To most people, the notion of complex financial transactions conducted through shady offshore accounts belongs in the fiction of John Grisham. But to regard offshore finance as a marginal element in the world economy would be wrong, and would underestimate the importance of ensuring effective global oversight. Offshore financial centres (OFCs), or tax havens, play an increasingly central though still predominantly unseen role in the global financial system.
The murky world of hedge funds, offshore finance and the global flow of money has recently been the focus of headlines in Italy and Britain, thanks to bribery and corruption charges against prime minister Silvio Berlusconi, relating to past business dealings of the Italian leader. While Italy's electorate may be unfazed by the accusations levelled at their premier Berlusconi has, after all, faced similar charges on half a dozen occasions in the past the investigations by Milanese magistrates have a wider resonance.
For example, the charges against Berlusconi have led to closer investigations of David Mills, a British international tax lawyer and estranged husband of Tessa Jowell, a cabinet minister and key political ally of prime minister Tony Blair. Amid accusations that Mills received a substantial payment from Berlusconi in return for favourable testimony in an earlier investigation an allegation both men deny Italian investigators have been combing financial centres from London to the British Virgin Islands, to Guernsey, Malta and the Isle of Man as they seek to uncover complex financial transactions relating to their business dealings.
For the world's super-rich, offshore accounts are integral to "wealth management" strategies to protect them from the "overbearing" personal tax regimes of large industrialised nations. Tax Justice Network (TJN), an NGO which campaigns for greater financial transparency in the world's seventy-odd tax havens, estimates that approximately $11.5 trillion of assets are held offshore by high-net-worth individuals, and that the tax not paid as a result of these funds being held offshore might exceed $255 billion each year. Much of this wealth is invested in hedge funds, domiciled offshore but, in effect, managed from major onshore financial centres such as London and New York. While the secrecy of these funds means that no exact figures are available, experts estimate that there are now over 9,000 hedge funds worldwide, holding assets of over $1 trillion.
In an increasingly competitive market, offshore jurisdictions are seeking new ways to attract high-net-worth individuals to their shores. In February 2006, the Isle of Man's government announced that it would abolish company tax and cap personal income tax at £100,000 ($175,560) in a bid to attract the super-rich and budding entrepreneurs to the island.
Transnational corporations are responsible for much of the growth in the global offshore financial sector, attracted by the reduced regulation and taxation on offer from tax havens. Offshore practitioners argue that OFCs provide no- or low-tax legal space in which complex financial deals can be structured deals which might not otherwise happen "onshore". But campaigners argue that multinationals avoid paying billions of dollars in corporation tax by conducting business in or through OFCs.
Moreover, development charities such as Christian Aid argue that the problem of income and corporate tax avoidance is particularly acute in developing countries. According to Boston Consulting Group, more than half of the total holdings of cash and listed securities of wealthy individuals in Latin America is held in offshore tax havens. The equivalent figure for Africa is likely to be higher still.
A problem of regulation
For the foreseeable future, it will be decision-makers in Europe and North America who will dictate global policy towards OFCs. Public opinion seems to favour "honest taxation". A survey published in February 2006 by the IRS Oversight Board, the United States government commission responsible for overseeing the work of the country's federal revenue-raising authority, found that 87% of American taxpayers thought it was "very important" to ensure corporations were honestly paying what they owe.
Politicians on the stump have tried to play to this sentiment. During the US presidential election campaign of 2004, Democratic candidate Senator John Kerry promised to tackle tax evasion and banking secrecy in British-owned tax havens used by US companies.
Investors have also raised concerns about insufficient regulation in offshore jurisdictions, particularly in the aftermath of a string of corporate scandals in the early part of the decade, including those involving Enron, WorldCom and Tyco in the US, and Ahold in Europe. Most notably, major institutional investors led by the California Public Employees' Retirement System called on US businesses not to register offshore.
In response, policy-makers in Europe and the United States, often acting through international institutions, have attempted to exert political pressure to increase the transparency of financial activity that occurs in or through many OFCs. However, it is questionable how effective they have been.
In 1998, the Organisation for Economic Co-operation and Development unveiled its "initiative against harmful tax competition" and went on to identify 34 "uncooperative" tax havens. While many of them subsequently agreed to cooperate, intransigency on the part of the new Bush administration led to many of its provisions being heavily watered down. More recently, the International Monetary Fund (IMF) has undertaken its own programme of assessments of regulatory structures and financial supervision in the world's OFCs.
In addition, the European Union has implemented its Savings Tax Directive in member-states, some offshore financial centres in Europe and the Caribbean under the jurisdiction of the British and Dutch crowns, and certain third countries such as Switzerland. But European elites have been keen to avoid measures which might simultaneously damage their own financial services sectors. The UK treasury was reported to be concerned about the EU's original proposal for a "withholding tax", fearful of the damage it might do to the City of London, Britain's economic crown jewel, and its lucrative Eurobond market. Other EU states namely Austria, Belgium and Luxembourg sought certain concessions to protect bank secrecy before agreeing to implement the directive.
Offshore, onshore
Indeed, this dilemma for national policy elites lies at the crux of any concerted global efforts to increase financial transparency in tax havens. As both academics and offshore professionals have argued, the distinction between offshore and onshore is becoming increasingly blurred. "Many of the offshore financial centres are actually situated onshore", argues a leading offshore practitioner. "And the day-to-day relationship between offshore jurisdictions and the other major financial centres of the world in New York, London, Tokyo and Hong Kong is intimate and often mutually supportive."
At the same time, more established offshore centres like Switzerland and Jersey have complained that they are feeling the squeeze from the EU's recent efforts to increase financial transparency, and that they are haemorrhaging business to what they argue are less regulated jurisdictions. OFCs such as Singapore have already reported rapid growth in their financial services sectors as businesses switch from competitors in Europe and the Caribbean.
So far, the international response to the rise of the "offshore world" has been piecemeal. This is perhaps unsurprising given its complexity, not to mention the considerable vested interests involved. Much of the deliberation has taken place beyond the scrutiny of the public eye.
Perhaps, those global institutions responsible for financial governance, so often accused of acting undemocratically and harming the world's poorest, should take note. The IMF is already undergoing a process of reform. With greater legitimacy and more say for developing countries, alongside new mechanisms to allow the voices of citizens to be heard, such institutions could position themselves at the forefront of efforts to oversee a prosperous, stable and fair global financial system.
