Certificate in Offshore Banking Practice

Transcription

Chartered Banker
STUDY TEXT
Certificate in Offshore Banking
Practice
In this 2013/14 edition

A user-friendly format for easy navigation

Updated on recent developments

A chapter review at the end of each chapter

A full index
Published September 2013
ISBN 978 1 4727 0770 3
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CONTENTS
Page
I n t r o d u c t i o n
v
F o r e w o r d
vi
C h a p t e r
1
1
Introduction to Offshore Banking
C h a p t e r
2
17
3
53
Regulation
C h a p t e r
International Financial Markets
C h a p t e r
4
71
Products and Services
C h a p t e r
5
89
6
109
7
125
8
141
Private Banking
C h a p t e r
Taxation
C h a p t e r
Trusts
C h a p t e r
Offshore Centres Case Studies
C h a p t e r
9
157
Future Developments in Offshore Banking
A n s w e r s
t o
Q u e s t i o n
T i m e s
165
G l o s s a r y
181
I n d e x
197
iii
iv
INTRODUCTION
The aim of this module is to provide knowledge and understanding of offshore practice in the banking
industry and develop the practitioner’s skills and ability to analyse information, apply principles and make
professional judgements and informed decisions.
Learning outcomes
The main learning outcomes associated with this module should enable you to:
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Describe the offshore banking market and the key regulatory principles that affect offshore
banking activities
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Explain the importance of international financial markets and the significance of these to offshore
banking institutions and their customers
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Describe the range of products and services offered by offshore banks
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Explain in detail the tax treatment of offshore accounts
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Explain the principles of creating and administering trusts offshore

Critically analyse the operations of a range of offshore centres
Assessment structure
An online restricted response examination will consisting of 100 questions undertaken in closed book
examination conditions. The examination will contain 75 restricted response questions and 25 case study
based restricted response questions in 2 hours. Candidates must score 60% to be awarded a pass.
v
FOREWORD
As a general introduction to this subject, presented here is an edited version of an article by Geoff
Cook, Chief Executive, Jersey Finance based on his address to the CSFI Round Table on 31 May
2009.
What do offshore centres involved in international finance do?
Do they have a future?
Firstly let’s deal with the term ‘offshore’. Offshore financial centres (OFCs) are niche international
finance centres also known as IFCs and to a large extent geography and location are irrelevant. Over 70
nations in the world offer some kind of preferential tax treatment to the non-resident investor with the
UK by far the largest, followed closely by the USA – thus the United Kingdom and the USA are the largest
Offshore Financial Centres.
OFCs attract capital from where it is not needed around the world and then conduit that capital into
economies where it can usefully be put to work.
OFCs compete for international business in exactly the same way as do many OECD and G20 nations; on
a mix of financial expertise, lower costs, attractive tax regimes, political and social stability, and robust,
flexible laws and regulations.
The offshore centre acts as a ‘way station’ that facilitates complex international trade and investment
flows. There are no taxes or low taxes in the “way station” because tax has been paid on money before
it reaches them and after it leaves. Taxes are paid at the beginning and at the end of the journey, just
not along the way. In addition, centres manage and warehouse wealth for high net worth individuals.
That is to say … tax neutrality provides for no additional taxation over and above that which is due at the
point of origination or the point of destination funds. It does not negate the need for the investor to
discharge their tax obligations to the relevant tax administration authority.

So what are the benefits of OFCs?
–
OFCs promote efficient allocation of capital
–
They enhance liquidity in the global economy
–
They increase economic activity in proximate states and are a net economic benefit to
countries with whom they work
–
OFCs regulatory models have been cited as amongst the best globally by the IMF
But … controversy has surrounded OFCs and the pejorative label of 'Tax Haven' has come into
common currency. Detractors have sought to forge a linkage between OFCs and the global
financial crisis – some question their future … and have levelled criticisms.

Are they justified?
Let’s examine these criticisms which can broadly be grouped around four headings:

–
Tax competition
–
Regulatory standards
–
Tax transparency
–
Financial stability
Tax competition
The United Kingdom and the USA would not be able to fund significant deficits running into many
hundreds of billions without offering preferential regimes including no or low taxes to the non-
vi
resident, and in the case of the UK to the non-domicile. Large nations cannot justifiably criticise
small nations for participating in the global financial services market place on the same basis.

Tax transparency
I would contend there are only two types of International Finance centre wherever they are
located:

–
Cooperative, transparent and well regulated, or
–
Secretive, opaque and less well regulated – more commonly known as tax havens.
Regulatory standards
Some of our detractors say that we are poorly regulated. Evidence of the compliance of OFCs vs
OECD countries is contained in recent research by Professor Jason Sharman, a political scientist at
Australia’s Griffith University:
“The most egregious examples of banking secrecy, money laundering and tax fraud are found not
in remote alpine valleys or on sunny tropical isles but in the backyards of the world’s biggest
economies.”

Financial stability
The world has seen problems in the banking system and these are well documented.
However, as Professors Craig and Boise have observed:
“As anyone who has read the FT’s coverage of the financial crisis would know, its roots lie not in
Grand Cayman or the Isle of Man but in New York and London.”
Martin Wolf of the FT, widely regarded as one of the world’s leading economic commentators, has
written a speech he proposed President Obama delivered to the G20:
“First we must set priorities. I note with consternation Europeans’ obsession with regulating
hedge funds and tax havens. Did they cause the crisis? No. Europeans also call for regulation of
all markets, products and participants without exception. This is like calling for research into
Radar whilst the Titanic sinks. Do they realise that the systemically significant banks at the heart
of this crisis are the most regulated institutions we possess? Let us not be diverted from today’s
priorities.”
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viii
chapter 1
INTRODUCTION TO OFFSHORE
BANKING
Contents
1
What is offshore banking?............................................................................................2
2
Development of offshore banking..................................................................................5
3
Rationale for offshore banking ......................................................................................8
4
Institutions and markets ..............................................................................................9
Key words ..................................................................................................................... 14
Review ......................................................................................................................... 15
1
CERTIFICATE IN OFFSHORE BANKING PRACTICE
Learning objectives
By the end of this chapter, you should be able to:





explain what is meant by offshore banking
describe how offshore banking developed
identify the factors that have led to the expansion of the offshore banking marketplace
explain the rationale for offshore banking activities
describe the types of institution that are active in the offshore banking market.
Introduction
Offshore banking has a higher profile than ever before. The increasing globalisation of markets and the
greater mobility of individuals mean that customers are no longer confined to doing business with
domestic institutions. What was once a niche range of products and services for an exclusive minority is
now accessible to millions of people worldwide.
This chapter sets the scene on offshore banking by describing what the term means and then setting out
the trends and developments that have resulted in its continued expansion since the Second World War.
1
What is offshore banking?
Firstly, it has to be stated that the term ‘offshore’ is in itself a misnomer. To most people, the term
implies something relating to an island or a group of islands, and this in itself is sufficient to confuse, as
the very important banking centres of Liechtenstein, Luxembourg and Switzerland are regarded by most
as offshore banking centres but are entirely landlocked.
Q U I C K
Q U E S T I O N
Which parts of the British Isles are homes to offshore banking activities?
Write your answer here before reading on.
In the United Kingdom, the term ‘offshore’ was traditionally used in relation to the Channel Islands of
Alderney, Guernsey and Jersey, which have a unique constitutional framework, thereby enabling
institutions located on these islands to offer special benefits to customers, whether resident in the islands
or elsewhere. The Isle of Man also has particular constitutional features that have enabled it to develop
as a significant banking and financial centre.
2
1: INTRODUCTION TO OFFSHORE BANKING
Q U I C K
Q U E S T I O N
What are the features of the Channel Islands and the Isle of Man that make these territories attractive
for financial institutions and their customers?
The most obvious feature of these territories is that they have a high degree of autonomy, including the
right to decide policies on residency and taxation. They are Crown Dependencies but their affairs are
managed by local people. In particular the Tynwald, the Isle of Man’s legislature, lays claim to being one
of the oldest parliaments in the world.
So while the Queen is the head of state as the ‘Lord of Man’, the island is not a constituent part of the
United Kingdom, and it is not a member of the European Union. The Channel Islands have similar status
as ‘bailiwicks’ located within British Crown territory, even though they are much closer to France than to
England.
Outwith the United Kingdom but within the British Isles, the Republic of Ireland rapidly developed as an
offshore centre from the 1980s onwards. This was given added impetus by the creation of the
International Financial Services Centre (IFSC) in Dublin. As a fast expanding economy within the
European Union, the finance sector was seen by the Irish government as a platform upon which
prosperity could be built. This objective has frequently been the catalyst for emerging nations seeking to
establish a presence in the offshore market.
In a worldwide context, some offshore centres portray similar characteristics. Examples include the
Bahamas and the British Virgin Islands, both of which have the Queen as their head of state. However,
this also applies to Australia and Canada, and neither would fall within the ‘conventional’ definition of
offshore centres. So what is it that defines ‘offshore’, ‘offshore centre’ and ‘offshore banking’?
When we consider banking and financial services, doing business offshore means that the individual
chooses to conduct some or all of their financial affairs with a financial institution, or several institutions,
located outside that person’s country of residence. There are plenty of institutions worldwide that are
prepared to offer their services to non-residents, so this description is extremely wide. In recent years,
the barriers to conducting one’s financial affairs on this basis have eroded significantly, and
developments in communications and information technology now mean that it is unlikely that even the
most repressive governments can prevent it.
An offshore centre is easier to describe, if not define, precisely. An offshore centre is a country or locality
that sets out to attract business from non-residents. For some countries this is an essential characteristic,
as without such business they would be considerably poorer. For example, much of the prosperity of the
Bahamas is based on the country’s ability to attract deposits from overseas individuals and legal entities,
not least US citizens and wealthy Europeans.
Offshore banking is the practice of offering banking services to people and legal entities located outside
the jurisdiction in which the banking institution is situated. There are two ways in which this is done:
3

Firstly, domestic institutions offer their services to non-residents based on an array of benefits
that they can provide over and above institutions in their customers’ own countries. A classic
example of this is the Swiss banking sector, which built its reputation on high standards of
personalised service and absolute confidentiality.
Originally, a key to the growth of the Swiss banking sector in respect of international customers
was the ‘numbered bank account’, which guaranteed the customer absolute confidentiality. The
name of the account holder would be kept secret, and the customer would often not even be
known to the official dealing with the account, as a code would be used as an identifier rather
than the customer’s name. The public perception of such banking facilities is generally negative
and associated with tax evasion and other illegal practices. However, in Switzerland and some
other countries (such as Austria and Liechtenstein) with a tradition of offering numbered bank
accounts, it is regarded domestically as the normal way of conducting business. Today, numbered
bank accounts rarely enjoy total anonymity, as most countries permit access to records, albeit
usually subject to a court order and strict criteria.
Q U E S T I O N
T I M E
1
Identify other examples of countries whose financial services providers specifically target offshore
business.
Write your answer here then check with the answer at the back of the book.

4
Secondly, banking institutions set up subsidiary companies registered in offshore centres to offer
their services to residents. For example, all of the large UK retail banks have offshore subsidiaries,
and many of these regard UK residents as the primary target market for their products and
services. The motive for setting up offshore subsidiaries is usually a desire of the institution to
capture new customers by enabling them to capitalise on the benefits of offshore banking. Put
simply, in an increasingly global market place, if these institutions did not provide the service,
many customers would go direct to providers of the services that are based in offshore
jurisdictions. Greater cooperation has increased the risk to those who seek to use numbered bank
accounts to evade tax. For example, in his Autumn statement, the Chancellor stated that £5
billion would be brought into the UK from ‘secretive’ bank accounts in Switzerland.
Q U E S T I O N
T I M E
2
Identify examples of UK-based retail banks that have offshore subsidiaries. Is it only the banks that are
involved in this market?
2
Development of offshore banking
Offshore banking services have been available for many years. It is generally acknowledged that the
formative developments came during the 1930s, with predominantly Caribbean-based institutions
offering their services to citizens and companies located in the USA.
In these early years, the most important centres were the Bahamas and the Cayman Islands. In Europe,
the first countries to exploit the idiosyncratic legal and environmental features favourable to offshore
banking were the Swiss banks, who, as we have seen, had a proud tradition of discretion and privacy,
and financial institutions located in small states with low taxation regimes, such as Luxembourg.
It is only in recent times that they have become accessible to any other than a privileged wealthy
minority. For example, for nearly thirty years after the Second World War, the British government
maintained currency exchange controls through which it was forbidden to convert more than a specified
maximum amount of pounds sterling into foreign currency. A British holidaymaker going on a package
holiday in the 1960s was only allowed to change up to £50, and the policy was rather clumsily and
inefficiently enforced by inspections at ports and airports.
Before the development of microchip technology and advances in information systems, operating one’s
affairs through offshore institutions was logistically cumbersome. The main means of communication was
the postal system, and it could take days or even weeks to correspond with offices located overseas.
Any advantages were quickly offset by the inevitable problems that would arise. Deposit protection
schemes were practically non-existent, so if an offshore institution went into liquidation, the investor
could lose everything. It is only in recent times that some offshore centres have introduced deposit
protection schemes.
Under such circumstances, offshore banking tended to attract wealthy individuals who would be
prepared to accept the risks associated with banking offshore as well as the fact that their funds would
be relatively inaccessible in the short term.
Various developments mitigated in favour of the development of the offshore banking sector:

Governments accepted that deregulation would be a catalyst for increased efficiency in markets.
As early as 1971, Anthony (later Lord) Barber, the British Chancellor of the Exchequer, introduced
a radical new framework for policy called ‘Competition and Credit Control’, which sought to free
financial institutions from many of the institutional constraints that limited their activities. By the
time this policy was launched, the United Kingdom had already committed itself to joining the
(then) European Economic Community, which has a founding principle of seeking to create
5
‘political, economic and monetary union’. Therefore, maintaining barriers to movements of capital
would be totally at odds with this principle.

A decade later, the report of the Wilson Committee advocated further lifting of the regulatory
burdens that faced the banking sector. The 1980s saw unprecedented deregulation as the
conventional demarcation between the activities of the various types of financial institution were
either removed or eroded by natural competitive forces.
Q U E S T I O N
T I M E
3
Now that exchange controls have been mostly eliminated within the European Union, is it permissible to
take very large amounts of cash, carried on the person, from one EU country to another?
6

Although there are some exceptions, most developed countries now freely permit inbound and
outbound flows of capital. The development of communications technology and the increased
availability of information on offshore banking products and services have made it impossible for
governments to exercise control without employing sophisticated systems and enormous numbers
of people.

Also in the 1980s, information technology had moved forward to the extent that computers were
becoming accessible to the general public. The first personal computers went on general sale in
1985, although they were very much more expensive than they are today in both real and
nominal terms. Inevitably, developments in the internet opened the door to on-line banking,
which by the end of the 1990s had become an almost universally accepted way of doing business.

Money transmission systems were introduced that made international payments less troublesome,
though not cheap. Recognising the limitations of the high volume, low value systems such as
foreign drafts, eurocheques and travellers’ cheques, the banks built on the existing domestic
electronic platforms such as BACS and CHAPS to make international payments facilitated by
messages transmitted through SWIFT more accessible. SWIFT is the Society for Worldwide
Interbank Financial Telecommunications.
Q U I C K
Q U E S T I O N
Is SWIFT a money transmission system?
SWIFT was founded in 1973 as a cooperative organisation, owned by its members. Although the SWIFT
system does not actually transfer money in itself, it enables banking institutions that have arrangements
between themselves to communicate with one another. In recent years, SWIFT has also played an
important role in software development.

Social trends had an important role to play in encouraging the growth of offshore banking. By the
1980s, the presumption of a ‘job for life’ had all but disappeared, which meant that people
became more mobile, often because they had to do so. They became prepared to change job
several times during a career, and this sometimes meant moving to other countries, or doing
business in several countries while with the same employer. Greater job mobility across
international frontiers is now assumed by many large companies. In order to reduce the political,
economic, social and cultural barriers to doing business internationally, many multinational
organisations adopt human resources policies that provide middle and senior managers with work
experience in several countries as part of the individual’s development. In this way, the business
creates greater understanding of the diversities across international market places, as well as
fostering a working climate that is more understanding in relation to international differences. The
workforce is also more flexible, in that managers can be transferred between different countries
as needs change over time.

In the last years of the twentieth century, people had already become more outward looking. The
package holiday had been around since the 1960s, so those who could afford to do so aspired not
only to holding foreign currency accounts but also even owning property overseas. Changes in the
political climate of central and eastern Europe further broadened the horizons of businesses that
sought to benefit from the opening up of new markets. It is perhaps significant that many people
first became aware of offshore banking opportunities by reading advertisements in the in-flight
magazines of charter airlines.

The incredible growth of the global economy has most certainly broken down the old parochial
and nationalistic attitudes of society, and more people than ever before are prepared to consider
the financial services that they purchase from the point of view of what the service will do for
them, as opposed to where the provider is located. While offshore banking was once mostly
focused on attracting lump sum deposits from high-end investors, there are now many banks of
all sizes offering practically a full banking service through their offshore subsidiaries. At the same
time, many long-established offshore centres have become better known and more accessible to
worldwide investors.

The financial services consumer has become less nationalistic and often more oblivious to the
broader implications of banking across frontiers over a relatively short period of time. For
example, the collapse of the Icelandic banking sector, and in particular the potential losses of
customers of Icesave (a brand owned by Landsbanki), demonstrate that a relatively small
7
institution (in global terms) from a relatively small country can attract a significant number of
customers if the product or service appears to be right for them.
Q U I C K
Q U E S T I O N
What are the attractions of offshore banking for the customer?
3
Rationale for offshore banking
Offshore banking may be attractive to the customer for one or more of the following reasons:

it may be possible to eliminate, reduce or defer tax liabilities in respect of income, , capital gains
or inheritance

it may be possible to receive interest on a gross basis and subsequently deal with any taxes
payable through self-certification

many offshore centres enable the client to establish and run legal entities such as limited
companies and trusts, with minimal bureaucracy and licensing requirements

some centres enable the client to set up special purpose vehicles (SPVs), thereby separating the
client’s affairs from those of the SPV

there is often no need for financial institutions and/or corporate structures to have a physical
presence in the offshore centre, except perhaps for a representative office

the client’s affairs are usually treated with a high level of discretion and confidentiality, particularly
in centres that traditionally guarantee secrecy.
The International Monetary Fund (IMF) believes that several factors continue to attract financial
institutions to offshore centres, including:

fiscal regimes that offer lower taxation and therefore increased profit margins

ease of set up, incorporation and reporting in respect of legal entities, particularly private limited
companies and trusts

regulations that safeguard principal-agent relations

proximity to major financial centres (such as Liechtenstein and Luxembourg)

tradition and reputation

freedom from exchange controls and other monetary restrictions.
These benefits must, of course, be supported by the underpinning needs of customers and a willingness
of customers to do business through such centres.
8
Q U E S T I O N
T I M E
4
For each of the bullet points above, identify an example of an offshore centre that features the
characteristic (starting with ‘fiscal regimes’).
4
4.1
Institutions and markets
Banking
Offshore banking providers offer some but not all of the products and services provided conventionally
by domestic providers. These are discussed more fully later in the book. Larger offshore banking
providers with a retail focus tend to concentrate on gathering savings and investments from their
customers, though most do provide a limited range of credit products.
Q U E S T I O N
T I M E
5
What factors would inhibit a UK-based retail bank from offering personal loans and credit cards through
an offshore subsidiary?
4.2
Investments
Offshore banking built its reputation on high balance, high interest investments, originally without the
safety net of domestic deposit protection schemes. In doing so, such providers face the obvious
disadvantage that arises when confidence in markets is low. For example, the stock market crash of
1987 saw a flight of capital away from institutions that were perceived to pose greater risk and in favour
of apparently safer havens for funds.
9
Offshore providers have been especially active in the market for collective investments. These products
enable many thousands of investors to pool their funds, which are then managed by professional fund
managers with a view to generating income, capital gains or both.
The operating model is simple. Investments are collected from several thousands of customers, either as
lump as sum investments or regular instalments. The customer buys shares or units in the fund at a
specified price. There is usually a choice of investment strategy for the investor, such as a ‘stable fund’
orientated towards low risk government bonds or an aggressively managed fund, which is more likely to
include a significant equity content. The funds are then invested with a view to generating income,
growth or a combination of income and growth. As the fund grows, investors can choose to stay in the
fund or sell their shares. If units are purchased in the fund, the price at which the fund is prepared to
buy them back should increase over time if the investment strategy is successful.
Conventional economics suggests that more aggressively managed funds propose higher growth
strategies at a higher risk, while more stable managed funds should realise more modest benefits but
with less risk. A major innovation of the last few years has been the managed fund, in which the fund
manager exercises discretion in pursuit of the aims of the scheme. Domestically, many life assurance
products with built-in investments (such as endowment policies) and personal pensions offer a managed
fund approach.
The best examples of collective investments in the United Kingdom are unit trusts and investment trusts
(and the relatively newer open-ended investment companies, or OEICs). In an international context,
these funds are often referred to as mutual funds, and the instruments offered come in many forms,
including SICAVs. This abbreviation can refer to the French term ‘société d’investissement à capital
variable’ or the Spanish equivalent ‘sociedad de inversion de capital variable’. They are the most common
forms of mutual fund in many northern and western European countries.
Mutual funds can be closed (available up to a maximum level of capitalisation) or open-ended (where the
provider can continue to create further equity stakes in the fund). The market for these funds has taken
an increasingly international dimension with the enactment of the EU’s UCITS Directive. UCITS
represents ‘undertaking for collective investments in transferable securities’, which is the generic term
used for indirect investments in most of Europe.
4.3
Private banking and wealth management
Many institutions provide focused products and services for high net worth individuals and wealthy
organisations. The service is invariably backed by access to high quality advisory services and a
willingness to deal with complex banking and other financial arrangements for clients. Private banking
and wealth management are discussed in a specific chapter later in the text.
Q U I C K
Q U E S T I O N
What is a trust?
10
4.4
Trusts
A trust is a legal entity that enables assets to be ringfenced, thereby reducing their exposure to tax
liabilities. By setting up a trust, the settlor creates rights in favour of a beneficiary, administered under
the control of one or more trustees. Trusts can be especially effective in mitigating income tax, capital
gains tax and inheritance tax liabilities.
Many countries have created specific structures within which trusts can operate effectively, with minimal
bureaucracy and costs. One example of this is the Foundation, which can be created under the laws of
the Bahamas. It is a legal entity that resembles a trust, but has many of the characteristics of a limited
company, in that there is no limit to the life of the entity and it is managed in most cases under the
Foundation Articles (similar to the articles of association of a limited company). The entity is given legal
recognition by legislation (the Foundations Act 2004) and is incorporated by registration with the
government of the Bahamas. The minimum capital requirement is only $10,000 (Bahamas dollars).
The Foundation is a good example of an investment vehicle that has state support, with a view to
bringing funds into the country. The legislation addresses the sensitive issue of confidentiality, as the
founder’s names do not have to be registered, whilst maintaining a relatively high standard of
compliance in relation to international anti-money laundering and terrorist financing laws. Importantly,
the entity is protected by investor protection laws, notably fraudulent dispositions legislation.
Foundations can be created under the explicit wishes set out in the will of a deceased person.
4.5
Limited companies and special purpose vehicles
Offshore banking institutions often benefit from the characteristics of legislation in specific offshore
centres that offers the opportunity to establish limited companies and special purpose vehicles.
A limited company is an ‘artificial legal person’ that exists independently of the owners (members or
shareholders) and those who manage it (the directors). As such, income and capital gains generated are
identifiable with the entity and not the members or management. It is only when such income or gains
are transferred to the individual that potential liabilities to tax arise.
Q U I C K
Q U E S T I O N
What is the significance of a company being a separate legal ‘person’?
The significance of separate legal personality is that assets owned and liabilities incurred by a company
are completely separated from the members or shareholders. The same applies to the income and
expenditure generated by the company. In the UK, as in many other countries, it is possible to establish
a private company with just one member and one director, and they can usually be the same person.
This means that the individual member/director can choose to do business through the company or in
their own name.
For example, profits generated by the company may be subject to corporation tax, while only the wage
or salary drawn by the individual, and any dividends declared and paid to that individual, will be subject
to income tax. Depending on the personal and corporate taxes regime in the country of domicile of the
11
individual and that of the company, business dealings can be organised to minimise tax liabilities. It also
means that if the company runs into financial difficulties, the individual investor is shielded from potential
insolvency to some degree. Quite often, the directors lend money to the company rather than taking
shares in it, as in the event of liquidation the creditors are paid ahead of the shareholders.
Q U I C K
Q U E S T I O N
If a bank is approached by a customer who wishes to raise credit in the name of his company of which
he is the only director and the only shareholder, what special steps should the bank take to minimise the
risks that would arise from sanctioning a loan?
In order to comply with internationally accepted anti-money laundering and terrorist financing
obligations, the bank would have to request information from the individual in respect of his company as
well as personal information. For example, it would have to check the registration details of the company
to ensure that it is properly incorporated and it would have to ensure that the applicant was a bona fide
director and shareholder. The underpinning principle is that the bank has to determine the ‘mind and
management’ of the company. The director/shareholder would have to submit confirmation of identity.
All this information would then have to be verified.
If the loan was to be made in the company’s name, it would be common practice to request that the
director/shareholder sign a personal guarantee, ensuring that if the company did not pay, the guarantee
could be called in. If the director/shareholder had already made loans to their own company, the bank
could also insist that they subordinate their own claims against the company to the bank’s claims arising
from the loan.
There are special problems arising from propositions such as this when the loan is sought by a person or
company residing in a different jurisdiction to the bank itself. For example, the bank could find it difficult
or impossible to carry out electronic searches of the credit file of the individual, and could encounter
similar differences when carrying out a companies registry search in the company’s home state.
A loan application of this type can be supported by a personal guarantee, by a back-to-back arrangement
against cash deposited elsewhere or by taking collateral over land, securities or other assets.
Many offshore centres have quick and efficient company formation procedures, with little bureaucracy.
As such, they have become very attractive as a means of holding assets and doing business. For
example, many hundreds of companies whose primary business activities are carried out in Hong Kong
are actually registered in the British Virgin Islands.
In particular, such locations usually offer:
12

speed of registration and incorporation

low costs of registration

few reporting requirements (for example, in some countries companies do not have to submit an
annual return to the government)

low tax regimes in respect of corporation taxes or equivalent.
Therefore, an individual can establish such an entity at an offshore location and transfer an asset or
range of assets to the entity, knowing that when income or capital flow inward to the owner only then
will potential liabilities arise and duties become payable.
The term ‘special purpose vehicle’ (or SPV) is more generic in that the entity may be a company or other
form of business. For example, some SPVs are limited partnerships. In many cases, SPVs are used to
hold assets in order to shield the original owner of the assets from potential risk, including that which
may arise in the event of insolvency.
An SPV may be owned by:






an individual
several individuals
a company
several companies
a trust
a not-for-profit association.
SPVs can be set up to minimise tax or to shield the individuals or entities that establish them from being
identified with the assets, transactions or other activities.
4.6
Insurance
From a retail perspective, offshore markets in insurance for personal customers have been relatively slow
to develop. For example, it is still unlikely that an individual or family will find an offshore provider willing
to insure their car, though the company they use may be a UK subsidiary of an overseas company.
Many corporate bodies establish captive insurance companies as part of their risk management
strategies. These are insurance companies that are owned by other companies, or in association with
other companies. The captive may be able to write policies in relation to risks that would be difficult to
underwrite through existing domestic channels.
Certain specialist markets have distinctive global characteristics. The reinsurance market, for example,
would find it extremely difficult to function if it was not possible to spread risks on a global basis.
13
KEY WORDS
Key words in this chapter are given below. There is space to write your own revision notes and add any other
key words or phrases you want to remember.









14
Offshore centres
Exchange controls
SWIFT
Collective investments
SICAV
UCITS
Private banking
Wealth management
Captive insurance company
REVIEW
Now consider the main learning points which were introduced in this chapter.
Go through them and check that you fully understand each point.

The term ‘offshore banking’ refers to the provision of banking services between a customer located in
one jurisdiction and a financial services provider located in a different jurisdiction.

An offshore centre is a territory that offers an environment conducive to the provision of offshore
banking services. Offshore centres may be island territories, but many established centres are actually
landlocked states.

Historically, offshore banking provided high-end services to a wealthy minority, with emphasis on the
provision of high value lump sum investment accounts, often not protected by deposit protection
schemes.

Many factors have contributed to the expansion of offshore banking, including deregulation,
developments in communications technology, social trends and globalisation.

In addition to providing conventional retail banking services, offshore centres offer investments, some
forms of credit and niche services such as private banking and wealth management.
Various innovations enable the benefits of offshore banking to be realised in tax-efficient ways, including
trusts and special purpose vehicles.

15
16
chapter 2
REGULATION
Contents
1
The need for regulation ............................................................................................. 19
2
Incorporation and licencing ........................................................................................ 20
3
Capital adequacy ...................................................................................................... 22
4
Money laundering ..................................................................................................... 23
5
Customer due diligence ............................................................................................. 29
6
Risks associated with specific types of financial service ................................................. 33
7
Organisation for Economic Cooperation and Development (OECD)................................... 39
8
Financial Action Task Force (FATF).............................................................................. 39
9
Other relevant bodies ................................................................................................ 43
10 International cooperation on taxation .......................................................................... 45
11 UK Independent Report on Offshore Centres ................................................................ 46
Key words ..................................................................................................................... 50
Review ......................................................................................................................... 51
17
Learning objectives

explain the reasons why it is necessary to regulate offshore banking activities

describe the difficulties experienced by national and supranational regulatory bodies in attempting
to regulate offshore banking activities

explain why banks have to be properly incorporated and licenced

list the principles underpinning capital adequacy and describe the main features of the systems
developed by the Bank for International Settlements

explain the role of the Organisation for Economic Cooperation and Development in seeking to
regulate offshore banking

define money laundering and terrorist financing, and understand how these crimes are
perpetrated

explain the steps typically taken by offshore banks to reduce the risks of money laundering and
terrorist financing

explain the purposes and functions of the Financial Action Task Force

explain what is meant by ‘tax evasion’ and ‘tax avoidance’, and distinguish between the meanings
of these terms.
Introduction
This chapter sets out the purposes of regulation and describes policies and initiatives implemented by
various bodies, including governments and private organisations, to regulate offshore banking activities.
Offshore banks cannot be regulated in a consistent manner, as they are located in many different
countries, all of which have their own idiosyncratic laws and sets of rules. However, this does not mean
that they cannot be regulated, and there are few jurisdictions in the world where financial institutions
can do as they wish, entirely unhindered by government actions.
In order to survive and then prosper, financial institutions need capital. In this chapter we define capital
and discuss why it is necessary. We then consider capital adequacy requirements in the context of the
framework developed by the Bank for International Settlements.
It is a popular myth that offshore banks pursue liberal policies in order to achieve their primary economic
objectives. This is a simplistic view, as it is now almost impossible for financial institutions to escape from
the gaze of regulatory bodies, even if they wish to do so. Various initiatives have been introduced in
recent years to ensure that the practices of offshore institutions comply with generally accepted legal
principles as well as ethical and moral values. The need to regulate, of course, became only too apparent
with the escalation of terrorist activities in the early years of the twenty-first century. Terrorist activities
cannot be effective without funding, so it has become imperative for governments, individually and in
concert with one another, to close off opportunities to use financial systems for these illegal purposes.
Q U I C K
Q U E S T I O N
Why is it necessary to regulate the banking sector? What would be the potential consequences of having
no regulations in place?
18
2: REGULATION
1
The need for regulation
Banking is inherently a business in which decision takers have to balance return with risk. A substantial
proportion of funds that pass through the banking system belongs to personal and corporate customers,
and not the institutions themselves. This implies a duty to maintain consistently high levels of integrity
from a position of trust.
Banks have to be profitable in order to satisfy their shareholders, who own the business and expect a
return on their investments in equity. Mutual organisations, owned by their members, have a similar
responsibility. Without regulation, institutions could adopt high risk strategies that could endanger the
wealth of their stakeholders, as well as future cash flows that their stakeholders should reasonably
expect through payments of dividends and interest.
As the raw material with which banks operate is money, opportunities arise for criminals to use the
banking system to pursue illegal objectives. The exposure to such risks is arguably greater now with the
evolution of globalisation and the ease with which vast sums of money can be transferred between
different countries and across all continents.
Financial institutions always have to be mindful that customer perceptions are vitally important in order
to maintain confidence of investors and markets. Reputations that are built over several decades or even
centuries can be severely damaged within a single day. The recent credit crisis has provided timely
reminders that an otherwise trusting public can become hostile within a relatively short time.
The underlying purposes of regulation are summarised by the three statutory objectives of the Financial
Conduct Authority, which protects consumers in the UK financial services sector:

protect consumers

enhance integrity of the UK financial system

help to maintain competitive markets and promote effective competition in the interests of
consumers.
These objectives would be appropriate if there happened to be a sole regulator for international banking
operations. However, there is little consensus between individual countries on how regulation should be
structured and applied. Most countries acknowledge that it is impossible to develop a comprehensive set
of rules that would endure in anything but the short term, and therefore favour a principles-based
approach. Given the huge differences that exist between the regulatory systems, it is hard to envisage
an integrated regulatory framework that would satisfy all needs and circumstances, so much effort is
made to create and maintain universally acceptable general principles that will be sufficiently robust and
permanent. On the other hand, some countries are more comfortable with a more prescriptive, so-called
rules-based approach, where ‘hard and fast’, binding practices are imposed. Such an approach has been
favoured by the United States, especially in reaction to crises.
Q U E S T I O N
T I M E
6
You have probably come across the USA’s Sarbanes-Oxley Act in the course of your studies. Why was
this introduced and what are the implications for banking institutions?
19
2
Incorporation and licencing
Incorporation is the process of creating a business that has a separate legal personality in law. Nearly all
banking institutions are incorporated. This is achieved by setting up an organisation and registering it
with an appropriate governmental authority.
In the UK, the relevant body is Companies House which maintains comprehensive public files on all
companies registered in the UK. As its name suggests, the public file can be searched by any member of
the public, who can obtain basic details of every company. Additional details may be accessed on
payment of a nominal fee. Companies House has offices in Cardiff, Edinburgh and Belfast, though most
people who need access to files can obtain information on-line at www.companieshouse.gov.uk.
Nearly all countries have a similar registry, though the extent to which files may be searched varies. It is
also important to note that reporting requirements also vary. In the UK, all companies have to file an
annual return and basic financial accounts, but this is not the case in all countries.
The implication of having a separate legal personality is that the body can own its assets and incur
liabilities on its own behalf. It can enter into contracts and be accountable for civil wrongs. It can sue
and be sued in its own name. At the same time, the shareholders enjoy limited liability, in that in the
event of insolvent liquidation they only stand to lose the value of their equity investments (and any
deposits held that are not fully covered by deposit protection schemes).
Most large banking institutions are public limited companies whose shares are listed on a recognised
capital market, such as the London Stock Exchange. They usually have many thousands of shareholders,
some of whom are personal investors and others are institutional investors, such as other banking
institutions, insurance companies and pension funds.
The other common corporate form is the private limited company, in which the shares cannot be publicly
traded. Most smaller institutions and some larger ones prefer to adopt this model of operation. As there
is less separation between ownership and management, most legal jurisdictions impose less onerous
laws than those applicable to public limited companies. Many offshore banks are wholly or partly owned
subsidiaries of larger banking groups. In such cases, the institutions is usually a private limited company.
Many offshore banks have their registered offices in countries that have simplified incorporation
procedures and minimal annual reporting requirements. For example, several Caribbean island countries
enable investors to buy companies ‘off the shelf’ for a small fee, and thereafter operate as a name on a
register, with no formal annual reports submitted. Companies can often be established with one
shareholder who can also be the sole director, though it would be extremely rare for a bank to operate in
this way.
Recent initiatives by international organisations have sought to limit the ability to establish and operate
so-called ‘shell banks’, which are privately owned and often managed from personal residences of
powerful individuals. It is important to note that even if a company is a wholly owned subsidiary of a
larger banking group, it has a separate personality in law from that of its parent. If the subsidiary is
registered in an offshore centre, it is the law of that offshore centre and not the jurisdiction of the parent
company that dictates how it operates. In practice, however, the operating philosophy of the subsidiary
will often closely mirror that of the parent company.
20
2: REGULATION
Q U I C K
Q U E S T I O N
If a subsidiary company of a large banking group becomes insolvent, what effect would this have on the
parent company?
As implied in the previous paragraphs, the subsidiary company has a separate personality from its owner,
and so the insolvency of the subsidiary will not necessarily bring down the parent company. There would
be an adverse effect on the statement of financial position (balance sheet) of the parent company, as it
would by definition own the shares of the subsidiary, which would become worthless on insolvency.
C A S E
S T U D Y
The effects of insolvency were demonstrated by the collapse of the Insurance Corporation of Ireland in
1985, a subsidiary of Allied Irish Banks plc, then the largest clearing bank in the Republic of Ireland.
If the parent company had to take responsibility for the insolvent company, in this instance it could have
brought down AIB. The losses of the insurance company were eventually met through a levy imposed by
the Irish government on insurance premiums. The cost to the Irish taxpayer exceeded £400 million.
Depending on the jurisdiction in which an offshore bank is located, it may need to obtain a banking
licence in order to operate (for example, within the European Union, there is a standard banking licence
requirement under the Second Banking Coordination Directive). In addition, it may also need to be
authorised by a central bank or financial regulator, or obtain permission to offer specific products and
services.
Q U I C K
Q U E S T I O N
What do you understand by the term ‘capital’? And what is meant by ‘capital adequacy’?
21
3
Capital adequacy
Today, the financial operations of most banking institutions are driven by the statement of financial
position (balance sheet), or asset and liability management. A minimum expectation is that they will
maintain adequate capital to meet unforeseen losses.
The capital of a bank is:

the value of the original funds invested in the bank by its shareholders (not the current market
value of its shares)
plus

reserves (retained profits over all the years that the company has operated)
plus

any other resources that can be designated as capital.
This capital is not a cash buffer. It is a measure of net worth, representing a liability to the owners of the
company. Theoretically, if the bank liquidated all of its assets and repaid all of the obligations due to
third parties, the capital would remain. This ignores, of course, the reality that the statement of financial
position is only meaningful if the institution it represents remains a going concern.
As well as retained profits, there are other liabilities that may be regarded as capital. One example is
subordinated debt, which is borrowing from providers of long term funding who agree to relegate their
claims against the company to the extent that they will be paid back their capital after all other
obligations have been met in the event of insolvent liquidation.
Some of the banks that were previously building societies have inherited permanent interest-bearing
shares (PIBS) from their former operations. PIBS are not available over the counter but are purchased
through stockbrokers. They can be bought and sold in the secondary market. They usually pay a fixed
rate of interest. PIBS are undated, which means that although they can be bought and sold, they cannot
be cashed by the holder unless the issuer chooses to redeem them. As they are permanent capital, they
are repaid after all other obligations in the event of the insolvency. They are said to be subordinated to
the interests of all other claimants and may therefore be regarded as capital.
International capital adequacy rules are laid down in the Basel Accord, which is an international
agreement created by the Bank for International Settlements (BIS). The BIS is a supranational body that
was established by the central banks of major trading nations to promote international cooperation
between them. It should be noted that some offshore banks do not adhere to internationally recognised
capital standards.
As there have been two versions of the Basel Accord, the most recent set of rules is commonly referred
to as Basel II, although Basel III has been agreed and is being introduced during 2013. This agreement
proposes a risk-weighted approach. A financial institution that has commercial assets with a high risk
profile is expected to maintain a higher level of capital commensurate with that level of risk. Conversely,
a financial institution with a lower risk profile is expected to maintain a comparatively lower level of
capital.
22
2: REGULATION
Q U E S T I O N
T I M E
7
What factors should be considered when assessing the quality of an offshore bank’s mortgage book?
The European Union has regulations that reflect the principles of the Basel Accord. The main Directives
relevant to this section are:


the Own Funds Directive
the Solvency Ratio Directive.
The solvency ratio is a measure of the capital that should be maintained to comply with normal
prudential standards. ‘Own funds’ are the categories of capital that may be regarded as such. The level
of own funds is used to calculate the solvency ratio. The solvency ratio, when calculated with reference
to the risk-weighted assets of a financial institution, should be equal to or greater than 8%.
As explained earlier, mortgage assets are subject to lower levels of default, and hence lower risk, than
many other types of loan. However, not all mortgages are the same. For example, commercial
mortgages are usually more risky than residential mortgages.
There are other risk factors, including:





historic lending policies reflected in the current loan book
size of loan
nature of the security
concentration within specific geographical areas
quality of recovery and default procedures.
In the UK, the Prudential Regulation Authority adopted a proactive approach to the capital adequacy of
financial institutions by conducting a rigorous analysis of each institution’s financial position and
performance and setting a capital requirement for each on an individual basis. This is referred to as the
threshold ratio. However, this ratio is a minimum standard and management is not absolved from the
responsibility of maintaining a higher ratio if market conditions so dictate.
The Independent Commission on Banking (the Vickers Report) has recommended rigorous new
standards to reduce capital risk further.
The capital position should be the starting point for the management of assets and liabilities. The
financial plan has to ensure that capital balances on both sides of the statement of financial position
must be capable of enabling the organisation to remain within the required capital adequacy limits.
4
Money laundering
Money laundering is the process through which the monetary proceeds of criminal activities are
converted into financial assets that appear to have a legitimate origin. The term ‘laundering’ is used by
way of analogy to suggest that these illegally acquired assets are ‘cleansed’ by filtering them through the
monetary system, just as dirty washing is cleaned in a conventional laundry.
23
By engaging in money laundering, criminals are able to avoid prosecution and continue their illegal
activities. Until they are exposed and brought to account before the law, crime does indeed pay,
sometimes very richly indeed. Money laundering is a criminal offence with major implications for all
financial institutions, other organisations and those who work for them.
Q U I C K
Q U E S T I O N
Who is responsible for minimising the opportunities for money laundering in the UK financial services
industry?
Money laundering laws are applicable not only to the financial institution but also to everyone who works
for the organisation. For most actions by employees in the normal course of their duties, the law
recognises the concept of vicarious liability, which means that the employer takes responsibility for the
actions of the employee. Under the money laundering regulations, both the organisation and the
individual can be held accountable. In the UK, the Crown Prosecution Service can therefore indict not
only the organisation but also every individual who fails in their duties as laid down in the legislation.
Q U I C K
Q U E S T I O N
Why are money laundering regulations so heavily focused on activities of financial services organisations?
Financial institutions are the conduits through which illegal funds must pass. If they do not, the criminal
activity will probably remain small scale and remain of relatively little concern to the authorities. All
financial institutions are exposed to these activities, with the favourites being banks, insurance
companies and securities firms. Billions of pounds of transactions pass through these organisations every
day, and it is simply impossible to track every one of them.
Attempts to prevent money laundering have been likened to trying to repair a leaky garden hosepipe –
as soon as the hole in the pipe is repaired by the gardener, three more appear.
24
2: REGULATION
Money laundering is especially relevant to offshore institutions. Some nations’ financial institutions have a
well-established reputation for secrecy and historically this has given those who have had the opportunity
to place illicit funds ample opportunity to do so with little or no risk of detection.
In today’s sophisticated economy in which many organisations have a global focus, it is generally
acknowledged that technology has created more challenges in containing the level of criminal activity.
Just as information technology specialists accept that hackers and other abusers of computer systems
are ahead of those trying to prevent them creating their havoc, those who seek to disguise the origins of
illegally obtained funds continually develop new methods of achieving their objectives.
4.1
The money laundering process
The process of money laundering follows three broad stages:
4.1.1
Placement
This involves the initial disposal of the proceeds of criminal activity into an apparently lawful business
activity or property.
E X A M P L E
A drug trafficker acquires a run-down semi-professional football club as the only shareholder and only
director. Under UK company law, it is possible to operate a private limited company on this basis.
This is a cash-driven business in which money enters the company principally through gate receipts paid
by spectators. Assuming that supporters pay £10 admission to a match, the gate receipts can be inflated
by 750 persons – any more may prompt suspicion from those who can judge the size of a crowd by
observation.
This gives the criminal the opportunity to deposit £7,500 of illicit funds with the football club’s bankers on
average every fortnight (the average frequency of home games). Further laundering could be achieved in
the same company by placing additional funds in non-existent takings at the club shop, refreshment
kiosks, bars, programme sellers and other cash handling outlets.
This is an actual example of a fairly simple money laundering operation that was terminated only by the
vigilance of the local police force and special branch officers.
Q U E S T I O N
T I M E
8
Why did the criminal choose a small, semi-professional football club? Surely a larger one would have
more money running through its accounts and the crime would have been more easily achieved?
25
4.1.2
Layering
This involves transferring money from business to business, thereby concealing the initial source. Having
placed the money, the funds are spread out so that those who handle the funds are completely unaware
of their origins.
In the above example, some of the funds could be deployed in wages and salaries, renovations of the
stadium, taxes, repayments of loans and other normal expenditure of the business. However, the funds
are of no use to the criminal if they are spent on these activities that bring no personal gain. Therefore,
the criminal may combine funds in different placement accounts into larger accounts to disguise their
origins.
It is generally accepted that the most efficient way of achieving this is through electronic transfers to
different financial institutions. In fact, the banking system offers a tempting range of options – BACS and
CHAPS enable the funds to be transferred within the UK and SWIFT is the ideal vehicle for moving funds
out of the country.
Layering can in fact be a very complex process. For example, the funds may be placed in an offshore
account and this can then be used as security for a loan in another country. In the past, some criminals
have used funds deposited in a Swiss bank as a fund to guarantee borrowing in a different country. The
criminals would choose Switzerland for its historical commitment to maintain confidentiality through
numbered bank accounts, but also because many Swiss banks have a good reputation internationally. If
the Swiss bank were prepared to offer a supported guarantee (backed of course by its customer’s
deposit), a bank in a different country would regard this as a very secure base on which to take a
lending decision. Therefore, apparently legitimate borrowings in one country are raised using illegal
funds as surety.
Prior to the enactment of money laundering regulations, another popular placement activity was buying
long term life assurance, often through a single premium investment. Who is going to suspect a lump
sum payment to the policyholder twenty-five or thirty years later?
4.1.3
Integration
This is the final stage of the money laundering process and involves the transfer of layered funds. By this
time, the criminal hopes that the funds become untraceable to their original source and can be used
apparently legitimately once filtered into international financial markets.
For non-cash money laundering, it is not necessary for the criminal to go through the three stages at all,
but simply to conceal and disguise the funds.
4.2
The main offences
Money laundering laws differ from country to country. Under the Proceeds of Crime Act 2002, in the UK
there are three major offences:



laundering the proceeds of crime
failure to report knowledge or suspicion of money laundering
tipping off the suspected money launderer.
These offences are broadly similar to those defined in most other countries.
4.2.1
Laundering the proceeds of crime
The Act defines what is meant by ‘criminal property’ as:
‘… property which the alleged offender knows (or suspects) constitutes or represents
benefit from any criminal conduct.’
(section 340(3))
26
2: REGULATION
In turn, ‘criminal conduct’ is conduct that:
‘… constitutes an offence in any part of the United Kingdom, and would constitute an
offence in any part of the United Kingdom if it occurred there.’
(section 340(2))
The Act states that it is an offence to:
‘… conceal, disguise, convert, transfer or remove criminal property from the United
Kingdom.’
(section 327)
The first two of these activities may involve concealing or disguising the nature, source, location,
disposition, movement or ownership, or any rights connected with it.
Q U I C K
Q U E S T I O N
Is there any difference between ‘conceal’ and ‘disguise’? Define both terms.
Concealing something is hiding it, whereas disguising something is making it appear to be something
other than it is. It is possible to conceal funds without disguising them, and vice versa.
There are several defences that may be accepted when such potential breaches occur. For example, an
offence is not committed if:

an authorised disclosure is made as soon as possible after the transaction has been effected

the disclosure is made before the act take place and the person making the disclosure has
obtained appropriate approval

there was a reasonable excuse for not disclosing.
Offences committed in respect of these matters are punishable with a fine and up to 14 years
imprisonment.
The police often have to take possession of the alleged illicit funds by transferring them to an interestbearing account.
Q U E S T I O N
T I M E
9
Criminal law in the UK assumes innocence before guilt is proven. Is taking possession of funds of a
person who has not yet been convicted consistent with this principle?
27
4.2.2
Failure to report knowledge or suspicion of money laundering
Under sections 330-332 of the Proceeds of Crime Act, it is an offence not to report a person who is
known or suspected to be engaged in money laundering. The report must be made to the appropriate
authority.
The offence of failure to report applies to individuals who are acting in the course of business in any
sector regulated by the legislation.
The appropriate authority may be:


the Money Laundering Reporting Officer or other nominated person of the organisation, or
the Serious Organised Crime Agency (SOCA).
In a banking organisation it is likely that the report will be made to the Money Laundering Reporting
Officer. All financial institutions have written procedures in place and are obliged to ensure that staff are
familiar with these and updated on them on a regular basis.
The Money Laundering Reporting Officer takes appropriate action under the policy of the organisation,
and is obliged to document his/her conclusions and pass on information to SOCA as soon as practicable if
it is considered that the suspicions are well founded. Failure to do so is also an offence under the same
section of the Act. These obligations are set out in detail in the money laundering regulations.
SOCA is the unit responsible for collecting and disseminating information relating to money laundering
specifically and financial crime generally in the UK.
Offences relating to failure to report are punishable with a fine and up to five years imprisonment.
4.2.3
Tipping off
Under section 333 of the Act, it is an offence to make a disclosure that may prejudice a money
laundering investigation that is being undertaken or is about to be undertaken. This arises if the
individual on whom the report is made is alerted to the fact that internal processes have been triggered
or if a report is to be made to SOCA. By tipping off the individual it is possible that this may enable action
to be taken that will endanger the prospects of gathering relevant evidence.
The Act specifies that the person who tips off the customer may offer the defence that he/she did not
know or suspect that the disclosure would prejudice the investigation or future investigation.
Tipping off is punishable with a fine and up to five years imprisonment.
Q U E S T I O N
T I M E
1 0
Which individuals working in a banking environment are most likely to be in a position to tip off?
28
2: REGULATION
5
Customer due diligence
Customer due diligence, or CDD, forms the backbone of policies to reduce the risks of money laundering
and terrorist financing. In the UK, CDD processes were introduced by the Money Laundering Regulations
2007. These replaced the former ‘Know Your Customer’ regime, administered under the Money
Laundering Regulations 2003.
Section 5 of the 2007 Regulations defines the meaning of CDD measures as follows:
(a)
identifying the customer and verifying the customer’s identity on the basis of documents, data or
information obtained from a reliable and independent source
(b)
identifying, where there is a beneficial owner who is not the customer, the beneficial owner and
taking adequate measures, on a risk-sensitive basis, to verify his identity so that the relevant
person is satisfied that he knows who the beneficial owner is, including, in the case of a legal
person, trust or similar legal arrangement, measures to understand the ownership and control
structure of the person, trust or arrangement; and
(c)
obtaining information on the purpose and intended nature of the business relationship.
‘Beneficial owner’ can have several different meanings, depending on the type of entity. Section 6 of the
Regulations elaborates on this by providing the following definitions:
Type of entity
Definition of beneficial owner
Company other than listed plc
One who directly or indirectly owns or controls more than 25% of the
voting rights
Partnership other than LLP
One who ultimately is entitled to or, directly or indirectly, controls
more than a 25% share of the capital, profits or voting rights, or
otherwise exercises control over the partnership
Trusts that benefit individuals
Any individual with a specified interest in at least 25% of the capital
of the trust property, or any individual who has control over the trust
Trusts other than those that
The class of person in whose main interest the trust is set up or
benefit individuals
operates, or any individual who has control over the trust
Regulated firms must apply CDD measures when:

establishing a business relationship

carrying out occasional transactions (as defined in the regulations)

money laundering or terrorist financing is suspected

doubt exists as to the veracity or adequacy of documents, data or information previously obtained
to support identification or to verify identity.
CDD measures must also be instigated at other appropriate times on a risk-sensitive basis. However, the
regulations make specific provision for CDD to be applied to all anonymous accounts and passbooks on
or after 15 December 2007 before they are used. This continues to be relevant to accounts that have
remained dormant since the implementation of the regulations.
The risk-based approach means that firms must make an informed but ultimately subjective judgement.
This will be influenced by the type of business relationship, product or transaction.
The regulations make it clear that CDD should be applied not only when forming business relationships
and carrying out transactions, but also in actively monitoring relationships. Firms are expected to carry
29
out ongoing monitoring, exercising appropriate scrutiny in relation to sources of funds and the
consistency of transactions with the customer’s business and risk profile.
Documents, data and information used to carry out CDD must be kept up to date.
5.1
Timing of verification
Identity must generally be verified before a business relationship comes into existence, or an occasional
transaction is made. However, it may be verified during the process of forming the business relationship
if this is necessary in order not to interrupt the normal course of business, or if there is little risk of
money laundering occurring. In such cases, verification must be completed as soon as is practicable.
In relation to life assurance contracts, verification may be completed once the business relationship has
been formed, but it must take place before any payout on the policy or before any other right vested in
the policy is exercised. Likewise, the verification of identity of a bank account holder can be carried out
after the account has been opened, but this must be done before any transactions are carried out by the
holder, any withdrawals are made, or the account is closed.
5.2
Requirement to cease transactions
If a regulated firm is unable to apply CDD to a customer, it must:

not carry out a transaction with the customer or on their behalf through a bank account

not form a business relationship or carry out an occasional transaction with the customer

terminate any business relationship with the customer

consider whether a disclosure should be made to the enforcement authorities under the Proceeds
of Crime Act 2002 or the Terrorist Act 2000.
These requirements do not apply to certain professional advisers in relation to some of their duties.
5.3
Simplified CDD
Certain relationships and transactions pose a lower risk, as they are carried out with organisations which
themselves are regulated firms or public authorities. In such cases, the provider must confirm that the
relationship or transaction is indeed eligible for simplified CDD.
The following qualify for simplified CDD:

a credit or financial institution which is subject to the requirements of the Money Laundering
Directive
30

a credit or financial institution in a non-EEA state which is supervised for compliance with
requirements equivalent to the Money Laundering Directive

companies listed on a regulated EEA state market or a non-EEA market which are subject to
disclosure obligations

beneficial owners of pooled accounts held by a notary or independent legal professional (financial
services firms are not required to apply CDD to the third party beneficial owners of omnibus
accounts held by solicitors, provided the information on the identity of the beneficial owners is
available upon request)

UK public authorities

a non-UK public authority which:
–
is entrusted with public functions pursuant to the treaty on the European Union or the
Treaties on the European Communities, or Community secondary legislation
–
has a publicly available, transparent and certain identity
2: REGULATION
–
has activities and accounting practices that are transparent
–
is accountable to a community institution, the authorities of an EEA state or is otherwise
subject to appropriate check and balance procedures

certain insurance policies, pensions or electronic money products

products where:
–
they are based on a written contract
–
related transactions are carried out through a credit institution which is regulated under
the Money Laundering Directive or subject to equivalent requirements
–
they are not anonymous
–
they are within relevant maximum thresholds under Schedule 2 of the Money Laundering
Regulations
5.4
–
realisation for the benefit of a third party is limited
–
investment in assets or claims is only realisable in the long term, cannot be used as
collateral and there cannot be accelerated payments, surrender clauses or early
termination.
Enhanced CDD
This term refers to the more rigorous verification processes that must be applied to higher risk business
relationships. The grounds on which enhanced CDD must be applied are set out in section 14 of the
Money Laundering Regulations.
Enhanced CDD must be applied when:

the customer has not been physically present for identification purposes

proposing to deal with a correspondent bank from any non-EEA state

conducting a business relationship with, or carrying out an occasional transaction for, a politicallyexposed person.
When dealing with persons who are not physically present, a firm must take specific and adequate
measures to compensate for the higher potential risk. These might include ensuring that the person’s
identity can be confirmed by additional documents, data or information, supplementary measures to
verify the information submitted, confirmatory certification by a credit institution that is subject to the EU
Money Laundering Directive, and/or ensuring that the first transaction is carried out through an account
opened in the customer’s name with a credit institution.
When dealing with another institution outside the EEA for the purpose of correspondent banking, the
firm is expected to undertake rigorous checks including:

gathering sufficient information on the counterparty in order to understand the nature of its
business

determining from publicly available information the reputation of the counterparty, and the quality
of supervision to which it is accountable

assessing the institution’s anti-money laundering and terrorist financing controls

obtaining approval from senior management before establishing any new relationship

documenting the responsibilities of both parties to any agreement between them

being satisfied that, in respect of those of the respondent’s customers who have direct access to
accounts of the correspondent, the respondent has verified the identity of, and conducts ongoing
monitoring in respect of, such customers; and is able to provide to the correspondent, upon
31
request, the documents, data or information obtained when applying customer due diligence
measures and ongoing monitoring.
Q U I C K
Q U E S T I O N
What risks arise when seeking to verify identity?
5.5
Putting anti-money laundering policies into practice
In order to reduce the risk of offshore accounts being used for criminal purposes, banking institutions
invariably take various steps, when the account relationship is initially formed and thereafter.
It is standard practice to gather information in order to satisfy CDD requirements generally applied by
most regulatory regimes. This usually involves some or all of the following:

gathering evidence of identity from the applicant

verifying the evidence of identity submitted by the applicant

seeking information from institutions with which the applicant already has a banking relationship
(it would be unusual for an applicant not to have an existing banking arrangement elsewhere)

obtaining the applicant’s consent to make submissions of information to relevant authorities

obtaining the applicant’s consent to make manual and electronic checks as appropriate

where appropriate (such as offshore banks operating within the European Union), confirming that
deductions of withholding tax will be made in the absence of evidence that this should not be
done

confirming to the applicant that the bank may make the information submitted available to other
service providers in the same marketing group

informing the applicant that the application may be declined, or services provided suspended, if
the requirements in respect of validation of information on identity proves unsatisfactory.
No identification and verification policies can be absolutely effective. The general risks that apply to all
forms of identity documentation are:
32

the person using the document could be assuming the identity of another living person with a
different name, with or without that person’s consent or knowledge

the documentation may relate to a different person of the same name, again with or without that
person’s consent or knowledge

the documentation may relate to a recently deceased person

most documents can be forged (with varying degrees of complexity or difficulty)
2: REGULATION

the documentation submitted may be in a foreign language or different foreign languages.
The test generally applied when considering whether know your customer policies are sufficiently sound
and robust is that the system should provide reasonable assurance that its objectives will be achieved.
In all cases, firms should request a range of documents rather than rely on one single source of
identification. To overcome some of these difficulties, it may be necessary to combine documentary
evidence with electronic checks. Offshore banks may however be constrained in the extent to which they
can use electronic checks due to their limited access to relevant databases.
Once an account relationship has been formed, the banking organisation must monitor the conduct of
the account to minimise the prospect of the facility being used for illegal purposes. Therefore, it is
necessary for the institution to have systems in place through which suspicious activity reports can be
generated and acted upon. These policies are formulated at the highest level of the bank. In all cases,
the implementation of such policies will be the responsibility of a Money Laundering Reporting Officer or
nominated person.
The detection of suspicious transactions is not a precise science, but the following behaviours may alert
the bank to possible concerns:
6
6.1

unexplained and sudden significant increases in cash deposits or levels of investment

transactions made through different banks or financial firms

regular large or unexplained transfers to and from countries that are known to represent a higher
money laundering or terrorist financing risk

large numbers of electronic transfers in and out of an account

significant, unusual or inconsistent deposits by third parties

resurrection of dormant accounts into highly active accounts.
Risks associated with specific types of financial service
Insurance companies
The products offered by life assurance companies are attractive to money launderers because once the
funds are placed in life assurance policies, there are sometimes no transactions for several years. For
example, most life assurance companies offer single premium policies, usually either unit-linked or
endowment assurance, that can be purchased with a single premium paid up-front, regularly monthly
premiums or less regular but larger premiums. The policy may remain in place for several years, by
which time it is outside the scrutiny of compliance functions.
The longer the policy is in place, the more difficult law enforcement agencies will find it to trace the
origin of the funds and match them with the maturities. Invariably, the life assurance company makes
standard and sometimes enhanced checks on identity and reports suspicious transactions, but once that
hurdle has been cleared, the money launderer is very difficult to detect. In the case of mature and
organised criminal operations, sophisticated techniques will already have been deployed to prevent
detection.
33
Q U I C K
Q U E S T I O N
Do these risks apply to all types of life assurance policy?
Small weekly premium policies (‘industrial insurance’), mainly for protection and/or modest savings
purposes, are not generally attractive to criminals as the sums that can be disbursed and accumulated
are quite small, even over several years.
Most whole of life policies are for protection only and have no value on surrender or lapse of the policy.
Unless the criminal wishes to use the funds to provide for future generations, these would not be used.
Term assurances only pay out if the person assured dies during the term. These policies are purely for
protection purposes.
Criminals are most likely to use:

endowment and unit-linked policies, which combine protection with very long term investment

insurance and investment bonds, which have a token life assurance value and in reality serve as
single premium lump sum investment vehicles.
E X A M P L E
John has £50,000 that represents his accumulated income from the vice trade. His business uses a guest
house and a massage parlour business as cover. He has managed to run the funds through his trading
account by manipulating his accounts and keeping a separate set of records. He purchases five
investment bonds with different life assurance companies, each for £10,000. These are one-off
transactions and are below the reporting threshold. The money will be realised when the bonds are
liquidated in several years time.
FATF has identified several typologies in relation to money laundering through insurance policies:
34

single premium policies, as described earlier

early redemption of life assurance policies, including instances where this action is unusually early
or uneconomic (for most types of endowment assurance, early redemption results in a surrender
value that is less than the value of premiums paid in – FATF give the example of an investor who
was prepared to lose 40% of the investment in order to liquidate funds in this way)

fraudulent general insurance claims involving high value goods purchased with funds that were
obtained criminally

cash payments to purchase insurance, which are especially common in developing markets (most
UK insurance companies require that regular premiums be paid through direct debit)
2: REGULATION

obtaining refunds during the initial cooling off period – this enables the launderer to invest ‘dirty’
money and to receive ‘clean’ money by way of refund during the period in which the contract may
be cancelled without penalty

collusion between an insurance intermediary and insurance company employees – the
intermediary accepts illicit funds and transfers them in return for high commissions

payments of premiums by third parties who have not been subject to identification and
verification procedures

payment of policy premiums from a foreign bank account (or more than one foreign bank
account)

payment of claims to a foreign bank account

fraudulent customers, insurance companies and reinsurance companies – FATF has examples in
its casebook of companies that have been specifically established to enable funds to be
transferred illegally.
Although it is impossible to quantify the level of money laundering through the insurance sector, FATF
estimates that the most prevalent typologies for money laundering are international transactions, general
insurance claims for goods purchased with illicit funds and early redemption of life assurance policies.
There are various indicators of which insurance companies should be mindful. Some of these are generic
and applicable to all regulated firms, whereas others are specific to insurance companies.
Generic factors

Large one-off cash transactions, which is probably less common in well established jurisdictions
than developing ones.

Use of false addresses and post office box numbers.

Overseas business from high-risk jurisdictions.
Factors specific to the insurance sector

The policyholder is a known criminal or a known associate of a known criminal.

Erratic or abnormal behaviour by the policyholder, such as sudden or unexplained lifestyle
changes (these might become apparent during a fact find or needs review exercise).

High premiums in proportion to verifiable income or means.

Lack of concern about charges that will be incurred or surrender/early redemption costs.

Undue interest in early payout options; for example, where the customer seems uninterested in
investment returns but very concerned about conditions applicable to early surrender or
redemption.

Change of beneficiary or assignment.

General insurance effected for assets with a value that seems inconsistent with the customer’s
income, assets or circumstances.

Early or suspicious general insurance claims.

Multiple sources of funds to pay premiums.

Significant topping up of insurance policies.

Overpayment of premiums, especially where followed by a request for repayment to a third party
or to a different jurisdiction.

Use of a bancassurer to move funds around (a bancassurer is a company that originates both
banking services and insurance services).

Unusually high commission charges.
35

6.2
Transactions by relatively unknown or new companies in the insurance sector, especially if their
operations do not appear to be transparent.
Bank guarantees
A guarantee is a written, contractual undertaking to discharge an obligation if the principal debtor fails to
do so. Guarantees can be used to move money from one country to another without an immediate
physical transfer of funds.
E X A M P L E
Amanda has 500,000 Swiss francs on deposit in a bank account in Switzerland, accumulated from dealing
in contraband goods. She wishes to transfer funds to the UK. She approaches a UK financial institution
and asks to raise an equivalent sum, backed by the guarantee of the Swiss bank, which has an excellent
credit rating. She can then transfer lesser sums over a long period of time.
6.3
Groups of companies
An established way of disguising the true nature of cash flows is to construct a group of companies
combining a parent with subsidiaries located in numerous jurisdictions. This was one of the techniques
used by the disgraced Enron Corporation.
A further layer of concealment can be implemented by setting up private (‘shell’) bank arrangements
within the group. Shell banks are discussed further under the FATF (see later).
6.4
Alternative remittance systems
The normal remittance systems used in the UK are paper-based and electronic. The main paper-based
system is the use of cheques and similar instruments such as drafts, postal orders and travellers’
cheques. The electronic payments systems are high volume transactions through BACS, subject to a
three day clearing cycle and higher value, same day, guaranteed transactions made through CHAPS.
Internationally, the SWIFT system facilitates transfers and is now well established.
For many reasons, several alternative remittance systems have developed. An alternative remittance
system is defined as:
‘… any system used for transferring money from one location to another and generally
operating outside the banking channels.’
(FATF)
Alternative systems are not in themselves illegal. Most of the systems are created for legitimate
purposes. However, these systems can be used for illegal purposes, mainly because they can be
established before any regulatory body becomes aware of them. They are also notoriously difficult to
regulate even when a regulatory authority does identify them.
Systems vary widely according to the countries, communities and individuals they serve. There are
various different terms used to describe them:



informal funds transfer
alternative remittance
parallel banking.
Alternative systems that are specific to certain ethnic groups include:


36
hawala
hundi
2: REGULATION


da shu gong si
black market peso exchange.
Some systems operate in place of conventional banking channels while others operate alongside
conventional channels.
6.5
Institutional responses to alternative systems
Alternative remittance systems are illegal in some countries. For example, hawala transactions are
commonly encountered in Asia but are actually illegal in India. In some jurisdictions alternative systems
are illegal but the authorities either turn a blind eye to them or do not take any overt action against
them. Some jurisdictions permit alternative systems to operate but require them to be licensed and
accountable to a regulator or other oversight body.
It is important to note that attitudes to these systems change over time. In the Republic of Ireland, for
example, many private individuals used to take advantage of the fact that the banks and building
societies were an unofficial tax haven, in that non-resident accounts were not sampled by the Revenue
Commissioners (the Irish tax authority) for many years.
Therefore, accounts were opened on a non-resident basis, often on the pretext that they would be
beneficially owned by a relative of the same name as the true owner of the funds, living in the UK or the
USA. During the 1990s official attitudes to this practice hardened and subsequent changes in legislation
revealed not only tax evasion but also some cases of fraud perpetrated by bank officials.
The USA has a large illegal immigrant population. Historically, this has included many Mexican and
Puerto Rican citizens with no official right of residence, so alternative remittance was the only practical
way for these persons to send money to their countries of origin. Since the World Trade Center atrocity
in 2001, the US Treasury has sought out and acted on intelligence relating to alternative remittance
systems more actively, making it more difficult for criminals to move funds through this medium, but also
creating real problems for legitimate transferors of funds.
Q U I C K
Q U E S T I O N
So should alternative remittance systems be outlawed?
Alternative remittance systems have become more popular and hence more common for several reasons,
most of them legitimate:

in countries where there are large immigrant communities, these systems provide a convenient
(and sometimes the only) means of transferring money back to the individual’s homeland

the systems can be less expensive than conventional methods of sending funds across
international boundaries

many systems are well established and highly efficient, and are therefore trusted by the users
37

some countries continue to maintain exchange control regulations that restrict or prohibit the
transfer or funds, or impose practical barriers such as several levels of bureaucracy to clear the
funds

some users of alternative systems do not easily fulfil the identification requirements imposed by
states with money laundering regulations, so in some cases alternative systems may circumvent
this by having an agent carry out the remittance on behalf of the individual.
The fees and charges incurred by the parties may be significantly lower than those paid through
conventional banking channels. Quite often there is no need to open a formal banking facility as the
system can serve many people and many locations as part of a comprehensive service. The parties may
also have various methods of payment available to them.
As most alternative remittance systems are international in scope, their control and monitoring is
dependent on international cooperation through bodies such as FATF, central banks and regulatory
authorities in individual countries. However, it is generally accepted that as detection methods become
more sophisticated, criminals attempt to engineer solutions that are more difficult to detect.
6.6
Common characteristics of alternative remittance systems
There are six generic types of alternative remittance system. They share the following characteristics:

an initial transaction is made with a retail outlet – this is designed to dispose of criminally
obtained cash or to obscure the audit trail

the trail of the money from the retail outlet through to the eventual beneficiary is deliberately
complex

the transaction will typically pass through several jurisdictions

each jurisdiction may be able to gather some evidence, but no single one of them may be able to
form a complete picture.
Specific features of these systems include use of the conventional banking system for at least some of
the operation. Often, pure transfers will be interspersed with commercial transactions in order to further
disguise their nature, so when goods are sold, a corresponding transfer of funds takes place. The funds
collected are used to purchase more goods that are then moved to the target location and sold. The
funds derived from this are then moved to the beneficiaries.
6.7
Remittance corridors
The term ‘remittance corridor’ refers to the bilateral flows between two jurisdictions. It is possible to
identify well-established remittance corridors between various countries and regions:



from Canada and the USA to Latin America and Asia
from European Union countries to Eastern Europe and North Africa
from the Arabian Gulf to South and South-East Asia.
Some of these corridors are ‘mature’ (such as from the USA to Mexico) while others are ‘nascent’ (such
as from Canada to Vietnam), the term ‘nascent’ meaning in the course of transition to a mature stage.
Remittance corridors do not all share like characteristics. They are likely to be shaped by:





38
the nature of the sender
the types of flows transferred (volumes, values)
the channels used
use of technology
incentives (including cost factors) applicable to channels and influencing the choice of channel.
2: REGULATION
7
Organisation for Economic Cooperation and Development
(OECD)
According to the OECD’s website, it ‘brings together the governments of the countries committed to
democracy and the market economy from around the world to:






support sustainable economic growth
boost employment
raise living standards
maintain financial stability
assist other countries’ economic development
contribute to growth in world trade’.
The role of the OECD is relevant to our study in several respects:

it was the driving force behind the creation of the Financial Action Task Force (FATF), whose
objective is to fight financial crime in an international context

it has led various initiatives to combat ‘harmful tax practices’, particularly focusing on the use of
‘tax havens’ for unscrupulous purposes

it has created a framework for best practices in corporate governance.
Q U E S T I O N
T I M E
1 1
What do you understand by ‘corporate governance’? Is it relevant to regulation of banking institutions?
8
Financial Action Task Force (FATF)
The Financial Action Task Force (FATF) is an inter-governmental organisation that was set up to combat
money laundering and terrorist financing activities. Its objectives are:



to promote unified policies by different governments in order to fight money laundering
to issue guidance for governments
to indicate whether countries offer a reasonable level of deterrence and enforcement.
The FATF has issued 40 recommendations of best practices, supplemented by nine special
recommendations on the financing of terrorist activities.
The FATF was originally conceived as an initiative by members of the Organisation for Economic
Cooperation and Development (OECD). Its offices are within the OECD headquarters in Paris. It was
formally established at the G7 Summit in 1989.
The original brief of FATF was:


to examine money laundering techniques and trends
to review action at national and international level
39

to set out measures that need to be taken to combat money laundering.
Not all countries actively participate in the FATF. It has a membership of 36 countries. There are several
countries that are non-members but are designated as observers. At any given time, the FATF has a
published list of countries that it regards as non-cooperative.
Q U E S T I O N
T I M E
1 2
What would be the consequence of the UK government refusing to implement a recommendation of the
FATF, or a conflict between FATF recommendations and UK legislation?
8.1
FATF recommendations
It is not necessary in this course to explain all 40 recommendations in detail, and candidates for the
examination would not be expected to memorise these. However, this section of the book summarises
some of the key elements of the recommendations.
Legal system
Recommendations 1 – 3 provide a general description of the scope of the criminal offence of money
laundering and propose that members have systems in place to ensure that the proceeds of money
laundering activities can be confiscated by the relevant authorities.
Prevention
Measures to prevent money laundering and industry best practices are set out in recommendations
4 – 12.
Many countries have secrecy laws, but the FATF recommends that these laws should not inhibit the
implementation of its recommendations.
Financial institutions should not keep anonymous accounts in obviously fictitious names, and measures to
validate the identity of customers and normal due diligence practices should be implemented to prevent
this. Additional measures may need to be put in place in relation to dealings by ‘politically exposed’
persons.
In relation to cross border correspondent banking, the FATF recommends that additional measures over
and above normal due diligence should be applied.
Special attention should be given to the risks of money laundering opportunities arising from new and
developing technologies.
Countries should develop and implement criteria for dealings with third parties and intermediaries.
The FATF recommends that record keeping requirements be laid down, stating that a five year period is
appropriate.
Measures should be implemented to monitor complex and unusually large transactions, and series of
transactions that display unusual patterns with no apparent economic or visible lawful purpose.
40
2: REGULATION
Lastly in this section, the FATF recommends that money laundering controls be applied to certain types
of non-financial organisations, including:





casinos
real estate agents
dealers in precious metals and stones
legal professionals and accountants
trust and company service providers.
Q U E S T I O N
T I M E
1 3
Why are casinos and real estate agents included in this list?
Reporting of suspicious transactions and compliance
These matters are dealt with in recommendations 13 – 20.
Countries should have systems that compel prompt reporting, while maintaining protection for
institutions and employees who submit reports in good faith.
Financial institutions should develop policies and procedures in relation to money laundering to
incorporate detection and reporting but also controls, training and audit.
All countries should have effective, proportionate and dissuasive sanctions to deter money launderers.
Measures should be in place to prevent the approval or operation of ‘shell banks’.
The FATF defines a shell bank as a bank:
‘… with no physical presence (ie meaningful mind and management) in the country
where it is incorporated and licensed, and not affiliated to any financial services group
that is subject to effective consolidated supervision’.
(Bank for International Settlements:
‘Shell Banks and Booking Offices’,
Basel Committee on Banking Supervision)
Typically, shell banks have their management located in a different jurisdiction, often in offices of an
associated entity or even a private residence. They maintain only a registered agent in the country of
incorporation, and this agent often has little or no dealing with the bank in operational terms. It is
therefore difficult or impossible to supervise the business. Section 16 of the Money Laundering
Regulations 2007 prohibits any firm from conducting a correspondent banking relationship with a shell
bank, or any other firm that has a banking relationship with a shell bank.
The FATF recommendations propose that systems be established to report transactions above a specified
threshold.
41
Measures should be implemented in respect of dealings with countries that have inadequate anti-money
laundering laws.
The measures described in this section of the recommendations should be applied to non-financial
businesses where appropriate.
Regulation and supervision
These matters are dealt with in recommendations 23 – 25.
Countries should establish adequate regulation and supervision, administered by a competent authority.
The authority should produce guidelines and provide feedback on applying the regulations and reporting
suspicions.
Institutional and other legal measures
Recommendations 26 – 32 set out how countries should deal with information and the powers of
regulators in respect of information.
Countries should establish a body to deal with information on a centralised basis.
Designated enforcement agencies should have responsibility for anti-money laundering investigations.
Special investigative techniques should be developed to make the measures more effective. These
organisations should have a right to secure documents and information in the course of their
investigations. These should be underpinned by adequate legal powers for regulators. Where different
bodies are involved in different facets of anti-money laundering activities, there should be cooperation
between them and coordination of activities. Regulatory and enforcement bodies should be adequately
resourced. There should be ongoing review of mechanisms by competent authorities.
Q U E S T I O N
T I M E
1 4
What are the designated bodies in the United Kingdom?
Transparency
Recommendations 33 and 34 propose that unlawful use of legal persons by money launderers should be
prevented. This should be supported by reliable information on the beneficial ownership and control of
legal persons. In this context, legal persons refers to any entity that has a separate legal personality,
such as a limited company. There should also be measures to prevent unlawful use of legal
arrangements such as trusts.
International cooperation
The remaining sections of the recommendations refer to cooperation between countries and their
designated agencies.
International agreements such as the Vienna Convention and the Palermo Convention should be
implemented.
42
2: REGULATION
There should be mutual assistance between states and their competent authorities, including the
recognition of extradition as a means of enforcement.
Countries should take appropriate action in response to legitimate requests from foreign states. Such
actions may include identification, freezing, seizure and confiscation of funds.
The FATF plays a vital role in identifying and anticipating new methods of laundering money. For
example, in relation to international transactions, the FATF has researched and published findings on
alternative remittance systems. These include:
9

‘hawala’ transactions through which no money crosses international boundaries – it permits
migrant workers to send money home with reciprocal funds being transferred for business
investment

debit cards that are ready-loaded with a credit balance, purchased for cash and used with a
personal identification number

SIM cards used in mobile telephones.
Other relevant bodies
There are cross-border marketing rules that govern the provision/sale of services to customers resident
around the world, that is, what can and cannot be offered to clients with respect to the relevant
regulatory rules in the client’s country of residence.
9.1
The Moneyval Committee
Moneyval is the shortened name of the Committee of Experts on the Evaluation of Anti-Money
Laundering Measures and the Financing of Terrorism. The Moneyval Committee is a Council of Europe
initiative. This has the purpose of evaluating the laws of member states with a view to achieving
consistency and effectiveness. The member countries include the Russian Federation and some other CIS
(former Soviet Union) states.
9.2
Interpol anti-money laundering unit and Europol (European Police
Office)
The Interpol anti-money laundering unit maintains an international database of suspicious activity reports
(SARs) and provides access to this for the police in different states. It also provide information such as
DNA, fingerprints, stolen identities and suspicious persons. A body that works closely with Interpol is
Europol, a police office that operates within the European Union.
9.3
Financial Crimes Enforcement Network (FinCEN)
In the USA, the Financial Crimes Enforcement Network (FinCEN) promotes collaboration on anti-money
laundering activities. It is administered by the Department of the Treasury.
FinCEN’s aim is:
‘… to enhance U.S. national security, deter and detect criminal activity, and safeguard
financial systems from abuse by promoting transparency in the U.S. and international
financial systems.’
FinCEN’s responsibilities were increased in relation to the prevention of of money laundering and terrorist
financing under the PATRIOT Act. This legislation was enacted shortly after the attacks on the World
Trade Center in New York in September 2001, building on existing powers of the Treasury implemented
under the Bank Secrecy Act of 1970. This earlier legislation empowered the Treasury to obtain
information and reports where intelligence was required to fight financial crimes and those related to
money laundering and terrorism.
43
9.4
The Egmont Group
The Egmont Group comprises financial intelligence units (FIUs) from over 100 countries. The group
facilitates the exchange of information between its members. It is especially important as it includes
numerous countries that provide tax havens for overseas investors.
The Egmont Group is named after the Egmont Arenberg Palace in Brussels where it was established as
an informal group in 1995. Now known as the Egmont Group of Financial Intelligence Units, the FIUs
meet regularly to find ways to cooperate, especially in the areas of information exchange, training and
the sharing of expertise.
The goal of the Egmont Group is to provide a forum for FIUs around the world to improve cooperation in
the fight against money laundering and the financing of terrorism. Its activities include:

promoting international cooperation in the reciprocal exchange of information

increasing the effectiveness of FIUs through training and promoting personnel exchanges to
improve the expertise and capabilities of their personnel

facilitating better and secure communication among FIUs through the application of technology,
such as the Egmont Secure Web (ESW)

fostering increased coordination and support among the operational divisions of member FIUs

promoting the operational autonomy of FIUs

promoting the establishment of FIUs in conjunction with jurisdictions with an anti-money
laundering programme in place or under development.
The Egmont Group publishes case histories of FIUs in action on its website: www.egmontgroup.org.
9.5
Others
There are numerous region-specific anti-money laundering activities, including:






Eurasian Group (Russia and central Asia)
CAFTF (Caribbean)
APC (Asia-Pacific)
GAFISUD (South America)
ESAAMLG (Southern Africa)
GIABA (Western Africa).
Q U I C K
Q U E S T I O N
What is the difference between ‘tax avoidance’ and ‘tax evasion’?
44
2: REGULATION
10
International cooperation on taxation
Tax avoidance is the process through which an individual or organisation legitimately minimises tax paid
to the government through optimal use of the applicable rules and regulations. For example, in its
simplest form, tax avoidance by an individual living in the UK might involve placing deposits in tax-free
accounts such as ISAs and certain NS&I accounts, or by choosing to hold assets in a trust. For higher net
worth individuals, tax avoidance involves more complex planning processes and proactive portfolio
management.
Tax evasion is a criminal offence. It occurs when an individual or organisation deliberately circumvents
tax liabilities through activities such as concealing or disguising funds, not declaring taxable income and
providing false information to the authorities.
Offshore banking products have long been considered as efficient media through which both activities
may be undertaken. For example, many individuals have held assets in jurisdictions where the anonymity
of the investor is preserved. This is not confined to the proverbial ‘Swiss bank account’ made famous in
fiction and popular legend. Until comparatively recently, bank and building society accounts in the
Republic of Ireland offered completely confidential banking arrangements through which investors could
be absolutely confident that their affairs would not be disclosed to the Revenue Commissioners.
The system was overhauled and reformed radically during the 1990s, when scandals involving nonresident accounts attracted daily national headlines.
Many offshore banking institutions are located in so-called ‘tax havens’. These are countries or
principalities in which low tax regimes exist. Typically, the tax rates applicable to residents of such
centres are low, which has traditionally meant that investments could be made, legally or otherwise, by
non-residents with little fear of detection. In nearly all countries, banking offshore does not absolve the
individual or entity from domestic tax responsibilities, and this is emphasised by those providing products
and services in all responsible financial service providers. In many instances, countries that host offshore
banking institutions go to great lengths to encourage due adherence to rules relating to verification of
identity and reporting of suspicious transactions.
Major trading nations have historically had little option but to tolerate tax havens, as the laws applicable
in these jurisdictions are no business of other countries. Furthermore, many economists favour the
notion of ‘tax competition’, through which it is argued that higher tax countries will seek to reform their
systems and provide better value governance for their citizens if forced to adopt policies that do not
result in outflows of wealth and income. Therefore, governments have to balance the need to encourage
(or coerce) citizens to pay the legitimate duties payable with the need to respect their rights to maximise
personal wealth and income through legitimate means.
Recent initiatives by larger trading nations have focused on the need for governments to adopt more
transparent policies. This has been an intermittent international issue for many years, and originally
became prominent when Swiss banks were accused of holding Nazi gold and other assets. More recently,
Liechtenstein was accused by both Germany and the USA of being uncooperative in respect of efforts to
expose the affairs of certain investors. While conserving the sanctity of tax policy as a matter of
sovereign right, efforts have been made to reduce the opportunities for individuals and companies to
hide their financial affairs and thereby escape from their legal obligations.
The OECD has led several initiatives to increase transparency in relation to taxation. Although the OECD
has a facility to blacklist what it regards as uncooperative tax havens, few countries have ever appeared
on its blacklist. In 2008, several OECD member countries decided to compile a new blacklist which would
be drawn up on the basis of investigations concerning about 40 countries. This agreement was prompted
by the financial crisis amid allegations that many investors, including some powerful but largely
unregulated hedge funds, were illicitly holding funds where they stood least chance of being detected.
Emotions in Europe currently run high on this issue – in recent times both France and Germany have
urged the OECD to blacklist Switzerland as an uncooperative country in relation to transparency. On the
other hand, Switzerland has made numerous efforts to improve international perceptions of the extent to
45
which its traditional secrecy regime, particularly the use of numbered bank accounts, protects criminals.
In 2003, for example, the Swiss banks introduced a code of conduct in respect of due diligence.
The preamble to the code sets out its objectives:
‘With a view to preserving the good name of the Swiss banking community, nationally
and internationally,
with a view to establishing rules ensuring, in the area of banking confidentiality and
when entering into business relations, business conduct that is beyond reproach,
with an effort to provide effective assistance in the fight against money laundering
and against financing acts of terrorism,
… the banks hereby contract with the Swiss Bankers Association in its capacity as the
professional body charged with safeguarding the interests and reputation of Swiss
banking:
(a)
to verify the identity of their contracting partners and, in cases of doubt, to
obtain from the contracting partner a declaration setting forth the identity of
the beneficial owner of assets;
(b)
not to provide any active assistance in the flight of capital;
(c)
not to provide any active assistance in cases of tax evasion or similar acts, by
delivering incomplete or misleading attestations.’
Codes of practice do not, of course, have legal force, as they are voluntary statements of minimum
standards that will be applied by their signatories.
11
UK Independent Report on Offshore Centres
The British government commissioned an independent review of British offshore centres in the preBudget Report in 2008. The report was carried out by a team led by Michael Foot. The final report was
published in October 2009. This section of the text summarises the key findings and recommendations of
the report.
The report considered nine territories that are regarded as significant offshore centres. Three of these
are Crown Dependencies and the other six are Overseas Territories.
The Crown Dependencies are:



Guernsey
Isle of Man
Jersey.
The Overseas Territories are:






Anguilla
Bermuda
British Virgin Islands
Cayman Islands
Gibraltar
Turks and Caicos Islands.
The primary purpose of the review was to work with these territories in order to identify the
opportunities and challenges arising from the credit crisis and subsequent difficulties in international
markets. The report was partly prompted by concerns about economic conditions, but also by the
conclusions of the Public Affairs Select Committee that the Overseas Territories had not yet reached the
regulatory standards attained by the Crown Dependencies in matters relating to banking, insurance,
securities and money laundering.
46
2: REGULATION
The G20 nations also decided to raise regulatory standards in the financial sector and focus their
attention on offshore centres that were regarded as tax havens and possible conduits for facilitating
money laundering and other financial crimes.
The report stated that the territories were significant for British and world financial markets for different
reasons, reflecting their own idiosyncrasies:

the Cayman Islands are a major centre for hedge funds and a significant wholesale banking
sector, with high volumes of overnight deposits from the USA

Bermuda is the third largest reinsurance centre in the world and the second largest host for
captive insurance companies, with substantial business written on behalf of entities in the UK and
the USA

the British Virgin Islands are the main host for international business companies, being a
jurisdiction of choice for many Asian businesses and having strong links with the USA

Gibraltar is a gateway to the European single market

the Crown Dependencies are a gateway for the routing of funds to various financial centres,
including London, and also service the needs of many non-domiciled British citizens.
The offshore centres are significant to the UK for two main reasons:
11.1

the flow of funds between these territories and the UK

the reputational and financial risks arising from the UK’s responsibilities for ensuring good
governance and agreed international standards.
Financial flows
Generally, the UK is a new recipient of funds from the nine territories, offset to some extent by net
outflows to the Cayman Islands.
The Crown Dependencies contribute to the liquidity of UK financial markets. In particular, funds are
generated by insurance business and associated fees earned by UK-based professional firms as well as
asset managers. The report estimates that Bermuda-based insurers and reinsurers wrote nearly one third
of premiums at Lloyd’s of London in 2008.
11.2
Risk exposure
The UK is ultimately responsible for the financial affairs of the jurisdictions, giving rise to both financial
and reputational risk. Such risks include any failure to meeting international standards on taxation,
financial regulation and combating financial crime. Specifically in relation to Gibraltar, the UK is
responsible for compliance with European Union requirements.
Although the UK has intervened in the past to support Overseas Territories, the UK does not subsidise
them. Conversely, there is no expectation on the part of these jurisdictions that the UK would be called
upon to do so. The British and Commonwealth Office monitors the finances of the territories and
publishes borrowing guidelines in the expectation that governments will stay within limits and maintain
adequate reserves.
In some cases, there is evidence that territories have built up reserves during growth periods which
serve as a buffer in more austere financial conditions. The report commented that during the financial
crisis one government had suggested that the UK be prepared to act as a lender of last resort, which
would be a significant undertaking were it to be invoked. The view of the authors was that governments
be urged to put measures in place to minimise the risk of such an eventuality.
The report discussed some of the effects of the economic downturn and concluded that it had a more
serious effect in jurisdictions where tourism and the construction industry were important contributors to
the local economy. The downturn had affected Anguilla, the Cayman Islands and the Turks and Caicos
Islands more severely than the other six jurisdictions. Bermuda and the British Virgin Islands had
47
experienced reductions in government revenues. The downturn has provided a salutary reminder of the
need to put in place robust economic planning and fiscal control measures.
11.3
Taxation
The territories need to ensure that the need to be competitive is balanced with the responsibility for
meeting revenue needs. Where new taxes or fees are introduced, it is essential to ensure that the
system does not easily facilitate avoidance. Work carried out by Deloitte in support of the report
concluded that the territories differentiated themselves from conventional taxation models either through
the rates of tax struck by each jurisdiction or the absence or near absence of certain types of tax
altogether.
Tax regimes, along with stable legal structures and prudent governance, are strong incentives to do
business through these locations. Deloitte considered that there was scope for achieving consensus on
value added tax and corporation tax, and also concluded that jurisdictions that did not have a goods and
services tax should consider the need for introducing such a tax. This will be particularly important if the
trend for reducing import duties continues.
11.4
Transparency
The report’s findings on tax transparency were generally favourable. Principles of transparency and
exchange of information had already been developed and published by the Organisation for Economic
Cooperation and Development (OECD) by the time the report was commissioned in 2008. By the time the
G20 met in Spring 2009, most of the nine jurisdictions were considered to have ‘substantially
implemented’ the agreement, with just two of them making progress towards it.
The report stressed the need for territory governments to apply the spirit as well as the letter of the law,
and anticipated that eventually there will be automatic exchange of information with a view to reducing
the risks of tax evasion facilitated by cross-border transactions. There remains some concern that the
structure of legal entities in some jurisdictions still permits a lack of transparency.
The report concluded that the UK should take the lead by urging improvements in:



CDD minimum standards
monitoring of ‘politically exposed persons’
transparency of beneficial ownership of companies and trusts.
Referring to drives by the International Monetary Fund and the Financial Action Task Force to raise
regulatory standards and tackle financial crime, the report stated that most of the nine jurisdictions had
‘a good story to tell’, whilst acknowledging that there was no room for complacency.
11.5
The retail sector
The report commented specifically on two developments:
11.6

it acknowledged the efforts of jurisdictions to introduce deposit protection schemes, whilst
stressing the need to ensure that the schemes should not confuse those affected

it noted that only one of the nine jurisdictions had introduced an Ombudsman scheme to deal
with complaints on an independent basis.
Recommendations
The main recommendations of the report are:
(1)
48
The UK should discuss and consider governance arrangements with the jurisdictions to ensure
that there is a shared understanding of respective responsibilities and expectations.
2: REGULATION
(2)
The quality and extent of financial planning in the jurisdictions should be aligned with that in the
best performers (the Crown Dependencies). In particular, jurisdictions should implement a
prudent approach to managing government finances by developing: a diversified tax base to
maximise sources of revenue; mechanisms to measure and control public spending; and by
building financial reserves during periods of economic growth.
(3)
The UK should be proactive in satisfying itself that the Overseas Territories in particular have
frameworks capable of identifying and responding to external shocks and encouraging local
governments to undertake responsible adjustment programmes where these are necessary.
(4)
To meet international standards, jurisdictions which have not already done so should:

meet the international standard on tax transparency set by the OECD and continue, even
after meeting the current minimum of 12 tax information exchange agreements (TIEAs), to
negotiate further TIEAs, giving priority to those jurisdictions with which they have
significant financial links

set up the administrative procedures necessary to ensure full delivery of the OECD
standard, to a level of compliance that will satisfy the peer review process that is being put
in place

make an early commitment, with a timetable for implementation, to automatic exchange of
tax information under the EU Savings Directive

ensure that the regulatory authorities have the necessary resources and expertise to
implement and enforce international financial sector regulatory standards

move to amend laws and procedures as necessary to achieve compliance with the FATF 16
‘key and core’ Recommendations.
(5)
At an international level, the UK should press for improvements in CDD minimum standards and
promote moves towards improved transparency of beneficial ownership of companies and trusts
and the monitoring of politically exposed persons.
(6)
All jurisdictions should ensure that:

governance arrangements in their regulatory authorities are sufficient to maintain the
integrity and independence of all decisions taken

responsibility for promotion of the financial centre is separated from the regulator in both
letter and spirit.
(7)
Those jurisdictions that offer (or propose to offer) protection to retail depositors must ensure that
compensation schemes can be understood by those depositors.
(8)
Jurisdictions that lack an Ombudsman scheme should consider whether one is justified.
(9)
Any jurisdiction that has not already done so should undertake a thorough examination of the
range of powers to resolve a crisis in its financial services sector.
(10)
Local governments should require the regulator to maintain close oversight of any large locally
incorporated financial institutions, the failure of which might lead to requests for financial help
from the UK. This should be backed by the option of a periodic independent and external review,
paid for by the institution itself, commissioned by the local authorities on their own initiative or at
the request of the UK.
(11)
The UK should discuss with those jurisdictions in need of technical assistance to fight financial
crime how that assistance might be delivered and the benefits of assistance secured in the longer
term.
49
KEY WORDS
Key words in this chapter are given below. There is space to write your own revision notes and add any other
key words or phrases you want to remember.





















50
Incorporation
Authorisation
Banking licence
Capital adequacy
Reserves
Bank for International Settlements
Basel, Basel II
Subordinated debt
Money laundering
Failure to report
Tipping off
Placement
layering
Integration
CDD
Organisation for Economic Cooperation and Development
Financial Action Task Force
Shell bank
Tax avoidance
Tax evasion
Tax haven
2: REGULATION
REVIEW

Regulation is necessary in order to ensure that financial institutions comply with the law, and that their
actions and behaviours are consistent with maintaining confidence in the financial sector. It is also
necessary in order to minimise the risks of the banking system being used to perpetuate financial crime.

Most banks are incorporated bodies. The most common business form is the limited company. Offshore
banks are usually incorporated in the country or principality in which their operations are based. They are
subject to the laws of the jurisdiction in which they are located. Increasingly, universally accepted
international regulatory norms are being adopted.

All banks need capital in order to provide safeguards for depositors and to provide the basis for
expansion without the creation of undue risk. Most banks adhere to the capital adequacy standards set
out in Basel II.

Money laundering is the crime through which illegal funds are cleansed by passing them through the
financial system.

Offshore banks require applicants for business to provide evidence of identity and then verify the
evidence provided by making appropriate checks. Once an account relationship is formed, account
activity is monitored in order to detect suspicious transactions and make appropriate reports.

The OECD promotes international cooperation in the fight against money laundering, tax evasion and
other crimes.

The Financial Action Task Force is a source of external intelligence and provides guidelines to financial
institutions in relation to anti-money laundering and terrorist financing policies.

Although offshore banks encourage their clients to maximise the tax efficiency of their financial plans,
they also discourage the use of their services for tax evasion. Various initiatives have been introduced in
recent years to promote greater transparency and increase the contributions that offshore banks can
make to reducing tax evasion.
51
52
chapter 3
INTERNATIONAL FINANCIAL
MARKETS
Contents
1
What is a financial market? ........................................................................................ 54
2
Money markets ......................................................................................................... 55
3
Relevance of money markets to offshore banks and their customers ............................... 57
4
Foreign exchange market ........................................................................................... 58
5
Relevance of foreign exchange markets to offshore banks and their customers................. 61
6
Eurocurrency market ................................................................................................. 62
7
Capital markets ........................................................................................................ 62
8
Relevance of capital markets to offshore banks and their customers................................ 65
9
Eurobond markets ..................................................................................................... 66
10 Offshore interbank market and other developments ...................................................... 67
Key words ..................................................................................................................... 68
Review ......................................................................................................................... 69
53
Learning objectives





define a financial market
describe the features of money markets
describe the features of foreign exchange markets
describe the features of capital markets
explain the relevance of these markets to offshore banking institutions and their customers.
Introduction
The raw material of all banking institutions is money, so the study of financial markets is essential in the
context of offshore banking practice. By definition, offshore banking institutions deal predominantly with
those who have personal and business dealings across international boundaries. The characteristics of
various financial markets are therefore highly relevant to their dealings.
Q U I C K
Q U E S T I O N
What do you understand by the term ‘market’?
1
What is a financial market?
A financial market is a mechanism through which those who need to raise funds and those who have
funds to invest are brought together. Historically, the transactions in many financial markets took place
in a single physical location. Developments in information technology now enable the coming together of
those in deficit and those in credit on a remote basis.
In addition to bringing together disparate individuals and legal entities, markets fulfil several additional
important functions:
54

some financial markets enable risk to be shared or transferred, including insurance, reinsurance
and derivatives markets

some financial markets underpin other dealings, such as the purchase and sale of goods,
including markets in international bills of exchange.
3: INTERNATIONAL FINANCIAL MARKETS
Q U E S T I O N
T I M E
1 5
What are:
(1)
derivatives?
(2)
bills of exchange?
2
Money markets
The purpose of money markets is to provide liquidity for financial institutions. Although some individuals
participate in money markets, the main players are financial institutions and companies. In order to
engage in mainstream lending activities, financial institutions need to raise funds. The two traditional
ways of doing so are through retail and wholesale markets.
Retail funding is obtained by offering savings, deposits and investment products mainly to personal
customers. In order to attract funds, financial institutions offer products with a range of benefits,
including interest, convenience of access and money transmission facilities. Customers also want to know
that the funds deposited are safe, so that they are certain that they will get their capital back when
required. Since the Second World War, British banks have gradually become less dependent on retail
savings and deposits and have not been unduly worried that many customers now choose alternatives
such as NS&I (the Post Office) and building societies.
Wholesale funding is raised by going to the money markets. At any given time, some institutions will
have surplus funds while others need to raise funds. The price that has to be paid for these funds is the
interest rate. This price is determined by many factors but is underpinned by the forces of supply and
demand. Therefore, if many institutions seek to raise funds and there is a shortage of liquidity in the
market, the interest rate will increase. Conversely, if there are many lenders but comparatively few
borrowers, the interest rate will fall.
Q U E S T I O N
T I M E
1 6
What factors will decide whether a financial institution chooses to be reliant on mainly retail or mainly
wholesale funding?
55
In the domestic money markets, a good indication of the price of money (the level of interest rates) is
the London Interbank Offered Rate, or LIBOR. This is the interest rate at which banking institutions are
prepared to lend to each other. Unlike the interest rates that personal savers and borrowers receive and
pay respectively, LIBOR can change frequently according to market conditions.
In 2012, several large financial institutions were implicated in a scandal involving the manipulation of
LIBOR. As LIBOR is a vital indicator of the true price of money, this led to a major investigation and
criminal prosecutions. The scandal involved banks in at least ten countries across three continents.
With increasing globalisation, financial institutions have been able to avail themselves of wholesale
funding not only from the domestic money markets but also internationally. As we saw in chapter 1, the
barriers to doing business on this basis have gradually been rolled back, so there is some incentive for
financial institutions to seek funding from the market place at the best price relative to risk, and the
source of this funding may be located domestically or overseas.
Q U I C K
Q U E S T I O N
How do Treasury departments raise their funds?
Funding can be raised in various ways. Treasury departments publish interest rates that they are
prepared to offer for maturities ranging from overnight to several months. Various financial instruments
are available, including short term bonds (representing debt, with the bond certificate serving as a
receipt), certificates of deposit (CDs), which are securities issued with specified maturity dates and
floating rate notes (FRNs), which are bonds with variable (hence ‘floating’) interest rates usually set at a
premium above LIBOR or some other reference interest rate.
Some financial institutions raise funds by issuing securities backed by cash flows from existing assets,
such as mortgages. Issuing such securities was until recently a highly attractive way of raising capital, as
mortgages in the UK were perceived to be very secure (due to low default rates), with a correspondingly
low level of risk. The process of issuing securities backed by existing assets is called securitisation.
Strictly speaking, securitisation can only be regarded as a feature of money markets (as opposed to
capital markets) if the lifetime of the security is relatively short.
Many of the securities that are issued by financial institutions are marketable, in that they can be sold on
to other players in the market place. This gives rise to a secondary, or parallel, market.
Significantly, the international credit crisis that first affected UK banking institutions in autumn 2007
(starting with Northern Rock’s emergency funding package facilitated by the Bank of England) occurred
at a time when many of the larger players in the UK financial services market were net borrowers from
the US money markets. Therefore, as US markets became less liquid, this created a funding dilemma for
nearly all UK banks. Some of the smaller institutions, such as many of the regional building societies and
credit unions, were at least temporarily shielded from this crisis as they had stronger retail deposit bases
and therefore less need to raise funds in wholesale markets.
56
Q U I C K
Q U E S T I O N
How are money markets relevant to the offshore banking environment?
3
3.1
Relevance of money markets to offshore banks and their
customers
Relevance to offshore banks
Transactions in the money markets are a major influence on short term interest rates and ultimately
determine the prices that offshore banks have to pay for their funds and the rates they must charge their
customers.
In practice, banks pay a range of interest rates for their funding, depending on the type of instrument,
whether it is backed or not and the market’s perception of risk. Likewise, banks pay and charge a range
of interest rates for their products, with factors such as customer profile, maturity, product features and
so on determining the price of each product.
Q U I C K
Q U E S T I O N
Are money markets relevant to personal customers? If so, how?
3.2
Relevance to customers
Money market rates impact on the return on savings, investments and deposits as well as the prices
borrowers must pay for the funds that they wish to raise. Increasingly, financial institutions are
facilitating increased accessibility to money market products, with many offering personal and corporate
customers the opportunity to invest at money market rates. For example, during the 1980s and 1990s,
57
many Treasury departments opened their doors to retail customers, usually subject to specified minimum
investment thresholds.
4
Foreign exchange market
The foreign exchange (or forex) market is that which arises from the buying and selling of currencies.
The value of a currency against other currencies is expressed as exchange rates. At any given time,
there are many exchange rates between one currency and another. For example:

the buy and sell rates at foreign exchange bureaux are different to one another, with the socalled ‘spread’ representing a margin for the bureaux

the exchange rate offered in the two countries may be different

there will be different exchange rates for different amounts of money to be exchanged

powerful players in the market place will be able to command more favourable exchange rates
than less powerful players at any given time

the exchange rate offered for travellers’ cheques will be different to that for cash, even though in
many countries travellers’ cheques are as good as cash.
Q U E S T I O N
T I M E
1 7
If many different sellers of foreign currency offer different exchange rates, why do individuals not make
a profit by carrying out many transactions to take account of the margins?
As in any market, the forces of supply and demand determine the price of a currency. The demand for a
currency is in turn is a derived demand, as individuals and entities will generally require a currency for
specific purposes, such as international trade. Therefore, if the goods and services supplied by a
particular country are highly sought after, this will bid up the price of the currency. When the demand for
goods and services falls, the value of the currency will fall relative to other currencies.
This interplay between buyers and sellers in a market rather over-simplifies the foreign currency market,
as several other forces may have an effect at any given time. As it is possible to forecast the conditions
in the currency markets, at least in the short to medium term, there will be expectations of some
currencies increasing in value and some falling in value. It is therefore possible for speculation to affect
the relative prices of currencies. The impact of expectations can be seen in the forward market for
currencies, which puts a price on each currency for purchases in (say) one, two or three months time.
The forward price may differ significantly from the current (or spot) price, giving a clear indication of
what buyers and sellers in the market expect to happen in the future.
58
Q U E S T I O N
T I M E
1 8
What would be the implication of the forward price of a currency exceeding its spot price?
Sometimes, governments decide to support a currency by buying it in the market, thereby bidding up its
price. Although this is not a policy of the British government at the moment, at times of crisis the Bank of
England may purchase sterling through the Exchange Equalisation Account to prevent a collapse in its
value (see below). Historically, many countries have chosen to keep the values of their currencies
artificially high in order to maintain prestige.
Conversely, countries with a persistent balance of payments deficit may decide to devalue in order to
make exports more attractive to foreign buyers and imports more expensive for domestic citizens. For
example, in 1967 the British government reduced the value of sterling from US$2.80 to US$2.40 even
though members of the International Monetary Fund (IMF) maintained fixed exchange rates against the
dollar (although some fluctuation was permitted under this so-called ‘adjustable peg’ system).
Some economists argue that trends in exchange rates are more significant over relatively long periods of
time.
Other economic factors impact on exchange rates over time. A country with strong economic growth
(increases in gross domestic product over time) will tend to find that its currency will strengthen.
Conversely, high levels of price inflation generally have an adverse effect on the value of a currency.
At various times in history, the trading of speculators in currencies has had a significant effect on foreign
exchange markets. Due to market imperfections, it is possible to make large profits by buying and selling
currencies, effectively gambling on what will happen in the future. This is known as arbitrage. Those who
are able to forecast future movements in exchange rates can make significant profits.
E X A M P L E
The most infamous example relevant to the value of sterling occurred in 1992, when the pound, which
had been a member of the Exchange Rate Mechanism (ERM) of the European Union, was effectively
forced out of the mechanism due to speculative trading. The ERM was the precursor to the creation of
the euro as an international currency. The day that the British government withdrew sterling from the
ERM (16 September 1992) became known as ‘Black Wednesday’.
Prior to the withdrawal, the government had frantically purchased sterling in order to try to keep it within
the bands that applied to the ERM at the time. The traumatic aftermath of this crisis put back any
attempt of subsequent British governments to join the euro regime by many years.
59
C A S E
S T U D Y
George Soros
George Soros is a Hungarian born arbitrageur who made a fortune from dealing in foreign currencies. His
activities during the sterling crisis in 1992 are estimated to have generated over $1 billion in profits. He
achieved this by selling more than $10 billion equivalent in pounds sterling at a time when the Bank of
England hesitated in raising its interest rate to the levels of other European countries.
At one stage, it is estimated that he was prepared to gamble as much as the British Chancellor of the
Exchequer was willing to invest to secure the position of sterling within the ERM. Contemporary
headlines at the time dubbed Soros as the ‘man who broke the Bank of England’.
Soros learned his trade working in fund management, and now runs the Soros Fund Management
company. Soros has since been cast as both a hero and villain by the media. He is regarded as a
champion of ethic minorities in the USA, but was also found guilty of insider trading by a French court in
2006.
Some currencies are not freely convertible, which means that they cannot be readily purchased in the
market place. Several countries have controlled exchange regimes, which means that in practice the
currency can only be obtained at a centrally determined ‘official’ exchange rate. Control is exercised by
restricting the amount of the currency that can be exported from the country. In practice, such artificial
interventions in the value of currencies are diminishing in importance over time, though they still play a
major role in setting the prices of some important currencies, notably the Chinese renmimbi (yuan) and
the Russian rouble.
C A S E
S T U D Y
The euro
The euro is the single currency of 16 of the 27 member countries of the European Union. It was
introduced on 1 January 1999. However, its history goes much further back in time. When the Treaty of
Rome established the (then) European Economic Community (EEC) in 1957, one of the primary aims was
to create ‘monetary, economic and political union’. The creation of the euro was a major step to
achieving monetary union.
The aspiration towards monetary union was dealt a severe blow in 1971, when the IMF’s adjustable peg
system that linked major currencies to the US dollar collapsed. A subsequent attempt to revive it in 1972
failed, resulting in most currencies freely fluctuating in the market place. This of course was the opposite
of what the members of the EEC wanted to see – their objective was convergence. Negotiations between
member states led to the creation of the Exchange Rate Mechanism (ERM) in 1979, confirming that even
if world currencies could not be pegged, European countries would try to peg theirs. The ERM was based
on a parity grid that permitted 2.25% variations in rates between countries (though the Italian lira
operated wider bands). The short history of the ERM was turbulent, with volatility in world markets
causing several countries (including the UK) to abandon the system in the early 1990s.
The Maastricht Treaty in 1992 paved the way for the launch of the euro, as well as the launch of the
European Central Bank (ECB).
Membership of the euro is conditional on meeting various budgetary and financial conditions, though the
limits set are almost routinely broken in some member states. The major implication of membership of
course, is that domestic monetary policy can no longer be formulated within a state that has adopted the
euro, as interest rates are decided centrally by the ECB.
Although the UK temporarily embraced the notion of monetary union during the period that the ERM
operated, the prospects of the pound sterling being replaced by the euro seem to have diminished even
in the long term. Successive governments of the UK have consistently argued that the UK economy
60
generally, and sterling specifically, represent a special case that does not fit the single currency model at
all.
The reticence of politicians to consider the euro as a serious policy option is reinforced by the high
proportion of UK citizens who buy their own homes with variable rate mortgages. Therefore, if eurozone
interest rates rise, there is little that can be done to alleviate the effects of this. This, together with the
emotional and xenophobic arguments advanced by the popular media, make it easy to reject the
prospects of membership out of hand.
Despite the reluctance of the UK and some other countries to enter the euro, it is now the second most
traded currency and second most important reserve currency in the world.
5
5.1
Relevance of foreign exchange markets to offshore banks
and their customers
As offshore banking institutions operate in a global market place, the conditions in foreign exchange
markets are highly important and can affect their business plans significantly.
Many of the customers of offshore banking institutions hold account balances and carry out transactions
in more than one currency, so both the existing and forecast economic conditions affecting major
currencies have to be taken into account when formulating strategies for the future.
Obviously, uncertain conditions in the foreign exchange markets have a major effect on the value of the
institution and its cash flows. To some extent, this uncertainty can be managed by using sophisticated
financial instruments such as futures, options and swaps.
Q U I C K
Q U E S T I O N
Why are foreign exchange markets particularly relevant to customers of offshore banking institutions?
5.2
The imperfections of foreign exchange markets are the raison d’être for many customers conducting their
affairs in more than one currency.
A private individual who exchanges pounds sterling for foreign currencies on a regular basis will
invariably lose out in real terms as he or she will have to pay for the margins that foreign exchange
dealers make. These losses will accumulate quickly if the individual has to make many transactions, or an
increasing number of transactions every year.
61
In addition to funding the spread between buy and sell rates, many transactions are subject to a
commission, usually expressed as a percentage of the value of the individual transaction. This effect is
most visible to the occasional traveller, such as the person who takes the family on a foreign holiday –
transactions made with a domestic ATM card may be subject to a fee as well as being denominated in an
extremely unfavourable exchange rate.
Obviously, those making larger transactions, such as purchases of real estate and securities, are even
more vulnerable to conditions in foreign exchange markets.
Offshore banking organisations enable their customers to conduct their personal affairs and do business
in a more convenient and less expensive manner.
6
Eurocurrency market
The eurocurrency market consists of banks (generically referred to as eurobanks) that accept deposits
and make loans in foreign currencies. A eurocurrency is a freely convertible currency deposited in a bank
located in a country which is not the native country of the currency. The deposit can be placed in a
foreign bank or in the foreign branch of a domestic bank.
The eurocurrency market has grown rapidly mainly due to the existence of various US regulations that
have raised costs and lowered returns on domestic banking transactions. In other words, the
eurocurrency market has become popular because of the absence of restrictions, which has led to
attractive deposit rates for savers and attractive loan rates for borrowers.
In the eurocurrency market, investors hold short term claims on commercial banks which intermediate to
transform these deposits into long term claims on final borrowers. The eurocurrency market is dominated
by the US dollar or the eurodollar. Occasionally, during weak dollar periods (latter part of the 1970s and
the 1980s), the euroSwiss franc and the euroDM markets increased in importance.
The eurodollar market originated post World War II in France and England due to the fear of Warsaw
Pact countries that dollar deposits held in the US would be attached by US citizens with claims against
Communist governments.
By using euromarkets, banks and financiers are able to circumvent or avoid certain regulatory costs and
restrictions. Some examples are:



reserve requirements
requirement to pay FDIC (Federal Deposit Insurance Corporation) fees
rules or regulations that restrict competition among banks.
Continuing government regulations and taxes provide opportunities to engage in eurocurrency
transactions. However, ongoing erosion of domestic regulations has rendered the cost and return
differentials much less significant than was once the case. As a result, the domestic money market and
eurocurrency markets are closely integrated for most major currencies, effectively creating a single
worldwide money market for each participating currency.
7
Capital markets
The main purposes of capital markets are to enable finance to be raised and to provide a mechanism
through which buyers and sellers of securities can facilitate their transactions. The highest profile capital
markets are the stock exchanges of major trading nations, such as the London Stock Exchange and the
New York Stock Exchange. Internationally, a stock exchange is sometimes referred to as a ‘bourse’,
which is the name given by French speakers to the stock exchange in Paris.
62
7.1
Share capital
Businesses raise capital by issuing shares and by borrowing on a long term basis. The shares in a
company are the owners’ equity in the business. The most popular type of share is the ordinary share,
which gives the owner extensive rights, including:

dividends, if the company makes sufficient profit to pay them

information, such as the financial accounts and official communications of the company

participation in decision taking by attending and voting at general meetings, or by voting on a
remote basis

return of capital on liquidation of the company, though this right is subordinate to the claims of
creditors and most other payables.
Preference shares offer a fixed dividend, expressed either as a percentage of the nominal value of the
share (the value indicated on the share certificate) or, less commonly, a fixed monetary sum. The
owners of these shares invariably have a right to be paid their dividend ahead of the ordinary
shareholders and in most cases will be repaid some or all of their capital in the event of liquidation
before the ordinary shareholders receive anything at all.
Preference shares are therefore considered to be a safer form of investment, but in common with
ordinary shareholders, their owners will lose out if the company makes no profits for a sustained period
of time and will also receive less income than ordinary shareholders when the company is doing well.
Preference shareholders are usually only entitled to vote at class meetings on matters affecting their own
relationship with the company. They cannot usually vote on resolutions put to the annual general
meeting.
Some companies issue redeemable shares. As their name suggests, these enable the holders to get their
capital back, either when they choose to do so or when the company decides to repay the funds. The
conditions for redemption depend on the clauses in the Articles of Association (internal constitution) of
the company.
Other than redeemable shares, the shares in a company are permanent capital in that the funds can only
be withdrawn by the member (shareholder) under very restricted circumstances.
7.2
Loan capital
Loan capital takes the form of debentures, which are long term loans. These may be secured on the
assets of the business or unsecured. The relationship between the company and the debenture holder is
that of debtor-creditor.
The company pays interest on debentures, usually at a fixed rate, on the capital owed. Crucially, interest
payments are a contractual obligation, so if the company cannot pay, this represents default on the debt.
The rights of the debenture holder are set out in the contract between the two parties. Many debentures
issued in the UK are written under a trust deed, conferring powers on the manager specified in the trust
deed to act on behalf of the creditors.
63
Q U E S T I O N
T I M E
1 9
What factors affect the rate of interest that a financial institution offers on a bond?
Debentures may be issued for any maturity period, and may even be undated. In the latter case, the
company repays the capital when it chooses to do so.
Q U E S T I O N
T I M E
2 0
Undated bonds – why would anyone buy a bond if they did not know when the capital would be repaid?
7.3
Government bonds
Government bonds are loans to the government by individuals and organisations. The government issues
bonds to meet its own capital requirements, including the replacement of existing bonds that are
maturing.
In the UK, government bonds are called gilt-edged securities, as they are guaranteed to be repaid by the
government. Therefore, such debt is regarded as bearing no risk as long as it is purchased domestically.
UK resident purchasers of bonds issued by foreign governments bear some risk, just as foreign
purchasers of British government securities also bear risk. These risks are currency (or exchange rate)
risk and in some cases country (sovereign) risk.
Government bonds can be issued for a maturity period and can also be undated. It is customary to refer
to bonds with a life of up to 5 years as short dated, 5 – 15 years medium dated and those in excess of
15 years as long dated.
Most government bonds pay fixed interest, but governments can and sometimes do issue variable
interest rate bonds and index-linked bonds.
64
7.4
Primary market
The primary market is the system through which new shares and debentures are issued. New securities
are issued to existing or new investors.
Private limited companies are restricted by law in relation to offering their shares to the public. Public
limited companies that decide to become members of a stock exchange can issue their shares through
various methods. In the UK, the most common method is called an offer for sale, though a more
commonly used international term is an initial public offering, or IPO.
With increasing globalisation, it is becoming more common for companies to:


offer their securities through more that one stock exchange in more than one country
in some cases, offer their shares only through a stock exchange located outside their home state.
Similarly, members of a stock exchange can make their bonds available through a recognised capital
market.
7.5
Secondary market
A stock exchange provides a market place for holders of existing equities and bonds to buy and sell their
securities. This is known as a secondary, or parallel, market.
7.6
Other functions of the stock exchange
In addition to offering a market place for the purchase and sale of new and existing securities, the Stock
Exchange sets standards to which its members must adhere. These are the listing rules. In order to join
the Stock Exchange, a company must comply with specified minimum standards, including the value of
the company, proportion of securities to be traded, financial track record and external audit.
Companies are also expected to comply with generally accepted standards of corporate governance.
In the UK, these are set out in the voluntary UK Corporate Governance Code (formerly the Combined
Code on Corporate Governance). The Stock Exchange also sets standards for takeovers and share
repurchases (buybacks). These standards do not guarantee a high degree of integrity but do provide
reasonable assurance that the majority of listed companies will be compliant.
The Stock Exchange provides a barometer of economic performance. In the UK, the FTSE 100 index can
be used to track the value of the biggest listed companies, giving some indication of the confidence of
the market in their fortunes. Other indices are published for groups of companies of varying sizes.
8
8.1
Relevance of capital markets to offshore banks and their
customers
Many offshore banking institutions are members of stock exchanges and as such are governed by the
laws that apply to public companies and the listing rules of the relevant exchange. They are therefore
exposed to the impact of changes in the market as well as expectations and sentiment that affect the
future prices of securities.
A capital market offers the opportunity to raise finance by issuing shares or bonds. The ease or other
wise of doing so, and the relative costs of equity and loan capital, affect the financial operations of the
business. Analysis of these factors will be crucial determinants of the capital structure of the institution.
65
Whether listed on a stock exchange or not, offshore banking institutions deal with many customers
whose investments include portfolios of securities. It is therefore necessary to offer services that reflect
this including:





share and bond dealing
collective investments
financial advice
wealth management
portfolio management services.
While some offshore banking institutions provide these services directly or through subsidiaries, others
find it more cost effective and efficient to do so by forging strategic alliances with specialist institutions.
Q U I C K
Q U E S T I O N
From time to time we read about the increased volatility of stock markets. Why do customers take risks
by investing in assets that do not guarantee either a regular income or maintaining their capital value?
8.2
Although there is no guarantee that market-related investments will outperform other types of asset, it is
generally accepted that over the medium to long term, the income and capital gains will exceed the
returns on bank deposits and risk-free products. As a consequence, many offshore banking customers
choose to invest in the capital markets, either directly in equities and bonds or indirectly through mutual
funds (collective investments such as unit trusts, investment trusts and open-ended investment
companies, or OEICs).
Customers now have more access to information than ever before, so many will expect the banking
institution to offer products and services that will match their immediate and future needs. Although the
deregulation of the 1980s did not increase the proportion of citizens owning securities as was originally
expected, offshore banking institutions tend to target their services at customers who would be
interested in owning shares, bonds and related investments.
9
Eurobond markets
Eurobonds are bonds sold outside the country in whose currency they are denominated. They are similar
in many ways to public debt sold in domestic capital markets. However, the eurobond market is entirely
free of official regulation and is self-regulated by the International Capital Market Association (ICMA),
(formerly the Association of International Bond Dealers).
66
Borrowers in the eurobond market are typically well known and have impeccable credit ratings (for
example, developed countries, international institutions and large multinational companies). The
eurobond market has grown rapidly in the last two decades and exceeds the eurocurrency market in
size.
About 75 % of eurobonds are dollar denominated. The most important non-dollar currencies for
eurobond issues are the euro, the Japanese yen and the British pound (a Swiss central bank ban has led
to the absence of Swiss franc eurobonds).
Fixed rate eurobonds pay coupons once a year, unlike the half-yearly coupon paid on domestic bonds in
the US market. Borrowers compare the all-in cost, that is, the effective interest rate, on eurobonds and
domestic bonds.
10
Offshore interbank market and other developments
Eurocurrency transactions are the bulk of offshore banking operations and include transactions between
banks and original depositors, between banks and ultimate borrowers, and between banks themselves
on the interbank market. The latter constitute the majority of eurocurrency transactions, making the
eurocurrency market essentially an interbank market. The underwriting of eurobonds floated in
international capital markets is also a significant part of offshore banking activities.
The IMF reports that, although the use of over-the-counter derivative instruments blossomed over the
last decade, most of it seems to have been concentrated in major financial centres rather than offshore
centres.
The emergence of the offshore interbank market in the 1960s and 1970s can be traced to the imposition
of reserve requirements, interest rate ceilings, restrictions on the range of financial products, capital
controls, financial disclosure procedures and high effective taxation in several OECD countries.
The IMF has stated that activity in eurocurrency markets increased further after 1966, when US money
market rate increases rose above dollar deposit rates, provoking a credit crunch as depositors sought
higher yields, and inducing banks to rely more on eurocurrency funding.
In Asia, offshore banking markets began to develop after 1968 when Singapore launched the Asian dollar
market. In Europe, Luxembourg began attracting investors in the early 1970s, due to low income tax
rates, no withholding taxes on interest and dividend income, and banking secrecy rules. In the Middle
East, Bahrain began to serve as a collection point for the region’s oil revenue surpluses during the mid
1970s, after enacting legislation to facilitate the incorporation of offshore banks.
67
KEY WORDS
Key words in this chapter are given below. There is space to write your own revision notes and to add any other
words or phrases that you want to remember.
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

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68
Financial market
Money market
Retail funding
Wholesale funding
London Interbank Offered Rate (LIBOR)
Certificates of deposit
Floating rate notes
Securitisation
Spread
International Monetary Fund
Arbitrage
Exchange Rate Mechanism
European Central Bank
Eurocurrency
Share capital
Loan capital
Debenture
Eurobond
REVIEW

A market is a system through which individuals and entities are brought together to trade in specified
goods and services to their mutual advantage.

Physical market places have been steadily replaced by virtual trading.

Money markets enable financial institutions to lend to one another in the short term. These markets
enable financial institutions to manage their liquidity as well as offering a repository for funds that are
not required for mainstream business purposes in the short term.

Foreign exchange markets bring buyers and sellers of currencies together.

The prices struck in this market place are exchange rates.

Exchange rates are governed by the forces of supply and demand, but influenced by a wide range of
economic, social and psychological factors.

Capital markets enable buyers and sellers of securities to trade with one another. Their main purpose is
to provide a source of finance for companies and other organisations.

The two main types of security issued by companies are shares and debentures (loans). Shares
represent ownership of a company, while bonds are debtor-creditor contracts. The government also
participates in capital markets by issuing government securities, as well as buying and selling securities
to influence interest rates.
69
70
chapter 4
PRODUCTS AND SERVICES
Contents
1
Savings and investments – general characteristics ........................................................ 72
2
Currency accounts .................................................................................................... 74
3
Savings and investment accounts................................................................................ 75
4
Lending products ...................................................................................................... 78
5
Card products........................................................................................................... 82
6
Insurance products ................................................................................................... 82
7
Corporate services .................................................................................................... 83
8
Captive insurance companies...................................................................................... 84
Key words ..................................................................................................................... 86
Review ......................................................................................................................... 87
71
Learning objectives

describe the main features of savings and investment products and services offered by offshore
banks

describe the main features of lending products and services offered by offshore banks

describe the main features of insurance products and services offered by offshore banks

explain the purposes and activities of captive companies.
Introduction
The original functions of offshore banks were orientated towards the provision of savings and investment
products, with most organisations seeking to attract lump sum investments from high net worth
customers. As the activities of offshore banking institutions have developed, however, they have
expanded their product ranges to include most types of retail and wholesale banking facilities.
This chapter does not explore issues relating to taxation and private banking, which are discussed in
separate chapters.
1
Savings and investments – general characteristics
Savings and investment products provide deposit facilities for those who wish to set aside funds for
various purposes. There are many reasons why customers do so, including the need to have funds
readily available for transactions (such as instant access accounts), putting aside cash for precautionary
reasons (the proverbial ‘rainy day’) and perhaps to accumulate wealth by retaining or expanding capital
sums, and in doing so accumulating interest.
The range of products offered by offshore companies is extremely broad. Some offer a full suite of
products while others concentrate on providing a narrow range of accounts targeted at specific market
segments.
Most institutions are prepared to offer accounts in sole and joint names, though some restrict the
number of account holders (typically four persons). The basis on which funds are held is joint and
several ownership, which means that each individual will have full proprietary rights over the whole sum
deposited and any interest accrued.
Q U E S T I O N
T I M E
2 1
What are the implications of joint and several ownership for the customer?
1.1
Interest and interest rates
Historically, offshore institutions paid gross interest, leaving it up to the individual to declare or selfcertify any duties payable to HM Revenue & Customs or other tax authority. This has now changed (for
those living in the European Union) with the introduction of a pan-EU withholding tax regime under the
72
4: PRODUCTS AND SERVICES
Savings Tax Directive. The impact of this is discussed in more detail in the chapter on taxation. For now
it suffices to say that some organisations pay gross interest while others may deduct withholding tax,
depending on the location of the offshore centre and the rules of the jurisdiction within which it falls.
Most organisations quote their interest rates using an Annual Equivalent Rate (AER). This is a wholly
transparent way of demonstrating the actual return to the depositor in a one year period. It takes
account of the number of times interest is credited to an account and the effect of capitalising interest.
For example, a savings account that pays interest of 3% per annum, with interest credited on 30 June
and 3 December has an AER of 3.02%, as the interest for the second half of the year is calculated on the
capital balance plus half a year’s interest.
Most offshore banking institutions permit the depositor to choose accounts with fixed or variable interest
rates. The latter may be subject to movements in general levels of interest rates in international markets,
or may be tracker based.
Q U I C K
Q U E S T I O N
What do you understand by the term ‘tracker’?
If a tracker rate option is chosen, the interest rate on the account will move upwards or downwards with
reference to a stated market rate, such as the parent bank’s own base rate or a more universal indicator
such as the three month LIBOR (the London Interbank Offered Rate, which is basically the rate at which
banks will lend to each other in the wholesale funds market).
Some institutions offer an introductory bonus in order to attract new depositors. This is often expressed
as a fixed additional return for a specified initial investment period.
1.2
Account management and administration
Medium sized and larger offshore institutions enable the customer to access account information and
make transactions through various media, including:



the postal service
telephone contact centres
the internet.
In particular, the internet is expanding rapidly as a channel to market as more people obtain access to
broadband technology. Despite the security risks posed by hacking and identity theft through phishing
and pharming, customers are more confident than ever before when dealing with their financial affairs
through this medium. The clear advantage is the ability to access accounts and make transactions all
day, every day.
73
Q U E S T I O N
T I M E
2 2
What is ‘phishing’?
2
Currency accounts
Offshore banks offer their customers a choice of currencies in which their funds are held. These are most
often in major currencies such as the euro and the US dollar, but larger institutions offer banking
facilities in Japanese yen, Canadian dollars, Australian dollars and other ‘hard’ currencies.
Currency accounts are often suitable for those who receive their income, hold their assets or incur
obligations in the relevant currencies, as they provide the opportunity to eliminate or greatly reduce
currency risk. International currency markets are far from perfect, so those who need to convert
currencies frequently may be disadvantaged by either having to pay commission or accept unattractive
exchange rates. This is particularly important when small amounts have to be converted frequently.
E X A M P L E
John is a self employed consultant, based in the UK. He has clients in the UK and Europe. He has a home
in Birmingham and a holiday apartment in Alicante, Spain, where he spends about 80 days per year.
There are mortgages on both homes.
John can overcome his exposure to some currency risks by holding a sterling trading account with his
domestic bank and a euro trading account with an offshore bank. He can then issue sterling invoices to
his UK clients and euro invoices to some or all of his European clients (which they will probably prefer if
located within the eurozone). Furthermore, John could fund the UK home with a sterling currency
mortgage taken out with a domestic bank and the Spanish apartment with a euro mortgage taken out
with an offshore bank (or alternatively he could take out both mortgages with the offshore bank).
2.1
Validation of identity
Despite the popular belief that offshore banks enable their customers to bypass the legal formalities
associated with purchasing domestic banking products, most offshore banks insist that new customers
provide evidence of identity and take steps to ensure that such evidence is authentic. Although each
jurisdiction has its own domestic requirements in respect of validation of identity, nearly all countries
seek to minimise the risk of bank accounts being used for money laundering or terrorist financing
purposes.
74
Failure to impose certain minimum standards in relation to identification of clients can result in the
relevant jurisdiction being regarded as high risk for money laundering and terrorist financing purposes.
This could result in the country being ‘blacklisted’ by the Financial Action Task Force (FATF), with a
consequence of potential restrictions on inbound and outbound cash flows by more compliant nations.
Q U E S T I O N
T I M E
2 3
What identity checks would you expect to be carried out when a new customer opens an account?
2.2
Depositor protection
Offshore accounts have always been particularly attractive for lump sum investments, usually offering
highly competitive rates, but with loss of the protection provided by depositor compensation schemes.
This risk was highlighted by the failure of Icesave, a brand of Landsbanki of Iceland, in 2008, when the
Iceland government decided that domestic deposits would be protected but not those gathered from the
UK and the Netherlands (in October 2009 the Iceland government announced that limited compensation
would be paid). Some offshore jurisdictions now have, or are developing, their own compensation
schemes. These are considered later in the text.
3
3.1
Savings and investment accounts
Instant access accounts
Although most offshore institutions are not governed by the laws of the United Kingdom, it is generally
accepted that ‘instant access’ in the context of deposits must mean exactly that. For example, an account
that permits immediate withdrawals by cheque or draft without loss of interest is not an instant access
account as the availability of ready cash is not instantaneous.
The evolution of real time money transmission systems has however resulted in the ability of financial
institutions to make funds immediately available through transfers to accounts accessed by ATM cards
and accounts from which transfers can be made in real time. Therefore, although the typical offshore
banking customer rarely (if ever) has the opportunity to ‘drop in’ to the bank to make a transaction, it is
possible to gain access to funds very quickly indeed.
Many offshore institutions offer instant access accounts. These accounts almost invariably pay interest,
sometimes on a tiered basis – as the balance held triggers specified thresholds, the interest rate
increases. It is common for the bank to make a transaction charge when the funds accessed are in a
different currency to that in which the account is denominated.
Instant access accounts can often be managed as current accounts, though a minimum initial deposit is
usually required.
75
Many offshore banks offer their instant access accounts subject to a minimum capital balance being
retained by the depositor. Over time, offshore banks have broadened their potential customer bases by
steadily relaxing the minimum balance requirements.
Q U E S T I O N
T I M E
2 4
How is an AER calculated?
3.2
Restricted access accounts
These accounts resemble the notice accounts offered by many onshore retail banking providers. The
main difference between an instant access account and a restricted access account is that the customer
either has to give notice that a withdrawal is required, or alternatively may make a maximum number of
withdrawals in any given year. If funds are required urgently, the bank may be prepared to waive the
notice period subject to loss of interest equivalent to the number of days for which notice of withdrawal
is ordinarily required.
As access to funds is restricted, the interest rates on these accounts are generally higher than those
offered for instant access accounts. Again, the customer usually undertakes to maintain a specified
minimum balance.
Q U I C K
Q U E S T I O N
Which customer groups might find regular income accounts most attractive?
76
3.3
Regular income accounts
These accounts offer the depositor a regular income from a capital sum deposited. Although they may or
may not be specifically targeted at particular market segments, monthly income accounts may be
particularly appealing to older depositors who wish to supplement their pension or other income with a
return on their savings. There is always a minimum balance requirement for these accounts, as a regular
income facility becomes meaningless once there are relatively small balances held.
Most offshore banks offer the opportunity to hold balances in a choice of major currencies, and to remit
interest on a monthly or less frequent basis.
The interest rates offered on regular income accounts may be tiered with reference to the balance held,
and a choice of interest rates may be given, subject to the restrictions on access that the account holder
is willing to accept, such as a limit to the size or number of withdrawals in a given period.
There are important tax implications for the investor when considering a regular income facility (see the
chapter on tax).
3.4
Lump sum investments
Many offshore banks were set up as an additional method of gathering funding resources, with lump sum
accounts at the forefront of their marketing efforts. The features of these accounts resemble those of
term deposits offered by UK domestic banks, NS&I and term shares (or capital bonds) offered by many
building societies.
Lump sum investments offer high rates of interest on deposit that are placed and will remain with the
bank for a specified period of time. The rates offered are usually tiered with reference to various
thresholds. Some accounts offer flexibility by permitting a limited number of withdrawals during the term
of the investment.
Though mainly offered to the corporate market, offshore banks may offer fixed deposits to their personal
customers. The bank quotes an interest rate effective on the day of investment for the required period,
such as 3 months or 6 months.
During the 1980s and 1990s, some of the offshore subsidiaries of Irish banks marketed their lump sum
investments in a distinctive manner. The products enabled the customer to select a rate of return on
capital, such as 20%, 30% and so on, and would then quote the period of investment (in years and
months) for the return selected.
Q U E S T I O N
T I M E
2 5
Most offshore banks do not offer personal loans. Why is this the case?
77
4
Lending products
As a general rule, offshore banks are often not suitable for everyday borrowing needs, such as personal
loans and small business loans. By definition, the offshore bank is often located in a different country to
that of the borrower, so this creates difficulties when it is necessary to pursue recovery of the debt. For
this reason, many offshore banks originally developed as funding enterprises, complementing the
resource gathering of their domestic parent companies.
In recent times, however, several offshore banks have introduced lending products with specific benefits
for certain customers. These benefits are usually specific to certain market segments, such as:
4.1

those who wish to optimise their use of lending products based on residency, ordinary residency
or domicile

those who have income and/or obligations in different countries

the expatriate community

high net worth customers.
Offshore mortgages
An offshore mortgage is very similar to a mortgage taken out with a domestic banking institution. The
main difference is that the capital sum borrowed may be denominated in a selected currency to suit the
borrower’s circumstances. Most offshore banks offer mortgages in major currencies such as US dollars
and euros, and some offer a wide choice of currencies.
Q U E S T I O N
T I M E
2 6
Why would a prospective borrower consider taking out a mortgage in a foreign currency?
The most direct benefit of taking out a mortgage in a foreign currency arises when some or all of the
borrower’s income is in that currency. This eliminates currency risk in two respects:


it means that there is greater certainty in respect of the capital sum due at any given time
the borrower eliminates the risk of currency fluctuations and their effect on regular repayments.
In addition to the ability to eliminate currency risk, taking out a mortgage in a foreign currency can also
have tax advantages, depending on the borrower’s position in respect of residency, ordinary residency or
domicile.
Mortgages are secured on real estate and the sum borrowed is set with reference to the value of the
property for lending purposes. The borrower enters into a contract with the lender, and this sets out the
rights and obligations of the parties.
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Q U I C K
Q U E S T I O N
What is meant by a regulated mortgage contract?
Several offshore banks that are subsidiaries of UK-based marketing groups refer to ‘regulated mortgage
contracts’. This term means that the loan falls within the definition of a regulated contract under the
Mortgage Conduct of Business (MCOB) rules. These rules govern most domestic UK mortgages taken out
on land partly or wholly for residential use. They affect loans to individuals and some unincorporated
businesses, such as sole traders and unlimited partnerships. The rules also apply to some buy-to-let
mortgages (mainly those taken out by individuals rather than professional property investors and
developers), as well as equity release products.
4.2
Lending limits
The maximum that an applicant can raise is the lowest of:


a multiple of annual gross income (or joint gross incomes), and
a percentage of the valuation of the property.
Many lenders have moved away from using gross annual income multiples and now consider monthly
disposable income instead.
Income has to be substantiated and verified by documentary evidence. Generally, reputable lenders
consider affordability to be more important than the value of the collateral. The existence of good
collateral is not, per se, a good reason to lend in itself.
4.3
Repayment methods
Most lenders are prepared to offer mortgages on a capital and interest or interest only basis. The former
guarantees to pay off the loan if the repayments are met in full over the contracted period. The latter
requires the borrower to discharge the capital at the end of the term, often from the proceeds of a long
term investment product, such as an Individual Savings Account. The lender may or may not wish to see
evidence of a suitable long term investment at application stage, depending on its policy. Interest only
mortgages are now taken out by a very small proportion of new borrowers, but can be attractive to high
net worth customers for financial planning purposes.
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Q U E S T I O N
T I M E
2 7
What are the risks to the customer of taking out an interest only mortgage?
4.4
Rates of interest
In common with most domestic mortgages, offshore mortgage contracts are most often subject to
variable (or floating) rates of interest that move up and down with general movements in market interest
rates. Lenders may be prepared to offer a fixed rate, but only for an initial period, such as 1-3 years. At
the end of the fixed period, the interest rate reverts to the variable rate established in the mortgage
deed.
Offshore banks set their rates with reference to:

a central bank’s rate, such as the Bank of England base rate, set each month by the Monetary
Policy Committee of the Bank of England, or

a market rate, such as the three month LIBOR.
Variable interest rates that follow such indicators are said to be ‘trackers’. Tracker rate mortgages are, of
course, common in the UK domestic mortgage market. Although laws vary between different
jurisdictions, most offshore banks follow the UK common law principle that a mortgage can be repaid in
part or in full at any time. Early repayment or part repayment may be subject to a fee, most often
referred to as an early repayment charge. This term must be used to describe such a fee in the UK.
4.5
Arrangement fees
Some lenders charge an arrangement fee for setting up the mortgage. As well as covering some of the
administration costs, this always includes some charge for booking the finance if the mortgage involves
an initial fixed rate period.
4.6
Buy-to-let mortgages
These mortgages enable the borrower to purchase a property with a view to generating income by
letting the property to tenants. The mortgage contract operates in the same way as other types of
mortgage. However, the lending criteria are usually set with reference to distinctive variables, including:
80

the projected cash flows that will be generated by letting the property, suitably adjusted to take
account of voids (periods in which the property will be empty or partially occupied)

(usually) a lower maximum loan-to-value ratio than that applicable to residential mortgages

the personal income and wealth of the applicant

a minimum loan amount

a maximum loan amount.
Buy-to-let mortgages are considered to be higher risk than residential mortgages and may be subject to
more restrictive lending criteria, such as a shorter maximum repayment term and/or a higher rate of
interest.
Q U I C K
Q U E S T I O N
Sandie has a deposit of CH Fr750,000 with a Swiss bank and is a UK resident, Why would she consider
taking out a back-to-back loan?
4.7
Back-to-back loans
A back-to-back loan secures finance on assets owned by the borrower. In effect, the asset of the
borrower secures the obligation to the lender. Why would a customer wish to do this?
One common form of debt structuring is where the customer of the bank owns assets offshore but
wishes to raise funds domestically. If the customer transfers the funds onshore, this may give rise to a
tax liability. Therefore, a solution to this dilemma is to use the assets held offshore as collateral.
Back-to-back loans can be arranged by offering the offshore assets as direct collateral for the loan, or
alternatively by entering into a guarantee contract whereby a subsidiary liability is created to support the
covenant to repay.
Q U I C K
Q U E S T I O N
What are the main card products available to customers of banks?
81
5
Card products
The card products offered by offshore banks are:



ATM/debit cards for money transmission purposes
credit cards
charge cards.
These cards offer similar services to those provided by card products of onshore banks. The distinctive
feature of most of these products is that the account can be managed in a currency of the customer’s
choice.
Credit cards enable the account holder to purchase goods and services and debit these purchases to the
account. At the end of each month, the customer can choose to repay the full balance owed or any sum
equal to or more than the minimum amount payable (usually 3% or 5% of the total debit balance).
Charge cards enable the account holder to pay for goods and services by debiting the card. The full
balance due on the account must be paid at the end of each month. Transactions on charge cards do not
incur interest, but late payments are subject to penalty charges.
Most ATM/debit cards are managed under the Maestro/Cirrus brand and therefore provide access to
funds across international frontiers. Credit cards are usually provided under the Mastercard or Visa
brands (or both). The main charge card partner for offshore banks is American Express.
Offshore banks are more likely to recognise the need for their clients to make transactions in several
countries, and therefore less likely to ‘stop’ a transaction based on unusual activity.
Many domestic banks have had to introduce rigorous controls on foreign transactions due to the increase
in card fraud and identity theft, and this has become a major problem since fraudsters have occasionally
managed to subvert ‘chip and PIN’ security systems. A consequence of this is that the occasional
traveller using a card issued on a domestic account in a foreign country that is perceived to be ‘high risk’
will have a transaction refused pending verification of its integrity.
6
Insurance products
The insurance products offered by offshore banks fall into two generic categories: general insurance and
life assurance. Products are usually provided on an agency basis, either by insurance companies that are
members of the same marketing group, or third party companies.
General insurance products are concerned with mitigating the effects of risk and uncertainty. Some
products are compulsory for customers, such as property insurance for mortgaged properties. The
borrower has freedom to choose whether to insure through the lender’s agency or to make independent
arrangements. However, if the latter option is chosen, the lender always insists on insurance cover being
of an appropriate quality and continuously in place, with the lender’s interest noted on the policy. Other
products are highly desirable, such as income protection and critical illness insurance.
Life assurance contracts are concerned with certainty, in that a policyholder will either live or die while
the policy is operational. Term assurance can be used to provide a cash sum in the event of death during
a specified term, while whole of life assurance provides a cash sum on death, whenever the death
occurs. Endowment assurance combines life cover for a specified period and long term investment.
Many offshore companies offer life assurance products that maximise the tax benefits to their clients.
Many of these products resemble insurance or investment bonds from which annual sums may be drawn
down. Special tax rules apply to these policies; for example, investment returns can be rolled up tax free
and a liability to tax generally arises only on maturity (if the investor is UK resident at that time). For
non-UK domiciled investors, the rules also permit annual tax-free drawdowns of initial capital, subject to
maximum limits. The tax considerations of these investments are considered when we discuss tax in
detail in subsequent chapters.
82
Q U I C K
Q U E S T I O N
What corporate services can offshore banks provide?
7
Corporate services
Offshore banks provide services for corporate bodies such as commercial companies, financial institutions
and managers of trusts.
Investment, fund management and treasury services include fixed deposit accounts at money market
rates and foreign exchange services. Treasury clients can choose investment periods, such as 1, 3, 6, 9
and 12 months, each for the rate of interest prevailing at that time. Larger offshore banks offer call
accounts for corporate clients, offering immediate access to funds. A particular benefit of dealing with an
offshore bank is that most offer a wide range of currencies in which funds may be invested.
Offshore banks may offer financial institutions and advisers the opportunity to become introducers of
business or intermediaries. These business relationships are always subject to a due diligence exercise
when the application is made but not thereafter, except in those matters that require statutory
monitoring and reporting.
Q U E S T I O N
T I M E
2 8
TUV Financial Advisers Ltd wishes to apply to become an introducer for an offshore bank. What
information would the offshore bank expect TUV Financial Advisers Ltd to provide in order to assess its
suitability as an introducer?
83
8
Captive insurance companies
In contrast with the products and services discussed so far in this chapter, captive insurance companies
provide a business-to-business (B2B) service. They have no relationship with the retail customers of
financial institutions, but provide a service to financial institutions.
A captive insurance company is a legal entity that is registered as a company with the sole purpose of
spreading the risks retained by a parent company. The captive company is usually wholly or partly
owned by a parent company that wishes to avail itself of the captive’s services.
The benefits of forming captives by way of collaboration between different financial institutions is
generally recognised as desirable from a risk management perspective. For example, specific provisions
of the Building Societies Act 1997 gave any two or more societies the right to form captives as joint
ventures (though few have done so, as the scale of operations of most building societies is too small to
realise these benefits).
Q U I C K
Q U E S T I O N
Does insuring with a captive insurance company really transfer risk?
Insurance is a risk transference mechanism through which losses are compensated. There is some
debate as to whether the formation of a captive represents genuine risk transference, but as most
captive companies utilise the reinsurance market, their operations can be regarded as an effective way of
accommodating business risks.
Many captive companies are registered in offshore jurisdictions in order to benefit from streamlined
registration facilities, minimal or non-existent corporate reporting requirements and tax advantages. For
example, the British Virgin Islands and the Cayman Islands have no formal annual reporting
requirements for limited companies registered in their jurisdictions.
The captive insurance company can be used by its parent organisation to insure its own business risks,
such as property and liability insurance needs. It can also be used to spread risks that arise in the course
of business, such as losses on defaults.
E X A M P L E
In a UK context, during the late 1980s and early 1990s, many banks and some of the larger building
societies formed captive insurance companies in order to spread the risks of potential losses on high
loan-to-value (LTV) mortgages (generally, loans in excess of 75% LTV). This followed the tightening of
the policies of insurance companies in respect of mortgage indemnity guarantee policies funded by
higher lending charges.
The attraction of captive insurance became particularly evident following the introduction of rigorous
guidelines issued by the Association of British Insurers (ABI) for these policies during the housing slump
84
in 1991. The ABI recommended that its members should adopt more robust underwriting practices as
well as imposing a 20% excess on claims. In response to this, many lenders formed captive companies
to which their premium income from mortgage applicants would be paid. Some lenders used their
captives to insure the exposure to the 20% excess.
Several US states (notably Vermont) as well as offshore centres as diverse as Switzerland, Labuan
(Malaysia) and Vanuatu (Pacific islands) have become recognised as suitable locations for the registration
of captive companies.
85
KEY WORDS













86
Joint and several
Savings Tax Directive
Annual Equivalent Rate (AER)
Tracker rate
LIBOR
Currency accounts
Instant access accounts
Restricted access accounts
Regular income accounts
Lump sum accounts
Offshore mortgages
Back-to-back loans
REVIEW

Offshore banks provide a wide range of savings and investment products for personal customers,
including instant access, restricted access and lump sum accounts. Customers can choose to invest in
different currencies to suit their individual needs.

Lending products include mortgages for residential, buy-to-let and equity release purposes. Owing to the
potential difficulties associated with enforcing lending contracts in default across international frontiers,
few offshore banks offer personal loans, but can usually provide access to these products through their
domestic partners.

Many offshore banks offer credit, debit and charge card products. Credit cards may be denominated in
currencies of the customer’s choice. They are invariably operated through the Mastercard and Visa
brands.

Insurance services include general insurance and life assurance products. The latter can be structured in
a tax-efficient manner for those fulfilling certain residency and domicile requirements.

Corporate services include fund management, treasury and trust management.

Captive insurance companies offer insurance services to their parent companies. They may be used to
spread risks in respect of the company’s own needs, and may sometimes be used to reduce the potential
impact on losses on certain products, such as higher loan-to-value mortgages.
87
88
chapter 5
PRIVATE BANKING
Contents
1
Private banking customers ......................................................................................... 90
2
Where does offshore banking fit in? ............................................................................ 92
3
Private banking products and services ......................................................................... 92
4
Investment portfolio management............................................................................... 98
Key words ................................................................................................................... 106
Review ....................................................................................................................... 107
89
Learning objectives



describe what is meant by private banking
describe the types of customers who utilise the private banking services of offshore banks
explain the products and services offered to the private banking customers of offshore banks.
Introduction
Private banking offers banking and financial services to high net worth customers. Historically, such
services were provided by banks specifically set up to cater for such customers, and there are still many
banks that concentrate on this market alone. Today, many of the larger banking groups have either
wholly-owned subsidiaries or specialised divisions operating in this market segment. For example, Coutts
and Co is a subsidiary of the Royal Bank of Scotland Group.
Organisations that offer private banking services should not be confused with private banks, which are
usually set up with the purpose of providing banking services for specific organisations.
Q U E S T I O N
T I M E
2 9
Why would an organisation set up its own private bank?
1
Private banking customers
By definition, private banking is concerned with the provision of services to a specifically defined market
segment. Until quite recently, banks defined such customers with reference to a specified minimum level
of personal assets. Acknowledging the increasing diversity of banking customers as well as their
lifestyles, private banking is now available to a broader range of customers than in the past.
Banks may now define private banking customers as:

those who have a specified level of total assets

those who have certain types of assets valued in excess of various criteria; for example, one bank
describes its private banking customers as those whose financial assets exceed a specified sum
and whose non-financial assets exceed a different sum

those who work in certain jobs.
When considering the net asset profile of customers, financial assets would be regarded as cash,
deposits, savings, equities, bonds and collective investments (such as unit trusts, investment trusts and
open-ended investment company shares), while non-financial assets comprise real estate and physical
assets such as vehicles, valuables and other personal belongings.
90
5: PRIVATE BANKING
Q U E S T I O N
T I M E
3 0
What types of financial assets would a high net worth individual typically hold, and why is it desirable to
hold different types of asset?
Banks are reluctant to be too specific in respect of who would or would not be regarded as acceptable
customer types. However, some banks do define thresholds in terms of net worth. This will usually range
from £500,000 to £2 million.
Q U I C K
Q U E S T I O N
Which occupations might be targeted by private banking providers?
The more obvious market segments to which private banking should appeal include:






company directors and executives
wealthy entrepreneurs
specialists such as surgeons and some scientists
professionals such as lawyers
wealthy expatriates
media and sports celebrities.
You will almost certainly have identified additional categories. Some banks do make conscious efforts to
attract business from some of these groups. For example, HSBC International has a specific section on its
website aimed at sports persons. However, private banking facilities are generally offered with the
individual’s needs in mind rather than the way in which they might live their lives. After all, there are
many wealthy trades people just as there are many poor lawyers.
In identifying potential customers, the bank has to be mindful that only a small proportion of the client
base require the value added service that private banking provides over conventional banking services. It
is equally important to accept that private banking must retain certain exclusivity if it is to be
differentiated from general banking services.
91
Q U I C K
Q U E S T I O N
Why might a private banking customer deal with an offshore bank rather than a domestic bank?
2
Where does offshore banking fit in?
Originally, offshore banking mainly focused on attracting relatively large, lump sum deposits from those
who were prepared to sacrifice the security afforded by domestic services in favour of premium rates of
interest and absolute confidentiality. All offshore banks continue to offer such products and services,
though these tend to be only one aspect of the offering to the market place.
As we have already seen, many of the mainstream services offered by offshore banks are more flexible
versions of those provided by domestic banks. Flexibility is provided by offering deposit and credit
facilities in different currencies and high-speed access to funds through international money transmission
systems. It is no coincidence that many individuals and organisations who seek to avail themselves of
such services would fit the client profile of private banking providers. For this reason, many offshore
banks now offer private banking services to such clients.
Conversely, individuals and organisations who can satisfy their needs for banking services through
domestic providers have no need for offshore banks.
3
Private banking products and services
Private banking differentiates itself by providing a value added banking service that must treat each
customer as an individual and not an account number. For this reason, most private banking providers
give the customer access to a personal banker who serves as a contact to meet ongoing needs. The
concept of the personal banker is not new – during the 1980s, Barclays Bank introduced this concept in
its retail offices in the UK, seating its advisers in general office areas rather than behind screens and
desks.
However, the personal banker working with private banking clients takes the individual service much
further by:
92

having the discretion to facilitate most actions required by the customer quickly and efficiently (or
by having direct access to managers or individuals who can authorise these actions)

dealing with the full range of banking needs rather than having to arrange for different specialists
to give advice

playing a more proactive part in organising the customer’s affairs; for example, when market
conditions change suddenly, the customer would expect the personal banker to either take
appropriate actions within his or her mandate or make contact rather than wait for the customer
to give instructions.
5: PRIVATE BANKING
Although no personal banker can be an expert in all areas of banking practice, it is necessary to have a
sufficient understanding of most products and services so that the customer can be advised up to a
stage where specialist expertise is required.
Q U E S T I O N
T I M E
3 1
What specialists might be useful contacts for the personal banker to a high net worth customer?
3.1
Deposits and money transmission
Private banking customers generally have larger funds to deposit and often need to make substantial
payments and transfers without delay. For this reason, the banker has to know the customer extremely
well in order that large legitimate transactions are not impeded by anti-money laundering checks, while
at the same time taking all reasonable steps to discharge statutory responsibilities under the Proceeds of
Crime Act 2002 and the equivalent laws in other countries.
As the customer is likely to have a substantial balance in deposits, it is the banker’s responsibility to
ensure that the customer optimises the use of such funds. As we have seen, most banks offered tiered
rates of interest, but many private banking providers have taken the concept further by linking
conventional deposit accounts with market-based investments, such as collective investments (mutual
funds), often enabling the customer to choose between different strategies, according to the individual’s
risk appetite or risk aversion.
This concept was pioneered in the 1980s by Merrill Lynch, whose ‘Money Management’ product proved to
be an astonishing success. Today’s version of this account is the ‘Cash Management Account’, which
takes ‘idle cash’ from the customer’s account on a weekly basis into investments that will generate a
return and enables the customer to meet immediate needs for liquid funds from a Visa card.
3.2
Investments
Private banking customers expect advice on complex investment and investment arrangements. This
may relate to:

deposit-based investments offered by the bank itself

bonds and equities

indirect investments such as unit trusts, investment trusts, open-ended investment companies
(and their foreign equivalents, such as SICAVs)

property

commodities.
As private banking customers tend to have a diverse range of assets, some may seek to maximise
efficiency by setting up special purpose vehicles (SPVs, alternatively referred to as special purpose
entities). These usually involve setting up a company, or several companies, to take assets under
93
management. They can often be used to reduce the customer’s tax liability or to structure the return on
the investment so that it is subject to capital gains tax instead of income tax, or vice versa.
Many banks offer a share dealing service. This may be execution only, where the bank acts entirely on
the customer’s instructions, or discretionary portfolio management, where an inhouse or outsourced
stockbroker takes investment decisions on behalf of the investor.
High net worth clients may have access to treasury products, which were once the exclusive domain of
commercial investors such as companies and other businesses. These products offer money market rates
of interest and include fixed deposits, government and corporate bonds and certificates of deposit (CDs).
Typically, these products offer fixed rates of interest for fixed periods of time. The rate of interest is
struck on the day that the contract is formed, or in the case of secondary market purchases, when the
original security was issued.
It is quite usual for money market rates to change on a daily basis, and sometimes several times within a
single day.
Q U E S T I O N
T I M E
3 2
Stanley has been quoted 2.5% for a one month deposit, 2.25% for a three month deposit and 1.75% for
a nine month deposit. Why would the treasury department offer lower rates of interest for longer term
deposits?
Loans
Private banking subsidiaries of offshore banks are generally unsuited to offering large commercial loans,
as there is a limited ability to take appropriate security and often difficulty in carrying out appropriate
checks at application stage. However, many offshore banks offer mortgages, either for residential
purposes or as buy-to-let investments. High net worth customers can usually take out high value
mortgages as their financial circumstances enable them to service such obligations.
Many private banking providers offer property services, including estate management and search
facilities. However, such services are more likely to be provided by onshore private banking
organisations, as to be utilised effectively there has to be relatively frequent personal contact between
banker and client.
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Q U E S T I O N
T I M E
3 3
What property services might be provided by an offshore bank?
3.3
Credit and charge cards
Private banking providers can differentiate their products from traditional credit cards by offering some
or all of the following:







very high credit limit (perhaps £50 – 100,000)
cash advances
choice of currency in which the account is denominated
link to deposit account (such as the Cash Management Account described earlier)
reward points
frequent flier points
concessionary car hire and hotel rates with partner companies.
Q U I C K
Q U E S T I O N
Some private banks also offer charge cards. How does a charge card differ from a credit card?
The main difference between a charge card and a credit card is that the charge card account balance
must be settled each month, therefore there is no interest payable on a charge card, though the card
issuer reserves the right to impose penalty charges if the account is in arrears. There is no credit limit on
charge cards.
The most popular charge card is issued by American Express, which offers green, gold and platinum
versions (there is also a black ‘Centurion’ card which is highly exclusive and available by invitation only).
95
3.4
Trustee services
A trust is a legal entity that holds assets and may incur liabilities on behalf of its owner. The persons
responsible for management of the trust are the trustees, who are appointed by the person(s) setting up
the trust, usually referred to as the settlor.
By setting up a trust it is often possible to ‘ring fence’ assets in order to separate them from the affairs of
the settlor or the beneficiary. In this way it is sometimes possible to create significant tax advantages,
both within and outside the trust.
Most banks can offer expertise in managing and administering trusts and have specialist advisers
available to guide their customers. This service can also be extended to dealing with matters pertaining
to executorship. Private banking customers often have complex financial affairs and may therefore
benefit considerably by involving the bank’s specialists in their financial plans.
3.5
Wealth management
Wealth management is concerned with taking an holistic approach to financial planning, including some
or all of the above services.
As in all financial advisory scenarios, wealth management has to begin with a fact find that will enable
the adviser to identify and quantify:

assets (the current position, and perhaps the projected position based on expectations of
inheritance and future intended divestments)

liabilities (again, taking into account the current situation and known future changes that can be
measured or estimated)

income

expenditure

existing structure of the above, including a breakdown of investments, other assets held, etc)

tax position in relation to residency, ordinary residency and domicile).
This analysis alone will enable the adviser to form an overview of the customer’s situation and the likely
ways in which the bank will be able to provide products, services and advice.
Before any advice can be given, however, it is also necessary to gather qualitative information including:

future plans and expectations in relation to his or her financial affairs

attitude to risk

subjective views that will influence wealth management strategies, such as unwillingness to own
certain types of asset or deal with particular companies.
It is important to take these qualitative aspects into account. For example, many wealthy individuals
were prepared to invest millions of pounds in loss-making motor racing teams, and even in high quality
sports cars sold to the general public, in the period immediately following the Second World War. This
was a matter of personal choice rather than commercial judgement. Today, many investors will not
consider doing business with environmentally unfriendly companies or countries that have oppressive
civil rights regimes.
The wealth management strategy produced from the above analysis and interactions will take account of
needs in relation to the following:

Liquidity
The customer must be sure that there will be sufficient liquid assets to meet immediate and very
short term transaction needs. Liquidity refers to cash and assets that can be turned into cash at
reasonably short notice.
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5: PRIVATE BANKING

Safety and security
There are several aspects to consider here:

–
The investor will wish to ensure that existing assets and cash flows are protected, which
implies the need for prudent asset management and consideration of appropriate risk
transfer mechanisms, such as general insurance and life assurance.
–
The customer must formulate plans that are consistent with his or her personal level of
risk appetite or risk aversion.
Tax efficiency
Most high net worth individuals must pay tax, but they will wish to ensure that their affairs are
structured in a manner that will provide a legitimate shield from tax obligations that could be
avoided. Remember that tax avoidance is a key benefit provided by offshore institutions.

Return
The adviser is expected to ensure that the customer can generate appropriate returns on assets
owned. Generally, those who are prepared to take higher risks have a greater potential for long
term returns, but will be exposed to a greater probability of losses. The type of return is usually of
vital importance. For example, it may be beneficial from a tax perspective to minimise income and
maximise capital gains or vice versa.

Future plans
The high net worth individual must be mindful of the need to plan for the medium and long term
future, and also for his or her estate on death. Making a will is essential, and revising the will if
circumstances change drastically is usually desirable.
If the individual has assets in different countries, it is essential that advice be taken on any legal
implications of this, such as whether a will would be recognised in these countries. This is especially
important, as some countries do not recognise the claims of unmarried partners, civil partners, children
born out of wedlock and stepchildren who have not been legally adopted.
The bank can provide advice on appropriate mechanisms through which the estate will eventually be
distributed and managed, including trusts and divestment strategies.
Q U E S T I O N
T I M E
3 4
Geoff and Jill married in 2007. Geoff is 40 years old and has no children. Jill is 41 years old and has four
children from her previous marriage. Geoff made a will when he was married to his previous wife, but
this marriage ended in divorce in 2005. Jill has never made a will. Both are British citizens and they have
always lived in Birmingham.
What is the situation in relation to inheritance if both Geoff and Jill are killed instantly in a car crash?
97
4
Investment portfolio management
The process of managing an investment portfolio never stops. Once the funds are initially invested
according to the plan, the real work begins in monitoring and updating the status of the portfolio and the
investor’s needs.
The first step in the portfolio management process is for the investor to construct a policy statement.
This is a ‘road map’ in which investors specify the types of risks they are willing to take and their
investment goals and constraints. All investment decisions are based on the policy statement to ensure
they are appropriate for the individual investor. Because investor needs change over time, the policy
statement must be periodically reviewed and updated.
A policy statement is an invaluable planning tool that will help the investor understand their needs better
as well as assist an adviser or portfolio manager in managing a client’s funds. While it does not
guarantee investment success, a policy statement will provide discipline for the investment process and
reduce the possibility of making hasty, inappropriate decisions.
There are two important reasons for constructing a policy statement:

it helps the investor decide on realistic investment goals after learning about the financial markets
and the risks of investing

it creates a standard by which to judge the performance of the portfolio manager.
An important purpose of writing a policy statement is to help investors understand their own needs,
objectives and investment constraints. As part of this, investors need to learn about financial markets
and the risks of investing. This background will help prevent them from making inappropriate investment
decisions in the future and will increase the possibility that they will satisfy their specific, measurable
financial goals. Thus, the policy statement helps the investor to specify realistic goals and become more
informed about the risks and costs of investing.
The process of investing seeks to peer into the future and determine strategies that offer the best
possibility of meeting the policy statement guidelines. In the second step of the portfolio management
process, the manager should study current financial and economic conditions and forecast future trends.
The investor’s needs, as reflected in the policy statement and financial market expectations, will jointly
determine investment strategy.
Economies are dynamic; they are affected by changes in industrial structure, politics and changing
demographics and social attitudes. Thus, the portfolio will require constant monitoring and updating to
reflect changes in financial market expectations.
The third step of the portfolio management process is to construct the portfolio. With the investor’s
policy statement and financial market forecasts as input, the advisers implement the investment strategy
and determine how to allocate available funds across different countries, asset classes and securities.
This involves constructing a portfolio that will minimise the investor’s risks while meeting the needs
specified in the policy statement.
The fourth step in the portfolio management process is the continual monitoring of the investor’s needs
and capital market conditions and, when necessary, updating the policy statement. Based upon all of
this, the investment strategy is modified accordingly. A component of the monitoring process is to
evaluate a portfolio’s performance and compare the results relative to the expectations and requirements
listed in the policy statement.
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5: PRIVATE BANKING
Q U I C K
Q U E S T I O N
What do you think are all the major factors that have to be considered in determining investment
objectives?
4.1
Investment objectives
The investment policy contains the client’s objectives and constraints, and the guidelines that the
investment manager must follow. Objectives often receive the most attention from investors, at the
expense of the other policy considerations. Objectives are determined from a thorough discussion with
and knowledge of the client’s needs, preferences and resources.
Major considerations are:

Return
In discussion with the manager, the client must determine whether they prefer a strategy of
return maximisation, where assets are invested to make the greatest return possible while staying
within the risk tolerance level, or whether a required minimum return with certainty is preferable,
generating only that much return with the emphasis on risk reduction. In addition, the manager
should be conscious of the proportion of current income versus capital gains in light of the client’s
tax position and needs, as well as the split between current income received as interest versus
current income received as dividends.

Risk
There are many ways to assess the risk tolerance of a particular investor, from the very
rudimentary to the very sophisticated. Each has its value in measuring what degree of risk the
client is prepared to take, and is a vital element in the ultimate design of the portfolio, as it will
govern the selection of securities to be included.
It is important to recognise the difference between the risk of an individual security and the risk
of the portfolio as a whole. Because the risk of a portfolio is less than the average risk of its
holdings, the client’s risk tolerance should be matched to the risk of the overall portfolio and not
to the risk of each security.

Inflation
Although most retail clients will need some degree of inflation protection, the extent will vary. For
example, a retired person with a long time horizon and the goal of using the portfolio to generate
income will be very concerned about what the purchasing power of the cash flow from the
portfolio will be. Another person using short term trading strategies and interested in
maximisation of capital gains may concentrate less on this particular factor.
99
Although most retail clients will need some degree of inflation protection, the extent will vary. For
example, a retired person with a long time horizon and the goal of using the portfolio to generate
income will be very concerned about what the purchasing power of the cash flow from the
portfolio will be. Another person using short term trading strategies and interested in
maximisation of capital gains may concentrate less on this particular factor.

Time horizon
A major factor in the design of a good portfolio is how well it reflects the time of its goals.
Fundamentally, the time horizon is the period of time from the present until the next major
change in the client’s circumstances. In other words, just because a client is 25 years of age and
normal retirement is at age 60 does not necessarily mean their time horizon is 35 years.
Clients go through various events in their lives, each of which can represent a time horizon and a
need for a complete rebalancing of their portfolio. For example, finishing university, planning for a
career change, the birth of a child, the purchase of a home and many other events besides
retirement represent the end of one time horizon and the beginning of a new one.
While some major events in a client’s life cannot be predicted, such as a serious health problem
or loss of employment, a client’s time horizon should still be the period of time from the present
to the next major expected change in circumstances.

Liquidity
Liquidity can have several meanings, including the net working capital of a business and the
ability to sell a security quickly without a significant sacrifice in price. In portfolio management,
liquidity means the amount of cash and near-cash in the portfolio.

Taxation
An investor’s marginal tax rate will dictate, in part, the proportion of income which should be
received as dividends versus income, and therefore, in part, the proportion invested in preferred
shares versus other fixed income securities such as bonds. Taxation levels and rates will also
guide the choice of tax-advantaged securities.

Market timing
Two approaches to investing include the buy and hold approach and the market timing approach.
As the name indicates, buy and hold means long holding periods through various market cycles
for long term growth and income. Market timing involves timing the short term entry and exit
points in the market in pursuit of quick trading gains over and above the commission incurred.
Clients generally have a preference for one of those approaches over the other, usually also with
a much smaller preference indicated for the other. Some clients very much enjoy the excitement
of trading gains and will increase their risk tolerance to accommodate this desire.

Other
Clients usually do not communicate with their investment adviser in terms of risk, return etc, but
instead, primary investment goals might be stated as a desire to retire at a certain age, the
acquisition of a business, a holiday home or yacht, or the pursuit of some other tangible goal.
With care and explanation to the client, the adviser can translate such events with the client’s full
agreement and understanding.
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5: PRIVATE BANKING
Q U I C K
Q U E S T I O N
What constraints might exist for the investor?
4.2
Constraints
Constraints provide some discipline in the fulfilment of a client’s objectives. Constraints, which may
loosely be defined as those items which may hinder or prevent the investment manager from satisfying
the client’s objectives, are often not given the importance they deserve in the policy formation process.
Perhaps this is because objectives are a more comforting concept to dwell on than the discipline of
constraints.
Possible constraints include:

Legal
Certainly, any investment activity which contravenes legislation or regulation must be considered
a constraint.

Moral/ethical
Some transactions and investment activities may not be against the law, but should invariably be
treated as if they are. While clients may have preferences for certain types of securities, they may
also have strong aversions to certain others. For example, perhaps because of personal
convictions, a client may instruct that no alcohol or tobacco stocks be purchased. Although it is
not normally against the law to purchase these types of securities, and although these securities
may fit the client’s other objectives perfectly, if the client has instructed the manager not to
purchase them, then that order must be respected.

Emotions
As full an assessment as possible should be made of the client’s temperament. Through
discussion and active listening, the manager can fulfil much more of the customer due diligence
requirements than if this arena is given only cursory treatment.

Investment knowledge
Should a certain strategy be followed if the client clearly does not understand it? For example,
writing covered options or using protective puts and other positions may be warranted by the
client’s circumstances, but the client may not understand them, and particularly will not if they
end up losing money! However, serious discussion with the client, coupled with active listening,
can result in a clear agreement on what is permitted. It is the responsibility of the investment
manager to explain the investment process to the client, especially where the client is not
sophisticated but is interested.
101

Willingness to take risk
Although risk has already been mentioned in the context of market volatility, here it relates to the
client’s level of comfort with volatility in income and volatility in the principal. Despite the ability of
a client to take risk, their willingness may be lower than expected. If a client is interested in
stocks and makes worried calls several times a day for a quote, chances are that this product is
not appropriate for them. The extra expected return is not worth it if the client cannot sleep
because of the extra risk involved. On the other hand, a client may be quite comfortable with
speculative currency or options strategies where their tolerance for risk must be much higher.

Ability to take risk
The greater the client’s need for income from their portfolio, the lower their ability to take risk
and impact the strategic asset allocation of their portfolio. Suppose the client has living expenses
in addition to salary, pension and other income which requires $20,000 per year in cash flow from
the portfolio to meet these expenses. A portfolio may be structured to generate a good total
return, but it must also be assured that there is $20,000 in current income from the portfolio or
the client will not be able to live on the income.

Other
Questions related to each of the above constraints can reveal a great deal about the client’s
attitudes and constraints. However, there is also a place for a final overall question, such as: ‘Is
there anything else, which we haven’t talked about, which might be important?’ It is surprising
what can come from such a question, such as a family member who is an insider (legal
constraint), a serious illness (income and time horizon implications), size of the account (very
small, or a huge lottery winning) or a pending marital breakup, which somehow was not
discovered in previous conversations.
4.3
Major investment objectives
Having discovered the client’s objectives and constraints, the next step in designing an investment policy
is to summarise this information in terms of the three major objectives of income, capital gains and
preservation of capital. It is these major objectives that will help determine the appropriate asset
allocation for that client.
Income
This major objective refers to regular series of cash flows from a portfolio, whether in the form of
dividends, interest or some other form, and is a broader definition than the basic minimum income
referred to as a constraint. The taxation of dividends and interest income will be a major determinant of
the split between income received from debt or equity securities. This split is decided at the time the
asset mix is set. Income is influenced by return, risk, inflation and basic minimum income, among others.
Capital gains
Capital gains is a term related to increases in capital due to sale proceeds being higher than cost bases
(ie selling something for more than it cost). Here the emphasis is on security selection and market
timing, and generally is a trade-off against preservation of capital. Capital gains is a major objective that
includes risk, return, market timing and emotional considerations as well as others.
Preservation of capital
One major objective is to have some assurance that the initial capital invested will remain largely intact.
If this is the main concern among the three major objectives, the client is effectively saying that,
regardless of whether a small, large or nil return is generated on the capital, the manager should try to
avoid erosion of the amount initially invested. The manager should clarify if the portfolio is to cover at
least the impact of inflation. There is one simple strategy to make the preservation of an investor’s
principal fairly certain.
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5: PRIVATE BANKING
E X A M P L E
Assume an account size of $1,000,000, and a Treasury bill rate of approximately 5%. Roughly $950,000
can be invested in Treasury bills, which are considered risk free and which will mature in one year’s time
at $100,000, restoring the principal amount. The other $50,000 can be invested in some other venture,
and even if $1,000,000 is lost completely, the investor will receive their principal back.
Preservation of capital is derived from several objectives and constraints, including risk, market timing,
inflation, return and emotion.
4.4
Investment policy statement
Ideally, the objectives and constraints, and perhaps even the manager’s style, are written down in a
formal document called an investment policy statement. This document forms the basis for the
agreement between the manager and the client and is in effect the manager’s job description. Policy
statements can be either elaborate or quite simple, but most cover the objectives and constraints of a
portfolio, a list of acceptable securities and a list of prohibited securities, as well as the method to be
used for performance appraisal.
4.5
Setting the asset mix
The next step in the asset allocation process is to determine the appropriate balance among the selected
asset classes. Using only cash, fixed income and equity asset classes, the following are some examples
of asset mixes determined by the client’s risk tolerance and investment goals.
Capital preservation
Investors want to minimise their risk of loss – this is a strategy for strongly risk-averse investors or for
funds needed in the short run.
Bonds 50%
Bond range 40% – 60%
Prefs 30%
Prefs range 20% – 40%
Equities 15%
Equity range 0 – 15%
Income
A fairly conservative portfolio with emphasis on fixed income securities with a little risk for a slightly
higher return.
Bonds 40%
Prefs 25%
Equities 25%
Equity range 5% – 45%
Income and growth
A portfolio allocation and management method aimed at balancing risk and return. Such portfolios are
generally divided equally between equities and fixed income securities.
Cash/FD 10%
Cash/FD range 0 – 20%
Bonds 30%
103
Growth
A portfolio with a higher weighting of riskier assets than fixed income securities for a higher expected
return.
Cash/FD 5%
Bonds 20%
Prefs 15%
Equities 65%
Aggressive growth
An asset allocation strategy that seeks to maximise capital appreciation or the increase in value of a
portfolio or asset over the long term.
Q U I C K
Cash/FD 5%
Bonds 15%
Bond range 0 – 15%
Prefs 20%
Prefs range 0 – 20%
Equities 80%
Q U E S T I O N
Why is asset allocation important?
4.6
Importance of asset allocation
A major reason why investors develop policy statements is to determine an overall investment strategy.
The policy statement provides a guideline as to the asset classes to include and the relative proportions
of the investor’s funds to invest in each class. How the investor divides funds into different asset classes
is the process of asset allocation. The asset allocations noted above have ranges within which the
investment manager can allocate the portfolio’s assets within a given asset class. These ranges allow the
investment manager to actively manage the portfolio while maintaining the client’s asset allocation
strategy.
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5: PRIVATE BANKING
C A S E
S T U D Y
Private banking HQ in Singapore
Standard Chartered set up its Private Banking global headquarters in Singapore aiming to tap the rapidly
growing wealth in Asia. Besides launching its headquarters here, the Standard Chartered Private Bank
also rolled out centres in nine other markets such as Hong Kong, Shanghai, Mumbai, Dubai and London
by the end of June 2007. It planned to invest up to ‘… mid tens of millions of dollars in the private
banking business in 2008 and 2009’, said Peter Flavel, the bank’s global head of private banking, at the
launch of the headquarters. ‘The private bank market is an incredibly attractive market for us. It’s large,
it’s growing very quickly in our home markets. So it’s a natural extension of our existing wealth
management businesses,’ he said.
The Merrill Lynch Capgemini Wealth Report estimated that global high net worth financial wealth would
grow at an annual rate of 6 percent to reach 44.6 trillion U.S. dollars by 2010. Asia is expected to reach
10.6 trillion U.S. dollars by then, close to the European wealth market, according to Singapore’s Second
Minister for Finance, Tharman Shanmugaratnam, who spoke at the opening ceremony.
The minister also pointed out that the silver industry was a major opportunity for private banks.
‘According to one industry wealth report, the purchasing power of the over 60s has increased 7 times in
the last 20 years. They would tend to have less active income and instead the desire to spend an
increasing proportion of their time and money on leisure. They would also often want to transfer part of
their wealth to the next generation,’ he said. He added that the elderly consumers would need tailored
financial advice and wealth planning solutions to meet their needs.
Bank of China, the nation’s second-largest state-owned commercial lender, launched private banking
services for millionaires in Beijing and Shanghai on Wednesday, March 28, 2007. Only clients with
financial assets exceeding one million U.S. dollars are eligible for the service that is being offered in
conjunction with the Royal Bank of Scotland, which owns a 4.4 percent stake in the bank.
Yuan Kuntao, general manager of the UK-based bank’s Asia-Pacific division, said the private banking
service would be able to meet the customised needs of Chinese customers, adding that it was almost on
a par with its overseas peers. China was home to 320,000 millionaires in 2005, according to a report by
Capgemini and Merrill Lynch.
Wang Lei, general manager of BOC’s private banking division, said the service had huge room to grow as
an increasing amount of rich customers are starting to think about financial assets management.
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KEY WORDS












106
Financial assets
Non-financial assets
Personal banker
Indirect investments
Share dealing services
Treasury products
Property services
Premium credit/charge cards
Trustee services
Executorship
Wealth management
Portfolio management
5: PRIVATE BANKING
REVIEW

Private banking provides a highly personalised service to high net worth customers.

Wealthy customers often have a more diverse and more complex set of needs than other banking
customers. This means that it is necessary for those providing private banking services to have a high
level of knowledge and skill, as well as access to specialist advice as and when required.

Offshore private banking serves the particular needs of those with financial interests in more than one
country, and those who need to facilitate cross-border transactions on a regular basis.

Offshore private banking products mirror those of mainstream banking and include deposits, savings,
investments, lending, card products, trusteeship, executorship and portfolio management.
107
108
chapter 6
TAXATION
Contents
1
Income tax ............................................................................................................ 110
2
The Savings Directive .............................................................................................. 111
3
Capital gains tax (CGT)............................................................................................ 113
4
Inheritance tax (IHT) .............................................................................................. 113
5
Resident and domicile ............................................................................................. 115
6
Remittance basis .................................................................................................... 117
7
Double taxation agreements ..................................................................................... 117
8
Mitigating the effects of tax ..................................................................................... 118
Key Words .................................................................................................................. 122
Review ....................................................................................................................... 123
109
Learning objectives


define the terms ‘resident’, ‘ordinarily resident’ and ‘domicile’ in the context of taxation
explain the tax treatment of offshore accounts for individuals and companies.
Introduction
The main taxes that are relevant to individuals and trusts in the UK are income tax, capital gains tax and
inheritance tax, there is also a new tax regime for high value dwellings that are ‘wrapped’. The profits of
companies are subject to corporation tax. Generally, UK citizens are assessable for personal taxes
throughout their lives. Although most individuals do not start to generate regular income until they leave
school or university, they are in fact liable to tax from birth. Similarly, those who retire continue to be
liable to tax on income and capital gains beyond the date of their retirement.
Offshore income and gains are treated in a similar manner to any other form of income, but there are
special considerations that apply depending on the precise status of the individual in relation to residency
and domicile. Many customers are able to manage their finances in a more tax-efficient manner by
availing themselves of offshore banking services. Reputable offshore banks encourage their customers to
avoid tax legitimately but discourage the illegal practice of tax evasion (see double tax treaties later in
the text).
1
Income tax
As the term suggests, income tax is levied on most forms of income received by individuals and some
profits attributable to individuals from their participation in legal entities, such as sole traders and
partnerships. Income tax is not chargeable on profits made by limited companies, as profits are subject
to corporation tax. However, income from companies, such as wages, salaries and dividends, are subject
to income tax. In most countries, income tax is the main source of government revenue.
Income can take many forms, including wages and salaries, dividends, interest, rents and State benefits.
Generally, all sources of income are taxable unless specifically exempt under government regulations. In
the UK, for example, interest on some NS&I accounts is not taxable, and every individual is permitted to
receive tax-free income from certain Individual Savings Accounts (ISAs), subject to maximum annual
investment limits.
Q U E S T I O N
T I M E
3 5
Apart from the above, list other types of income that are tax free.
Everyone is entitled to a tax-free allowance, which is the maximum that an individual can receive in a
given tax year before incurring an income tax liability. Once income exceeds the tax-free allowance,
income tax is charged at different rates, depending on the total taxable income of the recipient.
It is important to note that the country from which income is received is largely irrelevant in relation to
the liability incurred (see double taxation agreements).
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6: TAXATION
There are various ways in which income tax is collected. Some income is received gross and duties
become payable on specific dates. Self-employed persons, for example, are entitled to receive gross
income from business turnover and then discharge their income tax in two instalments each year. By
contrast, employed persons have income tax deducted through PAYE (Pay As You Earn).
Most types of deposit account pay interest with tax deducted at source. Only those who can self-certify
that they are non-taxpayers are entitled to gross interest. The tax deducted at source for taxpayers only
represents the basic rate of income tax, so higher rate income taxpayers have an additional liability.
Q U E S T I O N
T I M E
3 6
Is it likely that customers of offshore banking institutions would be non-taxpayers?
Income from offshore sources can be treated in one of two ways, depending on whether the source is
within or outside the European Union (see also double taxation agreements):

If the income is from outside the European Union, it is paid to the owner on a gross basis and
must then be declared as ‘foreign income’ for each tax year.

If the income is from within the European Union, the owner is paid net of withholding tax, unless
they can self-certify that the tax is not applicable.
Q U I C K
Q U E S T I O N
How does income differ from a capital gain?
2
The Savings Directive
The European Union does not administer taxation policies in respect of duties payable in member states.
However, the Savings Directive was enacted in 2005 in order to reduce the prospect of citizens of
111
member states evading tax liabilities by not disclosing interest arising from deposits outside their own
states of residence.
The Directive provides for:

exchange of information between member states

retention of a withholding tax in respect of interest paid to private individuals on deposits, bonds,
money market funds, mortgages and some other loans.
The withholding tax has been implemented on a sliding scale over time:
1 July 2005 – 30 June 2008 15%
1 July 2008 – 30 June 2011 20%
1 July 2011 onwards 35%.
The tax is not levied on citizens residing outside the European Union. Therefore, Jersey is within the
British Isles and has a special constitutional relationship with the UK, but it is not a member of the
European Union and as such its residents do not have tax withheld. Likewise, the residents of some
countries outside the European Union, such as Switzerland, that have signed an agreement with the
European Union do not have tax withheld.
Some countries have special sensitivity in relation to disclosure of information and have not agreed to
make such disclosures. These include Austria, Belgium and Luxembourg. However, they have agreed to
introduce a withholding tax. Outwith the European Union, many states have implemented similar
arrangements, including Anguilla, the British Virgin Islands, the Cayman Islands, Jersey, Guernsey and
Switzerland.
In addition to its provisions on withholding interest on savings, the Directive also provides for withholding
monies payable from certain savings and investment instruments where the income can be expressed as
a capital gain.
Several countries have no policies in place to disclose information or deduct withholding tax, including
Barbados, Bermuda, Hong Kong and Singapore.
The implication of the Savings Directive for customers of offshore institutions is that where the institution
is situated in a country that agreed to disclosure or deducting withholding tax, prospective depositors are
required to make a declaration if they wish to receive gross interest.
Q U I C K
Q U E S T I O N
In what circumstances is capital gains tax payable?
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3
Capital gains tax (CGT)
This tax is charged on gains arising from the disposal of most types of asset. For example, if an
individual bought a piece of land for £1 million in 2008 and sells it in 2014 for £2 million, the profit (or
gain) is usually assessable for capital gains tax.
CGT is relevant to many types of investment, including:




investment properties, at home or abroad
equities
bonds
some collective investments, when income is accumulated within the collective.
It does not affect savings and investments from which an income is derived but the capital remains
unchanged in value, such as most bank and building society deposits.
Any gain made on the disposal of a private residence used exclusively for owner-occupation of the owner
is exempt, therefore, provided the property used as security is a residential dwelling, there is no liability
for CGT when it is sold. If the residence is used to any extent for business or other commercial purposes,
there is normally a liability for CGT on the sale of the property should a gain be made.
A CGT liability may be reduced by:

an annual exempt allowance of £10,900 per individual, personal representative or trustee for a
disabled person, and £5,545 for other trustees, applicable in the year of disposal of the asset (tax
year 2013/14)

the costs of acquiring the asset when originally purchased

the costs of disposing of the asset

costs of improvement but not running costs/maintenance

a deflator applied to account for inflation, calculated as an indexation allowance for years prior to
April 1998 and as taper relief subsequently

Disposals that qualify for entrepreneur’s lifetime relief are taxed at 10% up to £10,000,000.
Since the tax year 2011/12, CGT has been levied at 18% and 28% for individuals (the tax rate depends
on the total amount of taxable income, so this must be calculated first). 28% is levied in trustees or for
personal representatives of a person who has died. Those qualifying for entrepreneurs relief pay CGT at
10%.
Capital gains tax is relevant to customers of offshore banking institutions because the location at which a
gain is made is largely irrelevant in ascertaining the individual’s liability. Therefore, the profit on the
disposal of a holiday home in Spain is just as liable for capital gains tax as that made on the disposal of a
holiday home in England or the country that has issued the passport, Ie a passport does not assume UK
tax domicile.
4
Inheritance tax (IHT)
Inheritance tax is levied on the estates of deceased persons when the total value of the estate exceeds
the threshold determined by the tax authority. In the UK, gifts and transfers of assets within seven years
of the death of the individual are also deemed to be part of the estate.
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Q U E S T I O N
T I M E
3 7
Why should transfers of assets made within seven years of death be regarded as part of a deceased
person’s estate? What would be the potential consequence if this rule did not exist?
In relation to estates where property is mortgaged, the taxable value of the estate is the net value after
stripping out obligations secured on the property. Therefore, if a property is worth £200,000 but there is
a mortgage outstanding of £140,000, the value for IHT purposes is £60,000. If a property has been used
as security in an equity release scheme, the value of the estate is reduced by the total sum outstanding
to the lender. This will always comprise capital but may also include rolled-up interest (which may be
substantial), a share in the appreciation of the property and fees and charges payable on redemption of
the loan.
IHT is charged at 40% on the value of the estate over and above the nil rate band threshold, which for
the tax year 2013/14 is £325,000. Since 6 April 2012, those who leave 10% or more of their estate to
charity pay a reduced rate of 36%.
For estates where disposals of properties have occurred within seven years of death, a sliding scale is
applied:
Years between gift and death
% of value chargeable
0–3
100%
3–4
80%
4–5
60%
5–6
40%
6–7
20%
If an individual disposes of an asset but retains some use of the asset or benefit from it, this will result in
the asset being regarded as part of the estate. This is called a gift with reservation. For example, a
person may transfer an apartment to a son or daughter but retain use of the property.
Some transfers within the seven year period are exempt, including transfers to a spouse and some gifts
made in respect of marriages of close relatives.
Inheritance tax is relevant to many customers of offshore banking institutions, as a key market segment
is high net worth individuals. As a result of this, many institutions offer facilities that can legitimately
reduce or eliminate a liability, including special purpose vehicles and trusts (see later).
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Q U I C K
Q U E S T I O N
What do you understand by the terms ‘resident’ and ‘domicile’?
5
Resident and domicile
These terms have specific meanings under the rules of HM Revenue & Customs (HMRC). They are
relevant in determining personal tax liabilities.
5.1
Resident
UK rules to decide whether an individual is UK resident have changed substantially since 5 April 2013.
From this date, older terms such as being ‘ordinarily resident’ have largely been abolished.
From 5 April 2013, the rules, known as the ‘Statutory Residence Test [SRT]’, apply, which will decide for
most people their UK residence status for tax purposes.
Note: The residency rules as set out by the HMRC are detailed and specific. General coverage of these
rules is given below [for more detailed coverage, refer to the HMRC website].
5.1.1
Statutory Residence Test
HMRC rules are that an individual will be resident in the UK for a tax year [except under ‘split year
treatment’] if they don’t meet any of the ‘automatic overseas tests’, and they meet either:


5.1.2
one of the automatic UK tests; or
the sufficient ties test.
Automatic UK tests
An individual is considered automatically UK resident if they:
5.1.3

spend 183 days or more in a UK tax year

have their only home in the UK for a period of 91 consecutive days of which at least 30 fall in a
tax year

work for at least 3 hours a day in the UK for more than 75% of a 365 day period in a given tax
year

had their only home in the UK in a tax year when they die.
Sufficient ties test
An individual who does not meet the ‘automatic UK test’ [or ‘automatic overseas tests’] needs to consider
whether over the previous three tax years they have any of the following UK ties:


a family tie
an accommodation tie
115


a work tie
a 90 day tie.
Having considered these ties, the more days in the given tax year spent in the UK, the fewer of the ties
that are needed before an individual is considered as being UK resident. [See HMRC for more detail of
these rules].
5.1.4
Automatic overseas tests
If an individual meets any of the automatic overseas tests for a tax year, then they are automatically
non-resident for the tax year. The tests apply if an individual:
5.2

spends less than 16 days in the UK in a tax year after being UK resident in one or more of the
previous three tax years; or

spends fewer than 46 days in the UK in a tax year after being non-resident in the UK for none of
the previous three tax years; or

works full time overseas in the tax year without ‘significant breaks’, and spend fewer than 91 days
in the UK in the tax year and work (for more than three hours per day) for fewer than 31 days in
the UK.
Domicile
The simple definition of domicile is the country in which an individual considers to be his or her place of
residence. HMRC stresses that there is no single legal definition of this concept, but it is a matter for
general law. The factors that HMRC consider to be most important in respect of domicile are that an
individual:




cannot be without a domicile
can only have one domicile at a time
will normally be domiciled in the country where his or her permanent home is located
will continue to have the same domicile until a new one is acquired.
Domicile is distinct from nationality or residence, though both can have an effect on the domicile of the
individual. Whether or not a person can vote in a particular country is generally irrelevant to domicile; or
the country that has issued the passport, that is, a UK passport does not assume UK tax domicile.
One’s domicile of origin is usually acquired from one’s father at the time of birth, or if one’s parents were
not married at the time of birth, from one’s mother. This may be a different country to the one in which
the individual is born, as the father may be domiciled elsewhere on that particular date. Conversely,
being born in the UK does not automatically mean that the individual is domiciled in the UK.
A person born to a non-domiciled father but is then adopted by a UK domiciled family becomes UK
domiciled. The person’s domicile is said to be ‘displaced’.
Any person can change their domicile by moving to another country. This becomes their domicile of
choice. However, the act of moving abroad does not automatically change the individual’s domicile, and
HMRC considers several factors in deciding whether this is the case for tax purposes. These factors
include the location of permanent residence, future intentions, family, personal and business interests
and any will that has been made.
A final concept in relation to domicile is the individual’s domicile of dependence. As a general rule, the
domicile of an individual is dependent on the person on whom he or she is legally dependent, and this
cannot be altered until the person has the legal capacity to change it. For most people, this arises at the
age of 16 years.
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Q U E S T I O N
T I M E
3 8
What factors other than age might limit an individual’s capacity to change domicile?
6
Remittance basis
Until recently, an individual who was UK resident but non-UK domiciled was taxed on a remittance basis.
This meant that foreign income and capital gains that were not transferred to the UK could not be taxed
domestically. Once remitted, they would be subject to UK income tax and capital gains tax. Tax would
also arise on any benefits enjoyed in the UK from funds that were not remitted.
These rules were changed with effect from 6 April 2008, then further amended in 2012. An individual
who has been a UK resident for seven of the last nine years but non-UK domiciled can now be treated on
the remittance basis subject to a charge of £30,000. The charge for Individuals who have been UK
resident in at least 12 of he last 14 tax years is at the higher rate of £50,000 from 2012/13. If this
charge is paid, any income or capital gains will not be taxable until remitted. This effectively shelters the
income and capital gains enjoyed, though of course this will only apply to those with significant
investments and/or assets.
Those who cannot fulfil the ‘seven to nine years’ rule continue to be able to hold offshore deposits and
be taxed on the remittance basis without paying the £30,000 (or £50,000 for the 12-year residence test)
charge.
7
Double taxation agreements
It is a fundamental principle underpinning tax administration that an individual or legal entity should not
be unduly penalised by having to pay tax on the same income or asset in two different countries. Were
this principle not to be observed, the incentive to work in more than one country would be greatly
diminished, and the overall level of economic activity would suffer.
The UK has many agreements with states both within and outside the European Union through which tax
recognised overseas will be regarded as offsetting liabilities within the UK. Such agreements facilitate the
exchange of information between jurisdictions in order to ensure that appropriate but not excessive
taxes are paid.
In the European Union there is a multilateral agreement between member states through which
information is exchanged. This is especially relevant in tracking the potential liabilities of individuals and
companies who claim exemption from withholding tax (on savings interest) on the basis of nonresidency. Subsequent failure to declare such income in the individual’s home state would be regarded as
tax evasion.
117
8
8.1
Mitigating the effects of tax
Offshore trusts
A UK resident who is non-UK domiciled can shelter assets from capital gains tax (CGT) in an offshore
trust. This applies to UK assets as those held outside the country. Capital gains made by the trustees are
not taxed in the UK, unless a capital payment (or distribution) is made. In this case the tax liability can
be avoided by retaining the distribution outside the UK on payment of the £30,000 (or £50,000 if the 12year residence test applies) annual remittance charge, if appropriate.
E X A M P L E
Stephen is UK resident but non-UK domiciled. He is buying a property located in the UK through an
offshore trust with a view to letting the property which is worth £1.5 million. If the property is
subsequently sold for £2.0 million, no CGT will be payable on the gain arising in the offshore trust. The
gain of £500,000 will only become subject to CGT in the UK when a capital payment is made by the
trustees to Stephen. This will be taxed at the rate prevailing at the time of the capital payment. If
Stephen is a higher rate income taxpayer, this will be at 28%. His liability for tax assuming this current
rate of CGT would therefore be £140,000.
If he retains the distribution outside the UK, Stephen can avoid liability to CGT if he pays the £30,000 (or
£50,000) annual remittance charge. This is conditional on having been a UK resident for seven of the
previous nine tax years.
If he retains the distribution outside the UK, Stephen can avoid liability to CGT if he pays the £30,000 (or
£50,000) annual remittance charge. This is conditional on having been a UK resident for seven of the
previous nine tax years.
A person who is UK resident and domiciled can use an offshore trust to shelter assets from CGT, but
lineal relatives such as a spouse or civil partner, children and grandchildren must all be excluded from
benefiting from the trust. The trust can benefit friends and other third parties who are not lineal
relatives.
There is no tax payable when trustees make capital gains. Tax is only payable if these gains are
distributed to UK resident beneficiaries (who may still avoid being taxed if they themselves are non-UK
domiciled and pay the £30,000 annual remittance charge where appropriate).
Non-UK domiciles who are resident in the UK can create a trust to hold non-UK assets, or those assets
that are exempt from inheritance tax but are UK sited, which can remain outside the scope of inheritance
tax (IHT), even if the individual subsequently becomes UK domiciled. Any non-UK domicile who has been
resident in the UK for 17 of the past 20 years will be deemed to be UK domiciled for IHT purposes and,
once they are UK domiciled, their worldwide estate will come within the scope of UK IHT. This situation
can be avoided by setting up an excluded property trust, and transferring certain assets into the trust,
prior to the individual becoming a UK domicile.
Any non-UK assets transferred to the trust will be outside the scope of IHT. IHT may also be avoided on
UK property if the property is transferred to an offshore company which is itself owned by the trust
(effectively, a special purpose vehicle). The transfer must take place before the individual is considered
to be domiciled in the UK. The important feature of this structure is that the trust owns shares in an
offshore company, which is a non-UK asset and therefore excluded from the scope of UK IHT.
Unless the trust is an excluded property trust for IHT purposes, IHT charges will arise at a maximum of
6% every ten years on the value of the trust assets sited in the UK less an allowance currently of
£325,000.
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6: TAXATION
Q U E S T I O N
T I M E
3 9
Can an asset be subject to capital gains tax and inheritance tax at the same time?
8.2
Offshore companies
A non-UK domicile who wishes to own assets that are legally situated in the UK, such as land or UK
equities, can avoid exposure to IHT on his or her death by holding the assets in an offshore company. If
the asset is the individual’s main residence in the UK, this might create other tax issues which necessitate
further advice.
A non-UK resident who owns UK property that generates an income is liable to pay UK income tax at a
maximum rate of 45%. This exposure can be reduced to 20% by owning the property in an offshore
company.
Q U E S T I O N
T I M E
4 0
Is there any real difference between owning an asset personally and owning it via a company in which
there is only one shareholder and only one director?
119
E X A M P L E
Miranda is neither UK resident nor a UK domicile. She is considering purchasing a property in the UK.
If the property is purchased via an offshore company, the liability to UK taxation on the rental income
can be restricted to 20% provided she remains a non-resident.
There will be IHT benefits for Miranda’s beneficiaries on her death if she holds the property via an
offshore company. Any UK property held directly by her will be subject to 40% IHT on her death. If the
UK property is held via an offshore company, the asset included in Miranda’s estate on death will be the
shares owned by her in the offshore company, which are a non-UK asset. As a consequence, no IHT will
be payable on the UK property on death.
For UK residents investing in UK property and doing so through a company, an offshore company is
nearly always more tax efficient than a UK company. This is because a UK company pays corporation tax
at a maximum rate of 23% (2013/14) on any profit on the sale of the company. A company may bear Its
own taxes but on a liquidation of the company, In the hands of the individual taxpayer, further income or
capital gains taxes may be charged In addition.
Gains arising from other assets (such as shares in private companies and non-UK assets) can be
sheltered from CGT through an offshore company. This is achieved by using another company
incorporated in a country with which the UK has a double taxation agreement. The effect is to defer the
tax on any capital gain arising until the proceeds are paid out as a dividend. This tax, in turn, can be
avoided by being non-UK resident at the time.
8.3
Offshore life assurance policies
A life assurance policy taken out with a non-UK insurance company can be a highly tax-efficient savings
vehicle. Provided the policy is not regarded by HMRC as a highly personalised bond, the investment
return within the policy can be rolled up tax free.
Tax only arises at the point at which the policy is surrendered, encashed, etc, or otherwise matures, and
then only if the policyholder is UK resident at the time. In addition, a tax-free annual withdrawal of up to
5% of the initial capital is permitted, which can therefore generate an effective tax-free income stream.
Non-UK domiciled policyholders are not required to pay the £30,000 additional remittance charge (even if
otherwise appropriate) in order to enjoy the benefits of rolling up or the 5% withdrawal from the policy.
E X A M P L E
Seema is a non-UK domiciled individual who has lived in the UK for more than seven consecutive years.
Consequently, she must pay the £30,000 annual remittance charge in order to avoid paying UK income
tax on her foreign income except to the extent the amount is remitted to the UK.
Her only foreign capital is £400,000 which she wishes to invest in a tax-efficient manner. Paying the
annual charge would eliminate the benefits otherwise available to Seema.
If Seema places the £400,000 of foreign capital in an offshore bond to mature in 20 years time, she can
make an annual withdrawal of 5% (£20,000) of the initial value of the bond tax free, even if the funds
are brought into the UK.
Provided Seema keeps the bond and does not withdraw more than 5% of the initial premium each year,
any capital gains or income arising within the bond are not subject to tax in the UK.
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6: TAXATION
If Seema is a higher rate income taxpayer, she will pay UK income tax when the bond matures, is
surrendered or encashed at a rate of 45%, assuming she remains a UK resident.
Let’s assume that the bond matures after 20 years and the value of the bond on maturity is £800,000.
Annual withdrawal of 5%
Maturity value of the bond
(800,000, of which £400,000
is the original investment)
Amount
£20,000
£400,000
UK tax payable
Nil
£180,000
If Seema owns the bond via an offshore company then she can sell the shares in the company
immediately prior to maturity of the policy. This avoids the income tax liability on maturity. The sale of
shares would be a chargeable capital gain and therefore subject to capital gains tax at a rate of 18% (or
28%), or the rate prevailing at the time.
If the capital gain on the sale of the offshore company is £400,000, then £112,000 tax would be payable.
Alternatively, if the capital gain were high enough, Seema could avoid CGT by not remitting the proceeds
to the UK and paying the £30,000 annual charge. So the tax payable would be £30,000 if the annual
remittance basis was claimed (assuming that the 7-year test applies)
If Seema leaves the UK before maturity of the bond, she could encash the bond without having to pay
any UK tax. In such instances it is not necessary to hold the bond through an offshore company.
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KEY WORDS
















122
Income tax
European Union Savings Directive
Withholding tax
Tax-free allowance
Capital gains tax
Annual exempt allowance
Inheritance tax
Remittance basis
Resident
Ordinarily resident
Domicile of origin
Domicile of choice
Domicile of dependence
Offshore trust
Offshore company
Offshore life assurance policy
6: TAXATION
REVIEW

The three main personal taxes relevant to customers of offshore banking institutions are income tax,
capital gains tax and inheritance tax.

Income tax is payable on most forms of income, including interest from deposits and investments. The
European Union Savings Directive provides for exchange of information between members states and
retention of a withholding tax on interest paid to personal depositors.

Capital gains tax is levied on the profits on disposals of certain assets.

Inheritance tax is payable on the value of estates on death and certain gifts and other transfers made
within seven years of death.

The tax treatment of the individual is dependent on three factors: residency, ordinary residency and
domicile. Specific rules apply to the first two of these, while domicile is a common law concept applied
with reference to the circumstances of each individual.

The impact of personal taxes on the individual can be mitigated by prudent use of offshore trusts,
offshore companies and offshore life assurance policies.
123
124
chapter 7
TRUSTS
Contents
1
What is a trust? ...................................................................................................... 126
2
Trustees ................................................................................................................ 128
3
Beneficiaries........................................................................................................... 129
4
Purposes of trusts ................................................................................................... 130
5
Types of trust......................................................................................................... 133
6
Terminology ........................................................................................................... 137
Key words ................................................................................................................... 139
Review ....................................................................................................................... 140
125
Learning objectives






define a trust
explain how a trust is created
identify the main parties involved in setting up and administering trusts
explain the role of trustees
explain the benefits of trusts, with particular reference to their role in offshore banking
describe the main generic types of trust.
Introduction
We have seen that offshore banking relies heavily on the confidence of customers in respect of tax
efficiency and confidentiality. Many customers also use the services of offshore banking institutions for
the purposes of estate planning. As mentioned briefly already, a trust is a medium through which these
objectives can be pursued.
This chapter looks at trusts in a little more detail. As you work through it, be mindful that legislation on
trusts differs greatly from country to country, so the ability or otherwise of customers to avail themselves
of these benefits is determined by their residency and domicile status. Even within the United Kingdom,
there are significant differences between the laws of Scotland and the rest of the country in relation to
trusts.
Q U I C K
Q U E S T I O N
Write down what you understand by the term ‘trust’?
1
What is a trust?
A trust is a legal entity through which assets can be held, and in many cases, liabilities incurred in its
own right. If assets are transferred into a trust, this usually has the effect of separating them wholly or
partly from the transferor.
1.1
Creation of a trust
The person or entity that directs that assets be placed or transferred into a trust is called the settlor. The
person or entity that benefits from the trust, now or in the future, is called the beneficiary. There can be
more than one beneficiary. The person or entity responsible for managing the trust is called the trustee.
There can be more than one trustee. Trusts can be created by written document (express trusts) or by
implication (implied trusts).
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7: TRUSTS
Q U E S T I O N
T I M E
4 1
You are probably familiar with the Prince of Wales Trust and the Princess Diana Trust. Who are the
settlors, beneficiaries and trustees of these trusts?
Typically, a trust is created by one of the following:

a written trust document created by the settlor and signed by both the settlor and the trustees
(often referred to as an inter vivos or ‘living trust’)

an oral declaration

the will of a deceased person, usually referred to as a testamentary trust

a court order (for example in family proceedings).
In some jurisdictions certain types of assets cannot be the subject of a trust without a written document.
1.2
Formalities
Generally, a trust requires three certainties:

intention – there must be a clear intention to create a trust.

subject matter – the property subject to the trust must be clearly identified. One cannot, for
example, settle ‘the majority of my estate’, as the precise extent cannot be ascertained. Trust
property can be any form of specific property, be it real or personal, tangible or intangible and is
often, for example, real estate, shares or cash.

objects – the beneficiaries of the trust must be clearly identified, or at least be ascertainable. In
the case of discretionary trusts, where the trustees have power to decide who the beneficiaries
will be, the settlor must have described a clear class of beneficiaries.
Q U E S T I O N
T I M E
4 2
Think about how a trust might be used by a customer of an offshore bank. What would be the typical
objects of such a trust?
127
The beneficiaries of a trust can include people not born at the date of the trust (for example, ‘my future
grandchildren’). Alternatively, the object of a trust could be a charitable purpose rather than specific
beneficiaries.
Q U I C K
Q U E S T I O N
What are the responsibilities of a trustee, and how are they established?
2
Trustees
The trustee can be either a person or a legal entity such as a limited company or other form of
association. There can be (and often are) multiple trustees (in the UK there must be a minimum of two
for a trust in relation to land so that they can provide a receipt in the event of a sale.
A trustee has many rights and responsibilities, and these can vary depending on the type of the trust. A
trust generally will not fail solely for want of a trustee; if there is no trustee, whoever has title to the
trust property will be considered the trustee. Otherwise, a court may appoint a trustee, or in Ireland the
trustee may be any administrator of a charity to which the trust is related. Trustees are nearly always
appointed in the document (instrument) which creates the trust. Most trusts are created by trust deed.
It is very important to remember that a trustee has a huge responsibility and may be held personally
liable for any issues which arise with the trust. For example, if a trustee does not invest trust monies
with a reasonable degree of care and skill in order to fully expand the trust fund, they may be liable for
potential or actual losses.
There are two main types of trustees: professional and non-professional. Liability is different for the two
types.
The trustees are the legal owners of the trust’s property. The trustees administer all of the affairs
attendant to the trust, including:
128

investing the assets of the trust

ensuring that the trust property is preserved and productive for the beneficiaries

accounting for and reporting periodically to the beneficiaries concerning all transactions
associated with trust property

filing any required tax returns on behalf of the trust

and many other administrative duties.
7: TRUSTS
Q U E S T I O N
T I M E
4 3
Does a trustee have complete freedom in making investments on behalf of a trust?
In some cases, the trustees must make decisions as to whether beneficiaries should receive trust assets
for their benefit. The circumstances in which this discretionary authority is exercised by trustees is
usually provided for under the terms of the trust instrument. It is then the trustees’ duty to determine in
the specific instance of a beneficiary request whether to provide any funds and in what manner.
By default, being a trustee is an unpaid job. However, in modern times trustees are often lawyers or
other professionals who rarely work for free, so a trust document will often state specifically that trustees
are entitled to reasonable remuneration for their work.
A trust can be created without the trustees having any knowledge of its existence. However, it is usual
for the settlor to make arrangements with potential trustees (for example, friends or a professional)
before creating the trust.
3
Beneficiaries
In common law countries, the beneficiaries are beneficial (or equitable) owners of the trust property.
Either immediately or eventually, they will receive income from the trust property or they will receive the
property itself.
Q U E S T I O N
T I M E
4 4
What is meant by the term ‘equitable owner’?
129
The extent of an individual beneficiary’s interest depends on the wording of the trust document. One
beneficiary may be entitled to income (for example, interest from a bank account), whereas another may
be entitled to the entirety of the trust property when he reaches 25 years of age.
The settlor has much discretion when creating the trust, subject to limitations imposed by law.
Q U E S T I O N
T I M E
4 5
What are examples of limitations imposed by law?
4
Purposes of trusts
Common purposes for trusts include:

Privacy
Trusts may be created purely for privacy. In some jurisdictions the terms of a will are public and
the terms of a trust are not. In some families this alone makes use of trusts ideal.

Spendthrift protection
Trusts may be used to protect oneself against inability to handle money. It is not unusual for an
individual to create an inter vivos trust with a corporate trustee who may then disburse funds only
for causes specified in the trust document – these are especially attractive for spendthrifts. In
many cases a family member or friend has prevailed upon the spendthrift/settlor to enter into
such a relationship.
Q U I C K
Q U E S T I O N
How might a trust be used for estate planning?
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7: TRUSTS

Wills and estate planning
Trusts frequently appear in wills (indeed, technically, the administration of every deceased’s
estate is a form of trust). A fairly conventional will, even for a comparatively poor person, often
leaves assets to the deceased’s spouse (if any), and then to the children equally. If the children
are under 18 years of age, or under some other age specified in the will (21 and 25 years of age
are common), a trust must come into existence until the contingency age is reached. The
executor of the will is (usually) the trustee and the children are the beneficiaries. The trustee will
have powers to assist the beneficiaries during their minority.
Q U E S T I O N
T I M E
4 6
When used for estate planning, trusts can be used to mitigate tax. Which types of tax are such trusts set
up to avoid?

Charities
In some common law jurisdictions all charities must take the form of trusts. In others,
corporations may be charities also, but even there a trust is the most usual form. In most
jurisdictions, charities are heavily regulated for the public benefit (in England and Wales, for
example, by the Charity Commission).

Unit trusts
The trust has proved to be such a flexible concept that it is capable of working as an investment
vehicle – the unit trust. This is a type of collective investment through which the units purchased
by hundreds or thousands of investors are pooled in order to invest in a range of assets, such as
deposits, government bonds, equities and property. The unit trust is established under a trust
deed, even though it may appear to the investor that it is simply a subsidiary of the bank or other
financial institution that offers it.

Pension plans
Occupational pension schemes are typically set up as a trust, with the employer as settlor and the
employees and their dependants as beneficiaries. This legal separation has been especially
important following the shortcomings of law revealed by the Maxwell Communications plc scandal
in the late 1980s and early 1990s, in which thousands of employees and former employees of
Mirror Group Newspapers lost some or all of their pension rights.
131
Q U E S T I O N
T I M E
4 7
Who are usually the trustees of trusts set up on behalf of occupational pension schemes?

Corporate structures
Complex business arrangements, most often in the finance and insurance sectors, sometimes use
trusts among various other entities (such as corporations) in their structure.

Asset protection
The principle of asset protection is for a person to divorce him/herself personally from the assets
they would otherwise own, with the intention that future creditors will not be able to attack that
money, even though they may be able to bankrupt him/her personally. In doing this they are said
to ‘ringfence’ the relevant asset.
It should be noted that under UK law it is an offence to protect assets in this way if it is carried
out as a deliberate act to avoid responsibilities to creditors in the event of bankruptcy.
One method of asset protection is the creation of a discretionary trust, of which the settlor may
be the protector and a beneficiary, but not the trustee and not the sole beneficiary. In such an
arrangement the settlor may be in a position to benefit from the trust assets, without owning
them, and therefore without them being available to the creditors.
Such a trust will usually preserve anonymity with a completely unconnected name (such as ‘The
Teddy Bear Trust’). This is a considerable simplification of the scope of asset protection and it is a
subject which straddles ethical boundaries. Some asset protection is legal and (arguably) moral,
while some asset protection is illegal and/or (arguably) immoral.

Tax planning
The tax consequences of doing anything using a trust are usually different from the tax
consequences of achieving the same effect by another route (if it is possible to do so). In many
cases the tax consequences of using the trust are better than the alternative, and trusts are
therefore frequently used for tax avoidance.
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7: TRUSTS
Q U I C K
Q U E S T I O N
Recap – what is meant by the terms ‘tax evasion’ and ‘money laundering’?

Tax evasion
In contrast to tax avoidance, tax evasion is the illegal concealment of income from the tax
authorities. Trusts have proved a useful vehicle for the tax evader, as they tend to preserve
anonymity and they divorce the settlor and individual beneficiaries from ownership of the assets.
This use is particularly common across borders – a trustee in one country is not necessarily bound
to report income to the tax authorities of another. This issue has been addressed by various
initiatives of the Organisation for Economic Co-operation and Development (OECD) and is also
monitored through double taxation agreements.

Money laundering
The same attributes of trusts which attract legitimate asset protectors also attract money
launderers. Money laundering is a criminal activity through which the proceeds of crime are
disguised and concealed. ‘Dirty money’ is made to look clean by moving it through the banking
system. Many of the techniques of asset protection, particularly layering, are techniques of money
laundering also, and innocent trustees such as bank trust companies can become involved in
money laundering in the belief that they are furthering a legitimate asset protection exercise,
often without raising suspicion.

Co-ownership
Ownership of property by more than one person is facilitated by a trust. In particular, ownership
of a matrimonial home is commonly effected by a trust with both partners as beneficiaries and
one, or both, owning the legal title as trustee. Under the Law of Property Act 1925, one of the
main statutes affecting real estate ownership in England and Wales, a maximum of four persons
can hold title to freehold, leasehold or commonhold estate.
Therefore, a maximum of four names can be entered into the proprietorship register at HM Land
Registry. If there are more than four owners of the property, the Act permits the four registered
owners to hold the property in trust for the unregistered owners.
5
5.1
Types of trust
Constructive trust
Unlike an express or implied trust, a constructive trust is not created by an agreement between a settlor
and the trustee. A constructive trust is imposed by the law as an ‘equitable remedy’. This generally
occurs due to some wrongdoing, where the wrongdoer has acquired legal title to some property and
cannot in good conscience be allowed to benefit from it.
133
A constructive trust, essentially, is a legal fiction. For example, a court of equity recognising a plaintiff’s
request for the equitable remedy of a constructive trust may decide that a constructive trust has been
‘raised’ and simply order the person holding the assets to the person who rightfully should have them.
The constructive trustee is not necessarily the person who is guilty of the wrongdoing, and in practice it
is often a bank or similar organisation.
The laws of England, Wales and Northern Ireland, but not Scotland, recognise constructive trusts.
5.2
Express trust
An express trust arises where a settlor deliberately and consciously decides to create a trust, over his/her
assets, either now, or upon his/her later death. In these cases this will be achieved by signing a trust
instrument which will either be a will or a trust deed.
Almost all trusts dealt with in the trust industry are of this type. They contrast with resulting and
constructive trusts. The intention of the parties to create the trust must be shown clearly by their
language or conduct. For an express trust to exist, there must be certainty to the objects of the trust and
the trust property.
5.3
Fixed trust
In a fixed trust, the entitlement of the beneficiaries is fixed by the settlor. The trustee has little or no
discretion. Common examples are:



5.4
a trust for a minor (‘to x if she attains 21 years of age’)
life interest (‘to pay the income to x for her lifetime’)
a remainder (‘to pay the capital to y after the death of x’).
Hybrid trust
A hybrid trust combines elements of both fixed and discretionary trusts. The trustee must pay a certain
amount of the trust property to each beneficiary fixed by the settlor, but the trustee has discretion as to
how any remaining trust property, once these fixed amounts have been paid, is to be paid to the
beneficiaries.
5.5
Implied trust
An implied trust, as distinct from an express trust, is created where some of the legal requirements for
an express trust are not met, but an intention on behalf of the parties to create a trust can be presumed
to exist. A resulting trust may be deemed to be present where a trust instrument is not properly drafted
and a portion of the equitable title has not been provided for. In such a case, the law may raise a
resulting trust for the benefit of the grantor (the creator of the trust). In other words, the grantor may
be deemed to be a beneficiary of the portion of the equitable title that was not properly provided for in
the trust document.
5.6
Incentive trust
This is a trust that uses distributions from income or principal as an incentive to encourage or discourage
certain behaviours on the part of the beneficiary. The term ‘incentive trust’ is sometimes used to
distinguish trusts that provide fixed conditions for access to trust funds from discretionary trusts that
leave such decisions up to the trustee.
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7: TRUSTS
Q U I C K
Q U E S T I O N
What do you understand by ‘irrevocable’?
5.7
Irrevocable trust
In contrast to a revocable trust, an irrevocable trust is one in which the terms of the trust cannot be
amended or revised until the terms or purposes of the trust have been completed. Although in rare cases
a court may change the terms of the trust due to unexpected changes in circumstances that make the
trust uneconomical or unwieldy to administer, under normal circumstances an irrevocable trust cannot be
changed by the trustee or the beneficiaries of the trust.
5.8
Offshore trust
Strictly speaking, an offshore trust is a trust which is resident in any jurisdiction other than that in which
the settlor is resident. However, the term is more commonly used to describe a trust in one of the
jurisdictions known as offshore financial centres (tax havens). Offshore trusts are usually conceptually
similar to onshore trusts in common law countries, but usually with legislative modifications to make
them more commercially attractive by abolishing or modifying certain common law restrictions. By
extension, ‘onshore trust’ has come to mean any trust resident in a high tax jurisdiction.
5.9
Private and public trusts
A private trust has one or more particular individuals as beneficiary. By contrast, a public trust (also
called a charitable trust) has some charitable end as beneficiary. In order to qualify as a charitable trust,
the trust must have as its object certain purposes such as alleviating poverty, providing education,
carrying out some religious purpose, etc. The permissible objects are generally set out in legislation, but
objects not explicitly set out may also be an object of a charitable trust by analogy. Charitable trusts are
entitled to special treatment under the law of trusts and also the law of taxation.
5.10
Protective trust
Here the terminology is different in the UK and in the USA:

In the UK, a protective trust is a life interest which terminates on the happening of a specified
event such as the bankruptcy of the beneficiary or any attempt to dispose of the interest. They
have become comparatively rare.

In the USA, a protective trust is a type of trust that was devised for use in estate planning. (In
another jurisdiction this might be thought of as one type of asset protection trust.)
135
5.11
Purpose trust
More accurately, this is a non-charitable purpose trust (all charitable trusts are purpose trusts).
Generally, the law does not permit non-charitable purpose trusts outside of certain anomalous exceptions
which arose under the eighteenth century common law. Certain jurisdictions (principally offshore
jurisdictions) have enacted legislation validating non-charitable purpose trusts generally.
5.12
Resulting trust
A resulting trust is a form of implied trust which occurs where a trust fails, wholly or in part, as a result
of which the settlor becomes entitled to the assets; or a voluntary payment is made by A to B in
circumstances which do not suggest gifting. B becomes the resulting trustee of A’s payment.
5.13
Revocable trust
A trust of this kind can be amended, altered or revoked by its settlor at any time, provided the settlor is
not mentally incapacitated. Revocable trusts are becoming increasingly common in the United States as a
substitute for a will to minimise administrative costs associated with probate and to provide centralised
administration of a person’s final affairs after death.
5.14
Secret trust
This is a post mortem trust constituted externally from a will but imposing obligations as a trustee on one
or more legatees of a will.
5.15
Spendthrift trust
As mentioned earlier, this is a trust put in place for the benefit of a person who is unable to control their
spending and gives the trustee the power to decide how the trust funds may be spent for the benefit of
the beneficiary.
5.16
Standby trust or pourover trust
The trust is empty at creation during life and the will transfers the property into the trust at death. This
is a statutory trust.
5.17
Testament trust or will trust
A trust created in an individual’s will is called a testamentary trust. As by definition a will can become
effective only upon death, a testamentary trust is generally created at or following the date of the
settlor’s death.
5.18
Unit trust
A unit trust is a trust where the beneficiaries (unitholders) each possess a certain share (units) and can
direct the trustee to pay money to them out of the trust property according to the number of units they
possess. A unit trust is a vehicle for collective investment, rather than disposition, as the person who
gives the property to the trustee is also the beneficiary.
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7: TRUSTS
6
6.1
Terminology
Appointment
In trust law, ‘appointment’ often has its everyday meaning. It is common to talk of ‘the appointment of a
trustee’, for example. However, it also has a technical trust law meaning, either:

the act of appointing (giving) an asset from the trust to a beneficiary (usually where there is some
choice in the matter, such as in a discretionary trust), or

the name of the document which gives effect to the appointment.
The trustee’s right to do this, where it exists, is called a power of appointment.
6.2
Protector
Sometimes, a power of appointment is given to someone other than the trustee, such as the settlor, the
protector or a beneficiary. A protector may be appointed in an express, inter vivos trust, as a person who
has some control over the trustee, usually including a power to dismiss the trustee and appoint another.
The legal status of a protector is the subject of some debate. No one doubts that a trustee has fiduciary
responsibilities. If a protector also has fiduciary responsibilities, then the courts (if asked by beneficiaries)
could order him/her to act in the way the court decrees. However, a protector is unnecessary to the
nature of a trust - many trusts can and do operate without one. Also, protectors are comparatively new,
while the nature of trusts has been established over hundreds of years. It is therefore thought by some
that protectors have fiduciary duties and by others that they do not. Case law is not yet definitive on
this.
Q U I C K
Q U E S T I O N
What does the term ‘fiduciary’ mean?
6.3
Fiduciary duty
A fiduciary is a person who has a responsibility for the welfare of another. In common law countries the
concept of fiduciary duty is rooted in equity, whereas in codified law countries it is usually specifically
provided for in legislation.
137
Examples of fiduciary duties are:


the duties of partners in a partnership to one another
the duty of a financial institution to a depositor who is a minor (young person in Scotland).
A trustee has a fiduciary duty to the beneficiaries of the trust. As such, they owe the highest duty of care
under the law to protect trust assets from unreasonable loss for the trust’s beneficiaries.
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7: TRUSTS
KEY WORDS




























Express
Implied
Settlor
Beneficiary
Trustee
Inter vivos
Testamentary
Trust deed
Unit trust
Tax evasion
Constructive trust
Fixed trust
Hybrid trust
Incentive trust
Irrevocable trust
Offshore
Private trust
Public trust
Protective trust
Purpose trust
Resulting trust
Revocable trust
Secret trust
Spendthrift trust
Standby (pourover) trust
Appointment
Protector
Fiduciary
139
REVIEW

A trust is a medium through which assets and liabilities may be transferred in order to separate them
from the transferor.

There are three parties relevant to a trust: settlor, beneficiary, trustee. There may be one or more of
each of these parties. Unless otherwise specified by law, these parties may be individuals or legal
entities.

A trust can be created expressly or impliedly. Most trusts are express trusts and are created by trust
deed. However, different jurisdictions have their own laws on how trusts are created and administered.

Trusts play a vital role in maintaining confidentiality, estate planning, portfolio management and tax
planning.

Trustees are accountable under the laws of the country in which the trust is formed. Trustees also have
a fiduciary duty, which means that they must act with reasonable care and skill.
140
chapter 8
OFFSHORE CENTRES
CASE STUDIES
Contents
1
The Bahamas ......................................................................................................... 142
2
The British Virgin Islands ......................................................................................... 144
3
The Cayman Islands ................................................................................................ 145
4
Guernsey and Jersey ............................................................................................... 147
5
The Isle of Man ...................................................................................................... 149
6
Luxembourg ........................................................................................................... 151
7
Vanuatu................................................................................................................. 152
Key words ................................................................................................................... 154
Review ....................................................................................................................... 155
141
Learning objectives

describe the business environment in eight offshore centres

identify the key benefits for financial institutions and customers doing business in these offshore
centres.
Introduction
This chapter takes a selective look at eight major offshore centres.
First we consider three centres in the Caribbean (the Bahamas, the British Virgin Islands and the Cayman
Islands). We then go on to consider three case studies which are located within the British Isles, namely
Jersey, Guernsey and the Isle of Man. As one of the longest established financial centres in Europe, we
look at Luxembourg, a small state with enormous importance at the hub of the European Union. Finally,
we consider the tiny state of Vanuatu, occupying perhaps the most isolated position of all financial
centres in the South Pacific Ocean.
The centres to be discussed in this chapter have been selected to demonstrate the diversity of offshore
banking activities and how different countries portray very different profiles.
As this chapter is descriptive, there are no ‘Quick Question’ exercises, as you are not expected to be
familiar with the distinct characteristics of the locations. Likewise, you are not expected to remember
most of the names of organisations and terms, so there is no ‘Key Words’ section. However, it is useful
for the purposes of your study to understand the roles and functions of the various regulators and how
they differ between offshore centres.
1
1.1
The Bahamas
Overview
The Bahamas comprises a group of islands in the Caribbean. Formerly a British colony, the Bahamas
became independent in 1973 but remain a member of the British Commonwealth. The Bahamas is a
democracy with Parliament, comprising the House of Assembly (lower house) and the Senate (upper
house). The legal system is based on the English common law model, while the economy is heavily
dependent on tourism and offshore banking services.
1.2
Currency
The currency of the Bahamas is the Bahamian dollar.
1.3
Taxation
There is no income tax, capital gains tax, corporation tax or value added tax. Government revenue
streams are derived from import duties, stamp duty, property tax and licence fees. A payroll tax funds
the social insurance system.
1.4
Regulation
The main regulatory institutions are the Central Bank of the Bahamas and the Securities Commission of
the Bahamas. The mission of the Central Bank is:
‘… to foster an environment of monetary stability conducive to economic
development, and to ensure a stable and sound financial system.’
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8: OFFSHORE CENTRES CASE STUDIES
The Central Bank plays a key role in the implementation of monetary policy and is also the regulator and
supervisor of the banking system. In 2001 the Central Bank laid down formal corporate governance
requirements for banking institutions licensed to operate in the Bahamas. In the same year, the Central
Bank also issued comprehensive regulations relating to minimising risks of money laundering and
terrorist financing.
The mission of the Securities Commission of the Bahamas is:
‘… to effectively oversee and regulate the activities of the securities and capital
markets, to protect the investors while strengthening public and institutional
confidence in the integrity of those markets.’
Q U E S T I O N
T I M E
4 8
What are the equivalents of these two bodies in the United Kingdom?
The Commission oversees the International Stock Exchange of the Bahamas as well as brokers, brokerdealers, investment funds and securities investment advisors.
The Bahamas was named by the Financial Action Task Force (FATF) as an uncooperative state in respect
of anti-money laundering controls until as recently as 2001. Since then, a much more robust framework
has been created.
The Bahamian government plays a direct role in the financial services sector through the state-owned
Bahamas Mortgage Corporation and the Bahamas Development Bank.
1.5
The financial services sector
For many years the Bahamas was regarded as the leading and most sophisticated offshore financial
services centre in the Caribbean.
There are over 400 banking institutions located in the Bahamas. The financial services sector represents
about 15% of gross domestic product.
Various categories of investment fund may be established. The Professional Fund is an open-ended
collective investment vehicle that enables investors to generate income and capital gains as well as
spread risks.
There are several ‘SMART’ (Specific Mandate Alternative Regulatory Test) funds. Some of these are
limited to a few investors while others permit a broader investor base. These must meet regulatory
conditions laid down by the Securities Commission. For example, all except one version of these funds
must be audited annually, though audit by a foreign firm is acceptable.
Trust law is highly developed. There is a robust legal framework that enables almost anyone to establish
a trust with minimal outlay. Over 60% of Bahamian financial institutions offer trust services. Trusts are
exempt from most taxes, so those setting up such a vehicle only pay a one-off stamp duty charge. In
143
addition to the trust, the Bahamas permits the creation of Foundations for personal, charitable or
commercial purposes. Foundations were discussed further in the chapter on trusts.
The Bahamas also enables investors to create most types of commercial legal entity. These include some
unique Bahamian forms, such as the Limited Exempt Partnership (similar to the rarely used, old style
limited partnership in the UK) and the Segregated Accounts Company which enables investors to
ringfence assets and obligations, even though it is not a separate legal entity.
Q U E S T I O N
T I M E
4 9
What is a limited partnership?
2
2.1
The British Virgin Islands
Overview
The British Virgin Islands are a British overseas territory situated in the Caribbean. The head of state is
the Queen, who is represented by a Governor. Legislative functions are exercised by a single house of
Parliament called the House of Assembly. This is democratically elected.
The legal system is based on common law. The judiciary mirrors the structure of the courts in England
and Wales, with the Privy Council in London serving as a court of final appeal.
The biggest sector by employee is tourism. However, the financial services sector is vitally important to
the BVI economy, with over half of government revenues coming from licence fees paid by offshore
companies.
For a tiny territory with just over 20,000 inhabitants, the BVI accounts for over 40% of offshore company
formations. It is the jurisdiction of choice for many entrepreneurs from Asia, notably Hong Kong.
2.2
Currency
The currency of the BVI is the US dollar.
2.3
Taxation
The BVI is a tax haven, with no income tax applicable to onshore or offshore individuals, or to legal
entities. Income tax was abolished in 2005. Employers, however, are subject to a payroll tax. Revenues
are derived from property taxes levied on residents, based on the size and value of their properties, and
from import duties. The BVI is likely to introduce a goods and services tax in the near future. In common
144
with other British overseas territories, the BVI adopted the European Union Savings Directive, which
imposes a withholding tax on interest on deposits.
2.4
Regulation
The regulator of the financial services sector is the BVI Financial Services Commission. This body was
established in 2001 to take over the roles formerly fulfilled by the Financial Services Department. At the
time this represented a very visible response to concerns that the BVI was both a gateway to the US
drugs trade and a centre that was highly vulnerable to money laundering and other financial crimes.
The roles of the Commission are to promote understanding of the financial system and its products,
monitor and control regulated activities, reduce financial crime and prevent market abuse.
2.5
Much economic benefit for the BVI is derived from business activities involving the formation of
International Business Companies, or IBCs. There are over 300,000 IBCs registered in the BVI.
The BVI Offshore Financial Services Information Center lists the following advantages of the BVI:

British Overseas Territory status

Political and economic stability and a growth-oriented local Government

English legal system (final right of appeal to the Privy Council in London)

Codification of modern banking, company, mutual fund, insurance and trust laws

Innovative, flexible, user-friendly legislation with minimal regulations

No taxes on IBCs; low tax rate for domestic companies

No wealth, capital gains or estate taxes

Asset security, and the freedom to transfer and merge assets

Protection of wealth benefits, inheritance wishes and trust interests

Legislative exemptions for qualified institutions

Internationally recognised reputation and respectability.
In contrast with many other offshore centres, there are relatively few licensed banks (less than ten).
Mutual funds are well established, with over 3,000 registered funds responsible for investments of over
US$100 billion. Domestic legislation recognises three generic types of mutual fund:
3
3.1

private funds have a maximum number of 50 investors, with opportunities confined to their
members

professional funds are only available to professional investors with in excess of US$100,000 each
to invest

public funds offer their services to the general public – this is effectively a ‘catch all’ type of fund,
as the legislation defines it as ‘any fund that is not a private fund or professional fund’.
The Cayman Islands
Overview
The Cayman Islands are British overseas territory situated in the Caribbean. Although a Governor is
appointed by the Queen, the Islands have an elected Legislative Assembly which enacts laws on behalf
145
of the people. Legislation is subject to Royal Assent, and theoretically the Governor has powers to
override domestically-made laws. International relations are the responsibility of the British government.
The legal system is based on the British common law model.
3.2
Currency
The currency of the Cayman Islands is the Cayman dollar.
3.3
Taxation
There are no direct taxes in the Cayman Islands. Government revenues are primarily from indirect
taxation, including tourist taxes and import duties.
3.4
Regulation
The financial services regulator is the Cayman Islands Monetary Authority (CIMA). Its mission is:
‘… to enhance the economic wealth and reputation of the Cayman Islands by
fostering a thriving and growing, competitive, and internationally recognised financial
services industry, through appropriate, responsive, cost-effective and efficient
supervision and a stable currency.’
The four principal functions of CIMA are:
Monetary
The issue and redemption of Cayman Islands currency and the management of currency reserves.
Regulatory
The regulation and supervision of financial services, the monitoring of compliance with money laundering
regulations, the issuance of a regulatory handbook on policies and procedures and the issuance of rules
and statements of principle and guidance.
Cooperative
The provision of assistance to overseas regulatory authorities, including the execution of memoranda of
understanding to assist with consolidated supervision.
Advisory
The provision of advice to the Government on monetary, regulatory and cooperative matters.
The regulated sectors are banking, money services business, cooperatives and building societies, trusts,
corporate services, insurance, investment funds and securities.
3.5
The Cayman Islands are an established financial centre, with banking, hedge funds, captive insurance,
structured finance and securitisation and general corporate activities dominating the sector. In its 2009
Report on Offshore Centres, the British government noted in particular the importance of the Cayman
Islands as a centre for establishing and operating hedge funds.
146
Q U E S T I O N
T I M E
5 0
What is a hedge fund?
According to CIMA, the Cayman Islands are the world’s fifth largest financial centre, a position of
prominence that is aided by the territory’s relatively close proximity to the USA.
Despite the strong performance record of the Cayman Islands, the jurisdiction has been vulnerable to
drug trafficking, money laundering and other criminal activities in the past, though recent reports by the
International Monetary Fund have noted that there are now robust systems in place to minimise the risks
of such activities taking place.
The growth of the corporate sector is supported by a liberal companies registration regime. It is relatively
inexpensive and quick to set up incorporated bodies and there are minimal annual reporting
requirements.
4
4.1
Guernsey and Jersey
Overview
Guernsey and Jersey are bailiwicks located in the Channel Islands off the coast of Normandy, France. A
bailiwick is defined as a territory or province over which a bailiff has authority. They are the two largest
Channel Islands, though not the only inhabited ones. They are possessions of the British Crown but not
part of the United Kingdom or the European Union, though the British Nationality Act 1981 acknowledges
the islands as ‘British’. The UK has the responsibility for the defence of the Channel Islands.
The two islands each has its own government called the States of Guernsey and the States of Jersey.
The former includes representatives of the smaller island of Alderney. The Queen is the head of state.
The legal systems are a hybrid of the British common law system and Norman customary law. The court
of final appeal is HM Privy Council.
In addition to the financial services industry, which dominates business activities, the islands benefit from
tourism, e-commerce and agriculture.
4.2
Currency
The currency of Jersey is the pound sterling. The government of Jersey prints its own banknotes. Euros
are widely accepted due to Jersey’s close proximity to France.
147
4.3
Taxation
Both Guernsey and Jersey have a flat rate of income tax of 20%. In Jersey the Goods and Services Tax is
the island’s equivalent of VAT and is set at 5%. There is no equivalent in Guernsey.
4.4
Regulation
The financial services sector in Guernsey is regulated by the Financial Services Commission. Its formal
aim is:
‘… to regulate and supervise financial services in Guernsey, with integrity and
efficiency, and in so doing help to uphold the international reputation of Guernsey as
a finance centre.’
Company registration is dealt with by the Guernsey Registry, which also maintains an intellectual
property register.
The financial services regulator in Jersey is also called the Financial Services Commission. This body also
serves as the Companies Registry.
The statutory purposes of the FSC is:
To maintain Jersey’s position as an international finance centre with high regulatory standards by:

reducing risk to the public of financial loss due to dishonesty, incompetence, malpractice or the
financial unsoundness of financial service providers

protecting and enhancing the reputation and integrity of Jersey in commercial and financial
matters

safeguarding the best economic interests of Jersey

countering financial crime both in Jersey and elsewhere.
In support of the key purpose, the Commission aims to:
4.5

ensure that all entities that are authorised meet fit and proper criteria

ensure that all regulated entities are operating within accepted standards of good regulatory
practice

match international standards in respect of banking, securities, trust company business and
insurance regulation, and anti-money laundering and terrorist financing defences

identify and deter abuses and breaches of regulatory standards

ensure the Commission operates effectively and efficiently and is properly accountable to the
Minister for Economic Development.
Both Guernsey and Jersey are long established as financial services centres. Most of the British banks
and some of the larger building societies have subsidiaries located on one of the islands. Particular
strengths of the economies have been private banking, funds management and the provision of legal and
advisory services.
Guernsey has had a deposit protection scheme in place since 2008. It protects personal depositors for up
to £50,000 (the UK Financial Services Compensation Scheme (FSCS) protects up to £85,000). It is funded
partially by a levy on authorised financial institutions, with additional cover provided through a captive
insurance company.
The Jersey Bank Depositors Compensation Scheme was approved in 2009 and also offers protection of
up to £50,000.
148
5
5.1
The Isle of Man
Overview
The Isle of Man is a British Crown dependency situated in the Irish Sea. The head of state is the Queen,
who is represented on the island by a Lieutenant Governor. The Isle of Man is not a part of the United
Kingdom and is not a member of the European Union, though some treaties of the latter have limited
application.
The main sources of income are offshore banking services, tourism and manufacturing. Services account
for over 85% of GDP. In recent years the island has become a centre for on-line gambling companies.
The Manx government actively promotes the island as a location for film making.
The island is self-governing. Its parliament is called the Tynwald. It comprises the House of Keys and the
Legislative Council. The UK accepts responsibility for defence and certain other strategic matters.
5.2
Currency
The currency of the Isle of Man is the pound sterling.
5.3
Taxation
Income tax is levied on personal incomes, but at significantly lower rates than those applicable in the UK.
The highest rate of income tax is 18%. The total income tax payable by an individual is capped. There
are no taxes on capital gains, wealth or inheritance. There is also no stamp duty.
5.4
Regulation
The banking sector is regulated by the Financial Services Commission. The Commission was established
by legislation in 1983.
Its functions are:

the regulation and supervision of persons undertaking regulated activities (ie deposit taking,
investment business, services to collective investment schemes, fiduciary services, money
transmission services) in or from the Isle of Man

the maintenance and development of the regulatory regime for regulated activities

the oversight of directors and persons responsible for the management, administration or affairs
of commercial entities.
The Commission issues banking licences on either a full or restricted basis. A full licence entitles a bank
to offer both retail banking and investment banking services. The Commission classifies different types of
banking business into ‘classes’, which may or may not require separate licences.
In order to avoid a proliferation of shell banks, the Commission imposes a ‘fit and proper’ test as a
condition of granting a licence. Continuing tests are applied in relation to capital adequacy, integrity,
compliance, track record and staffing.
A deposit protection scheme operates with a £50,000 ceiling for most personal investors and a £20,000
ceiling for certain types of investor.
Unlike most British dependencies and overseas territories, the Isle of Man has a Financial Ombudsman
Scheme that deals with complaints on an independent basis.
Insurance and pension business are regulated by the Insurance and Pensions Authority.
149
Q U E S T I O N
T I M E
5 1
How do the functions of an Ombudsman differ from those of a deposit protection scheme?
5.5
The Isle of Man hosts a broad spectrum of financial institutions. The mainstream retail banks are
represented either as wholly owned subsidiaries or as representative offices. Most banks operating on
the Isle of Man provide specialist private banking services to high net worth individuals and families.
Other financial services providers include:




general and life assurance companies
captive insurance companies
fund management companies
collective investment providers.
Q U E S T I O N
T I M E
5 2
Summarise the benefits for customers of using banking services provided by banking institutions located
on the Isle of Man.
150
6
6.1
Luxembourg
Overview
Luxembourg is a Grand Duchy situated between Belgium, France and Germany.
Legislative power lies with the Chambre des Deputes, Government and Council of State. Each entity
serves a separate function. Members of parliament are democratically elected. The Grand Duke gives
assent to legislation as head of state.
The courts and tribunals exercise judicial power. The system of law follows the codified (civil) law system
that exists in most mainland European states.
Luxembourg has one of the highest standards of living in the world. Its economy is now service driven,
though the state once had a thriving steel industry.
6.2
Currency
The currency of Luxembourg is the euro.
6.3
Taxation
In contrast to several offshore centres discussed in this chapter, Luxembourg has relatively higher taxes.
The state levies taxes on income and corporate profits, as well as value added tax on goods and
services. However, indirect taxes are significantly lower than some neighbouring states, which attracts
large numbers of visitors to take advantage of price differentials between Luxembourg and their home
states.
Tax laws define individuals as either resident or non-resident. A stay of more than six months is sufficient
to be regarded as resident.
Luxembourg applies the European Union Savings Directive.
6.4
Regulation
The financial services regulator in Luxembourg is the Commission de Surveillance du Secteur Financier.
Its statutory aims are:




promoting a considered and prudent business policy in compliance with regulatory requirements
protecting the financial stability of the supervised companies and the financial sector as a whole
supervising the quality of the organisation and internal control systems
strengthening the quality of risk management.
Note in particular that the last two of the FSSC’s objectives refer much more directly to specific aspects
of corporate governance than the equivalent objectives of the UK’s regulatory authority.
Luxembourg has a deposit protection scheme managed by the Association pour la Garantie des Dépôts
Luxembourg (AGDL). There are two thresholds, with cash deposits covered up to 100,000 euros and
‘non-guaranteed deposits’ covered up to 20,000 euros.
6.5
Luxembourg is an important centre for banking, with most multinational banks having subsidiaries or
representative offices in the state. There are over 150 banks registered.
151
Luxembourg is the second largest funds management centre in the world (after the USA), specialising in
cross-border funds administration.
Luxembourg is the largest private banking centre in the eurozone. In recent times it has attracted several
internet banking start-ups.
7
Vanuatu
7.1
Overview
Vanuatu is an archipelago located in the south-west Pacific Ocean. Historically it was ruled by the British
and the French, but has been an independent nation since 1980.
Vanuatu is a democracy with a single house, elected Parliament of Vanuatu. The President is the head of
state. The Prime Minister is the head of the executive, with responsibility for affairs of government
through a Council of Ministers.
The legal system is a hybrid of the English common law model and the French codified model.
The main economic activities are tourism, offshore financial services and agriculture.
7.2
Currency
The currency of Vanuatu is the vatu.
7.3
Taxation
Most tax revenues come from import duties and a goods and services tax. Non-nationals must pay for a
residency permit. There are no taxes on income, profits, capital gains or inheritance. There is also no
withholding tax on interest paid or credited on deposits.
7.4
Regulation
Monetary and financial regulation is the responsibility of the Reserve Bank of Vanuatu. Its mission and
purposes are to:

establish appropriate monetary conditions for price stability

establish financial conditions and adopt policies that will ensure an adequate level of foreign
exchange reserves to meet external obligations

provide proactive and sound advice to Government

develop an internationally reputable financial system

inspire public confidence in the Reserve Bank

meet the currency needs of the public

disseminate timely and quality information

recruit, develop and retain a professional team dedicated to the pursuit of quality practices

ensure sound banking practices so as to provide the protection of depositors.
The Vanuatu Financial Services Commission regulates non-deposit taking institutions and also serves as
the companies registry.
152
7.5
There are over 100 registered banks in Vanuatu, though only five are registered as ‘domestic’ banks and
eight are registered as ‘international’ banks.
Vanuatu has become a recognised tax haven for company formations. To form an offshore company it is
necessary to adopt either the International Company or the Exempted Company form as prescribed by
law.
Many offshore companies establish their mutual funds operations in Vanuatu to maximise the benefits of
the low tax regime.
153
KEY WORDS







154
The Bahamas
The British Virgin Islands
The Cayman Islands
Guernsey and Jersey
The Isle of Man
Luxembourg
Vanuatu
REVIEW

The profiles of the offshore centres described in the chapter are highly diverse.

While some rely heavily on long-standing reputations for privacy and low taxation regimes, others are
reliant on niche services.

Competitive advantage in some centres is determined by location. For example, the Bahamas, the BVI
and the Cayman Islands benefit from close proximity to the USA. Luxembourg benefits from its central
location within the eurozone.

Some centres capitalise on their constitutional status. This is notable in the cases of the offshore
locations situated within the British Isles.

Initiatives by international bodies such as the OECD, the IMF and FATF have caused many locations to
dilute, or eliminate altogether, the guarantee of total confidentiality that once shielded criminals from
detection.

Increasingly, the reputation of offshore centres is enhanced by adopting robust anti-money laundering
and terrorist financing laws.
155
156
chapter 9
FUTURE DEVELOPMENTS IN
OFFSHORE BANKING
Contents
1
The future ............................................................................................................. 159
Review ....................................................................................................................... 163
157
Learning objectives

summarise the current position regarding offshore centres and their future likely development

provide a reasoned assessment of likely future trends in offshore practice, including the regulation
of offshore banks.
Introduction
The offshore investment marketplace provides a location for institutions and professionals to develop and
sell their services and products and within which they operate for the benefit of the local (offshore)
economy and international investors, wherever located.
The offshore marketplace is generally based in and oriented towards international markets. Recent
technological innovations in such areas as data processing and telecommunications have significantly
reduced the costs of gathering, processing and producing information from anywhere in the world. Such
technological improvements have facilitated the process of arbitrage across national financial markets,
which in turn brought prices of securities with similar risks and returns.
The world’s financial centres are undergoing rapid changes to accommodate the demands of an
increasingly integrated global economy. Offshore centres will continue to develop by offering tax-efficient
structures and investments to individuals and companies located in other countries. Also, the main
rationale for offshore financial centres will be to provide diversified services and products, focused at
complementing those services and products available in the onshore environment rather than competing
directly with them. The major difference is that they are focused internationally.
Offshore investment providers seek to market products and services that:

are fiscally as neutral as possible, minimising the impact of taxation

provide an attractive return for depositors and investors, commensurate with risk

provide competitive interest rates for borrowing

meet the needs of those who have to reduce or eliminate the risks of doing business in several
countries with different currencies

meet the needs of particular market segments, particularly those who live or do business in several
countries and high net worth individuals and families.
Offshore banking is vulnerable to reputation risk and has therefore important implications for financial
systems surveillance, in particular to consider the extensive Risk Management Guidelines within the Basel
II directives. Offshore banking tends to be less transparent than normal cross-border banking due to
complexity of ownership structures and relationships among the different jurisdictions involved.
The International Monetary Fund (IMF) concludes that a number of legitimate factors continue to attract
financial institutions to offshore centres, including:

more convenient fiscal regimes which lower taxation and increase net profit margins

minimum formalities for incorporation

adequate legal frameworks that safeguard principal-agent relations

proximity to major financial centres

the reputation of the particular offshore centre

complete freedom from exchange controls.
Offshore centres however, can be exploited for dubious purposes, as they promise anonymity and the
possibilities of tax avoidance or evasion.
158
9: FUTURE DEVELOPMENTS IN OFFSHORE BANKING
1
1.1
The future
Terrorist finance tracking program
A series of articles published on June 23, 2006 by The New York Times, The Wall Street Journal and The
Los Angeles Times revealed that the United States government, specifically the Treasury Department and
the CIA, had a programme to access the SWIFT transaction database after the September 11 attacks,
potentially compromising the traditionally high degree of privacy enjoyed by offshore banking centres.
Since that time a number of data leaks have released secret customer information to both the public and
the relevant tax authorities. Whistleblowers have also revealed that electronically stored information is
rarely entirely secure from security services and other powerful interested parties.
1.2
Regulation of offshore banks
The regulation of offshore banking is allegedly improving, although critics maintain it remains largely
insufficient. The quality of the regulation is monitored by bodies such as the IMF.
Banks are generally required to maintain capital adequacy in accordance with international standards.
They must report at least quarterly to the regulator on the current state of the business. In the
aftermath of the collapse of Lehman Brothers, concerns over the capitalisation of offshore banking has
led to stricter capitalisation requirements.
Since the late 1990s, especially following September 11, 2001, there have been a number of initiatives to
increase the transparency of offshore banking, although critics such as the Association for the Taxation
of Financial Transactions for the Aid of Citizens (ATTAC), a non-governmental organisation (NGO),
maintain that they have been insufficient.
E X A M P L E
The tightening of anti-money laundering regulations in many countries, including most popular offshore
banking locations, means that bankers are required, by good faith, to report suspicion of money
laundering to the local police authority, regardless of banking secrecy rules. There is more international
cooperation between police authorities.
In the US, the Internal Revenue Service (IRS) introduced Qualifying Intermediary requirements, which
mean that the names of the recipients of US-source investment income are passed to the IRS.
Following the attacks on the World Trade Center in 2001, the US introduced the USA Patriot Act which
authorises the US authorities to seize the assets of a bank, where it is believed that the bank holds
assets for a suspected criminal. Similar measures have been introduced in some other countries.
The European Union has introduced sharing of information between certain jurisdictions and enforced
this in respect of certain controlled centres, such as the UK offshore islands, so that tax information can
be shared in respect of interest.
In 2009, a diplomatic row erupted between the governments of Liechtenstein and Germany when the
latter purchased information on German resident deposits held in Liechtenstein banks obtained by
computer hackers, thereby compromising the secrecy of the banks. The German government justified its
purchase of information obtained by criminal actions by demonstrating that the cost of the acquisition of
the information was more than compensated by clawing back of tax that should have been paid by the
depositors.
Joseph Stiglitz, 2001 Nobel laureate for economics and former World Bank Chief Economist, told reporter
Lucy Komisar, investigating the Clearstream scandal:
159
“You ask why, if there’s an important role for a regulated banking system, do you
allow a non-regulated banking system to continue? It’s in the interest of some of the
monied interests to allow this to occur. It’s not an accident; it could have been shut
down at any time.
“If you said the US, the UK, the major G7 banks will not deal with offshore bank
centers that don’t comply with G7 banks’ regulations, these banks could not exist.
They only exist because they engage in transactions with standard banks.”
In the 1970s and through to the 1990s, it was possible to own your own personal offshore bank;
mobster Meyer Lansky had done this to launder his casino money. Changes in offshore banking
regulation in the 1990s in the form of “due diligence” (a legal construct) make offshore bank creation
really only possible for medium to large multinational corporations that may be family owned or run.
DTT’s Global Financial Services group’s report suggests that, although offshoring is now a common
operating practice for the global financial services industry, the contribution that offshoring makes to the
competitive advantage of a financial institution varies enormously.
1.3
Measures to combat tax evasion in offshore jurisdictions
A number of international agreements have been signed in recent years, most with the objective of
combating tax evasion. A number of these have explicitly targeted offshore banks and their customers.
In many instances, the impact on customers using offshore banking services will be increasingly
transparent disclosure of the ownership of offshore assets and accounts to relevant tax authorities.
1.3.1
The US Foreign Account Tax Compliance Act (FATCA)
The Foreign Account Tax Compliance Act (FATCA) came into US law in March 2010. Its main aim is in
combating tax evasion by US taxpayers holding foreign accounts.
The FATCA requires that individuals who are US citizens or US resident and who own certain specified
foreign financial accounts and offshore assets must report these to the Inland Revenue Service (IRS),
[on a form attached to their income tax return] if the total value of these assets is above threshold limits.
The FATCA also contains key provisions which require Foreign Financial Institutions (FFIs) which are
outside the US to provide certain information to the IRS about accounts held by US customers. Failure to
comply with these reporting requirements can lead to a 30% withholding tax being levied on the
financial institutions in question.
Implementation details in draft form were published in February 2012.
The FATCA requirements on FFIs increased the administrative burden on Foreign Financial Institutions
[such as UK banks] including new requirements to report information on US taxpayer accounts back to
the IRS.
This in turn lead to potential conflicts with existing data protection laws in various countries.
1.3.2
The UK/US IGA
In September 2012, the UK government and the US government signed an intergovernmental agreement
(IGA) to improve international tax compliance and to implement FATCA.
This US/UK intergovernmental agreement provides a mechanism whereby a UK financial institution could
pass relevant information (on accounts held by US citizens and residents) to the UK HM Revenue and
Customs, who would then transfer this information to the US Inland Revenue Service (IRS). In doing so,
UK financial institutions are able to comply with FATCA without a greatly increased administrative burden
and UK data protection laws would not be breached.
160
1.3.3
UK agreements with additional jurisdictions
The UK Government, made clear that they wanted to use the UK presidency of the G8 in 2013 to explore
greater exchanges of tax information between jurisdictions as a part of a broader goal of reducing tax
evasion.
In a UK government press release, ‘New UK multilateral action to combat tax evasion’ published 9th April
2013, an agreement between the UK, France, Germany, Italy and Spain to develop and pilot an
automatic exchange of a wide range of financial information between these countries was discussed.
This pilot aims to build on the model developed in the UK/US intergovernmental agreement (IGA) to
improve international tax compliance and to implement FATCA discussed above.
The UK is also negotiating the implementation of similar agreements with the Isle of Man, Jersey and
Guernsey for reciprocal exchanges of information, and agreements for information to be passed from
Crown Dependencies to the UK.
1.3.4
UK Offshore evasion strategy
In addition to the measures described above, the UK has also implemented a number of further
measures including:
2

The Liechtenstein Disclosure Facility (LDF) which allows people with unpaid taxes or assets
associated with offshore accounts the opportunity to voluntarily settle their tax liabilities before
April 5th 2016. (The HMRC states in their report ‘No safe havens – Our offshore evasion strategy
2013 and beyond’ that they expect to recover £3 billion via this approach

The UK/Swiss Tax Cooperation Agreement which was described in the HMRC report ‘No safe
havens – Our offshore evasion strategy 2013 and beyond’ as being ‘the largest ever tax evasion
settlement in UK history’. This is expected to achieve £5 billion from a one off payment to address
past tax evasion and from withholding taxes from future income and gains. New approaches have
also been introduced to allow the UK to obtain information about Swiss bank accounts.

The UK Autumn Statement 2012 announced that £6 million would be allocated over the next two
years to set up a new ‘offshore evasion strategy team’ as a part of a wider approach to tackle tax
evasion.

Penalties payment of up to 200% of any offshore tax evaded are available to HM Revenue and
Customs.
Future developments
Huge opportunities exist for the application of best practice across offshore operations in financial
services. Offshore giants with established offshore operations need to focus on scope and scale,
streamlining their systems and processes. New offshorers and planners have the opportunity to rapidly
adopt best practice from the industry leaders.
Onshore giants need to improve operational efficiency by streamlining onshore operations. Smaller
onshorers face the toughest challenges in the future, as they need to continually look at a variety of
strategic options. They may need to consider shared service back offices to gain economies of scale.
There is no doubt that offshoring has become a competitive necessity in the financial services industry.
The future of offshore banking is likely to see:

increased regulation and scrutiny, particularly by cooperation between supra-national bodies such
as the IMF and the European Union

continuous product innovation and development, particularly in areas where offshore banking
institutions can complement the services of onshore providers

increasing transparency of offshore accounts to relevant tax authorities

some rationalisation through mergers and acquisitions
161
162

increasing use of modern technology and systems to offer products and services through multiple
channels to market

an expansion of business continuity management to plan for ‘disaster’ situations such as
hurricanes and possibly terrorism

ongoing need for qualified advisers and specialists within offshore financial institutions.
REVIEW

The world’s financial centres are undergoing rapid changes to accommodate the demands of an
increasingly integrated global economy.

Offshore centres will continue to develop by offering tax-efficient structures and investment products to
individuals and companies located in other countries.

They are expected to offer increasingly complementary services, targeted at specific market segments,
including the geographically mobile, those with complex financial affairs, those who benefit from
specialist services such as SPVs and trusts, and high net worth individuals, families and companies.

The regulation of offshore banking is increasing, although critics maintain it remains largely insufficient.
The quality of the regulation is monitored by bodies such as the International Monetary Fund (IMF).
Generally, scrutiny by supranational bodies is expected to intensify in the future.
163
164
ANSWERS TO QUESTION TIMES
165
Question time 1
There are many examples. In Europe, Austria and Liechtenstein are famous for their privacy laws, which
have brought them into conflict with supranational bodies in respect of universally accepted money
laundering principles. In the Caribbean, several states maintain confidential relationships with companies
registered in their jurisdictions, including the British Virgin Islands and the Cayman Islands. Some
countries are tax havens, which means that by creating legal entities or opening bank accounts, it is
possible to avoid tax by legitimate means. You may have identified other examples.
Question time 2
Examples include: HSBC (which despite being established originally in Hong Kong is registered in
London), Bank of Scotland International and Barclays.
The formation and management of offshore subsidiaries is by no means confined to the mainstream
banks. Several building societies, insurance companies and mutual funds companies have formed
offshore subsidiaries.
Question time 3
It is not advisable to take large volumes of cash through border controls. Although there is in theory
complete freedom in respect of movement of capital, the authorities are conscious that the physical
transfer of cash is one route used by criminals to launder money. Typically, customs authorities reserve
the right to seek explanations about the sources of cash when the total value carried on the person
exceeds £10,000 or foreign equivalent.
Question time 4
Benefit
Examples
Fiscal regimes that offer lower taxation
and therefore increased profit margins
Isle of Man, Bahamas
Ease of set up, incorporation and reporting
in respect of legal entities, particularly private
limited companies and trusts
British Virgin Islands
Cayman Islands
Regulations that safeguard principal-agent relations
Austria, British Virgin Islands,
Liechtenstein, Switzerland
Proximity to major financial centres
Bermuda, Cayman Islands,
Liechtenstein
Tradition and reputation
Luxembourg, Switzerland
Freedom from exchange controls
and other monetary restrictions
Almost all offshore centres
Question time 5
The main inhibiting factor is that most offshore banks do not have ready access to electronic sources of
data, such as Equifax or Experian, therefore credit checks have to be carried out in a more labourintensive manner. In addition, most customers of offshore institutions have adequate credit lines in place
through domestic arrangements, therefore offshore banks tend to target specific market segments, such
as high net worth individuals.
166
Question time 6
The Sarbanes-Oxley Act was passed in the USA as a regulatory response to the collapse of Enron, a
massive energy company. In the criminal investigation that followed the crisis, several serious fraudulent
acts perpetrated by senior executives were uncovered, and some of these executives received long
prison sentences as a consequence. Enron was by no means the only scandal, as there had been several
other high profile company failures in the USA and elsewhere.
The Sarbanes-Oxley Act is an example of rules-based regulation. It contrasts sharply with the mainly
voluntary (principles-based) regimes in most other countries, including the UK, where the Combined
Code on Corporate Governance applies.
Sarbanes-Oxley introduced many mandatory requirements that apply to all public companies that are
listed on recognised stock exchanges, including:

the Chief Executive Officer and the Chief Finance Officer to certify the appropriateness of financial
statements and that they fairly present the operations and financial position of the company

the same officers to forfeit any bonuses if the company has to prepare a restatement of accounts
due to non-compliance with standards laid down

annual reports to include internal control reports stating the responsibility for establishing an
adequate internal control structure and procedures for financial reporting

whistle blower protection for employees and auditors of companies quoted on a recognised stock
exchange

the establishment of a Public Oversight Board to register and regulate accounting firms

retention of audit working papers for several years

the introduction of quality control standards for auditors in order to provide reasonable assurance
to those referring to the financial accounts

prohibition of auditors from carrying out certain services for their clients, including bookkeeping,
systems design and implementation, appraisal, valuation, legal expert or actuarial services,
management services (including human resources management and investment management)

other services provided by auditors require prior approval from the audit committee

rotation of audit partners every five years

all members of audit committee to be independent and at least one member to be a financial
specialist

audit committee to be responsible for the appointment, compensation and oversight of auditors

establishment of complaint procedures in relation to accounting, internal controls and audit

appropriate disclosure of off-balance sheet transactions.
Question time 7
The quality of an offshore lender’s mortgage book may be judged according to several criteria:

the extent to which the historic lending practices of the lender have been legally compliant

the nature of the products, such as methods of repayment and types of mortgage

the consistency of lending policies and practices with generally accepted best practices in respect
of factors such as suitability and affordability assessments

the extent to which the lending book diversifies default risk

the quality of collateral and guarantees
167

social, economic and demographic profile of borrowers

efficiency and effectiveness of arrears management and collections policies.
Question time 8
Large football clubs have too high a profile and are subject to much scrutiny by shareholders, media and
licensing authorities. In addition, many larger clubs are public companies and their annual turnover is
such that external audit is mandatory.
Private companies are subject to much less public attention. Their full accounts do not have to be
disclosed to the public at large. At the same time, they have large volumes of cash passing through the
turnstiles and ticket offices, making it easier to filter illegally obtained funds.
Question time 9
Freezing accounts and stopping transactions appears to be inconsistent with the principle, but one of the
reasons that money laundering has become a more serious problem is that laws were inadequate to
enable prevention and detection.
There are other examples of laws that enable transactions to be prevented. One such case is the freezing
order, formerly called a Mareva injunction, which is a common law remedy for creditors who fear that a
debtor may flee the country. The injunction enables the court to freeze assets pending settlement of the
debt.
Question time 10
By far the most likely persons to be in a position to tip off are point of sale staff, such as call centre
operatives, cashiers and those working in customer-facing roles.
Question time 11
Corporate governance is the system through which an organisation is directed and controlled. The
Organisation for Economic Cooperation and Development (OECD) has identified five principles that
should be applied in pursuing good corporate governance practices:
Rights of shareholders
The corporate governance framework should protect shareholders and facilitate their rights in the
company. Companies are obliged to generate investment returns for the risk capital put up by the
shareholders. Directors should be accountable to shareholders in this respect.
Equitable treatment of shareholders
All shareholders should be treated equitably (fairly), including those who constitute a minority,
individuals and foreign shareholders. Shareholders should have redress when their rights are
contravened or where an individual shareholder or group of shareholders is oppressed by the majority.
Stakeholders
The corporate governance framework should recognise the legal rights of stakeholders. The company
should facilitate cooperation with stakeholders in order to create wealth, employment and sustainable
enterprises.
Disclosure and transparency
Companies should make relevant and timely disclosures on matters affecting financial performance,
management and ownership of the business.
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Board of Directors
The Board of Directors is responsible for setting the direction of the company and monitoring the
management of the company in order to achieve its stated objectives. The corporate governance
framework should underpin the Board’s accountability to the company and its members.
These principles are highly relevant to financial institutions, which have been extremely vulnerable to
reputation risk in recent times. The FCA alludes to the importance of the principles in its sourcebooks. It
also refers to the principles in regulations applicable to other bodies, such as building societies (which
are not limited companies, and are not quoted on the Stock Exchange).
Question time 12
There is no obligation for any sovereign government to comply with FATF recommendations, and in the
event that UK laws conflict with FATF principles, the former will apply. However, as a major trading
nation and a member of G20, the UK has committed itself to compliance with internationally agreed
standards that reduce the risks of international crime. Therefore, failure to comply would affect the UK’s
credibility in world affairs very seriously.
In addition, any country that fails to comply with internationally agreed standards runs the risk of being
‘blacklisted’ by FATF and listed as ‘non-cooperative’ by the International Monetary Fund. At present, Iran
and North Korea are listed as non-cooperative. Over 15 other countries are regarded as ‘high risk’.
Question time 13
Casinos handle large volumes of cash every day. Many one-off customers carry out single transactions
which would not ordinarily be monitored, as they are not classified as ‘business relationships’.
Estate agents are engaged in large single transactions when properties are sold, therefore an illegal
transaction can transfer a large amount of cash all at once.
Question time 14
The Serious Organised Crime Agency is responsible for dealing with suspicious activity reports and
matters relating to money laundering. The Special Branch deals with many matters relating to national
security and terrorism. The Serious Fraud Office deals with major fraud cases.
Question time 15
(1)
Derivatives
A derivative is a type of security used to spread financial risk. It protects an investor from adverse
movements in share prices, exchange rates or other variables. The conditions applicable to the
derivative refer to a particular security or other asset, hence the value is ‘derived’ from the
underlying asset.
There are many examples of derivatives:

A call option is an agreement that gives an investor the right, but not the obligation, to
buy a stock, bond, commodity or other instrument at a specified price within a specific
time period. A call becomes more valuable as the price of the underlying stock appreciates
relative to the strike price.

A put option is an option contract giving the owner the right, but not the obligation, to sell
a specified amount of an underlying security at a specified price within a specified time. A
put becomes more valuable as the price of the underlying stock depreciates relative to the
strike price.
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(2)

The two main types of options are the American option and the European option. The
American option allows the owner to exercise at any time before or at expiration, while the
European option can only be exercised at expiration.

Forward contracts are private agreements between two parties and are not as rigid in their
stated terms and conditions. Because forward contracts are private agreements, there is
always a chance that a party may default on its side of the agreement. It is a cash market
transaction in which delivery of the commodity is deferred until after the contract has been
made. Although the delivery is made in the future, the price is determined on the initial
trade date. Most forward contracts don’t have standards and aren’t traded on exchanges.
A farmer would use a forward contract to ‘lock in’ a price for his grain for the upcoming
harvest.

Futures are financial contracts obligating the buyer to purchase an asset (or the seller to
sell an asset), such as a physical commodity or a financial instrument, at a predetermined
future date and price. Futures contracts detail the quality and quantity of the underlying
asset; they are standardised to facilitate trading on a futures exchange. Some futures
contracts may call for physical delivery of the asset, while others are settled in cash.

A currency forward contract is an agreement today to exchange two currencies at a
predetermined exchange rate, the forward rate, on a predetermined date.
Bill of exchange
A formal definition of a bill of exchange is:
‘… a definite order in writing by one person to a second person to pay a precise sum of money to
that first person, or to a third person or to a bearer at or after a definite date.’
Normally the second person owes money to the first person. The first person is the drawer of the
bill. The drawer is therefore a creditor of the second person, or debtor, and instructs the debtor to
pay the drawer or somebody to whom the drawer owes money.
How bills of exchange work in practice
For example:

the drawer has exported goods to a foreign buyer, the drawer’s debtor

the drawer wishes to be paid for the goods

the drawer draws (writes out) a bill of exchange on the foreign buyer

the drawer sends this bill of exchange to the foreign buyer who acknowledges the debt by
signing across the front of the bill - this is known as accepting the bill

the acceptance can be for payment at a future date or for immediate (‘at sight’) payment

if the bill is a sight bill, then the acceptor will have to pay the drawer or the other person
named on the bill immediately

if the bill is not a sight bill, the acceptor returns the bill to the drawer who can either
submit it for payment to the acceptor on the due date or sell it to a bank or discount house
for less than its face value in order to get immediate payment.
A bill of exchange must be presented by the holder (or his/her representative) at the proper place
– at the acceptor’s address or at the place indicated in the acceptance. This must be done at a
reasonable hour on a business day.
A time bill must be presented at the proper place on the day it falls due. If this is not done, the
drawer and the previous endorsers are discharged of any liability in the bill. The acceptor,
however, remains liable for a period of five years under the rules of prescription.
A demand bill must be presented within a reasonable time after its issue for the drawer to remain
liable on it, and within a reasonable time after the endorsement to render the endorser liable on
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it. If this is not done, then again the drawer and endorsers are discharged of liability under the
bill. Again, the acceptor remains liable to the holder of the bill for a period of five years.
Question time 16
The main determinants of the decision to fund from retail or wholesale sources are the conditions in the
two markets and expectations of how these conditions will change in the future. The relative costs of the
sources of funds are vitally important, as this has a direct effect on the interest rates that must be struck
to generate sufficient profit margins.
The profile of the financial institution’s liabilities is a significant factor. For example, a bank or building
society that has many thousands of depositors with small balances should find that the customers are
not especially rate sensitive, which is a major advantage to small and medium sized institutions that can
rely on predictable and inexpensive deposit bases. This is one reason why many regional financial
institutions were less adversely affected by the credit crisis that larger ones. Not only is it desirable to
gather financial resources from retail depositors, but it is important to avoid forays into the wholesale
market if the institution does not have in-house expertise or would only be able to buy in specialist
advice at a high price.
Question time 17
The practice of making successive trades to take advantage of exchange rate differentials is colloquially
referred to as ‘round tripping’. The spreads between buy and sell rates make this impractical for most
private individuals. There is also a downside risk that exchange rates may move adversely between
transactions. For smaller transactions, foreign exchange companies usually charge a commission
expressed as a percentage of the value of the deal, thereby making trades less attractive.
Question time 18
The implication of the higher forward price is that the exchange rate is expected to appreciate in the
next few months.
Question time 19
The factors that will affect the interest rate on a bond are:







the supply and demand conditions in the debt market
whether the bond is secured or unsecured
if secured, the nature of the security
the term of the bond
the perceived risk attached to the issuer, which will broadly be reflected in its credit rating
market expectations in relation to future interest rates
market expectations in relation to the issuer’s performance.
Question time 20
The fact that a bond is undated should not deter an investor. Conceptually, this differs little from buying
shares, as shareholders cannot usually demand a return of their capital (unless the shares are
redeemable shares).
If the bondholder needs to raise capital, the bond can be sold, though the market price, and the
existence of a buyer, is not guaranteed.
Ultimately, the wise investor will consider the return relative to risk, compared with the expected values
of alternative investments. The investor should also consider the time value of money by discounting
future returns to their present value.
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Question time 21
Joint and several ownership is especially important in relation to access to an account and dealing with
the account when the customer dies.
The funds in a joint deposit account are owned by two or more persons, invariably on a joint and several
basis. This means that every individual account holder owns all the money deposited. If the account can
be operated on any one signature, every joint account holder has access to all of the funds. Therefore, if
an account with two holders has a balance of £1,000, each of them has access to all of the money.
Most financial institutions are prepared to offer account operating safeguards, so that if the joint holders
choose to require more than one signatory to authorise a withdrawal or transfer, this restricted mandate
can be attached to the account.
If a joint account holder dies, the funds are automatically owned by the survivor(s). It is therefore not
possible to make provision in a will for funds held jointly and severally with others, unless the other
account holders agree to these conditions.
Debts incurred on a joint and several basis, such as joint mortgages, are treated in exactly the same
way.
Question time 22
Phishing is the practice of obtaining access to personal information by various techniques involving
computers and telephones. One of the most common ways of doing this is by sending spam emails that
purport to be from a financial institution. The message may ask the recipient to confirm their personal
details such as username, password, PIN, National Insurance number and so on. This is often done
under some pretext, such as a fictitious problem involving security on the account. Telephone phishing is
a similar practice through which such details are sought by telephone.
Phishing is illegal in the UK under the Computer Misuse Act 1990 and the Fraud Act 2006. However, it is
difficult to prevent as the source of the emails and telephone calls is often outside the UK.
As customers have become more familiar with such scams, phishing techniques have become
progressively more sophisticated. One variant is called ‘pharming’. This clones the web pages of
legitimate financial services providers, adding a greater degree of perceived authenticity to the
communication.
Question time 23
The minimum requirement is to provide two separate pieces of identification. One of these should have a
photograph (such as a passport or modern driving licence) and the other should include the current
address and be dated within a specified period of the date of opening the account.
Practices vary from company to company in respect of confirmation of identity. Special systems are
usually in place to identify socially excluded persons (who often have no banking arrangements at all),
foreign nationals who are residing in the UK for a specific period (such as students) and politically
exposed persons.
Question time 24
The AER takes account of any interest credited to an account during a year as well as the annual rate.
Assume that an account with a balance of £1,000 pays 5% interest per annum, with interest credited on
30 June and 31 December.
On 30 June the account will have capital of £1,000 plus interest of half of £50 = £25. The balance is now
£1,025. On 31 December interest of 5% for the remaining six months of the year will be credited.
However, this will be calculated on £1,025 = £25.63. The account balance is now £1,050.63.
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The AER is therefore 5.063%, and would usually be presented to two decimal places as 5.06%.
This calculation is approximate, as the interest would be worked out on a daily basis (probably 182 or
183 days per six months).
Question time 25
The main problem is that offshore banks cannot carry out the same checks as domestic banks:

they may not have ready access to credit files of bureaux

they can rarely carry out face-to-face interviews and therefore have limited ability to ask
questions other than those that are included in standard application forms.
It is also probable that personal loan products are not an attractive market for many offshore banks, as
they involve processing large numbers of applications for comparatively small credit balances.
Question time 26
There are several reasons why borrowing in a foreign currency could be attractive:

the borrower may be paid by an employer (or clients if in business) in that foreign currency,
enabling him or her to match income with outgoings in one currency

the borrower may be planning to move to another country that uses the currency in the near
future

the borrower may perceive that future changes in exchange rates will make the proposition less
expensive in the medium to long term.
Question time 27
The main risk is having to provide for the eventual capital sum that will be due at maturity. This risk
arises because most long term repayment vehicles do not guarantee a minimum capital sum, including:






Individual Savings Accounts
low cost with profits endowment assurance
unit-linked assurance
personal pensions
unit trusts
other collective investments.
Only two products guarantee repayment of capital. The without profits policy guarantees a specific sum
but has no investment element. This is virtually obsolete, as the product was designed to take advantage
of tax concessions that no longer exist. The full with profits endowment assurance policy also guarantees
a basic sum assured on either death or survival, but is expensive and will usually lead to a much larger
outlay each month.
In addition to these risks, those who take out interest only mortgages do not know, and cannot
accurately predict, whether the overall investment/borrowing package will be advantageous over a
conventional repayment mortgage.
The borrower also has the prospect of greater exposure to risk if future income is interrupted due to a
protracted period off work or other factors, as the capital outstanding remains constant. This has been
brought to prominence during the credit crisis, as many borrowers have discovered that there is no
guarantee that replacement borrowing can be sourced at an attractive rate of interest.
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Question time 28
The offshore institution would wish to carry out a due diligence exercise to establish:

the financial position of the firm

corporate form – partnership, private company, public company, other (the suffix ‘Ltd’ suggests
private limited company, but this may depend on the domicile of the company)

who represents the firm (directors and other executives)

who is the ‘mind and management’ of the firm

core business – both past track record and current profile

client base

peripheral or secondary businesses

links with other companies, subsidiaries, associated companies.
Question time 29
The main motives for establishing a private bank are convenience, cost and control.
A private bank is convenient because there is an ongoing, direct relationship between the bank and the
company. The relationship is predictable, and provided the bank is legally constituted and run prudently,
there should be no problems in relation to dealings with third parties.
The private bank inevitably charges less for services if its ownership is tied into that of the same
marketing group.
Those responsible for governance of the marketing group can also exercise absolute control over the
bank’s mission, objectives and operations.
The main problem arising from private banks is that they can be used for illegal or unethical purposes.
Under such circumstances, the consequences can be very serious. For this reason, the Financial Action
Task Force and other organisations responsible for developing principles and practices to minimise the
prospects of financial crime pay close attention to the activities of private banks.
Question time 30
A high net worth individual is likely to hold:
174

cash and demand deposits

short term investments than can be liquidated at immediate or very short notice

savings accounts to take advantage of all available tax breaks (such as ISAs)

term deposits

equities (company shares) and bonds

collective investments, such as unit trusts, investment trusts and shares in open-ended
investment companies

real estate

personal belongings (‘chattels’), such as motor cars, antiques and jewellery

personalised investments, such as stakes in privately owned companies, special purpose vehicles
and trusts.
Question time 31
The specialists would include:

stockbrokers and other experts in equity and bond markets

real estate specialists and mortgage providers and advisers

lawyers specialising in various areas, including securities, company formations, trusts,
executorship, contracts and so on

accountants specialising in corporate finance, tax advice and corporate structuring

investment analysts

fund management specialists

fund administrators

foreign exchange dealers

derivatives dealers.
Question time 32
The most likely explanation is that there is an expectation in the markets that interest rates will fall in the
foreseeable future.
Question time 33
The bank may be able to provide:

referrals to companies that can search and locate properties for purchase or let by the client

estate agents, when the client wishes to sell properties

property management companies

facilities management companies (these may deal with certain aspects of property management
such as maintenance of buildings and grounds)

lettings services

mortgages

trustee services.
Question time 34
Geoff’s will is void as he has remarried.
As it cannot be established whether Jill or Geoff died first, the common law assumption is that the older
of the two died first. Therefore, at one instant in time, any assets owned jointly and severally pass
automatically to Geoff. As Geoff also died in the crash, any of these assets will then pass to blood
relatives according to laws of intestate succession, and Jill’s children will have no entitlement to them.
Jill’s children may have a claim on any assets individually owned, by Jill as only the first £250,000 passes
down Geoff’s bloodline, with the remainder vested in Jill’s children as ‘remaindermen’. However, it can be
seen that the financial interests of Jill’s children have been severely compromised by the simple oversight
of the couple not having made a will.
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Question time 35
Other income that is tax-free includes:



winnings from gambling
income from tenants received by occupiers of property under the ‘Rent A Room’ scheme
certain State benefits.
Question time 36
Some non-domiciled individuals may be non-taxpayers as there is no income tax system in their country
of residence.
Additionally, some non-residents have insufficient income to use up their tax-free allowance. For
example, many ex-pats choose to live in countries that have low standards of living and costs of living
and can quite easily live on modest incomes. This does not mean that the income is actually tax free, but
simply that they do not generate enough income each year to pay any tax.
Question time 37
The regulation exists to prevent individuals from deliberately diluting the value of their estates by gifting
assets in anticipation of death. If the regulation did not exist, it would be possible for individuals to
transfer all of their assets and avoid any tax altogether. Most people do not know when they will die, but
actuarial evidence suggests that most British people live for about 80 years (on average, females for
about four years longer than males), so the wise individual would start distributing assets some time in
advance of this, and the Exchequer would receive nothing.
Question time 38
Factors include:

mental incapacity

insolvency

legal conditions imposed by a court, such as ‘release under life licence’ for those serving life
prison sentences.
In addition, the choice of trading form may hamper choice of domicile. An ordinary partner in an
unlimited partnership would find it difficult or impossible to opt for a domicile of choice if also employed
under a contract of employment.
Question time 39
This is not possible.
Question time 40
A company has a separate legal personality and so it is legally possible for a company owned and run by
one person to separate his or her assets in this way.
Under certain circumstances, the courts will ‘lift the corporate veil’ in order to expose the individual to
personal liability if the doctrine of separate legal personality is abused.
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Question time 41
The settlors are those who established the trusts, giving the instructions in respect of the precise
purposes of the trusts and how these will be managed. In the case of the Prince of Wales Trust, this
would be Prince Charles, and in the case of the Princess Diana Trust, it would be those charged with
responsibility by the estate of the late Princess.
The beneficiaries of the trusts are those who will receive grants, income and other benefits from trust
activities. The Prince of Wales Trust was established to promote the interests and welfare of young
people, while the beneficiaries of the Princess Diana Trust include victims of land mines and AIDS/HIV.
The trustees are those appointed under the respective trust deeds to manage and administer the trusts
on behalf of the settlors.
Question time 42
Typical objectives of an offshore trust would include ringfencing specific assets in order to benefit family
members, business associates or charities.
Question time 43
No. The activities of trustees are regulated and they are required to act in the best interests of the trust
and in a manner consistent with its objectives. However, under the laws of England and Wales most of
the prescriptive rules relating to specific types of investments that can be made have been repealed.
The trust deed itself may also impose specific limitations on the powers of the trustees.
Question time 44
The word ‘equitable’ refers to ‘that which is fair and just’. The courts recognise equitable rights if it is
considered that an individual or entity has a fair clam. However, in property law, equitable rights are
usually subordinate to legal rights, such as those established in contract or by legal registration.
An example of an equitable right is where a lender has received the deposit of a life assurance policy but
has not insisted on a deed of assignment. The fact that the policy has been deposited by the policyholder
is evidence of the creation of an equitable right in favour of the lender.
Another example is where a property owner has secured a loan by handing over the title deeds to a
lender without the lender taking a legal charge over the property. However, the lender’s rights are
severely compromised in this instance, as under the Law of Property (Miscellaneous Provisions) Act 1989,
no equitable mortgage can be enforced unless evidenced in writing.
Question time 45
A settlor cannot create rights that would give rise to illegal acts. Therefore, any conditions that would
obviously result in crimes being committed would be void. A trust would not be able to permit actions by
an individual who would be disallowed from such acts by legislation. For example, a trust cannot confer
absolute rights on a minor to own property in his or her own name, as under the Law of Property Act
1925 a minor may not enjoy absolute ownership of real estate (this is only applicable in England, Wales
and Northern Ireland).
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Question time 46
Trusts may be set up to mitigate liabilities for:




income tax
capital gains tax
inheritance tax
property and other wealth taxes imposed in overseas jurisdictions.
Question time 47
The trustees will normally be a professional firm of lawyers or accountants, or representatives of the
workforce, or a combination of these.
Question time 48
The equivalent bodies in the UK are the Prudential Regulation Authority (PRA) and the Financial Conduct
Authority (FCA).
Question time 49
There are two types of limited partnership in the UK:

The Limited Liability Partnership (LLP) is a relatively new business form, introduced by legislation
in 2000. It is a hybrid of a conventional partnership and a limited company. The LLP has
designated partners who bear limited liability and may also have unlimited partners. The LLP has
a separate legal personality and is registered at the Companies Registry. The LLP is becoming
increasingly popular, especially in the professions such as law and accountancy.

The Limited Partnership is an older business form, rarely used today. It is based on legislation
enacted in 1907. This type of partnership has one or more limited partners who invest in the
business and take profits but play no active role in management or administration. It has general
partners who bear unlimited liability. This type of partnership also has to be registered. Some
entrepreneurs in the creative arts use this business form, such as when proposing to produce a
musical or drama. The investors are colloquially referred to as ‘theatre angels’.
Question time 50
A hedge fund is a specialised form of investment company. The majority of hedge funds invest in long
term assets including equities, bonds and commodities. The term ‘hedge’ refers to the practice of
hedging (or diversifying) risk.
Many hedge funds are owned or run by a limited number of investors and have highly specific objectives,
such as specialising in certain markets. Such markets may include derivatives, debts of organisations in
crisis and securities issued by certain types of corporate body.
Many hedge funds are established in offshore centres to avoid regulatory constraints applied to more
mainstream investment funds and collective investment companies.
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Question time 51
An ombudsman scheme deals with complaints by personal customers with a view to mediation and
resolution. Most ombudsman schemes provide for compensation to be paid if a complaint is upheld.
A deposit protection scheme protects personal depositors if a member organisation becomes insolvent.
Membership of the UK’s schemes is mandatory for all authorised banking institutions.
Question time 52
The benefits include:

most institutions are long established with proven track records, and the business of many of
them is underpinned by their owners, who are often major banking groups

institutions offer an extremely wide range of services, from mainstream banking products to
specialist services

the Isle of Man has an ombudsman scheme, which is not a common feature of offshore
jurisdictions

the Isle of Man has a low tax regime

the Isle of Man has a robust regulatory structure.
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180
GLOSSARY
181
182
GLOSSARY
Glossary
Age allowance
Relevant to income tax. An enhanced tax-free
allowance for persons over 65 years of age in the UK.
Alternative Investment
Market
The second market of the London Stock Exchange. It
features the securities of smaller companies than those
quoted on the Official List, and is used extensively by
companies with high growth potential to raise capital.
Annual exempt allowance
The annual capital gains that a UK resident may make
before being liable to capital gains tax on disposal of
chargeable assets. This is effectively a tax-free
allowance.
Arbitrage
Making transactions to take advantage of differentials
in ‘buy’ and ‘sell’ rates in two or more different
markets. Arbitrage is common in foreign exchange
markets, derivatives markets and mutual funds.
Articles of Association
The constitution of a limited company.
Authorisation
In most countries it is necessary for financial
institutions to obtain authorisation from a regulator to
offer some (or any) banking products. Authorisation
regimes have historically been orientated towards
depositor protection.
Balance sheet
See Statement of Financial Position.
Bancassurance
A term used to describe financial institutions that
originate both banking and insurance services.
Bank for International
Settlements (BIS)
A supranational organisation representing the central
banks of major trading nations. In the context of this
course, the BIS is most relevant to capital adequacy.
The BIS publishes capital adequacy standards agreed
by its members, commonly referred to as Basel I and
Basel II.
Banking licence
A licence issued by a regulator that enables a financial
institution to trade. A single licensing regime operates
under the laws of the European Union, though the
licence may be only one condition of carrying out
banking activities.
Basel I, Basel II, Basel III
International agreements that set out capital adequacy
requirements for financial institutions. The Bank for
International Settlements, which originated these
agreements, is located in Basel, Switzerland.
Beneficiary
Relevant to trusts and also voluntary representation
agreements, such as powers of attorney. A beneficiary
is an individual or legal entity that will benefit from the
relevant legal structure. Therefore, the beneficiaries of
a trust will be those on whose behalf the trustees are
obliged to act.
Bid price
The price at which a unit trust will buy units back from
its investors.
183
184
Bond
A security issued by a government, bank or company
representing a loan.
Bonus issue
A free allocation of additional shares to existing
shareholders in proportion to their existing holdings.
Sometimes called a scrip issue.
Bourse
A general term referring to any stock exchange.
British Bankers’ Association
The trade association of British banks.
Building society
A mutual organisation that specialises in retail savings
and residential mortgages. Many building societies
have diversified into mainstream banking services since
deregulation in the 1980s.
Capital
To an organisation, capital is made up of shareholders’
funds (including accumulated profits, or reserves) and
long term loans. Working capital is a term used to
describe the operating assets of a company, such as
inventories of raw materials and finished goods as well
as cash, accounts receivable net of payables and workin-progress. To a depositor or an investor, capital is the
sum invested plus any income to the assets that has
been capitalised.
Capital adequacy
Relevant to capital structures of financial institutions. A
capital adequacy regime minimises the risk of a
financial institution’s capital being insufficient to back
its commercial activities.
Capital gains tax
A direct tax on private individuals and some corporate
entities. It is levied on the gains made in relation to
chargeable assets.
An insurance company that is wholly or partly owned
by a parent company for whose benefit it operates.
Often based offshore to take advantage of streamlined
incorporation procedures and a low or zero tax
environment. It is a risk transfer vehicle, operating
within a single group of companies. In some industries,
captives are jointly owned by several companies.
Certificate
A negotiable instrument issued by a financial
institution.
Certificates of deposit
A form of loan capital issued by a financial institution to
raise short term funds.
Collective investments
A form of indirect investment in equities, bonds,
property and deposits. The funds of many investors are
pooled in order to invest in other assets. The main
examples operating in the UK are unit trusts,
investment trusts and open-ended investment
companies. Internationally, they are referred to more
often as ‘mutual funds’.
Commission
A fee for carrying out a transaction, usually expressed
as a percentage of the value of the transaction. This
term can also refer to the payment made to a broker to
carry out a transaction on behalf of a principal.
GLOSSARY
Conceal
Relevant to money laundering legislation. Concealment
of illegal funds is a criminal offence under the Proceeds
of Crime Act 2002.
Constructive trust
A trust created by a court of law as an equitable
remedy for a person or entity that has been wrongfully
deprived of rights, such as unjust enrichment by a third
party. The concept is recognised by courts in England,
Wales and Northern Ireland, but not Scotland.
Corporation tax
A tax on the profits of limited companies and some
other types of legal entity.
Coupon
The rate of interest payable on a bond.
Cumulative preference share
A preference share on which the dividend is carried
over to the next year if the company is unable to pay a
dividend in the current year.
Customer due diligence (CDD)
This forms the backbone of policies to reduce the risks
of money laundering and terrorist financing. In the UK,
CDD processes were introduced by the Money
Laundering Regulations 2007 and replaced the former
‘Know Your Customer’ regime, administered under the
Money Laundering Regulations 2003.
Debenture
A type of long term loan capital. A generic term for any
written acknowledgement of a long term debt.
Debentures can be secured against the assets of a
debtor, or may be issued unsecured.
Deposit protection scheme
A scheme, usually introduced and administered by a
government, that provides a specified minimum level
of protection for personal depositors in the event of the
insolvency of a financial institution.
Deregulation
The process through which a government removes or
reduces the laws and other regulations that impact on
financial institutions and markets. Deregulation was
most visible in the UK during the 1980s.
Derivative
A financial instrument such as a future, option or swap,
based on an underlying asset such as equities, shares
or commodities.
Direct tax
Any tax payable directly to the government, such as
income tax, capital gains tax or inheritance tax.
Disguise
In the context of money laundering, disguising the true
nature of funds in order to ‘cleanse’ them as they pass
through the financial system is a criminal offence under
the Proceeds of Crime Act 2002.
Domicile
An individual’s domicile is the country that the
individual regards as his or her home country. In tax
law, the extent to which HMRC will acknowledge a
chosen domicile depends on many factors, including
the location of the permanent home and where the
activities of everyday life are conducted.
185
186
Dual pricing
A system of pricing for certain investments. Particularly
applicable to unit trusts, for which an offer price is
stated for buyers of units and a bid price is stated for
buying back the units.
Equity
An alternative term for ordinary shares. The term is
also used to describe the difference between the
market price of a property and any loans secured on it.
Equity release mortgage
See lifetime mortgage.
Equivalent annual rate (EAR)
The rate of interest quoted on deposit that takes
account of the compounding effect of interest credited
more than once a year.
Eurobond
A medium to long term debt instrument issued in a
currency other than that of the issuer by a government
or large company.
Euro commercial paper
Short term, unsecured promissory notes issued by
banks and some companies.
Euronotes
Short term debt instruments issued by international
banks.
European Central Bank
The central bank responsible for a coordinated
monetary policy for countries within the European
Union that have adopted the euro as their currency.
European Interbank
Offered Rate (EURIBOR)
The short term interest rate at which banking
institutions within the eurozone lend to one another.
European Union
Savings Directive
Introduced a withholding tax regime in order to ensure
consistent treatment of interest received by depositors.
Exchange controls
Controls implemented by a government to restrict the
amount of domestic currency that can be exchanged
for foreign currencies. These controls no longer exist in
the UK, though personal travellers may have to explain
the origin of their funds if they carry large amounts of
cash through international borders. Exchange controls
are now uncommon in Europe, though they exist in
some major world economies, such as China and
Russia.
Exchange rate
The price of one currency expressed in another
currency.
Exchange Rate Mechanism (ERM)
A system introduced by the European Union to
minimise the fluctuations in value between the various
currencies of member states. The system was the
forerunner for the creation of the euro.
Executor
An individual or entity that acts as a personal
representative for a deceased person. The executor is
named in the will of the deceased.
Failure to report
Relevant to money laundering. Failure to report a
suspicious transaction or other activity is a criminal
offence under the Proceeds of Crime Act 2002.
GLOSSARY
FATCA
The Foreign Account Tax Compliance Act. A US act
requiring disclosure of overseas assets and accounts
held by US individuals and firms.
Fiduciary
A person or entity that is entrusted with certain duties
towards the welfare of another. A director owes a
fiduciary duty to a company. Each partner in a
partnership owes a fiduciary duty to all other partners.
The concept is recognised in common law, so breach of
fiduciary duty may give rise to a liability for
compensation.
Financial Action Task Force (FATF)
A supranational body set up by many governments to
minimise the risks of money laundering, terrorist
financing and other international criminal activities.
Financial assets
The assets of an individual or entity that comprise cash
or claims representing cash, such as deposits,
investments and securities.
Financial Conduct Authority (FCA)
Responsible for regulation of conduct in retail and
wholesale financial markets and the infrastructure that
supports those markets.
Financial market
A mechanism through which buyers and sellers of
financial assets and obligations are brought together.
This includes money markets, capital markets and
foreign exchange markets.
Financial Services and
Markets Act 2000
The Act of Parliament that provides the structure of
regulation for the financial services industry in the UK.
The Financial Services Act 2012 subsequently
transferred significant prudential regulation to the
Prudential Regulation Authority (PRA) and created a
conduct of business regulator, the Financial Conduct
Authority (FCA)
Financial Services Authority (FSA)
Until recently, the sole regulator of the UK financial
services industry.
Fixed trust
A trust in which the entitlement of the beneficiary is
decided by the settlor.
Flexible trust
A trust in which the settlor may change the
beneficiaries or the way in which the trust property is
allocated.
Floating rate
A variable rate of interest.
Floating rate notes
A short term debt instrument issued by a financial
institution or company offering a variable rate of return
to the purchaser.
Forward rate
The exchange rate for a currency that will apply for
contracts concluded now for delivery of the currency at
a specified future date.
187
188
Gift with reservation
Relevant to inheritance tax. It occurs when an
individual transfers an asset to another person but
retains some benefit in the asset. If benefit is reserved
and the transaction relates to an asset divested within
seven years of death, it is regarded as part of the
estate.
Gilt-edged security
A bond issued by the British government, so called
because it is risk free.
Globalisation
The process through which international frontiers have
become less important, thereby enabling greater
freedom of movement of assets, obligations, people
and other resources.
Grant of Probate
Authorisation by a court to distribute an estate for
which there is a will.
Gross interest
The interest on a deposit before taking account of
withholding tax.
Hybrid trust
The trustee must pay a certain amount of the trust
property to each beneficiary fixed by the settlor, but
the trustee has discretion as to how any remaining
trust property, once these fixed amounts have been
paid, is to be paid to the beneficiaries.
Incentive trust
A trust that uses distributions from income or principal
as an incentive to encourage or discourage certain
behaviour on the part of the beneficiary.
Income tax
A direct tax imposed on an individual’s income.
Incorporation
The process of creating a legal entity, such as a limited
company, by registering it with a government agency,
such as the Companies Registry in the UK.
Incorporation results in the creation of a separate legal
identity in law, through which the affairs of the
separate entity are distinguished from those who own
the business (shareholders) and those who manage it
(directors).
Index-linked
A rate of return linked to price inflation or some other
index. Some British government bonds are issued on
an index-linked basis.
Indirect investments
A generic term applied to companies and other media
through which investors pool their funds in order to
invest in assets on a collective basis. They include unit
trusts, investment trusts and open-ended investment
companies. A personal pension is also a form of
indirect investment, though the term is rarely used in
this context.
Indirect tax
Any tax on expenditure, such as value added tax.
Inheritance tax
A tax on the estate of a deceased person. Certain gifts
and other transfers that took place within seven years
of death may also be regarded as forming part of the
estate.
GLOSSARY
Insider dealing
A criminal offence under the Criminal Justice Act 1993.
It involves dealing with listed securities on the basis of
access to price-sensitive information that is not yet in
the public domain.
Integration
The final stage of the money laundering process,
through which the proceeds of crime are brought
together by the criminal in order to realise their
benefits. This stage is preceded by placement and
layering.
Interest
The price of money, paid by a deposit taker to the
investor.
Inter vivos
Relevant to trusts. An arrangement between living
persons.
International Monetary Fund
A body set up by the Bretton Woods Conference in
1944 in order to promote monetary cooperation
between members. The IMF administered a semi-fixed
exchange rate system between 1946 and 1971. It
provides assistance to countries that are experiencing
financial difficulties and coordinates efforts to align
international monetary policies.
Investment trust
A company listed on the stock exchange that issues
shares and debt instruments to its members in order to
make investments in assets such as equities, bonds,
property and cash deposits.
Irrevocable trust
A trust in which the terms of the trust cannot be
changed until its purposes have been achieved.
Isle of Man Financial
Supervision Commission
The regulatory body in the Isle of Man.
Joint and several
ownership/liability
An asset is jointly and severally owned if two or more
holders have absolute ownership of the whole value of
the asset. In the event of death, the surviving party or
parties already own it. The same principle applies to
obligations such as loans.
Law of Property Act 1925
This law created definitions of freehold and leasehold
estate in England, Wales and Northern Ireland as well
as the methods of creating legal and equitable
mortgages over land. It does not apply to Scotland.
Layering
The second stage of the money laundering process. It
follows placement and precedes integration. Layering
involves concealing and disguising the nature of funds
by obscuring their origins.
Lifetime mortgage
A mortgage that enables the owner of a property to
raise capital. Lifetime mortgages are designed to be
repaid on the death of the borrower or when the
property is sold. They are usually available to those
over a specified age (typically 55 years of age).
189
190
Listing rules
The rules laid down by a stock exchange. They set
down the criteria for applications for membership and
also minimum standards of conduct of member
companies. The listing rules are not legally binding, but
serious breaches of the rules may result in dealings in
a member company’s shares being suspended, or the
company being removed from membership altogether.
Loan capital
Long term borrowings of a company, such as secured
and unsecured obligations with more than one year to
maturity.
London Interbank
Offered Rate (LIBOR)
The wholesale market rate at which financial
institutions are prepared to lend to each other.
European Economic Co-operation (OEEC), formed in.
Market
Any mechanism for bringing those in credit and those
in deficit together.
Market capitalisation
The value of a company measured by the price of its
shares multiplied by the number of shares.
Money laundering
The process through which the financial institution is
used to conceal and disguise illegally procured funds in
order to make them appear to be legitimate. A criminal
offence under the Proceeds of Crime Act 2002.
Money market
A mechanism for transactions in short term deposits
and other debt instruments.
Mortgage
A secured loan that enables the owner of real estate to
raise capital. Commonly used to purchase a property.
Mutual institution
An organisation owned by its members or
shareholders. All building societies and some life
assurance companies are mutuals.
Net interest
The interest due on a deposit having deducted
withholding tax.
Nominal value
The face value on a share certificate or bond.
Non-financial assets
Assets such as property and personal possessions
(chattels), as distinguished from financial assets such
as bank accounts, investments and securities.
Offer price
The price at which a unit trust sells units to its
investors.
Official List
The main board of the London Stock Exchange.
Offshore centre
A centre for banking and other financial transactions
that deals mainly with individuals and entities residing
outwith the state.
Offshore company
A company that is registered in a jurisdiction other
than its main place or places of commercial activity.
Offshore life assurance policy
A life assurance contract created outside the
jurisdiction in which the policyholder resides. Offshore
life policies enjoy certain tax privileges and can be
used to reduce or defer tax obligations.
GLOSSARY
Offshore trust
A trust set up in a jurisdiction other than that in which
the beneficiary and/or settlor resides.
Open-ended investment
companies (OEICs)
A type of collective investment, combining the features
of unit trusts and investment trusts. OEICs are limited
companies with variable share capital.
Ordinary share
The main type of share issued by companies to their
members. Ordinary shares confer the right to attend
and vote at general meetings. If payable, dividends are
declared by the directors and are based on the
profitability of the company and the decision of the
directors regarding the need to retain profits for
reinvestment. Ordinary shares are sometimes referred
to as common stock.
Organisation for Economic
Cooperation and
Development (OECD)
The forerunner of OECD was the Organisation for
European Economic Co-operation (OEEC), formed in
1947 to administer American and Canadian aid to
Europe after World War II. The OECD took over from
OEEC in 1961. It helps members to achieve sustainable
economic growth and employment and to raise their
standards of living while maintaining financial stability.
Pay As You Earn
The system through which income tax is deducted
from the wage or salary of an employee by the
employer at source.
Personal banker
Relevant to private banking. An individual who is
responsible for providing personal service and advice to
the individual customer on a tailored basis.
Personal representative
An individual who has authority to deal with the estate
of a deceased person.
Placement
The first stage of the money laundering process
through which illegal funds are deposited or invested in
order to conceal or disguise their origins.
Portfolio management
The process through which the assets and obligations
of an individual are managed on his or her behalf by a
professional financial adviser.
Preference share
A share issued by a company offering a fixed dividend,
expressed as a percentage of nominal value or as a
fixed monetary sum. The dividend is contingent on the
company having distributable new realisable gains.
Preference shareholders have very limited
constitutional rights in the company. However, their
entitlement to dividend ranks ahead of the ordinary
shareholders. In most UK companies, preference
shareholders also rank ahead of ordinary shareholders
if the company is liquidated.
Premium credit/charge cards
Plastic cards issued on an exclusive basis to high net
worth individuals or those who earn privileges through
loyalty or frequent use of services.
Primary market
A market for newly created securities sold to initial
investors.
191
Private banking
An exclusive banking service, limited to those with high
net worth.
Privatisation
The sale of government-owned assets to private
investors. The term can also refer to a listed company
being bought back or bought out by investors, thereby
shedding public status.
Promissory note
A document that gives an undertaking to pay a sum of
money to a specified person on a specified date.
Protective trust
UK – a life interest which terminates on the happening
of a specified event such as the bankruptcy of the
beneficiary or any attempt to dispose of the interest.
USA – a trust used for estate planning.
192
Protector
Where deemed appropriate, a protector can be
appointed in order to limit the powers or actions of a
trustee.
Prudential Regulation Authority (PRA)
A subsidiary of the Bank of England, responsible for
promoting the stable and prudent operation of the
financial system through regulation of all deposit-taking
institutions, insurers and investment banks.
Remittance basis
Relevant to tax. The remittance basis is the rule
governing the taxation of income and assets brought
into the UK having been held offshore.
Reserves
The undistributed profits of a company or other legal
entity. The reserves are a liability to the owners
(shareholders) of the business. They represent all of
the profits accumulated since the business started its
operations.
Resident
From 5 April 2013, the rules, known as ‘Statutory
Residence Test (SRT), apply. This will decide for most
people their UK residence status for tax purposes.
Resulting trust
A form of implied trust which occurs where a trust fails,
wholly or in part, as a result of which the settlor
becomes entitled to the assets
Retail funding
Funding raised by a financial institution from personal
customers, such as savings and other deposit
accounts, ISAs and so on.
Revocable trust
A trust that can be amended or revoked at any time by
the settlor.
Revolving credit
An open-ended credit facility that enables the borrower
access to funds up to a predetermined credit limit. The
best example of revolving credit is a credit card.
Ringfence
Protecting an asset from tax and other obligations,
usually by transferring ownership to a trust or special
purpose vehicle.
Scrip issue
See bonus issue.
Secondary market
A market for existing securities.
GLOSSARY
Secret trust
A post mortem trust constituted externally from a will
but imposing obligations as a trustee on one or more
legatees of a will.
Securitisation
Issuing debt securities backed by the cash flows due
on existing assets. A common example in the UK is
mortgage-backed securities.
Settlor
The individual(s) who establish a trust for the benefit
of a defined person or entity.
Share capital
The owners’ equity on the business, mainly comprising
ordinary shares and preferences shares. It can also
include redeemable shares and deferred (founders’)
shares.
Share dealing services
Specialised services offered by some financial
institutions, either through a department or an
arrangement with an external provider.
Shell bank
A private bank established to serve the banking
requirements of a specific company, group or
companies or a family.
SICAV
Société d’Investissement à Capital Variable. A common
type of collective investment in European countries,
similar to a unit trust or investment trust.
Special purpose vehicle (SPV)
A legal entity established to separate the assets or
other financial affairs of a person from him or herself in
order to mitigate tax or enhance privacy.
Spendthrift trust
A trust established to benefit an individual but with
controls in place to restrict access to benefits due to
the potential that the benefits may be squandered.
Spot rate
An exchange rate for a currency that is obtainable at
immediate notice.
Spread
The difference between the buy and sell rates for a
currency or for investments in a unit trust.
Stamp duty
A tax payable when certain documents, such as those
relating to share transfers and real estate conveyances,
are executed.
Standby (pourover) trust
The trust is empty at creation during life and the will
transfers the property into the trust at death.
Statement of Financial
Position
The statement of assets and liabilities of a company or
other legal entity. The commonly used term until
recently was the balance sheet.
Stock
In the UK this term refers to fixed interest securities. In
the USA, the term refers to ordinary shares.
Stock exchange
A market in which securities are bought and sold. A
stock exchange also enables newly listed companies to
raise capital.
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194
Subordinated debt
A form of long term debt issued by a financial
institution. The word ‘subordinated’ refers to the debt
ranking after all other creditors’ claims in the event of
insolvency.
SWIFT
Society for Worldwide Interbank Financial
Telecommunication. A message system that enables
international payments to be processed.
Taper relief
An allowance applied to a capital gains tax liability to
take account of inflation.
Tax avoidance
A generic term for legitimate practices that use existing
laws and regulations to minimise a tax burden.
Tax evasion
A criminal offence. Tax evasion occurs by failing to
declare income to the appropriate authorities. The
perpetrator may also under-declare income, conceal
income in other transactions or overstate deductible
expenses.
Tax-free allowance
The amount of income that an individual can generate
in a specified tax period before any liability to income
tax arises.
Tax haven
A jurisdiction used extensively for the purpose of
minimising or eliminating tax obligations. These
jurisdictions usually have extremely low rates of
personal and corporate taxation.
Testamentary
Relating to the will or wishes of a deceased person.
Tipping off
A criminal offence under the Proceeds of Crime Act
2002. It occurs when an individual processing a
transaction makes the customer aware that the
transaction will be subject to scrutiny. This may enable
the customer to withdraw from the transaction,
resulting in the enforcement agencies failing to made
aware of it.
Treasury bill
Short term bills issued by the government to fund
borrowing requirements.
Treasury products
A generic term for the investments, deposits and other
services offered through the Treasury function.
Trust
A vehicle through which the assets, obligations and
other affairs of a beneficiary may be managed
independently of the individual. A trust is set up by a
settlor and managed by a trustee.
Trust deed
A document that sets down the precise terms of a
trust. Its provisions bind the trustee and the
beneficiary.
Trustee
An individual who manages a trust under the provisions
of a trust deed.
Trustee services
The specialist services offered by a financial institution
to trustees. The work of this department often includes
services in relation to executorship.
GLOSSARY
UCITS
A generic term used in European Union law to refer to
all types of collective investment, including unit trusts,
investment trusts, open-ended investment companies,
SICAVs and so on.
Undated
A security issued with no maturity date. The capital is
repaid when the debtor chooses to do so.
Unit trust
A form of collective investment through which unit
holders purchase units within a fund managed under a
trust deed. The units are pooled to purchase equities,
bonds, property and other assets. Units can be
purchased with single cash sums or through regular
instalments.
Universal bank
A bank that provides a full range of banking services
and also holds equity stakes in institutional investors.
Warrant
A security that enables the owner the right to purchase
shares at a specified price for a given period of time.
Wealth management
Usually offered by private banks, wealth management
is the service provided to high net worth customers. It
is characterised by highly personalised service, dealing
with multiple products and services.
Wholesale funding
Funding of a financial institution raised from the
markets, as distinguished from deposits raised from
personal customers.
Withholding tax
Any tax that is levied at source on interest payable to a
depositor by a financial institution.
195
196
INDEX
197
198
A ccount management, 73
Alderney, 2, 147
Alternative remittance systems, 36, 37, 38, 43
Annual equivalent rate (AER), 73
Annual exempt allowance, 113
Appointment, 137
Arbitrage, 59, 158
Arrangement fees, 80
Asset allocation, 104
Asset protection, 132, 133, 135
ATM/debit cards, 82
Automatic overseas tests, 115, 116
Back-to-back loan, 81
BACS, 6, 26, 36
Bahamas, 3, 5, 11, 142, 143, 144, 155
Bank for International Settlements (BIS), 18,
22, 41
Bank guarantees, 36
Basel II, 22, 52, 158
Basel III, 22
Beneficial owner, 29
Beneficiaries, 38, 118, 120, 127, 128, 129, 131,
133, 134, 135, 136, 137, 138
British Virgin Islands, 3, 12, 46, 47, 84, 112,
142, 144, 145, 155
Buy-to-let mortgage, 79, 80, 81
Capital adequacy, 18, 21, 22, 23, 52, 149, 159
Capital gains, 8, 10, 11, 66, 97, 99, 100, 102,
110, 117, 118, 120, 143, 145, 149, 152
Capital gains tax (CGT), 11, 94, 110, 113, 117,
118, 121, 123, 142
Capital market, 54, 56, 62, 65, 66, 67, 69, 98
Captive insurance companies, 13, 47, 84, 87,
150
Card products, 82, 87, 107
Cayman Islands, 5, 46, 47, 84, 112, 142, 145,
146, 155
Certificates of deposit (CDs), 56, 94
Channel Islands, 2, 3, 147
CHAPS, 6, 26
Charge cards, 82
Charities, 131
Collective investments, 10, 66, 90, 93, 113
Confidentiality, 4, 8, 11, 26, 46, 92, 126, 140,
155
Constructive trust, 133
Co-ownership, 133
Corporate governance, 39
Corporate services, 83, 87, 146
Corporate structure, 8, 132
Creation of a trust, 126
Credit and charge cards, 95
Credit cards, 82
Crown Dependencies, 3, 46, 47, 49
Currency accounts, 7, 74
Customer due diligence (CDD), 29, 30, 32, 48,
49, 101
Debenture, 63, 64, 65, 69
Depositor protection, 75
Deposits and money transmission, 93
Deregulation, 5, 6, 15, 66
Derivatives, 54
Development of offshore banking, 5
Domicile, 11, 47, 78, 87, 96, 110, 115, 116,
118, 119, 120, 123, 126
Double taxation agreements, 117, 133
Egmont Group, 44
Enhanced CDD, 31
Equitable owner, 129
Estate planning, 131
Eurobond market, 66
Eurobonds, 66
Eurocurrency market, 62, 67
European Union (EU), 3, 10, 23, 32, 38, 43, 47,
49, 59, 60, 72, 111, 112, 117, 123, 142,
145, 147, 149, 151, 159, 161
Europol (European Police Office), 43
Evasion, 158
Exchange controls, 5, 6, 8, 158
Exchange Rate Mechanism, 59, 60
Executorship, 96, 107
Express trust, 134, 126, 140
Failure to report, 26, 28
FATF, 34, 35, 36, 38, 39, 40, 41, 43, 75, 155
FATF recommendations, 40
Fiduciary, 137
Fiduciary duties, 137, 138, 140
Financial Action Task Force (FATF), 18, 39, 48,
52, 75, 143
Financial Conduct Authority (FCA), 19
Financial crime, 28, 39, 43, 47, 48, 49, 52, 145,
148
Financial Crimes Enforcement Network
(FinCEN), 43
199
Financial intelligence units (FIUs), 44
Investment trust, 10, 66, 90, 93
Financial market, 26, 47, 54, 98, 158
Irrevocable trust, 135
Financial services, 3, 7, 15, 19, 49, 56, 143,
Isle of Man, 2, 46, 142, 149, 150
144, 145, 146, 147, 148, 150, 151, 152,
153, 160, 161
Jersey, 2, 46, 112, 142, 147, 148
Fixed trust, 134
Joint and several ownership, 72
Floating rate notes (FRNs), 56
Know your customer, 29, 33
Foreign Account Tax Compliance Act (FATCA),
160
Foreign exchange (or forex) market, 54, 58, 59,
61, 62, 69
Forward price, 59
Future developments, 157
General insurance products, 82
Global economy, 7, 158, 163
Globalisation, 2, 15, 19, 56, 65
Government bond, 10, 64, 131
Guernsey, 2, 46, 112, 142, 147, 148
High net worth individual, 91
Hybrid trust, 134
Implied trust, 126, 133, 134, 136
Incentive trust, 134
Income tax, 11, 67, 94, 110, 117, 119, 120,
121, 123, 142, 144, 148, 149
Layering, 26, 133
Lending limits, 79
Lending products, 72, 78, 87
Licencing, 20
Liechtenstein, 2, 4, 8, 45, 159
Liechtenstein Disclosure Facility (LDF), 161
Life assurance contracts, 82
Limited companies, 8, 11, 20, 65, 84, 110
Liquidity, 47, 55, 96, 100
Loan capital, 63, 65
London Interbank Offered Rate (LIBOR), 56,
73, 80
Lump sum investments, 10, 72, 75, 77
Luxembourg, 2, 5, 8, 67, 112, 142, 151, 155
Money laundering, 18, 23, 24, 25, 26, 28, 33,
34, 35, 39, 40, 41, 42, 43, 47, 52, 74,
133, 143, 145, 146, 147, 159
Incorporation, 8, 12, 20, 41, 67, 158
Money Laundering Regulations 2007, 29
Independent Commission on Banking, 23
Money Laundering Reporting Officer, 28
Indirect investments, 93
Money market, 54, 55, 56, 57, 62, 67, 69, 83,
Industrial insurance, 34
94, 112
Inflation, 59, 99, 102, 103, 113
Money transmission systems, 6
Inheritance tax (IHT), 11, 110, 113, 114, 118,
Moneyval Committee, 43
120, 123
Mortgage Conduct of Business (MCOB) rules, 79
Insolvency, 21
Instant access accounts, 72, 75, 76
Insurance, 13, 34, 35, 46, 47, 54, 72, 82, 84,
87, 97, 120, 132, 142, 145, 146, 148, 149,
150
Non-taxpayers, 111
Insurance companies, 33
OEIC, 10, 66
Insurance products, 72, 82
Offshore banking, 1, 2, 3, 4, 5, 6, 7, 9, 11, 15,
Interest only mortgage, 80
18, 45, 54, 61, 62, 65, 66, 67, 72, 73, 75,
Interest rates, 72
92, 110, 113, 114, 123, 126, 142, 149,
International cooperation, 22, 38, 42, 44, 45,
158, 159, 161, 163
52, 159
International Monetary Fund (IMF), 8, 48, 59,
60, 67, 147, 155, 158, 159, 161, 163
200
Need for regulation, 19
Offshore centres, 3, 7, 8, 11, 12, 15, 20, 47,
67, 73, 85, 141, 142, 145, 146, 151, 155,
158, 163
Interpol anti-money laundering unit, 43
Offshore companies, 72, 82, 119, 123, 144, 153
Investment objectives, 99
Offshore interbank market, 67
Investment portfolio management, 98
Offshore life assurance policies, 120
Offshore mortgage, 78, 80
Revocable trusts, 135, 136
Offshore trusts, 118, 123, 135
Risk exposure, 47
Open-ended investment company, 10, 66, 90,
93
Sarbanes-Oxley Act, 19
Ordinary share, 63
Savings and investment accounts, 75
Organisation for Economic Cooperation and
Savings and investment products, 72
Development (OECD), 18, 39, 45, 48, 49,
Savings and investments, 9, 72, 113
53, 67, 133, 155
Savings Directive, 112
Overseas territories, 46, 47, 49, 145, 149
Savings Tax Directive, 73
Own Funds Directive, 23
Secondary market, 22, 65, 94
PATRIOT Act, 43
Secret trusts, 136
Securitisation, 56, 146
Personal banker, 92
Serious Organised Crime Agency (SOCA), 28
Phishing, 74
Settlor, 127
Placement, 26
Share capital, 63
Politically exposed persons, 48, 49
Shell bank, 20, 36, 41, 149
Pourover trust, 136
Simplified CDD, 30
Power of appointment, 137
Solvency Ratio Directive, 23
Preference shares, 63
Special purpose vehicles (SPV), 8, 11, 13, 15,
Primary market, 65
93, 114, 118, 163
Private and public trusts, 135
Spendthrift trusts, 136
Private banking, 10, 15, 72, 89, 90, 105, 148,
Spot price, 59
150, 152
Standby trusts, 136
Private trusts, 135
Statutory Residence Test (SRT), 115
Proceeds of Crime Act 2002, 26, 28, 30, 93
Stock Exchange, 65
Property services, 94
Sufficient ties test, 115
Protective trusts, 135
SWIFT, 6, 7, 26, 36, 159
Protector, 132, 133, 137
Switzerland, 2, 4, 26, 36, 45, 85, 112
Prudential Regulation Authority, 23
Public trusts, 135
Tax avoidance, 18, 45, 97, 132, 133, 158
Purpose trusts, 136
Tax efficiency, 52, 97, 126
Purposes of trusts, 130
Tax evasion, 4, 18, 37, 45, 46, 48, 52, 110,
Rates of interest, 77, 80, 92, 93, 94
Tax havens, 135
Rationale for offshore banking, 2, 8
Tax regimes, 48
Regular income accounts, 76, 77
Tax transparency, 48
Regulated mortgage contract, 79
Taxation, 3, 5, 8, 45, 47, 48, 109, 133, 135,
Regulation, 17, 66, 142, 145, 146, 148, 149,
151, 152, 158, 159, 160, 161, 163
117, 133
142, 144, 146, 148, 149, 151, 152, 158
Tax-free allowance, 110
Reinsurance, 13, 35, 47, 54, 84
Terrorist Act 2000, 30
Remittance basis, 117, 121
Terrorist Finance Tracking Program, 159
Remittance corridor, 38
Terrorist financing, 11, 12, 18, 33, 39, 43, 52,
Reporting of suspicious transactions, 41
Resident, 2, 4, 23, 45, 64, 82, 110, 115, 117,
118, 119, 120, 121, 135, 144, 151, 159
74, 75, 143, 148, 155
Testament trusts, 136
The insurance products, 82
Restricted access accounts, 76
Tipping off, 26, 28
Resulting trusts, 134, 136
Tracker rates, 80
Retail funding, 55
Tracker rate options, 73
Retail sector, 48
Transparency, 42, 43, 45, 48, 49, 52, 159
201
Treasury departments, 56
Treasury products, 94
Trustee services, 96
Validation of identity, 74
Trustees, 11, 96, 107, 113, 118, 126, 127, 128,
Vanuatu, 85, 142, 152, 153
129, 133, 140
Trusts, 8, 11, 15, 42, 48, 49, 83, 96, 97, 110,
114, 118, 123, 125, 126, 143, 146, 163
UCITS, 10
Vickers Report, 23
Wealth management, 10, 15, 66, 96, 105
Wholesale funding, 55, 56
Will trusts, 136
UK Autumn Statement 2012, 161
Wills and estate planning, 131
UK Independent Report on Offshore Centres, 46
Withholding tax, 32, 67, 72, 111, 112, 117,
UK/ Swiss Tax Cooperation Agreement, 161
Undated bonds, 64
202
Unit trusts, 10, 66, 90, 93, 131, 136
123, 145, 152

Certificate in Offshore Banking Practice

Transcription

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