This part of the industry isn’t much discussed, people don’t like talking about it, it’s taboo. But I think it’s one of those things, which we need to talk about. Because often, the reality behind the hype is quite different to the hype itself. Education, as always, is lacking. And the papers, just want to sell, well, papers.
On-shore and offshore
A lot of the off-shore jurisdictions have come under fire lately. We had the panama papers just a few weeks ago, and rightly so. Panama was one of the few places who hadn’t signed up to the OECD guidelines and there have been a whole host of people, from all over the world, making the most of the kind of banking secrecy regulations that haven’t existed in other countries for a very long time.
Offshore and legal
What strikes me when reading the list, is that the clients of the firm Mossack Fonseca ranged from some of our top ministers of state around the world, to corporate businesses, as well as the kind of unsavoury folk you would expect to hide money off-shore. After everything that has happened to poor Iceland, their Prime Minister still finds it a reasonable location to hold assets there. He, and the other ministers, have put themselves on the same level as people they probably wouldn’t have over for dinner. In the case of the ministers, it might not be illegal to hold off-shore accounts, but it is morally offensive to their voting public, and understandably so.
Offshore and illegal
Although it is not fair to say that everything held off shore is illegal, certainly the use of shell companies with false ‘Directors’ covering up the ultimate beneficial owners, most definitely is. It will not be possible for Panama to stay outside the rules of the OECD if they want to continue with their financial sector for very long, since the name is now so synonymous with corruption it will be difficult for them to keep trading with other countries.
The great inequality
Not all financial centres are treated equally when it comes to conversations about tax. In November 2014 we had LuxLeaks, and the apparent revelations of one of the Big4 setting up specific tax rulings for their clients. But wait, doesn’t this happen in every single onshore jurisdiction around the world? In the UK, Germany, The States, governments have the power to agree specific tax rulings for multinationals in advance. In many cases it is a pre-requisite to companies doing business in that country. This happens in the UK, Germany, Netherlands, France, Asia, Africa, actually, everywhere.
I was shocked to read the front page of the FT on a Sunday after Luxleaks declaring that ‘Luxembourg pledges to end banking secrecy.’ Actually, the beginning of the end of private banking secrecy started way back in 2004 with the introduction of the Savings Directive. At that time, Luxembourg and others, who had agreed to give up banking secrecy agreed to do so in unison, but were held back by the competitive move of other countries such as Switzerland, who wanted to hold onto it. By the time Luxleaks came out there was already significant weight behind dropping it, not least because the industry had been prevented of signing double tax treaties with other countries as a result of it. It had already fallen out of favour.
But the disclosure of the tax rulings, via an investigative journalist, of ‘secret’ deals made the whole thing look a lot worse. They might be confidential, but they are only as ‘secret’ as all the other tax rulings of all the other governments in all the rest of the world. You just don’t expect to see them on the front page of a paper.
When you look up ‘tax ruling’ online, there is a note in the main body of the Wikipedia text referring to Luxembourg specifically. While Luxembourg does not have a perfectly spotless reputation, can you name one financial sector around the world that does? Is it right that for many years in the UK and the US it has been possible to establish the same kind of tax rulings and trust structures (think Cayman, Delaware, BVI, Isle of Man, Jersey) that have been set up in Luxembourg, but they have not received the same level of media attention? I am not saying that structures used in those countries are necessarily wrong either, I actually think they too can serve an equally great purpose, but I think the lack of understanding about how Luxembourg works creates an unfair disadvantage to the country. There are reasons investors vote with their feet, and Luxembourg is the second largest fund centre in the world and it is not just about tax.
No jurisdiction has a spotless reputation when it comes to their finance industry, or in fact anything else. That’s because they are all equally made up of us, human beings. It was not long ago that bankers in the US created such misleading derivatives, repackaged them into triple A products, which landed us all in the last financial crisis. And what about France, the country that was home to Jérôme Kerviel, the world’s largest ever rogue trader. Kerviel’s transactions, which apparently went unnoticed by his seniors, were worth €4.9 billion. To put that into perspective, that is a whopping five times larger than Nick Leeson who brought down Barings Bank in the early 90s, and three times larger than Kweku Adoboli in London the year before. With that amount of cash you can employ over 120,000 people on good EU salaries for one entire year. It is said that many traders’ managers turn a blind eye to losses, since the returns in the face of such risk taking, can still be so good. Never mind that it’s basically gambling. The sizes of our Investment Banks have been in decline ever since.
Why Tax rulings are important
The world is a very complicated place, even for very small companies like ourselves, the administrative legal and tax nightmare of being cross-border is a huge burden. Add on top that it’s an investment business, and it’s incredibly complicated, with every layer of regulation making it more-so. No sooner have you sorted something out, then another issue emerges. With so many significantly opposing forces in working in international business, countries simply have to provide some level of agreement to companies in advance about how they will be treated, and what is acceptable to the governing jurisdiction in their transposition of the law. The law is sometimes (actually, often) a very mean-able thing and it is not immediately clear how it relates to some transactions, and some conditions, so tax rulings are important for companies to be able to ensure that they are not over-taxed or the lose out unfairly by paying tax twice in two jurisdictions. The point is that it is important to pay taxes, while also not overpaying them to the extent that it makes our companies financially unsuccessful. That would not be helpful to any of us.
Explaining the above image:
This image appeared last weekend in the International New York Times. Firstly, Luxembourg is not an offshore jurisdiction. Secondly, there are several other reasons that Funds and Investment Businesses use chain structures in an investment, that are not actually to do with Tax at all. They are largely to do with security, transparency, flexibility (for shareholders), and remaining legally-compliant. In the case of problems with the Fund, the Bankruptcy protection rules in Luxembourg enable the bank or the first lender in the transaction to exercise what is called a ‘pledge on shares’, and can take over the asset. This is unique to Luxembourg and this type of shareholder protection is a key reason behind the level of investor confidence that has built up here.
Secondly, the debt at each level of the transaction will be serviced first before moving on through the structure, and this is something that is assured not just through legal documentation, but through structuring the deals in this way. Transparency is assured this way.
Thirdly, operating a regulated structure in Luxembourg enables investment companies to sell their fund (i.e. distribution) in other countries in Europe, because they have built up the correct legal and regulatory connections with other EU centres to keep investors safe. This makes it both safer, and more secure, for investors from any other country in Europe to invest in funds, than probably anywhere else in the world. Luxembourg Funds are not a world-leading success for no reason.
Finally, we have to make it possible for Asset Managers to do their work, and they can only do that if they have investors. We must ensure that we are not making it less financially-interesting for investors to invest in for example Real Estate Funds, than it is to invest directly into the Real Estate itself. If we do that, then we are not doing our job. If they are overtaxed by irregular and inflexible regimes, (by unfairly paying tax in two jurisdictions for example), the system will no longer work.
You might think that it’s just the sector that will suffer, but just take a moment to think about the wider waterfall impact on our cities and the development of our world. Who else is going to redevelop the Spanish real estate industry, were it not for real estate funds who can make it viable? Who else can develop countries in South America, like the combined power that Funds have?
Privately run, privately financed, these companies are building our major roads and hospitals, to time, and below government budget, through PPP. In all cases, the Public Private Partnerships include a transfer of significant risks to the private sector for these public projects. Who else would be lending to our promising businesses, and ensuring they grow quickly, providing valuable jobs, using the right metrics for growth, were it not for Private Equity Investors? And who will buy from the stock market, if it is not our own pension funds, designed to allow us to retire one day?
It’s time to talk about Tax. In a new way.
Two years ago we started talking about a project called FundsTV, our aim is to explain the work of the Asset Management Industry clearly and openly, and to turn the fear back into trust with the people outside it. On leap day in 2016, we went live with about 50 close , senior members of the industry present. We are privately-run and passionately privately financed, because we like our independence that way. Since the site went live 7 weeks ago we have had over 4,000 visitors, without any marketing. Please support us if you like us.
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