money laundering and tax havens

july'08

'Dirty' money is the fruit of many kinds of criminal activities e.g. drug dealing, secret arms sales, counterfeiting, protection rackets, smuggling, embezzlement, insider trading, computer fraud etc. The rewards of such activities usually come in one of two forms - cash or money transfer. In the form of notes and coins there is usually very little that can be done to prove that cash has been gained illegally unless of course the money is forged. However only small amounts of cash can be carried without arousing suspicion and small amounts are not what big criminals are about. Large amounts of cash are usually paid by money transfer which requires funds being paid into the payee's bank account. And money laundering is the process by which the proceeds of crime are accepted by a financial institution into an account opened under the control of the criminals.

Money laundering can occur anywhere in the world but criminals will generally seek out areas like offshore tax havens where there is a perceived low risk of detection due to weak and ineffective government legislation or find a 'friend' somewhere on the inside of a bank/ financial institution who is willing to help them.

Offshore tax havens then were seen as the perfect place to launder ill-gotten gains. Apart from minimal controls, the popularity of tax havens rested on two things:-

1. bank secrecy laws meant that financial information requested from governments abroad was often rejected. And on the occasions when information was forthcoming, tracking down a stolen money trail often ended up with little or no joy as investigators found that companies they were investigating had been set up and registered without revealing shareholders, directors or owners.

2. tax havens don't normally tax interest on the bank accounts of non-residents leaving the accountholders with the decision of whether or not to declare it to their own tax authorities.

Tax havens come in many shapes and forms and they are found all over the world. It might surprise many to know that U K is responsible for several dependent states which operate offshore banking centres. Apart from Guernsey, the Isle of Man and Jersey, the U K Treasury is responsible for Anguilla, Bermuda, British Virgin Islands, Cayman Islands, Falkland Isles, Gibraltar, Montserrat, Pitcairn Island, St. Helena and the Turks and Caicos Islands. And the Cayman Islands have been so successful in attracting funds that it is now the 5th largest financial centre in the world after London, New York, Tokyo and Zurich.

One notorious offshore centre, in the middle of the Pacific Ocean, is the island of Nauru. There, if you have a spare $25,000 (£12,500) you can set up your own bank and enjoy life with little or no regulation. It is even estimated that almost 400 banks operate there from the same government mailbox. And it was in Nauru in 1998 that according to the Russian Central Bank $70bn (£35bn) vanished never to be seen again.

In total, in 2000, it was estimated that there were 4,000 offshore banks licensed by nearly 60 offshore jurisdictions controlling an estimated $6 trillion (£3 trillion) in assets.

In 1989, the OECD felt that action was needed to counter money laundering by international criminals. To this end they set up the Financial Action Task Force (FATF) based in Paris. It was charged with drawing up a set of universal standards covering law enforcement, financial regulation and international co-operation. This list eventually ran to 40 recommendations which has now been adopted by all 32 member states. What it now means is that:-
no longer will anonymously numbered bank accounts be tolerated
all OECD countries will have a common interpretation of 'dirty' money and
requests for information from one OECD government to another will be dealt with expeditiously.

These guidelines also mean that banks must now become policemen and are in the forefront of tackling crime. They must Know Your Customer (KYC) which includes finding out the purpose of any account and then monitoring the expected profile of it. And any suspicious transactions must be reported immediately to the Financial Intelligence Unit (FIU).

But it is not just banks that can be used to 'clean' money - lawyers, accountants, betting shops, casinos, car dealers, real estate agents, dealers in precious metals, insurance companies and securities houses can all be involved. In total, throughout the world, the IMF estimates that $1 trillion ($1,000,000,000,000) is laundered annually equivalent to 3% of global GNP.

After 9/11 international financial regulations and co-operation took on greater force. Draconian measures to impound terrorist assets were introduced and the U S threatened immediate sanctions against countries and institutions that failed to co-operate. As a result, hundreds of bank accounts were frozen and the search for the origin of their funds given top priority. This brought to light the fact that it was not always through money laundering that terrorist groups received most of their funds but often from legitimate sources.

The OECD now wants all countries to adopt their uniform code of conduct and make it difficult for all criminals to enjoy the fruits of their illegal actions. Initially, in 2001, 23 jurisdictions were deemed to fall short of OECD requirements and were designated as Non Co-operative Countries and Territories. However, after continual monitoring all these countries, including Nauru, have now been removed from this list.

However, three countries, Andorra, Liechtenstein and Monaco, are still giving concern to the OECD over their lack of commitment to transparency and the effective exchange of information. Strong pressure is now being exerted on these 3 countries and if they continue to fail to comply sanctions could be imposed.

(Here should be mentioned the informal banking system known as Hawallah which was invented by the Chinese over 1,000 years ago to cope with political turmoil and the distrust of banks. By this method, if someone wants to send money from say Birmingham to Bombay, he would visit a trader where he would deposit a sum of money. In return he would be given a chit. On sending this out to his family in Bombay, they would take it to the local trader who would pay out the same sum of money less a small commission. As Hawallah is paperless banking, it avoids official records and thus relies on trust and IOU's which are hard to trace. This system is used mainly by people who have no bank accounts but it is obviously useful, too, for money launderers around the world be they terrorists, arms dealers or drug traffickers.)

Bringing standards up all over the world and keeping them there is paramount in tackling financial crime. But perhaps the OECD should go further. Operating a level playing field is all very well and it should deter ‘money laundering’ in the future but what about those who have already slipped through the net.

All banks now have access to lists of Politically Exposed Persons (PEP) which contain the names of all government ministers in all countries of the world. Surely it would not be difficult to go backwards and produce a 'Who was Who' in past governments. And armed with this FATF investigators could search anywhere for personal accounts and 'dig' down through front companies and client fund accounts to look for money that may have been stolen in the past. In this way, for example, money embezzled by ministers in the governments of Marcos of the Philippines and Mobutu of Zaire could possibly be traced and then if proved to have been stolen sent back to the country of origin. In this way perpetrators of financial crimes in the past as well as the present will never be able to rest thinking they have beaten the system. And at the same time offshore centres will take on added respectability.

However, here the OECD has its own internal problems as Switzerland, which has an estimated 1/3rd of the 'offshore' money of wealthy people and Luxembourg and Austria are refusing to sign up declaring a breach of banking confidentiality and fear of competition from new money centres like Singapore. These three countries would prefer to continue with the present system of withholding tax on non-resident savings income instead of exchanging information. And because of this disagreement the OECD is unlikely to obtain any world wide uniformity in tax matters for some time.

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