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A Finance Greatly Marked by Offshore
A finance marked by international offshore holdings of financial assets (materialized in securities, i.e., deposits) and, conversely, liabilities have increased considerably in recent years. According to data from the International Portfolio Survey, from $5.9 trillion in 2007, stocks of internationally held securities rose to $39.3 trillion in 2017 and after the crisis downturn (-1.7 to -8.2 trillion) above the precrisis level of $39.5 trillion in recent times. These are the figures identified by the International Monetary Fund (IMF) in statistics which, to be defective due to the inability to identify the final recipient as well as the ultimate investor (but with “interesting” anomalies), speak for themselves, revealing the weight of offshore finance, its singular nature, and some of its mysteries. Some of the securities identified by the IMF are not finely identifiable as belonging to a particular country. $1534.3 billion is not “ventilateable” either under the assets of international organizations ($876.8 billion), confidential or not “technically” attributable (478.6 billion of dollars).
These are the figures identified by the IMF in statistics which, to be defective due to the inability to identify the final recipient as well as the ultimate investor (but with “interesting” anomalies), speak for themselves, revealing the weight of offshore finance, its singular nature and some of its mysteries. Some of the securities identified by the IMF are not finely identifiable as belonging to a particular country. $1534.3 billion is not “ventilateable” either under the assets of international organizations ($876.8 billion), confidential or not “technically” attributable (478.6 billion of dollars). The distribution of international assets by destination country highlights the weight of developed economies but also the importance of offshore financial centers. Countries listed as “developed countries” account for $23,848 billion in financial investments, or 60% of total issued financial securities held from abroad. They also hold a considerable amount of financial securities abroad. According to estimates by ExpertActions ExiGlobal Group, the capital they hold in this way is $21,401.1 billion.
The comparison of these two data, however, indicates that, overall, the countries in question are indebted, with some of them, Japan in particular, finding themselves net creditors, in very variable proportions. On the other hand, the United States emerges as a particularly large net debtor. It should be noted that other countries, known as “singular countries,” whose economic size does not seem to justify this situation, appear to be major recipients of transnational financial investments. The total amount of financial securities held in these countries is $7 billion, equivalent to more than a quarter of foreign-held securities in developed countries. By comparison, “emerging” countries hold a place that seems almost secondary. The considerable importance of the Cayman Islands, Luxembourg, and Ireland as centers for financial investment is noted. Between them, they surpass Germany and France, combined as international investment destinations. This situation is obviously unrelated to their own funding needs. It corresponds to an international structuring of capital that follows the contours of a highly differentiated global taxation system and can be influenced by often dubious regulatory arbitrages. In fact, these countries export a considerable amount of capital, even more than they enjoy.
They appear as net creditors. This situation calls for some explanations. Just because their national savings are high does not mean that they are in that position. Rather, it is probably at the valuation differentials between their assets and their liabilities that they owe this situation. In comparison, the BRICS appear to be more in response to the economic analysis of the position emerging markets. They appear to be net debtors of capital that contribute to the local financing needs of developing countries. Beyond that, three observations are necessary: international financing, in terms of the financial role of individual countries, of the veiy opposite realities. Three situations seem to be distinguishable: developed countries where the need for capital but also financing is open to the rest of the world while the corresponding to dull economic situations with the involvement of both nonfinancial sector than financial sector companies; emerging countries less involved in the international financial system and probably following this dual model; countries whose financial exchanges almost entirely reflect the role of the financial sector alone; offshore centers are so integrated into third-party financial zones that they appear as mere financial appendages of these other zones; statistical inconsistencies abound, which leads to the IMF’s call to undertake the progress required by a census that is not only informative but which, in addition to the political transparency issues it carries, must be of sufficient quality for better design macroeconomic and prudential policies that it can influence.
This phenomenon particularly affects some Organisation for Economic Co-Operation and Development satellite countries. Their liabilities to foreign countries are mainly from developed countries. These countries hold an average of SI428 billion in assets in satellite economies. Satellite countries hold fewer assets in singular countries than they do at home. The weight of the capital provided by Switzerland, for example, is considerable, but the crucial financial integration is earned out with Luxembourg, reflecting the importance of this financial center in the international allocation of financing. The discrepancy between active and passive positions vis-à-vis singular countries is notable. It does not find itself with the same acuity in financial relations with developed countries. This discrepancy may arise from underreporting of assets held abroad, as the structural difference between assets and liabilities, which may have an effect on their respective valuations, does not appear to be sufficient to explain this deviation. These countries are mainly net debtors for bond debt, with Luxembourg “carrying” nearly 10% of bond debt.
This leads us to explore the issue of dangerous links between innovative finance and offshore. A large number of financial entities developed by financial innovation in recent years have been established in offshore centers. This is the case for securitization vehicles, derivatives trading platforms or hedge funds. Financial actors highlight the legal advantages offered by these territories. The role of the tax motive is minimized as well as the tax risks of this situation. In total, the communication on these points is oblivious to certain public interest, which must be remembered: the legal advantages of offshore, which can be ambiguous, are also very ambivalent and they are accompanied by loopholes that are not eligible under the financial stability imperative; tax factors cannot be considered secondary if only because offshore assets can be easily concealed and thus be, in addition to a vehicle of financial risk, a vehicle for tax evasion. International Bank executives justify the establishment of banks in various jurisdictions with generally recognized characteristics such as those of an offshore center for a variety of reasons, from which the legal dimension has emerged as a major.
Private banking activities in Luxembourg are not located there, “for tax reasons, but because asset management regulations are particularly flexible. Luxembourg has been the birthplace of the asset management industry and remains the global platform for coordinated distributions. This is the international benchmark for fund promoters, especially the Americans, who dominate the market. The advantages are numerous: an administrative system of great simplicity, which allows to obtain quickly approvals, a suitable legal regime ... This is why a number of funds are domiciled in Luxembourg. To finance certain assets, such as aircraft for example, it is referred to special puipose vehicles located mostly outside national jurisdictions, in jurisdictions that allow the creditor to seize the asset very quickly in case of default payment. Delaware’s choice is not about taxation but about banking law. The mortgage credit system in most Organisation for Economic Co-Operation and Development countries is far from offering the same guarantees. The credit-export agencies, which act on behalf of the states by giving their guarantee, recommending that bankers themselves locate special purpose vehicles in these jurisdictions. Debt security depends on the ability to quickly apprehend assets.” This is just one example of the general justifications for the development of banks’ offshore activities, as evidenced by a research reported by Prof. Amedzro St-Hilaire, detailing the benefits offered by the Cayman Islands that illustrate large widespread attitudes and a generally lenient communication on the subject.
This territory would be attractive only for legal reasons related to the benefits offered to investor creditors and adapted to securitization operations: absence of conciliation procedures that could “paralyze” the rights of creditors or even to prevent them from carrying out the security, possibility of carrying out the claims on the basis of the price of the securitization vehicle outside the evolution of the underlying), unrestricted operability of compensation agreements before and after the occurrence insolvency, a very limited list of preferred creditors in the Cayman Islands. These characteristics are not seen only as attractiveness factors for investors in securitization vehicles (the “demand” aspect of the market); there are also the prospects for optimal marketing (the “offer” aspect of the market).
Thus, the legal security offered would have the favor of the rating agencies which condition their rating to the insusceptibility of the bankruptcy of a securitization issuer and the proposed “leads.” Various criteria are envisaged in this regard, including independence between stakeholders in the securitization operation and the stability of the shareholding, which can be a form of guarantee since it would prevent the emergence of conflicts interests over the life of the vehicle. The trust regime that is widely available in the Cayman Islands would guarantee this because of the intuitu personae that dominate in these entities. Historically, these assets would have plagued Japanese investors primarily for legal security reasons.
The fiscal advantages of the Cayman Islands tend to be considered marginal. Of course, it is recalled that there is no tax on the island, neither on profits nor on transfers of income, gains, or capital gains. In addition, a 20-year tax guarantee is offered to funds. Moreover, the funds in question would not be intended to generate profits for the benefit of their shareholders but to distribute profits and losses to their creditors, depending on their rank in product structuring. In these circumstances, the tax to be considered would be that of the issuer of the debt securities and its investors. This presentation is emblematic of some of the regrettable reflexes of contemporary finance: ambiguous to the point to be considered misleading, it neglects a series of problems, some of which will be noted.
It must be present that the ambiguity surrounding the presentation of the legal assets of the Cayman Islands begins with the proposed presentation of the adequacy between the proposed formulas in the Cayman Islands with the rules of independence between stakeholders’ securitization operations. While it is true that these rules are a component of investor safety, it cannot be overlooked that the systematic lack of supervision of operators is likely to limit the practical scope of the territory’s legal institutions. Moreover, the opacity of trusts must be taken into account. It can destroy the argument of stability of their composition; the manager of the trust may be only an interposed person concealing the real economic interests governing the structure.
In the same way, the legal protection of creditors is mentioned without nuance. The interest of other stakeholders, particularly debtors who are capable, and the financial crisis has shown abundantly, assert legitimate rights, are completely ignored. It is understandable that, since the note was written for the purpose of marketing receivables, this consideration weighs little. However, there is a certain cynicism in not considering debtors when one is the source of debts that we know are particularly unbalanced for many of them, both so much that after they have been constituted one tries to exfiltrate them. Moreover, the emphasis on the legal status of receivables itself stems from a form of illusionism when thinking of the concrete possibilities of recovery associated with their economy.
An acute form of irresponsibility comes with the observation put forward that changes in the value of the underlying serves without any effect on the conditions of realization of the claims held by securitization vehicles. There is no mention of the mechanisms that allow it or the risks involved. In addition to ignorance of economic fundamentals, there is a neglect of public interests, the absurdity of which can be illustrated by a scenario that borrows from the reality of the unwinding of compromised debts in the subprime market. Presumably, some of the securitized assets in the Caymans benefited from real estate security that the funds are implementing. Under these conditions, funds registered in the Cayman Islands will probably hold a nonnegligible portion of the U.S. housing stock. By the way, we note the tax questions that such a situation can pose, particularly when it comes to identifying the tax debts associated with the holding of assets in such schemes.
Finally, of course, the lack of supervisory impact on securitization structures to international financial instability should not be overlooked, both because of the undesirable effects on the risk level disseminated in the global economy. That, in turn, impact on the disruptions caused by shadow banking structures. The lack of reliable data on this one is the result of regulatory holes in offshore centers that lead to a complete return to the alleged benefits of these territories, even for the promoters of the products located there and offshore more generally. It is in a way the “watering sprinkler” effect that looms on the horizon of an “offshorized” finance. Also, the tax advantages cosmetically minimized are to be emphasized. It is true that, in theory, securitization vehicles are not intended to generate income for their shareholders. However, this lack of vocation is certainly not general, especially since it is tempting to house in these structures products that have little chance of being able to be taxed. On the other hand, the management fees levied there, in any case, find a particularly appreciated tax refuge, it seems. However, the tax problems associated with these vehicles are not limited to the taxation of their income. We must also consider the fate of the losses and their imputation.
Finally, the tax neutrality regime is clearly one of the drivers of the development of the Cayman’s financial center far beyond securitization operations. The word “neutrality” can be given two connotations: one euphemistic, instead of the more common expression of “tax haven;” the other, more technical, covering the absence, and for good reason, of the tax impact associated with the registration of SPVs in the Caymans. In this case, the term neutrality is particularly poorly chosen. Neither from a regulatory point of view nor from a tax point of view, the Caymans are “neutral.” In reality, they are not in at least two ways: by the risks they contribute to accumulating in contemporary finance and by the negative effects they exert on organized political spaces.
Therefore, it is necessary to ask whether offshores are under pressure these days. Indeed, NGOs that monitor capital evasion and tax evasion do not corroborate this assessment. According to them, the relative weight of the various offshore centers is only moving. In fact, the growth of offshore centers has been uneven for some time. The gains of the Cayman Islands stand out as much higher than those of Switzerland in recent years (more than a trillion dollars against “only” 397 billion for Switzerland). Similarly, Hong Kong's relative growth, which quadrupled its securities registration positions between these two dates, is far more dramatic than that of the latter, which has done less than triple them. A recomposition of the offshore seems to be underway, which seems to follow macroeconomic developments, seems to be underway, which seems to follow macroeconomic developments, seems to be following specific dynamics.
The example of Switzerland: a moving financial account? The Swiss financial account of the “rest of the world,” which tracks “stocks of liabilities and assets” with foreign countries, and their evolution has changed significantly over the past several years. They seem to be the result of autonomous financial phenomena, even if additional information is not fully understood. Short-term liabilities are in sharp decline. It was in the order of $550 billion and reflects a decrease in Switzerland’s total debts to foreign countries.
This decline is mainly due to a very large decrease in deposits, a variation that other liabilities items do not experience. Deposits declined by more than $563 billion during this period. It is not possible to explain these movements in detail, nor can it be attributed to the disaffection of foreigners because of the threats surrounding the preservation of Swiss banking secrecy, but it is possible that this factor plays a significant role. Assets held abroad by the countiy have been reduced but less so. The decline in deposits held abroad was more frank than that of deposits held in Switzerland by abroad ($597 versus $563 billion). However, it was offset by an increase in foreign debt securities as well as by holdings in foreign entities. Financial movements between Switzerland and the rest of the world are differentiated depending on the country being envisaged.
Financial assets held abroad (portfolio investments) have been declining for some time, but this trend mainly affects those held in Europe (from $782.9 to $597.3 billion) in Central and South America (from $98 to $54.5 billion). Assets held in North America (from $170.7 to $183.5 billion) and Asia (from $36.5 to $38.8 billion) increased.
In Europe, Luxembourg is by far the largest destination for investment from Switzerland ($136.2 billion in 2019-$174 billion in 2015), a situation that has been explained by tax differences (particularly in withholding tax) combined with regulatory homologies (on bank secrecy and the supply of opaque structures, in particular). The second host country is Germany (87-133 billion) followed by France (with remarkable date stability around 85 billion), the Netherlands and the United Kingdom (for 68.4 and 63.9 billion, respectively). U.S. assets increased from $152 to $157.7 billion. Switzerland declares its assets in what it calls “offshore financial centres.” In Europe, it is the Channel Islands and Gibraltar. In America, 10 territories are covered by this topic. Since 2015, the assets held in these entities have decreased (from 90 to 20 billion for European entities; from 94.2 to 46.8 billion for South American areas). No doubt these macrofinancial developments should be taken with caution. Data are lacking to appreciate it according to the explanations of ExpertAc-tions ExiGlobal Group. The share of assets that cannot be distributed is expected to be high and stable at around SI 05 billion, or about 10% of the total investments in the portfolio.
However, lessons from more systematic studies (such as those on the effects of information exchange agreements) highlight the mobility of one offshore center to another based on the perceived risks of standardization of certain areas. These movements are not innocuous. There is a race for financial resources around the world that the strengthening of prudential standards and their effects on the use of debt to ensure economic balance could accentuate. Referring to the privilege of the dollar’s seignior age and the special capital needs of the United States, it will be indicated that the United States is in a unique position to pursue particularly offensive objectives in this regard. However, the relocation of offshore centers can mean a reorganization of financial power as financial intermediaries and states are not also positioned in the various centers. This observation does not support the disarmament of the fight against tax havens. Rather, it argues for a symmetrical and universal struggle, which assumes that Europe is not followed in the actions underway against certain financial flows.
This analysis raises the question of whether the good days of offshore are not over. If we were to rely on the black or grey lists adopted by government organizations, one would tend to believe that offshore is only an empty concept. The application of criteria more in line with reason requires opposite statements. This leads to the judgment that offshore is not a matter of exotic territories. It includes states that their legal status generally excludes from the offshore field but which undoubtedly belong to the offshore by their practices.
We must go beyond that: contemporary finance is deeply “extra territorialized” even in countries where it appears more regulated than elsewhere. In short, offshore is everywhere. Moreover, offshore cannot be mentioned as one of the main causes of the contemporary economic crisis because it is one element among many. Beyond offshore, general regulatory and control negligence is important. Offshore appears to be one of the particularly dangerous points of the application of this neglect. There are three concepts that need to be distinguished around this theme. The first is offshore as a money-laundering entity and terrorist financing. A second element later came about: the fight against tax evasion and evasion. Part of the crime of fraud is dealt with in the fight against money laundering. Tax evasion, on the other hand, has only recently been recognized by the international community as a major problem. The last and absolutely essential point emerged with the crisis: the universalization of the rales of prudence to all global entities, including offshore.
This vision testifies to the existence of an insidious offshore linked to the defects of regulation and vigilance of supervisors. The need to undertake a reregulation of finance is essential. This objective is often presented as having to be met by the adoption of new rales. The consultations rise to the problem of shadow banking bearing witness to this approach and confirming the existence of an offshore from the inside.
But the adoption of new rales would not be far-reaching without a change in the culture of supervisors. On this point, contrary to what many think, the Fund is not the gendarme of international finance: it does not have the legal means to do so, and therefore it does not have the intellectual means either. The second reason for this excessive risk-taking is that the constable is not armed enough. When a Ferrari exceeds speed limits, the gendarmes are not launched in a sedan. Similarly, supervisors must have the same technical skills as they monitor. How do you do that when, on the other side of the fence, you earn a hundred to two hundred times more than what the public authorities are able to offer? As a result, the gendarmes are far behind. Let us admit that prudential authorities and central banks must ask themselves this question all the time, especially in this context of high-frequency trading where infinitesimal fractions count to become more efficient. Almost all the players come to think about moving a few hundred meters to be closer to the central machine running a market to save the time that light takes to travel this distance. It will be necessary to try to master technological advances as best as possible, the problem being that as soon as a new technology appears, it is adopted without prior evaluation. Like the languages of Aesop, technology is capable of the best and the worst.