Offshore Financial Centers Face New Regulatory Pressures BY CHARLES PIGGOTT St. Peter Port in the Channel Islands a self-governing crown dependency of Britain is home to Guernsey's growing offshore financial services industry. Like most offshore financial centers, it has thrived on the back of the surging international wealth-management industry during the past decade. In this tranquil harbor town, the offices of large international private banks like Credit Suisse now jostle alongside the tourist shops looking out over the quayside yachts. This year, bank deposits in Guernsey banks topped #60 billion ($88 billion), 8% more than the year before. The neighboring Channel Island of Jersey, just 15 miles off the coast of France, has a similar story to tell. "Money is flowing in and this is very encouraging," says Richard Pratt, director-general of Jersey's Financial Services Commission. Deposits in Jersey's banks have grown to more than #115 billion, while Jersey-based investment funds reached #88 billion earlier this year, up 50% from the year before. Yet despite the healthy growth of offshore private banking, even well-regulated tax shelters like the Channel Islands face a difficult paradox: the more successful they become, the more pressure there is to close them down as large countries worry over lost tax revenue Larger countries want tax shelters to cooperate not just in the fight against money laundering and fraud, but in more routine matters of tax collection. On the other side of the debate, offshore jurisdictions with minimal tax and spending requirements resent outside interference in their internal affairs. Laurie Morgan, Guernsey's most senior politician and president of the island's advisory and finance committee, says: "Nobody, not the EU nor the OECD, nor any other body is suggesting that we change our tax code, only that we apply it fairly to residents and non-residents alike. We have no quarrel with other countries taking steps to guarantee their tax revenues, but what we do object to is large countries grouping together to bully us into how to run our country. Offshore shelters like Guernsey in the Channel Islands are now confronted with calls for greater transparency. Since last spring, a series of international initiatives against money laundering, tax evasion and bank secrecy have stepped up the pressure on offshore financial centers. First, in April the Financial Stability Forum (FSF), a G-7 arm set up in the wake of the 1997 Asian financial crisis, published a report on offshore financial centers based on a survey of financial regulators. The report listed Hong Kong, Luxembourg, Singapore, Switzerland, Dublin (Ireland), Guernsey, Isle of Man and Jersey among the best-regulated centers. But among the 27 worst-regulated were European centers Cyprus and Liechtenstein. The FSF report warned that in the event of continued nonadherence to international standards of regulation, transparency and cooperation, offshore centers could face sanctions including the withdrawal of aid from institutions like the International Monetary Fund and other multilateral development organizations. The report also suggested that regulators could stop domestic companies from doing business with or in problematic offshore financial centers. In June another intergovernmental group, the Financial Action Task Force, published a list of 15 "noncooperative jurisdictions" whose "detrimental practices" hamper the fight against money laundering. Included in this list were Russia, Lebanon, Israel and Liechtenstein. Later that month, the OECD also published a list, this time of 35 "harmful" tax shelters. Included in the OECD list are European financial centers such as Andorra, Gibraltar, Guernsey, Isle of Man, Jersey, Liechtenstein and Monaco. Other centers, such as the Cayman Islands, Cyprus and Malta, missed out on inclusion only by promising to cooperate with initiatives to close tax loopholes. Frances Horner, head of the OECD's tax competition unit in Paris, says: "What we want is to stop the illegal nonreporting [of investment income]. In other words, we do not want the veil of secrecy in one jurisdiction to encourage citizens in any other to break the rules laid down by their own domestic authorities." . The OECD wants offshore centers to exchange information with overseas tax authorities not just in criminal investigations such as serious fraud and money laundering, but also in routine civil matters. Tax shelters included in the OECD list have until next summer to cooperate or face inclusion in a second definitive list of harmful tax shelters and the possibility of sanctions from OECD countries. Guernsey and Jersey were added to the OECD list after they refused to sign a letter of commitment, even though both were given a clean bill of health by the other recent reports into offshore financial centers. Guernsey politician Mr. Morgan explains: "The OECD wanted us to make the highest-level political commitment to do whatsoever it might require in the future. We wouldn't dream of signing such an open-ended agreement. So now we have 12 months in which to reach an accord." Some have complained that the OECD and other groups have given little guidance on how blacklisted financial centers can get themselves off the list. Jersey Financial Services' Mr. Pratt says: "None of these organizations designed a process through which [jurisdictions] can get themselves off these lists and they have yet to come up with an appropriate exit strategy." Multilateral negotiations between offshore financial centers and intergovernmental groups like the OECD and G7 are now likely, but little progress has been made so far. In addition to mounting pressure from the OECD and G7, low tax jurisdictions also need to convince the European Union that they pose no threat to EU plans to close tax loopholes on its own doorstep. Like the OECD, the EU also wants tax shelters to share information on private bank accounts. Since 1997, EU member countries have been able to choose between implementing information-sharing agreements with other members, or charging a withholding tax on savings accounts. After 2010, however, all EU countries will be expected to implement information-sharing agreements. This will effect Luxembourg and Austria, whose secrecy laws forbid banks from handing over client information to foreign tax authorities in all but the most serious criminal investigations. The abolition of bank-secrecy laws in Europe is still the subject of hot debate. Lucien Thiel, managing director of the Luxembourg Bankers' Association says: "The problem isn't bank secrecy, but the abuse of bank secrecy, where it is used to hide dirty or criminal money." Both non-EU Switzerland and the EU's Luxembourg abstained from the OECD's recent recommendations that countries should loosen bank-secrecy codes. Meanwhile, Mr. Thiel says Luxembourg would only agree to EU plans on information sharing if non-EU countries accept the same conditions. Luxembourg fears that it will lose bank deposits to countries that preserve higher levels of confidentiality, particularly Switzerland, if it holds out for bank secrecy. There are reports that private-bank clients are already reacting to increasing disclosure between high-and low-tax jurisdictions. Says Linda Foster, a partner at Andersen Consulting in London: "[Offshore] private banks are starting to encourage their clients to at least think about full disclosure. So yes, money is flowing back onshore, but not necessarily just because of tax." Europe's tax shelters will have to walk a tightrope in the next 12 months between cooperating with larger governments and losing deposits to less scrupulous jurisdictions. "We must not chase money out of Europe. If other countries are not subject to the same conditions, money will simply go further afield," says Mr. Thiel, of the Luxembourg Bankers' Association.