Opposing forces

In the aftermath of the global financial crisis the spotlight has, rightly or wrongly, been turned onto offshore financial centres (OFCs). Onshore governments have actively sought to make OFCs less attractive places to do business by individually enacting discouragingly restrictive domestic provisions and collectively by exerting political pressure through international forums and the like.

One of the key factors that enable OFCs to continue to meet their customers’ needs, while still complying with their international obligations, is the necessary timelag between the ‘enactment’ of legislation and the ‘enforcement’ of it. However, this flexibility places those with the task of enforcement in a difficult position. While they are responsible for enforcing the law, they must also be acutely aware of the need to moderate their enforcement actions in order to achieve the broader policy objective of retaining and attracting the business upon which OFCs are dependent.

Pressure for change
Over the past year the noise generated by the governments of the leading economies about taxation practices and banking secrecy in OFCs has risen to a roar. The US has had several stalled attempts at enacting ‘anti-tax haven abuse’ legislation, the Organisation for Economic Cooperation and Development released its tax haven blacklist, and now the EU is placing pressure on the UK to bring its European dependencies into line. Largely, the pressure has worked. Most OFCs managed to enter into enough information exchange agreements to escape blacklisting. Liechtenstein, the former Fort Knox of banking secrecy, agreed to open

its vaults to HM Revenue & Customs investigators, while the Channel Islands and the Isle of Man are considering seriously the future of their ‘0-10’ taxation settings.

This recent ramping up of regulatory policy comes on the back of the previous push, earlier this decade, for widely implemented anti-money laundering legislation. No longer can these places trumpet so loudly the ‘light-touch regulation’ that was formerly one of their key selling points. Instead these ‘respectable’ OFCs now sell the expertise of their workforces and, somewhat perversely, the ‘safety’ brought about by increased regulation. It is a race to the top, not the bottom, in the hope that their customers will need to fly to quality rather than from it.

Anecdotally, this new approach is being reflected in the approach of such OFCs’ regulatory agencies. Traditionally offshore regulatory agencies were required to take a softly-softly approach to supervision in order to maintain market share. While the out-and-out crooks would still be caught, those companies in the middle tier that may not have paid sufficient attention to their regulatory obligations would be assisted to get back on track if a problem arose. This made sense: what kind of business seeks to make their customers’ life more difficult than it needs to be? The funding model of these regulators, whose salaries were met by licence fees or subscriptions paid by the regulated entities, is a reflection of this approach.

A tougher approach
However, in the past few months the attitude adopted by regulators has become noticeably different. Rather than sorting out any concerns over an informal discussion, regulators are deploying their full range of investigatory tools, and doing so publicly. Financial services businesses are now subject to rigorous site visits and external reviews. It cannot be long before licensing action and civil penalties follow. Already businesses have been driven to insolvency by the sheer cost of responding to regulators’ actions.

This type of regulatory enforcement philosophy is closer to that employed in larger enforcement-led onshore jurisdictions, where this strategy is seen as both necessary and appropriate. While OFCs may have proportionately more financial services businesses per capita in terms of sheer numbers of regulated entities, onshore regulators have a much bigger task – so big that they simply cannot provide the same level of individual attention to each entity. Instead onshore regulators must deploy their resources to have the greatest possible impact. Generally that means targeted enforcement action focusing on particular market segments or regulatory issues of current concern, resulting in a relatively small number of high-profile enforcement outcomes. The true value of such outcomes is not the sanction imposed on the particular subject, but the deterrent effect on the rest of the market.

Toeing the line
However, in the offshore world it is questionable whether this style of regulatory enforcement is as necessary, or given the market development focus, particularly appropriate. There are several reasons for this.

First, there simply is not the risk (and gravity) of misconduct in OFCs that there is in onshore jurisdictions. Regulated businesses in OFCs are in general staffed by some of the brightest and most experienced professionals in their fields. The businesses themselves are generally international organisations with global reputations. Their customers are not ‘ma and pa’ high street investors, but sophisticated, well-advised institutions and high-net-worth individuals. Accordingly, with less risk of serious non-compliance, the high-profile public hangings do not have the same deterrent value because there is little if any potential misconduct to deter.

Second, the press generated by a stringent enforcement policy risks being detrimental to the reputation of an OFC. There are two reasons for this. Regulatory enforcement action means that there was misconduct to find in the first place. While one isolated sanction probably would not paint the OFC as a den of thieves, too much negative press risks creating that impression. Conversely, compliant entities do not want to spend a fortune on compliance costs in meeting the requests of too stringent regulation.

That is not to suggest that there should be no regulation. Aside from the need to comply with important international obligations with respect to money laundering and terrorist financing, purely from a market perspective there needs to be some degree of confidence that there are rules in place and the rules will be enforced if something does go wrong. No business will be tempted to relocate to the next Antigua.

Finding the right balance
This, then, is the difficult job of OFC regulators. To do their job properly they need to try to walk the line between inspiring confidence, not scaring away the business and catching the very rare crook.

One solution may be to return to where they started – assisting their regulated entities to be compliant. With this they can remain active and visible in the marketplace and try out some of their new rules and regulations without necessarily needing to bring home heads on sticks. A quality business will still have the reassurance of a secure marketplace, in which serious misconduct is identified and dealt with, but it can also have some confidence that compliance costs will be kept to a minimum, with both parties able to adopt a cooperative approach to their compliance activities, which actually improves the business rather than ruins it.

Michael Adkins is an associate at Collas Day