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Offshore Industry

Offshore Finance Industry and Offshore Financial Centers

Generally the term, Offshore Financial Industry, refers to the financial services of banks, investment funds, re-insurance companies and other entities provided to non-resident individuals, corporations and governments. Services generally associated with the offshore financial industry are tax planning, banking, hedge fund management, re-insurance, trusts, International Business Company (IBC) activity, expatriate services, gaming licenses, shipping, yacht, and airplane registries.

Offshore Financial Centers (OFCs)

An OFC is where offshore activity takes place. Generally offshore activity has been based in small jurisdictions. Examples would be Isle of Man, Cayman Islands or Jersey. While they boast of few natural resources, these small jurisdictions have found that they can compete on the basis of their ability to attract financial capital from all over the world.

A more practical definition of an OFC is that it is a center where the bulk of financial sector activity is offshore on both sides of the balance sheet, (that is the counter parties of the majority of financial institutions liabilities and assets are non-residents), where the transactions are initiated elsewhere, and where the majority of the institutions involved are controlled by nonresidents. Thus OFCs are usually marked by the following characteristics:

• OFCs have large numbers of financial institutions that are not engaged in local commerce, but rather transact primarily in business with non-residents.
• OFCs generally have financial systems with external assets and liabilities that are disproportional to domestic financial intermediation designed to finance domestic economies.
• OFCs offer many services including: minimal if any taxation, reduced and streamlined financial regulation, banking privacy, political stability, and discretion (which is really a rightful exercise of a nation's sovereign authority to not help a foreign government tax economic activity inside its own borders).

Better governed countries are much more likely than others to become tax havens, this according to a recently released paper by James Hines and Dhammika Dharmapala entitled, "Which Countries Become Tax Havens?"

The City of London's Global Financial Centres Index (GFCI) for September 2008.

Further Classifications

There are attempts to classify Offshore Financial Centers based on the type and effectiveness of regulatory infrastructure standards and enforcement. For example:

• International Financial Centers (IFCs) — IFCs such as London, New York, and Tokyo. These international full-service centers are established and well-developed. They are marked by advanced settlement and payments systems, large supporting domestic economies, with deep and liquid markets where both the sources and uses of funds are diverse, and where legal and regulatory frameworks are adequate to safeguard the integrity of principal-agent relationships and supervisory functions. IFCs generally borrow short-term from non-residents and lend long-term to non-residents.
• Regional Financial Centers (RFCs) — RFCs such as Hong Kong, Singapore, and Luxembourg. These countries have fairly small domestic economies but have well-developed financial markets, infrastructure and intermediate funds in and out of their region.
• Offshore Financial Centers (OFCs) — A third categorization are the OFCs. They are for the most part much smaller and provide more limited specialist services. The infrastructure of the financial markets is not nearly as well developed as in an IFC or an RFC. OFCs tend to be more narrowly focused. Their range encompasses centers that offer specialist and skilled services to centers that are lightly regulated and the services offered are almost entirely tax driven.

There are many benefits that accrue to smaller nations that become Offshore Financial Centers. Licensing fees generate much needed revenue for the government. Businesses generate income producing activities that result in increased employment in the local economy.

OFCs have many legitimate functions. Users can take advantage of: (1) lower tax rates that result in a higher after tax profit; (2) simpler prudential regulatory frameworks that reduce implicit taxation; (3) reduced government bureaucracy for forming corporations and other legal entities; (4) legal frameworks that safeguard and defend the integrity of principal-agent relations; (5) the proximity to major economies, or to countries attracting capital inflows; (6) the reputation of specific OFCs, and the specialist services provided; (7) freedom from exchange controls; and (8) protecting assets from the impact of litigation.

It is popular to assert that OFCs can be used for dubious purposes like money-laundering. But criminals generally launder money where it has been obtained. Taking money out of the country leaves a paper trail that criminals try to avoid.