How Luxembourg became a secrecy jurisdiction
The Luxembourg financial centre: history and background
Luxembourg is one of the world’s most important secrecy jurisdictions. Sandwiched between Germany, France and Belgium at the heart of Europe, this tiny constitutional monarchy has a population of just over half a million – making it relatively easy for the financial sector to exert a strong degree of ‘capture’ over the political system, the media and even the zeitgeist of the entire Duchy. With commuters from across the border making up nearly 45 percent of the workforce, and foreigners making up over 70 percent of the working population, Luxembourg always had a strong international orientation, which fits its fast-developing ‘offshore’ character.
Faced with European Union efforts to curtail tax evasion, Luxembourg works actively and aggressively to defend financial secrecy. Alongside its secrecy offerings it has many other ‘offshore’ offerings: it is a prolific source of tax loopholes for transnational corporations and wealthy individuals, and it offers a wide range of opportunities in the area of lax financial regulation.
Its history as a financial centre stems from three main developments: first, tax-free facilities for non-resident corporations, dating from 1929; second, the emergence of offshore Eurodollar and ‘Eurobond’ activity in the 1960s, attracted by Luxembourg’s regulatory laxity and tax-free status; and third, tight secrecy rules, first enshrined in the Banking Law of 1981. Breaking secrecy laws can result in a prison sentence. Luxembourg’s secrecy score of 67 is fully deserved, indeed its role as an active political spoiler of European efforts to promote financial transparency – a role that is not reflected in our data – suggests that our index may underplay the damage inflicted on other countries by Luxembourg’s financial sector.
Underpinning the financial sector, as with its competitor Switzerland and other financial centres, is the country’s political stability, its neutrality, and its location at the heart of Europe, both geographically and politically: it was a founder member of the European Union. Its stability is bolstered further by the fact that politics has been dominated for the past half-century by a right-wing political party, the Chrëschtlesch Sozial Vollekspartei (CSV) which has strongly supported financial secrecy and the financial centre’s ‘offshore’ orientation. Like Ireland, another competitor for global financial services, Luxembourg not only provides most of the offerings of ‘traditional’ tax havens like the Cayman Islands but its membership of the European Union and its wide range of tax treaties gives it better access to European and international markets than is available to more peripheral tax havens.
Luxembourg offers a wide range of international and offshore services, grouped into five ‘strategic pillars’: wealth management; asset management & investment funds; international loans; insurance; and structured finance. Outside what might traditionally be regarded as the financial sector, it also runs a lucrative line in hosting holding companies of transnational corporations, principally to help them avoid (and evade) tax. It is also strenuously seeking to build up an industry based on Islamic finance, and in October 2012 achieved a further fillip when a group of major Chinese banks said they were departing the (very lightly regulated) London markets in favour of the even less regulated Luxembourg.
In general terms, Luxembourg has sought to tailor specific legislation in sector after sector through a “light-touch”, tax-light, rather secretive ‘offshore’ model, with a historically heavy emphasis on “keeping assets based in Luxembourg secret from national tax authorities,” as a top Luxembourg regulator explains. In this approach, Luxembourg has been highly successful: in the words of Luxembourg for Finance, its promotional body, Luxembourg is the
“second largest investment fund centre in the world after the United States, the premier captive reinsurance market in the European Union and the premier private banking centre in the Eurozone.”
Luxembourg is home to alternative, specialised and venture capital investment funds, international pension funds, covered bond issuing banks, securitisation vehicles and many family wealth management companies; the country has a six percent share of the global private banking industry, about a quarter the size of Switzerland’s, boasting publicly of the sector’s ‘complete discretion’. Its investment funds industry has assets under management worth over $2.5 trillion, as well as 140 banks with some $800 billion in assets under management in 2011. The Luxembourg stock exchange is the biggest in Europe for the listing of international bonds, with over 40 percent of the total, and despite being landlocked, Luxembourg even has a shipping registry.
Banking secrecy is based significantly on the privileged nature of professional lawyer-client relationships, rather than classic Swiss-styled banking secrecy; however other forms of secrecy are provided. In September 2013 Luxembourg was on the verge of approving a new Private Foundations law (see TJN’s post here) that would create powerful new secrecy facilities for wealthy individuals – a move that has added three full points to Luxembourg’s secrecy score. It is also reportedly setting up a major high-security warehouse to help clients store assets such as paintings, gold bars or bearer bonds with minimal or no disclosure to foreign tax authorities. Complementing all these offshore facilities, Luxembourg is also a major haven for transnational corporations, actively helping them carry out transfer pricing and other abuses through the provision of multiple and deliberately crafted tax loopholes.
Hosting large tax-evading and other criminal assets from around the world, Luxembourg has historically flown under the radar, attracting far less criticism than Switzerland. Luxembourg has a well resourced lobbying network that has actively sought to undermine criticism of its role as a secrecy jurisdiction, with repeated claims that it is ‘not a tax haven’ and sometimes somewhat repressive moves against its few domestic critics. TJN’s director John Christensen has called Luxembourg the “Death Star” of financial secrecy inside Europe because of its leading role, in close political partnership with Switzerland and Austria, in fighting against information-sharing schemes in Europe.
Although Luxembourg today rivals Switzerland in size and scope as a European secrecy jurisdiction, the origins of its financial sector are far younger. Emerging as a neutral and partly independent (impoverished) nation only in 1867, Luxembourg did not gain its own independent ruling family until 1890. Rapid economic growth for much of the early part of the 20th Century was based on large iron ore deposits and the emergence of a strong iron and steel industry.
In 1929 Luxembourg took its first steps as an offshore financial centre with a new regime for holding companies, under which transnational corporations could establish ‘holding company’ subsidiaries in Luxembourg (set up purely to own assets elsewhere) that would be exempt from income and capital gains tax. Although justified as a way to help transnational corporations avoid getting taxed twice (once in their ‘home’ country and then again in the country where they were investing,) in reality they were used increasingly to achieve double non-taxation: that is, to escape tax in both countries.
In the 1960s, the Luxembourg financial industry began to take off properly. The big milestone – a top Luxembourg financier suggested this was Luxembourg’s financial “Big Bang” – was the launch in July 1963 of the world’s first ever offshore Eurobond (for the Italian motorways company Autostrade.) Though the deal itself was mostly hammered together in the City of London, it was listed on the Luxembourg stock exchange: partly for tax reasons, and partly due to Luxembourg’s regulatory laxity (for example, the bond issue did not even require a prospectus). By the year’s end there were already 93 bonds listed there (and four decades later, that figure had grown to about 20,000.) The Eurobond markets are a central pillar of the larger Euromarkets today.
Eurobonds were bearer bonds: classic tax evasion and secrecy instruments because no withholding tax was charged, and whoever physically held them in their hands was entitled to the income and capital. The Euromarkets got a large boost in 1965 when U.S. President Johnson, worried about Vietnam-era deficits, tried to restrain U.S. companies from sending capital abroad to invest overseas: in response, U.S. corporate giants started seeking funding from Euromarket centres such as Luxembourg for their non-U.S. investments.
Meanwhile, Luxembourg banks enjoyed a growing stream of individual customers from neighbouring Germany, Belgium and France: a steady flow of middle-class or wealthier citizens from those countries who would present their bonds and attached coupons at local banks and be paid in cash, no questions asked. Beth Krall, a banker who worked in a Luxembourg bank’s back office in the Eurodollar boom years, gave a flavour (Treasure Islands p216) of those times:
‘We were dealing with those “Belgian dentists” who keep bonds under the mattresses,’ Krall remembers. ‘Sometimes they all came in at once – what we called the coupon bus would arrive. They came from Belgium, Germany, the Netherlands, filling the lobby, spilling out the door, getting angry, waving their coupons and getting their cheques.’ The vaults held, among other things, enveloppes scellées (sealed envelopes) relating to ‘Henwees’ – HNWIs or high net worth individuals. ‘We didn’t know what the hell was in there,’ she said. ‘The private bankers and relationship managers put those things in there – we never had an inkling.’
Luxembourg’s regulatory laxity, tolerance of bearer bonds, secrecy and tax-free benefits has attracted significant criminality over the years. It was no coincidence that the global fraudster Bernie Cornfield established his first mutual fund in Luxembourg in 1962. Later, the Bank of Credit and Commerce International (BCCI), widely regarded as the most corrupt bank in history, incorporated itself jointly in Luxembourg and Cayman, (with headquarters in London.) Each centre provided the tax-free status and required lack of scrutiny – allowing BCCI to get involved in the financing of terrorism, drugs smuggling, slavery, tax evasion, fraud, racketeering and much more. In March 2010, newspapers reported that Luxembourg hosted US$4 billion in assets for North Korean leader Kim Jong-Il, which were shifted there after Swiss banks tightened up procedures. As the Telegraph newspaper reported:
“Mr Kim’s operatives then withdrew the money - in cash, in order not to leave a paper trail - and transferred it to banks in Luxembourg. The money is the profits from impoverished North Korea selling its nuclear and missile technology, dealing in narcotics, insurance fraud, the use of forced labour in its vast gulag system, and the counterfeiting of foreign currency.”
Luxembourg’s financial regulator, the Commission de Surveillance du Secteur Financier (CSSF), is riddled with conflicts of interest. As the IMF politely reported in 2011,
“The current legal framework does not sufficiently guarantee the full operational independence of the CSSF; the CSSF is placed under the direct authority of the Minister; its missions include the “orderly expansion” of Luxembourg’s financial center; its general policy and budget are decided by a Board whose members are all appointed by the government upon proposals from supervised entities and the Minister.”
"The head of ProtInvest, an investor-protection group, has sent a letter to Michel Barnier, an EU commissioner, in which he criticised Mr Frieden’s move to appoint his senior adviser Sarah Khabirpour to the board of the CSSF, the country’s financial regulator. The letter pointed out Ms Khabirpour also sits on the board of Banque International a Luxembourg, one of the country’s biggest banks, and is a director of the Luxembourg Stock Exchange – both institutions the CSSF regulates.
Ms Khabirpour’s multiple jobs showcase the cosy relationships that tie Luxembourg’s business community, which centres largely on fund management, to its regulators and political leaders."
Europe’s “Death Star” of financial secrecy
In contrast to the systemic global importance of Luxembourg's financial system, the assessment of Luxembourg's anti-money laundering regime by the Financial Action Task Force in 2010 was devastating. Out of 49 assessed criteria, only one has been rated as compliant, nine as largely compliant, 30 as partially compliant, and nine as non-compliant. Our database report has various other examples of failings in the Luxembourg’s supervisory apparatus: many of them deliberately crafted as part of the jurisdiction’s see-no-evil offshore model.
What is more, the European Union has for some years been trying to boost financial transparency through its Savings Tax Directive, under which member states (and other participants) automatically share information with each other on certain types of cross-border income, or withhold tax. The Directive is full of holes, but work is underway to plug them. Under the Directive, nearly all EU members have agreed to the gold standard of “automatic information exchange”, under the savings tax directive - but EU members Luxembourg and Austria have refused. Most importantly, the Directive is subject to a series of powerful Amendments, still awaiting approval, which will close the most egregious loopholes and would be expected to bring large amounts of income accruing to European taxpayers into the appropriate tax net. But Luxembourg – in alliance with Austria and Switzerland – is engaged in a complex political dance to sabotage progress on these Amendments: Switzerland says it will not yield on secrecy unless Luxembourg and others do; meanwhile Luxembourg has cited bilateral Swiss deals with the UK, which politically undermine the directive, as a reason for blocking further progress. Read more about this dance of the secrecy jurisdictions here.
Mouldy political governance, repression of critics
Like many small secrecy jurisdictions, Luxembourg has poor political governance related to financial sector policies – even though broadly it is a social democratic state with fairly strong redistributive policies locally. The Luxembourg analyst Jérome Turquey describes “an insulated culture that systematically excludes any information that could contradict its reigning picture of reality,” adding that “dishonest professionals fail to be pushed out of business, in large part because of Luxembourg’s small size where ‘everybody knows everyone else’ – and this creates conflicts of interest." The conflict between financial sector governance and wider political governance is consistent with a pattern common in offshore centres, where financial actors require governance of the financial sector to be ring-fenced against domestic politics, and thus rather immune to appropriate reform, all under the financiers’ threat of ‘don’t tax or regulate us too much or we will run away to Geneva / London / Hong Kong.’ (This broad phenomenon of ‘country capture’ by financial services, common in many financially-dependent economies, is documented painstakingly in the e-book, The Finance Curse.)
Luxembourg has at times proven to be quite harsh when its financial sector is criticised. The local media only rarely dares speak out against finance or financial secrecy, and numerous examples exist of the repression of alternative views. For example, in October 2008 Arlette Chabot, information director for French TV station France 2, had to write a craven apology to Luxembourg after airing a programme (which was admittedly rather short on specifics) critical of its financial secrecy. In July 2009, when a group of non-governmental organisations (NGOs), the Cercle de Coopération, published a report in July 2009 critical of Luxembourg’s status as a secrecy jurisdiction, and pointing out a deep conflict with its foreign aid policies, the response was ferocious. Prime Minister Jean-Claude Juncker in a long speech lambasted it as a ‘primitive study’ and told the NGOs that they should refrain from criticising the financial sector; the Cercle was forced to withdraw the study within a week. (The Luxembourg Bankers’ Association cited ‘inaccuracies’ in the report yet has so far failed to offer correct statistics when challenged to do so.) The German NGO WEED has made the study available here.
Perhaps the best known victim of Luxembourg’s approach is Denis Robert, a French journalist whose 2001 book Revelation$ about the Luxembourg-based clearing house Clearstream, alleging its role in facilitating money-laundering and flows of dirty money, led to him being subjected to almost sixty lawsuits in French, Belgian and Luxembourg courts.1 Later, in August 2011, the Wall St. Journal reported that a group of nearly 1,000 U.S. victims of terrorism were suing Clearstream for helping Iran move money connected to the 1983 bombing of a U.S. Marine Corps barracks in Beirut.
In a testament to Luxembourg’s willingness to accommodate financial interests in whatever they want – a classic feature of any secrecy jurisdiction – the Luxembourg Bankers’ Association (ABBL) boasts that one of Luxembourg’s core strengths is “easy access to decision-makers; limited red tape.” The authoritative Progressive Tax Blog added:
“It is well known jibe within the industry that favourable low-tax deals with the Luxembourg tax authorities can be reached over dinner (Michelin starred of course.)”
“One very important aspect of the Luxembourg financial centre is the absolutely scandalous discrepancy between the texts of the law, and their application in everyday judicial life. . . . while international pressure managed to force Luxembourg to adapt stricter legal constraints to the financial activities under its jurisdiction, looking into the lack of judicial application of said constraints becomes even more important.
. . . Unlike in larger countries, there is no such thing as an independent representation of any civil interests in a tiny country like Luxembourg. You just don’t make it in this country unless you’ve proven your absolute loyalty to the system in place, including being ok (if not more) with all of its malpractices.”
- This 2007 New York Times story, looking at Luxembourg’s lobbying in defence of special tax privileges enjoyed by the likes of iTunes, Skype, eBay, AOL, Amazon and other big Internet companies, provides an example of its role (and to see a photo of itunes’ massive European holding company, illustrating its ‘letter box’ nature, click here.)
- For a technical description of how Luxembourg is used to escape tax, see the Progressive Tax Blog’s exploration of the UK’s Vodafone case.
- Fragen aus entwicklungspolitischer Sicht, Cercle de Coopération a.s.b.l., July 23, 2009