Jersey: A Case Study in Path Dependence

Update April 2014: For more information on secrecy see here.

This blog is part of a series highlighting the narrative reports from a number of secrecy jurisdictions around the world, explaining how they became offshore financial centres.

Jersey ranked ninth on the 2013 Financial Secrecy Index.  This ranking is based on a combination of its secrecy score of 75 (poor) and the island's tiny share of the global market for offshore financial services.  For decades the island has pursued a development strategy which has given primacy to offshore finance.  It is now victim to The Finance Curse.  Any attempt to diversify away from financial services will need to grapple with a host of issues arising from what development economists term the island's 'path dependence', the biggest of which are the extraordinarily high cost of living and the narrow skills base of the island's workforce.

French protestors spell out their vision of Jersey

The Jersey financial centre: history and overview

Jersey, the largest of the Channel Islands, lies 135 kilometres south of the UK and just 45 minutes by jet from London. Proximity to the UK means that the island’s financial centre is intimately linked to London and the majority of inflows to Jersey are ultimately destined to the City.

Despite its tiny size, with a population of around 95,000, the island hosts a major offshore financial centre in its capital, Saint Helier, with a sophisticated cluster of international banks, trust companies and law firms – including many top players in the self-styled ‘Offshore Magic Circle’.  

For decades offshore trusts have been a mainstay of the island’s wealth management sector, which attracts capital inflows from around the world. Jersey also hosts hedge funds, shadow banks and has specialised in offshore securitisation of loans.

With its tiny population and economy, and a long history of weak political governance, Jersey is 'captured’ by the financial services sector. Despite regular protestations that it is clean and transparent, Jersey’s very high secrecy score and large financial sector means it fully deserves its place in the top ten global secrecy jurisdictions.

History

For centuries, part-British Jersey has taken advantage of its peculiar constitutional relationship with Britain to maintain its fiscal autonomy. It was a relatively early entrant to the offshore financial services market.  In the 1920s UK high net worth individuals either emigrated to the island or shifted their wealth to Jersey registered offshore trusts and companies for estate planning purposes. Income tax was originally introduced in 1928 at a rate of 2.5 percent, but subsequently raised to 20 percent in 1940 by the German military government. The personal income tax rate remains 20 percent, but corporate profits and capital gains are not taxed. As academic researchers have noted (Offshore Finance Centres and Tax Havens, p181): “a large proportion of the transactions conducted in Jersey are tax driven (that is, transactions that are booked there without the requirement of adding value so that there is little real activity) which is a key identifier of a tax haven.”

Before the abolition of British exchange controls in 1979 under Prime Minister Margaret Thatcher, all banks in Jersey came under the Bank of England exchange control regulations, but the Bank of England has historically been relatively content to operate a regime of benign negligence with respect to Jersey. Offshore banking expanded rapidly from the 1960s as London-based secondary banks expanded their offshore Euromarket activities: Hill Samuel from 1961, then Kleinwort Benson and Royal Trust of Canada in 1962, Hambros Bank in 1967 and then the first U.S. bank, First National City, the following year.  Within a decade 30 international banks were operating from Saint Helier, including Citibank, Bank of America, Deutsche Bank, Banque Nationale de Paris, Barclays Wealth, HSBC and Bank of India.

The link with Britain and the City of London

A British Crown Dependency since the 13^th Century, Jersey’s key officials, including senior law officers, the president of the States of Jersey (the legislature), and the island’s Lieutenant Governor are all appointed by the British monarch. 

One commentator describes (The offshore Interface, p154) Jersey’s relationship with Britain as “within and yet without, of being under the UK umbrella and yet with the space to have a surprising amount of freedom”.  Jersey Finance, the self-styled Voice of the International Financial Centre, admits:

“For many corporate treasurers, institutional bankers and treasury specialists, fund promoters, brokers and other corporate financiers, Jersey represents an extension of the City of London.”

All legislation agreed by the island’s legislature must be ratified by the UK monarch’s Privy Council before being enacted.  And yet politically Jersey is not part of the UK and, through smoke and mirrors, regularly projects itself as being free from UK interference.  This provides comfort to British elites using Jersey for tax cheating, while at the same time reassuring them that if the worst arises they can protect their interests through appeal to the UK Supreme Court.  This odd relationship with the UK is echoed in the peculiar relationship between Jersey (and its fellow Bailiwick of Guernsey) and the European Union.  Strictly, Jersey is inside the Customs Union for the purposes of trade in tangible goods, but is not party to EU Directives or treaties such as the Single Market Act or the Maastricht Treaty. 

This inside-outside relationship with Britain is also reflected in the island’s culture and social relations.  Superficially the island feels very British, but with Norman-French street names.  And, as author Nick Shaxson notes in his book Treasure Islands, the tiny scale amplifies many of the problems of contemporary Britain: conflicts of interest and corruption are rife, social inequality has corroded all sense of community, and the elite have made their own interests synonymous with the interests of the entire population.  In the near-absence of opposition politics and independent media this is a recipe for stifling dissent – especially when it challenges the dominant offshore financial sector.

Sun, sea and secrecy

Although Jersey does not have formal banking secrecy backed by criminal law (as is the case in Switzerland or the Bahamas, for example) secrecy is provided in various other ways, including via Jersey trusts, offshore companies and, since 2009, foundations.  These legal arrangements, combined with judicial separation from the UK, provide an effective secrecy space that attracts illicit financial flows from across the world.  While the funds were flooding in during the 1980s and 1990s the island’s regulatory authorities did little to intervene to prevent dirty money from rushing through Saint Helier en route to London. On September 17, 1996, in a searing article about an accumulation of scandals in Jersey, the Wall Street Journal described this secrecy jurisdiction as “an offshore hazard . . . living of lax regulation.” Two years later, in response to a major regulatory failure involving the Jersey subsidiary of Swiss banking giant UBS and a convicted foreign exchange dealer operating from offices in the island, New York assistant district attorney John Moscow was quoted in the Financial Times:

“The Isle of Man authorities see their job as keeping the bad guys out.  Jersey sees its job as co-operating with criminal authorities when the law requires it, without necessarily keeping the bad guys out.”

Such articles are usually met by a frenzy of public relations activity, along the line ‘we are clean, well regulated and cooperative; and our critics are motivated by foul motives.’  In addition, when major wrongdoing has been uncovered and publicised, Jersey authorities argue that this kind of activity all happened a long time ago, and point to their position (alongside nearly every other secrecy jurisdiction) on the OECD’s failed 2009 white list.  

Matters became particularly bad in the 1990s and 2000s amid a phase of management buyouts, whose financial arrangements meant that the directors of trust companies were under tremendous and unprecedented pressure to maximise short-term financial performance. This led to a wave of particularly unscrupulous practices and tolerance of a wave of financial criminality.  In more recent years, however, Jersey has had to respond to changes, which in some cases have led to reforms of its offshore sector. These pressures have come in several forms. First, external pressure from the OECD, the Financial Action Task Force, the European Union and other groupings have forced Jersey to make some changes. Second, the global financial and economic crisis has impacted Jersey’s financial sector, although the response has typically be to respond to falling revenues by increasing taxes on local people. Third, these external pressures have to some extent weakened the inter-relationships of a previously closely intertwined and mutually protective élite among the owners of Jersey trust companies and other offshore firms, somewhat mitigating though not eliminating a feeling of impunity in the face of potential criminal actions against them.  Insiders also tell us that cultural changes now underway in Jersey have made some practitioners, particularly younger ones, less tolerant of some of the more egregious and illegal acts. One other change of the past few years is that the Jersey Financial Services Commission, previously an unresponsive rubber-stamp, has started to become more aggressive (and hence more unpopular) in trying to stamp out some of the more outrageous practices.

The 2013 Financial Secrecy Index demonstrates through undisputed legal facts and assessments by international financial institutions, that these repeated claims of probity and transparency, don’t hold water.  Jersey’s sophisticated wealth management structures, notably its trust industry, keeps the island open to tax-evading/tax-avoiding and other illicit financial flows from around the world.

In addition, the OECD-backed Global Forum on Transparency and Exchange of Information for Tax Purposes in a (leaked) Peer Review report on Exchange of Information (EOI) shared our view when it started to look at the detail of how Jersey actually implements tax information exchange: 

“The highlighted provisions in some of Jersey’s EOI agreements may limit the effectiveness of information exchange. Further, in one case to date, the interpretation applied by Jersey appears to be inconsistent with the definition of ‘criminal tax matters’, and is preventing the exchange of information under that TIEA.
…  
Jersey’s domestic legislation which provides access powers to obtain information for exchange contains impediments which may significantly affect access to relevant information although to date they have not restricted access.”

Even less reassuring is the fact that Jersey chose to remain outside the EU’s automatic information exchange process, even though fellow Crown Dependencies Guernsey and Isle of Man signed up since 2009.  Local officials justified this on the grounds that they felt the need to be “internationally competitive”, though this raises questions about what they are competing for.  Legitimate activities have no need to hide behind ineffective tax information exchange agreements.

Foundations: a new step backwards

Our concerns that Jersey remains largely an unreconstructed secrecy jurisdiction have been reinforced by the recent adoption of foundations into Jersey law.  Private foundations do sometimes have legitimate purposes, but they can also provide a particularly malign form of secrecy.  As an offshore law firm in Panama puts it:

“Foundations were designed not by the rich but by the super rich to protect their assets, insulating them from seizure and confiscation. These asset protection tools are so good they should be illegal but they are not illegal. The big difference between a trust and a foundation is the foundation is a separate judicial person. The term judicial person means an unnatural person.” 

The Jersey Foundations (2009) Law, which mimics similar laws in Liechtenstein and Panama, appears to be an attempt in part to move in on Asian wealth management markets, amid rising pressure from European countries seeking to tackle their own domestic tax evaders.

Another angle on the adoption of the Jersey Foundations Law was provided to us (hat-tip to Richard Murphy at Tax Research UK) by an experienced and highly qualified industry insider:

. . . the main reason for the foundation law was to avoid fiduciary responsibility. A number of court decisions in Jersey held trustees responsible for the activities of the corporations they controlled. Obviously this increased trustee risk to a very high level. When a foundation is involved the new foundation law absolves the agents creating and managing them from responsibility.

This interpretation of the rationale for enacting the Jersey Foundations Law illustrates the insidious nature of the offshore-led regulatory race to the bottom: when managing agents are effectively absolved of responsibility for the activities of the legal entities they create and manage, legal protection of third parties effectively ceases to exist.

Enactment of this new law has directly fed through into an increase in the island’s secrecy score and is clear evidence of the authorities’ commitment to maintaining a development strategy based largely on providing secrecy and lax regulation to non-residents.

The lack of an alternative development strategy should be a cause of great concern, not least for the islanders themselves.  Jersey is already highly dependent on its role as a secrecy jurisdiction and has all the hallmarks of a captive state.  The offshore financial centre in Saint Helier accounts for over 50 per cent of gross value added in the local economy, and virtually every other sector operates downstream of its activities.  In such a monoculture economy, and without any serious prospects to break free from such extreme economic dependence, Jersey’s authorities are loath to introduce effective regulation to curtail illicit financial flows and tax evasion.  As researchers have recently argued, they are locked into a political economy over which they have little control:

“They have limited scope for reducing their dependence on offshore financial services. With approximately one quarter of its economically active population directly employed in the OFC, and the majority of the remaining workforce employed in secondary sectors like construction, distributive trades and catering, there is virtually no alternative skills base on which new industries can draw. This path dependence has been reinforced by the extraordinary high costs of land and labour, which have crowded-out pre-existing industries. Taking measures to diversify the local economy will therefore require politically unpalatable steps to significantly reduce the domestic cost base.” 

For all of the above reasons, plus the continued lack of transparency of Jersey trusts and offshore companies, and despite the flurry of tax information exchange agreements signed since 2009 (which are highly ineffective anyway), Jersey is assessed with a secrecy score of 75 and clearly well deserves its position at number nine in the overall ranking.

Sources and further reading

-          Hampton, M (1996), The Offshore Interface: tax Havens in the Global Economy, Palgrave Macmillan: Basingstoke.

-          Hampton, M and Abbott, J (eds.) (1999), Offshore Finance Centres and Tax Havens: The Rise of Global Capitalism, Palgrave Macmillan: Basingstoke.

-          Shaxson, N (2012), Treasure Islands: Tax Havens and the Men who Stole the World, Vintage Books: London.

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[i] This narrative report is based on information up to date at 21^st October 2013, however all references to FSI scores or ratings reflect the 2013 results.