory authorities on the Islands. Secondly, it may
be unduly sanguine to believe that Edwards’ proposals, even with the necessary
political will and additional funding, will be easily implemented: each
Island will have to recruit around 20 extra individuals to operationalise
Edwards’ reforms, yet the pool of high calibre individuals with substantial
high-level regulatory experience is strictly limited.
*Senior Lecturer in Business Law, University of Sterling.
**Lecturer in Finance, University of Sterling.