Offshore 2 Offshore

* The Continuing Impact of International assessments on finance centres







Lecture
Marcus Killick
CEO Gibraltar Financial Services Comission
3rd September 2007


1.1 Introduction Two major events took place during the 1970’s which radically altered the balance of control between regulators and the firms they regulated.
The first was the announcement by President Nixon on the 15 August 1971 that the USA was no longer backing the dollar with gold. This decision led to the collapse of the Bretton Woods Agreement which had operated since 1944 to fix exchange rates between major currencies.
The resultant move to floating exchange rates removed a distortion in the market however the initial effects did not see an increase in economic activity, given the fact it was followed shortly thereafter by the first Oil Shock of October 1973. Indeed annual growth fell (in the UK from an average 3.1% in 1960-73 to 1.55% in 1973-78).
Nevertheless the liberalisation provided the spur for subsequent globalisation.
The second factor was the abolition of exchange controls in much of the developed world, from the late 1970’s onwards. Exchange controls severely inhibited the ability of individuals to invest outside their own jurisdictions. For instance, in the UK, the controls stipulated that purchase by UK residents of foreign exchange to invest overseas could be made only from the sale of existing foreign securities or from foreign currency borrowing.
The removal of such controls therefore brought with them a dramatic increase in inter jurisdiction financial services activity. Flows of funds were able to cross borders with little if any restrictions. Investors and depositors were able to seek out returns unencumbered by geographical constraints. With this growth came significant international expansion of financial services firms.
In the United Kingdom this process was accelerated by “Big Bang” which took place on 27th October 1986 following a change in the London Stock Exchange (LSE) regulations. The deregulation resulting from Big Bang permitted market makers to combine the functions of stockbrokers and stockjobbers, the abolition of the restrictions on ownership of UK stockbrokers as well as ending fixed commissions on trades and the introduction of the Stock Exchange Automated Quotation system (SEAQ) which replaced the trading floor of the Stock Exchange with a screen-based quotation system used by brokers.

The combination of these effects was dramatic. Artis and Taylor1 have estimated that a net £30 bn outward flow of portfolio investment between1980 and 1989 can be attributed to the abolition of exchange control. The market value of corporate stocks quoted by the LSE grew from £210.8bn in 1980 to £1,834.3bn in 1990. Much of these was due to foreign securities attracted to London. By 1990 quoted foreign corporate
stocks accounted for 61.4% of the value of all quoted securities. The effect impacted not merely financial institutions themselves but also those in ancillary sectors, for instance, the law firm Allen & Overy, doubled in size in the second half of the 1980s.
as a result of "Big Bang" and deregulation more generally.


However this deregulation brought with it both systemic and firm specific risks.
Whereas historically a regulator could tightly monitor the activities of its licensed entities, such activities were now increasingly taken place outside that regulator’s own jurisdiction and therefore were not easily monitored or controlled.
Investors and depositors, now free to use overseas financial institutions were often unaware that regulatory safeguards that existed in their home countries did not exist abroad.
Many financial institutions themselves were ill prepared for the risks the new deregulation brought them. The abolition of fixed exchange rates gave rise to greatly increase exposure to currency risk. Greater freedom to lend internationally increased counterparty risk. As financial firms raced into new and lucrative markets, so some would inevitably make errors.
Furthermore there were no consistently applied benchmarks. Solvency margins for banks varied from jurisdiction to jurisdiction, auditing standards differed. As firms diversified around the globe no regulator had a consolidated picture of that firm’s activities. Indeed groups were free to use different auditors for different subsidiaries.
Therefore as the firms themselves became more international, so the prudential and other standards under which they operated had to become more international in nature 1.2 The rise of the international standard setters 1.2.1 The Bank for International Settlements (BIS) and the Basle Committee on Banking Supervision (BCBS)

The Bank for International Settlements had been established in 1930 as part of the Young Plan, which dealt with the issue of the reparation payments imposed on Germany by the Treaty of Versailles following the First World War.
The new bank took over the functions previously performed by the Agent General for Reparations in Berlin: collection, administration and distribution of the annuities payable as reparations. The Bank's name came from this original role. The BIS was also created to act as a trustee for the Dawes and Young Loans (international loans issued to finance reparations) and to promote central bank cooperation in general.


Therefore under the BIS a standing committee [originally named the Committee on Banking Regulation and Supervisory Practices] was formed comprising bank supervisors from the Group of Ten (G10) countries, together with Switzerland and Luxembourg. Its aim was to enable the co-ordination of the prudential supervision of banks. Its membership now comprises Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, United Kingdom and United States.
The Committee was initially known as the Cooke Committee after the name of its first chairman, Peter Cooke, an associate director of the Bank of England. The Committee had and still has no direct power itself, rather it relies upon the ability of its members to exert influence.
One of the Committee’s first actions was the issuance of a paper on the supervision of banks foreign establishments. This paper covered the risk to solvency and liquidity posed by such establishments because of the lack of comprehensive and consistent regulatory coverage. Amongst the solutions suggested was greater inter regulatory cooperation and a nascent consolidated supervision via inspection by parent authorities of their domestic bank’s foreign establishments.
Indeed consolidated supervision became a significant focus of the Committee’s attention over the following years. In 1975 the Committee agreed a concordat on international banking supervision and the adoption of the principle that banks’ international business should be monitored by the parent authority on a consolidated basis. This also led the Committee to express concern as to the banking secrecy legislation available in some jurisdictions.

A revision to the Concordat was made in 1983, partially in light of the collapse of Banco Ambrosiano Holdings (BAH) in 1982. This collapse had raised concerns over the supervision of bank holding companies, of which BAH was one.. This revision extended the concept of the regulatory goal of “effective consolidated supervision”.
The revised concordant also formed the basis of the EU 1983 Directive on Consolidated Banking Supervision.
It became clear, however that greater international conformity, particularly concerning the level and treatment of capital was vital and in 1988 the central bank governors of the G10 endorsed the final version of the Committees recommendations for the 1976 (http://www.bis.org/publ/bcbs00a.pdf) “Banking secrecy and international co-operation in banking supervision” (August 1981) convergence of capital measurement and capital standards. This is referred to as the Basle Capital Accord Further significant progress was achieved in 1997 with the creation of the "Core Principles for Effective Banking Supervision", which was aimed to provide a model for how an effective supervisory system should operate. It is these core principles which are the benchmark against which jurisdictions have been subsequently assessed.. In October 1999, to assist in such assessment, the Committee developed the "Core Principles Methodology".
In the following years the BCBS further refined its approach to creating a unified global supervisory structure producing papers ranging from credit risk to electronic banking. However it is the core principles that remain at the heart of the current global assessment programme of the quality of banking supervision.
BCBS seeks to be inclusive, by, for example permitting attendance by a representative of the Offshore Group of Banking Supervisors; it also circulates to non member banking supervisors throughout the world papers providing guidance on banking supervisory matters and consults widely on its developments. Nevertheless, its structure, with restrictions on full membership, is inherently unrepresentative. This
inevitably results in its considerations and recommendations being focused upon the needs of its members rather than the banking supervisory community globally.
1.2.2 International Organisation of Securities Commissions (IOSCO) IOSCO origins came from an inter-American regional association which had been created in 1974. This evolved in 1983 into a global body though the acceptance of members from outside the Americas (initially securities regulators from France,
Indonesia, Korea and the United Kingdom).
Over the following twenty years,, IOSCO became the international standard setter for securities markets. It now claims that its membership regulates more than 90% of the world's securities markets and that IOSCO is the world's most important international cooperative forum for securities regulatory agencies.
Like the BCBS, IOSCO produces and publishes a significant number of papers, however, in the case of IOSCO, these focus upon securities supervision.
IOSCO adopted in 1998 a comprehensive set of Objectives and Principles of Securities Regulation (IOSCO Principles), which became the international regulatory benchmarks for all securities markets. In 2003 it endorsed a methodology (IOSCO Principles Assessment Methodology) that enables an objective assessment of the level of implementation of the IOSCO Principles in the jurisdictions of its members.
Like the BCBS Principles the IOSCO ones now form a core element of the current global review process.
Whilst IOSCO;s membership is ostensibly larger than that of BCBS a number of issues exist. Some leading offshore centres have not been allowed membership at
present, including the Cayman Islands and British Virgin islands. Gibraltar only gained admittance in 2005 following the withdrawal of Spanish objections based primarily around Gibraltar’s constitutional position rather than its regulatory standards.

Even amongst members the position is inconsistent. Under the membership rules, full (voting) membership is granted to one regulator per jurisdiction. All others are eligible for associate membership, which allows participation but no vote.
Jersey, Guernsey and the Isle of Man which had previously been granted associate membership (an incorrect classification based on the false belief that the UK was ultimately responsible for their financial regulations) were granted full status in 1997,
but a new byelaw was added preventing them from having voting powers. The argument being that to give them full votes would have strengthened the voting power of the UK. Instead they are required to share the UK vote, even though the UK exercises its vote without consultation with them. Bermuda, who is in the same
constitutional position (as it is also a UK dependency) does have a vote, as it was one of the original members of IOSCO.
Hong Kong retained its vote after the handover to China in 1997. Both Ontario and Quebec have separate votes (as original members) but the other Canadian provinces are associate members.

1.2.3 International Association of Insurance Supervisors (IAIS)

The International Association of Insurance Supervisors (IAIS) was established in 1994 to “promote cooperation among insurance regulators and also with regulators in other financial sectors.”
Currently insurance supervisory authorities from about 100 jurisdictions are members. In addition, almost 70 organisations and individuals are, or have applied to be, observers. These represent industry, professional associations, insurance and reinsurance companies, consultants and international financial institutions.
The IAIS is led by an Executive Committee, with 13 members from different regions of the globe. It is supported by a Secretariat located at the Bank for International Settlements in Basel, Switzerland.
Like BCBS and IOSCO, IAIS has established core principles and supporting methodology. These were originally consolidated in October1998 and most recently updated in 2003.
IAIS has the most open membership of any international financial regulatory standard setter. Offshore centres, not permitted membership of BCBS and IOSCO (such as
the Cayman Islands, British Virgin Islands and Turks and Caicos Islands) are full members.


1.2.4 Impact

All three international standard setting bodies now have principles and other general requirements. Yet for some jurisdictions, principally offshore finance centres, many of these standards have been set without their participation net alone consent. Indeed some have been refused admittance to those bodies or have been given restricted rights. This has prevented the offshore community from influencing the development of those standards or ensuring that they were fit for purpose for off as well as on shore.

Whilst the requirement of observance to such standards was restricted to the members of these bodies this was not an issue. However as the next section shows, these standards are now being applied globally.

1.3 International assessment bodies and Offshore Financial
Centres


1.3.1 Introduction

The development of international standards has run parallel with an increasing level of concern within the international community that certain jurisdictions, through the weak application of regulatory supervision were creating a systemic risk to the global financial system as a whole. Whilst much of the developing world had weak or even non existent financial regulatory structures, these jurisdictions were not considered risks internationally.
The collapse of a banking system in a developing nation would be a significant issue to the country itself, however it was not an international systemic risk.. Therefore focus was placed on centres regarded as under regulated but which held a much more central role in the global financial community. These were considered predominantly to be the offshore finance centres.
Whilst those regulators of offshore centres which were members of the standard setting bodies could be required as part of that membership to conduct self assessments of compliance with those standards or even be subject to peer group review, many of those felt to be at risk were not members and therefore, technically were not subject to compliance with those standards. Many of these were the offshore centres over which concern was being expressed. To correct this certain national governments and international bodies sought ways to impose the standards on a global basis.
The first international body to seek to address this (outside the area of tax) was the G7.

1.3.2 G7


The G7 consists of the United Kingdom, the United States, France, Canada, Italy, Japan and Germany. Ministerial meetings of G7 had, for a number of years, expressed concern as to weak regulatory regimes in offshore finance centres. Initially focus had been more general in respect of international crime, For instance,
in 1996 the P85 endorsed the recommendations of the Senior Experts on Transnational Organized Crime This paper covered such areas as international cooperation and extradition but made no reference to offshore centres Nevertheless offshore centres were rising up the political agenda, the FATF had made several references of the use of Offshore Finance Centres for Money
laundering purposes in its typologies report of 1996.

It was therefore unsurprising that, in the G7 1998 London meeting, the ministers concluded:
“We are concerned at the number of countries and territories, including some financial offshore centres, which continue to offer excessive banking secrecy and allow screen companies to be used for illegal purposes.”
By 1999 a more generic concern was being expressed. Not only was there a fear of criminal use, but also whether offshore centres were gaining a competitive advantage by applying laxer standards than onshore. To G7 low standards had an additional threat, in an increasingly integrated world there were fears that offshore centres could pose a significant systemic risk.
For example the 1997/99 Asian financial crisis led to concerns as to the systemic risk posed by offshore investment funds. It was argued by some that these funds, because of the absence of tax and low regulatory controls were more likely to be engaged in “positive feedback” trading (buying when the market was rising and selling when it fell) or in herd trading (following others in the market), rather than trading on the basis of underlying fundamentals. This approach resulted in higher market volatility and therefore instability. Even though some criticism of offshore has been subsequently questioned, particularly whether offshore funds actually created more volatility than onshore ones, the image persisted.
The image was further helped by the revelation that a number of financial institutions placed bad debts off balance sheet by putting them into special purpose vehicles located in offshore jurisdictions. Through this mechanism they were able to disguise lossess from the regulator and investor. One such firm was Yamaichi securities

Yamaichi was one of the four largest securities houses in Japan with clients’ assets of ¥22 trillion. It also had banking subsidiaries in the United Kingdom, Germany, the Netherlands and Switzerland. In November 1997 it was revealed that the firm has massive off balance sheet liabilities, amounting to more than ¥200 billion Some of these losses had been hidden using corporate vehicles in the Cayman islands. Similarly the near collapse of the hedge fund Long Term Capital Management (LTCM) in late1998, which forced the Federal Reserve to broker a $3.6 billlion bailout, had sent shockwaves through the regulatory system8. Whilst LTCM itself did not have a significant offshore element, a number of other leveraged hedge did and so it was inevitable that the crisis would result in further attention being focused on offshore centres. The issues surrounding the financial crisis’s had led G7 at its Washington meeting of
October 1998 to ask Hans Tielmeyer then President of the Deutsche Bundesbank to:
“consult with other appropriate bodies and to consider with them the arrangements for cooperation and coordination between the various international financial regulatory and supervisory bodies and the international financial institutions interested in such matters, and to put to us expeditiously recommendations for any new structures and arrangements that may be required.“

His report included a recommendation that:
“The G7 should take the initiative in convening a Financial Stability Forum.
Such a Forum should meet regularly to assess issues and vulnerabilities affecting the global financial system and to identify and oversee the actions needed to address them. The Forum would report to the G-7 Ministers and Central Bank Governors. It would replace the series of ad hoc groups that have been convened by the G-7 over the past few years with a view to strengthening the international financial system.”
The report also set out the issues the forum should seek to address, these included identifying vulnerabilities in national and international financial systems and ensuring
the implementation of international standards of best practice. His report, however did not single out or even mention offshore centres.
As a result of this report the G7 in February 1999 created the “Financial Services Forum” to “promote international financial stability through information exchange and international co-operation in financial supervision and surveillance” Even though the report had not mentioned OFCs, by the beginning of 1999 pressure to “do something” about offshore, which collectively was estimated by the IMF to hold assets of $5000 billion had become a political as well as regulatory issue. Indeed, at their Cologne meeting the G7 Finance Minister’s stated as an objective:
“encouraging offshore financial centres (OFCs) to comply with international standards. Financial market participants need to compete on a level playing field. Therefore, as we continue to strengthen our own regulatory standards, it will be important for OFCs to strengthen their supervisory systems and standards.”
Therefore it was of little surprise that, even without a specific brief to do so, the FSF turned its immediate attention to Offshore Centres.


1.3.3 Financial Stability Forum (FSF)

The FSF first met on the 14th April 1999 and brought together senior representatives from the national finance ministries, central banks, and supervisory agencies of some countries (Australia, Canada, France, Germany, Hong Kong, Italy, Japan, Netherlands, Singapore, United Kingdom, United States) together with International Financial Institutions charged with surveillance of financial systems, and monitoring and fostering implementation of standards (International Monetary Fund, World Bank, Bank for International Settlements, Organisation for Economic Cooperation and Development). Standard setter such as BCBS, IOSCO and IAIS were also included. The FSF immediately set up three working groups to recommend policy actions.
These were in the areas of (a) highly leveraged institutions; (b) capital flows; and (c) offshore financial centres. Indeed it was at the FSF meeting on 14th April that the issue of Offshore Centres was first given explicit coverage.

The Offshore working party was asked to:
“evaluate the impact on global financial stability of the uses made by market participants of financial offshore centres, and the progress made by such centres in enforcing international prudential standards and in complying with cross-border information exchange agreements.”
The FSF gave no official reason why Offshore Centres were to be subject to investigation by a specific working party rather than simply part of a more generic assessment (international regulatory cooperation for instance).. Clearly, however the Forum felt that these centres were in need of specific analysis.
Membership of the working part came. predominantly from onshore regulators, with only one offshore centre (Singapore) being present.
In conducting their assessment the FSF developed their own view of what characterised Offshore Centres. According to the FSF, the term OFC had traditionally implied some or all of the following
• Low or no taxes on business or investment income;
• No withholding taxes;
• Light and flexible incorporation and licensing regimes;
• Light and flexible supervisory regimes;
• Flexible use of trusts and other special corporate vehicles;
• No need for financial institutions and/or corporate structures to have a physical
presence;
• An inappropriately high level of client confidentiality based on impenetrable secrecy
laws; and
• Unavailability of similar incentives to residents.
Even though the FSF said this did not apply to all OFC’s (in which case it was, by definition, an inadequate definition) this definition was regarded as highly prejudicial by a number of centres as it concentrated not on the economic or financial characteristics of those centres but rather on perceived evils and then defining
offshore centres as those which display those evils.
In November 1999 the working party met with representatives of the offshore centres.
This meeting discussed the preliminary findings of the group. The view that offshore was, in general, inferior to onshore in terms of regulation was already detectable.
The preliminary findings contained a section on “actions needed in onshore jurisdictions”, This stated:
“Encourage more effective consolidated supervision in the banking and insurance sectors, recognising the important responsibilities of home country supervisors, so that the ability of offshore activities to “escape” oversight is reduced”
The statement is interesting because of the mind set in reveals. In effect it is saying.
Onshore has to make sure offshore doesn’t get away with it. It makes no attempt to distinguish good from bad supervision, only onshore from offshore. The impact of this terminilogical bias will be discussed further in the next chapter.
In early 2000 the FSF working group on offshore financial centres reviewed 42 centres, publishing its findings in April of that year. By this time its briefing had evolved to:

• consider the implications of offshore financial centres (OFCs) for global financial stability;
• evaluate the adherence of OFCs with internationally accepted standards and good practices; and
• make recommendations on the above, including the observance of standards by problematic OFCs.
The report concluded that:
“OFCs, to date, do not appear to have been a major causal factor in the creation of systemic financial problems. But OFCs have featured in some crises, and as national financial systems grow more interdependent, future problems in OFCs could have consequences for other financial centres.”
Far from damning Offshore Centres, the report had, at least in part, exonerated them from a number of accusations made. Nevertheless the accusation that the offshore centres may be a risk (albeit an undefined one) in the future allowed further action to be initiated.
Indeed the “future crime” statement was subsequently repeated as authority for concern. The Introduction to the OECD report on the misuse of corporate vehicles stated that the FSF had concluded “that the misuse of corporate vehicles could threaten financial stability from a market integrity perspective”. The FSF themselves tended to forget their actual findings when they issue subsequent updates on the ir report.
The report itself, had, in total, made 11 recommendations concerning prudential and market integrity issues. The first of these was that there needed to be an assessment process for OFCs’ adherence to international standards. Under the second recommendation, such an assessment should be undertaken by the IMF.
In doing so it divided the offshore community into three groups. These are set out below.

FSF categorisation


“Group I
The jurisdictions in this category are generally perceived as having legal infrastructures and supervisory practices, and/or a level of resources devoted to supervision and co-operation relative to the size of their financial activities, and/or a level of co-operation that are largely of a good quality and better than in other OFCs.
These jurisdictions are Hong Kong SAR, Luxembourg, Singapore, and Switzerland.
Dublin (Ireland), Guernsey, Isle of Man, and Jersey are also generally viewed in the same light, though continuing efforts to improve the quality of supervision and cooperation should be encouraged in these jurisdictions.


Group II
The jurisdictions in this category are generally perceived as having legal infrastructures and supervisory practices, and/or a level of resources devoted to supervision and co-operation relative to the size of their financial activities, and/or a level of co-operation that are largely of a higher quality than Group III, but lower than Group I. These jurisdictions are Andorra, Bahrain, Barbados, Bermuda, Gibraltar, Labuan (Malaysia), Macau SAR, Malta, and Monaco.


Group III
The jurisdictions in this category are generally perceived as having legal infrastructures and supervisory practices, and/or a level of resources devoted to supervision and co-operation relative to the size of their activity, and/or a level of cooperation that are largely of a lower quality than in Group II. These jurisdictions are Anguilla, Antigua and Barbuda, Aruba, Belize, British Virgin Islands, Cayman Islands, Cook Islands, Costa Rica, Cyprus, Lebanon, Liechtenstein, Marshall Islands, Mauritius, Nauru, Netherlands Antilles, Niue, Panama, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Samoa, Seychelles, The Bahamas, Turks and Caicos, and Vanuatu.”
This categorisation was criticised on the grounds that it was purely based on the perceptions of third parties (who responded to a questionnaire sent to them) and involved no on-site visits and no review of the jurisdiction’s legislation or regulation.
As such the final categorisation was subject to rumour, historical anecdotes and undisclosed subjective criteria/bias. .The review had no means of distinguishing between recent experience and ancient prejudice in the respondents Furthermore some offshore centres, for example Montserrat, were missing from the
list. Also missing were, the “offshore” US States such as Delaware, Nevada and Wyoming. Additionally the use of the “implied character” definition detailed above allowed many large offshore centres, such as London or New York to be excluded.
The list was not, in fact used by the IMF. It was however used in the private sector to classify centres. Finally, in March 2005 the FSF announced that the list was no longer operative.


1.3.4 The International Monetary Fund
In 1999 the International Monetary Fund and the World Bank jointly developed a Financial Sector Assessment Programme (FSAP) which had the aim of identifying strengths and weaknesses in a country’s financial sector. Part of this included an assessment of the country’s observance with international regulatory standards, namely BCBS, IOSCO, IAIS and the FATF.
The assessments are used as part of the Financial System Stability Assessment (FSSA) reports and also serve as the financial sector modules of the Report on the Observance of Standards and Codes (ROSC).
The ROSC process compiles the FSAP reports as well as other summary assessment modules prepared by the Fund and the Bank of other standards, such as the Special Data Dissemination Standard (SDDS), the Code of Good Practice on Fiscal Transparency, corporate governance and other similar guidelines.

A pilot programme for the review was undertaken in 1999 with the full programme following thereafter.
Following the request from the FSF, the IMF agreed, in June 2000, to extend its programme to cover OFC’s. However some centres such as Switzerland and Singapore were already within the existing FSAP programme and so remained within that.
The OFC programme focused upon observance with international regulatory standards without the FSAP financial stability analysis. There was no requirement to publish the assessments; however jurisdictions were encouraged to do so.
Whilst the quality and consistency of these reviews, particularly when compared to assessments made of onshore centres will be discussed in the next chapter. The IMF were able to state that:
“Compliance levels for OFCs are, on average, more favorable than those for other jurisdictions assessed by the Fund in its financial sector work”.
The IMF did find shortcomings, however the most significant of these were located in the OFC’s with lower per capita income.
Despite this the IMF decided to embark upon a second round of visits, these were not scheduled according to the problems highlighted on the previous visit (ie a risk based assessment), rather the programme simply began again visiting first those who had been visited first on the previous round.


1.3.5 OECD
The FSF OFC working party also requested that the OECD draft a report to develop new channels to reduce the vulnerability of corporate vehicles to misuse for illicit purposes".13 This work was undertaken by the OECD Steering group on Corporate Governance and the subsequent report “Behind the Corporate Veil: Using Corporate Entities for Illicit Purposes “was published in May 2001.
The report’s objectives had been to:
• Form an understanding of how corporate vehicles can be misused for illicit purposes;
• To identify and analyse the factors ;limiting the capacity of supervisors
• To develop a menu of possible options that countries can adopt tp obtain and share such information
This report focused upon OFC’s. The OECD gave three reasons for this, the first two, excessive secrecy in some OFCs and the use of shell companies could be seen as fairly typical given the prevailing world view. The third however was more surprising. This was that the development of some OFCs’ and particularly their regulatory systems, “may serve as useful models for other jurisdictions seeking to improve the functioning and transparency of their regulatory, supervisory and legal systems”

The report concluded that, in order to combat the misuse of corporate vehicles for illicit purposes all jurisdictions had to establish effective mechanisms that enable their authorities to obtain information on beneficial ownership and control and could share this information.
To achieve this the report recommended that jurisdictions adopted one of three approaches:

Option 1 – primary reliance upon an upfront disclosure to the authorities (eg by arequirment to notify beneficial ownership to the companies registry)

Option 2 – primary reliance upon intermediaries (such as company formation agents) to maintain details of beneficial ownership

Option 3 – primary reliance of investigative powers to find the information The report considered that different options would be suitable for different jurisdictions, with option 3 being mainly suitable for those with effective investigative powers.

Unfortunately, by providing three options the report allowed jurisdictions to avoid facing the issues posed by bearer shares and nominee shareholders with their ability to provide anonymity to the underlying owner. Whilst option 1 and 2 could provide a solution to this option 3 would not. Investigative powers are useless if no one is required to maintain the information the investigation is seeking.
Yet even though the report highlighted the risks posed by bearer shares and corporate directors it did not recommend that action be taken to prohibit them.
Indeed whilst the report focused upon OFC’s it did not conclude that OFC’s per se were of greater risk than onshore jurisdictions. Some OFC’s such as Nauru and the Cook islands were highlighted as being at risk. However others such as Bermuda and jersey were commented on for the strength of their defences.
This was not the first OECD initiative in respect of OFCs . In 1994 it had established a Working Group on Bribery in International Business Transactions part of whose mandate was to investigate the role of foreign subsidiaries and of offshore centres in bribery transactions


1.3.6 The Financial Action Task Force (FATF)


The FATF had expressed concern over the use of OFC’s in money laundering for a number of years. Indeed FATF was not alone, and the existence of “placebo” jurisdictions, i.e. jurisdictions which have established regulatory structures but which have under-resourced the regulator or restricted his powers so that enforcement of the regulations becomes impossible, was being raised at the beginning of 1996 .
In 2000 the FATF conducted a review of specified countries and territories to assess whether they posed a particular risk in the fight against money laundering. This became known as the NCCT Review (for Non-Cooperative Countries and Territories). In February of that year the initial paper set out 25 criteria against which the jurisdictions were to be assessed.
The review then assessed the specified jurisdictions in order to produce a list of those it considered based on the criteria were non cooperative and, as such should be subject to counter measures if they did not improve. These counter measures were built around FATF Recommendation 21 which states:
“Financial institutions should give special attention to business relationships and transactions with persons, including companies and financial institutions, from countries which do not or insufficiently apply the FATF Recommendations. Whenever these transactions have no apparent economic or visible lawful purpose, their background and purpose should, as far as possible, be examined, the findings established in writing, and be available to help competent authorities. Where such a country continues not to apply or insufficiently applies the FATF Recommendations, countries should be able to apply appropriate countermeasures.”
The first list of NCCTs was produced in June 2000. The list predominantly (11-4) consisted of OFC’s, including Cayman, Bahamas and Liechtenstein. Of the onshore centres only Israel, Lebanon the Philippines and Russia were named.
FATF’s second review, which took place the following year, resulted in the removal of four offshore jurisdictions and the inclusion of 6 new ones all from onshore centres.
A further review in 2001 added Grenada and the Ukraine.
In total 47 jurisdictions were reviewed. 23 of which were identified as NCCT (15 in 2000 and 8 in 2001). Over the following four years the vast majority of these were removed.
After 2001 no further jurisdictions were added to the list. Whilst the list continues to be in effect, it now only contains Myanmar and Nigeria, both onshore centres. The last offshore centre, Nauru, was removed in 2005. Neither of the remaining centres are subject to countermeasures.

The next chapter analyses the weaknesses of the NCCT process as well as inconsistencies in the treatment of jurisdictions. For instance, Russia was only moved from the non cooperative list in 2002 yet became a full FATF member in 2003. Additionally, jurisdictions exposed to international sanctions by other bodies such as the UN or with known corruption, drug or terrorist issues such as Afghanistan, Pakistan and Zimbabwe never made it to the list.

1.4 The power of the assessments

Unlike the standard setters themselves, who are able to suspend or expel members who fail to comply, the FSF, FATF and IMF lack any formal disciplinary power.
Whereas the IMF wields significant influence over those to whom it lends money, many offshore centres were not borrowers, nor were many even IMF members.
This lack of direct power did not, however, result in a lack of actual power and OFCs not only invited the IMF in, but also, in the main, published its findings and committed to implement its recommendations.
There are a number of reasons behind this apparent surrender of sovereignty.
Firstly, the IMF kept to safe ground. It’s focus was exclusively on regulatory and anti money laundering issues. It did not cover the far more sensitive issue of tax.
Therefore the OFCs had fewer grounds to oppose being reviewed. It would have been difficult to refuse to be assessed against internationally accepted regulatory standards.
Secondly the standards of the assessment were internationally accepted. They were the standards of bodies seen as credible and neutral. They were standards against which on as well as offshore would be measured.
Thirdly the reviews could be seen as the development of a pre existing programme within the IMF, therefore this was not a radical new venture solely targeting the OFCs.
Fourthly the cultural change after 9-11 meant that jurisdictions were less likely to wish to appear un cooperative for fear of punitive sanctions, particularly from the USA.
Indeed the threat of bilateral action against an OFC which failed to cooperate with an assessment was seen as a powerful inducement. Whilst the IMF itself could do nothing its members could, if they so wished economically isolate an individual OFC.
This could be achieve by imposing additional AML obligations on those doing business with them or simply closing their doors as a market to them. This had been threatened to the Seychelles in the 1990’s and resulted in the Seychelles Government reversing legislation seen as being pro money laundering. The fact that
many OFC’s are dependencies of IMF countries also provided an opportunity for pressure on these from their “parent” jurisdiction The ability to “name and shame“ an OFC, so causing reputational damage was also a force for cooperation. With a range of centres to choose from, private sector firms may shun a damaged centre for fear that their reputation may be damaged by association.
The OFC’s themselves, as described in the previous chapter, were not a united force. There was therefore no opportunity to present a combined argument concerning the scope, timing and consistency of the review process. As will be discussed in the next chapter, this inability has led to a reversal in the slope of the playing fields, with OFCs now being measured against higher standards than their onshore competitors.
Finally whilst the FSF has repeatedly noted, that “significant reforms were initiated by many OFC jurisdictions in response to the FSF initiative and the IMF assessment program.”, the true catalysts for change in some OFC’s were wider. In the case of the
Channel islands and the Isle of Man, the Edwards report which occurred prior to the FSF report was the prime cause for change, for the British Overseas Territories in the Caribbean and Bermuda, the KPMG review which was already under way at the time the FSF report was published provided a greater spur. In the case of Gibraltar there was a statutory obligation for the regulator to match UK standards of supervision.
For others the FATF report on non cooperative countries and territories was the impetus.
Indeed, whilst the IMF reviews themselves have been a cause of change, and as the FSF recommended the creation of the IMF assessment programme, it had an impact, it is difficult to see the FSF being directly responsible for any of the changes that
have occurred in the OFCs’.


1.5 Conclusion


As can be seen from the preceding sections, whilst regulatory issues do exist in certain offshore centres, little, if any, evidence exists to show that these centres present a clear and present systemic threat. Indeed, as the IMF itself have acknowledged the leading centres are better regulated than their on shore
counterparties.
Yet the reviews continue. The FATF typologies reports16 still uses “offshore” in a generic and misleading sense. For instance their 2002-2003 report states “The establishment of various offshore entities through which funds may be channelled offers another way of obscuring the true intent of the operation.”