Offshore secrets? Grand Cayman, Cayman Islands

With the publication this month (February 2020) by Tax Justice Network of their 2020 financial secrecy index, MATTHEW FEARGRIEVE considers the role of offshore financial centres (OFCs) in the sphere of global asset management, and challenges the four basic premises on which attacks on them are based.

The NGO Tax Justice Network (TJN) has published its 2020 “financial secrecy index”. The index establishes the top ten “suppliers of financial secrecy” as being:

1 Cayman Islands

2 US

3 Switzerland

4 Hong Kong

5 Singapore

6 Luxembourg

7 Japan

8 Netherlands

9 BVI

10 UAE

These jurisdictions, says TJN, promote the secrecy that keeps “tax abuse feasible” and “drug cartels bankable”.

Whilst the naming and shaming of “secrecy jurisdictions” has always been a political football, it was the financial crisis of 2008 that saw a sharp escalation in anti-offshore rhetoric, which peaked in the lead-up to the G20 Summit in April 2009, with reform of offshore jurisdictions being promised in many quarters.

The outcome? Why, an OECD list of course, ranking countries according to the extent to which they had implemented the OECD’s tax information exchange standard. In effect, the OECD white-, grey- and black- listed its selected jurisdictions. The US, UK, France and Germany were amongst the inhabitants of the white list. The black list of baddies was populated by Costa Rica, Uruguay, Malaysia and the Philippines. The grey list of compliance-dawdlers, split between what the OECD asserted were “tax havens” and “other financial centres”, included Switzerland and the Cayman Islands.

At the time of the G20 Summit, there was a real anxiety that offshore financial centres (OFCs) should be part of a global solution to a global crisis and not permitted to remain aloof, and this anxiety found expression in traditionally the easiest means of exerting pressure on OFCs: compliance in matters relating to sharing of tax information. Fair enough? Well, almost. The exercise tellingly ignored two basic truths: first, that OFCs were not central to the financial crisis; secondly, that many of the OFCs being impugned already had in place information-exchange and cooperation agreements. Significantly, the exercise was tangential to the central thrust of the G20 Summit, namely that financial institutions (including hedge funds) needed better regulation.

City of Secrets? Geneva, Switzerland

In the aftermath of the financial crisis it was very easy for politicians, tax justice lobby groups and, ultimately, the OECD to paint OFCs as boltholes in which taxable monies could be secreted by wealthy individuals and institutions. Stigmatising them as “tax havens” was- and is- an easy piece of scapegoatism and a vote-winner for economically and politically embattled governments. But this routine response relies on some flawed premises. This blog looks at four of them, in the context of global asset management.

1. OFCs are objectionable because they are low- or zero- tax jurisdictions

Why should OFCs not enjoy the same tax sovereignty prized by larger nations?

2. OFCs facilitate tax evasion

How ironic that the US should find itself at the top of TJN’s index, along with the Cayman Islands. Multiple times during the past decade, the US government has routinely totted out the tendentious rhetoric traditionally directed at OFCs, particularly in downturns. The mantra goes as follows: “Some countries make it easy for US taxpayers to evade or avoid US taxes by withholding information about US-held accounts or giving favourable tax treatment to shell corporations created just to avoid taxes”.

Note the oblique reference to tax enforcement. The reality is that OFCs do not aid or abet those who find ways of getting around domestic tax laws, nor do they obstruct or prevent the charging of taxes outside their territories. They are, however, entitled to presume that domestic anti-evasion laws in other countries are effective. Nonetheless, OFCs assist other countries in enforcing their own laws by agreeing with them to share information relating to criminal or civil tax matters, and by providing other means of assistance. Many are doing this independently of OECD involvement.

The reference to shell corporations is pure political rhetoric, and cannot conceal the inconvenient truth that the registering of legal entities in OFCs is no materially different from the functionality provided by certain tax efficient states to the rest of the US, like Delaware (home to some 600,000 brass plate corporations and pervasive secrecy practices).

The focus in Europe has been largely on reform of financial services regulation. Not surprising, given that the EU includes Ireland, Luxembourg, Malta and Gibraltar, all offshore financial centres in their own right. Much like the US with its homeland Delaware financial centre and its backyard OFC of choice, the Cayman Islands, the EU has its own difficulties and inconsistencies when it comes to OFCs. There is a large degree of acknowledgment in the Eurozone of the true functionality of OFCs, particularly in the asset management sector (think Luxembourg and Ireland, weighing in at positions 6 and 29 on TJN’s index), as jurisdictions that exist quite legitimately in their own right as sovereign countries, with their own tax regimes, which facilitate international transactions and the formation of tax transparent pooling vehicles like investment funds (and in so doing help to lubricate the flow of capital around the word) by levying low or zero-rate taxes. Ireland, at 29 on TJN’s index, is no different in this fundamental respect to Cayman at the top of the index.

Zurich, Switzerland

3. OFCs are non-transparent secrecy jurisdictions

The notion that all OFCs are shrouded in secrecy is wide of the mark. Many have long standing tax information sharing and other cooperation treaties with a number of countries. The ability to assist and cooperate with other countries on civil and criminal tax matters is often hardwired into the constitutions of their financial services regulators.

The top three jurisdictions on TJN’s index- Cayman, the US and Switzerland- are all “third countries” in the jargon of the EU Directive on alternative investment fund managers (AIFMD) and as such have all been under serious and sustained commercial and political pressure to sign Tax Information Exchange Agreements (TIEAs) with EU member states, enabling non-EU fund managers to sell their investment products into EU member states. In the asset management space, most of the main “secrecy” jurisdictions have been sharing tax information with EU regulators on an enhanced basis for more than a decade.

4. OFCs are inadequately regulated

The “tax haven” tag is particularly insidious because it can be made to denote poor regulation as well as dubious tax status.

In the field of investment fund regulation, offshore regulators work from the basic principle that the onshore manager, not the offshore fund, is the source of financial and operational risk. The corollary of this is that the offshore regulator effectively piggybacks on the regulatory oversight (by the Securities &Exchange Commission, the Financial Conduct Authority, etc.) of the manager onshore, leaving the fund subject to the offshore regulator’s own regime. That regime is appropriate to ensure oversight of the offshore fund, for what it is- a tax transparent pooling vehicle- and is correspondingly different from the onshore regulation of the manager. There have been cries for increased regulation of both managers and funds. But increased regulation of the fund offshore is not the direct result of increased regulation of the manager onshore. Offshore fund and onshore manager are different animals, and different regulatory regimes are required for each.

Given its primary focus on regulation of the manager, the AIFMD broadly upholds the distinction between the separate functionality of the manager and the fund. The focus of its third country provisions (applicable to funds domiciled outside the EU) on OECD tax standard compliance is somewhat tangential to this.

The leading asset management jurisdictions (in terms of AUM) of Cayman, US, Switzerland and Luxembourg regard robust regulatory oversight and compliance with international standards on anti-corruption and money laundering, including those espoused by the IMF, as being central to their role of international financial centres.

Matthew Feargrieve is an investment management consultant. You can read more of his blogs here: