Safe investing in offshore markets
What are the other centres in which UK retail investors can invest?Do they offer anything you cannot get elsewhere, and what are the pros and cons of investing in these places?
Most UK retail investors are familiar with offshore centres such as Dublin, Luxembourg, Jersey and Guernsey, but the success enjoyed by these countries has inspired many other small countries to enact regulation to encourage offshore investment.
According to the CIA World Factbook, five of the ten most prosperous countries in terms of GDP per inhabitant are Offshore Financial Centres (OFC) and the top two are Luxembourg and Bermuda. The five countries displaying the highest life expectancy, which is considered to be another indicator of quality of life, are Andorra, Macau, San Marino, Singapore, Hong Kong, which are all offshore centres.
The main similarity among offshore fund centres (OFCs) is the conscious effort to attract foreign financial activity through regulation. Creating and sustaining confidence necessitates proper law enforcement and political stability.
Rule of law and economic freedom are essential features of OFCs and the Heritage Foundation regularly ranks Hong Kong, Singapore and Luxembourg as the places with the greatest levels of economic freedom, while other OFCs also rank very well in their respective geographical areas.
However, UK investors want to invest somewhere where they feel comfortable that their money is safe. Unfortunately, with many of the aspiring offshore centres this is not the case. Hong Kong and Singapore may have a lot of economic freedom, but political freedom is limited in those countries. For instance, there is a perception that the Chinese government could clamp down on the free movement of capital in Hong Kong - although the likelihood of this actually happening is small, the concern is still there in the minds of investors and that is what counts.
A major difference between offshore centres around the world is the different fund structures they offer such as SICAVs in Luxembourg, OEICs in Ireland and unit trusts in Jersey/Guernsey, but fund structures themselves have relatively little impact on where the fund manager chooses to base the fund. A fund manager is more likely to choose a location because of taxation arrangements, with the quality of the local workforce in second place.
Indeed, in the past, much of the attraction of OFCs has been through their tax-free environment, in other words they have been used to evade tax. However, major changes are at work in the offshore fund industry and following pressure from international organisations such as the Organisation for Economic Co-operation and Development (OECD) and the Financial Action Task Force (FATF), regulation has become more constraining offshore.
Along with regulatory changes meant to deter money laundering, many OFCs have had to introduce a withholding tax on the income of foreigners from developed countries, particularly the EU. This ensures the client details remain confidential, compared with the alternative of exchanging this information with the tax authorities. Withholding tax in Europe is currently at a rate of only 15% but this will rise to 35% from 2010, so it will be interesting to see how offshore centres develop in time.
The effectiveness of withholding tax can be questioned, but loopholes will gradually be closed. For instance, many UK investors with offshore accounts in the Channel Isles thought they were well away from the clutches of the taxman, but Barclays have recently been forced to divulge the names of more than 100,000 customers with offshore accounts to the Revenue.
So offshore fund centres will need to come up with something other than tax advantages to be attractive.
This could simply be a case of having the right infrastructure. Why is Luxembourg still attracting huge amounts of business? To a certain extent it is because it is a good place in which to set up funds. Luxembourg has an adequate supply of administrators, lawyers and accountants.
The regulatory regime is relatively benign and innovative. There is a sensible fund taxation regime. There is a strong, though rather expensive, multi-cultural workforce.
So will new offshore centres catch on with UK investors? It's still too early to tell but they will have their work cut out to challenge the traditional centres with their politically and economically stable environments and efficient infrastructures. For the next 10 years no new location looks likely to challenge the established centres.
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