Thursday, August 28, 2008

Macavity and the hitch-hiker's guide to nowhere

TJN has been thinking about secrecy jurisdictions, and what they do. Its director John Christensen and senior adviser Richard Murphy have been pursuing approaches to the problem that have converged in important ways. John's recent keynote speech to the Alpbach Forum (which we blogged recently) was entitled "The Hitchhiker’s Guide to Nowhere: A journey into economic anarchy."

Why "nowhere?" Bear with us.

John was previously economic adviser to the states of Jersey:

"Working in Jersey for 14 years helped me understand how secrecy jurisdictions facilitate capital flight and tax evasion. Most of my work involved creating elaborate structures for shifting profits out of producer countries and consumer countries into offshore structures. Tax evasion, typically dressed up as tax avoidance, was the principal motive."

And then he added:

"I was trained to create tax dodging schemes spanning three, sometimes four or even five different jurisdictions, each scheme carefully designed to prevent investigation by external authorities. . . . reading through the files of clients from all over the world revealed indisputable cases of insider trading, market rigging, non-disclosure of conflicts on interest, fraud, bribe paying, international sanctions busting, and, of course, tax evasion on a epic scale. These crimes are seldom exposed because they occur in a milieu of legal secrecy and judicial non-cooperation."

It goes on to provide much fascinating detail. But this blog focuses one aspect: as he put it,

"Most offshore tax evasion schemes employ multi-jurisdictional structures carefully designed to avoid regulation, by ensuring that transactions occur on paper outside the scope of the regulatory authorities of the jurisdictions in question."

In our offshore dictionary, following our editorial in the newsletter Tax Justice Focus which looked at the role of tax havens in helping create the global environment of lax regulation underpinning the current credit (and economic) crisis, we translated the phrase "This should be regulated elsewhere" into what it really means: "This will be regulated nowhere."

Richard Murphy is currently in Montreal to give a presentation on this. In a TJN presentation he wrote for the UK Treasury Select Committee on tax havens, called Creating Turmoil, he explored this question in some depth. His Montreal presentation (with a longer paper here) expands on this, and contains an excerpt from one of this blogger's favourite poems from childhood:

Macavity's a Mystery Cat: he's called the Hidden Paw -
For he's the master criminal who can defy the Law.
He's the bafflement of Scotland Yard, the Flying Squad's despair:
For when they reach the scene of crime - Macavity's not there!

How appropriate. As Richard puts it: the secrecy jurisdiction creates (lax) regulation and a veil of secrecy for the benefit of non-residents: its legislation is designed for use "elsewhere" - a ring fence is created between the secrecy jurisdiction's domestic economy and the "elsewhere." Page 29 of his presentation provides a dramatic illustration of what can happen: it shows an offshore arrangement with the UK as the investment location, Guernsey as the secrecy provider, then it has an unregulated settlor located in the UK, a trust located in the British Virgin Islands, a company located in Jersey, with directors located in Cayman.

Who regulates this arrangement? Clearly nobody does. This is why secrecy jurisdictions have been able to say, without even feeling the need to put tongue too far into their cheek, things like:

"Jersey is well known . . . . as a Crown Depencency with a well regulated Finance Industry."

It's a big confidence trick. Technically, such a statement may (or may not) be true. As Richard puts it, the issue is not the finance industry in the secrecy jurisdiction. It's the finance industry in the secrecy space. And where is this secrecy space? It is, of course . . . . nowhere.

"It is in the grey secrecy space that the unregulated market exists," Richard said. Secrecy providers move transactions from the regulated "here" into the "unregulated spaces that are mythical locations 'elsewhere' or maybe 'nowhere' at all . . the secrecy space surrounds, but is not in, any secrecy jurisdiction."

The challenge is to extend regulation into the secrecy space. Efforts to regulate only the secrecy jurisdictions, then, will face a monumental challenge. Regulation has to move way beyond the secrecy jurisdictions, and into secrecy spaces exploited by the accountancy, banking, and legal professions, among many others. In the relationship between these secrecy providers and the jurisdictions, the providers have all the power: they can simply relocate elsewhere if they don't like the regulation (and this, incidentally, provokes the race to the bottom on regulation.) So it's them, more than the tax havens themselves, that Richard says must primarily be targeted.

What tools can be used in this respect? There are several, and this is a work in progress for TJN. One major one, again developed by Richard Murphy, is Country by Country reporting (also available in French and German). This is important: the World Bank and others use a figure for $1-1.6 trillion of dirty money flowing annually across borders through the secrecy space, half from developing and transitional economies, and Richard notes that even though an estimated 60% of cross-border world trade happens within corporations (it is sometimes called "intra-group" trade):

"The secrecy disappears from view in consolidated accounts. . . not one cent is in published glossy accounts."

Country-by-country reporting would bring the secrecy space out into the public domain.

It's also worth noting that the $1-1.6 trillion is just part of the picture (see more here), for it focuses on illicit flows. Tax avoidance structures, amply using the secrecy space, are an additional, and very large, problem (by definition, tax evasion is illegal while tax avoidance is legal - though alo by definition it seeks to bypass the wills of elected legislatures - and there is a very large grey area between avoidance and evasion.)

We have already shown how we need to re-think the geography of corruption. We also need to re-think the geography of regulation.

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