Switzerland Tops The Financial Secrecy Index
When the HSBC Holdings plc (ADR) (NYSE:HSBC) (LON:HSBA) Swiss leaks story broke the big shock was that someone had produced evidence, not that one of Switzerland’s notoriously secretive banks had helped people evade taxes. We know that trillions are stashed away in tax havens around the world (the ICIJ estimates at least $7.6 trillion) as we are occasionally reminded whenever another corporation is accused of dodging taxes. But there’s no precise definition of what actually constitutes a tax haven, and according to researchers at the Center for Global Development that ambiguity is a serious impediment to reform.
“The imprecision of the term tax haven […] not only allowed questionable pressure on a group of typically small, politically isolated jurisdictions, but it has also underpinned the failure, to date, to find a comprehensive global response to the financial secrecy that thwarts the effective taxation of income and profit, and facilitates money laundering, abuses of market regulations, and the financing of terrorism,” write Alex Cobham, Petr Janský and Markus Meinzer.
Financial Secrecy Index: Switzerland ranks No. 1
Instead, they argue that we should focus on countries contribution to ‘opacity in global financial flows’ and create a Financial Secrecy Index to show which countries are doing the most harm. The result is a completely different list than the Basel Anti–Money Laundering Index (BAMLI) or Transparency International’s Corruption Perceptions Index (CPI), and Switzerland takes top billing.
Measuring impact with the Financial Secrecy Index
To build their index the researchers first calculated each jurisdiction’s secrecy score according to four criteria: knowledge of beneficial ownership, regulatory efficiency, corporate transparency, and compliance with international standards. The last two are self-explanatory, and the first is important because if beneficial ownership is defined too loosely it’s easy to set up shell companies to pass money through. Regulatory efficiency is important because the researchers have found that financial secrecy is sometimes hidden behind a combination of cumbersome rules and a pronounced lack of monitoring that tacitly encourage non-compliance.
Samoa gets the worst secrecy score, but there’s a reason that you haven’t heard the island’s name thrown around in every other news story about tax havens – it doesn’t have a big impact on the rest of the world. The researchers measured global scale weight (GSW) as a country’s proportion of cross-jurisdiction financial services. In other words, if a country doesn’t offer financial services to foreigners than it would have a GSW of zero, no matter how large its economy or how much financial activity is happening within its borders. Only the external impact is factored into the Financial Secrecy Index.
Then they take scale the two factors so that they have comparable levels of variation (raw GSW has a much larger variation than the raw secrecy scores).
“[The FSI] shows a spectrum of secrecy rather than a binary distinction between tax havens and others. The resulting global mapping reflects the pervasiveness of secrecy and the leading role of some major economies including those of the United States and the United Kingdom.”
Cayman Islands dramatically underreports financial assets
As an aside, there are two ways to calculate the GSW which ought to be equivalent: assets or liabilities. For example, if an American opens a Swiss bank account that would show up as a Swiss liability and a US asset. If you add up all of the foreign liabilities owed to the US it should match reported financial assets, with some fuzziness because it’s hard to capture data perfectly either way.
So the CGD paper starts with assets data to calculate GSW and used liabilities data to make sure the assets data made sense (and to extrapolate where gaps exist). The size of the error was reported as the ratio of the difference to GDP (ie (liabilities – reported assets)/GDP). There were only two jurisdictions where the ratio was above 10: the now defunct Netherlands Antilles, and the Cayman Islands. In the Cayman Islands the factor was above 250 every year from 2001 to 2011 and in some cases higher than 500, apparently because it doesn’t report on what the Hedge Funds based there are doing.
