How the IFSC ‘HQ’ became shadow of its intended self
OPINION: Study of 46 treasury management firms at the IFSC found that 39 reported no fixed assets and that median employment was zero, writes JIM STEWART
RECENT DISCLOSURES in The Irish Times (Carl O’Brien, “More global firms moving here for tax reasons”) have again drawn attention to several “tax-haven” type features of the Irish economy. These are: effective tax rates which are likely to be lower than the nominal 12.5 per cent rate; ease of incorporation; and “light touch” regulation. Light touch regulation was once seen as a key aspect of Irish economic policy. Former EU commissioner Charlie McCreevy said in New York in 2005: “As finance minister in Ireland I saw what great entrepreneurial energies that a ‘light touch’ regulatory system can unleash.”
What is perhaps less well known is that, by law, the financial regulator was required to promote the development of the financial services industry. Considerable resources were devoted by the regulator to “meeting and greeting” prospective regulated entities – instead of to the overriding need for adequate regulation. Aspects of this policy have now changed, particularly in regard to regulation. But the broad thrust of economic policy remains the same.
The most recent Finance Act (2010) widened some tax reliefs and introduced several more of direct benefit to multinational companies and to firms in the financial services area. The cost of several of these changes have been described in a Department of Finance Report on Tax Expenditures as low or minimal; the cost to other exchequers is not quantified, while employment gains are either not identified or are vague. One of the changes was stated to make Ireland more attractive as a location of “head office” operations. Costs are estimated to be minimal and no employment gains are identified.
The Guardian reported in February 2009 that the “head office of several firms who claimed to have moved to Dublin, were either empty or the office of accountants”. My study of 46 treasury management firms of the over 400 located at the IFSC found that 39 reported no fixed assets, median employment was zero, yet they were highly profitable and had median financial assets of €643 million. This is likely to be a feature of many IFSC type activities – large assets but minimal employment. Total foreign investment in Ireland in 2008 amounted to €2,300 billion. The IFSC accounted for 72 per cent of this. This is over 13 times the size of foreign direct investment and approximately 11 times GNP.
Another aspect of Ireland’s tax-haven type features – light touch regulation – has led to other difficulties. Financial centres such as the IFSC formed a major part of what has been called the “shadow banking sector”. Paul Volcker and others have argued the growth of this sector is a major cause of the current crisis. The “shadow banking” system consists of non-bank financial institutions such as securitised investment vehicles and hedge funds that borrow short term and lend long term. The IFSC is a major centre for administering hedge and other funds in Europe. In 2008, 8,000 funds were located in the IFSC, with €1,560 billion of assets. Yet the Irish financial regulator has been quoted as saying in 2007 that the Irish regulator had no responsibility for entities whose main business is raising and investing in funds based on subprime lending. These financial institutions are subject to risk and uncertainty. One source of risk arises from liquidity but in contrast to banks, non-bank financial firms did not have access to central bank lending facilities but relied on interbank lending for liquidity and as a source of funding. Once this market collapsed, those financial firms dependent on the inter-bank market as a source of funds either found that the cost of funds increased dramatically or were unable to raise funds at any price.
Part of the attraction to managing hedge funds from the IFSC is that the regulatory requirement of a stock market quotation can be met. The Irish Stock Exchange states that the exchange has “standards of regulation to stockbrokers and listed companies which are acknowledged to be among the highest in Europe”, and as a result the exchange is recognised as an appropriate regulator from “the market authorities in many jurisdictions including Japan and the United States”.
In spite of these stated high standards, many of the funds that have collapsed in value because of liquidity difficulties are listed on the Irish Stock Exchange. The collapse of the subprime market in turn led to large losses at subsidiaries of two German landesbanks (Sachsen Bank and WestLB) as well as IKB, located in the IFSC. The largest and potentially most serious losses occurred at Depfa Bank, an Irish-registered bank located in the IFSC which became a subsidiary of Hypo Real Estate in 2007. Losses at these banks required large amounts of state aid from the German government. It has been reported to have led to a request from the German government to the Irish Government to assist in the bailout of Depfa Bank.
Hedge funds quoted in Dublin are often managed in London, some administrative functions may be performed in Dublin but domiciled in a tax haven/low-tax regime. All three funds announcing a closure on one day (March 18th, 2009) were managed in London, quoted in Dublin but domiciled in a tax haven. Lansdowne Partners had seven funds consisting of 148 sub funds quoted in Dublin and all but one were domiciled in the Cayman Islands. Rab Capital had seven funds and 23 subfunds quoted in Dublin, 19 were domiciled in the Cayman Islands, three in the Isle of Man, and one in the British Virgin Islands. New Star had three main funds and eight subfunds quoted in Dublin and all were domiciled in Bermuda.
While Ireland and other countries may oppose moves towards tax harmonisation, it is likely that at EU level, a limited form of corporate tax harmonisation or tax co-ordination will be introduced. It is also likely that intra-firm financial flows will be subject to greater scrutiny. EU bodies will be far more active in financial regulation.
Many EU countries have announced reductions in corporate tax rates. In Germany corporate tax rates will be reduced from 39 to 30 per cent in 2008, and in France it is proposed to reduced corporate tax rates from 33 to 25 per cent. General reductions in corporate tax rates reduce the relative attractiveness of low-tax centres especially if it is the case, as in the UK, that effective tax rates are lower than nominal tax rates. It leads to policies (as in Ireland) to enhance fiscal incentives by, for example, allowing unused tax credits to be refunded in cash, thus narrowing the tax base further.
In the short term, changes in tax regimes raise issues for economies dependent on financial centres or low-tax regimes as a key component of economic strategy. But longer term, tax-haven type activities are unlikely to provide a basis for a diverse, skill-based economy. Such activities may attract an increasing share of resources in terms of talented individuals working on tax and regulation avoidance activities and in terms of State agencies and legislators ensuring tax and other legislation facilitates the operation of low-tax, low-regulation type activities. Such legislation may in turn unintentionally diffuse to the wider economy.
As a result of the economic and financial crisis, a new political economy is emerging within the EU. Competition for investment via low tax rates and light touch regulation may no longer be an option.