FinTech

Uncovering Offshore Financial Centers: Conduits and Sinks in the Global Corporate Ownership Network Scientific Reports

Multinational corporations use highly complex corporate structures of parents and subsidiaries to organize their global operations and ownership structure. For example, the Britain-based banking and financial services company HSBC is composed of at least 828 legal corporate entities in 71 countries. The largest brewing company in the world, Anheuser-Busch InBev, consists of at least 680 corporate entities involving 60 countries.

Offshore Financial Centers

Signally, EU members are routinely not screened by activists including the EU itself. Oxfam, which has entities and activities in jurisdictions such as Lichtenstein, Luxembourg, Netherlands and Delaware, has become a prominent critic of OFCs and has produced reports with the Tax Justice Network, to try to depict their point of view. Since the financial crisis, the EU and the OECD have increased pressure on tax avoidance, with modest effects. We hope that our approach can help regulators target the policy to the sectors and territories where the offshore activity concentrates. Some cross-border financial centres play a role intermediating between regions. Similarly, about half of Malta’s (MT) liabilities are owed to creditors outside Europe, but 80% of its assets remain invested within the region.

Others have grown in recent years, such as the Netherlands (NL) and Mauritius (MU). We measure cross-border intermediation as the minimum of external financial assets and liabilities. This captures the extent to which a country acts as a conduit for financing between non-residents, as opposed to a source or destination for investments. The minimum underscores a country’s role in cross-border financial intermediation and disregards its role as an external creditor or debtor.

A few economies, such as the Netherlands (NL), Hong Kong SAR (HK) and Singapore (SG), are examples of cases in the boundary zone between cross-border and global centres. Several other economies were classified as cross-border centres in the past but had fallen out of the group by 2020 (orange dots). Finally, we investigated if the geographical specialization in conduits correlates with a sectoral specialization. Since conduit-OFCs have favorable legislation for the establishment of only a few concrete types of entities (e.g., head offices, or holding companies), we expected that the majority of the value going through a conduit-OFC would be concentrated in one or a few sectors. Figure 5B shows the sectoral specialization for different conduit-OFCs as well as Luxembourg and Hong Kong, given their relevance as sink-OFCs and their position in the European Union and in proximity of China.

Offshore Financial Centers (OFCs) facilitate these structures through low taxation and lenient regulation, but are increasingly under scrutiny, for instance for enabling tax avoidance. Therefore, the identification of OFC jurisdictions has become a politicized and contested issue. We introduce a novel data-driven approach for identifying OFCs based on the global corporate ownership network, in which over 98 million firms (nodes) are connected through 71 million ownership relations. This granular firm-level network data uniquely allows identifying both sink-OFCs and conduit-OFCs. Sink-OFCs attract and retain foreign capital while conduit-OFCs are attractive intermediate destinations in the routing of international investments and enable the transfer of capital without taxation. In addition, a small set of five countries – the Netherlands, the United Kingdom, Ireland, Singapore and Switzerland – canalize the majority of corporate offshore investment as conduit-OFCs.

Offshore Financial Centers

Their rise has put competitive pressure on global and national financial centres to reduce costs, innovate and improve the quality of their services (Rose and Spiegel (2007), Hines (2010)). At the same time, to the extent that cross-border financial centres facilitate regulatory arbitrage and obscure risks, they can undermine international efforts to strengthen the resilience of international financial intermediation. The advantage of being closer to customers helps explain why cross-border financial centres tend to have more of a regional focus than global centres do. To gauge the geographic reach of a financial centre, we use the BIS locational banking statistics to examine bilateral links between banks and their counterparties abroad (Graph 5).

Also, if you receive a transaction of $10,000 or more from your offshore account, your domestic bank in the United States has to report it to the IRS. While consolidated supervision acts as a safeguard against regulatory arbitrage in banking, the non-bank financial sector poses a greater challenge to regulatory consistency. An important step to strengthen the resilience of NBFIs is taking a less fragmented and more consolidated supervisory perspective on their activities (Carstens (2021)). The Financial Stability Board is leading international efforts to strengthen the resilience of non-bank financial intermediation (FSB (2021)). It then outlines the growth of activity in cross-border centres, before turning to the factors that influence a country’s emergence and persistence as such a centre. The concluding section outlines potential challenges to regulatory consistency and transparency arising from the role of cross-border centres in international intermediation.

It is within every individual’s self-interest to seek out natural advantages and is compelled to do what is within its own self-interest. Offshore Financial Centres work by first offering capital a place to exist without being continuously taxed. Low tax opportunities are given to capital that remains outside the borders in which the entity is incorporated.

  • Unlike previous attempts at identifying OFCs, this granular firm-level network data allowed us to identify and distinguish what we call “sink-OFCs” and “conduit-OFCs.” With some surprising results.
  • Second, favorable regulatory regimes in OFCs can be used by companies to avoid corporate accountability and public scrutiny of their operations, i.e. regulatory arbitrage.
  • The rest of us cover the difference — or, more commonly, can’t, leaving treasuries bereft of monies needed to build roads, schools and tackle existential threats like climate change and global pandemics.
  • Sink-OFCs attract and retain foreign capital while conduit-OFCs are attractive intermediate destinations in the routing of international investments and enable the transfer of capital without taxation.
  • For example, in the British Virgin Islands, over 5000 times too much value ends.

One recent example of a dummy nominee company was the use of Regula by Deutsche Bank. Consultants, wealth managers and tax lawyers, who advise on how best to avoid taxes and hide money from authorities. Rules differ by jurisdiction, but you will usually have to provide a form of identification and answer questions about how you made your money, and the purpose of the new business. Tax havens make significant income from fees paid by people and companies who create and use shell companies. Mauritius, for example, has said 5,000 people would lose jobs if the country stopped being a tax haven. Some tax havens, like Niue and Vanuatu, have cleaned up their act under international pressure while others, like Dubai, are emerging as new hotspots of illicit wealth.

The sink-OFC number indicates roughly how much more value sinks in this country as compared to what should sink in it based on the size of its economy. For example, in the British Virgin Islands, over 5000 times too much value ends. The current research presents results based on one snapshot of the global ownership network. Offshore financial centers (OFCs) are jurisdictions that oversee a disproportionate level of financial activity by non-residents.

Offshore Financial Centers

In contrast to these qualitative approaches, Zoromé has defined OFCs as jurisdictions that ‘provide financial services to nonresidents on a scale that is incommensurate with the size and the financing of their domestic economies’14. Zoromé14 as well as Cobham et al.15 used flow data on the export of financial services to calculate Starting Up An Independent Broker-dealer ratios that indicate how significantly a jurisdiction acts as an OFC. Fichtner further expanded this approach by using stock data on international banking assets, portfolio investment, and foreign direct investment (FDI) in relation to the gross domestic product (GDP) of a jurisdiction to calculate an ‘offshore-intensity ratio’16.

Hiding stolen assets abroad is clearly illegal, but buying a luxury yacht with a shell company may not be. Lawyers and accountants are very good at proposing technically legal ways to spend or stash cash offshore. Shell companies typically exist only on paper, with no full-time employees, and no office.

Offshore Financial Centers

Countries such as the Netherlands and the United Kingdom play a crucial yet previously hidden role as conduits of offshore finance on its way to tax havens. Since the mid-1990s, activity in cross-border financial centres has shifted away from banking toward non-bank financial intermediation. Today business with non-bank entities, such as fund managers and other NBFIs, accounts for the largest share of most centres’ cross-border activity. Their interbank liabilities (including intragroup positions) fell from close to 40% of total liabilities in 1995 to about 5% in 2020 (Graph 7, left-hand panel, green bars).

The most relevant regulations include ceilings on deposit rates, reserve requirements and deposit insurance premiums (McCauley et al (2021)). Geography naturally entails some dispersion of activity across financial centres. The physical reality of time zones requires several financial centres that allow for trading, clearing and settlement around the clock.