The Prospect for Offshore Financial Centers in Europe
By: Mattias Levin

Since a couple of years, much attention has been devoted to offshore financial centers (OFCs). Little is known, however, about OFCs and the business environment in which they operate. This article analyses the concerns often raised with OFCs - money laundering, financial instability and harmful tax competition - but puts them in relation with the global competition for the location of financial services. It also provides a survey of the major European offshore centers.

International actions targeting OFCs are partly motivated out of genuine concerns. Rich, industrialized countries fear erosion of their tax bases. They claim that OFCs may offer a safe harbor for money launderers. Finally, they claim that OFCs may endanger international financial stability. As a result, OFCs have faced "attacks" from the OECD on tax matters, from the Financial Action Task Force (FATF) on money laundering and the Financial Stability Forum (FSF). In addition, European centers are being pressured by the European Union (EU) to engage in information exchange.

Cut-throat competition between financial centers

The actions aimed at curbing OFCs also have to be read through the prism of the cut-throat competition between financial centers for the location of lucrative financial services. Over the last 20 years, OFCs have managed to carve out a sizeable market share in private wealth management. While the world's roughly 70 OFCs only make up 1.2% of the world's population and 3.1% of the world's GDP, they are managing one-quarter of the world's financial assets. The sum of bank deposits and funds under management in the European OFCs surveyed in this paper alone exceeds €800 billion. In that context, the main beneficiaries of curbing them will be the leading onshore financial centers, primarily the City of London and New York.

By and large, the action to curb some of the characteristics of OFCs has been more successful than expected at the outset. The success of action has, however, varied from issue to issue and depends on the validity of the underlying argument. On money laundering and financial stability, the recommendations have been more or less swiftly implemented by the OFCs, as the norms and principles underpinning these areas were relatively widely shared. On tax matters, things have progressed much more slowly, as the underlying economic case is weaker.

Part of the success can be explained by the events of 11 September, which provided new momentum. Any remaining doubts about the merits of the FATF's recommendations quickly evaporated, as OFCs and onshore jurisdictions raced against one another to avoid having their reputations tarnished from any association with the act of harbouring money connected with terrorist activities. This same concern over their reputation has convinced a majority of the blacklisted OFCs to start cooperating with the OECD.

The future for OFCs

The future for OFCs therefore looks rather bleak, as the FATF has decreased OFCs' regulatory advantage, and the OECD has taken one step further towards curbing their tax advantages. This is particularly true for European centers, which in addition to global demands, are faced with requests from the EU for action in two areas:

EU Taxation. The EU agreement on the taxation of savings income is dependent upon European OFCs imposing equivalent or similar measures to the ones envisaged by EU members. While little is known about the current status of negotiations between the EU and the OFCs, the advance of the OECD process will not harm the EU's position.

EU Financial regulation. The constitutional links between the EU and European OFCs vary widely. All of them are, however, not entirely free to develop their own regulatory framework as they see fit, as the EU's Single Market programme in one way or another affects the margin of freedom enjoyed by European OFCs.

Therefore, OFCs in general and EU OFCs in particular will find it increasingly difficult to defend their regulatory and tax advantages. In particular: