House of Commons - Public Accounts - Thirty-Seventh Report

Select Committee on Public Accounts Thirty-Seventh Report

FOREIGN AND COMMONWEALTH OFFICE: CONTINGENT LIABILITIES IN THE DEPENDENT TERRITORIES

OFFSHORE FINANCIAL SERVICES

General

30. The offshore finance industry has grown significantly over the last ten years, in many cases replacing traditional industries, as the Caribbean Dependent Territories' main source of revenue and employment. The most developed financial centres are Bermuda, the Cayman Islands and the British Virgin Islands; but the other Caribbean Territories also view the sector as an area for potential growth.[31]

31. The constitutional position of the Caribbean Dependent Territories varies and with it responsibility for the regulation and supervision of the financial services sector. In four of the Caribbean Territories the Governor has direct responsibility for offshore financial services. In the British Virgin Islands and Bermuda this responsibility lies with the local Minister of Finance; both Territories have co-operated fully with the Foreign Office in the conduct of their offshore finance sector. The United Kingdom has reserve powers to override local governments and to regulate the sector but the Foreign Office consider that it would be inappropriate to transfer responsibility to the Governor in all but extreme circumstances.[32]

Banking

32. International banking and business scandals in the 1980s resulted in a greater awareness of money laundering and a demand for higher standards of financial control and monitoring, particularly in offshore financial centres. Like many countries, the Dependent Territories face the risk of criminals trying to exploit weaknesses in their banking systems.[33] The Cayman Islands now have the world's fifth largest banking market. There was no hint of the Caribbean markets being affected by the Asian banking crisis; indeed they might stand to gain from it.[34]

33. All of the Caribbean Territories have implemented revised banking licensing guidelines setting strict criteria for new applications. The new guidelines give banking regulators enhanced powers and have brought the Territories' banking sector up to international standards.[35] Since 1991 the Foreign Office have been encouraging Territories to improve their regulatory control, including taking account of the work of the Financial Action Task Force, established by international agreement in 1990.³³ The Foreign Office were sure that this body acted independently on behalf of the consumer.[36]

34. In September 1995 the Foreign Office asked the Caribbean Dependent Territories to update, by spring 1996, their anti-money laundering legislation to cover the proceeds of all, not just drugs-related, crimes.[37] The Foreign Office told us that the money laundering situation, while better, needed to get a lot better still.[38] The Foreign Office told us that, by early 1998, there would be all crimes anti-money laundering legislation in place in all the Caribbean Dependent Territories, except in Montserrat and Bermuda.[39] However there remained a fiscal exemption clause in the Cayman Islands which the Foreign Office wished to change.[40] The Governor would make sure that it disappeared by March 1998.[41] The Foreign Office also thought that the Bermuda law was defective and needed adjustment.[42]

35. In response to a 1993 Treasury review, the Caribbean Territories amended their legislation to allow regulators to share otherwise confidential information with overseas regulatory authorities.³⁵ The Foreign Office told us that they were extremely keen to encourage the better regulation of these markets. They saw next steps as improved investigative powers; these would include statutory powers for assisting overseas regulators and for improved co-operation with the host country of a bank which wanted to establish a branch in the Caymans or British Virgin Islands.³⁴

36. After some teething troubles, relating to management and the unwillingness of some Dependent Territories to accept FBI involvement, an Anglo-American White Collar Crime Investigation team has been set up. The Foreign Office regarded it as a very good development, especially against money-laundering.[43]

International Business Companies

37. In 1995 the Cayman Islands and British Virgin Islands failed to respond to the Foreign Office's proposed legislation to enhance their regulation of international business companies. In February 1996 the Foreign Office sent revised guidelines to the Caribbean Territories for new legislation and regulation to enhance the record keeping and due diligence requirements of company formation agents, with a 12 month deadline for implementation.³⁵ The Foreign Office believed it very important for the draft legislation in the Caymans and British Virgin Islands to be passed.[44]

Insurance Businesses

38. In December 1995 the Foreign Office sent the Caribbean Territories a questionnaire to ascertain the types of insurance business they were undertaking, and their regulatory practices. The Department of Trade and Industry are analysing the responses to consider whether the existing legislation and standard of supervision are appropriate.³⁵ The Foreign Office told us that, while broadly adequate, the quality of the legislation needed to be improved.[45]

Supervisory Resources

39. The supervisory structure differs markedly between the Caribbean Territories reflecting, to a large degree, the respective sizes of their financial centres. All the supervisory bodies are funded by the local governments, accounting for between 3 per cent and 83 per cent of the revenue arising from financial services.[46] In the Turks and Caicos Islands for example seven people are responsible for supervising nearly 13,000 business companies, insurance companies and banks. Annual government income from these bodies is about £1.6 million whereas the cost of supervision is less than £0.2 million.[47]

40. The Foreign Office consider it very important that regulation should keep up with the development of offshore financial services in the Dependent Territories. They could not say that all was for the best; the Territories needed constant encouragement and nagging.[48] The level of regulation had some way to go before it caught up with where the City of London was before 1 May 1997. The Foreign Office would go on pressing the Dependent Territories for improved regulation of offshore company formation regulation in the British Virgin Islands; and improved regulation of the offshore insurance industry in the Turks and Caicos Islands.[49] Strengthening the law enforcement and other justice agencies was very important.[50] It was in the Dependent Territories' interests to be seen to be clean and sound.⁴⁹

41. For their part the Foreign Office have assisted by providing regulators in Anguilla, the Turks and Caicos Islands and the British Virgin Islands. In the last three years these Territories have all shown a scale of enforcement effort not seen 20 years ago. Four years ago there were 55 offshore banks operating in Anguilla; now there are three. Offshore insurance companies in the British Virgin Islands are now down to about 180 through effective regulation; the same effort has been made in the Turks and Caicos Islands.⁴⁸

42. One of the tasks of the Foreign Office's policy review was to examine the scope for further limiting potential contingent liabilities. Some of the possible changes would involve amendments to existing powers; others could be made within them. The aim would be to modernise existing systems so as to protect the Dependent Territories' rapidly developing offshore financial sectors from being open to abuse or subject to criticism.[51]

Gibraltar

43. The Gibraltar Government has been keen to develop the financial services sector while recognising that a sound regulatory framework was needed to attract new and reputable finance business. In 1991 it created a Financial Services Commission to act as an independent regulatory authority. In 1992 a United Kingdom Treasury review concluded that the standards of regulation and supervision would have to be strengthened if financial institutions in Gibraltar were to be allowed to participate in the single European market.[52]

44. To assist the Financial Services Commission in achieving the required standard, the United Kingdom has provided information on supervisory standards in the United Kingdom, offered legal advice to assist in drafting new legislation and contributed £160,000 for three staff to boost the Commission's supervisory capacity. However progress has been slow and the Commission did not reach full strength until 1997.[53] If the United Kingdom is satisfied that specified criteria have been met, Gibraltar authorised financial institutions will be allowed to operate in the United Kingdom and in other European Union member states.[54]

Future Actions

45. In his statement on 4 February about the results of his Department's review the Foreign Secretary wished all the Dependent Territories to have in place a comprehensive set of financial legislation to the highest international standards. The Department's checklist of measures included:

a package of regulatory legislation which fully met recognised international standards;

comprehensive measures to combat money laundering, which extended to all financial institutions and were sufficiently thorough to allow checks to be made on companies incorporated in the Dependent Territory but based elsewhere;

legislation to allow the Dependent Territories to co-operate fully with overseas investigations; and

licensing and regulatory regimes for all financial activity that created a level playing field between the Dependent Territories.

46. The Foreign Secretary hoped that the Dependent Territories would have all the measures in place by the end of 1999. He would also be writing to Chief Ministers asking them to ensure that their regulatory authorities were genuinely independent, if necessary through ring-fenced funding from an industry levy.

Conclusions

47. Offshore financial services are becoming increasingly important to the economies of the Dependent Territories, notably those in the Caribbean, and it is essential that they are effectively regulated for the reputation of the Territory itself and of the United Kingdom and because of the potential for large financial commitments to accrue, if such services are not well regulated. We therefore endorse the checklist of measures referred to by the Foreign Secretary, within which we regard comprehensive legislation and fully effective regulatory regimes as fundamentally important.

48. The Committee note that Territory regulators are now able to share otherwise confidential information with their overseas counterparts; that the Caribbean Dependent Territories have set strict criteria for new bank applications; that there have been reductions in the numbers of offshore banks and insurance companies in a number of Territories; and that the Anglo-American White Collar Crime Investigation Team is seen as a useful development. However, we are disturbed at the Foreign Office's admission that the regulation of offshore financial services in the Dependent Territories is still not fully effective.

49. It is particularly worrying to note the Foreign Office's assessment that the situation on money laundering needs to get a lot better; and we agree with the Foreign Secretary that comprehensive and thorough measures are needed. We note the Foreign Office's evidence that, by early 1998, there would be anti-money laundering legislation in all the Caribbean Dependent Territories, but we are disturbed that there remains a fiscal exemption clause in the Cayman Islands and that the law in Bermuda is defective. We look for these weaknesses to be remedied by March 1998. There should be statutory powers for assisting overseas regulators and improved co-operation with the host countries of banks.

50. On the regulation of international business companies, we regard it as unacceptable that the Cayman Islands and the British Virgin Islands failed to respond to the Foreign Office's proposals, made in 1995 and 1996, designed to secure enhanced regulation in this area. We are concerned that the quality of the legislation governing offshore insurance companies also needs to be improved. We urge the Foreign Office to see that satisfactory legislation in these two areas is passed without further delay.

51. Regulation needs to keep up with the development of offshore financial services and its effectiveness needs to be continuously monitored and improved. We are disturbed at the relatively small size of many regulators compared to the number of bodies they are required to oversee; and that the regulators have relatively few professional staff. Since several of the Dependent Territories earn considerable sums from offshore financial services, it would be entirely reasonable for more of this revenue to be ring-fenced, as envisaged by the Foreign Secretary, and spent on professionally-led regulatory activities. Otherwise there remains potentially large risks for investors, for the Territories' governments, and for the United Kingdom taxpayer.



© Parliamentary copyright 1998	Prepared 21 May 1998