• Strategy
  • The Economist

What It Takes to Succeed

For offshore financial centres, not only low taxes but a great deal besides.

Whiter Than White

Being a successful OFC is tougher than it used to be. The best-run of them compete not only with offshore rivals but also, in certain industries, with onshore ones. Bermuda’s biggest competitors in captive insurance (of which more below) are Vermont and South Carolina.

The costs of running OFCs have also increased. Complying with the raft of international standards for financial services introduced since the late 1990s involves a lot of effort. And as standards rise, more is expected of the public companies that use OFCs as well. They must not only make profits, but be good corporate citizens too: paying bosses enough but not too much, for instance, making sure their operations in poor countries are run ethically (no child labour, no sweatshops) and steering clear of shady jurisdictions. So OFCs that are careless about their reputation may find themselves shunned by the big, listed multinationals that are their lifeblood.

OFCs complain that the bar is set higher for them than for their onshore counterparts. When Stanley Works, an American toolmaker, announced in 2002 that it was moving its headquarters to Bermuda, it caused a furore. Along with other firms that had moved to tax havens, including Tyco and Ingersoll Rand, it was pilloried as “unpatriotic”, even though it was acting entirely legally. Partly as a result, new American captive-insurance businesses now often stay onshore. A regulator in Europe comments: “Tax havens have to be whiter than white. It is the only way to shake off their bad reputation — which some of them deserved not too long ago.”

Being whiter than white does not come cheap. Introducing anti-money-laundering and other regulations, beefing up bank supervision and tracking down financial crooks takes money and expertise. A paper published last August by the Commonwealth Secretariat, a group of 53 former members of the British Empire, estimated that in 2002-05 the direct cost of new regulations for Barbados was $45m and for Mauritius $40m — big numbers for tiny islands with small budgets. The indirect hit could be even bigger. For example, the number of offshore banks in Vanuatu plummeted to 7 from 37 in a year after new rules required banks to open a permanent office with at least one full-time employee on the island. The paper concludes that for these three jurisdictions, “the costs involved in meeting the new standards have exceeded…identifiable short- to medium-term benefits.”

The start-up costs for new OFCs are also much higher than they used to be. As one regulator in a tax haven explains, in the old days jurisdictions were able to build a critical mass of business before turning their attention to legal and regulatory structures. Many OFCs that opened their doors in the 1960s and 1970s have put in place anti-money-laundering systems only in the past few years, for instance. This means that some bad money came in with the good that had to be flushed out later.

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