2007 September » Tax Research UK

Jersey – taking hedge fund regulation to the bottom

Accounting, Economics, Ethics, Jersey, Tax Havens Comments Off

Sep 302007

“The race to the bottom” is a well known phrase in offshore tax. It is the seemingly inevitable way in which tax havens are used to reduce both the headline and effective rates of tax charged on capital (such as corporation tax, taxes on investment income, capital gains and wealth). No one can deny that the downward trend in the rates of these taxes is real.

There is though a second race to the bottom which is as pernicious, and which the tax havens also facilitate. This is that in regulation abuse. Contrary to what those in the capital markets say (unless they’re faced with an impending financial crisis, when they rapidly change their tune) regulation is a good thing fort the efficiency of markets. The reason is simple. Whatever benefits unfettered markets bring on the blackboards of economics lecturers, they cannot deliver the goods in reality precisely because the assumptions that economists make to show that they are beneficial cannot be reproduced in real life. Just look at the ‘requirements‘ section here and you’ll see why.

So regulation is needed to ensure that the failures of the market are corrected so that the imperfect market that we have can deliver the best results possible for all. Nowhere is this more necessary in finance. As the recent credit crisis has proven, markets need strong and directed regulation if they are to neither fail or abuse those involved.

So Jersey’s latests foray into modifying its hedge fund regulations is both staggering as to timing, and as to intent. Put simply Jersey has announced that it will no longer regulate any hedge fund that requires that an investor have at least $1 million invested in it. The Wall Street Journal is incredulous about this. It says:

This summer’s credit crunch showed just how little investors and regulators know about the assets owned by financial companies. But even as regulators and politicians around the world push for greater oversight of hedge funds, the small English Channel island of Jersey — a haven for funds thanks to its light regulatory touch and low taxes — is relaxing its rules even further.

It is a shift that could trigger a race to the bottom among offshore financial centers: The demands that the Financial Services Commission, Jersey’s regulator, places on some funds where investors have put in a minimum of at least $1 million will effectively fall to zero as of January.

Funds that choose to set up shop in Jersey — already home to hedge funds with a total of more than £40 billion, or $81 billion, under management, including the $2.8 billion Ermitage Group and the $640 million Altis Partners Ltd. — will be able to opt for a regime that requires no regulatory authorization to register, no outside audit and no public filings of prospectus changes, Jersey officials say.

As they note:

Jersey’s decision to introduce a new regime “was based on demand from the hedge-fund and other alternative-investment management community, which wanted an unregulated product,” said Robert Kirkby, a technical director at Jersey Finance

You bet they did. No one who wants to exploit the abuses that unfettered markets allow wants regulation: it gets in the way of exploitation; exploitation that Jersey has just licenced.

As the WSJ puts it:

Offshore financial centers are outside the purview of U.S. and European regulators, placing oversight of the funds out of reach, even if fund managers are based in financial centers like London and New York.

Too true, and which makes a complete nonsense of Jersey Finance’s comment that:

because funds already face regulatory requirements in places like London, they’d rather not suffer an extra layer of time-consuming and duplicating regulation where their funds are incorporated.

They know that’s complete nonsense. These funds are incorporated in Jersey to avoid regulation in London and now there won’t be any for many of them in Jersey either. Financial Armageddon here we come, care of the States of Jersey – a parliament in name, a small town council in aptitude and a prisoner of the financial services industry in practice.

PWC – compromised on Northern Rock

Accounting, Ethics, PWC 2 Responses »

Sep 302007

The Observer has noted today that:

Northern Rock’s accountant PricewaterhouseCoopers is facing accusations of a damaging conflict of interest after it emerged that it earned bigger fees for helping the crisis-hit lender to sell on its loans, and borrow funds in the wholesale markets, than for auditing the business.

The bank’s annual report reveals that PwC was paid £500,000 in 2006 for auditing and £700,000 in ‘non-audit fees’, specifically ‘in respect of securitisation transactions and the raising of wholesale funding’.

Just in case there’s doubt, this is what the financial statement reports:

These services do, of course, relate to the Granite companies about which I have written on this blog.

Vince Cable for the Liberal Democrats said:

This appears to be a serious conflict of interest. I would worry about the fact that the auditor appears to be making enormous fees from what turned out to be the most disastrous aspects of the Northern Rock situation.

My comment was perhaps more robust:

It’s a complete conflict of interest: it’s absolutely absurd. Once they’ve endorsed these structures, for the purposes of raising the money, they can’t turn around and say, this is no good for the purposes of an audit.

This is obvious, surely: there is no way that you can both report on the Granite prospectus (as PWC did, and for which no doubt these fees were paid) and then only a short time later when some of the debt of that company, or its related parts, comes up for refinance turn round and say its lack of marketability means that the company is in jeopardy. It was obvious from the moment that PWC did the report on the Granite prospectus that its objectivity with regard to the audit was gone.

As Austin Mitchell MP (who has done much good work in this area along with Prem Sikka) said to the Observer:

The conflict of interest comes where [auditors] make the highest profits on other services, which means the audit becomes more compliant; more accommodating. They don’t want to alienate the clients: the audit becomes a market stall from which they sell other services.

And perhaps as tellingly the Observer notes:

Rosemary Radcliffe, a non-executive director at Northern Rock, is a former chief economist at PwC.

She may have been the most scrupulous non-exec director on earth, but appearances matter. And this does not look good.

Surely then, now, when a British bank has been brought to its knees those of us who raise questions of the ethics and independence of our profession will be heard? Or am I being too optimistic?

The Observer on Special Purpose Vehicles

Economics, Ethics, Tax Havens Comments Off

Sep 302007

I asked recently why no one was talking about the risks to ordinary people in the UK from the use of ‘special purpose vehicles’ (SPVs) by banks such as Northern Rock’s Granite companies and HBOS’s Grampian set up.

Well, now the Observer has. Which is great news because people have to know that the City might add value to the UK economy (and I don’t dispute that) but equally, some of it what it does is simply harmful to their potential well-being.

I have little doubt that SPVs fall into the latter category. The reason is simple. These things change the balance of risk in banks so that the City’s is reduced and that of depositors is increased.

That’s unreasonable. First the City has the means to assess the risk and the depositor has not. Second, the government is now underwriting the depositor. This now means that by default the City taking risk with public money. I resent that, very much. No one wants to pay tax to bale out banks.

Domicile change soon?

Domicile Comments Off

Sep 302007

The Scotsman has reported that UK cabinet minster Tessa Jowell said at a Labour conference fringe meeting:

Over the past 10 years, as part of this process of global change, we have seen the arrival of the super-rich. And rich to a degree that would have been unimaginable 10 years ago. And I think that in time we will come back to consider the position of the people who are non-domiciled but who are resident in the UK and pay no tax.

In time is disappointing. But I really do not think Jowell would have said this without clearing it.

Which makes the comment of George McCrachan, tax partner at Grant Thornton, quoted in the same article seem even more absurd. He said:

It would be a brave thing of any government to do. A lot of people working in the City of London, and to a lesser extent in Edinburgh, will be non-domiciled and will not be paying tax on all their income. If you change the law, will they take off somewhere else?

Two questions to Grant Thornton:

1) Why is raising an additional £4.3 billion brave?

2) Where are these people going?

If there are no answers to those questions, then these comments ring more hollow then they have ever done in the past.

It’s really time that these firms came to recognise that change is on the cards. Soon.

IFRS 8 – what an independent expert says

Accounting, Europe, IFRS 8 Comments Off

Sep 282007

Nicholas Veron of the Bruegel Group was asked to advise the European Parliament on IFRS 8 and the EC’s report on its adoption. This is what he told them last week:

The IFRS 8 standard on operating segments was included in the IASB-FASB convergence program in February 2006 and subsequently adopted by the IASB in November 2006, in spite of widespread negative sentiment about it among investors and other users of financial statements, which the IASB should have given attention to but chose to ignore.

Compared with what is provided under the existing standard IAS 14, the management approach on which IFRS 8 is based is not accompanied by sufficient safeguards to ensure that segments reflect economic reality and convey a proper understanding of risks. There are no requirements to make segment information consistent with consolidated information, which may negatively impact the value of the former. And geographical information is likely to be lost.

The Commission’s Report on IFRS 8 does not provide an adequate basis for informed decision, due to severe methodological flaws and insufficient disclosure of feedback received by the Commission during the consultation phase. The current process which may lead to IFRS recognition in the United States does not provide a convincing argument to adopt IFRS 8 in view of the standard’s shortcomings. To defend the objective of high-quality standards, the European Union should not adopt the current version of IFRS 8.

And I thought I was critical!

Note one line in particular:

And geographical information is likely to be lost.

It’s good to have impartial support for what we’ve said all along.

I have also seen Nicholas Veron’s PowerPoint for this presentation. His conclusion?:

Not adopting IFRS 8 will be beneficial to IFRS success. IAS 14 is better, and likely to be recognised as such in the US

I really hope the Parliament takes note and still rejects this madness.

But if not that it accept the amendments I have suggested.

EU Parliament on IFRS 8

Accounting, Europe, IFRS 8 1 Response »

Sep 282007

The EU Parliament’s Economic and Monetary Affairs Committee is to consider IFRS 8 on October 3. The resolution they will consider is here.

Three things are glaringly obvious. The Parliament is

1) quite unhappy about the EU process for approving IFRS

2) not convinced by objectiveness of the review undertaken by the EC on IFRS 8

3) not convinced that IFRS 8 adequately deals with geography

4) not convinced that IFRS 8 reporting will result in comparable financial statements

5) Gives just about the most qualified endorsement it can, if this resolution is passed:

All that being noted, there remains room for improvement. I’m sending three suggested amendments to the motion.

Amendment 1 clarifies the governance position and has the advantage of being based on text taken straight from the EU Commission’s own website. It says

It is noted that:

With regard to the responsibility of board members, the prevailing principle in Europe is – in contrast to the US – collective responsibility for the financial statements. As can be seen in the Action Plan on Company Law and Corporate Governance the Commission intends to clarify the application of this principle and to extended it to key non-financial information.

Many companies are organised in group structures. However, operations, intra group transactions and the group’s transactions with related parties often lack transparency seen from the perspective of investors, shareholders and other stakeholders. This can make it difficult for them to assess the true risks of investing in the companies.

In consequence it is requested that the Commission note the adoption of IFRS 8 and report back to the European Parliament no later than 2011 on changes in the level of reported transparency on the operations, intra group transactions and group’s transactions with related parties consequent upon the introduction of IFRS 8.

Amendment 2 picks up the the anti avoidance measures from IAS 14 (para 11 and para 12) which also cover internal state risks. It says:

It is noted that according to IAS 14 which IFRS 8 replaces that:

A single business segment does not include products and services with significantly differing risks and returns.

Similarly, a geographical segment does not include operations in economic environments with significantly differing risks and returns. A geographical segment may be a single country, a group of two or more countries, or a region within a country.

In consequence it is requested that the Commission note changes in the number and nature of reported segments for which information is supplied as a consequence of the the adoption of IFRS 8 and report back to the European Parliament no later than 2011 on changes in the nature and geographic definition of reported segments consequent upon the introduction of IFRS 8.

Amendment 3 notes the request that information on tax paid by country be disclosed by those campaigning against IFRS 8 and says:

It is noted that requests have been made by civil society organisations that information on tax paid be provided on a segment and geographical basis and that the Commission has suggested that this matter be addressed through better Corporate Social Responsibility reporting.

In consequence it is requested that the Commission note changes in the reporting of taxation paid on a segment and geographical basis in the period following adoption of IFRS 8 and notes changes in the same information provided in the Corporate Social Responsibility reports of those companies to which IFRS 8 applies and report back to the European Parliament no later than 2011 on the changes noted.

Offshore Banking Business

Ethics, Tax Havens 1 Response »

Sep 282007

Just watch it!

Thanks to Duncan Wigan for the link.

For more information.

HMRC revisits offshore – and faces criminal non-cooperation

Corruption, Domicile, Tax Havens 1 Response »

Sep 282007

PWC has reported that

HMRC held a meeting with representatives of up to 100 financial institutions on 25 September 2007 in connection with offshore evasion by UK bank customers holding offshore accounts.

HMRC’s pursuit of suspected offshore evasion by UK bank customers with offshore accounts is now expanding in scope, beyond the five major UK banks targeted hitherto.

According to reports HMRC asked the financial institutions to complete a questionnaire which should enable HMRC to decide on possible TMA 1970 s20(8A) notices to enforce the supply of data on offshore accounts.

As PWC also noted though:

HMRC accepted the legal constraints faced by some banks with subsidiaries in countries with banking secrecy laws, such as Switzerland, Austria, Belgium and Luxembourg and that the Isle of Man also has laws which could impede disclosure.

There has been doubt as to whether HMRC could override foreign secrecy laws and force banks to disclose information held by a foreign subsidiary.

As the FT has noted,

The Revenue needs to find out whether information relating to offshore accounts is available, either because it is on a UK-based server or because UK bank officials are authorised to access information held abroad.

There’s no doubt that if they don’t the law is less clear than if they do.

But doesn’t this give rise to one , obvious, point, that when bank secrecy is used to assist crime (and tax evasion is a crime) then those countries that provide it are parties to that crime, and so are those who defend the secrecy arrangements that they offer?

Try offering me an alternative explanation.

What part of loophole don’t you understand?

Ethics, Private equity, Tax management Comments Off

Sep 282007

The Guardian has noted that the back tracking on private equity has begun in the Treasury.

Gordon Brown said on Wednesday that:

Private equity will be dealt with in the PBR. I can assure you that we will do so.

Th[e] matter will be looked at in a few days and weeks and wherever there is a loophole that there should not be, we will take action. I may say that since 1997 we have closed a massive number of loopholes where they exist. Sometimes it is very difficult to do so because there are lawyers and accountants who are always trying to find loopholes. On this issue of private equity, I can assure you that we will do so.

Now the Treasury has said:

The [private equity] review was still under discussion and no decision had been taken. The prime minister’s statement merely reinforced the government’s conviction that tax abuses would be tackled.

and:

We don’t believe he said that the private equity industry was abusing tax loopholes.

This almost beggars belief. I know the Treasury is full of market economists providing it with a massive bias towards market abuse that creates enormous tensions with HMRC, with whom they share the building, but to suggest private equity interest reliefs, its extensive use of offshore, manipulation of the domicile rule and the abusive nature of the agreement on the taxation of carried interests are not the exploitation of loopholes is just plain daft.

Everyone knows that private equity is exploiting loopholes. That debate is over. As such it’s time the Treasury faced reality. Which means dropping some of the blinkers that an economist customarily uses to avoid doing so.