We need to enforce stricter regulations of international finance, the author writes. Caymans are just tip of the iceberg

The placid political waters of the Cayman Islands were roiled recently by an unprecedented announcement. Premier McKenna Bush instituted an expatriate-only payroll tax of 10 percent — immediately sparking an outcry among the wealthy people and international corporations that have built the Caymans’ massive financial sector on the premise of a tax-free paradise. More than 9,000 mutual funds, 260 banks and 80,000 companies are now based on an island of roughly 54,000 people.

While this move is rooted in the island’s budget wrangling with London, it comes just as such “offshore financial centers” are under increasing scrutiny for their role in an international financial system tainted by suspicion and scandal. From tax dodging to money laundering, from shady derivatives trading to the manipulation of the LIBOR rate, the lack of transparency and effective regulation in world finance has led to serious problems.


In U.S. politics, places like the Cayman Islands have emerged as rhetorical weapons for campaign attacks on the evils of corporate tax evasion and outsourcing. President Barack Obama has long made clamping down on offshore tax havens a priority, regularly citing the issue in the 2008 race and, once elected, promoting aggressive tax code changes to reduce U.S. companies’ ability to shelter profits from taxes by keeping them overseas.

Now, of course, the Obama campaign has pounded former Massachusetts Gov. Mitt Romney for his Cayman Island accounts, using them to attack what many see as a culture of unscrupulous selfishness among a global elite. Combined with persistent questions about Romney’s refusal to release his tax returns, the implied charges of shady financial dealings could add up to a potent character weakness for his campaign.

However, since the Cayman’s new tax only targets wages, it would leave the passive investments and corporate profits of the super-rich, like Romney, untouched. And this is really where the action is. Between $21 billion and $32 trillion is hidden offshore each year, the watchdog group Tax Justice Network estimates, meaning nearly $200 billion of lost government taxes annually.

These lost revenues, however, are just the tip of the iceberg of an international financial system that has grown so sprawling, complex and secretive that regulators face a near-impossible task. That’s the way many financial players – legitimate and otherwise – want it.

Not only do criminal enterprises benefit from no-questions-asked banking. But international corporations take advantage of it to streamline global operations with a minimum of red tape. These multinationals lobby against greater regulation — arguing that these liberties grease the wheels of international trade and promote growth.

They may have a point – but it has a dark side. As tax evasion and other white-collar crimes sap government revenue, this lack of transparency also facilitates money laundering, terrorist financing and political corruption.

Indeed, money laundering is the linchpin of the criminal universe. Without it, the billions generated by drug sales, human trafficking and the like would be trapped in the unwieldy form of cash. But once it enters the global financial system – whether through the fabricated profits of shell companies or unmonitored deposits – it becomes infinitely more useful. It can be used to pay suppliers, manage international criminal supply chains, fund preferred politicians and make legal investments in legitimate activities — that then get funneled back into the original criminal enterprise.

The alarming aspect of this new financial architecture is the ease with which it allows criminal enterprises to enter the legitimate economy, blurring distinctions between licit and illicit and compromising trusted institutions. Even the largest financial institutions struggle to identify illicit proceeds – there is too much and the oversight too weak.

For example, The Treasury Department fined British giant HSBC in 2005 for its customers’ ties to the Taliban, Iran and Syria, among others. Yet problems persisted, and in 2010 the Mexican finance ministry found that drug cartels were still creating shell companies through HSBC.

Revelations of rot in the system keep coming. New York regulators just accused the venerated British institution Standard Chartered of laundering $250 billion in illicit Iranian funds over the past decade. Shockingly, this appears to be more than a few bad apples and was instead allegedly an institutionalized practice. Investigators obtained bank memos and emails that apparently reveal an elaborate cover-up, code-named “Project Gazelle,” to systematically skirt U.S. sanctions against Iran’s banks. While Standard Chartered has vehemently denied the charges, if true it would mean that the program had been approved at the highest management levels in London. Regulators allege that these funds were a key source of funding for Iran’s financial support of terrorist groups, as well as its nuclear program.

Unfortunately, the answer is not just adding more regulations. Whether it’s HSBC or the LIBOR rate-setting banks, a culture of looking the other way has been allowed to take root — at times with the tacit blessing of the regulators themselves. In the case of Standard Chartered, there is evidence that not only was the bank’s highest leadership involved, but that independent monitors working for the financial accounting firm Deloitte & Touche bowed to pressure to omit key findings from their reports to shield the laundering operation.

To end this kind of impunity, there must be a shift in fundamental values. Bankers who participate in laundering have to realize that they cannot escape, for example, some responsibility when that money buys the assault weapons used to massacre civilians in Mexico. They already have tools to help shut off the spigot of illicit money – for example, by vigorously applying the Anti-Money Laundering frameworks that already exist, like the Know Your Customer protocols that require due diligence on legitimacy of all customers and partner banks.

In a way, the very ubiquity of regulatory authority allows malfeasance to slip through. The mess of confusing, redundant rules and jumbled jurisdictions means that, from the regulators’ perspective, the left hand often doesn’t know what the right is doing. Both corporations and criminals game the system — knowing that the over-extended regulators can’t keep up with the tangle of loopholes, caveats and innovative financial instruments.

If we’re serious about shining light on the underbelly of international finance, we need to make regulations not only strict, but, more important, enforceable. That means clear lines of authority; well-funded regulatory agencies able to communicate and coordinate with each other, and proactive engagement with financial institutions to help them comply with best practices before problems arise.

That – more than maintaining the rights of companies to enjoy regulation-free offshore tax havens – is what will promote sustainable, legitimate international trade.

Sally Painter is the co-founder and chief operating officer of Blue Star Strategies.