Offshore Financial Centres

Mark Pritchard Excerpts

Wednesday 21st July 2010 Westminster Hall

[Mr Mark Field (Cities of London and Westminster) (Con)]

As international organisations and major Governments seek to understand the cause of the global financial crisis, small international financial centres have repeatedly endured political attacks and misguided criticisms—from pejorative sniping about their being tax havens and offshore centres for avaricious bankers, to allegations that they provide secrecy jurisdictions for shady figures in the international business community. Those criticisms suggest that they are partly to blame for the shortcomings in the financial markets. The debate about the role of small IFCs has, to date, been remarkably one-sided, which is unfortunate as it demonstrates a fundamental lack of understanding about their function and the benefits that they provide to the wider global economy.

Before the United Kingdom and our global partners look to develop further rigorous international standards on financial regulation, it is critical that politicians and policy makers should formulate and implement policy in an informed, consistent and balanced manner and vital that we should now take a dispassionate view of the offshore IFCs and look sensibly at the significant benefits that they can offer, both to our nation and the broader global financial system.

The UK has an almost unique position in the debate about IFCs. We have a constitutional relationship, through our Crown dependencies and overseas territories, with half of the top 30 offshore financial centres. With the Chinese Government successfully lobbying the G20 last month for both Macao and Hong Kong to be excluded from any OECD grey list on matters of tax transparency, it looks increasingly likely that the standards and regulations currently being formulated may be imposed in some jurisdictions yet overlooked in others. Not only is that incompatible with the need to find a global response to the formation of new financial regulation, but it risks undermining the UK’s financial sector and the wider British economy, which is a major recipient of investment capital raised through small IFCs.

Some small international financial centres, such as Jersey and Guernsey, are used by the global financial community for various reasons, including political stability and a favourable economic outlook; familiar legal systems, often based on English common law; a very high quality of service providers; the ability to meet important investor requirements, such as a legal infrastructure to sell shares; a lack of foreign exchange controls that remove restrictions on the payment of interest of dividends; tax neutrality—not to be confused with tax evasion—which enables investors from multiple jurisdictions to ensure they do not meet multiple layers of taxation as funds pass through the global financial system; and legal neutrality, which ensures that no nationality is given special treatment.

For those reasons there has been a mutually beneficial relationship between the City of London, in my constituency, and many Crown dependencies and overseas territories. That is demonstrated not only by the massive capital flows between the two, aiding market liquidity and investment in the UK, but by the legal and constitutional similarities and the transfer of skilled professionals.

To give some idea of the scale of the capital flows, I should say that UK banks had net financing from Guernsey alone—one of the 30 top centres—of $74.1 billion at the end of June 2009. Unfortunately, because the public debate is largely myopic in respect of IFCs, these benefits are often overlooked or conveniently ignored, in part as a result of small IFCs’ relatively low profile and partly because of a lack of seats on intergovernmental bodies that design global financial regulation.

There now needs to be a much greater understanding of the role and proven benefits provided by small international financial centres as part of the City of London’s transaction chain. I therefore seek to dispel some of the popular myths that surround such centres. The first myth is that IFCs have a negative impact on growth in the global economy. In reality, many of the smallest IFCs are able to provide a stable, well regulated and neutral jurisdiction through which to facilitate international and cross-border business. Investment channelled into small IFCs will in turn provide much-needed liquidity, further investment opportunities, genuine competitiveness and access to capital markets for businesses and investors in both the major developed world and, increasingly, in countries with vast emerging markets.

The recent Treasury review of this area, undertaken by Michael Foot—not that one, Mr Caton—concluded:

“The Crown Dependencies make a significant contribution to the liquidity of the UK market. Together they provided net financing to UK banks of $332.5 billion in the second quarter of 2009.”

Those funds are largely accounted for by the up-streaming of deposits collected by UK banks to their UK head offices, including the nationalised or part-nationalised Lloyds Banking Group and Royal Bank of Scotland, as well as Barclays, HSBC, Santander and a number of building societies.

In addition to aiding capital flows, a report by the university of Michigan’s Professor James Hines on the relation between IFCs and the world economy reveals that expanding investment opportunities through offshore centres leads to increased domestic investment and employment, creating jobs both at the financial centre and in the domestic economies.

Small IFCs play an important role in helping to allocate capital efficiently. To this end, they act as important financial intermediaries, matching the capital provided by savers in one country with the investment needs of borrowers in another. Although that has, understandably, led to concerns about “round tripping”, in which capital is recycled through an offshore centre to give it the appearance of foreign investment and attract a more favourable tax regime, the experience of China and India throws those concerns into doubt, because both of those countries have removed tax breaks for foreign investment during the past decade and both have seen internal and inward investment continue to soar. As a major net recipient of capital flows from small IFCs, our firms in the City might suffer if they found it more difficult to access capital via the international markets.

A second myth is that small IFCs played a part in causing the global financial crisis over the past three years. Although it is convenient to blame offshore centres for causing the crisis, even those who work in the financial markets do not accept that small IFCs were a major cause. Last year, the Treasury Committee found that Guernsey did not contribute at all to global financial contagion. Indeed, it could be argued that the liquidity provided by the small IFCs was significantly positive for the UK during the crisis.

The third myth is that IFCs engage in harmful tax practices. The Foot review suggested that the potential for tax leakage from so-called full tax jurisdictions, such as the UK, towards low-tax or zero-tax regimes, is relatively limited. Although the TUC has argued that the tax gap created in UK Government tax receipts as a result of offshore centres is some £25 billion, the Deloitte report commissioned by the Treasury at the time of the Foot report showed that only £2 billion is potentially lost in tax leakage per annum. Foot also concluded that the real figure might even be lower than that.

Concerns about the UK’s tax base being stripped by unfair competition have also been overstated. It is clear that the debate about tax competition needs to be properly redefined and any further policy initiatives need to protect the important principle of tax sovereignty, as well as adequately recognising the impact of tax regimes on the productive sector. The OECD has clearly warned about the detrimental effects of high corporate tax on productivity. In that regard, I welcome the moves to reduce corporation tax and peg capital gains tax. The recent attacks on the zero-10 tax regimes reveal a worrying trend, in which the sovereignty of independent states to set their own tax rates is undermined and high-tax countries seek to export their high tax rates around the world.

Economic models vary country by country. The adoption of a tax regime premised on the principles of lower tax burdens, efficient government and dynamic private sector activity is legitimate and some degree of tax competition should therefore be recognised as positive. Regardless of that, small IFCs have shown a willingness to engage with the concerns raised by their tax regime—for example, Guernsey and Jersey are voluntarily undertaking a corporate tax review to act within the spirit of the EU tax code.

A fourth myth suggests that small IFCs have a negative impact on transparency, regulation and information exchange. With the G20 placing tax transparency at the top of its agenda, understandably, small IFCs are actively participating in the expansion of the Global Forum on Transparency and Exchange of Information. Indeed, an International Monetary Fund review of Jersey’s regulatory standards in September last year concluded that it was in the top division of financial centres, and gave it the highest ranking ever achieved by a financial centre in respect of compliance with IMF recommendations.

[Mark Pritchard (The Wrekin) (Con)]

My hon. Friend makes an important point about tax transparency, and he also mentions capital flows. Does he accept that offshore centres such as the British Virgin Islands, which are on the OECD’s white list and peer review group, have set the trend in many ways on transparency? The Government should recognise that, and that such centres help rather than hinder the UK’s economy.

[Mr Field]

I agree, and that is greatly to the credit of the British Virgin Islands and other overseas dependencies, as well as some of the Crown dependencies to which I have referred. They have played an important role and led the way in the transparency agenda.

One of the great myths to have grown up is that small offshore centres do not benefit developing countries. Small IFCs have been accused of supporting capital flight out of developing countries, but the Commonwealth secretariat is publishing a new report this month to illustrate the importance of the role played by IFCs in helping developing countries, by enabling them to rent financial expertise from other countries while they develop their own financial centres. Crucially, they also offer investors greater protection of their property rights against domestic political uncertainty.

It is no exaggeration to say that without smaller offshore financial centres many developing countries would not secure key funding for project finance, which makes a substantial improvement to the lives of some of the most vulnerable global citizens. Furthermore, the financial action task force gives many IFCs a positive assessment in meeting its 49 rigorous recommendations on anti-money laundering and terrorism finance. Centres such as the Channel Islands perform better in fighting financial crime compared even with bigger countries such as France, Italy, the US or—dare I say it?— the United Kingdom.

Finally, the UK’s Crown dependencies are often accused of being fiscally unsustainable. Again, nothing could be further from the truth. The debate within the UK Government has, naturally, been framed by events surrounding the collapse of Iceland’s banking system. When the Icelandic banks imploded in September 2008, it quickly became apparent that the contagion would spread to British savers and ultimately to British taxpayers. Furthermore, the role of the Isle of Man as a core financial intermediary between British savers and Icelandic borrowers illustrated the UK’s exposure to offshore centres.

However, the subsequent Treasury review went some way towards allaying the two main concerns. In particular, the worries over the fiscal sustainability of UK Crown dependencies proved to be massively overstated. Throughout the years, IFCs such as Gibraltar, the Isle of Man, Guernsey and Jersey, have amassed large budget surpluses while actively diversifying their tax base, as Foot recommended. Indeed, the Foot report commented on the fact that none of Britain’s Crown dependencies has taken on significant levels of borrowing.

It is important that the G20 summit in Korea later this year is made aware of the beneficial role that small IFCs play in the global economy. Above all, we must stand up to misinformed or narrow views of the valuable contributions that small IFCs can offer to the world economy in terms of liquidity, efficiency, investment and economic growth. Let us make no mistake: ensuring that the voices of small IFCs are heard in Korea is very much in our national interest. If we look at the example of Jersey and its positive effect on the wider UK economy, we see that the island provides a conduit through which mobile capital from around the world can be aggregated and invested, primarily here in London.