When OECD governments began forking out billions to save their banks in 2008, they knew it was going to be politically unpopular at home. Lets face it, the only group of people less popular than bankers, are real estate agents – and only just. Faced with the biggest crisis of our times, our visionary OECD leaders snapped into action; and began looking for foreign scapegoats. Their attention soon fell on the usual suspects: international financial centres in small states. Their thinking was that small IFCs were already unpopular and sufficiently distant and small as to not protest too loudly to being used as a political football. Never mind that small IFCs had next to nothing to do with the crisis.
The global financial crisis: a failure of domestic regulation
Britain’s Northern Rock and Germany’s IKB – the first two institutions to fail – were not offshore banks. The main regulators for Bear Sterns, Lehman Brothers and Citigroup were not located in sunny places – but in New York and London. And regulators in these jurisdictions had the power to ask banks for information about what they were doing elsewhere – this is the point of “home-country” regulation that these regulators championed – so the notion that these institutions were squirreling away risks out of the sight of regulators is a convenient misrepresentation.
The reality is that this crisis was a failure of domestic regulation and a failure of the regulatory philosophy promulgated by the large financial centres. Regulators were aware of the trends, if not all the numbers, but thought that they did not need to know more, because securitisation, credit derivatives and other financial innovations were spreading risk and widening access to credit. However they try to touch up their role today, the regulatory philosophy promoted before the crisis is well documented in the Financial Stability Reviews of the major financial centres for the past five years.
In “Sending the herd off the cliff edge” (2000) and “Liquidity Black Holes” (2001), I argued that what determined whether financial risks were being spread or concentrated, was not whether risk was moving from one institution to many, through securitisation for example, but whether the new holders valued and hedged their risks with greater diversity than when these risks were on bank balance sheets. If the new holders, not having originated the risks and so less expert than those that had, valued, hedged, and traded these risks according to common, homogenous, standards; risk was not being spread, but being concentrated. These players would be buying risk at the same time, and selling risk at the same time. Officials responded that I was overstating the risks to systemic liquidity.
International pressure on IFCs
Governments looking for scapegoats like to argue that gaps in regulatory coverage around IFCs were part of the problem. This is a possibility, but it is also a self-serving idea. Many IFCs, like Barbados, have tougher bank regulation than “light touch” Britain. Nameless nominees can set up companies in Delaware and Nevada; but not in Barbados. Icelandic banks were allowed to operate in Britain; not Barbados. Barbados has turned away many a Russian bank, now freely operating in London. Barbadian regulated banks and the Canadian parents of Barbadian subsidiaries did not join in the credit derivative game. The biggest discoveries of money laundering have been traced, not to Caymans, but to Zurich, London and New York. The biggest fraud investigation to be squashed by political interests did not centre around Zimbabwe, but Britain’s $50bn, BAE contract to build fighter aircraft for Saudi Arabia. And dont forget to mother of all frauds, the $23bn Boeing air tanker scandal of 2002.
But the pressure on international financial centres will not be eased by a nod to reality. So far the bank bail-outs have cost around $2trn and the final bill is likely to approach $4trn. OECD countries are short of cash; desperately so. In their search for cash they have settled on the idea that IFCs take cash away from them through low tax rates.
This is another form of double-think. The biggest users of tax competition are the industrialized countries. Nissan is not in Sunderland and Kia is not in Georgia, USA, for the weather – but for the kind of tax breaks that small developing countries could never afford. In the debate around whether Italy’s Fiat would buy Germany’s Opel, it was pointed out that for some time Opel has not paid a single euro of German taxes. President Obama, has recently called for a crackdown on tax havens and almost in the same breath called tax breaks for companies doing research in America – this is nothing more than a research tax haven that will accelerate the brain drain from developing countries. President Obama is trying to use tax competition to create a comparative advantage in the US for research. This is not a bad idea, but let us have less of the attacks on others who try to do the same. Small states have many natural comparative disadvantages compared with large states – small markets, expensive supply chains, tight labour markets and more – but one natural comparative advantage is that in absolute terms they do not have expensive governments and can charge lower taxes for international businesses that can scale beyond the size of the country.
Faced with a world that appears to have double standards, well-run IFCs can do a few things: establish quality standards of business – especially in niche areas neglected by the one-size-fits-all approach in the major centres – communicate these standards internationally and enter into tax and investment treaty agreements with the major centres. No Caribbean country has done this better than Barbados.
Barbados is recognized as having the highest standards
Barbados began establishing a series of bilateral income tax and investment treaties over 20 years ago and this network is the principal reason why Barbados was the only small Caribbean financial centre to be on the OECD’s “white” list of tax jurisdictions when it was published after the G20 meeting in April 2009. Another reason is that the Barbados authorities recognize the importance of responsible financial services to the long-term development of the country. It is the second pole around which development is centred, the other being high-end tourism. Consequently, Barbados is prepared to fight its corner and it has earned high respect in the corridors of the OECD in Paris and elsewhere.
Countries on the OECD’s “grey” and “black” lists are trying to catch up with Barbados by initialing Tax Information Agreements, but these TIAs are not based on a Treaty. Terms and conditions can change without notice. Moreover, Barbados did not develop its financial service industry as a secrecy jurisdiction – as was the case for Lichtenstein, Andorra, Switzerland – and so these new demands for transparency will provide fewer issues and uncertainties in Barbados than elsewhere.
Barbados’ tax treaties with the United States and Canada were the bedrock of its financial services industry in the early years, but more recently Barbados has signed a number of investment and income tax agreements with countries where the potential for investment is enormous, but investors want the protection a Treaty can bring. Barbados investment and tax treaties with China and Venezuela have already become important for international investors, benefitting all parties. Much is expected of the recent treaties with Mexico, Brazil and Cuba and the outcome of on-going negotiations with India.
The new Financial Services Commission
Barbados cannot rest on its laurels. Pressure on IFCs will continue. Barbados is seeking to remain competitive by continuing to be an attractive tax jurisdiction for residents and by spreading its high standards of regulation across all financial sectors. The watchword for the new unitary, Financial Services Commission, scheduled to be established in 2010, will not be light-touch, or over-touch, but right-sized regulation. Barbadians in the financial sector feel that the current noises coming out of Washington and European capitals suggest that the regulation of hedge funds, private equity funds and insurance companies will not be appropriate. Appropriate, responsible regulation would differentiate far more between those institutions that are systemically important, and those that are not, in particular between those that are leveraged and those that are not. Responsible regulation is more to do with putting the right risks in places with a capacity for that risk, than blindly requiring larger and larger amounts of capital to be set aside, irrespective of whether risk is being matched to risk capacity. This is a particular issue in the regulation of insurance companies where long-term savings institutions are being increasingly penalized in the US and Europe, rather than encouraged, to invest in long-term assets.
The Barbados banking sector has been a rare success story in this crisis. Temptation to excess was well controlled, limiting current stresses. No retail bank has been “bailed out”. The responsible approach to international taxation has been recognized by the least generous of arbiters, the OECD. This is a solid base from which to build a responsible IFC. New tax and investment treaties in countries with strong investment opportunities but weak investment protection, such as China, Venezuela, Cuba, India and others are likely to provide substantial mutual benefit. And extending responsible regulation across from banks to securities and investment firms will deepen Barbados’ attractiveness as a domicile – quite apart from the prospect of debating the financial crisis with friends, on the beach with some Extra Old and Coke in hand.