countering illicit and unregulated money flows

8/13/2019 Countering Illicit and Unregulated Money Flows

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1Cr ime & Globa l i sat ion , December 2009

T R A N S N A T I O N A L I N S T I T U T E

T N I B r i e f i n g S e r i e s

Countering Illicit and

Unregulated Money FlowsMoney Laundering, Tax Evasion and Financial

Regulation

CRIME &GLOBALISATION

DEBATE PAPERS

DECEMBER 2009


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2 Cr ime & Globa l i s at ion , December 2009

Contents

Money Laundering, Tax

Evasion and Financial

Regulation

Construction of the

international AML regime

The AML/CFT regime

Effectiveness of the AML

regime

Tax evasion

International efforts to

regulate the grey nancial

system

Secrecy jurisdictions

Credit crunch

The way forward

Financial Secrecy Index

Glossary of main terms

and abbreviations

Bibliography

Countering Illicit and Unregulated Money Flows

3

4

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37

AUTHOR:

Tom Blickman

EDITOR:

David Aronson

DESIGN:

Guido Jelsma

PRINTING:

Drukkerij PrimaveraQuint

Amsterdam

FINANCIAL SUPPORT:Ministry of Foreign Affairs

(The Netherlands)

CONTACT:

Transnational Institute

De Wittenstraat 25

1052 AK Amsterdam

The Netherlands

Tel: -31-20-6626608

Fax: -31-20-6757176

[email protected]

www.tni.org/crime

Contents of this booklet may be quoted

or reproduced,provided that the source of

information is acknowledged.

TNI would like to receive a copy of the

document in which this booklet is used orquoted.

You may stay informed of TNI publica-

tions and activities by subscribing to TNIs

bi-weekly e-mail newsletter. Send your

request to [email protected] or register at

www.tni.org

Amsterdam, December 2009ISSN 1871-3408


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By om Blickman

In July 1989, the leaders o the economic

powers assembled at the G7 Paris summit

decided to establish a Financial Action ask

Force (FAF) to counter money laundering

as an effective strategy against drug trafficking

by criminal cartels. Here began an inter-

national anti-money laundering (AML)regime. Since then it has expanded its scope

to fight transnational organized crime and

counter the financing o terrorism. During that

time other illicit or unregulated money flows

have appeared on the international agenda as

well. oday, tax evasion and avoidance, flight

capital, transer pricing and mispricing, and

the proceeds o grand corruption are seen as

perhaps more detrimental obstacles to goodgovernance and the stability and integrity

o the financial system. Other international

bodies were tasked to tackle these public

bads.

ackling tax evasion is still in its inancy, and

there is a growing awareness that the AML

regime is not working as well as intended.

Experts still ponder how to implement onethat works. ax havens and offshore financial

centres (OFCs) were identified as acilitating

these unregulated and illicit money flows. Te

2007-2008 credit crisis made only too clear the

major systemic risk or all global finance posed

by the secrecy provided by tax havens and

OFCs. Tey were used to circumvent prudential

regulatory requirements or banks and other

financial institutions and hide substantial risksrom onshore regulators. Aer twenty years

o ailed efforts, the G20 (having supplanted

the G7) has again pledged to bring illicit and

harmul unregulated money flows under

control.

Tis briefing looks at previous attempts

to do so and the difficulties encountered

along the way. Can the G20 succeed or

is it merely ollowing the same path that

led to inadequate measures? What are the

lessons to be learned and are bolder initiatives

required? In brie, the paper concludes that

current initiatives have reached their sale-by

date and that a bolder initiative is required

at the UN level, moving rom recommen-

dations to obligations, and ully engaging

developing nations, at present le out in the

current club-oriented process.

This paper is a follow-up to the seminar on

Money Laundering, Tax Evasion and Financial

Regulation organized by the TransnationalInstitute (TNI) in Amsterdam, June 12-13,

2007, which brought together experts on

money laundering and tax justice and the

Wilton Park Conference Curbing Money

Laundering: International Challenges,

September 10-12, 2007. Just after these

meetings the credit crisis came about,

which added signicantly to re-think the

discourse on money laundering and nancial

regulation. The inputs of the seminars havecon-tributed signicantly to the develop-

ment of this paper but responsibility regard-

ing its content is the authors alone.

Inputs for the TNI seminar can be found at

http://www.tni.org/archives/act/16954

The report of the Wilton Park Conference

is available at http://www.wiltonpark.org.

uk/ documents/conferences/WP869/pdfs/

WP869.pdf


Money Laundering, Tax Evasion and Financial Regulation

Money Laundering,Tax Evasionand Financial Regulation


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Te AML regime was the first attempt at an

international level to get a grip on dirtymoney flows. Te primary objective was to

go aer the earnings rom drug trafficking, in

an effort to remove both the incentive (profit)

and the means (operating capital) to commit

crimes the so-called ollow the money

approach that had become popular during the

1980s. Concretely, this translated into identifi-

cation, tracing, reezing, seizure and oreiture

o drug-crime proceeds. Te concealment

or disguise o the nature, location, source,

ownership or control o crime proceeds

through laundering in legitimate financial

channels was identified as an obstacle to seizure

and confiscation. Removing the banking

system and financial institutions rom the

money laundering equation was seen as an

effective strategy to cut the supply o drugs

to the streets and oil their cultivation and

production.

Te initiative o the G7 ollowed intense

policy attention on illegal drug trafficking in

the 1980s. At its inception the AML approach

was primarily domestic, the United States

leading the charge. A crack cocaine boom

there led to a wave o violence on the streets

many cities. In Colombia, Peru and Bolivia,

where the raw material coca was cultivatedand refined into cocaine, ragile state institu-

tions nearly collapsed. Powerul drug tra-

ficking cartels1 and rebel guerrilla organisa-

tions that derived part o their war chest rom

taxing coca cultivation challenged the state,

corrupted both state officials and politicians.

Huge amounts o criminal wealth threatened

to undermine the integrity o financial in-

stitutions, compromise the judicial system,

undermine general prosperity, corrupt legal

business and subvert national security by

exposing countries to the perceived

ravages o crime cartels (Naylor, 1999).Something had to be done.

Te Reagan administration reinvigorated

Richard Nixons war on drugs. In 1970, the

Currency and Foreign ransactions Reporting

Act, better known as the Bank Secrecy Act

(BSA), was adopted ollowing Nixons get

tough on crime presidential campaign (Naylor,

1999; Naylor, 2007). It is effectively the first

effort to detect and sanction money laundering.

Te BSA required financial institutions to

maintain certain records and report certain

currency transactions, in an effort to prevent

banks rom being used to hide money

derived rom criminal activity or tax evasion.

Te purpose was not to outlaw money

laundering directly, but to create a regulatory

structure that provided an audit trail allowinglaw enorcement to track large currency trans-

actions (Cullar, 2003). Banks had to report all

financial transactions exceeding US$ 10,000

deposited in or withdrawn rom financial

institutions, and imports and exports o

more than US$ 5,000. Notwithstanding great

expectations, over the ollowing fieen years the

reporting requirements were widely ignored

and very little resulted rom these laws. Mean-while, the ollow-the-money law enorcement

policy gained in popularity, ed by the wide-

held belies that criminals should be hit where

it hurts most: in their wallet, and popular

notions that crime should not pay. In light

o the ailure o conventional law enorce-

ment strategies against drug trafficking and

crime, seizure o criminal proceeds seemed an


Construction of the international

AML regime

1. Reerring to drug-trafficking organisations as cartels is conusing and controversial as it implies the existence o two or

more cartels in the same market, which is a contradiction. However, to the word is now in common usage to describe large-

scale cocaine trafficking organisations in Latin America.


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attractive panacea. Te Reagan administration

revived the AML approach and money launder-

ing was criminalized in 1986 with the passing

o the Money Laundering Control Act

(MCLA).

With the increase o control measures, money

laundering grew more sophisticated, hence

requiring more and more complex regulations.

Since drug trafficking was a transnational

business the AML regime needed to expand

internationally, not in the least because US

banks elt at a disadvantage due to less rigid

legislation in other jurisdictions. Nations with

tougher regimes might lose financial business

to those with lax rules. A drive began to

establish a global level playing field via a

global regime. Te opportunity arose with the

negotiations in Vienna or the 1988 United

Nations Convention against Illicit raffic in

Narcotic Drugs and Psychotropic Substances.

Despite the absence o any reerence to money

laundering, provisions against it were includedin Article 3 o the convention. Te content

and wording owed much to US legislation

(UN, 1998). Most importantly, the creation o

money laundering as a criminal offence was

made mandatory or all parties to the con-

vention. Tat same year, the Basel Committee

on Banking Supervision (BCBS), comprising

bank and government representatives rom ten

major industrialized nations, draed a state-ment on the Prevention o criminal use o the

banking system or the purpose o money-

laundering, speciying ethical standards or

banks (Basel Committee, 1988). Among the

due diligence standards is the know your

customer rule, which urges banks to deter-

mine the true identity o clients.

At the 1989 Paris summit the G7 leaders issueda firm statement supporting and advocating

ratification o the 1988 UN Convention. Tey

nevertheless chose to set up a separate body,

the FAF, to implement the AML regime (Levi,

2005). Since the G7 had no secretariat or statute,

the FAF office was established at the Organisa-

tion or Economic Co-operation and Develop-ment (OECD). Te G7 established the FAF

specifically because they saw a deficiency in the

UNs ability to fight drugs. Contrary to the G7/8,

the UN has worldwide membership, but reach-

ing consensus is oen difficult. Its bureaucratic

structure and lack o resources make the organ-

isation ineffective. Rivalries between groups o

nations complicate efficient execution o tasks

and collective management (Rudich, 2005).

An American policymaker explained why the

UN was rejected as the watchdog: Any strategy

had to be global and multilateral, since unilateral

actions would only drive dirty money to the

worlds other financial centres. Yet Washington

could not afford to take a bottom-up approach

o seeking a global consensus beore taking

action; i the debate were brought to the UN

General Assembly, or example, nations withunderregulated financial regimes would easily

outvote those with a commitment to strong

international standards (Wechsler, 2001).

Although the 1988 UN Convention was essential

or creating the international legal ramework

against money laundering, the implementa-

tion o concrete measures was hijacked by

a small group o like-minded ree-marketeconomies. Te AML regime flourished

because o the financial backing provided

by the G7/8 and the show o consensus and

cooperation o its members. Te G7/8s strength

is its unique institutional capacity, enabled by

its small size, selected membership, flexible

structure, shared values and belie in democ-

racy and liberal capitalism (Rudich, 2005).

An alternate view is that great powers were

able to cajole, coerce, and enorce a global

Construction of the international AML regime


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anti-money laundering standard into exis-

tence that fit their interests best. Te UN with

its consensus decision-making would be in-

effective to enact the kind o financial regulation

the G7 wanted to counter money laundering.Even the International Monetary Fund (IMF)

and World Bank with their weighted voting

mechanism were ill suited, because o their

strong consensus norms. Tereore, the great

powers relied on their own club organisations

such as the OECD and the FAF to promul-

gate regulatory standards leaving out the vast

majority o nations worldwide (Drezner,

2005).

In 1990, less than one year aer its creation,

the FAF draed Forty Recommendations to

counter money laundering (see FAF web-

site). Instead o creating international law the

recommendations targeted harmonisation o

domestic laws through so law. Tese quasi-

legal instruments do not have binding orce,

but when a sufficient number o nations adopt

them they have sufficient political, institutionaland moral backing to evolve into international

norms. Te FAFs role is to issue regularly

updated AML recommendations aiming to set

legislative and regulatory standards and refine

those measures through research and guide-

lines. In 1996 the Recommendations were

revised to reflect the evolving methods o money

laundering. Te regime broadened rom ocus-

ing on drug trafficking to fighting overlappingissues such as transnational organized crime

and corruption. Te FAF and its recommen-

dations were strengthened by the provisions

in the 2000 UN Convention against rans-

national Organized Crime and the 2003 UN

Convention against Corruption, which called

upon parties to use as a guideline the relevant

initiatives o regional, interregional and

multilateral organizations against money-

laundering. 2

Aer the 9/11 terrorist attacks in 2001 in

the US, the FAF mandate was expanded to

combat the financing o terrorism (CF),

evolving into an AML/CF regime.3 Te

AML regime became ever more sophisticated

and accepted internationally. Te 2003 FAF

Forty Recommendations are today endorsed

by more than 170 jurisdictions and are

the current international AML standard

(FAF, 2008). It has provided the basis or a

system to monitor and police the behaviour o

countries, including both members and non-

members. In contrast, the 1988 UN Conven-

tion is a binding treaty, establishing ormal

legal obligations or all signatories. Unlike the

FAF system, however, the UN Convention

does not establish an enorcement system that

generates useul inormation about compliance,

because the Conventions provisions regardingthe detection o criminal financial activity are

extremely vague (Cullar, 2003).

Te AML regime developed during a period

o rampant ree market capitalism, charac-

terised by deregulation o financial markets

and diminished regulatory powers o states and

international institutions over the financial

system and its institutions (Levi & Reuter,2006). Ironically, the relaxation and ultimate-

ly abandonment o exchange controls and

the liberalization o financial services acili-

tated money laundering. What arose was the

increase o tax havens and OFCs offering low

tax, lax regulation, bank secrecy and high-level


2 . Article 7 o the 2000 UN Convention against ransnational Organized Crime and article 14 o the 2003 UN Convention

against Corruption.

3 . In October 2001, an additional Eight Special Recommendations or combating the financing o ter-rorism were included.Te Forty Recommendations and Special Recommendations were updated again in 2003. In 2004 a Ninth Special Recom-

mendation was added, urther strengthening the agreed interna-tional standards.


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confidentiality trusts and corporations. Tese

not only benefited money laundering but

acted as conduits and shelters or flight capital,

transer pricing, tax evasion and tax avoidance.

Te secrecy and lax regulations o OFCs and

tax havens played a major role in undermining

both the AML regime and measures against

tax dodging and evasion (Blum et al, 1998).

The AML/CFT regime

ENFORCEMENT

Civil and CriminalConscation / Forfeiture

Prosecution andPunishment

Investigation

Predicate crimes

PREVENTION

Administrative/Regulatory Sanctions

Regulation andSupervision

Reporting

Customer DueDiligence

The AML regime (source: Reuter and Truman)


8/40


be triggered or facilitated by informationfrom the prevention mechanism, but it isusually carried out by criminal investiga-tive agencies. In practice , the AML regime

is primarily a regulatory one focused onprevention. Although regulation andenforcement have different objectives andmandates their roles can be difficult todistinguish. For instance, there is growingconcern that bank employees arebeing turned into private detectives whenperforming their due diligence andreporting requirements.

At the core of the AML regime are the

Suspicious Activity Reports (SARs) orSuspicious Transaction Reports (STRs) as theprimary source of information from nancialinstitutions and other reporting sources.Produced by the prevention pillar, they areused by enforcement agencies. SARs arethe link between the two main pillars of thesystem (prevention and enforcement). Theproportion in high-reporting jurisdictionsseriously followed up is low. Whether this

is inherent or merely resource-constrainedremains unclear (Levi & Reuter, 2006).Defensive reporting to avoid potential penalties(and reduce internal review costs) seemsto be commonplace, leading to a deluge ofreports impossible to act on. A recent studyindicates excessive reporting fails to identifywhat is truly important by diluting theinformation value of reports (Takts, 2007).There are also serious doubts about private-sector institutions taking on (unpaid) animportant and unconventional law enforce-

ment role, for which their customers andshareholders pay, as well as serious privacyimplications. SARs result not from an objectivelydetermined threshold but from something in

the transaction or transactor, which raisessuspicion in the minds of bank personnel.The system puts a premium on rumour, biasand stereotyping according to critics, sincethe information is strictly subjective and theclient remains uninformed. An even more in-trusive system was introduced with the knowyour customer (KYC) rules, which seeksinformation about the client prior to anytransaction with, once again, the client remain-ing unaware. Here the nancial institution

is no longer passive or even reactive as withthe SARs, but proactive (Naylor, 2007).

To reduce over-reporting and cost andresource constraints there is a shift from arule-based to a risk-based approach, theformer considered ineffective.4High admini-strative burdens for nancial institutions andother reporting and supervisory agenciesinvolved costs neither compensated by

catching more criminals or nding moreillegal money. Judgments have to be maderegarding which kinds of business repre-sent a lower-than-average level of risk andaccordingly require fewer resources fortheir management.5 In that banks can settheir own internal rules regarding the risknature of the transaction, understanding theways in which SARs are led is all that moredifcult, and regulation moves away from thestate towards the nancial institutions them-selves.

4. Te rule-based approach is essentially passive and static. Proessionals apply a set o rules in all con-texts and allcases: i something meets the conditions specified in the rule, then the action (also speci-fied in the rule) is taken. Apartrom leading to over-reporting, another problem can arise. Since money launderers can have a complete knowledgeo an AML regulation set up on a rule-based approach, they may be able to adjust and adapt their money launderingtechniques in order to comply with the codified rules, consequently making illegal operations indistinguishable romlegal ones.

5. Te risk-based approach is not new as both supervisors and supervised institutions have always had to make judge-ments on how to best employ the limited resources at their disposal. Making a big distinc-tion between risk-based andrule-based approaches may be misleading, the existing system in the U.S., or instance, having a mix o both. For that

matter, one may conuse the risk o being sanctioned by regulators or prosecutors with the risk o actual laundering(Carrington & Shams, 2006; inputs rom Peter Reuter and Brigitte Unger at the seminar on Money Laundering, axEvasion and Financial Regulation, ransnational Institute, June 12-13, 2007).



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Te illegal and secretive nature o money laun-

dering makes assessments o the effectiveness

o the AML regime problematic. Te absence

o data, on money laundered and terrorist

financing activities or effectiveness in terms o

prevention or enorcement, severely limits any

assessment o the regime. A cost-benefit analy-

sis is hampered by the lack o evidence o the

benefits o the regime (singou, 2008). Regard-

ing the curbing o drug trafficking, organized

crime or terrorism the results are disappointing.

Despite the regimes original impetus to cripple

the international drug trade, seizures o drug-related assets have been minor in all countries

relative to what is believed to be the scale o

the trade (Reuter & ruman, 2004). Te Report

on Global Illicit Drugs Markets 1998-2007,

commissioned by the European Commission,

ound no evidence that the global drug

problem had been reduced during the period

1998-2007. Given the limitations o the data,

a air judgment is that the problem became

somewhat more severe (Reuter & rautmann,

2009).

In order to improve the effectiveness ofthe AML regime some countries, the US,the Irish Republic and the UK for example,introduced non-conviction-based cons-

cation to facilitate forfeiture of proceedsof crime. Although the approach is activelyadvocated in the international arena, asignicant number of jurisdictions oppose itas incompatible with their legal systems ofdue process and laws requiring convictionsprior to conscation.6Critics consider thatthe collateral damages of the regime, inparticular the issue of civil liberties, outweighthe positive aspects.7

Though the regime also targets terroristnances, modern terrorists need little money

for their operations. Substantial funds nan-cing terrorist acts are derived from lawfulactivities, including charitable donations,which make them difcult to detect. The

nal stage is the nancing of the terrorist actrather than the criminal realising his prots.Terror dollars can only be dened after thecommission of the act for which they havebeen used. Any evasion occurs before aterrorist act; and the money is certainly notintended to resurface in the legal economy(Naylor, 1999). But even if AML controlsare unlikely to cut off terrorist funds theymay yield useful intelligence (Levi & Reuter,2006).

6 . See, or instance, the discussion at the United Nations Commission on Narcotic Drugs on the review o the progressachieved and the difficulties encountered by member states in meeting the goals and targets set out in the Political Dec-laration adopted by the UN General Assembly Special Session on the World Drug Problem in 1998 (UNGASS). In thePlan o Action, member states are asked to consider, where compatible with undamental principles o domestic law,non-conviction-based confiscation (CND, 2008; CND, 2009).

7. In particular the intrusive regulatory apparatus that has turned the domestic, and increasingly the international,financial system into a global espionage apparatus. It puts financial institutions in a position o conflict o interestbetween their responsibilities to clients and shareholders and their duties to the police and national security agencies.Tere is an emerging tendency o civil oreiture, which condones the seizure o assets on increasingly loose criteria,

without the saeguards o the criminal justice system. Te offence o money laundering is unnecessary, according tosome. Existing legal concepts o aiding and abetting or accessory-aer-the-act or even criminal conspiracy could apply

just as well. Alternatively, underlying offences could be rewritten to attribute handling the money to the primary crime.Ordinary fiscal procedures are and have long been the most effective way to handle illicit financial flows: Using tax lawto seize unreported income produces the desired result with ew i any o the undesirable side-effects. Tere is no needin fiscal procedures to suggest that unreported or misreported income is criminal in origin to justiy taking it away itsuffices that it exists. Tus there is no need to tar someone with the brush o criminality without the right to a criminaltrial to determine truth or alsehood (Naylor, 2007).

Effectiveness of the AML regime



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In order to know what the impact o money

laundering is, one needs to have a sense o its

actual volume, but attempts to come up with

reliable estimates have ailed. In 1998, Michel

Camdessus (1999; FAF-OECD, 1999) o theInternational Monetary Fund (IMF) calcu-

lated that the annual aggregate size o money

laundering in the world could be between 2

to 5 percent o the worlds GDP. Using 1996

statistics, these percentages would indicate

that money laundering ranged between US$

590 billion and US$ 1.5 trillion. Te lower

figure is roughly equivalent to the total

economic output o Spain. Te actual basis o

this claim is unclear, and may be little more than

a wild guesstimate. Te FAF ailed to produce

an estimate (Reuter & ruman, 2004),8 and

now concedes that a reliable estimate o money

laundered is absolutely impossible to produce

and thereore does not publish any figures in

this regard (FAF Money Laundering FAQ).

Most studies rely on weak data and flawed

assumptions. Tey consider criminals rationalcost-benefit calculators and presume that

money laundering is a proession unto

itsel. While that may be true in some rare

occasions, evidence rom criminology

indicates that criminals are motivated by a

complex mix o psychological, social, and

economic actors, as well as cultural alien-

ation, criminal liestyles and other actors.

Tey might launder less than is assumedand spend their money on luxury items or

finance new ventures without going through

official bank channels. Tere are many

unanswered questions, such as whether money

rom crime is transerred into production

actors, real estate, high value assets or durable

valuables which can be traded. A significant

proportion o cash assumed to be laundered

may simply be hoarded (Van Duyne, 2003).

What is known is the amount o identified

laundered money in the largest economy inthe world, the United States, where approxi-

mately hal o the worlds laundering occurs

(Schroeder, 2001). According to the 2007

National Money Laundering Strategy, seizures

amounted to US$ 1,256 million in money-

laundering-related assets and US$ 767 million

in oreited assets in 2005 (NMLS 2007).

Combined, that would amount to about 0.02

percent o the 2005 GDP o US$ 11 trillion in

the US. Applying the lower end o Camdessus

range (2 percent), that would mean only 1

percent o all criminal assets is seized. A US

reasury Department official estimated that

99.9 percent o criminal money presented or

deposit in the United States gets into secure

accounts. A German and a Swiss banker reck-

oned it was 99.99 percent in their respective

countries (Baker, 1999; Baker, 2005: 173-74).

Tese estimates are more likely illustrationso rustration with the current process than

precise assessments. Nevertheless, they indicate

that either the estimates o hundreds o billions

o dollars laundered annually are exaggerated

or that the AML regime is doing a poor job.

In his book Capitalisms Achilles Heel, Raymond

Baker estimated that global cross-border flows

o dirty money range between US$ 1.06 tril-lion and US$ 1.6 trillion annually, o which

US$ 539 billion to US$ 829 billion comes rom

developing and transitional economies. He

estimates that two thirds o this flow is driven by

commercial motives (including reducing or

eliminating the payment o taxes through

transer pricing and ake transactions) and


8. Scholar and ormer Inter-American Development Bank and the World Bank official Francisco Toumi said he spent two

days at IMF headquarters to no avail, trying to find someone who could ex-plain the basis o the 2-5 percent o world GDPfigure. Not only is there no real basis, but also since no one can really estimate the denominator, the world GDP, the entire

exercise is questionable (NI, 2003).


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about one third is related to criminal flows.

Drug trafficking alone would amount to 12.5

percent o the illicit money flows.9Te estimate

does not include tax evasion by individuals nor

the more impressive tax avoidance. Te USInland Revenue Service (IRS) estimates that

the annual tax gap in the US is about US$ 345

billion, which was considered a significant

underestimate, without even considering

offshore tax-sheltering schemes (JN, 2007).

Te ax Justice Network (JN) estimated

an annual tax loss o US$ 255 billion due to

individuals use o tax havens. Te estimate is

based on US$ 11.5 trillion o offshore assets

o high-worth individuals, and conservative

assumptions on estimated rates o return and

possible tax paid. Offshore holdings o

corporations are not included in the calcula-

tion (JN, 2005).

In 2007, two retired IRS investigators decided

to put the AML system to the test in the

United States. Over the course o a month

and spending US$ 4,000, they establishedanonymously owned companies in Florida,

New York and Panama, and then wired mon-

ey between the firms bank accounts, using

their real names throughout the process and

obeying all laws. Te transactions would

be almost impossible to trace, the agents

said. Ironically, it was more difficult

to create an account in Panama, a notorious

money-laundering haven, than it was inthe US (USA oday, 2007). Te exercise

confirmed the findings o the IMFs report

on the observance o standards and codes

on money laundering in the US. Te evalua-

tion showed non-compliance on crucial issues

such as the beneficial ownership o companies

in some states and trusts in most states as well

as little attention to due diligence requirements

regarding casinos (IMF, 2006).10

According to IMF and World Bank officials,

there is no clear ormula to assess whether theAML/CF system has been effective in achiev-

ing its objectives: In the absence o a reliable

measure o how much money is being laundered

or how much terrorist unds are circulating,

the question o effectiveness becomes even

more elusive when it is couched in terms o

curbing money laundering and terrorist

financing. It is thereore impracticable to try to

measure the success o an AML/CF measure

by attempting to establish the extent to which

this measure has contributed to reducing the

amount o money being laundered or terrorist

unds being unnelled (Carrington & Shams,

2006).

One o the ew attempts to set out a ramework

within which to measure the effectiveness o

the AML regime, by Levi and Reuter, concluded

that, except at an anecdotal level, the effects onlaundering methods and prices, or on offenders

willingness to engage in various crimes, are un-

known. I any indication exists in the available,

data, it is that the AML regime has not had

major effects in suppressing crimes. Te regime

does acilitate investigation and prosecution o

some criminals who would otherwise evade

justice, but ewer than expected by advocates o

ollow the money methods. It also acilitatesthe recovery o unds rom core criminals and

rom financial intermediaries. However, the

volume is minor compared to the income or

even profits rom crime (Levi & Reuter, 2006).

In the Netherlands the Court o Audit in-

vestigated the AML/CF policy and concluded


9. Baker (2005: 172) estimates the annual money flow rom drug trafficking to be US$ 120-200 billion. Peter Reuter makes

the rough calculation o about US$ 150 billion in consumer expenditures on illicit drugs. In that case the trade flow wouldbe down to just US$ 20-25 billion since most o the street value is not being laundered (NI, 2003).

10. Publication o the ROSCs requires agreement o the country concerned.


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domestic AML regime.12Te financial services

industry in the City o London and the tax

havens and OFCs in its overseas territories

and crown dependencies were not keen on

including tax regulation.

Te AML regime emerged to roll back

deregulation in the non-tax sphere, combating

the dark side o globalisation, such as trans-

national organized criminals and eventually

corrupt officials and politicians. Nonetheless,

only in 2001 did France and the UK agree

to criminalize transnational bribery used

to sweeten overseas contract bids, and the

ormers political slush unds that were used

or domestic clientilist purposes (Levi, 2005).

Consistent with the FAFs mandate, the Forty

Recommendations did not and do not include

tax evasion on the list o predicate offences or

money laundering. Hence financial services

and proessional staff are not obliged to report

suspicions to the authorities. Both in Switzer-

land and the US, or example, oreign tax

evasion is not a crime. Te French governmenthad a strong interest in money-laundering

regulation, driven by its disapproval o

financial deregulation and concern about tax

evasion in offshore finance centres, in

particular those connected to the UK. Frances

domestic legislation listing tax evasion as a

money-laundering offence is undercut because

the offence is not reportable by financial

institutions (Levi & Reuter, 2006).

Te international tax system differs undamen-

tally rom the AML regime. While the AML

regime has the 1988 UN Vienna Convention

as a basis or international regulation, tax

regulation was never internationalised by way

o a multilateral agreement, but rather estab-

lished between states in an ever-increasing

number o bilateral Double axation Agree-

ments (DAs) or what many observers

consider double non-taxation treaties. DAs

were designed as a mechanism to ensure that

companies would not see their oreign-sourceincome taxed twice. While commendable in

some respects, the bilateral system o DAs is

raught with dilemmas or national authori-

ties and rich in opportunities or transnational

corporations and citizens, in particular high

wealth individuals (HWIs) with access to

the technical expertise o the private banking

sector.

ax havens and OFCs profit rom the bilateral

system. Trough an ever-increasing number o

DAs, transnational corporations and HWIs

take advantage o diversity in types, rates, and

definitions o tax. Due to poor design and

enorcement o the double tax treaties taxes are

oen paid in neither state. Aiming to reduce

the attractiveness o OFCs, OECD countries

responded by introducing ever more complex

legislation, such as Controlled Foreign Corpo-ration (CFC) rules, which attempt to bring into

their tax net the passive income channelled

into subsidiaries in tax havens. However, that

has simply exacerbated the problem by creating

new opportunities or transnational corpo-

rations and HWIs to engage in arbitrage and

reduce their tax liabilities. In particular, OECD

countries have been reluctant to characterise as

passive the income rom financial transactionsand investments. Tis explains, or example,

why 40 percent o hedge unds are organised

through entities ormed in the Cayman Islands.

A narrow view o sovereignty is central to why

taxation has so ar been le out o the inter-

national arena, the resultant separate national

taxation systems costing states dearly. Most

nations would gain rom stronger international

Tax evasion

12. Lessons or ax Regimes rom the War on Money Laundering, input rom Mike Levi at the seminar on Money Launder-

ing, ax Evasion and Financial Regulation, ransnational Institute (NI), June 12-13, 2007.


14/40


tax cooperation, but establishing a common

policy to address tax issues at an international

level appears to be more difficult than

instituting a common policy against money

laundering. Also, in the field o taxation thelines between legitimate, illegitimate, and

clearly illicit or criminal activities are oen

blurred, and highly paid advisers are eager

and ready to exploit any ambiguities. Picciotto

(2007) remarks that the ailure to achieve

any substantial progress regarding taxation

is a clear example o the deficiencies o inter-

national political governance. Cooperation in

this field would greatly strengthen national

states.

Excluding tax evasion rom the AML regime

was an important watershed. Non-payment o

tax is not as culturally resonant as crime and

even less so than terrorism, which are obviously

easier to oppose. Te difference is the per-

petrator as opposed to the crime or social

harm. One thinks o the violent criminal,

corrupt politician or official, or evil raudsterharming society as opposed to the otherwise

law-abiding citizen or company wanting to

shield their hard-earned money unlawully but

understandably rom the tax collector.

Criminals, o course, injure individuals and

society while earning their money via murder,

misery and mayhem. However, the damage

done to society through revenue uncollected

and unavailable to finance essential servicessuch as health care, education, or maintain-

ing an adequate criminal justice system, may

be even greater, due to its volume, than the

damage rom traditional crime.

However, including tax evasion as a predicate

offence might create serious implementation

problems or the AML regime. Criminals are

ew in number compared to tax evaders, thelatter perceived as occupying a less threat-

ening social niche. Te potential number o

Suspicious Activity Reports (SARs) generated

i tax evasion were a predicate crime would

be immense, urther burdening the existing

oversupply o reporting. Sharing inormation

between tax authorities that receive voluntarydisclosures and criminal enorcement agencies

gathering evidence to prosecute or a criminal

offence is a sensitive matter. Tese are two

different inormation flows, and although

inormation rom law enorcement to the tax

authorities is not problematic, the reverse

is, due to, or example, restrictions relating

to sel-incrimination in certain jurisdictions

(Carrington & Shams, 2006). Another difficulty

is the subjective way in which SARs are com-

piled. Te reports are filed on unusual persons

or unusual situations, not the people or corpo-

rations involved in tax planning to minimise

their taxes. And what effect would it have on

the relation between law enorcement authori-

ties and the financial institutions delegated the

task o identiying suspicious behaviour and

filing the SARs? Corporate and private banks

are paid to advise on tax planning to mini-mise tax liabilities. Te conflict o interest is

evident.

I tax evasion is to become a predicate offence

some serious reorm o the AML regime is

obligatory. Just adding another stack o SARs

to the already mountainous pile is not the

solution, rule- or risk-based approach not-

withstanding. I tax authorities were allowedautomatic access to SARs,they could correlate

them with other inormation in tax returns.

otal transparency in the orm o comprehensive

access to inormation rom banks and cor-

porate service providers, combined with

automatic inormation exchange would permit

the tax authorities to judge i a company is abus-

ing the tax system or not, rather than relying on

SARs filed by bank clerks conscripted to aidthe criminal justice system. However, institut-

ing a like reorm raises concerns about privacy,



15/40


inringements o civil liberties, and a general

sense o intrusiveness that need to be addressed.

Te current AML regime is remarkable or the

range o institutions involved and the centrality

o international agreements. Te World Bank/

IMF lists seven distinct international bodies

including itsel that either set rules or have

ormal monitoring responsibilities, mostly

either or specific industries (such as insurance)

or or parts o the process (like FIUs receiving

reports rom regulated institutions).13 Te re-

sult is a plethora o regulations and, because

money laundering is common to all highly

profitable crimes, AML has come to be written

into the effectiveness o all regulatory efforts.

I not in countering money laundering, the

regime has been successul in transerring

control policies, imposing them upon otheractors. Every international body with

finance and/or crime within its mandate

has taken on AML because politically and

bureaucratically, it cannot afford to neglect

this source o unds, influence and

prestige by ailing to be a player (Levi, 2005).

Mutual evaluation has become the core tool o

used by an international so law peer group

methodology. Te primary concern seems tobe output rather than outcome. Te goal o

affecting the organisation and levels o serious

crimes has been displaced by the more readily

observable goal o enhancing and standardis-

ing rules and systems, while critical evalua-

tion o what countries actually achieve with

their costly suspicious transaction report data

remains to be developed. Global rule mak-

ing on money laundering issues has becomesomething o a growth industry, according

to an AML consultant. A large number o

nongovernmental, multilateral, intergovern-

mental, and supranational organisations

are involved. Teir analyses, reports, and

recommendations reveal a disturbing tendency

to quote each others work; since they enjoy

substantially the same membership, this

practice amounts to sel-corroboration. More-

over, at times they offer overlapping sets o

rules and best practices to deal with money

laundering. It is ironic that the international

community would ail to produce a single,

unified set o rules to take on a criminal

activity that thrives precisely on exploiting

differences in laws and regulations (Morris-

Cotterill, 2001).

While the global AML regime developed,efforts to construct an equivalent regime to

tackle capital flight, tax evasion and avoidance,

and harmul tax competition became more

prominent. Once again the G7 was driven by

political concerns in setting new initiatives

against tax havens and OFCs. At the Lyon

summit in 1996 it concluded that globalisation

is creating new challenges in the field o tax

policy. ax schemes aimed at attractingfinancial and other geographically mobile

activities can create harmul tax competi-

tion between states, carrying risks o distort-

ing trade and investment, and could lead to

International efforts to regulate the grey financial system

International efforts to regulatethe grey financial system

13. Te bodies are the FAF, Egmont Group o FIUs, International Organization o Security Commis-sioners, United

Nations Office o Drugs and Crime (UNODC), Basel Committee on Banking Supervi-sion and the International Association

o Insurance Supervisors. Tese are merely the top layer o stan-dard-setting bodies, with a myriad o subsidiary public- and

private-sector bodies beneath, including the FAF-style regional bodies (FSRBs), such as the Asia/Pacific Group, Carib-

bean Financial Action ask Force, ESAAMLG (Eastern and Southern Arica), EAG (Eurasia), GAFISUD (Latin America),

MENAFAF (Middle East and North Arica), Moneyval (Europe) and the Offshore Group o Banking Supervisors is also

part o this network. In the private sector there are national industrial and proes-sional bodies (such as bankers associations,

notaries and so on), plus the Wolsberg Group o interna-tional banks (Levi & Reuter, 2006).


16/40


to eliminate both. Te publication sent shock

waves through the international tax avoidance

industry and the community o small island

tax havens (OECD, 1998; Christensen, 2007).

Scrutiny intensified when the Financial

Stability Forum (FSF) identified the huge

volume o private assets held offshore as a

potential source o global financial instability.

Te usual suspects money launderers and tax

evaders were reerred to, but the use o tax

havens and OFCs in circumventing onshore

prudential regulatory requirements was also

underscored. (See box Secrecy jurisdictions)

Te reports stimulated debate regarding the

adverse macroeconomic impacts that money

laundering, tax evasion and avoidance, as well

as harmul and tax competition create. Tey

also emphasised how abusive tax practices

distort global markets and undermine

development. On the basis o these reports,

the G7 finance ministers issued a plan o

action in 2000, entitled Actions against Abuseo the Global Financial System (G7, 2000).

Te report examined the connections between

money laundering and corruption; tax havens

and harmul tax practices; offshore financial

centres and their threat to the stability o the

international financial system by the elusion

o international standards regarding financial

supervision and cooperation; and the distortion

erosion o national tax bases. Te G7 urged

the OECD to vigorously pursue its work in

this field, aimed at establishing a multilateral

approach under which countries could

operate individually and collectively to limit theextent o these practices (G7, 1996). Tis posi-

tion provided political backing or the OECDs

Harmul ax Practices project, and a parallel

effort launched by the European Union, both

launched in 1998 (Picciotto, 2007).

Over the next two or three years key policy

circles appeared to concur that tackling the

use o the financial system or concealment

o dirty money required a concerted effort,

including measures to prevent acilitating

money laundering, tax avoidance and evasion,

as well limiting the disruptive role o offshore-

held capital. At the UN General Assembly

Special Session on drugs in 1998 the UN

published the report Financial Havens, Banking

Secrecy and Money Laundering, identiying

tax havens as an important conduit or money

laundering (Blum et al, 1998). Te sameyear the OECD tried to tackle harmul tax

competition, in particular as practiced by a

group o about three-dozen tax haven states. Te

OECDs report Harmul ax Competition: An

Emerging Global Issue identified two obstacles

to taxing geographically mobile activities: tax

havens and harmul preerential tax regimes.

Te report proposed implementing activities

Secrecy jurisdictions

Global governance over money flows hasbeen seriously compromised by the creationof tax havens and offshore financial cen-tres (OFCs), better described as secrecyjuris-dictions. They offer not only free-dom from tax, but also a shield against anynumber of rules, laws and regulations of otherjurisdictions. What these places have in

common is legal and financial secrecy.These entail a kind of privatisation of

sovereignty, in which a legal refuge offeringprivileges for certain types of privateparties and businesses is created, oftendesigned by lawyers acting as inter-mediaries between governments and privateinterests. The beneficiaries are providedwith a legal refuge or protection from thelaws of other states, without needing to

physically relocate as they can use the legalfictions of newly created corporations



17/40


18/40


2000, the FAF identified 15 non-cooper-

ative countries and territories on a list o 29

suspect jurisdictions (FAF, 2000). Te guilty

included the Cayman Islands, Bahamas,

Liechtenstein, Panama, Israel and Russia,

but not the British Virgin Islands, Gibraltar,

Guernsey, the Isle o Man and Jersey. Te FAF

warned that i those countries or territoriesidentified as non-cooperative maintained

their detrimental rules and practices, FAF

members would then need to consider the adop-

tion o countermeasures. Countermeasures

ranged rom issuing advisories to domestic

financial institutions to the most serious

o economic behaviour and erosion o national

tax bases. In conclusion, the G7 called upon

international financial institutions to take

action.

At the initial instigation o the U.S., but sup-

ported by the G7 aer the peaceul resolution

o some internal threats to blacklist each otheror non-compliance, the FAF overturned the

commitment to mutual evaluation and engaged

in a naming and shaming campaign, identi-

ying countries guilty o non-cooperation in

the so-called Non-Cooperative Countries or

erritories (NCC) initiative.15 In February

of the national treasuries and fairness tofellow taxpayers do not, legally speaking,concern tax planning. Countries like theNetherlands, Denmark, Sweden and Ireland

have all introduced special schemes to attractinvestment capital from internationalcompanies. Yet those countries are notgenerally considered to be tax havens. TheDutch, for instance, facilitate so-called con-duit structures which allow internationallyoperating companies to channel their finan-cial flows through the Netherlands in orderto reduce tax charges elsewhere (SOMO,2008).

The Dutch offer companies who would nototherwise seek residence in the Netherlandsthe means to reduce their tax charges oninterest, royalties, dividend and capital gains

income from foreign subsidiaries. AlthoughTax Justice Netherlands does not considerthe Netherlands a tax haven as such, it isof the opinion that its extensive network

of double taxation treaties and other taxregulation is regularly abused to avoid taxesin other countries. In May 2009, the UnitesStates issued a press release pointing at taxavoidance caused by fiscal constructionsabroad and lumped the Netherlands in witha group of low-tax countries some U.S.corporations use to avoid taxes in theUnited States. The Dutch Centre for Researchon Multinational Corporations (SOMO)estimates that at least 20,000 mailbox

companies use the Netherlands much likeJersey and probably with more moneyinvolved (SOMO, 2008; Tax Research,2009a).14

14 . Te White House press briefing announcing measures against tax avoidance and tax havens, pub-lished on 4 May2009, originally contained the ollowing sentence: Nearly one-third o all oreign profits reported by U.S. corporationsin 2003 came rom just three small, low-tax countries: Bermuda, the Netherlands, and Ireland. Te sentence was includ-ed as a bullet point in the introduction. Te next day, aer efforts by the Dutch Embassy in Washington, this sentencewas removed and explained as a misunderstanding (ax Research, 2009b). Te Dutch ministry o Finance underlinesthe active role o the Netherlands to promote transparency and inormation exchange, but does not seem to be willingto critically review the possibilities to abuse the Dutch tax treaties at the expense o other countries.

15 . Initially when the blacklist was being drawn up, the UK insisted that Switzerland be included be-cause o its financial

secrecy provisions. Te Swiss delegation replied that i Switzerland was on the list, they would retaliate by making sure the

UK was blacklisted as well. Subsequently both parties came to a quiet compromise whereby each agreed that the other would

be le off the list. Later, Ger-many criticised the United States or lack o due diligence and know your customer procedures

re-garding Delaware limited liability corporations, which could be established in 24 hours by ax. Te German delegations

remarks were summarily rejected. (Sharman, 2004).



19/40


approach. Tey lack the judgemental or assertive

declarative aspect that is the key eature o

blacklisting (Sharman, 2004). Auditing by the

IMF may be considerably less effective than the

blacklisting, which successully took advan-tage o the sensitivity o OFCs to reputational

damage.

Te NCC process has been criticised or

being arbitrary and lacking a consistent meth-

odology. Many have observed that the AML

regime reinorced the political character o FAF

and highlighted the influence o G7 countries.17

Te willingness (or capacity) o the FAF to

apply its consistent principles to the more

powerul nations has been questioned. Critics

argue the tighter control o off-shores is aimed

at generating a competitive advantage or FAF

members (Levi, 2005).18 Te United States

and Canada, or instance, have consistently

ailed to meet some o the crucial FAF Forty

Recommendations, yet there was never any like-

lihood that they would appear on the NCC list

(Sharman, 2004). In act, Delawares standardsare worse than those o some jurisdictions

on the list. Including the IMF in the regime

addressed some o the membership short-

comings o the FAF and renewed doubt

regarding the ability o financial assess-

ments to efficiently and legitimately deal with

standards closely linked to criminal justice

(singou, 2005). With the removal o Burma in

October 2006, there were no more countrieson the NCC list.

possible sanction: those members and non-

members alike who ailed to sufficiently satisy

AML criteria would be listed and punished by

enhanced due diligence (slowing down) or

conditioning, restricting, targeting, or evenprohibiting financial transactions with non-

cooperative jurisdictions (FAF, 2000; Econo-

mist, 2007).

Te NCC initiative served as a potent coercive

tool that shied many o the most recalcitrant

jurisdictions into legislative and institutional

reorm on money laundering at least on paper.

Following the 9/11 attacks, the G7 pressured

the IMF and World Bank in 2002 to become

involved in the AML regime in an effort to

raise its profile. As a consequence the NCC

initiative withered away. Te IMF insisted that

the FAF blacklisting be discontinued because

the practice was seen as inappropriate and

likely to be discredited as arbitrary and

discriminatory (Sharman, 2004; Drezner, 2005;

Levi, 2005).16 IMF endorsement o the FAF

recommendations was based on an agree-ment to wind down the NCC list, instituting

consensus, cooperation and a air and trans-

parent methodology in its place. Te inclusion

o AML/CF monitoring as part o the Reports

on the Observance o Standards and Codes

(ROSC) process seems to have had mixed e-

ects on the work that the FAF was already

conducting. Te IMF audits o offshore juris-

dictions are very different in conduct and tonewith a much more inclusive and consensual

16. In a November 2002 agreement with the IMF, the FAF agreed to discontinue its NCC list, al-though jurisdictions

which at that point were still on the list remained until they had enacted specified reorms (Sharman, 2004; BBC, 2002).

Monitoring o AML/CF standards was added to the ROSCs, which are a key component o the IMFs Financial Sector As-

sessment Program (FSAP), in November 2002.

17. Francisco Toumi notes that rom a Latin American perspective the AML regime is largely seen as a unilateralist ap-

proach to regulating financial markets, which didnt take into account the concerns o some o the key countries in Latin

America affected by money laundering when it was designed.

18. At the core o the regime, FAF promotes global standards but is essentially a political organisation in its membershipand practices; while its scope is global, its website states that to qualiy or member-ship a country has to be strategically

important (singou, 2005).



20/40


OECD proposals into relatively toothless

voluntary code o conduct.

Since its inception, the OECD has had a lead

role in dealing with international tax issues.However, its agenda has largely reflected the

interests o member states. Rising concern

about the role o tax havens, the majority o

which are directly or indirectly connected to

OECD member states, has demonstrated a

need or a more broadly based multilateral

orum, including developing counties. Te

OECDs Global Forum on axation does not

provide a genuinely multilateral ramework or

dialogue between equals. Participation is by

invitation only, the agenda is offset by OECD

countries, and decision-taking is generally

reserved to them in closed meetings.

A report commissioned by the International

rade and Investment Organisation, a group-

ing o small countries with international

finance centres, showed yet another weakness:

OECD member countries do not operate to ahigher standard than so-called offshore centres

and in important cases they operate to a lower

standard. Many US states, including Delaware

and Nevada, require no beneficial ownership

inormation rom companies. Te US, UK,

Canada, France, Germany, Italy, Switzerland,

Austria, Luxembourg and Costa Rica still

permit bearer share companies, hence

accepting reduced transparency. Major playersin international finance like Hong Kong and

Singapore restrict exchange o tax inormation

to domestic interests, Switzerland limiting it

to cases o tax raud and the like (Stoll-Davey,

2007).

Many OECD countries indeed have skeletons in

their own closets. Recent research by Sharman

(2009; Sharman, upcoming) shows that theUS, the UK and other OECD states collect

significantly less inormation on the beneficial

Te OECD blacklisting initiative against harm-

ul tax practices withered away as well. Strong

resistance came rom the tax haven com-

munity, banks in OECD and non-OECD

countries, and rom low-tax-lobbying organi-sations. A major weakness was that the OECD

proposals were restricted in geographical

scope to tax evasion by corporate and

individual residents o OECD countries. Te

OECD also restricted its list o tax havens

to 38 jurisdictions, mostly small island tax

havens, excluding major tax haven jurisdic-

tions like Luxembourg, Switzerland, the United

Kingdom and the United States. Te targeted

tax havens protested vigorously against this

discrimination, and their requent demands

or a more level playing field stalled the

process (Christensen, 2007; Rawlings, 2007).

Rather than instituting automatic exchange o

inormation, the OECD proposals opted or

inormation exchange on request through the

bilateral ax Inormation Exchange Agree-

ments (IEAs), which is ar weaker, moreexpensive and cumbersome consequently less

likely to deter tax evasion. Tese agreements

are extraordinarily difficult to negotiate. Te

onus remains on the requesting nation to prove

that the inormation sought is oreseeably

relevant to suspected crime or tax evasion,

which means applicant countries need to

provide evidence to support their requests.

Tis prevision is to thwart any fishingtrips or inormation. Furthermore, havens

and jurisdictions supporting secrecy are

not required to provide inormation they

do not normally collect. By 2005 the OECDs

process was effectively stalled. At the November

2005 meeting o the OECD Global Forum

on axation the organisation abandoned

the time periods it had imposed on tax

havens to comply with transparencyand inormation exchange requirements. Tis

major retreat effectively transormed the



21/40


I the blacklisting had been more effective than

the subsequent IMF approach, it was, at best,

flawed. Gregory Rawlings (2007) ound that

the blacklisting process might even have had

a reverse effect. Although a number o statesabolished their offshore acilities, reduced the

number o offshore financial products, or expe-

rienced such a loss o business that the acilities

continued viability is doubtul, other key OFCs

have seen business increase. Trough com-

plying with the OECD initiatives, OFC states

(or example, the Cayman Islands, Bermuda,

Jersey, Guernsey, and the Isle o Man, as well as

unlisted centres o international private bank-

ing like Singapore) have re-established their

reputation and political soundness in the eyes

o investors, and are now considered juris-

dictions with good governance, meeting the

highest international standards. By ulfilling

recommendations while tactully treading over

their intent, these OFCs have preserved their

fiscal sovereignty, enjoying a restored reputa-

tion and enhanced viability. Tey continue to

be ideal locales or structuring transnationalbusiness ventures or tax evasion and avoid-

ance.

Apparently the multilateral initiatives or

responsive regulation have brought about the

reverse o what was originally intended. Byallowing OFCs to demonstrate their good

governance they maintain their client base,

hence sustaining an ongoing fiscal competition

between states or tax revenues. Compliance

with the OECD, EU and IMF, has enhanced

offshore sovereignty and maintained its

continued appeal to international finance.

Te ailure to establish strong enorcement

capacities, meant that the multilateral approachwas vulnerable to bilateralism rom the outset

(Rawlings, 2007).

owners o anonymous shell companies than do

offshore financial centres. Identiying who is

really behind corporate vehicles and their bank

accounts is the key element in most important

global governance initiatives to fight moneylaundering, tax evasion, grand corruption and

corporate maleasance, and the financing o

terrorism. Requests were made to 45 different

corporate service providers in 22 different

countries to create anonymous corporate

vehicles and to set up bank accounts linked

to these shell companies. Seventeen o the 45

attempts to solicit anonymous corporate

vehicles met with success, and all but our o

the service providers were in OECD countries

(seven in the UK, our in the US, one in Spain,

and one in Canada). Only our service providers

(in Hong Kong, Singapore, Belize and Uruguay)

out o 28 in jurisdictions oen identified as

tax havens were willing to meet the request.

Corporate service providers in Bermuda,

the Bahamas, British Virgin Islands, Cayman

Islands, Liechtenstein, Seychelles and Panama

were meticulous in their customer duediligence.

Obtaining bank accounts proved to be more

difficult, as banks were rarely willing to open

a corporate account without the know your

customer documentation. Although the level

o international compliance was higher, the

same patterns applied as that regarding the

corporate service providers: on average, theUS and UK have a worse record o compliance

than offshore financial centres. In 2009, Shar-

man was able to create a Nevada company and

subsequently open an account at one o Amer-

icas most prominent banks producing only a

scanned copy o a drivers licence. In contrast,

when the author bought a Seychellois Interna-

tional Business Company with a Cypriot bank

account he had to provide notarised passportcopies, utility bills, bank reerences and com-

plete a long questionnaire (Sharman, 2009).


Credit crunch


22/40


sheet entities, and other non-bank financial

institutions such as insurance companies,

hedge unds, and private equity unds. Tanks

to credit derivatives, these new players can

replicate the maturity transormation role obanks, while escaping normal bank regula-

tion. At its peak, the shadow banking system in

the United States held assets o more than $16

trillion, about $4 trillion more than regulated

deposit-taking banks (UNCAD, 2009).

Te emergence o the shadow banking system

essentially went unnoticed, or unopposed, by

the regulators responsible or the integrity o

the financial system (Hannoun, 2008). Tis

lack o probity is all the more blatant in light

o the warnings in 2000 rom the FSF that

prudential regulatory requirements could be

thwarted, and effective supervision rustrated

by OFCs (FSF, 2000a). Te collapse o that

shadow banking system jump-started the cur-

rent crisis, instigated by an overabundance o

financial innovation and a lack o financial

regulation within the core economies o theOECD (Dieter et. al., 2009).19

Attention returned to the tax havens and OFCs,

which played a major role in the credit crunch

and the current financial crisis. Tey were not

the only cause o the crisis, but they were a

major contributing actor. According to

Daniel Lebgue, ormer vice-chairman o BNP

and present chairman o ransparency Inter-national France: I the international commu-

nity wants to regain control o the financial

system, increase monitoring o players and

promote international cooperation, then it must


An oen repeated justification to support the

AML regime is that it claims to counter the

dark side o neo-liberal globalisation and pro-

tect the integrity o the financial system against

the corruptive impact o crime money andlaundering (Van Duyne, 2003b). However, the

2007-2008 credit crisis revealed that the global

financial system wasnt jeopardised by a sinister

league o criminals but by law-abiding cohorts

o bankers and financial wizards. A remark-

able shi in vocabulary has taken place. A term

like shadow banking system is not associated

with the murky criminal underworld but with

the world o legitimate banks and the financial

services industry and their off-balance-sheet

special purpose vehicles. Tese vehicles are

not overpriced exotic cars bought with exces-

sive bonuses, but financial products very ew

people understand, and appreciate even less so

regarding their impact on the stability o the

financial system.

Since capital is costly, bank managers try to

circumvent regulation by either hiding risk orby moving some leverage outside the bank,

according to the Commission o Experts o

the President o the United Nations General

Assembly on Reorms o the International

Monetary and Financial System, better known

as the Stiglitz Commission. Te decrease in

the leverage ratio o commercial banks was

accompanied by an increase in the leverage

ratios o non-bank financial institutions.Tis shi o leverage created a shadow bank-

ing system, that is, a parallel network or

channelling investment and credit consisting

o over-the-counter derivatives, off-balance-

19. In his book Te Return o Depression Economics and the Crisis o 2008, Nobel laureate in econom-ics Paul Krugman

describes the run on the shadow banking system as the core o what happened to cause the crisis. As the shadow bank-

ing system expanded to rival or even surpass conventional bank-ing in importance, politicians and government officials

should have realized that they were re-creating the kind o financial vulnerability that made the Great Depression possible

and they should have re-sponded by extending regulations and the financial saety net to cover these new institutions.

Influen-tial figures should have proclaimed a simple rule: anything that does what a bank does, anything that has to berescued in crises the way banks are, should be regulated like a bank. He reerred to this lack o controls as malign neglect

(Krugman, 2009: 163).


23/40


jurisdictions by February 2010. Te Financial

Stability Board (successor to the FSF, including

G20 members not previously members o FSF)

was asked to report on progress in address-

ing non-cooperative jurisdictions with regardto international cooperation and inormation

exchange in November 2009 and to initiate a

peer review process by February 2010 (G20,

2009c).

In the Progress report on the actions to

promote financial regulatory reorm, issued

by the US chair o the Pittsburgh G20 sum-

mit, new initiatives to strengthen the AML

regime were outlined. Te FAFs Inter-

national Cooperation Review Group (ICRG)

agreed on new procedures to identiy high

risk and uncooperative jurisdictions. An in-

depth review is being undertaken, engaging

with jurisdictions o interest, and the ICRG

will report back to the FAF plenary with

recommendations in February 2010. Te FAF

will consider the progress o every publicly

identified jurisdiction on an ongoing basis andwill stand ready to use countermeasures where

necessary. Te FAF is reviewing elements

o the Recommendations, such as customer

due diligence (know your customer rules),

law enorcement, beneficial ownership o

assets, international cooperation, and whether

tax crimes should be considered as a predicate

offence or money laundering (G20, 2009d).

A new drive to regulate and monitor unregu-

lated and illicit money flows has been initi-

ated. When the domestic tax payer had to

cover the losses o large financial institutions

tax evasion and tax avoidance activities o the

financial industry and the rich became less ac-

ceptable than ever. Te global financial crisis

provided an opportunity or the first time in

years to curb tax evasion worldwide. Underpressure rom the EU, European tax havens

such as Switzerland, Liechtenstein, Andorra,

address this black hole o finance that has

built up underground, in the offshore finan-

cial centres. Tese places condone or acilitate

money-laundering operations rom criminal

activities. But they also acilitate or contributeto the diversion o huge sums produced by

other capital investments. Tey also deprive

states o resources. Moreover, as the current

crisis develops, these centres and the actors

they host constitute a major systemic risk or

all global finance (JN, 2008).

At the summit in London in April 2009 the

G20, having replaced the G7/8, recognised

the threat o unregulated and illicit money

flows. It is essential to protect public finances

and international standards against the risks

posed by non-cooperative jurisdictions. We

call on all jurisdictions to adhere to the inter-

national standards in the prudential, tax, and

AML/CF areas. o this end, we call on the

appropriate bodies to conduct and strengthen

objective peer reviews, based on existing

processes, including through the FSAP pro-cess (G20, 2009b). Te FAF was advised to

revise and reinvigorate the review process or

assessing compliance by jurisdictions with

AML/CF standards, using agreed evaluation

reports where available. Te G20 leaders

pledged to take firm action against the so-called

non-cooperative jurisdictions, including tax

havens. We stand ready to deploy sanctions

to protect our public finances and financialsystems. Te era o banking secrecy is over

(G20, 2009a).

In September in Pittsburgh, the G20 leaders

re-committed themselves to maintain the

momentum in dealing with tax havens, money

laundering, proceeds o corruption, terror-

ist financing, and prudential standards. Tey

promised to employ countermeasures againsttax havens rom March 2010 and called upon

the FAF to issue a public list o high-risk

Credit crunch


24/40


that they intended to abide by international

agreements in the uture. Whether this will

actually happen remains to be seen (Spiegel,

2009b).

G20 countries lack moral legitimacy when

demanding that smaller tax havens and OFCs

comply. According to participants in the

preparatory meetings leading up to the April

London summit, the Chinese categorically

reused to allow its two Special Administrative

Regions, Hong Kong and Macau to be placed

on the grey list, even though they are con-

sidered sae havens or tax evaders and merit

being placed on the black list. Te Chinese

threatened to let the entire list project ail.

Critics argue that the OECD and the G20 are

the wrong organisations to handle the issue

(Spiegel, 2009b).

Sharman (2009) suggests that the G20 coun-

tries, particularly the US and the UK, are much

more guilty o financial opacity than are the

exotic tax havens. Te G20 and OECD havefixated on the problem o the willingness

to exchange financial inormation between

countries. Tis ignores the prior issue that

unless countries enorce the obligation to

collect inormation on those entering the

financial system, there will simply be no

inormation to exchange. It is hardly credible

to say that major OECD centres lack the means

to enorce the know your customer standardsthey have designed, committed to and imposed

on others. Instead, it seems that these countries

have simply chosen not to comply with impor-

tant international benchmarks, or, in what

amounts to the same thing, have not sum-

moned the political will to ace down domestic

constituencies resisting tighter financial

regulation. It is thus indicative that these

governments o many onshore financialcentres have ailed to regulate corporate

service providers.

Austria and Luxembourg agreed to allow more

cross-border cooperation. Tey were orced to

conorm to current international standards

or tax inormation exchange in the OECD

Model ax Convention although this alls shortin some respects o those in the OECDs ax

Inormation Exchange Agreements (IEAs).

Critics remain sceptical. Te inormation

is only provided on request. Foreign tax

authorities are required to supply prima acie

evidence or their suspicions. Fears that oreign

authorities would make blanket requests or

inormation did not materialise (Financial

imes, 2009). In that the tax havens agreed

to cooperate only on a case-by-case basis any

vigorous onslaught was discouraged. Inor-

mation sharing would not be automatic as is

required by the European Savings ax Direc-

tive (Spiegel, 2009a).

Offshore centres reluctant to co-operate with

oreign tax authorities aced the threat o

being blacklisted at the April 2009 G20

summit in London. Sanctions ranging romhigher withholding taxes to restricting banking

transactions could be applied. However, within

five days aer the close o the London summit,

the OECD published the shortest blacklist o

all time, with exactly zero entries. Miraculous-

ly, all tax havens disappeared overnight, and

tax evasion had become a problem o the past.

Te non-list was primarily the result o skilul

diplomacy. o get off the OECD list, ajurisdiction needs twelve active tax-inor-

mation-exchange treaties. Autonomous

provinces like the Faroe Islands (population

48,000) suddenly ound themselves in great

demand to sign treaties with countries they

had never had any commerce with. Even

the most notorious OFCs managed to purge

themselves o all suspicions o aiding and

abetting tax evaders. All they had to do inorder to be removed rom the list was to

provide the OECD with the solemn assurance



25/40


that inormation with oreign authorities

(FSF, 2000: 18).

In 2009, the Stiglitz Commission, ormed in

2008 to advise the United Nations on the con-sequences o the financial meltdown and its

impact on development, did not see any im-

provements. While particular attention has

ocused on offshore financial centres in devel-

oping countries, so ar the principal sources

o tax evasion, tax secrecy, money laundering,

and regulatory arbitrage have been through

on-shore tax havens in developed countries

financial centres. Delaware and Nevada, or

instance, are two U.S. states that make the es-

tablishment o anonymous accounts ar easier

than almost all international banking centres.

Bank customer secrecy remains an issue in

several developed country financial centres.

Londons light touch regulatory regime has also

been a source o much regulatory arbitrage.

Te biggest money laundering cases involved

banks in London, New York, and Zurich. Te

European Commission has decided to reerour smaller member states to the European

Court o Justice over non-implementation o

the 2005 anti-money laundering directive, and

two large member states have been given a final

warning (UN, 2009b: 82-84). 20

Te new initiatives o the G20 to tackle non-

cooperative jurisdictions are remarkably simi-

lar to previous attempts to stamp out money

laundering and other illicit and unregulated

Secrecy regarding the beneficial ownership

o corporations is a much more serious ob-

stacle to countering money laundering than

bank customer secrecy, according to a report

prepared or the UN, as ar back as 1998 (Blumet al, 1998). In 2000 a study by ranscrime

(2000: 15-16) also concluded that establish-

ing the beneficial ownership o companies is

the most essential actor in the transparency

o a financial system. Failure to disclose ben-

eficial ownership results in a domino effect:

maximizing anonymity in financial transactions

migrates to other sectors o the law, thwart-

ing criminal investigation and prosecution.

Removing bank customer secrecy doesnt solve

any problem i the companies operating the

bank accounts remain anonymous. Contrary

to the premise that the problem was offshore,

the study ound that on average EU members

did worse than offshore centres regarding the

transparency o company law, and thus needed

to clean up their act beore lecturing others.

Similarly, the FSF identified access to timelyinormation regarding beneficial owner-

ship o corporate vehicles as crucial. While

there are international standards concerning

the disclosure o inormation about corpo-

rate vehicles (the FAF Recommendations

require financial institutions to know the

identity o corporate customers, beore open-

ing accounts), there are no international

standards or standard-setting body orcorporate ormation. As a result, practice varies

widely across jurisdictions, both onshore and

offshore, on arrangements whereby authorities

can obtain inormation about the beneficial

ownership o corporate vehicles registered

in their jurisdiction and the powers to share

20 . In the US, Senator Carl Levin has sponsored a bill that would require all states to require the names o the beneficial

owners o companies, and to release that inormation to law enorcement i subpoe-naed. Whether that bill, S-569, will

become law is still an open question. In 2007, beore the economic meltdown, Levin with the then Senator Barack Obamaintroduced a similar bill, the Stop ax Haven Abuse Act. It made no progress. Subsequently, President Obama chose the

ormer senator rom Delaware, Joe Biden, as his vice president. Delaware opposes the new bill (Sharman, 2009).

The way forward

The way forward


26/40


Financial Secrecy Index

The Tax Justice Network compiled aFinancial Secrecy Index (FSI) rank-

ing the jurisdictions most aggressivein providing secrecy in internationalfinance, and which most actively shunco-operation with other jurisdictions.The FSI reveals that the majority ofglobal players in the supply of finan-cial secrecy are not the usual suspects,the tiny, isolated islands, but rich na-tions operating their own specialisedjurisdictions of secrecy, often wi thlinks to smaller satellite jurisdictions

acting as conduits for illicit finan-cial flows into the mainstream capitalmarkets.

The FSI focused on 60 secrecy juris-dictions, employing two measurements,

one

countering illicit and unregulated money flows

Documents