Essay: Go With The Flow

Go with the flow in which I argue the case for the contribution of IFCs to international investment, jobs, growth, and poverty alleviation.

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Allegations that International Finance Centres (IFCs) allow significant illicit capital flows that enable individuals and multinational enterprises to avoid paying a ‘fair’ amount of tax rest on poor data and analysis, and on mistakes about how financial transactions, international taxation, and anti-money laundering rules actually work.

In reality, IFCs such as Jersey have an important role to play in facilitating the free flow of global capital and increasing international investment in a perfectly legitimate and beneficial way. Despite various reports in some populist media, there is nothing illegal or untoward about anyone, whether a celebrity or not, having a bank account or trust in a well-regulated jurisdiction such as Jersey. In fact, there are many perfectly sensible reasons for doing so.

The efficiency with which capital can be moved around the world has never been more important, and it is against this backdrop that there is a need for more rational and considered thought around the exact role that IFCs play.

Many arguments against IFCs rest on a profound misunderstanding
Given the lack of accurate data available in this area, a more balanced view based on proper academic research is incredibly helpful. As a result, Jersey Finance commissioned an independent study to be carried out, published this summer and prepared by two leading academics from the United States who have examined in detail cross border finance and the international free flow of funds around the world.

The report, Moving Money: International Financial Flows, Taxes, and Money Laundering, has provided a powerful answer to the critics of offshore financial centres, and demonstrated the value of having an open global financial market in helping to boost global trade and economic growth.

Written by Professor Richard Gordon, director at the Institute for Global Security Law and Policy and professor of law at Case Western Reserve University, and Professor Andrew Morriss, dean at the Texas A&M University School of Law, the report shows that many arguments against IFCs rest on a profound misunderstanding of how and why money moves around the international financial system.

The Moving Money study identifies the two ends of a polarised philosophical debate concerning IFCs, tax policy, financial regulation and theories about how money is moved. The authors call those at one end of the spectrum Control First proponents, who believe that “the most important thing is to stop bad things happening in finance”. At the other end of the spectrum are those who believe (like the authors) in an Efficient Enterprise framework, where “the analysis should begin with the promotion of economic growth”.

By exploring the two approaches, the study ultimately finds that IFCs help to increase international financial flows, in so doing facilitating trade and investment and allowing the reduction of overall financial risk.

In fact, far from doing damage to the global economy as some commentators suggest, the removal of barriers to global trade has, according to the World Trade Organization (WTO), caused a doubling of income in 10 developing countries with a total population of 1.5 billion, while overall annual growth in the world economy – an average of 1.9% per year since the Second World War – is largely down to increased trade and global finance. 
If globalisation still offers the chance to enrich the lives of billions, including some of the poorest people on the planet, boosting cross-border trade and financial intermediation should be paramount. And offshore financial centres, the study argues, achieve just that.

Since the financial crisis in 2008, and more recently as global governments and institutions have come together to address the modernisation of the global tax system, many critics have suggested that the role of small IFCs, such as Jersey, will become redundant.

This is simply untrue and completely ignores the important role played by well-regulated centres such as Jersey as a conduit for investment into the UK and a benefit to the wider global economy.

Such benefits were first revealed in the government’s Foot Review in 2009, which showed that offshore financial centres make a huge contribution to the City of London’s market liquidity, in turn helping UK banks to finance the wider UK economy.

Then, in 2013, an independent report carried out by Capital Economics (Jersey’s Value to Britain) found that Jersey alone is the conduit for almost £0.5trn of the total stock of foreign inward investment into the UK economy, and that £1 in every £20 of money invested by foreign individuals and companies in assets located in Britain reaches the UK via Jersey. Far from being a drain on Britain, in fact Jersey supports nearly 180,000 jobs across the UK.

It is this sort of evidence that enables the authors of this study to say that jurisdictions “that lubricate trade by facilitating international financial transactions play an important role by offering transaction-cost-reducing innovations and services”.

Critics of IFCs often refer to money being moved around the world through pipeline-like conduits through small islands, an unnecessary detour on their way to a final destination, detracting from both developed and developing countries’ tax take en route, a misleading description that might well imply questionable activity. But the reality of how money moves around the system is quite different. IFCs are often chosen for their legal regimes and management skills that can ensure an investor’s funds are safely and efficiently managed on their way to ultimately buying goods and services, which is actually an entirely sensible practice.

As well as examining the benefits of free trade, Gordon and Morriss analyse the balance between over and under-regulation, and the philosophical disjoint between two ends of the spectrum.

For example, while there is greater justification for introducing preventative regulatory measures should there be a rise in criminal transactions, equally such measures necessarily add transactions costs, which can catch some criminal activity, but can also reduce legitimate, value-maximising transactions.

The authors of the study argue that demands for more regulation without considering cost and effectiveness rely on a belief that international financial transactions are “assumed illegitimate unless tightly controlled, rather than primarily reflecting the normal, legitimate workings of an efficient market”.

There are numerous reasons why people and multinationals use IFCs such as Jersey, and one of the most common reasons propagated by critics is to do with tax planning. The Moving Money report illustrates how attacks on IFCs like Jersey often fail to grasp the real nature of tax evasion and avoidance (most of which occurs onshore). The emphasis on tax evasion and avoidance is too simplistic an explanation for using an IFC. Indeed, as the study suggests, “it is important to keep in mind that financial innovations are not necessarily tax driven” and that some jurisdictions may “compete to provide services, regulatory regimes or dispute resolution services that facilitate business across borders”, not subvert or hinder it.

Where tax planning does come into consideration, however, it is entirely legitimate. The authors of the report call tax planning a “rational response to tax laws”, and go even further to say that it is in fact “the only response possible for an individual or firm faced with the need to comply with the conflicting provisions, definitions and exemptions of multiple jurisdictions’ tax laws”.

IFCs are among the most well-regulated, compliant and transparent market places – Jersey, for example, offers all the protection associated with the British common law legal system.

Jersey also adheres to the highest standards set by international bodies like the IMF and the Financial Action Taskforce (FATF), was an early adopter in signing up to the G5 pilot on automatic exchange of tax information and the OECD’s Common Reporting Standard, and has committed to the US FATCA framework of tax reporting.

Meanwhile, where confidentiality is concerned, legal systems need to find a balance between “privacy interests and law enforcement interests, permitting intrusion into private matters only under limited circumstances”, such as when there are suggestions that a crime has been committed or there is some form of other significant social interest at stake.

In addition, much more useful than denouncing IFCs, which provide robust rule of law services to the rest of the world, would be to devote more resources to helping to create honest, competent governments in jurisdictions where corruption is the norm.

In their analysis, the authors of Moving Money show that cross border trade in goods and services is simply not possible without the international movement of money. This has become especially important now that globalisation has opened trade channels between all four corners of the globe, between developed and developing economies. As a result, there is clearly huge value in reducing the financial costs of trade transactions.

Access to well-functioning, liquid capital markets is an important means of reducing financing costs, and IFCs often act as intermediaries in the flow of funds. This is particularly important for investors in developing countries who wish to diversify their portfolios by investing in jurisdictions that have greater levels of stability, are better performing economies and have stronger property rights protections than their domestic country.

There’s no doubt that the global financial network is a complex system that uses different jurisdictions for different purposes – some legitimate, some not. Of importance to policymakers is how much reworking the system can tolerate before the benefits it yields are too eroded.

Such discussions around international business and tax policy are too important to be debated on the grounds of baseless arguments. They should be firmly rooted in quantifiable economic research, and not the kind of “overly simplistic, conspiracy-theory view of international finance” promoted by some lobby groups.

The positive role of IFCs is being evidenced in a growing body of robust literature, such as the Jersey’s Value to Britain report published by Capital Economics last year, and the World Bank/Jason Sharman report Shell Games, which concluded that offshore centres were among the most compliant jurisdictions with respect to the laundering of proceeds of corruption. Among the least compliant were the US and UK.

Moving Money is another extremely important contribution to the international conversation in this area, and will prove valuable in driving discussions around IFCs away from the kind of sensationalist headlines far too often associated with the financial world.

The full report, written by Professor Andrew P. Morriss, University of Alabama School of Law and Professor Richard Gordon, Case Western Reserve University, is available at: jerseyfinance.je/moving-money

- See more at: http://economia.icaew.com/finance/september-2014/essay-go-with-the-flow#sthash.6jI0M9Rm.dpuf

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