Offshore Financial Centres - Treasury Contents

Memorandum from the Financial Services Authority

  1.  This Memorandum is submitted to the Committee's inquiry into Offshore Financial Centres. We address those matters within the inquiry's terms of reference that are relevant to the FSA, fall within our remit, or where we feel we can make a useful contribution. Additionally, we detail the international work, in which we are involved, which is relevant to the Committee's inquiry.

  2.  The key points we make in this submission are:

    —  There is no internationally agreed definition of what constitutes an offshore financial centre (OFC), but there are common perceptions.

    —  There has been considerable focus on OFCs within the international regulatory community in recent years, and they have been subject to extensive review.

    —  These reviews have tended to conclude that OFCs per se do not pose a threat to global financial stability, and that standards of regulation are generally comparable to those that apply in other jurisdictions.

    —  The FSA, in its regulatory procedures, does not draw any distinction between OFC and other foreign jurisdictions.

    —  The level of cooperation received from OFC regulators has generally been good, and has not typically been determined by factors that are unique to OFCs.


  3.  There is no internationally agreed definition of what constitutes an offshore financial centre (OFC). Generally, there is a tendency to adopt the approach of "you know one when you see one". Over the years, there have been many attempts to define the concept by academics, international organisations, regulators and others, and while there are common themes in the various proposals, there has been no real consensus. Definitions tend to be centred on the concept that an OFC provides financial services (usually in currencies other than that used domestically) primarily to non-residents, for whom it offers a favourable tax regime. While many jurisdictions are attractive to non-residents for the provision of financial services, it is typically the case (but not universally so) that OFCs are seen to be those where there is a significant imbalance of scale between the external business and the domestic financing needs of the local economy.

  4.  As a consequence, there has been a tendency to perceive a classic OFC as being a small island state that has legislated to create a highly favourable environment for the development of a financial services sector, which far exceeds what would have evolved naturally to meet domestic needs. However, at the other extreme, several commentators consider that OFCs include those financial markets that have developed naturally on the back, for example, of the provision of goods and services for foreign trade and related activities. Within this category these commentators might typically include the City of London, due to the highly international character of its financial services industry. In recent years, there has been a trend towards the creation of OFC enclaves within developing economies, for example the Labuan Offshore Financial Centre in Malaysia, or the Dubai International Financial Centre in the United Arab Emirates.

  5.  The majority of OFCs exist because they are able to offer an environment which isolates the financial service providers from the constraints that might arise in "onshore" financial centres. These include the results of measures designed, among other things, to address domestic economic, monetary and financial policy considerations. Onshore centres may have rules that are considered by service providers and their customers as too demanding, tax policies that are too restrictive, disclosure requirements that are too extensive, or overall costs that are simply too high. Successful OFCs will generally have legal, regulatory and tax structures that avoid these "problems", although it should be stressed that the standards to which they operate are not necessarily out of line with international expectations of a jurisdiction which wishes to offer appropriate incentives. Increasingly, financial institutions in primary onshore centres demand high operational and regulatory standards in OFCs with which they are associated.

  6.  The majority of OFCs tend to provide relatively traditional financial services. They do not seem to play an especially important role in the development of complex financial instruments, except to the extent that such instruments may be heavily used by entities based in such centres. Onshore financial centres, such as London and New York, remain the major development locations for new financial instruments, but the "engineers" of these instruments will naturally seek to identify the best legal, regulatory and tax environment in which to market the product.


  7.  While, in principle, the FSA, draws no distinction between OFCs and other financial markets in its regulatory and supervisory policies and procedures (see below), it participates actively in various international fora in which OFCs have been a focus of attention, either as a discrete issue or as part of a wider review of jurisdictions' adherence to international standards. The most comprehensive work looking solely at OFCs has been undertaken by the Financial Stability Forum (FSF). Shortly after its creation it established a working group to consider whether OFCs posed a threat to global financial stability. The working group's report was published in April 2000,[1] and concluded that,

    "OFCs, to date, do not appear to have been a major causal factor in the creation of systemic financial problems. But OFCs have featured in some crises, and as national financial systems grow more interdependent, future problems in OFCs could have consequences for other financial centres".

  8.  The report recognised the extent to which international standards relating to the regulation of financial services and the prevention of money laundering varied significantly from one OFC to another, and it also recognised that the failure to implement appropriate standards adequately could pose a future threat to financial stability. It identified 42 jurisdictions that it considered to be OFCs, and grouped them into three categories, based on the perceived level of compliance with international standards, drawing on a survey of the views of onshore and offshore financial services supervisors undertaken by the working group.

  9.  In the light of these findings, the FSF asked the International Monetary Fund (IMF) to assume responsibility for instituting an assessment process to determine the true level of compliance by these 42 jurisdictions. While priority was to be given to those OFCs that had been considered weakest, the IMF's OFC Program, which came into being in 2001, captured all 42 jurisdictions referred to in the FSF report, together with another four identified by the IMF. The initial phase of the programme was completed in 2005, and concluded that the OFCs' compliance levels with the four main international standards against which they were assessed[2] were broadly comparable to those of other jurisdictions, and, in some cases, better. However, the IMF noted that compliance levels were generally weaker in the securities and insurance sectors than in banking.[3]

  10.  To date, only a limited number of assessments have been undertaken in the second phase of the OFC Program since 2005. The IMF has reported that it continues to see improvements in the levels of compliance with the banking and insurance standards, but that the sample of OFCs with material securities sectors is currently too small to be statistically relevant. However, it notes that concerns remain about the implementation of some of the FATF Recommendations on anti-money laundering and the combating of terrorist financing (AML/CFT), for which revised standards were published in 2003. The IMF concludes that, while compliance by OFCs is broadly comparable with other jurisdictions, there are common weaknesses in the areas of customer identification, the monitoring of transactions, and international cooperation. However, such weaknesses are not restricted to OFCs; the levels of compliance globally with the FATF's customer identification requirements are currently poor (eg both the UK and US have been evaluated as only "partially compliant" with the standard).

  11.  The OFC Program has, by design, included all 46 jurisdictions referred to above, but the IMF Board agreed in May 2008 to merge this programme with its standard Financial Sector Assessment Program (FSAP). This will allow a more risk-based approach to the assessment process, in that it will focus resources on both the key jurisdictions and the significant activities within each jurisdiction. It will also allow the use of more developed assessment techniques, and extend the potential scope of the assessments to cover a broader range of international standards (eg corporate governance) than the four included within the OFC Program.

  12.  The FSA has strongly supported this move in the course of its participation in the IMF's annual OFC Roundtable discussion, and through its membership of the FSF's OFC Review Group. This group was established in 2005 to monitor the results of the IMF work and any other relevant initiatives by the standard-setters, and to advise the FSF on any follow-up action that it might consider appropriate. In September 2007, the FSF reported[4] that it considered that significant progress had been made in improving levels of compliance in OFCs (although acknowledging that some deficiencies remained), but that the Review Group stands ready to examine any material problems that might emerge.

  13.  Within the European Union, in September 2004, the Financial Stability Table of the Economic and Financial Committee invited the 3L3 Committees (CEBS, CESR and CEIOPS) to examine, in liaison with the Commission, "non-cooperative jurisdictions that are unable and/or unwilling to provide foreign regulators cooperation according to international standards". The 3L3 Committees decided to term such jurisdictions as OFCs, whilst recognising that the scope may extend to onshore jurisdictions. As part of this project the Committees have been asked to establish "common databases on the existing problems in relation to OFCs", and to develop a common approach for the supervision of business operations in such jurisdictions. In the latest report on this initiative, published in August 2007,[5] the Committees summarised the findings from a survey of European supervisors, seeking information on their experience in dealings with OFCs. These indicated that, on the banking side, "the vast majority of [the 30] respondents reported that they have no issues to be raised about OFCs and also stated that they had satisfactory dealings". A similar picture emerged from the securities side, while the insurance supervisors mostly indicated that their dealings with OFCs were very limited, but that they also had identified no particular problems. In most cases, the supervisors generally felt that any difficulties could be, and were best dealt with bilaterally with the relevant OFC.

  14.  The FSA participates in several other international bodies which have looked more generally at the issue of "non-cooperative jurisdictions". Although these initiatives have not focussed exclusively on OFCs, several of the jurisdictions that have fallen within their scope have been involved predominantly in offshore activities. The most high profile of these initiatives has been the FATF's Non-Cooperative Countries and Territories (NCCT) exercise, which resulted in the publication, in June 2000, of a first list of jurisdictions deemed to have significant deficiencies primarily in terms of their ability or willingness to cooperate internationally. This initiative has been highly successful in bringing about reform in the AML defences of several jurisdictions, with the result that there are currently no names on the list. A total of 47 jurisdictions were reviewed under the initiative (including 30 OFCs), leading to the nomination of 23 to the NCCT list (of which 11 were OFCs). After extensive engagement with the FATF, the last of the OFCs was removed from the list in October 2005. The FATF continues to monitor international cooperation issues very closely, and in February 2008 issued a statement[6] reflecting its concerns about the AML/CFT regimes in five jurisdictions and one geographical area, one of which is considered to host offshore activities.

  15.  In 2005, the International Organisation of Securities Commissions (IOSCO) launched an initiative to raise the standards of cross-border cooperation among securities regulators. This involves identifying jurisdictions that appear to be unable or unwilling to co-operate; prioritising follow-up work with those presenting the greatest risks to IOSCO's objectives of investor protection, maintenance of fair and efficient markets and financial stability; and entering into a dialogue with priority jurisdictions to develop a mutual understanding of their ability and willingness to cooperate, and to assist them in resolving problems. This initiative, which is not targeted specifically at OFCs, is undertaken on a confidential basis, and the identity of jurisdictions is not disclosed.

  16.  One benchmark for the exercise is a jurisdiction's ability to comply with the terms of IOSCO's Multilateral Memorandum of Understanding (MMOU), which establishes the framework in which securities regulators are expected to cooperate. To be a signatory to the MMOU jurisdictions have to be subject to a rigorous vetting process. Currently, approximately eight of the signatories are recognised OFCs, and several others either have applications pending or have formally notified IOSCO of their intentions to effect legal changes to permit signature.


  17.  In its bilateral relations with its foreign regulatory counterparts, the FSA draws no distinction between OFCs and other jurisdictions. This also applies to those OFCs that have close constitutional links with the UK (ie the Crown Dependencies and Overseas Territories). The basis of the relationships is typically determined by the presence of firms for which the FSA and the foreign counterpart have some form of common supervisory interest, and the need to obtain or exchange information for supervisory or investigatory purposes. For the most part, the cooperation sought from foreign counterparts relates to exchanges of supervisory information about individual firms, or the provision of very specific intelligence to assist an investigation or enforcement matter.

  18.  In general, there has been no material difference in the overall experience of dealing with OFC regulators compared with other counterparts. Relationships with several OFCs (including the Crown Dependencies) are particularly strong in terms of policy development, supervision and enforcement, and the FSA has routinely received valuable assistance from the regulatory authorities in many cases, and the criminal law enforcement authorities from time to time. Where the FSA encounters problems when seeking cooperation from specific OFCs, it will normally talk to the jurisdiction in an attempt to resolve the difficulties. This will typically be the case when we believe that there may be a need for further cooperation in the future.

  19.  Where there is a clear business case, the FSA may seek to enter into a Memorandum of Understanding (MOU) or similar arrangement with a foreign counterpart in order to lay down the framework for continuing cooperation. Currently, the FSA has MOUs with agencies in ten jurisdictions that may be considered OFCs.[7] The text of these documents is published on the FSA's website.[8] In addition, the FSA, as a signatory to the IOSCO MMOU, is entitled to expect cooperation from fellow signatories without the need for a bilateral arrangement.

  20.  The FSA will continue to promote, through whatever fora it considers appropriate, the implementation of international standards of regulation, transparency and cross-border cooperation. However, it does not see these issues as being specific to OFCs, however defined, and it will continue to advocate that the performance of individual jurisdictions should be judged on their own merits, rather than under some generic label.

16 June 2008

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2   The supervisory principles promulgated by the Basel Committee on Banking Supervision, the International Organisation of Securities Commissions and the International Association of Insurance Supervisors; and the anti-money laundering standards published by the Financial Action Task Force. Back

3   The staff reports on the progress of the OFC Program, together with copies of the jurisdictional reports can be found on the IMF website at A summary of the finding for the UK's Crown Dependencies and Overseas Territories may be found in the NAO report "Managing the Risk in Overseas Territories" ( Back

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5,com_docman/task,cat_view/gid,250/Itemid,151/ Back

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7   Bermuda, Cayman Islands, Dubai, Gibraltar, Guernsey, Hong Kong, Isle of Man, Jersey, Singapore, Switzerland. Back

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