Month: August 2014

“I wondered about how a semi-retired financial guy like me is equipped to keynote an expert panel on corruption and the rule of law, but then, as I thought of the developments in the financial world recently, maybe it’s obvious that I have a certain expertise.

For a long time I have been deeply concerned about the corrosive effects of corruption, both upon nations struggling to emerge economically, and upon the effectiveness of key financial institutions, and I include in that the United Nations itself.

These days, I don’t have to look elsewhere for evidence of the debilitating impact of corruption, perceived and real, in eroding trust in government processes. It’s also true with other relatively rich economies, presumably long imbued with the importance of the rule of law.

[W]idespread corruption makes strong rule of law an impossible dream

Vision, execution, hallucination
I recently undertook the initiative for a new institute that’s come to be known as the Volcker Alliance. The central idea is to focus attention by practitioners, academics, the political class and public at large on the need for effective and efficient ‘implementation’ of public policies. I emphasise the word ‘implementation’. There’s plenty of debate about what governments ought to do on grand policy, but the whole subject of management and administration seems to be in disarray and neglected. I ran across an apt quotation from Thomas Edison. It says ‘vision without execution is a hallucination’. Too often, it shows up in poor performance; it feeds the sense that government can’t be trusted.

At the first meeting of the Alliance, the conviction was strongly expressed that corruption had become the central issue of governance. It called for priority attention. I readily agreed, so it was natural to place that issue front and centre in a conference that the Alliance convened in Salzburg. We had some 40 attendees, drawn from government, universities and international institutions. Collectively, those attending reflected the concerns of both well developed and emerging economies in the effective implementation of public policies.

Yet, somewhat to my surprise, there were also strong warnings against committing investment of our limited financial and intellectual resources to the fight against corruption. It wasn’t because the issue was considered unimportant – to the contrary. The sense was widely shared that corruption was becoming more intractable, more pervasive, not less.

Breakdown in trust
You are no doubt familiar with the estimates that corruption might sometimes add 30 percent or more to the cost of contracts and implementing internationally financed projects. There is evidence that funds, for a significant number of international and national assistance programmes, are simply wasted. The adverse consequences are not simply the direct financial losses and inefficiencies involved, but a breakdown in the sense of trust essential to effective democratic, or for that matter, any government.

It’s worth noting that the two nations with the largest populations located side-by-side in Asia, one a turbulent democracy, the other a one-party state, are both riled by corruption. In both cases, it threatens their ability to sustain rapid growth as well as political stability.

So it was not the relevance, but the size of the challenge that seemed forbidding. The extent and nature of the problem, deeply embedded in national habits, often supported by local business and financial interests, in some cases tied into the production and distribution of drugs. It is of course these considerations that raise questions about the rule of law. Corruption cannot be combated successfully without a strong commitment to the rule of law. That’s a matter of prime significance for lawyers in their professional organisations, not for a tiny new institute, however ambitious, with a number of more manageable priorities.

Weak rule of law and perceived corruption is closely associated with stunted economic development, presents seemingly pervasive obstacles to an escape from poverty, and is accompanied by an absence of human rights. More positively, with a tradition of the rule of law, with relative freedom from corruption, confidence in government booms. So I’m not ready for the Volcker Alliance to abdicate. The relevant question for us is identifying, at the margin, where we can gain a better leverage.

Defining corruption
Are our schools of public policy paying attention to the need for education and training in corruption prevention? I might ask the same of our distinguished schools of law: are there promising areas for research that need support? Do reform-minded governments have access to appropriate frameworks and well-tested procedures for preventing and attacking corruption?

As I thought about this panel and what to say, I realised we were faced with some semantic and conceptual confusion. I took refuge in my dictionaries. I found ‘corruption’ is consistently defined as ‘the result of corrupt acts’. It didn’t help me very much. Corrupt actions are principally defined as bribing public officials, but isn’t it more sweeping than that? The definitions then do proceed with words such as ‘immorality’, ‘dishonesty’, ‘lack
of integrity’.

In contrast, ‘rule of law’ – unlike ‘rule of thumb’ – is not defined in my dictionaries. But the word ‘rule’ alone does seem to come close, implying a governing principle embodied in legislation or observed in practice. We add the concepts of consistency and transparency and we come close to the approaches formalised in both the OECD Anti-Bribery Convention, and more broadly, the UN Convention against Corruption.

I have great respect for the continuing efforts of the OECD over more than a decade to develop and enforce national efforts; to outlaw bribery of foreign public officials. Importantly in that case, there are provisions for the act of monitoring of both legislation and enforcement in the 40 signatory nations. That convention follows closely the precedent of the American Foreign Corrupt Practices Act, which became law more than a quarter of a century ago.

The UN Convention is more recent, entering into force in 2005. It now has, nominally anyway, 168 countries as partners. It is, as written, the most comprehensive approach, and extends way beyond criminalising bribery to other corrupt actions and money laundering. Extensive record-keeping and broad codes of conduct for civil servants are required, indeed in requiring honourable and proper performance of public functions, I quote, including fair and transparent government procurement systems, the convention comes close to defining the essence of the rule of law.

Avoiding complicity
So where in practice do we stand? At the least, with reasonable clarity, bribery of foreign officials has been outlawed in most countries. The complementary efforts of the World Bank, now increasingly joined by other multi-national institutions, has improved vigilance over the use of their own resources. One result is evident in identification of increased numbers of banks’ contractors engaged in corrupt activity.

A broader change in attitudes has been highlighted by the Siemens case of large-scale bribery, leading not only to huge fines, but to a reversal of the former leniency of the German government towards bribing foreign officials by its companies. But can any of us feel satisfied that such examples are sufficient. They only touch the surface of illicit behaviour. There are many important countries that, in my personal experience, don’t even seem to try. We had the Siemens case in Germany, we had on the other hand, the rather infamous case in Britain, where there were allegations that huge bribes were paid to assure large contracts in a foreign country, and they were not pursued to a definitive conclusion because it was stated in the end there were more important things than the rule of law.

I am certain those international agreements and activities, together with the sporadic evidence of a more aggressive approach by some individual countries, have by no means relieved the sense of frustration and alarm with which I began these remarks. In my own experience, with respect to both the inquiry I chaired into the administration of the Oil for Food programme at the UN, and my subsequent review of World Bank practices, I have been exposed to deep-seated resistance to effective action, even by those most affected international institutions and member nations. It was only in the mid-90s that a brave World Bank president took the position that, and I quote, corruption is a cancer on development. He said that his institution could no longer dodge the issue.

The World Bank and the OECD, both under strong leadership, have come a long way from the old attitude that corruption is ‘not our business’. There is frank recognition that the combination of a weak rule of law and corruption is not only economically debilitating, but threatening the political health of both new and old democracies.

I do not exclude the United States. We think of ourselves as exemplars of the rule of law. We are certainly world champions in the extent of legislation and regulation governing bribery, conflicts of interest, procurement procedures, campaign financing, protection of human rights and most of all, transparency. All of these are ingredients of what some think of as the rule of law. But we still face the sad fact that in the United States itself, only a quarter of Americans believe that corruption is not widespread in our country.

My feeling is that the impression of serious corruption has increased further, a reflection largely of the concern that campaign financing has come to gravely distort the political process.

Should we be satisfied that we live with a really effective rule of law, when the perceived need for heavy campaign spending has come to dominate our political process? We let those financing practices infringe in a very basic way upon the rule of law, with its sense of even-handedness and openness. Does it not breed behaviour that is accomplished by any reasonable definition of corruption?

I made the point earlier that the successful attack on corruption depends upon a strong sense of rule of law, but it’s equally true that widespread corruption makes strong rule of law an impossible dream. But here I am, addressing a prestigious group of lawyers: you carry the full weight of a long respected and honoured tradition. If we fail to maintain an effective rule of law and a strong defence against corruption, two sides of the same coin, then you can hardly escape complicity.”

This year’s IBA Annual Conference will take place in Tokyo, from 19-24 October, and will begin with a keynote address from Japanese Prime Minister Shinzo Abe.

The world recently took another step towards a unified personal tax-collection regime when Singapore agreed to the US Foreign Account Tax Compliance Act (FATCA) – it is the 48th country to do so. FATCA is fast becoming the world’s point of reference when it comes to tax issues, and with it, the hunt for tax evaders only grows stronger.

However, its global acceptance has put pressure on financial institutions to meet increasingly complicated reporting criteria and has caused many firms to abandon their US clients in attempts to avoid the associated hassle. Furthermore, some countries have complied begrudgingly, and some have only agreed to partial tax deals. The full consequences of the cross-country adoption of FATCA still remain to be seen, but one thing is clear, US clients are quickly becoming persona non grata and firms are sweating over tax compliance like never before.

Under FATCA, each non-exempt financial institution in a co-operating country will tell its home tax authority about the financial accounts of US customers, obliging the home tax authority to share the information with the Internal Revenue Service in the US. After the official worldwide rollout on July 1, 2014, foreign banks are now obliged to hand over the details of American account holders with over $50,000 in deposits or face serious repercussions. Institutions that fail to comply could effectively be frozen out of US markets. As a result, the majority are complying despite the regulatory burden.

[I]ts global acceptance has…caused many firms to abandon their US clients in attempts to avoid the associated hassle

Crackdown on tax evaders
The aim is to hit tax evaders where it hurts. If a foreign financial institution (FFI) does not subscribe to FATCA, all US-related deposits and transfers – including dividends and interest paid by US corporations – will incur a 30 percent withholding tax; this will also apply to gross sale proceeds from the sale of relevant US property. Currently, out of the 48 countries complying, only 26 have actually signed Model 1 or 2 intergovernmental agreements under FATCA – the rest have only complied to elements of the treaty. However, according to US authorities, this doesn’t exempt the countries in question from complying with FATCA, and that’s concerning news for the many high-net-worth individuals (HNWIs) being targeted as part of the rollout.

As a large amount of HNWIs’ income is self-certified, many of them are considered entrepreneurial “chancers”, with the IRS estimating that Americans underpay their taxes by about $345bn every year. But since the IRS stepped up its enforcement efforts in 2009, the revenue service has collected billions more. Essentially, the US is compelling the world’s financial industry to fall into line by using a big stick, namely, the threat of withholding 30 percent on all payments derived from US investments.

With the US being the largest recipient of inward investment in the world, it is virtually impossible for international financial firms to operate without investing, directly or indirectly, with the US, or dealing with financial institutions that invest in the US. As such, it’s a no-brainer for countries to comply.

“For over a year, the Swiss Bankers Association has spoken in favour of an agreement with the US and therefore the implementation of FATCA. The US implements FATCA not only in Switzerland but in all countries they have business relationships with. For Switzerland as a global financial market the implementation of FATCA is crucial and necessary, as it ensures market access to the most important financial market in the world. Non-participating financial service providers will factually be cut off from the US market,” said the Swiss Banking Association’s (SBA) Head of Communication, Daniela Flückiger, in an exclusive interview with World Finance.

To this end, FATCA has seen an increase in compliance during the first few months of this year, most recently signing Singapore under the Model 1 IGA. This followed calls from the US authorities to specifically target financial centres like Singapore, the Channel Islands, and the Bahamas to be more transparent when it comes to their financial affairs; the Singaporean authorities have also launched their own initiatives to prevent illicit funds from flowing into the country as its status as one of the world’s fastest-growing wealth management centres grows.

FATCA has come at a time when rising global wealth has prompted increasing inflows into financial centres like Switzerland and Hong Kong from HNWIs. According to the Capgemini and RBC World Wealth Report, Asia is expected to become the world’s largest market by value for people with investable assets of $1m or above by 2015 (see Fig. 1). Predictions suggest that Singapore will overtake Switzerland as the world’s largest private banking and wealth management hub.

Singapore’s fund management industry had SGD 1.63trn in assets in 2013 and speculators have explored whether the new tax deal will impact the successful financial hub in a negative way. According to asset management firm Lexico Advisory, the industry is unlikely to be hit hard by the new agreement as US citizens only account for one tenth of Singaporean wealth management clients – nevertheless, implementation can provide challenges.

“Financial contracts involving derivatives, involving note holders from different countries – you will have difficulty enforcing it. How do you ascertain, maybe out of a few hundred individuals, which ones are US citizens or US-related or what kind of entities are these,” said Jack Wang, a partner at Lexico Advisory in an interview with Channel News Asia.

“There will be a constant lack of information. How much can you ask the client to provide? And if they refuse, what does that mean for the overall tranche of notes? Private equity deals as well – when you deal with multiple parties, you may not know whether they are US-related, or fall under the guidelines.”

Differing deals
In its efforts to not be excluded from US capital markets, Singapore signed a Model 1 tax information-sharing agreement that allows Singaporean firms to report US account-holder information to their local tax authority, forwarding it to the US Internal Revenue Service. However, this is not the only tax deal available, and curiously, several key financial centres such as Bermuda, Switzerland and Japan have opted in for the Model 2 IGA, which entails reporting directly to the IRS rather than through a local tax authority.

When explaining why Switzerland opted in for the less popular model, Flückiger said: “Model 2 and 1 are different in many aspects. One of the main differences is that under Model 2, data is not exchanged automatically but only by the means of a group request from the US to Swiss authorities. Under Model 1, data of US/Swiss clients would be exchanged automatically between the tax administrations of the two countries. The core element of the [Model 2] solution is that the necessary exchange of data will be made directly with the US tax authorities and not, as in the implementation solution for the five big European countries, by means of centralised data gathering. This better takes into account the particular characteristics of the Swiss financial centre.”

However, Switzerland may not have a Model 2 agreement for long, as the Swiss authorities have announced new negotiations with US authorities that may change their IGA into a Model 1, and crucially, impact Swiss banking practices far more than anticipated. As mentioned, Model 2 allows for a more personable reporting system, where the Swiss financials can better take into account their unique privacy laws when
reporting. Model 1, with its automated data transference, could significantly change that system and possibly lead to the end of Swiss banking privacy.

Another pressing issue regarding the implementation of FATCA is the thousands of US citizens left out in the cold. Since it was first announced in 2010, firms have fought to avoid the expenses associated with the extensive tax reporting by eliminating US clients from their client roster. Deutsche Bank and HSBC blankly refuse to service US clients, while smaller firms have to refer loyal US clients to bigger players that have the compliance capacity to take on the FATCA requirements. “To this end, the SBA maintains that the banks are not to blame for leaving US clients behind. The problem lies largely in the complexity and rigidity of US tax reporting”, says Flückiger.

“With or without FATCA it is each banks’ responsibility to determine its own business policy. No customer group as a whole is discriminated. Yet, in individual cases banks can check whether an individual client relationship entails risks or not, and can thus decide whether to maintain the relationship or not. The reason for this decision lies not in a bank’s bad faith but in the complex US regulation,” she argues.

A far more alarming consequence is the amount of Americans who are renouncing their citizenship in an attempt to rid themselves of a persona non grata status with the world’s financial firms. At the moment, there are around six to seven million expat Americans. However, according to Federal Register data, 1,131 people gave up their US passports in the first six months of 2013 – a stark surge compared to the 189 US nationalities renounced by expats the year before.

Second-class citizens
What’s more, a “remarkably high” two-thirds of US expats are currently considering renouncing their citizenship due to FATCA. The international law-firm deVere Group asked 400 of its US expatriate clients if they’re thinking about relinquishing their US citizenship following FATCA, in response to which 68 percent said they’ve ‘actively considered it’, ‘are thinking about it’ or ‘have explored the options of it.’

“More and more of our internationally-based American clients are now telling us, usually with a heavy heart, that they would be tempted to give-up their US citizenship to avoid what they feel is the unfair, complex and oppressive burden of FATCA,” said Nigel Green, Founder and Chief Executive at deVere Group. “FATCA is a huge imposition on ordinary Americans who happen to live and/or work outside the US, and will involve significantly more expensive and laborious reporting requirements. In addition, due to the onerous and costly impact of FATCA, many non-US financial institutions will no longer work with Americans – even if they have been clients for decades – which can make life outside the US ‘challenging’ to say the least,” Green added in a statement at the time.

It’s worth noting that estimates of the additional revenue raised through FATCA seem to be heavily outweighed by the cost of implementing the legislation. The Association of Certified Financial Crime Specialists claims FATCA is expected to raise revenues of approximately $800m per year for the US Treasury, yet the costs of implementation are more difficult to estimate, with figures ranging from hundreds of millions to over $10bn. As the costs will be borne by foreign financial institutions, it is likely that this may create a strong incentive for foreign financial institutions to divest or refrain from investing in US assets, resulting in capital flight.

What’s more, forcing foreign financial institutions and governments to collect data on US citizens at their own expense and transmit it to the IRS is considered divisive by many state leaders who have felt pressured to agree to the tax deal despite it jeopardising local privacy rights. To this end, FATCA has obvious benefits in a world where tax evasion is a growing problem and where ironclad regulation is considered a post-crisis necessity. One can only suggest that financial hubs and US authorities keep a close eye on the costs of this legislation, as the loss of US clients could be the smallest of consequences in the longterm.