International Financial Centres: Good for the Global Economy?

By Richard Hay, Principal, Stikeman Elliott LLP (07/12/2009)

The global financial crisis has prompted re-examination of the conservative policy consensus which favoured deregulation and globalisation as the twin engines of growth over the last 30 years. Naked capitalism has become unfashionable; interventionist policies are the new mantra.  


Domestic politicians and regulators and their supranational agencies such as the IMF and the OECD are riding a tsunami of public opinion seeking change. New architecture for financial markets is at the top of the G20 agenda. More, but not necessarily better, regulation is the likely outcome.


The world’s small finance centres have been singled out (along with hedge funds) for special attention. Low regulatory standards in so-called tax havens are perceived to have contributed to the global financial chaos. Despite the prevalence of this perception amongst politicians and the general public, the consensus view of technically informed observers (such as the IMF) is that the best of such centres (including, for example, Singapore, Hong Kong and many of the British Crown Dependencies and Overseas Territories) are already generally better regulated than their big country counterparts. If this is true, why are ‘tax havens’ so consistently maligned in the mainstream media?


Lazy stereotypes on international financial centres (IFCs) persist. Such stereotypes do not reflect the now pervasive culture in the world's leading financial centres for rejection of tax evading clients (who bring trouble in their wake). Professional probity and high standards of rigorously enforced regulation are also the norm in the leading IFCs following ten years of hegemony for ‘global’ regulatory standards proposed by supranational agencies including the FATF, the OECD and the IMF. In a curious turn, such standards have generally been more consistently adopted and enforced in the smaller finance centres, while commercial and finance communities in the larger countries have occasionally benefitted from the regulatory arbitrage which flows from fending off implementation of expensive and onerous rules promoted by the agencies they fund and control.


In the current crisis, big country politicians and regulators could be forgiven for seeking scapegoats to deflect criticisms which may otherwise land closer to home. IFCs are rarely represented in the supranational clubs forging the new architecture and it is generally easier, and certainly more polite, to blame the absent. Small IFCs are convenient targets in these fora, as ‘low tax’ and ‘low regulation’ are easily confused and conflated. The ‘tax haven’ tag conveniently implies both, despite its literal confinement to the former.


Do low standards and low tax attract consumers as the media and politicians suggest? Consider the solicitations that regularly clogged email inboxes before the advent of spam filters. The invitations proposed financial transactions with outstanding returns and complete discretion. Regulation and tax levies (or data tracking to support such enforcement) were plainly not contemplated. Despite these blandishments, those solicitations were rejected by most recipients. Why? Consumers do not patronise poorly regulated centres. Centres with low standards are commercial failures, even in the absence of regulatory intervention.


Although the current malaise has given impetus to the challenge to IFCs, the pressures on them are not new, of course. Is there a more fundamental agenda which underpins the current thrust against such centres?  


The leading IFCs have played a key role as lubricants in globalisation. That many such centres are clustered near major financial markets such as the City of London and New York is no coincidence. Their tax neutral platforms have made them essential symbiots supporting the depth and success of such ‘onshore’ markets over the last thirty years.


IFCs do the following:


  • provide liquidity to markets, lowering the cost of capital for business;
  • allow companies to manage sudden risks, like foreign exchange fluctuations;
  • facilitate the movement of capital from inefficient businesses to ones that can use it more productively;
  • pool funds to act as portals for efficient collective investment into and out of metropolitan countries.


Globalisation is regarded with suspicion by many domestic politicians as it introduces competition, including on taxes. Despite formally welcoming such competition, most producers (including governments) prefer monopolies, or at least manageable cartels. So any tax competition fostered by international finance centres is often considered unwelcome, even while (or perhaps because) it prompts greater efficiencies in utilisation of onshore government finances.


The most important point in the challenge to small financial centres may be the desire to flex control over mobile capital. In a globalising world, is there any more important sovereign prerogative than controlling where mobile money alights? If centres like Jersey, Cayman or Bermuda are rejected by their longstanding natural allies, they could redirect substantial sums elsewhere in the process. Funds already in the UK or the US are more likely to be deployed domestically where they remain less disconcertingly beyond the control of the large governments.


Finally, despite recent turmoil, financial services jobs are highly lucrative. US government statistics appearing in the CIA fact book show that the top twenty economies in the world (measured by GDP per capita) are dominated by countries with either oil or financial services. Big countries want to control financial services business for sound commercial reasons. It would be unseemly to overtly demand surrender of such high paying jobs from competitors, but calls for heavy regulation on smaller market participants facilitates that same goal.


Is it in the interests of Western countries such as the UK and the US to pursue this agenda of maligning the small finance centres which surround them? The reputation of the UK’s offshore centres for probity, professional skills and financial sophistication enables them to attract capital from around the world. Such capital is then substantially directed into the UK, European and US capital, banking and securities markets. Capital goes where it is welcome, of course, so the erection of US or EU barriers to trade with international financial centres could steer their allegiances towards Asian, Middle Eastern or Latin American markets. Who will suffer most if UK or US relations with their financial centre territories are damaged?