Down But Not Out

So-called tax havens face pressure as regulators seek to stem malfeasance, but there are legit reasons to go offshore.

Offshore banking has been under relentless attack since the 2008 crisis, but it’s holding up pretty well.

Offshore assets under management grew by an estimated 3.7% in 2016, the latest year measured by Boston Consulting Group’s annual Global Wealth Report. That lagged a 5.4% increase in onshore money, but still shows an industry with an unquestionably beating pulse. “Offshore bookings will remain a key growth opportunity,” BCG concludes.

Offshore banking is staying alive by confounding its image as squirreling away illicit fortunes for drug lords, corrupt ministers, or dissolute European aristocrats. The fastest-growing centers are Hong Kong and Singapore—clearly fueled by entrepreneurial wealth from Asia. These jurisdictions, and traditional rivals like Switzerland and Liechtenstein, are now known as “midshores,” with secrecy regimes pliant to US and EU demands and vigilant know-your-customer policies. Client motivations, experts say, are less about avoiding taxes (which are low in Asia) than about legislation at home that could crimp global ambitions—like the capital controls China introduced in 2016 that limit individuals to $50,000 a year in foreign exchange.

“We observe a clear trend away from potentially illegal tax reasons toward a more legitimate use,” says Teodoro Cocca, a professor at Austria’s Johannes Kepler University who follows the field. He lists cites international diversification in jurisdiction and investments as the No. 1 reason for holding money offshore today. Off- and onshore business increasingly intermingles for the global elite, as evidenced by the $227 billion of M&A involving offshore companies last year, according to Appleby, the Bermuda law firm whose purloined records underpinned last year’s Paradise Papers.

Safe Havens

Offshore centers also provide a safe space for people of means in unstable countries, where wealth could be subject to arbitrary expropriation, become a magnet for criminal groups, or simply dwindle away through currency devaluation. Latin Americans are the heaviest proportional users of offshore structures, with fully 27% of their wealth stashed there, followed by those in the Middle East and Africa at 23% and Eastern Europe (including the ex-Soviet Union) at 20%, BCG reports. That compares to just 1% for rich folks in North America. Tax amnesties in Brazil and elsewhere have had little impact, as high-net-worth individuals remain wary of the future back home.

“The increase of offshore wealth will be driven by geopolitical and macroeconomic instability,” BCG concludes. Cybercrime is a secondary driver, as offshore centers are assumed to have better safeguards than home-country banks.

Not that offshore banking’s horizons are free of clouds. Asia’s nouveaux riches are entering the sector cautiously, with just 6% of their wealth offshore, according to BCG. Western Europe is nearly tapped out, due to legal and cultural changes and limp economic growth. BCG expects just 2% annual growth there through 2021. “The younger generation especially does not want to have untaxed money in a foreign account,” Cocca says. “It is just not worth risking it.”

Increased compliance and more demanding customers have slashed margins in a once-cozy business. Return on assets for European offshore banks fell from 102 basis points in 2007 to 80 in 2016, BCG calculates. “A lot of the profitability is flowing out, and there will be some more consolidation,” says Andreas Lenzhofer, who studied offshore banking for Booz & Company and now runs his own firm in Switzerland.

Regulatory assaults continue. China’s capital controls are likely to have a chilling effect on offshore transfers, though observers say it’s too early to quantify. Russia has had substantial success stemming capital flight—an effort that can only be boosted by US sanctions, which could freeze billionaires’ assets abroad.

Perhaps most significant is a bill passed by the UK House of Commons in May requiring the British Overseas Territories—which include a dozen offshore havens, from the Caymans to the British Virgin Islands (BVI)—to make the owners of companies registered there public by the end of 2020. This strikes at a key remaining bastion of financial secrecy: the faceless shell companies that control most offshore money. BVI Premier Orlando Smith described the move as “kicking us while we’re down,” following two hurricanes that passed through the Caribbean last summer.

Yet offshore banking has proved adaptable under stress—shifting activity to quasi-offshore zones within the US, like Delaware and Nevada, for instance. “There is a clear indication that the US is misused for criminal activities, as it remains one of the largest countries that allows a high level of anonymity when setting up company structures,” Cocca says. The rest of the world will have a hard time pressuring those places to open their books.