The integration of capital and financial markets has been driven by the removal of barriers between national markets – today no OECD country has controls on inward or outward investment or on exchange transactions – and by the rapid development of global communication networks and the information economy. In this more open environment financial services and investment have become increasingly mobile. These developments open up new opportunities for improvements in our economies, but also raise important challenges for policymakers, as the scope for financial crimes widens.
Money laundering, misuse of corporate vehicles, terrorist financing, tax crimes, and other inappropriate exploitation of regulated financial markets for personal gain: all have changed in both nature and dimension. Today the potential for financial abuse can threaten the strategic, political and economic interests of sovereign states. Widespread financial abuse undermines the integrity of the international financial system and raises new challenges for policymakers, financial supervisors and enforcement agencies. In certain jurisdictions such abuse may go so far as to undermine the democratic basis of government itself.
Veil of secrecy
Financial crimes thrive in a climate of secrecy where normal good governance measures are undermined by a lack of transparency and a failure of financial centres to co-operate effectively with the law enforcement agencies of other countries. And, of course, behind this veil of secrecy there is a darker reality. Terrorist networks, arms dealers, drug traffickers and other international criminal syndicates which exploit secrecy and non-transparent arrangements to legitimise the profits from their illegal businesses.
Poorly regulated financial markets not only open up new opportunities for financial crimes but can also threaten the stability of the international financial system. As new technologies reduce the importance of physical proximity to major on-shore financial centres so a new generation of Offshore Financial Centres (OFC) have emerged. Remote jurisdictions bereft of natural resources and too remote to benefit significantly from the global economy have established OFC characterised by strict bank secrecy, criminal penalties for disclosure of client information and a policy or practice of non-co-operation with law enforcement agencies of other countries. This new generation of OFCs have succeeded in attracting brass plate banks, anonymous financial companies, asset protection trusts and increasingly have become the focal points for private equity and hedge funds.
Enron, Worldcom and Parmalat have all revealed serious weaknesses in corporate governance and in certain market functions. Such scandals have lead to a massive destruction of financial wealth. Incentives were misaligned and key checks and balances failed. Market participants tolerated, and in some cases contributed to, deceptive practices. All this reflected shortcomings in the quality of corporate governance needed to insure investor confidence, economic dynamism and competitiveness. Good corporate governance serves as an early warning system to corporate and financial problems. Moreover, strengthening transparency and accountability in particular are critical in combating efforts to put wealth beyond the reach of law enforcement and tax agencies. An economy characterised by high standards of transparency and one in which members of management are accountable to their boards and the boards are accountable to their shareholders –including minority shareholders – is one where financial fraud and other financial crimes, including tax crimes, will be less likely to flourish.
Governments have responded to these threats by developing legislation to detect and deter financial crimes and by strengthening their law enforcement and tax enforcement capacity. Money laundering has been criminalised. Financial institutions are required to report suspicious transactions. Stricter regulatory and supervisory measures have been put in place. Access to beneficial ownership information and trust formation rules have been revisited and strengthened.
Fighting money laundering
These national initiatives are reinforced by multi-lateral actions. OECD countries took the lead in developing new international standards (see box out). In 1992 the Financial Action Task Force (FATF) was created to counter money laundering. It developed criteria to identify non cooperative jurisdictions and establish recommendations which guide governments in their fight against money laundering and, at a later date, terrorism financing. In 1997 the Financial Stability Forum was established to promote international financial stability through information exchange and international co-operation in financial supervision and surveillance. It also compiled a list of poorly regulated OFC which threatened the stability of the international financial system. In 1998 the OECD launched its effort to address the problems raised by tax havens as part of a broader initiative to counter harmful tax practices. Key features of this initiative are the promotion of transparency and effective exchange of information.
Each of these initiatives recognised that unilateral actions are insufficient. Each was launched by countries committed to high standards of financial integrity. While each initiative was separate, dealing with distinct issues and encompassing different country groupings – both OECD and non OECD – all were directed at establishing new international standards and within similar time frameworks.
The success of these initiatives can be seen from the way in which OECD and non-OECD countries have worked to implement these standards. Today OECD countries have criminalised money laundering and are in broad compliance with the FATF recommendations. Many key non-member countries including OFC’s have followed this lead. The FSF has been successful in promoting new supervisory standards. But the response to these initiatives has perhaps been most dramatic with regard to the OFC. Today almost all of the OFC’s identified in the FATF original list have been removed and 33 of the potential tax havens identified by the OECD in 1998 have committed to the principles of transparency and effective exchange of information. Clearly even in today’s global environment multilateral action can achieve high standards.
The role of the OECD in promoting financial integrity:
Promoting tax co-operation
The more open and competitive global market of recent decades has had many positive effects on tax systems. Tax rates have generally fallen and tax bases have been broadened. Some tax and tax-related practices, however, undercut the gains that tax competition generates. This occurs especially if some countries engage in practices that encourage non-compliance with the tax laws of other countries. The ultimate losers are honest taxpayers. They end up paying for dishonest practices by shouldering a greater share of the tax burden, and their confidence in the integrity and fairness of their tax systems, and in government in general, declines. Since 1998, the OECD has co-ordinated action so that countries – large and small, rich and poor, OECD and non-OECD – can work together to eliminate harmful tax practices with regard to geographically mobile activities, such as financial and other service activities. The concrete results of the OECD’s efforts are reflected in the commitments to transparency and effective exchange of information which have been made by Offshore Financial Centres. In parallel, all of the 47 harmful preferential tax practices identified in OECD member countries in 2000 have been either eliminated, modified or, on further inspection, found not to be harmful.
Promoting good corporate governance
The OECD Principles of Corporate Governance, issued in 1999, have become the international benchmark in this area. They cover six main areas: the legal and regulatory framework for effective corporate governance; shareholders rights; equitable treatment of shareholders; the role of stakeholders (employees, creditors, etc); transparency and disclosure, responsibilities of the board.
Counteracting the Misuse of Corporate Vehicles and Trusts
Corporate vehicles and trusts can be misused to facilitate financial crime such as money laundering, bribery, fiscal crimes, improper self-dealing and market manipulation, as well as terrorist finance. The critical concern is the potential for anonymity provided by the veil of a separate legality which may be strengthened in certain jurisdictions by stringent secrecy laws and the availability of instruments that obscure beneficial ownership. The OECD produced first a report giving a menu of alternative approaches that a jurisdiction could adopt and then a template that can be used for assessing a jurisdiction’s capacity for obtaining ownership and control information and sharing that information with authorities of other countries.
The fight against Money Laundering
The Financial Action Task Force (FATF) was established in 1989 to combat money laundering around the globe. Following the events of September 11 in 2001 the FATF began waging a financial war on terror as well. The members of the FATF have committed collectively to follow a set of ‘40 Recommendations,’ which were revised significantly in 2003. The FATF has also agreed to eight special recommendations to counter terrorist financing. Since 2000 the FATF has undertaken an initiative to help ensure that all significant financial centres adhere to international anti-money laundering standards. This initiative on Non-co-operative Countries and Territories (NCCT) has triggered significant improvements throughout the world. Some 23 jurisdictions were placed on the NCCT list in 2000 and 2001. Today only six remain on the list and of these five have enacted reforms significant enough to be placed in the ‘implementation stage.
Despite the initial success of these initiatives much remains to be done. Setting standards is but one step in the fight against financial abuse. Monitoring their implementation and getting a ‘buy-in’ from OFC’s is the next challenge. Jurisdictions that have committed to work with the FATF, the IMF and the OECD will require on-going assistance to implement their commitments: assistance which can be more effective if co-ordinated. The emergence of new financial centres will have to be monitored to ensure that they meet international standards. Renewed efforts will be required to ensure that financial centres which achieve high standards will not be put at a competitive disadvantage.
Moral leadership
OECD countries will continue to be the driving force behind initiatives to improve the integrity of financial markets (see box out). To maintain their moral leadership they will need to continue review their own money laundering, law enforcement, supervisory and tax enforcement powers. This in turn will require balancing integrity needs against legitimate privacy and competitive concerns and ensuring that there are no free riders in the system.
Offshore financial centres which meet and implement high standards will continue to play a role in the international financial system. Some, however, may decide that the costs of meeting such standards is too high in comparison to the expected gains and will decide to exit from this business. Some may decide – few I hope – that by not meeting these standards they will become more attractive to those who want to engage in illegal financial activities. These may prosper in the short term but risk inflicting long term damage on their economies and democracies as OECD countries take coordinating action to counter such abuse. International Institutions are committed to working with those financial centres that want to stay in the Financial Services business and enhance their reputation by implementing high standards of transparency and engaging in international co-operation.
Further information:
jeffrey.owens@oecd.org
