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Charles Lewis Sizemore, CFA
“It worked,” say the leaders of the twenty most influential world economies. They are speaking, of course, of their collective efforts to “fix” the world economy in the wake of the 2008 meltdown.
In the preamble to the Final Statement from the September G20 meeting in Pittsburgh, our leaders inform us that:
When we last gathered in April, we confronted the greatest challenge to the world economy in our generation. Global output was contracting at a pace not seen since the 1930s. Trade was plummeting. Jobs were disappearing rapidly. Our people worried that the world was on the edge of a depression. At that time, our countries agreed to do everything necessary to ensure recovery, to repair our financial systems and to maintain the global flow of capital. It worked.
Well, it’s certainly good that we have that settled. We were starting to worry.
No doubt, you may detect a hint of sarcasm in our writing. It is difficult for us to give the G20 as an organization much credit for fixing the global financial system. Firstly, by many measures, it is not altogether certain that the system is fixed. A recent report by the IMF suggests that the world’s banks still have roughly $1.5 trillion in bad real-estate-related debts to write off in the years ahead. Even after 2008’s meltdown, the banks have written off less than half of the losses that they may eventually have to. An undercapitalized bank is a “zombie” bank – it sucks in funds from depositors and the central bank, but it does not in turn loan out those funds.
That said, it does appear that the global economy is on the mend, however slow and torturous the process might be. And to their credit, the G20 leaders made the recapitalization of the banks a priority in their September Statement. This shows that the G20 has at least a few good ideas, even if it lacks the means to enforce them. (Our personal favorite among the unenforceable resolutions was the pledge by countries with trade surpluses to export less and consume more with the complimentary pledge by countries with trade deficits to consume less and invest more. How exactly does this work? Are Chinese citizens to be coerced into buying goods they didn’t previously want? And are their American and British counterparts to be barred from their local Wal-Mart or high street?) In other grandiose words, our leaders designated the G20 to be “the premier forum for our international economic cooperation.” This is quite ambitious for a body that represents only 15% of the world’s countries and which does not have an official charter, a full-time staff or a headquarters. Up until last year, the G20 member states had never even met at the head-of-government level; they had previously only met at the finance minister and central bank chief level. Still, it appears that the organization’s ambition knows no bounds.
This month, we’re going to take another look at the G20. This formerly insignificant talking shop has quickly evolved into a serious regulatory body that must be taken seriously. This is particularly true for hedge funds and expatriate investors, as the regulation of offshore finance is one of the stated priorities of the organization.
The G20: Six Months Later
The manifesto from the April 2009 G20 meeting was mostly lofty rhetoric with little real substance, but there was one particular point that sent a shock wave through the offshore financial community:
The G20 pledged “…to take action against non-cooperate jurisdictions, including tax havens. We stand ready to deploy sanctions to protect our public finances and financial systems. The era of banking secrecy is over. We note that the OECD has today published a list of countries assessed by the Global Forum against the international standard for exchange of tax information.”
This assessment led to the creation of the now infamous black list of “Jurisdictions that have not committed to the internationally agreed tax standard” and grey list of “Jurisdictions that have committed to the internationally agreed standard, but have not yet substantially implemented.” In a separate annex, the G20 leaders created a list of possible actions for states to take against these alleged wrongdoers including:
increased disclosure requirements on the part of taxpayers and financial institutions to report transactions involving non-cooperative jurisdictions;
withholding taxes in respect of a wide variety of payments;
denying deductions in respect of expense payments to payees resident in a non-cooperative jurisdiction;
reviewing tax treaty policy;
asking international institutions and regional development banks to review their investment policies; and,
giving extra weight to the principles of tax transparency
The strong wording and the determination behind it was enough to scare virtually all of the non-compliant states and jurisdictions into compliance. The four jurisdictions on the original black list — Costa Rica, the Philippines, Uruguay, and the Malaysian island of Labuan — have now been upgraded to the grey list by agreeing to adopt the standards. Meanwhile, Aruba, Austria, Bahrain, Belgium, Bermuda, the British Virgin Islands, the Cayman Islands, Luxembourg, Monaco, the Netherlands Antilles, San Marino, and Switzerland have all scrambled to sign the required 12 interjurisdictional agreements needed to move from the grey list to the white. (The requirement is to have at least 12 treaties in place for the exchange of financial information on request; at this stage, full automatic exchange is not required.)
In spurring this round of treaty signing, the G20 and OECD have made progress toward their goal of ending banking privacy—much to the chagrin of those who cherish that privacy. Still, information on request may be a compromise that expatriates and offshore financiers are willing to live with, so long as the intrusion stops there. Otherwise, the end result of this trend could be a race to the bottom in privacy protections in which the standard of the most invasive country becomes the new global standard by default. This has already happened to some extent.
Ironic intrusion
The irony has not been lost on the Swiss that one of the countries most involved in leading the charge against banking privacy—the United States—has strict constitutional provisions that forbid the government from conducting searches without a properly-obtained search warrant. Somehow, the right to be free of unlawful searches and seizures does not apply to banking. It is unfortunate, but rather than exporting its tradition of liberty and non-intrusive government, the United States has chosen instead to export the violation of those principles.
At any rate, not wanting to rest on their laurels, the G20 leaders continued the charge in the September Statement. Reiterating the points from April, they wrote:
We are committed to maintain the momentum in dealing with tax havens, money laundering, proceeds of corruption, terrorist financing, and prudential standards…. We stand ready to use countermeasures against tax havens from March 2010. We welcome the progress made by the Financial Action Task Force (FATF) in the fight against money laundering and terrorist financing and call upon the FATF to issue a public list of high risk jurisdictions by February 2010. We call on the FSB to report progress to address non-cooperative jurisdictions with regards to international cooperation and information exchange in November 2009 and to initiate a peer review process by February 2010.
Though this statement sounds forceful, there are several reasons to believe that it may be more bark than bite. The first is the issue of “peer review.” While the idea of your country’s trading partners colluding to assess your trade and financial policies may sound intrusive, it is actually a sign of the G20’s weakness. Remember, the G20 has no enforcement mechanism and no permanent bureaucracy. The organization is essentially trying to govern the world financial system with peer pressure and nagging. Even the harsher punitive actions in the April annex, such as “withholding taxes in respect of a wide variety of payments,” are nothing more than recommendations.
Enforcement action would have to be taken by individual states — individual states that often have conflicting motives and seldom act as a group.
An interesting case in point is China. The Chinese government agreed to support the G20’s assault on the offshore financial industry — but only after the language was watered down and Hong Kong and Macau were removed from the list altogether.
The UK too has been somewhat ambiguous in its intentions. At the close of the summit, Prime Minister Gordon Brown evaded direct questions as to whether Britain would follow the G20’s recommendations or the recommendations of any peer review. And given that the more “offshore friendly” Tories are likely to be running the country after the next election, Britain’s enforcement could be weakened substantially.
For better or worse, it is also highly unlikely that the United States would take peer review seriously. This means that while the country is still busily applying pressure to offshore financial centers to eliminate privacy provisions, its own anonymous Nevada and Delaware LLCs will likely remain an excellent tax and privacy haven for non-Americans.
With the world economy showing signs of improvement, the G20 is losing the sense of crisis that acted as its primary impetus. With any luck, competition among its members will insure that the organization recedes into the background as a largely powerless talking shop. The G20 is still a force to be reckoned with, but we believe and hope that its assault on legitimate offshore finance may be already reaching its high-water mark.
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