The EU tax blacklist and the Caribbean international financial centres


The EU tax blacklist is wreaking havoc on the stability – and in some cases, the survival – of the international financial services sectors of small Caribbean jurisdictions. This article discusses the EU tax haven blacklist and the responses of CARICOM and small Caribbean international financial jurisdictions.

In 2015, the EU issued its first blacklist, only to withdraw it after criticism by the OECD, international organisations, and others. In 2016, the EU issued new criteria to determine whether governments met the standards of ‘good tax governance’.

The EU standards to determine good tax governance are tax transparency, ‘fair taxation’ and compliance with OECD Base Erosion and Profit Shifting (BEPS) requirements.

Fair taxation rule 2.2 applies five factors listed in paragraph B of the Code of Conduct to determine if a violation has occurred. The factors are: (1) whether advantages are accorded only to non-residents or in respect of transactions carried out with non-residents, (2) whether advantages are ring-fenced from domestic market, so they do not affect the national tax base, (3) whether advantages are granted even without any real economic activity and substantial economic presence with the member state offering such tax advantages, (4) whether the rules for profit determination in respect of activities within a multinational group of companies depart from internationally accepted principles, notably the rules agreed upon within the OECD, and (5) whether the tax measures lack transparency, including where legal provisions are relaxed at administrative level in a non-transparent way.

For purposes of 2.2 and criterion three, the EU Council, in its proceedings with its delegations on Dec. 5, 2017, explained that real economic activity relates to the nature of the activity that benefits from the non-taxation at issue, while substantial economic presence relates to the factual manifestations of the activity that benefits from the non-taxation at issue.

The Council provided, as examples, the following elements that are taken into account when determining if a jurisdiction has real economic activity and a substantial economic presence: (1) adequate level of employees, (2) adequate level of annual expenditure to be incurred, (3) physical offices and premises, and (4) investments or relevant types of activities to be undertaken.

The Council explained that the absence of a corporate tax or applying a nominal corporate tax rate equal to zero or almost zero cannot alone be a reason for concluding that a jurisdiction does not meet the requirements of criterion 2.2. Besides these definitions and examples, the Council’s proceeding minutes do not provide further details on the meanings of real economic activity and substantial economic presence.

As of the start of 2019, the EU has ‘grey-listed’ jurisdictions that made commitments to comply with the EU criteria, including most of the Caribbean jurisdictions. The criteria for ‘fair taxation’ is especially problematic due to its vague and constantly changing nature.

Nevertheless, the EU has exercised its power to compel small jurisdictions to revise their laws.

In particular, the EU requires that entities in specific sectors meet ‘substance’ in the form of employees, premises, and expenditure if they are incorporated, operating in, or tax resident in low or no tax countries.

On March 12, 2019, the EU finance ministers updated the EU list of non-cooperative tax jurisdictions. The list now has 15 countries and is part of the EU’s fair taxation initiative.

The Commission explained that it assessed 92 countries based on three criteria: tax transparency, good governance and real economic activity, and the existence of a zero corporate tax rate. As a result of the assessment – and pressure to avoid the blacklist – 60 countries acted and eliminated more than 100 harmful regimes.

A major issue is that even though the OECD has taken the lead in formulating the BEPS rules in 2015 and requires small Caribbean jurisdictions to meet its criteria in Action 5 of the BEPS project, the EU has decided it wants to establish an independent, more aggressive set of standards.

On March 29, 2019, the Caribbean Community (CARICOM) issued a press release, noting that the EU has issued a revised list of countries that purportedly do not meet tax good governance, including the following five CARICOM members: Barbados, Belize, Bermuda, Dominica, and Trinidad and Tobago. In addition, the statement observed that the EU has placed several other CARICOM members on a monitoring list having made commitments to undertake reforms by December 2019 and they are acting to meet the deadline. They are Antigua and Barbuda, the Bahamas, St. Kitts and Nevis, St. Lucia, Anguilla, the British Virgin Islands and the Cayman Islands.

CARICOM characterises the statement made by the EU Council in support of the inclusion of the blacklisted states as “grossly misleading” and that it misrepresents the response, in good faith, of CARICOM’s members since the initial listing in December 2017.

CARICOM expresses concern that the new listing constitutes an infringement of its sovereign right of self-determination and is starting to border on anti-competitive conduct targeting the decimation of international business and the financial services sector in the Caribbean.

In particular, CARICOM observes the EU Council has stated that Barbados “has replaced a harmful preferential tax regime by a measure of similar effect and did not commit to amend or abolish it by the end of 2019”. Yet, Barbados reviewed its corporate tax regime in 2018 and decided to undertake tax convergence, removing the alleged preference accorded the international business sector. As a result, Barbados currently applies a tax rate of 1% to 5.5% on the taxable income of all corporations registered in Barbados.

The OECD sanctioned this policy and has continued to take the position that a low tax rate does not constitute an unfair tax regime. In addition, Barbados asked for clarification on the areas of variance in the requirements for a low-tax jurisdiction as established by the OECD Forum on Harmful Tax Practices (FHTP) and the EU’s fair taxation criteria. The EU finally responded to Barbados’s request on the day after the issuance of the revised blacklist.

On March 11, Barbados Prime Minister Mia Mottley wrote a letter to Pierre Moscovici, Commissioner of Economic and Financial Affairs, Taxation and Customs, explaining that the EU has not yet stated what enhanced spontaneous exchange of information it wants, or what the higher evidentiary threshold for high-risk intellectual property should be. Additional safeguards for detailed reports by companies on outsourced activities and detailed reported by service providers in terms of work undertaken on behalf of companies, inclusive of keeping time sheets, requires clarity. The EU request for unfettered access to beneficial ownership may violate the Barbados Data Protection Act, which was done to comply with the EU General Data Protection, and it may breach the EU’s international human rights laws. In addition, Barbados has learned that in the future divergence may occur between the OECD Forum on Harmful Tax Practices and EU Criterion 2.2. Prime Minister Mottley said blacklisting for not making open-ended commitments on matters not yet resolved by the EU would not be in good faith.

CARICOM also raises the fact the EU has changed its practice in the case of placing Belize and Bermuda on the grey list in order to monitor them once they gave high-level commitments to address alleged deficiencies.

With respect to Belize, the EU Council alleges Belize “has not yet amended or abolished one harmful preferential tax regime”, notwithstanding the legislative, administrative and tax reforms undertaken by Dec. 31, 2018, which the OECD blessed. The EU also states that Belize introduced a “new and preferential tax measure” in its 2018 tax reforms.

Belize argues that the mentioned tax rates of 1.75% to 3.35% on taxable income of international business companies and entities operating in Belize’s special processing areas are consistent with Belize’s actual income and business tax regime. Still, Belize acquiesced and provided, as the EU demanded, an undertaking to amend this so-called “new preferential tax measure” by Dec. 31, 2019. The EU said it would monitor this and an additional high-level political commitment to address any other concerns of the EU. Notwithstanding its commitments, the EU included Belize on the blacklist.

On March 15, 2019, Belizean Prime Minister Dean Barrow in his administration’s national budget address to Parliament said, “This is outrageous”, recalling that in October 2017, Belize was cited in an OECD FHTP Report because its International Business Companies (IBC) Regime contained potentially harmful tax features.

In response, Belize undertook to amend the regime. In December 2018, the Parliament passed a number of amendments to the IBC Act, the Income and Business Tax Act, and Stamp Duty Act. Simultaneously, it also passed a new Designated Business Processing Act to replace the Export Processing Zone Act about which the OECD had also complained.

Barrow said subsequently that the FHTP, after reviewing the action taken by Belize, reached a new conclusion that the Caribbean country’s IBC regime was no longer harmful.

Barrow said that the EU demanded more action by Belize. “Now it must be stressed that all this was despite the fact that EU Code of Conduct Group is itself a senior member of the OECD Forum. The same OECD Forum that just a few weeks before, with the full involvement of the Code of Conduct Group, had given Belize a “clean bill of health’,” Barrow said. Barrow properly explained that the power disparity in international relations is all that counts.

Bermuda’s inclusion on the list arises as a result of an omission which it corrected after the revised commitment date.

CARICOM underscores how the Dominican case demonstrates the insensitivity of the EU Council to a country that was devastated by two natural disasters – one in 2015 and another in 2017 – and lost its largest investor. Nevertheless, Dominica finished all the mandated legislative and administrative reforms to which the government had committed in mid-2018 to undertake. However, the EU has included Dominica in the revised blacklist because it “does not apply any automatic exchange of financial information, has not signed and ratified the OECD multilateral convention on mutual administrative assistance in tax matters as amended, and has not yet resolved these issues”. Yet, Dominica has signed the OECD multilateral convention and the OECD controls whether to accept its signature.

A press release by the Ministry of Finance in Dominica confirmed that the reasons for listing are unfair and misleading, insofar as, despite severe effects of hurricane Maria in September 2017, Dominica has tried to join the Convention, but received many questions and then the OECD has not responded to its communications.

Trinidad and Tobago faces the challenge in which the government does not have the parliamentary majority under the country’s constitution to provide the legislative reforms required to comply with the tax good governance standards. Nevertheless, the EU has kept Trinidad and Tobago on the blacklist because of the ‘non-compliant’ rating by the Global Forum on Transparency and Exchange of Information for Tax Purposes for the exchange of information on request.

CARICOM and its members have complained that the blacklisting has caused severe reputational harm to the small and vulnerable small jurisdictions. CARICOM complains that the EU is not abiding by the principles underlying the UN Addis Ababa Action, which require shared responsibility, mutual accountability, fairness, solidarity, and different and evolving capacities concerning the mobilisation of resources to achieve the 2030 Agenda for Sustainable Development. In this regard, the EU has not taken into account the limited capacities of small jurisdictions and the many demands on their resources by international organisations.

CARICOM laments that since the latter part of 2018 until now, the EU has regressed to the colonial days when the EU countries dictated policies. With respect to the ECOFIN Council’s allegation of “harmful tax regimes”, the allegation has lacked supporting empirical evidence. In some cases, such as Dominica and Trinidad and Tobago, the EU has selectively relied on the OECD tax governance process. In other cases, such as Barbados and Belize, the EU has ignored the conclusions of the OECD FHTP. CARICOM and other observers believe the ECOFIN council is trying to destroy the financial sector in CARICOM member states even as they try to develop resilience in their economic areas to mitigate their inherent vulnerabilities of small size, limited resources, exposure to natural disasters, and limited political power.

A criticism of the EU listing initiative is that it does not include the many EU countries with international financial services, such as Ireland, Luxembourg, the Netherlands, Cyprus, Austria, Hungary, and the UK. A continuing criticism is that, notwithstanding the EU’s statements of open and vigorous engagement, the targeted countries have complained about ever-shifting and obscure standards, as well as insufficient communication over the standards and the expectations from the EU.

While CARICOM says it will continue to resist the EU’s retrograde approach, its comparative lack of political power requires that it enlist support from other countries with comparatively more political power, such as those in the G7 and G20, and international organisations, including the OECD, the World Bank Group, and the United Nations, as well as from the business community. To develop such support will require establishing that the use of proliferating standards and blacklists undermines normal commerce and the stability of small jurisdictions with international financial sectors. They will need to show that more blacklisting will result in de-risking and further marginalisation of their international financial sectors and their ways of life. They will have to show that blacklisting will cause more unemployment and instability in their jurisdictions, leaving them vulnerable to anti-democratic forces inimical to the EU. The education of the EU and the stakeholders should be broad-based. Already to some extent the small jurisdictions are fighting an uphill battle.

The small Caribbean international financial jurisdictions that survive are likely to be the ones that continue to quickly innovate. Cayman, in particular, has achieved success in innovating due to the comparatively large size and sophistication of its financial sector, including professionals from around the world. In addition, the close collaboration between the private sector and the government has enabled Cayman to anticipate and quickly respond to international regulatory developments, such as the EU listing exercise.

Small Caribbean international financial jurisdictions may want to enlist in their cause some of the other black- and grey-listed countries. The non-Caribbean jurisdictions blacklisted include American Samoa, Fiji, Guam, Oman, Samoa, the US Virgin Islands, the United Arab Emirates, the Marshall Islands and Vanuatu.

The non-Caribbean countries on the grey list are Albania, Armenia, Australia, Bosnia and Herzegovina, Botswana, Cape Verde, Costa Rica, Cook Islands, Eswatini, Jordan, Maldives, Mauritius, Morocco, Mongolia, Montenegro, Namibia, North Macedonia, Nauru, Niue, Palau, Serbia, Seychelles, Switzerland, Thailand, Turkey and Vietnam.

A potential key actor is the United States government since the blacklisted jurisdictions include three US territories. On Feb. 13, 2019, the same day the EU announced its Anti-Money Laundering blacklist, the US Treasury issued a statement, criticising the list of “purportedly” high-risk jurisdictions “posing significant threats” to the EU’s financial system.

Treasury said it “has significant concerns about the substance of the list and the flawed process” used to develop it. Until now, the Trump administration has not prioritised tax transparency and has had tensions with the EU over trade matters. However, as of April 3, 2019, the Trump administration has remained silent on the EU tax haven blacklist.

The questionable benefits of beneficial ownership registers

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As much government as necessary, as little government as possible.” So goes the old classical liberal motto, concisely summarising a blueprint for freedom and security under the law. On the specific issue of public authorities’ access to the financial information of private individuals and firms, the slogan is as relevant as it has ever been. An increasing number of jurisdictions around the world, including the United Kingdom and the European Union, are establishing registers of the ultimate owners of companies and trusts. In many cases, there are no restrictions on who has access to this information. Even in the United States, historically more resistant to beneficial ownership registers, Democratic and Republican legislators have advanced proposals to create one.

The reason ownership registers enjoy broad-based support across the political spectrum is that they can serve many different goals. To conservatives, requiring company owners to register with the government promises to reduce the likelihood that wrongdoers will use “shell corporations” – those with no or only nominal assets and operations – to launder proceeds from illegal activities and to finance terrorism. Those on the political Left, for their part, believe this information will enable the government to collect more tax revenue from mobile high-net-worth individuals and multinational enterprises. Self-described ‘tax justice’ campaigners also relish the prospect of open access to sensitive details about the financial affairs of prominent people and companies.

Unfortunately, a policy’s popularity with politicians and the public is seldom an assurance of its economic desirability or compatibility with the rule of law. Beneficial ownership registers are in fact a heavy-handed way to combat illicit finance. Evidence from the jurisdictions that have registers in place is beginning to show that they pose a considerable burden on law-abiding firms, while failing to uncover those with evil motives. There are ways to more efficiently pursue the fight against crime – entailing lower costs to businesses and taxpayers, and more targeted action on the part of government agencies.

It is not unreasonable for public authorities to collect certain pieces of information about corporate entities under their jurisdiction. In a world of trans-national investment by individuals and firms, knowing the identity of the ultimate owner helps to assess an entity’s tax obligations in each location where it operates. Beneficial ownership information may also be needed to establish who is ultimately liable for the entity’s actions in case lawsuits arise.

The prevention and prosecution of financial crime is another reason cited by advocates of beneficial ownership registers. A 2011 World Bank report on the subject quoted the annual volume of corrupt financial transactions at $40 billion. Clearly, the public also wants governments to curtail the ability of terrorists and other criminals to use the financial system for illicit purposes. Wrongdoers are precisely the sort of people with the greatest incentive to conceal the true owners (and thus the ultimate beneficiaries) of legal entities.

The debate is not over whether any information should be collected. The key policy questions are how much information should be collected, by whom, and when it should be shared with government authorities.

These questions are a matter of principle but also cost-benefit analysis. In a free society, the government must have a legitimate public-interest motivation to request information from private individuals and firms. But even if such public-interest grounds are present, the costs of monitoring might be too high relative to the probable benefits.

For instance, the ability of law enforcement agencies to uncover and prosecute financial crime might conceivably increase if these agencies had to approve every single transfer of funds between people. But the costs of such a policy, in terms of the taxpayer money required to pay for the oversight infrastructure and in the form of a slower, clunkier financial system, would be prohibitive. Not a single liberal democracy has (yet) proposed to guard against potential criminal activity in this way.

Instead, the tendency has been to deputise financial institutions to perform the due diligence work on the state’s behalf, and to report suspicious transactions as they arise. The United States has applied that model since passage of the Bank Secrecy Act (BSA) in 1970, and the EU followed the same template in its first anti-money-laundering directive in 1990.

However, as reporting requirements have grown over the years, the costs to the financial system of acting as an agent of the government have mounted. A 2018 survey of smaller US banks, for example, found BSA-related regulations to be the most onerous. AML/KYC rules are estimated to cost financial institutions between $4.8 billion and $8 billion per annum. In 2018, the entities subject to the BSA and related legislation filed 5,241,847 suspicious activity reports with the Financial Crimes Enforcement Network (FinCEN), the US Treasury’s financial crime division. Yet less than 20% of these reports involved serious national security risks, such as cybercrime, money-laundering, and terrorist financing.

It is also worth noting that the number of money-laundering investigations by US law enforcement has been falling in recent years, even as the number of reports from financial institutions has escalated.

Despite mounting evidence of diminishing returns from AML/KYC regulation, officials have piled on new requirements. Last year, FinCEN’s customer due diligence (CDD) rule came into force, requiring banks, securities and commodities brokers, and other financial intermediaries to verify the beneficial owners of companies as they open their accounts. The CDD rule includes strict look-through provisions that require reporting firms to investigate the ultimate owner, even when the corporate client is owned by another legal entity with which the financial institution has no relationship.

According to the US government’s own impact assessment, the CDD rule will cost financial institutions as much as $1.5 billion over 10 years. This figure may seem trivial relative to the size of US financial markets but note that it is orders of magnitude higher than the annual net earnings of all but the very largest US banks. Even institutions with assets of $10 billion to $250 billion had an average net income of just $682 million in 2018. Because the impact of regulation is not proportional to bank size, the CDD rule may hit the bottom line of some institutions hard.

Indeed, outcry from the financial sector has been a major factor behind legislation to mandate that firms themselves report their beneficial ownership to FinCEN. A bill, currently under discussion, by New York Democratic Congresswoman Carolyn Maloney would require all businesses with fewer than 20 employees or less than $5 million in annual sales to report their ultimate owner to FinCEN, or face fines of up to $10,000 and up to three years’ imprisonment. The bill exempts financial institutions, large businesses, and non-profit organisations from reporting. Still, it would affect at least five million companies employing as many as 20 million Americans. Another estimate puts the number of covered entities at 12 million.

There are several problems with the Maloney bill. First, it would supplement, not replace, the FinCEN CDD rule, duplicating the compliance burden for most firms without any additional benefit. Financial institutions, some of which support this legislation, should worry that it is no guarantee that their own reporting burden will diminish. Second, the bill creates major new compliance costs for a very large number of firms, the vast majority of which have no intent to engage in criminal activity. Third, the bill would not apply to partnerships and trusts, allowing wrongdoers – who are typically acutely aware of legislative loopholes – to potentially escape its reach.

Finally, the information that Maloney and proponents of similar legislation want FinCEN to have is, for the most part, already in the hands of the Internal Revenue Service, the US tax collection agency. Thus, even conceding the claim that beneficial ownership data is crucial for the effective prosecution of illicit financial activity, there is no reason to place the onus of collecting this information on private firms. Government agencies should work together to make appropriate use of the information they have. The IRS already shares sensitive information for specific purposes.

Since 2016, the United Kingdom has required companies to report their ultimate owners – called Persons with Significant Control (PSC) – and made the information accessible to the general public. The EU’s fifth anti-money-laundering directive, a revision of the 1990 law which EU countries must implement by 2020, equally contemplates a public register for EU-domiciled corporations.

Public access to information suggests transparency, which may explain why most people readily accept the public release of beneficial ownership information as an unambiguously good thing. Yet it is hard to justify making sensitive details about the ultimate ownership of firms available to all, without restrictions. The ostensible goal of ownership registers is to allow government authorities to collect taxes and enforce the law. Giving them, not everybody, access to this information is sufficient to achieve this objective.

The UK government’s first regulatory impact assessment on the issue, published in 2002, claimed that a public register would enlist “civil recovery efforts” and “make use of private sector resources”. But it is the job of law enforcement to fight against crime. Outsourcing this task to the private sector does not reduce costs but merely moves them out of the government balance sheet. There are also troubling privacy implications from giving activist groups, who may have an agenda quite different from that of policymakers, access to the ownership data of perfectly law-abiding firms.

Moreover, the public availability of beneficial ownership data may be counterproductive, encouraging companies to underreport or misreport their ultimate owners out of fear that this information might be misused by special interest groups. Preliminary reports on the experience of the UK PSC register suggest that this is a widespread phenomenon, with 3,000 companies reporting their ultimate owner as another company. In addition, there are many data-entry mistakes. Finally, because companies must self-report, there is a risk that law-abiding firms carry the burden of compliance, while law-breaking entities simply avoid the register.

In response to the limited effectiveness of national public beneficial ownership registers, activist organisations are pushing for all countries to adopt them, hoping that a global reporting mandate will be impossible to escape. Britain has been at the forefront of these efforts. Last year, the British government announced it will force its Overseas Territories – which include the Cayman Islands, British Virgin Islands and Bermuda – to have public registers by 2023. Some British MPs want similar requirements for the Crown Dependencies – Jersey, Guernsey and the Isle of Man.

This major intervention is rightly opposed by offshore jurisdictions. There are no obvious benefits to a public register – indeed, the multi-country Financial Action Task Force (FATF), an expert body on global financial crime, does not include a public register in its list of recommendations to member countries. The push appears to be an attempt to reduce offshore competition by publicly shaming those who own entities there, however legitimately and legally.

There is an irony in American and British concerns for transparency from offshore jurisdictions: A 2014 investigation into shell company incorporation found ‘tax havens’ like the Bahamas, the Cayman Islands and Jersey to be much more compliant with FATF standards than America, Canada and the UK. Calling for offshore centres to enact public registers is a clever public relations exercise, but its relationship to transparency and the effective prosecution of financial crime is nebulous.

Beneficial ownership information can be useful for law enforcement. Its collection may even pose little additional compliance burden, if government authorities make efficient use of the data they already have. But beneficial ownership registers, as currently applied in Britain, soon to be applied in the EU and many offshore jurisdictions (against their will), and as proposed to the United States Congress, will involve very significant costs to firms, financial institutions, and privacy protections – for dubious benefit.

Diego Zuluaga is a policy analyst at the Cato Institute’s Center for Monetary and Financial Alternatives.

QuadrigaCX – Blockchain and Bankruptcy

In this article, we try to draw some lessons from the collapse of QuadrigaCX to help develop a more robust Blockchain industry in the Cayman Islands.

Quadriga filed for court protection from its creditors on Jan. 31, 2019, following the unexpected death of its CEO and founder Gerald Cotten, on Dec. 9, 2018. The filing has resulted in speculation that the death may have been a hoax, that significant cryptocurrency or the means to access it have been lost, that Quadriga’s trading may have been inflated, as well as creditor’s claims in excess of CA$260 million (US$ 195 million) and further damage to the fledgling Blockchain industry.

According to Canadian court filings, 0984750 B.C. Ltd was a Canadian company that did business as QuadrigaCX or Quadriga Coin Exchange (Quadriga), operating an online cryptocurrency exchange platform in Canada. Quadriga was founded by Gerald Cotten and launched on Boxing Day in 2013. In November 2018, Quadriga estimated it processed between 60% to 90% of the volume of digital currency exchange transactions in Canada.

Like many exchanges, Quadriga not only allowed users to buy and sell various cryptocurrencies on the QCX Platform, but also to store cryptocurrencies and deposit traditional currency in anticipation of purchase orders. Quadriga experienced difficulty in procuring traditional bank accounts with Canadian banks and was reliant upon the use of third-party payment processors to receive and return traditional currency.

Quadriga then maintained a series of ‘hot’ wallets – cryptocurrency wallets that are connected to the internet to facilitate immediate transactions – and ‘cold’ wallets that were offline and stored physically to avoid hacking.

The crypto boom in 2017 led to a significant increase in trading amid speculation in the bull run on bitcoin, which grew from US$975 in January 2017 to US$19,000 by the end of the year, and other cryptocurrencies during that year. Many blockchain businesses achieved significant growth during that period which stretch the operational limits of developing businesses and gave rise to unexpected issues.

The influx of fiat currency to Quadriga (to exchange into cryptocurrency) led to Quadriga having to co-ordinate multiple third-party payment providers and multiple wallets. Amid disputes arising in relation to CA$28 million (US$21 million) of fiat currency received from 388 depositors, the Canadian Imperial Bank of Commerce (CIBC) initially froze five accounts linked to Costodian Inc, one of Quadriga’s payment processors, and then successfully applied to the Ontario Superior Court to allow it to pass the funds over to the Accountant of the Superior Court, to then allow the court to identify the proper owners of the money. Given what transpired, these owners may ultimately be the lucky ones.

With other banks also restricting the intake on customer funds for the purpose of purchasing cryptocurrency, it is reported that Quadriga was unable to process all of the fiat currency received, leaving Quadriga unable to process user withdrawals with fiat currency on a timely basis. It is claimed that Cotten used personal money to fund some user withdrawals, but that would only have led to an inevitable commingling of assets.

Then, on Dec. 9, 2018, Cotten died unexpectedly, from complications related to Crohn’s disease, whilst travelling in India. At the time of his death, Cotten was the sole director of Quadriga. In 2015, Quadriga’s parent had been planning to go public but in 2016 all of the directors other than Cotton resigned and the British Columbia Securities Commission issued a cease-trade order. The boom of 2017 was therefore managed primarily by Cotton, who reportedly conducted many of Quadriga’s operations from his home.

Following his death, it took the company almost two months to elect new directors and the employees were not able to access all of Quadriga’s cold wallets. Suffering a significant liquidity crisis, on Jan. 31, 2019, Quadriga applied to the Nova Scotia Supreme Court for a moratorium on proceedings to stop a free-for-all grab for assets to allow it to propose a plan of action to its creditors. On Feb. 5, 2019, the Supreme Court appointed Ernst & Young Inc (Canada) as monitors pursuant to the Canadian Companies’ Creditors Arrangement Act.
Concerns about potential fraud

Prior to the appointment of the monitors, the issues surrounding Quadriga had resulted in an obvious liquidity crisis. However, court filings leading to the appointment of the monitor reveal that traditional currency had also been lost, either temporarily or permanently. It was also reported that the private keys to various of Quadriga’s hot and cold wallets were known only to Cotten, and therefore no longer capable of accessing. If a wallet’s private keys are lost, they can no longer be accessed and the funds stored on them are essentially lost. The claim that private keys are lost is a plausible (if negligent) explanation for the loss of assets and liquidity issues. However, those Quadriga keys that were not misplaced are leading to wallets with lower balances than they should be.

One of the significant benefits of cryptocurrency is the ability to trace transactions through the public ledger. Whilst the monitors continue in their role, professional and amateur sleuths are poring over the public ledger, tracing transactions involving Quadriga and highlighting evidence that Quadriga was engaging potentially questionable business practices, including back-to-back transactions on other exchanges, rather than accessing wallet storage even when Cotten was alive, to satisfy customer withdrawal requests.

This, together with revelations of apparently inadvertent transfers of significant sums into inaccessible cold wallets has fuelled the conspiracy theories that Cotten’s death was faked as he could no longer continue to maintain his scheme with the sudden collapse of crypto-prices at the end of 2018. That was not helped by the revelation that Cotten updated his will shortly before his death. The monitors have now, as of April 1, recommended that the bankruptcy transition to proceedings under the Canadian Bankruptcy and Insolvency Act which would allow for a bankruptcy trustee to have investigatory powers, in addition to the ability to sell assets and commence any appropriate legal proceedings.

Could, and how would, this happen in Cayman?

There is not yet an operational crypto-currency exchange in the Cayman Islands. The development of a regulatory sandbox may allow further businesses to develop here, including potential exchanges. However, many of the issues arising with Quadriga are common with custodians and analogies can be found with recent cases such as the liquidation of Caledonian Bank and the provisional liquidations of Abraaj Investment Management Ltd (Abraaj Manager) and Abraaj Holdings (Abraaj Holdings) in the Cayman Islands.

In the Cayman Islands we reserve the term ‘bankruptcy’ for individuals and use ‘insolvency’ for corporate entities, in contrast to Canada and the United States where bankruptcy is used for all of those processes which involve a debtor who cannot, or may not be able to, pay all their creditors.

‘Insolvency’ in Cayman is defined on a pure cash-flow basis – whether a corporate vehicle can pay its creditors as they fall due, rather than the balance sheet basis, which looks at the value of assets on a company’s books versus its liabilities. Accordingly, a company in Cayman with high value assets cannot stave off an insolvency process simply by pointing at accumulated assets but must have adequate measures in place to be able to pay its creditors as and when necessary. If not, then the company may be placed into liquidation by the court, with its estate being administered by neutral, court appointed liquidators.

Ignoring allegations of fraud, which will always inevitably result in losses to creditors, Quadriga’s liquidity issues appear to have been generated by classic failures in corporate governance – focusing too much control on one key man, inadequate back-ups for accessing cold wallets, lack of oversight and management of transactions involving all of the wallets, and insufficient provision in place to access liquidity when issues arose with payment providers. These would have been exacerbated by the extreme volatility of the market in which Quadriga was operating. Adequate contractual arrangements may have enabled the board to stave off pressing demands for payment but invoking a bankruptcy/insolvency process in a situation like Quadriga can ultimately lead to a preservation of greater value for all stakeholders. In a case like Quadriga’s the company may consider that its liquidity issues are not inevitably terminal, and that the business may recover, if given time to restructure its affairs and find those missing cold wallets (for example) – or allow potential fraud and misconduct to be investigated.

In the Cayman Islands, that process would involve the entity, or a ‘friendly’ creditor petitioning the court for an order that the company be wound up and official liquidators be appointed in place of its board. Whilst it may seem perverse that the first step in ‘rescuing itself’ may be to seek its own liquidation, this invokes a collective remedy, designed to prevent the fracturing of a company by creditors taking individual action, which would lead to greater costs in duplicating and defending multiple actions. Given it is a collective remedy, there is a rigid process that must be followed to give creditors due notice and protection and therefore further steps must be taken to get immediate assistance.

In Cayman, that process involves the appointment of liquidators on a provisional basis (provisional liquidators) and the imposition by the Court of a moratorium on creditor action, to allow the company to formulate and present a compromise to its creditors. The appointment of provisional liquidators is a flexible remedy and they can be given powers to work in conjunction with current management to explore and resolve financial issues.

Alternatively, provisional liquidators may be appointed at the request of creditors or shareholders to prevent further dissipation of assets or mismanagement – taking control, or joint sig rights of the private keys at an earlier stage may prevent further deterioration or loss of valuable remaining assets.

When appointed, therefore, provisional liquidators will look to secure and preserve the assets of a company. When looking at Quadriga’s assets, a distinction has to be drawn between those assets which it holds on trust for the users of its exchange, those assets in which property had passed to Quadriga and those assets its holds in its own right. Liquidation does not alter property rights and so to the extent that assets on trust can be identified they must be returned.

The distributed ledger, in theory, provides an ideal audit trail for tracing and verifying trust claims as cryptocurrency should not be capable of being mixed in a way that it loses its identity. This should provide some hope to Quadriga’s customer. In the recent freezes by Binance of funds stolen by hackers from Cryptopia customers were identified and alerted.

However, other common law rules or contractual triggers may lead to property in the currency being lost and to the extent that they have been mixed or misappropriated, the trust claim evaporates into an unsecured creditor claim that relies on the liquidators finding value in realising other assets of the estate.

The liquidation of Caledonian Bank in Cayman involved a substantial Cayman bank that was forced into liquidation as a result of regulatory issues in the United States (for which the SEC was later significantly criticised) with partners of Ernst & Young (also involved in Quadriga) appointed as liquidators. This led to substantial disputes about assets held on trust and the return of those to bank depositors outside of the ordinary context of liquidation. However, the liquidity crisis and inability to immediately locate crypto and traditional currency, suggests that unlike Caledonian, in which the majority of depositors ended up getting repaid most of the monies they were owed, many who think their assets were safely held on trust will be left reliant upon the liquidators to track down or take action to recover missing assets. If assets are returned to the liquidators, they may be traceable by specific customers. But being able to trace a property right into a wallet that is no longer accessible will provide scant comfort for customers and they may then be left with unsecured claims against the estate.

After the ring-fencing and return of trust assets, a situation like Quadriga could be analogous to the liquidation of the Abraaj Manager because in theory its primary value, other than outstanding commissions payable, is represented in its trading platform. Abraaj was a private equity firm operating across six continents with more than $13 billion of assets under management until turmoil in 2018 led to the appointment of provisional liquidators. Most of the assets under management were held through a network of investment vehicles, meaning that Abraaj Manager’s true value in the investment management platform through which those vehicles operated, but to which the investments were not tied. Abraaj Manager has been in provisional liquidation since mid-2018, seeking to market the investment management platform without the stigma of a full liquidation process. The QCX Platform, with its accumulated intellectual property and client base could, if purchased by a new company that took pains to correct the issues that led the current disaster, be sold for value that would see some return to those customers who have lost assets. A similar plan is being mooted by Brock Pierce, who claims he wants to rehabilitate Mt. Gox and effect a return to the victims of the Mt. Gox collapse by giving creditors a stake in a new platform. While a liquidator in the Cayman Islands could undergo a form of restructuring to allow for equity in the platform to be returned to creditors, the more usual practice is to auction the platform to a willing bidder and distribute the consideration to the creditors. Equity and rehabilitation (or restructuring as we would call it) provides potential upside return to those who lost out, but a sale and distribution provides an opportunity to close off losses and seek new opportunities.

There is clear utility in cryptocurrency and the markets will continue to develop until they are stabilised either by regulation or commercial market practices. In the absence of regulation, those who continue to invest in and utilise cryptocurrencies would be wise to follow some prudent strategies to ensure those exchanges with the best practices become the trusted players in the market and do not fall victim to another Quadriga or Mt. Gox: Conduct due diligence (initial and ongoing) on the exchange and its backers to ensure that sensible best practices are being used; diversify risk across various exchanges; seek to use non-custodial exchanges which split the exchange and custodian risk; and avoid depositing currency on exchanges for longer than necessary for a trade.

Cayman avoids EU tax blacklisting

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The European Union has not added the Cayman Islands to an expanded EU tax blacklist, but the council of EU finance ministers said in March that Cayman will have to amend its legislation by the end of this year.

The EU governments added 10 new jurisdictions to the tax blacklist, including Aruba, Barbados, Belize, Bermuda, Fiji, the Marshall Islands, Oman, the United Arab Emirates, Vanuatu and Dominica.

The Cayman Islands government last year passed a new economic substance law to fulfill commitments made to the EU in 2017 in order to avoid being classed as uncooperative in tax matters. The new law requires certain Cayman companies that are active in defined business areas to pass an economic substance test by demonstrating sufficient economic activity on island, in terms of staff, office space and expenditure.

The EU is targeting Cayman and other offshore financial centres for maintaining tax regimes that facilitate offshore structures which attract profits without requiring real economic activity locally.

The EU Council said Cayman, the Bahamas and the British Virgin Islands also committed to addressing the concerns relating to economic substance in the area of collective investment funds.

While the three jurisdictions had engaged in a positive dialogue with the EU Code of Conduct Group on Business Taxation and have remained cooperative, the EU Council said, they will “require further technical guidance”.

Cayman and the other offshore centres will have until the end of 2019 to adapt their legislation. But the EU noted that the deadline may be reviewed depending on the technical guidance that will be agreed by the Code of Conduct Group and the ongoing dialogue with the jurisdictions concerned.

The EU first referred to collective investment vehicles in a scoping paper in June 2018 but mentioned them in the context of “reduced substance” requirements similar to equity holding companies.

The substance test would include fund managers, the scoping paper said, as this is a mobile activity within the scope. “However, collective investment funds (CIVs) are of a different nature, except in rare circumstances where the manager and the CIV form one legal entity. Therefore, the usual substance requirements cannot automatically be applied to CIVs. Thus, and in part similar to pure equity holding companies, reduced substantial activities requirements adapted to CIVs should apply requirements in this regard can be paralleled with EU legislation on investment funds, in particular Directive 2011/61/EU on Alternative Investment Fund Managers,” the paper noted.

However, the EU then based its economic substance process on the global standard set by the OECD’s Forum on Harmful Tax Practices, which does not consider funds as an economic substance issue.

The Cayman Islands government responded to the EU Council’s findings by saying that the EU has acknowledged that further work will be needed to define acceptable requirements for collective investment vehicles (CIVs) or funds.

“While the government has committed to continuing its engagement and dialogue with the EU on this issue, it should be borne in mind that the global standard requiring economic substance for relevant financial and corporate entities, set by the OECD’s Forum on Harmful Tax Practices, does not include CIVs,” the government said in a statement. “As such, Cayman’s legislation is based on the global standards, and we will continue to adhere to global standards with regard to economic substance requirements for relevant entities.”
Overall, the Code of Conduct Group’s latest assessment of Cayman’s tax regime in early 2019 concluded: “Leaving aside the issue of collective investment funds, the Cayman Islands have implemented their commitment to introduce substance requirements.”

The addition of the 10 new jurisdictions to the tax blacklist brings the total number of listed countries to 15, including the previously listed Samoa, Trinidad and Tobago, and three US territories: American Samoa, Guam and the US Virgin Islands.

Citing the minutes of a meeting of EU envoys, news agency Reuters reported in March that Britain had pushed other EU states not to include Bermuda on the list, but then lifted its objections after the European Commission argued that the island had “been playing games” to dodge EU requirements.

According to the document, the Commission noted that Bermuda was supposed to change its tax rules by the end of February, but had added new loopholes in its revised legislation and did not provide a final text by the deadline.

The EU Council said it will also monitor how Bermuda addresses economic substance concerns in the area of collective investment funds by the end of 2019.

Blacklisted countries face restrictions on EU funding and investments from the European Investment Bank. They are likely to be subject to stricter controls on transactions with the EU, but member states have not agreed any uniform sanctions as yet.

Bermuda’s Premier David Burt called the island’s tax blacklisting by the European Union a “setback”, but said that he believes Bermuda is compliant with EU requirements and should be removed at the next EU Council meeting in May.

Bermuda’s Finance Minister Curtis Dickinson ascribed the problems with the EU’s Code of Conduct Group, which evaluates compliance with EU requirements, to “a slight typographical error”.

The omission meant that Bermuda’s submission was incomplete because one provision was not included.

Jersey was not blacklisted but will have to amend its own substance legislation to remedy certain issues that were highlighted after the latest EU blacklist was announced. The required amendments are, however, described as minor.

Money laundering report finds deficiencies in Cayman

The Caribbean Financial Action Task Force has identified a number of shortcomings in its latest evaluation of Cayman’s anti-money laundering framework.

Large money laundering investigations and prosecutions were non-existent and the use of the Financial Reporting Authority to initiate investigations was benign.

In addition, Cayman is not able to fully analyse and understand the risks from money laundering and terrorism financing, the regional affiliate of the global standard setter in anti-money laundering concluded.

The problems partially stem from a national risk assessment, conducted in 2015, that, given Cayman’s role as an international financial centre, did not focus enough on international money laundering and terrorism financing threats.

The evaluation report found that the risk assessment provided a “fair level” of understanding. However, it did not contain an assessment of legal persons or arrangements, nor did it include a sufficient analysis of risks faced by parts of the financial sectors that are not subject to supervision, like lawyers or excluded persons under the Securities and Investment Business Law.

“This has resulted in major deficiencies that have inhibited the jurisdiction’s ability to analyse and understand its risks,” the mutual evaluation report stated.

The high-level summary of the national risk assessment, therefore, did not contain enough information to help develop a comprehensive understanding of all the money laundering and terrorism risks faced by Cayman entities.

The evaluation of Cayman’s anti-money laundering rules and practices was adopted by the CFATF Plenary held in Barbados in November 2018, but only published March 2019. Based on a visit to the Cayman Islands in December 2017, the report analyses the level of Cayman’s compliance with 40 Financial Action Task Force standards to combat money laundering and terrorism financing.

Unlike previous anti-money laundering assessments of Cayman, the fourth round of mutual evaluations focusses on how effective Cayman’s anti-money laundering regime is in practice.
On a positive note, the CFATF assessors detected “a solid and highly professional institutional framework” and found that almost all financial and non-financial representatives they interviewed “displayed a solid understanding of risks and are skilled in applying relevant control measures”.

The CFATF further credited Cayman with “a high level of commitment” to ensuring the anti-money laundering framework is robust and capable of safeguarding the integrity of the jurisdiction’s financial sector.

The cooperation and coordination in the Cayman Islands through the Inter Agency Coordination Committee and the Anti-Money Laundering Steering Group works well, the CFATF said, but it requires further integration and cooperation among law enforcement organisations and the Financial Reporting Authority at the operational level.

Although money laundering offences are investigated and prosecuted, this involved almost exclusively minor domestic predicate offences. Given the shortcomings of national risk assessment, the report noted, this “may not be fully commensurate with [Cayman’s] risk profile”.

While money laundering investigations and prosecutions focus on the identification of assets that could be seized, the results are “modest” and there could be greater use of civil forfeiture.

Despite the resources available to the Royal Cayman Islands Police Service and the Office of the Director of Public Prosecutions, “large and complex financial investigations and prosecutions have not been identified, or pursued, and there is limited focus on stand-alone [money laundering] cases and foreign generated predicate offences”, the report said, adding that there remain fundamental challenges in how the jurisdiction identifies instances of money laundering and terrorism financing for investigation.

The Financial Reporting Authority, which deals with all suspicious activity reports in Cayman, does not have the tools to assist investigative authorities in the identification of cases, the CFATF said. Assessors found that the Financial Reporting Authority has not been able to sufficiently analyse and disclose the reports in time, nor does it have access to wider relevant information.

“The result is that there is a low level of usage of FRA’s disclosures to supplement investigations, and they have been used to a negligible extent to initiate investigations,” the report said.

Some of the legislative changes had not come in time for the assessors to evaluate their effectiveness. For instance, a risk-based supervisory regime for dealers in precious metals and stones, real estate agents and accountants had not been fully implemented.

In addition, the report said, more information should be collected on excluded persons under the Securities Investment Business Law, who must also implement appropriate anti-money laundering policies, procedures and controls.

In terms of transparency, basic information on legal persons is available through the General Registry’s website, but not for legal arrangements and exempted companies, the CFATF said. Challenges also exist in the verification and ongoing maintenance of the ultimate beneficial ownership information in the case of partnerships where the information required does not include the beneficial owner.

The Cayman Islands government responded to the report’s finding by appointing a dedicated task force, made up of the premier, the attorney general, the deputy governor, and the ministers for financial services, commerce and finance, to oversee the implementation of a “comprehensive action plan”.

The task force will coordinate the implementation of the plan and lead the several initiatives with the aim of remedying the identified shortcomings within a year.

“The Cayman Islands remain fully committed to upholding the highest global standards on money laundering and terrorist financing,” Premier Alden McLaughlin said. “Our anti-money laundering and counter-financial terrorism action plan will send a clear signal that we intend to maintain those standards.”

“Work is already underway to improve information gathering, more rigorously monitor financial activity and enhance enforcement including the confiscation of assets,” he added.
After a 12-month observation period, the FATF’s International Cooperation Review Group is set to issue a report on Cayman’s progress.

The OECD position on digital taxation fuels the global corporate tax push


In my previous contribution to the Cayman Financial Review, I discussed the European tax agenda for 2019, focusing on the EU initiatives in respect to the taxation of digital economy, as well as regulatory measures adopted by individual member states. Not only will the introduction of a tax on revenues from digital economic activity likely have a negative impact on competitiveness, it also reflects a highly aggressive approach to changing the regulatory framework of international taxation. Specifically, the advocacy of a digital tax is not rooted on the notion there is a need to (further) curb tax evasion (or avoidance) of Amazon & Co in the spirit of the BEPS reform, but it is rather built on the idea that there is a part of economic activity which currently is untaxed, which is perceived as inherently unjust by advocates of the digital tax.

As explained in the earlier contributions, the notion of untaxed economic activity is based on a fundamentally new concept of the ‘value of things’; i.e., the idea that value primarily depends on how and where people use specific ‘things’. Due to the glaring vagueness of the underlying idea, there is no consensus on how to translate the respective notion into sensible tax policy. In the given situation, I suggested that regulation based on ‘soft law’ was preferable to ‘hard law’ alternatives. While I do stand by my earlier arguments, the developments of last months have spawned doubts about how to best facilitate the adoption of such soft law regulation.

Having been of the opinion that the OECD, at least in the realm of transfer pricing, has generally been doing an adequate job of sustaining a coherent international framework (i.e., notably by maintaining consensus on the arm’s length standard), I advocated to rely on the OECD, in its role standard-setter, for taking the lead on shaping the regulation on digital taxation. I phrased this as follows: “Many neoliberals have a hard time accepting that the OECD can actually play a positive role. It has been said that BEPS is a concerted effort by high tax countries to sustain (and expand) their tax bases. There is certainly merit to this assessment. The pragmatic question in this context, however, seems to be whether accepting the OECD as a facilitator of soft law is the lesser of two … evils.”

The notion of untaxed economic activity is based on a fundamentally new concept of the ‘value of things’.The rationale for advertising a central role for the OECD was that sustaining consensus on the arm’s length standard as a sort of ‘meta regulation’ is sensible. In a nutshell, tax competition is preserved, and taxpayers can trust that national tax authorities will base their assessments on a coherent overarching principle. Looking at the position adopted by the OECD in the context of the public discussion on digital taxation, however, I feel the need to recant.

The OECD discussion draft on digital tax: One big disappointment

While we have seen many public discussion procedures, the public consultation document (PCD) on digital taxation is easily the most disappointing. To be sure, such policy papers are intended to facilitate discussion rather than presenting a thought-out policy proposal. In the case at hand, however, the proposal was ‘framed’ in a highly biased way. Specifically, the OECD failed to differentiate between untaxed digital activities (UDAs) and the earlier BEPS reforms. This is not a technicality, as a sensible discussion about international tax policy requires an accurate distinction of the issue at stake.

BEPS was focused on modifying the international tax regulations, including arm’s length-based transfer pricing, in a way that the resulting profit allocation between related (separate) legal entities would be (more closely) aligned with the commercial reality (or substance).

In other words, BEPS was explicitly targeted at preventing tax avoidance based on tax and transfer pricing structures that were deemed “high[ly] aggressive”; e.g., licensing structures that syphon the profits of multinational enterprises (MNEs) to entities without substance (i.e., zero or few employees) located in low-tax territories.

The “untaxed” digital activities now being discussed by the OECD, however, are not a result of aggressive tax planning by MNEs. The activities discussed are rather how Facebook (and other digital platforms) are being “used” by the consumers (“users”); i.e., the fact that there are Facebook users in a jurisdiction (“market country”) in which there is no legal entity of Facebook, as well as cases in which local entities merely render minor local support activities.

Hence, the proposals on the taxation of the digital economy have a fundamentally different aim compared to BEPS; namely redefining (broadening) the concept of what constitutes (taxable) value creation.

Whether or not the activities of local users, which from the perspective of MNEs are independent third parties (which qua definition are interacting on an arm’s length basis), should be subject to corporate taxation will be discussed in the concluding part of this article.

Such a discussion, however, must not be framed in a context suggesting that respective tax regulation is aimed at reducing tax avoidance. In other words, such proposals cannot be allowed to be promoted under the same ‘umbrella’ as anti-avoidance regulation such as BEPS. Framing the discussion in such a way, grants advocates of respective proposals a cloak of legitimacy they do not deserve. The OECD proposals contained in the public consultation document convey an overly pessimistic evaluation of the effectiveness of BEPS and can be interpreted as suggesting that a substantial erosion of the tax base is attributable to untaxed digital activities. The OECD position reflected in the public consultation document can be summarised by the following citation (PCD, Paragraph 65): “… by failing to acknowledge the reality that businesses can today have an active presence or participation in market countries without a physical presence, or one that would justify a substantial allocation of income to that jurisdiction, the existing international tax rules fail to properly allocate income to the locations in which an enterprise is understood to create value in today’s increasingly digitalised world”.

There are at least two intriguing aspects – and several related questions:

i. Is the current system really failing to allocate income “properly”? Does this notion imply that BEPS was not effective or are we really talking solely about a different concept of “value”?

ii. Now, if there is a physical presence (legal entity) within a market country, i.e., there is a taxable nexus, what is meant by “justify a sufficient allocation of income”? Would that notion not imply that the arm’s length profit allocated to such a local entity is not deemed “sufficient”?

In regard to the first aspect, it is highly unfortunate that the OECD neglected to reconciliate the policy proposals with any empirical analysis of the problem allegedly caused by untaxed digital assets (perceived tax gap?). As emphasised above, the OECD failed to delineate between UDAs and BEPS and, it seems clear, the perceived problem can only be attributed to a new concept of value creation; i.e., a concept of value creation that was alien to the BEPS.

It is the second question, however, that really is worrisome. Here, the OECD is embarking in a direction that is difficult to follow. What the OECD is essentially saying is, that the arm’s length principle (i.e., even when adhering to the post-BEPS interpretation including the DEMPE1 concept and other substantial reforms) is systematically not fit for ensuring an “appropriate” alignment of value creation and profit allocation. This is cause for concern for multiple reasons; first, “appropriate” or “fair” are weasel words that hardly constitute an acceptable basis for designing international tax regulations, and second, the OECD opens the ‘Pandora’s box’ by implying that traditional transfer pricing concepts, which are based on remunerating MNE entities performing low-value added, routine functions with a small but stable profit (e.g., a mark-up on costs), will no longer be considered viable in cases were “marketing intangibles” are assumed to exist.

These marketing intangibles (in simplified terms) can essentially be tied to “digital activity” that takes place in the market country (i.e., the mere existence of Facebook users).

Identifying such marketing intangibles will entitle the market country (the legal entity located there) to participate in the entrepreneurial profits of the MNE; i.e., there will no longer be a “remuneration” for local activities, but rather an allocation of global profits of the MNE (which the OECD much too generously ascribes to the existence of marketing intangibles). Worst of all, the OECD proposes formulary apportionment approaches (the anti-paradigm to the arm’s length principle) to calculate the share of market countries in the entrepreneurial profits.

Without discussing formulary apportionment mechanisms, it should be obvious that the effect will be a substantial shift in tax revenues to market countries, which tend to be large, high-tax economies.

It is hard to say where the OECD proposals on digital tax will ultimately lead. The OECD position, however, can be utilised by market countries as a justification for comparatively radical reforms. Market countries will have an irresistible incentive to emphasise the importance of marketing intangibles. When considering that the OECD, in parallel to the digital tax proposals, is also exploring whether the idea of “global corporate minimum tax” remains relevant, one cannot help but feel that the OECD is acting as an accomplice of a global corporate tax push rather than a principled standard-setter that facilitates consensus on the arm’s length standard as a market-based meta regulation.

Such an unprincipled position also erodes the understanding that jurisdictions are sovereign in setting their tax rates and that low tax rates alone are no cause for ostracism. Re-emphasising this understanding should be rather easy when you are confident in the BEPS reforms being effective. As there is no indication that BEPS will prove futile, I do not comprehend the promotion of hyper-aggressive tax regulation reflected in the public consultation document. Hence, I cannot, in good conscience, sustain my advocacy of a central role for the OECD in the context of digital taxation.

Do we really want to tax digital activity of users?

This is really the question that the OECD should have focused on much more diligently. Despite the critical comments made above, which are attributable to my concern about the erosion on the consensus of the arm’s length principle, there is no denying that the taxation of social media platforms, search engines and online market places is indeed difficult.

I can understand why there is a debate about the ‘nexus’ issue. What I do not understand, however, is that the nexus question is presented by the OECD as being inextricably tied to the question of profit allocation. The introduction of digital permanent establishment could, in my opinion, solve or at least mitigate the nexus issue, while application of the arm’s length principle would be suitable and feasible for profit allocation purposes. Granted, such an approach would be a more evolutionary policy reform, but what is wrong with that? To me, the entire debate is fuelled by the notion that the “users” of social media platforms create substantial value. Looking at individual users, this notion seems absurd. If you upload your kitten pictures on Facebook, that does not entitle you to any remuneration – let alone to share in the residual profits of Facebook.

You get free access to the platform and can set up your account, while in exchange Facebook gets access to your data and can display advertising to you. That is an arm’s length transaction. You do not like the arrangement, you do not set up an account. Some people make the argument that the users do not “understand” the value of their data and that Facebook profits of their ignorance. Really? Aside from the obvious paternalism, where do you draw the line? Will other market transactions also be second guessed for tax purposes?

The notion of value creation underlying the OECD proposals is that once you exceed a critical mass, these collective accounts are suddenly entitled to a share of the residual profits of Facebook and taxable by the respective market country. How such a critical mass can be defined in non-arbitrary terms is beyond me. Obviously, the customer base is of great value for Facebook, but is that not true of all customer bases, including those of traditional business models? I also should be pointed out that Facebook does not get a free ride on the infrastructure of the market country. There are no externalities that would justify compensatory tax. I would rather make the argument that Facebook will facilitate the creation of new (local) business that will in turn be taxable by the market country – i.e., there are positive externalities rather than negative ones.

Whether or not the above assumptions and questions regarding value creation are valid, is of secondary importance. What is important is to acknowledge that there are no foregone conclusions and that we need a serious debate – an opportunity wasted by the OECD. One thing we have to take seriously, however, and a lesson to be learned from BEPS, is that we need to ensure and communicate that the value-adding activities of MNEs; programming, marketing and the creation of all the respective intangibles, are taxed – and that profit allocation and taxation are aligned with the physical location where the activities are actually performed. We need to work towards building trust in utilising the post-BEPS assessment framework and a modern interpretation of the arm’s length principle. Establishing such trust will be the most effective safeguard against radical reforms and an unprincipled global corporate tax push.

To end on a bright note; the EU initiative for a digital tax was rejected in March, as Ireland and the Nordic member states remained opposed. So, at least for Europeans not being subject to the national versions of the digital tax, there is a reprieve that can be utilised to highlight that a digital tax on revenues is neither sensible for curbing tax avoidance nor for promoting any notion of “fairness”. The rejection of the digital tax could also dampen the enthusiasm for other ill-conceived centralisation initiatives such as the Common Consolidated Corporate Tax Base. Let us hope for the best. And, sadly, let us also hope the OECD does not further undertake to reinvigorate the high-tax member states in propagating centralisation and the introduction of a digital tax or a global minimum tax.


1 DEMPE is the concept of development, enhancement, maintenance, protection and exploitation of intangibles, which has resulted in significant changes in how multinational enterprises implement the arm’s length principle for transfer pricing.

A brief history of Argentina’s economy


This article will focus on how Argentina went from a semi-barbaric nation after the War of Emancipation to prodcuing one of the highest GDP per capita in the world, only to steadily decline and become a nation with a 30% poverty rate.

When the Spanish conquistadors arrived at what today is known as Argentina, they did not find anything of interest to them. In contrast to Peru or Mexico, the Pampas lacked gold or silver and the inhabitants were harder to subdue. During the colonial times, the northwestern regions of Argentina were more developed as they provided goods to the Alto Peru, an area rich in gold and silver. Buenos Aires and the Pampas, on the other hand, were little developed with leather production as the main economic activity.

In 1808, Napoleon Bonaparte conquered Spain and appointed his brother as King. By 1810, the locals in Buenos Aires determined that as the Viceroy did not represent the Spanish King anymore and the revolution quickly spread. The Spanish could not offer any resistance as their army presence was insignificant in the region.

After the independence war, each province in the viceroyalty became de facto autonomous and others, such as Uruguay and Paraguay, completely independent. It was a period of civil war and violence with little to no progress at all. Eventually, all the provinces, except Buenos Aires, joined a Confederation. In 1861, after the battle of Pavon, Buenos Aires and the Confederation united. Argentina finally experienced internal peace and constituted a central government. However, the territory remained underdeveloped and barely populated.

The period of 1880 to 1913 was the Golden Age for the newly formed nation. Argentina embraced a series of reforms that developed the nation, promoted immigration and integrated the country into the global economy. The liberal economic policies produced a booming economy, attracting immigrants mainly from Italy and Spain but also from Germany, Great Britain and France.

The main policies where:

  • Trade partnership with Great Britain: Argentina sold grain and livestock on the other hand; Great Britain sold manufactured products.
  • Free capital flow: Companies mainly from Great Britain, and to a lesser extent from France and Germany, started investing in the country, bringing railroads, ports, the telegraph, water, electricity and gas.
  • Access to land: Argentina was vast and scarcely populated; the government promoted the arrival of European immigrants to work the land and generate farming and livestock products for export.

This economic model was based on agricultural exports. By 1888, Argentina was the sixth largest exporter of grains and, by 1907, the third largest, surpassed only by the United States and the Russian Empire. During this period, the size of the government remained small, and public spending never surpassed 9% of GDP. International commerce and in immigration to Argentina were completely free. Inflation was low, paving the road to stability, which in turn attracted more capital and immigrants. Illiteracy decreased from 78% to 35%; the railroad network grew from 4,000 miles to 20,000 miles; the population of the country doubled; and grain exports skyrocketed from 389,000 tons to 5,294,000 tons.

The Golden Age ended with World War I. International commerce was disrupted, greatly affecting an export-oriented economy like Argentina. During this time, some light industry developed in the nation as a result of the inability to import manufactured goods from Europe. During this time, the GDP contracted, unemployment increased and the federal government faced fiscal deficits. On a positive note, Argentina remained neutral during the war even though some of its own merchant ships were sunk by German U-boots.

After the war, Argentina resumed its policy of exporting agrarian goods and importing manufactured products. However, the world had changed. Victorious nations implemented protectionist policies which made trading more expensive and difficult. Nonetheless, the country resumed its economic growth. During the period 1920-1929, GDP per capita in Argentina grew faster than that of the United States (1.75% vs 1.22% per year).

The financial crisis of 1929 had a negative impact on Argentina, albeit not as harmful as World War I. As a direct result of the crisis, President Hipolito Yrigoyen was removed from government by a military coup, starting a 50-year period during which the military got involved in politics, seizing the power of the federal government whenever it disliked a president.

The 1930s continued the industrialisation of the country in order to substitute imports, hampered by restrictions on international trade. During this time also, the notion that the government should play a bigger and more active role in the economy became a mainstream idea.

World War II stopped the flow capital and machinery needed to continue the expansion of inudstry. In 1943, Argentina suffered its second military coup. And yet, the country remained neutral during the conflict. From the coup a prominent figure arose among the young officers.

Juan Domingo Peron was in charge of the department of labour and became well-known among union workers. Eventually, Peron became divisive among the military rulers and was incarcerated in 1945. Five days later, a general protest pressured the government to free Peron and call for elections. He was released that same day and elections were scheduled for 1946.

Peron won the elections in 1946 and government involvement in the economy became main policy. Under Peron, a host of private industries became the property of the federal government, with a special focus on public services (telephone, water, gas, etc.) and transportation (airlines and railroads). Other policies involved the redistribution of wealth from capitalists to workers. and from farmers to industrialists. Peron’s goal was to transform the agriculatural-based economy to an export- an industry-led model.

In this new era, the government, rather than the market, regulated different industries and economic actors. Price controls kept certain products artificially low and with rent controls, salaried workers obtained a 13th monthly salary. Fiscal spending grew from 16% to 29% of GDP. Money supply expanded 250% during the period from 1946 to 1949, which resulted in a level of inflation never seen before in the country. To fund this aggressive plan of government intervention in the economy, Peron created the Argentine Institute for the Promotion of Trade. The government became the only agent that could sell agricultural products in the international markets. Farmers willing to export their production had to sell their products to IAPI, which gave them a price to ‘protect’ the farmers from international price fluctuations. In turn, IAPI sold agricultural products to international markets with a huge profit margin. During the first years, the IAPI generated revenue for the national government.

However, shortly after, the IAPI needed funds to cover losses stemming from a drop in international prices and internal corruption of the institution.

By 1949, the Peronist model was in crisis: agricultural exports decreased due to several harsh droughts that ravaged the country. This resulted in a sharp decrease of exports followed by an acute reduction of imports, which were now fundamental to the new light industry that the Peronist government promoted. Salaries started to grow more slowly than inflation; price controls generated a significant reduction on investments from the private sector that could no longer be replaced by government investment.

By 1952, Peron had been re-elected, but the economic plan needed a change. The economic crisis had lasted as long as the economic boom. The government opened certain industries to private investment, implemented new policies to boost agrarian productivity, froze salaries in an attempt to stop rampant inflation and reduced fiscal spending to control the fiscal deficit.

This plan partially succeeded: inflation decreased, GDP and agricultural exports grew once again. However, by 1955 Peron had lost the support of two powerful Argentinian institutions of that time, the military and the Catholic Church and was consequently thrown out of power by a military coup.

The Peronist regime only lasted 10 years and yet, it was a defining moment for the nation. During this time, economic policy radically shifted and workers unions were empowered.

Peron also granted new rights to the general population and transformed the role of government from one that protects its citizens through internal peace and administration of justice to being the patron and provider of basic needs. This generated an oversized and overstaffed government that, in order to finance its unproductive and expensive social plans, increased taxation to unbearable levels. The new role also led to government being involved in many key industries, like public services and energy, which provided subpar services with an expensive price tag. Over-regulation has since become the norm for most economic activities. The macro-economic distortions established an industrial sector that was unable to produce quality products at a reasonable price. In order to keep the industrial sector alive, the economy had to remain closed to foreign trade and at the same time receive subsidies from the government.

The results have been disastrous: Argentina went from being a prosperous rich nation, the envy of Latin America, with aspirations of becoming a first world country, to nation that cannot feed its 40 million inhabitants, 30% of whom live below the poverty line, while trying to match the economic performance of neighbouring nations like Chile.

The future looks grim for Argentina, even though the country escaped the tyranny of socialist Cristina Fernandez de Kirchner in 2015. President Macri did not carry out any of the reforms needed such as: decreasing the power of workers’ unions, reducing fiscal spending, reforming the pension system and revamping the tax code. His gradual approach to fix the macro-economic imbalances, generated more inflation, more unemployment, higher taxes and further depreciation of the Argentinian peso. In fact, his government expanded fiscal spending on social services, further exacerbating the fiscal deficit. This deficit has been funded by issuing debt in the international markets and expanding the monetary base. The country is now in stagflation and has not grown since 2012.

This year President Macri is running for re-election even though his popularity is low and his lack of courage to do serious reforms is notorious. Cristina Fernández de Kirchner, the former president, wants to run again and if she wins, Argentina will become the next Venezuela. A third candidate is Roberto Lavagna, former minister of economy during the presidencies of Eduardo Duhalde and Nestor Kirchner, whose economic views are Keynesian.

The main reason for Argentina’s decline was the initial shift made by the Peronist regime. After the 1950s, Argentina left its competitive advantage in agriculture by entering an era of industrialisation but was unable to compete with the rest of the world. At the same time, successive governments maintained an active role in the economy, generating distortions in the market that led to hyperinflation, crony capitalism, slow growth, external debt and taxation levels that make suffocate economic activity.

Eastern Caribbean Central Bank launches world’s first central bank-backed digital currency using blockchain technology

The ECCB CBDC pilot is the first of its kind and will involve a securely minted and issued digital version of the Eastern Caribbean dollar, known as the DXCD.

On Feb. 21, 2019, history was made at the Easter Caribbean Central Bank headquarters in Basseterre, St. Kitts and Nevis, when a watershed contract was signed between the ECCB and Barbados-based fintech company Bitt Inc. to conduct a blockchain-issued Central Bank Digital Currency (CBDC) pilot project within the Eastern Caribbean Currency Union.

The ECCB CBDC pilot is the first of its kind and will involve a securely minted and issued digital version of the (Eastern Caribbean) EC dollar, known as the DXCD. The digital EC dollar will be issued by the ECCB, the Monetary Authority for the eight member jurisdictions1 in the Eastern Caribbean, and distributed and used by licensed financial institutions and non-bank financial institutions in the ECCU.

The DXCD will be used for financial transactions between consumers and merchants, including peer-to-peer transactions, all using smart devices. For example, an individual in Anguilla will be able to send DXCD securely from his/her smartphone to a friend in Grenada in seconds – and at no cost to either party.

For the avoidance of any doubt, the digital currency will operate alongside cash. Indeed, the ECCB will soon launch a new family of bank notes using polymer. The objective of this pilot project as stated by the ECCB is to assess the potential efficiency and welfare gains that could be achieved from the introduction of a digital sovereign currency in terms of deeper financial inclusion, economic growth, resilience and competitiveness in the ECCU.

Announcing the project, ECCB Governor Timothy N. J. Antoine emphasised that in contrast to previous CBDC research and experiments, the ECCB is going a step further. “This is not an academic exercise. Not only will the digital EC Dollar be the world’s first digital legal tender currency to be issued by a central bank on blockchain, but this pilot is also a live CBDC deployment with a view to an eventual phased public rollout,” he said. “The pilot is part of the ECCB’s Strategic Plan 2017-2021 which aims to help reduce cash usage within the ECCU by 50%, promote greater financial sector stability, and expedite the growth and development of our member countries. It would be a game-changer for the way we do business.”

The governor detailed the history and reasoning behind the project. “Some of you may be wondering, what precisely, is the motivation of the Eastern Caribbean Central Bank in making this bold move? Simply put, it is shared prosperity for the citizens and residents of the Eastern Caribbean Currency Union.”

“For our region to improve our development prospects and performance, we must expedite our digital transition. To this end, regulators and innovators must work together. This pilot exemplifies such collaboration,” he added.

Bitt first approached the ECCB about two years ago with the idea of a digital EC dollar. As the ECCB continued thinking about transformation of the ECCU, the possibility of a digital fiat currency for the region was an interesting proposition.

At that time, the ECCB was finalising its Strategic Plan and made a decision to test and learn more about this idea through a pilot project. Five months after the launch of its Strategic Plan, the ECCB signed an MoU with Bitt in March 2018 to collaborate on this idea.

The decision of the ECCB to partner with Bitt was based on several considerations, Governor Antoine noted in a press briefing, including, “Our shared values in respect of innovation for development; our vision for a digitally integrated region; Bitt’s capacity: technical and financial; and Bitt’s Caribbean identity: presence and people.” The governor argued, “The transformation of the ECCU necessitates that we make a shift and a leap. We must move from our comfort zone to a challenge zone. But we must not stop there. From there, we must move into a creative zone. In this zone, we are obliged to challenge old assumptions, examine our cultural hang-ups and stretch our minds to embrace new possibilities.”

A cursory analysis of the ECCU confirms that while the exchange rate remains firmly entrenched with a strong backing ratio averaging around 98%, there remains a significant gap between the region’s growth target and actual performance. Last year, the region grew by 2.7%. This year, the ECCB projects growth of 3.1% and next year about 3.5%. While the direction is positive, the current growth trajectory falls well below the ECCB’s target of 5%. Furthermore, unemployment especially among youth is unacceptably high. In some countries, the rate of youth unemployment doubles the national rate of unemployment.

“Without a doubt, we need to elevate the CCU’s growth trajectory. Such elevation, external factors aside, requires a combination of smart reforms and investments in the ECCU,” Governor Antoine said.

To allay any fears that citizens and residents of the ECCU may have, especially those of an older generation, the governor noted that the aim is not to eliminate cash. It is convenient and will continue to play an important role in the economy for the foreseeable future.

However, the ECCB is committed to reduce the region’s use of cash and cheques, he said. Currently, 80% of all payments in the ECCU are effected using cash or cheques. “When we survey our current payments landscape, we cannot help but conclude that payments are still too slow and too expensive. Many of us know only too well, the high costs associated with certain banking services,” the governor said. “Although a full-scale analysis of the social cost of physical cash in the ECCU has not been carried out, it is indisputable that the costs of cash services, inclusive of transporting, storing and securing, are extremely high.”

These high costs are not fully recognised by many businesses and passed on to consumers. And within the informal sector, cash tends to be the dominant payment channel. “This reality means that the actors in the informal sector bear a significant burden of the cost inefficiencies of cash transactions,” Antoine said.

In cautioning against criticism of small businesses, the governor noted, that they too face real constraints. Some are required to pay as much as 3.5%, which reduces and, in some instances, removes the incentive for small businesses to offer their customers electronic options such as credit and debit cards.

It also reduces the ability of these businesses to offer their customers discounts. The ECCB aims to help remove some of these “financial frictions” and the digital EC currency pilot project, with a supporting digital payments and transfers infrastructure, is part of that effort.

IBM Hyperledger Fabric was selected as the blockchain platform because of its security architecture (private permissioned blockchain with strong identity management) and it is open source, which contributes to its security, flexibility and scalability among.

“While one acknowledges, the benefits of Distributed Ledger Technology (shared ledger that allows records/blocks to be added and securely maintained in a way that prevents tampering), the ECCB recognises that network security is a non-negotiable for a central bank digital currency construct,” Antoine said. “In light of this essential requirement, the private blockchain of IBM Hyperledger Fabric affords the ECCB, the ability to control who can access the network, submit and read the ledger of verified transactions, and who can verify them.

Hence, the decision to opt for a private rather than a public blockchain.”

During 2018, over a period of eight months, the ECCB engaged diverse groups of ECCU stakeholders (financial institutions, government institutions, private sector institutions, professional associations, merchants, consumers), as well as regional and international peer central banks, to identify the issues critical to the development of the customer value proposition and the resulting business requirements for the digital EC pilot.

The pilot will be deployed in three member countries based on the interest in participating by licensed financial institutions.

As part of pilot implementation, the ECCB will ramp up its sensitisation and education initiatives to facilitate active public engagement throughout all member countries in 2019.
These exercises will continue to focus on:

  1.  The appropriate treatment of the DXCD by the ECCB to safeguard the confidence in and the international value of the Eastern Caribbean currency.
  2.  The statutory business model as enshrined in Article 4 of the ECCB Agreement Act 1983 which is to: regulate the availability of money and credit; promote and maintain monetary stability; promote credit and exchange conditions and a sound financial structure conducive to the balanced growth and development of the economies of the territories of the participating governments; and actively promote through means consistent with its other objectives the economic development of the territories of the Participating Governments.
  3.  The quantity of DXCD units in circulation will be ultimately controlled by the ECCB, as is currently the case for our physical notes and coins.
  4.  DXCD issuance will be centralised with only the ECCB having the authority to issue and redeem DXCD. This restriction would ensure resilience in system operation and security.
  5.  DXCD units will be the liability of the ECCB as is currently the case with our physical notes and coins.
  6.  DXCD will be issued to licensed bank and non-bank financial institutions on a private permissioned blockchain platform.
  7.  KYC & AML/CFT Compliance.
  8.  DXCD storage and transactions will be conducted via DXCD accounts and wallets which form part of the design architecture.
  9.  Merchants/customers digital wallets will be a part of the digital payment network on the blockchain to facilitate transactions in DXCD.
  10.  The technical design of the DXCD system will prevent any transaction between DXCD wallets from increasing or reducing the overall supply of DXCD units in circulation, thereby eliminating credit and liquidity risks. The DXCD account cannot go into overdraft.

The pilot will be executed in two phases: development and testing, for about 12 months, followed by rollout and implementation in pilot countries for about six months. Throughout the 18-month period of the pilot, there will be education initiatives to facilitate active public engagement throughout all member countries as referenced above.

The pilot will be deployed in three member countries based on the interest in participating in the pilot expressed by licensed financial institutions domiciled in the countries, as well as other criteria, including: institutional capacity, geographic representation (Windwards and Leewards) and supporting technology infrastructure.

It will be conducted under the supervision of the ECCB and within a controlled environment (sandbox-type arrangement) and will have the appropriate safeguards to ensure the stability of the financial and monetary systems, including: Boundary; measures to ensure protection of participants (volunteer); risk management controls; and monitoring and evaluation mechanisms.

The ECCB is receiving technical support from Pinaka Consulting Ltd., the Blockchain technical adviser, with project execution.

Governor Antoine invited non-bank financial institutions, which provide wallet services, telecommunication service providers and other technology companies to join the effort.

Rawdon Adams, CEO of Bitt Inc., said his company’s mission is the practical application of cutting-edge technology to solve persistent financial problems. “It is about a successful currency union building on its impressive record of financial stability, development and integration to deliver a quantum improvement to the lives of all its 630,000 citizens.

Enhancing economic growth and the quality of life of ordinary people is the aim,” he said. The use of a digital currency will reduce the cost of doing business for the ECCB, he added.

This is indeed a bold and interesting development in the region, and it will be interesting to see how it develops over the next few years as the ECCB thrives to improve the lives and economic fortunes of the ECCU.


1 The ECCB was established in October 1983 and is the Monetary Authority for the eight member jurisdictions of the ECCU: Anguilla, Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts and Nevis, St. Lucia and St. Vincent and the Grenadines.

Has corporate management grown more brazen in abusing creditors?

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A pair of recent commentaries on high-profile battles between management and large financial creditors reveals two things: Such battles might be heating up, and opinions continue to differ sharply on what judges should do about this.

On a popular insolvency blog, corporate finance expert and Seton Hall law professor Stephen Lubben critiques a recent decision from the Southern District of New York reigning in an aggressive interpretation of an indenture covenant. The case involved the telecom conglomerate Windstream and the indenture governing some senior unsecured notes. To preserve access to value available to unsecured creditors in the event of any post-default collection efforts, the noteholders extracted a covenant that certain Windstream entities would not alienate any of their assets via sale-and-leaseback. Windstream management and its clever legal advisors devised an end-run around this covenant. They had not promised not to create any new entities within the corporate family, to transfer assets to those new entities, and to allow those new entities to enter into sale-and-leaseback arrangements with those transferred assets (with lease payments to be covered by the original Windstream entities, of course).

While the language of the covenant clearly did not prohibit this precise action, to a major hedge-fund noteholder, this sounded like the kind of sophistry offered by a clever child when caught with his hand in the cookie jar. Crucially, this investor is (in)famous for funding scorched-earth litigation, so the threat of wasted litigation expense on a risky legal challenge was not the deterrent in this case that it often would be. Surprisingly to many, especially Professor Lubben, the court sided with the noteholders, finding that the overly clever Windstream construction of the negative covenant could not reason away a breach of the indenture “as a matter of practical reality” by the “true” parties to the sale-and-leaseback deal, the original Windstream companies. Lubben echoes a longstanding academic critique of judges who rewrite the plain but insufficient language of financial contracts to track the “economic realities” of the case. Were not the major hedge-fund investor and its co-noteholders sufficiently sophisticated to negotiate proper covenant protection if they wanted it? Why grant such entities drafting hindsight that they “were not savvy enough to negotiate in the first place,” Lubben wonders? Lubben’s reaction is a common one among members of the corporate finance academy who emphasise a recurring jurisprudential theme, ‘If you want protection, you’d better contract for it’.

Taking an opposing stance on this issue are prolific UC Hastings law professor Jared Ellias and co-author Robert Stark, a Brown Rudnick partner. In their recent working paper, Ellias and Stark decry a “paradigm shift” in corporate management’s mistreatment of mid-level creditors that they call “control opportunism”. Lamenting the Delaware courts’ recent abrogation of actionable fiduciary duties to creditors, they highlight several horror stories that depict what they view as a sudden rise in brazen manipulation of the soft spots in corporate law and the bankruptcy and restructuring process: A $1.5 billion fraudulent transfer by PetSmart management away from creditors and to shareholders and a recently formed subsidiary; Forest Oil’s technically strained evasion of a change-in-control covenant to subordinate bondholders to $1.65 billion of legacy Sabine Oil & Gas Company secured debt; Cumulus Media’s transformation of a revolving line of credit into a senior secured term loan, subordinating existing unsecured term lenders to $305 million of prohibited, secured, high-interest new debt, now held by previously out-of-the-money bondholders.

Ellias and Stark express their disagreement with the welcome-to-the-jungle sentiment of academics like Professor Lubben. Even powerful institutional creditors, they argue, are not in fact situated to protect themselves adequately with negotiated contractual terms. No one can possibly foresee every clever manipulation of language and evasive maneuver by corporate counsel that might support the type of control opportunism witnessed increasingly today. Some degree of judicial intervention remains necessary, they argue, to smooth the rough patches. And not the type of management- and reorganization-biased judicial intervention so often observed in the US, Ellias and Stark hasten to add. They cite a Southern District of New York bankruptcy judge’s comment that the court’s “highest responsibility is to ensure that our patient [the debtor-company] doesn’t die on the operating table”.

Management manipulation of this very restructuring-friendly philosophy is part of the problem, the authors argue, as illustrated by a series of further case studies Ellias and Stark acknowledge the longstanding academic dispute about whether and to what extent judges should liberally construe covenant language to ensure fairness, or leave creditors to rely on contractual protections “strictly construed”. But their assertion that this is a new era of brazen corporate manipulation brought to mind a not-so-new case featured in a prominent Business Associations law school casebook. In the mid-1990s, Kaiser Aluminum needed to recapitalise to avoid bankruptcy but did not want to dilute the control rights of its primary shareholder. It thus proposed to split all of its existing shares into two new classes of high-vote and low-vote shares, issuing more only of the latter to raise new funds. Existing convertible debt holders seized on an obvious typographical error in the certificate, which seemed to entitle them to receive pre-conversion ‘common stock’ after any conversion of those securities into new classes of ‘common stock’. Ironically, Kaiser’s recapitalisation effort was defeated by a literal capitalisation error, as the Delaware courts accepted the sophistic arguments of the debt holders that the conversion could not take place without respecting their literal entitlement to ‘common stock’. This “hopelessly ambiguous contract” was construed against the drafter, which the court found to be Kaiser. Control opportunism is a weapon not only of management, but also of creditors. Perhaps there is an important role to play for more court intervention, but Kaiser demonstrates that such intervention has to be informed by reason and justice, not partisan doctrinal slogan.

Growing investor concern about Sweden

Economic policy, both fiscal and monetary, is an often-overlooked factor in investment forecasts. The role of government, even when not openly mismanaged, can easily make life more complicated for entrepreneurs and investors. But even worse are the occasions when politicians, through arrogance or ignorance, add insult to injury and aggravate economic downturns.

There are many examples around the world of how politicians have made life difficult for the private sector. Sweden, often seen as a place for profit-making, is now high on the list of countries where government can make a difference for the worse.

While having done some things right, such as creating a relatively favourable tax environment for corporations, the Swedish government also has a track record of clumsy fiscal policy stretching back some 30 years. It is this track record that now causes concern as the country approaches a new recession.

The economic crisis of 1992-94 was aggravated by a badly timed tax reform. On top of that, as the economy began recovering, the social-democrat government launched a destructive fiscal-policy campaign against the budget deficit. Consisting primarily of tax hikes, it almost killed the recovery and permanently lowered the growth potential in the private sector.

That history is about to repeat itself, as several signs point to trouble in the Swedish economy.

On March 29, the OECD reported that it has lowered its GDP growth outlook for Sweden. Their predicted 1.6 percent for 2019 would be a reduction by one third compared to 2018. However, their analysis does not factor in the negative repercussions of a government trying to balance its budget in the midst of a recession.

History and conventional political wisdom in Sweden suggest that government will disregard the consequences of higher taxes on an economy in decline. If higher taxes are combined with cuts in spending that benefit low- and middle-income households – a scenario also supported by previous experience – the macroeconomic deceleration in the OECD outlook could become serious.

However, there are yet more reasons for investors to be on the alert regarding the Swedish economy.

To start with, the Swedish krona is currently at a 15-year high vs. the U.S. dollar, trading at SEK9.26 on April 12. Notably, so far this year it has also fallen against the euro, despite the fact that the euro has weakened against the dollar. This suggests that Sweden is suffering an outflow of foreign capital.

According to, the stock market has remained in the 1550-1650 index bracket for two years, but with added volatility in the past six months. However, household indebtedness in general, and in particular mortgage debt, is potentially a more serious source of problems for the Swedish economy.

Generally, lending to households has slowed down since early 2018, from seven percent annual growth early last year to just over five percent in February 2019. This should be viewed in the context of the country’s high real-estate inflation: according to the Bank for International Settlements, since 2010 – the bottom of the last global recession – Sweden has had the 15th fastest growing housing prices in the world. Only three European countries, Estonia, Latvia and Austria, have seen stronger price increases.

As an early sign of a turn in the debt-growth trend, Statistics Sweden reports that the country’s banks have reduced their balance of outstanding debt by 22.5 percent in one year.

In and of itself, this is not an alarming number. If it correlated with rising interest rates there is an apparent, conventional explanation. However, the Riksbank – the Swedish central bank – has almost entirely refrained from raising interest rates. Its deposit rate, negative for almost five years, rose only marginally late last year from -1.25% to -1%. It was neither sized nor timed to explain the deceleration in household credit.

Another variable that could have explained debt deceleration is household earnings. If households were doing better, they would have chosen to finance more spending upfront, and put down larger down payments on homes. However, that would have shown up in a decline in private debt vs. GDP and household income – and no such trend is visible.

On the contrary, and again according to, the private debt-to-GDP ratio remains high. Having risen sharply ten years ago it has hovered around 270 percent since then. For comparison, the US ratio is around 200% while in Germany the same ratio has declined steadily for at least a decade, now being below 150%.

Specifically, the ratio of household debt to private income has been on a steady rise for a long time in Sweden. It passed 100% in 1997 and exceeded 186% in 2017. There is no sign of it tapering off.

When very low interest rates are combined with a slowdown in new debt and a sustained high debt-to-income ratio, the only explanation is rising concerns among lenders that debtors will not be able to make their payments. Factoring in the unusually strong inflation in Swedish real-estate prices, the possibility of a housing bubble becomes apparent. There is no reason to believe a mortgage-bubble burst is imminent, but what seemed a remote scenario a year ago is now reason for investor caution. In addition to the aforementioned variables, it is also important to note the reversal of the price trend in some key areas, such as Stockholm’s posh downtown. This shift has begun spreading geographically; should price deflation become the prevailing trend in the Swedish housing market, the case for a mortgage bubble will rapidly grow stronger.

A macroeconomic slowdown, as suggested by the OECD, could quickly reinforce a negative real-estate outlook.

What makes the Swedish situation worrisome is the fiscal-policy history of the Swedish government. Without it, the situation in Sweden would be one of normal concern in a recession, in other words not beyond what would generally be advisable for global investors.

However, the experience from the 1990s, and its consequences for Swedish economic policies since then, makes Sweden a particularly difficult place to predict.

There are two reasons to expect badly timed fiscal measures, the first of which is an interesting relationship between household debt and government debt. Before the mid-1990s the two types of debt essentially grew together. Since then, however, as Figure 1 reports the relationship has been reversed, almost perfectly mimicking what the classical Ricardian-equivalence theory predicts. See figure 1

There is an important reason why this relationship shifted in the 1990s, a reason that has strong bearing on what may happen in the Swedish economy in the next year or two. The shift has its origin in the economic downturn of the early ‘90s, when an unprecedented budget-deficit crisis hit the Swedish government. Its cause was trifold:

  • A global recession hit this export-dependent country hard, causing a rapid macroeconomic swing from growth to recession;
  • A supposedly revenue-neutral tax reform had shifted the bulk of the tax burden from personal income to consumption, making tax revenue even more vulnerable to the business cycle;
  • Very expansive welfare-state entitlement programmes, closely tied to the egalitarian principle of benefitting low-income families, led to sharp increases in government spending as unemployment exploded from 2% to more than 15% in a year and a half.

The political reaction to this downturn was at first neutral, with the incumbent centre-right administration under Prime Minister Bildt doing little in terms of anti-deficit policies. Their passive attitude had an alleviating effect on the economy, especially by keeping taxes stable and predictable. However, the large deficit was used by the social-democrat opposition to stir up worries about future debt costs and rising interest rates.

Consequently, after winning the 1994 election the new left-wing government launched an anti-deficit campaign to reduce the deficit. However, this was not done through promoting growth-oriented policies, but through sharp tax increases and unpredictable, disruptive cuts in entitlement programs that benefited low-income families. As I explained in detail in my book Industrial Poverty (Gower, 2014), two thirds of the fiscal value of their anti-deficit policies was accounted for by higher taxes.

Private businesses and households paid the price; household incomes have never quite recovered, despite at times reasonably strong economic growth. This is statistically visible in steadily growing household debt: borrowed money has supplanted growth in disposable income as a means of maintaining standard of living.

It is here that the fiscal-policy experience from the 1990s comes into play. The change in government vs. private debt was due to an institutional change in fiscal policy. As a result of mid-‘90s constitutional reforms, the Swedish parliament has to put its budget balance above all other fiscal-policy concerns. In a conflict between promoting growth and jobs creation on the one hand, and budget balancing on the other, constitutional and statutory features mandate that the parliament prioritize the latter.

As a consequence, government inevitably reinforces a recession, and its effect grows exponentially with its size. If government were small, higher taxes and spending cuts would have negligible effects on the rest of the economy; when government is large, its efforts to balance the budget in a recession have strong negative effects on the private sector.

Government spending and taxes are close to 50% of the Swedish economy. A full 70% of that spending is redistributive, in other words providing cash and in-kind entitlements through the welfare state. Cuts in spending therefore hit hard in income segments of the population where a recession has already made life tougher.

On the tax side, married couples face average income tax rates in the 38-39% bracket.

Together with a value-added tax of 25% on large segments of household spending, as well as other taxes (which, e.g., account for two thirds of gasoline prices), Swedish families already shoulder a heavy burden. Higher taxes to counter a deficit in the government budget would quickly translate into lower consumer spending.

As the icing on the cake, higher taxes could quickly conspire with rising unemployment to trigger mortgage defaults. Keeping in mind the high indebtedness of Swedish households and the aforementioned indicators that their finances are already stretched by their debt obligations, it is fair to say that the difference between a manageable economic downturn and financial calamity is in the hands of the country’s finance minister, Magdalena Andersson.
Again, the outlook on the Swedish economy does not yet merit the term ‘imminent crisis’.

However, anyone looking for reasons to be optimistic may be looking in vain. It is considered a political virtue in Sweden to balance the government budget at all times, and a sign of political ‘manliness’ to do it regardless of the consequences for the rest of the economy.
In short: this is a year of high risk for investors with assets in Sweden.

Learning, prosperity and government: A case example of the National Institutes of Health

Sources: NIH appropriations - Appropriations have been adjusted for inflation using the GDP implicit deflator from the National Income and Product Accounts, US Department of Commerce, Bureau of Economic Analysis. American Life Expectancy – National Vital Statistics Reports, Volume 64, Number 11, Sept. 22, 2015, Table 19. Estimated life expectancy at birth, in years, by race, Hispanic origin, and sex: Death-registration states, 1900-1928, and United States, 1929-2011. Note that early life expectancy data are based on a variety of non-standard state reporting and show larger year-to-year variation as a result. Updated to 2017 with the 2018 Annual Report of the Board of Trustees of the Federal Old-age and Survivors Insurance and Federal Disability Insurance Trust Funds, Table V.A4.

The rise of the university in the late Middle Ages and its gradual separation from rule by church dogma during the Renaissance was one of the important preconditions for our modern prosperity. To the extent it played a role at all in this growth of learning and prosperity, government contributed by slowly relinquishing its control of the academy and the economy. The absence of historical perspective has led to the widespread false belief that somehow the learning foundations of prosperity have their source in government because so many avenues to learning are dominated by government regulation and financing.1

In this brief essay, I will look at one example to show that it is time for a new Renaissance to separate learning from the overweening power of state dogma. Before the early 1960s, the budget for the US National Institutes of Health was relatively small, less than $300 million in constant 2009 dollars. Since then, NIH appropriations have been almost sacrosanct and, despite some recent slowing, have grown at a real rate of almost 5% per annum, about twice as fast as real GDP, and increased their total real resources by a factor of 13.

Yet there is no macro evidence of overall positive effects on the population from this massive spending. (See Figure 1: Trends in National Institutes of Health Spending and Life Expectancy.) Prior to 1960, life expectancy increased at a rate of 0.37 years per year, but after 1960 it grew by less than half that, 0.17 years per year. It is remarkable that the sharp increase in government spending on health research was accompanied by a sharp slowing in longevity improvement. See figure 1

Sources: NIH appropriations – Appropriations have been adjusted for inflation using the GDP implicit deflator from the National Income and Product Accounts, US Department of Commerce, Bureau of Economic Analysis. American Life Expectancy – National Vital Statistics Reports, Volume 64, Number 11, Sept. 22, 2015, Table 19. Estimated life expectancy at birth, in years, by race, Hispanic origin, and sex: Death-registration states, 1900-1928, and United States, 1929-2011. Note that early life expectancy data are based on a variety of non-standard state reporting and show larger year-to-year variation as a result. Updated to 2017 with the 2018 Annual Report of the Board of Trustees of the Federal Old-age and Survivors Insurance and Federal Disability Insurance Trust Funds, Table V.A4.

Without any significant government spending on health research prior to 1960, human longevity improved spectacularly. Once the government spending became significant and began to increase rapidly, the improvements slowed sharply. There is no systematic evidence that increased government spending on health research actually improved overall health outcomes. Stories about specific discoveries, cures and benefits from government projects are irrelevant because we cannot know whether similar or even better results might not have happened without government. We had 60 years of magnificent results with almost no government intervention. Antibiotics, vaccines, open heart surgery and even artificial hearts were all developed without government and produced big leaps in longevity.

During that 60-year period, physicians, group medical practices, hospitals and pharmaceutical companies made major medical breakthroughs as part of their daily business. Foundations such as the American Cancer Society, American Heart Association and Juvenile Diabetes Research Foundation, privately funded billions of dollars effective research. Private philanthropists from the early days to the more recent Bill and Melinda Gates Foundation have also supported health research.

One might think that the first 60 years showed significant improvement by dealing with the easy low-hanging fruit and, after that, progress would be slower. But the results like open heart surgery that look quick and easy from hindsight did not appear that way at the time.

The research that led to the elimination of the threats from smallpox, tetanus, typhoid, whooping cough, diphtheria and even polio was all funded exclusively by private enterprise and foundations.

It is possible that some theoretical upper limit to human longevity – such as approximately 125 years believed by some biologists – would also slow progress as we approached the limit. But we are a long way from any theoretical limit.

If either the low-hanging-fruit or the upper-limit theory were the explanation for the slowdown, one would expect the change to be gradual as difficulty increased incrementally or the limit was approached gradually. Instead, there was an abrupt shift indicative of some structural discontinuity. The slowdown after 1960 is even more puzzling considering the profound impact from smoking cessation – a behavioural change involving only minor contributions from research.

We might expect some lag between research and effects on life expectancy; so, it is possible that the observed slowdown had its origins in less robust private research some years earlier, thereby justifying government spending to counter it. But that argument would require life expectancy to resume its former faster pace after government’s injection of cash. It failed to do so for more than 57 years.

It would be hard to prove that increased government spending caused the entire slowdown, but government spending most surely did not improve the situation. The slower growth in longevity, however, is likely related to another government intervention. The 1962 Kefauver amendments placed new requirements on FDA approval of new drugs, requiring extensive testing on efficacy in addition the existing requirements for safety. These new regulations quickly slowed the approval of new life-saving drugs substantially.

There are likely some true public health interventions that require government research efforts. For example, diseases like malaria may require public policy to assure the mitigation of disease vectors that are not entirely controllable privately. Creating herd immunity for communicable diseases may also justify some minimal government activity. But even here, government’s spending should not dominate the research, but focus only on its unique role.

While the emotional appeals to end one disease or another or help suffering individuals are powerful, government spending is not usually required. Private-sector funding has several advantages. It will be more likely to focus on the research that is important to people and delivers value. Pharmaceutical and biotech firms will invest in those treatments that are in demand and have a reasonable probability of working. Private charities can raise money more easily for those conditions that are perceived as a threat. Government-funded research is prioritised by political criteria that will keep politicians in power, not those that are most beneficial.

Simply pointing to the putatively positive results from some government-funded research is not enough to justify its existence. The same, or even better, results might not have been obtained in the absence of government funding, but we may never know because when government is spending money on a specific type of research, there will almost invariably be less private spending, hence fewer private results. Economists call this phenomenon “crowding out”.

If government does research on the causes for some disease, private investors are less likely to spend money in the same area of inquiry because the return from that investment will, of necessity, be smaller. The benefit of any private results will be diluted by the government effort. This is not some ‘selfish’ motivation, but perfectly rational economics. Investors will put their money where they can expect a reasonable return. If government has entered the field, their chances for financial success in that field will be diminished, and investors will seek another opportunity. If government funding finds a cause or cure for a disease, that will most likely be because once government money entered the field, others reduced their effort or abandoned it altogether. Government was not smarter than the private investors; it drove them away. There are exceptions, of course, where private investment continues because the opportunity is so large or because they believe that the government approach is inefficient and ineffective.

Aside from the investors’ hesitancy owing to lower returns, there are also strong scientific reasons why government entry will crowd out other research. In most scientific fields, there are usually only a limited number of lines of inquiry that are believed likely for success. If government pre-empts those leading areas for investigation, private researchers will likely look elsewhere.

Research requires a corps of highly trained individuals. At any given point in time, there will be only a limited number of individuals qualified for specific research topics. If government hires a large portion of them, it will crowd out the interested private employers. Of course, if the demand is strong, new qualified people will become available – getting the needed training or upgrading their skills from a related field. That may increase the overall labour supply for the specific specialty, but in the meantime, the government-paid scientists are making progress and getting the results.

In short, a ‘good result’ from government research is not a validation of government’s prowess. It is validation of the scientists’ skills who did the work. The scientists worked for the government because government force compelled taxpayers to fund the work and, thereby, made it financially and scientifically harder, if not impossible, for the private sector to do it instead.

In addition to crowding out others, government will inherently waste vast sums of ‘research’ funds on stupid projects with political patrons. When a private company makes a dumb choice, the investors who voluntarily backed the effort may lose out. But when government stupidity wastes money, it destroys the wealth that it has extracted by force from you and me. This entire space could be filled merely listing stupid NIH projects.

This radical shift 50 some years ago in the way humanity ‘did’ science alarmed President Eisenhower, who had seen the effects up close both as President of the United States and as President of Columbia University. He warned in his Farewell Address in 1961: “The prospect of the domination of the nation’s scholars by the Federal employment, project allocation, and the power of money is ever present – and is gravely to be regarded.”2

At about the same time, the physicist Thomas Kuhn published a stinging critique of the scientific enterprise from the inside.3 He noted that scientific disciplines usually have a reigning paradigm at their core that purportedly explains most of the known aspects of the discipline, such as the standard particle model of particle physics or global warming in climate science. There are two things that have always been true about paradigms. (1) Each will eventually be replaced by a new, or at least radically revised paradigm, and (2) scientists are usually rewarded in their field for supporting, strengthening, and extending the ruling paradigm. As a result, our wisdom grows more slowly and painfully than it needs to.

Our retarded scientific development and the derivative growth in prosperity are products of the social-emotional side of our humanity overriding, at least temporarily and in part, the rational and scientific side that demands data to validate paradigms and rejects those that are not proven with data. Government’s intervention in the enterprise of science adds to the suppression of rationality by forcibly reallocating resources to the inquiries and to the preferred results that are favoured by the politically dominant rather than the scientifically challenging. The currently popular appeal to ‘settled science’ is a canary in the coal mine. The appeal to authority rather than challenge and verification is the instrument of government compulsion and allocation, not the principles of learning.


  1.  For in depth analysis of the general problem of government’s role in scientific research, see Terence Kealey, Sex, Science, & Profits, How People Evolved to Make Money. Vintage Books, London, 2008.Terence Kealey, The Economic Laws of Scientific Research, MacMillan Press, Ltd, London, 1996. He has aided my understanding on this topic, but the NIH example is my own fault.
  2.  President Dwight Eisenhower, “Farewell Radio and Television Address to the American People,” January 17th, 1961,
  3.  Thomas Kuhn, The Structure of Scientific Revolutions, (Chicago, University of Chicago Press, 1962).

A review of the world’s offshore financial centers: Malta


In this third article in a series about the world’s premier offshore financial centers we look at the Mediterranean island of Malta.

In large part due to its favourable tax climate and low tax rates, since the 1970s Malta has developed into a premier offshore financial centre, offering international investors and entrepreneurs a wide range of services including company management, trust and offshore banking services.

The official languages are Maltese and English. Being a former British colony and a common law country, English is widely used in business and government, signs are typically bilingual, many Maltese attended higher education in the UK, and nearly everybody speaks fluent English.

Tax system

Malta’s tax system is especially advantageous for foreign entrepreneurs, investors and wealthy individuals. Malta has no wealth, estate or gift taxes. Even though Maltese citizens who are residents of Malta are subject to personal income taxes on their worldwide income (progressive rates from 0% to 35%), Malta offers a number of beneficial residence schemes to foreigners wishing to relocate. As Malta is a member of the EU and a party to the Schengen treaty, non-EU nationals who become residents of Malta can enjoy visa-free access to the Schengen area. Various tax incentives are available to both corporations and their shareholders upon the distribution of dividends.

Domicile and residence

Malta’s income tax legislation refers to a person’s residence and domicile. The Income Tax Act defines the term ‘residence’ with respect to an individual, as a person who resides in Malta except for temporary absences. Generally, individuals are considered to be resident in Malta if they are physically present for at least 183 days in a calendar year. A corporation is considered to be resident in Malta if its management and control is exercised in Malta.

However, if a company is incorporated in Malta, it is considered to be resident in Malta irrespective of the location of its management and control.

Domicile, however, is not defined by law for the purposes of taxation. In practice, with respect to an individual, a domicile of origin is acquired upon birth and this may be changed with a domicile of choice if it is proven that the person intends to establish his permanent home in that other country. No person may have more than one domicile at the same time.

Persons who are resident and domiciled in Malta are subject to tax on their worldwide income. However, a person who is either resident or domiciled in Malta but not both, is only subject to income tax in Malta if the income arises in Malta or if income arising abroad is remitted to Malta. Lastly, a person who is neither resident nor domiciled in Malta is taxed in Malta only upon income arising in Malta.

Personal income tax

Malta has a progressive income tax with the maximum being 35%. However, due to the domicile and residence rules as mentioned above, in practice this means that foreigners resident in Malta are not subject to income tax in Malta on income arising outside Malta which isn’t remitted to Malta. This includes any foreign sourced capital gains, even when they remit these gains to a Maltese bank account, for example, capital gains made by selling shares.

Under certain conditions, a minimum tax of € 5,000 applies for income not remitted to Malta.

However, if you already pay € 5,000 (or more) in income tax on your salary as the director of your Maltese company, this will not affect you. In addition to this favourable tax climate, special programs also exist.

The (Global) Residence Programme

The (global) residence programme offers a fixed rate of 15% on foreign source income remitted to Malta. Maltese income is subject to the regular rate of 35%. A minimum tax liability of € 15,000 applies. The primary conditions for these schemes are that the individual has regular and sufficient income to support themselves and their family and owns or rents a qualifying property in Malta. A property is considered as “qualifying” when the purchase value is over € 275,000 or the annual lease value is over € 9,600.

The Highly Qualified Persons Programme

A special tax regime to attract highly qualified persons exists for financial services and e-gaming. The programme offers a fixed income tax rate of 15% to individuals. The primary conditions for this scheme are that the individual is not domiciled in Malta and obtains qualifying employment income in Malta of at least €85,016 per year.

The Retirement Programme

Any non-Maltese national who is a national of an EU Member State, EEA Member State or Switzerland can apply for the retirement programme, and consequently qualify for the 15% flat tax rate for Maltese income. Foreign income not received in Malta is not taxed in Malta. The primary conditions for this scheme are that the individual must have a pension income and owns or leases a qualifying property in Malta as mentioned above.

Social insurance and payroll taxes

Social insurance and other contributions are payable on employment income and certain self-employed income. Employers must withhold social security contributions from wages automatically, along with income taxes. Employers and employees must pay social security contributions in Malta on a graduated scale. The rates are up to € 46.53 per week for both employer and employee. Self-employed persons pay a rate up to € 69.79 per week depending on their income.

Corporate income tax

Companies incorporated in Malta under Maltese law are considered domiciled and resident in Malta. These companies are taxable on a worldwide basis. A non-Maltese incorporated company managed and controlled is also resident in Malta and subject to Maltese tax, but only on income arising in Malta and on income received in/remitted to Malta. Companies which are either not resident in Malta or not domiciled in Malta are only subject to tax on any income and certain capital gains arising in Malta and on income arising outside Malta which is remitted to Malta, if any. The nominal corporate income tax rate is a flat 35%, but exemptions and incentives will in many cases reduce the effective rate to 5%, the lowest rate in the EU. This can be combined with the EU’s treaty freedoms and the favorable decisions in tax matters by the European Court of Justice and the Maltese tax treaty network. Malta’s tax system has been deemed to be compliant by the European Commission with EU non-discrimination principles and has gained approval from the OECD.

Corporate income tax incentives and exemptions

Tax refund on distribution of profits

Malta does not levy withholding tax on dividends paid to shareholders. Furthermore Malta offers foreign shareholders tax refunds of 6/7 (30 percentage points) of the corporate income tax paid on distributed profits which have been subject to tax in Malta. This refund scheme thereby reduces the effective corporate income tax rate from 35% to 5% (with the exception for profits derived from real estate or profits subject to a final withholding tax). The refund is 2/3 of Maltese tax paid when the distributed dividend is derived from foreign sourced income that was relieved from double taxation.

Withholding tax on dividends, interest and royalties

No withholding tax is imposed on dividends distributed by Maltese companies (except for distributions of untaxed income to resident persons other than companies). Interest and royalty income related to qualifying intellectual property derived by non-residents is exempt from tax in Malta as long as certain conditions are complied with (e.g., they are not effectively connected to a permanent establishment of the recipient situated in Malta).

Industry and commerce

For industrial development, tax credits are available in respect of qualifying expenditure by companies which conduct business consisting solely of one or more qualifying activities.

These are activities related to manufacturing, information and communication technology, research and development (R&D) and innovation, logistics operations as well as activities carried out by companies licensed under the Malta Freeports Act. Also investment credits are available for wage costs of jobs created.

Aviation and shipping

Income of qualifying shipping organizations is not subject to income tax, however they are subject to an annual tax based on tonnage. Non-resident shipping companies only pay taxes on profits from the transport of passengers, mail, livestock or goods shipped in Malta.

Income from aircrafts used in the international transport of passengers or goods, is considered to be arising outside Malta. Therefore, a resident non-domiciled company will only be taxable in Malta if it remits its income to Malta.

Other incentives

Malta also has various other incentives for access to finance, investment aid, small and medium size business development, enterprise support, employment training and R&D which will only be mentioned here, but not discussed in further detail.

Participation exemption

The Maltese income tax system exempts from tax income and capital gains derived by a company registered in Malta from a participating holding or from the disposal of such holding. Under conditions the participation exemption also applies to branch profits.

In general a holding in another company is considered to be a participating holding if a company holds directly at least 5% of the equity shares of a company whose capital is wholly or partly divided into shares, and such holding confers an entitlement to at least 5% of any two of the following, a) the right to vote, b) profits available for distribution and/or c) assets available for distribution on a winding up.

Additionally, the participation exemption may apply if the shareholding has a minimal purchase value of at least € 1,164,000 and has been held for a continuous period of at least 183 days, or if the holding company has an option to buy the entirety of the outstanding shares of the subsidiary. Furthermore, if the holding company may appoint one or more members of the board, or has the right of first refusal in the case of sale, redemption or cancellation of the outstanding foreign company’s shares or holds a shareholding for the development of its own business and not only as stock for resale purposes, the exemption may also apply.

The exemption is not available in situations where immovable property situated in Malta is directly or indirectly owned by the subsidiary of the Maltese company. Also some anti-abuse rules may apply. If the income where the subsidiary is neither a resident nor incorporated in an EU country, or is subject to foreign tax of less than 15%, or has 50% or more of its income from passive interest and royalties. If the income from the entity has been subject to foreign tax of at least 5% and the investment is not a portfolio investment, the participation exemption should still be available to the Maltese company. Capital gains derived from a participating holding are not subject to the above anti-abuse rules and the Maltese company may claim a participation exemption without having regard to the above.

Value added tax

The standard VAT rate in Malta is 18%, 7% for the hotel and restaurant industry and 5% for certain goods (medicines, services and cultural goods, electricity, etc.).

Wealth tax

Malta has no wealth tax.

Inheritance and gift taxes

Malta has no inheritance or gift taxes.

Immovable property tax

There is no immovable property tax. There is a property transfer tax on the sale of immovable property. It is generally levied at a flat rate of 12% on the transfer value or the selling price, unless the following exception applies.

Capital Gains Tax

Capital gains tax (CGT) is a tax based on profits and other gains made throughout a calendar year. The final taxable amount is added up to the person’s total taxable amount, which would then be subject to a progressive rate of tax of up to 35%. It is available instead of property transfer tax in specific instances. If this specific tax regime is applicable, the taxable amount is the selling price with the deduction of the cost of acquisition an inflation element and several expenses related to the property and its transfer. Some exemptions exist for transfers to spouses and selling and replacing business assets, intercompany transfers and the sale of participations under the participation exemption.

General Anti-Abuse Rule (GAAR)

There is a general anti-abuse tax rule in Malta. Arrangements which have been put into place for the main purpose (or one of the main purposes) of obtaining a tax advantage that defeats the object or purpose of the applicable tax law, and are not genuine having regard to all relevant facts and circumstances are ignored for the tax law. An arrangement (or series of arrangements) is regarded as non-genuine to the extent that it is not put into place for valid commercial reasons which reflect economic reality. Additionally some anti-abuse rules exist for the participation exemption as mentioned above.

Tax treaty network

Malta has conducted agreements for the avoidance of double taxation with 71 countries across the world. These tax treaties serve to protect taxpayers from double taxation by restricting the right to tax of the contracting states.

Wealth and asset management

Malta’s wealth and asset management industry has been quick to catch the sights of esteemed individuals and affluent families. In fact, the industry is among the fastest growing on the island, fostered through well enacted legislation and business-friendly operating environments. This prime industry in Malta has established its stronghold by offering diverse services, ranging from succession planning to philanthropy, estate planning, and corporate structuring, amongst others. Complimenting this, a number of investment vehicles have been established, most notably trusts and foundations, that vary in complexity and cater to different levels of wealth. Malta has become one of the most stable jurisdictions in which to establish trusts, whether inter vivos or testamentary, and foundations, not least because of the level of professional expertise available in the country.

Malta Trusts

The setting up of trusts in Malta is regulated by the Trusts and Trustees Act. By adopting trusts into its legislation, Malta allows for the creation of domestic trusts and the beneficial, yet secure, protection of a person’s wealth and property. The law incorporates the provisions of the Hague Convention on the Law Applicable to Trusts and on their Recognition as ratified.

The Malta Financial Services Authority (MFSA) is the designated authority in charge of the authorization and supervision of trustees. Individuals can plan for future generations and efficiently distribute assets with certainty and security that is guaranteed through a number of annual requirements to which Malta Trusts are subject to, including the drawing up of accounting records and due diligence updates. The law allows for the setting up of a variety of trusts, including fixed interest trusts, discretionary trusts, charitable trusts, protective trusts, and unit trusts. There is no shortage of benefits that come with establishing a trust in Malta – to name a few, the process takes a mere three days and is completely authorised under the EU, it is fully confidential and flexible, and trusts can be set up for 125 years and can easily be re-domiciled to other jurisdictions.

Malta foundations

Malta foundations are efficient vehicles for structuring wealth and for estate planning purposes. Maltese law on Foundations was introduced in April 2008. Under the law, one can set up a private foundation or a purpose foundation – the latter being highly effective vehicles for wealth management and estate planning. As opposed to trusts, foundations have a separate legal personality with its own liabilities and obligations. Malta foundations are an excellent vehicle for asset protection and the creation of different patrimony, in addition to avoiding the splitting of estates. A Malta foundation can be set up either by means of a public deed or else through a last will published in Malta. Founders need to make an endowment of money or property worth at least €1,164.69 to the same foundation. This does not apply to foundations established exclusively for a social purpose or as non-profit making entities in which case the endowment amounts to at least €232.94.

Setting up in Malta

Malta company law

Having a pro-business approach, Malta is home to more than 70,000 foreign companies, with 30% having been registered in the past few years. The procedure for setting up a business in Malta or incorporating a company is fast and straight forward, with the process taking as little as one week. For an additional fee, a company may be registered within just 24 hours. No licences or permits are required, except for businesses operating in the sectors of pharmaceutical, iGaming, financial industry, insurance and medical which have specific regulatory requirements. Malta offers various forms of partnerships and limited liability companies including:

  • Public Limited Liability Company (plc)
  • Private Limited Liability Company (Ltd)
  • En commandite partnership
  • En nom collectif partnership

Businesses may take other forms including that of a sole trader, trusts, and branches of foreign companies. Whilst companies are generally set up with more than one shareholder, there is the possibility to set up a company as a single member company. Various persons or entities may hold shares, including individuals, corporate entities, trusts and foundations.

Alternatively, a trust company authorised by the Malta Financial Services Authority may act as trustee or fiduciary, and may hold shares for the benefit of the beneficiaries. While there are no legal requisites regarding the residence of directors or the company secretary, it is advisable to appoint Malta resident directors as this ensures that the company is managed effectively in Malta.

Fintech and blockchain


Whilst the traditional areas of financial services and capital markets present a realistic and substantial source of FDI for any financial industry, new areas of investment have emerged in recent years.

The merging of the financial services sector and technology has created the Fintech industry, which encompasses a variety of market players. This industry is releasing revolutionary technologies in order to compete with established market players such as retail banks and insurance companies. It includes peer-to-peer lending via crowdfunding platforms, money transfer solutions, virtual currency operators, online securities intermediaries and online wealth management services.

Fintech has gained significant popularity in recent years when cryptocurrencies and blockchain technology (also referred to as distributed ledger technology (DLT)) took centre stage. Malta is at the forefront of innovation, regulation, and facilitation of DLT, being one of the few countries which have sought to regulate this space which remains widely unregulated.
Ground-breaking legislation, dealing with blockchain-based businesses and their service providers, as well as cryptocurrencies and initial coin offerings, was brought into force in November 2018. Malta’s efforts to become a true Blockchain island are bearing tangible fruit, and several industry players, including Binance which is one of the largest cryptocurrency exchanges in the world, have recognised Malta’s prowess in the field and chose to set up shop here.


Malta is known for being a world-class jurisdiction for regulated online betting and gaming operations. The island offers many exciting opportunities for both new market entrants and established operators seeking a well-regulated and tax-friendly environment. The gaming regulatory framework provides wide-ranging incentives aimed at businesses related to remote gaming and licensed by the Malta Gaming Authority.


Infrastructure and maritime policy

Malta is the largest maritime registry in Europe and the 6th largest in the world, offering high service and safety standards and luring clients within Europe and beyond. It is one of the largest registries in Europe for pleasure yachts and superyachts.

The Malta Freeport is the third largest maritime and logistics centre in the Mediterranean region- and a highly prestigious and reputable one at that. Over recent years, the maritime industry in Malta has been largely privatised, with the private sector assuming more of an initiative role and the government focusing more on the regulatory aspect.

Fiscal benefits

Malta’s far-reaching success in the maritime industry is heavily attributed to two main pillars: the excellent reputation of its flag and register, and the possibility of fiscal planning and VAT payment minimisation particularly in the context of private yachts and super-yachts based on their use in the EU – including with regards to leasing. In fact, there is a possibility to reduce VAT down to 5.4% through Maltese financial yacht leasing. Qualifying shipping activities such as ship ownership, operation, and administration, also qualify for certain fiscal tax benefits.

Op-ed on the president’s memorandum on housing reform

With a ‘Memorandum on Housing Finance Reform’, issued by the US president in March, the Trump administration has begun to outline how it will address the status of the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac.

The president’s memorandum directs the Treasury to develop a plan for a housing finance system that roughly replicates what existed before 2008.These two government-backed companies, which dominate the US housing market, have been in a US government conservatorship since September 2008, when they were declared insolvent. During this 10-year period, the central question about their future has been whether they will be released from the conservatorship and restored to their original role in the US housing finance system, or whether their dominance in the housing finance system will gradually be reduced and their position taken over by the private sector.

The president’s memorandum is a major disappointment to those who had hoped that the Trump administration would begin to reduce the government’s role in the US housing finance system. Instead, it appears that the administration is planning to restore the GSEs to their original role in the US housing finance market. This will mean that the taxpayers will remain on the hook for over $7 trillion in mortgage debt today, with likely more in the future.

The best thing to say about the administration’s approach is that it is unlikely to be enacted, but it is troublesome nevertheless because it means US housing policy, through which the government controls one-sixth of the American economy, will remain unresolved at least through the end of President Trump’s first term. Meanwhile, the risks inherent in the GSEs’ policies will continue to increase, leaving the US economy open to another 2008-like financial crisis in the years to come.

The president’s memorandum directs the Treasury to develop a plan for a housing finance system that roughly replicates what existed before 2008. The key elements of that system were government backing for the obligations of the GSEs, together with affordable housing requirements that led the GSEs to engage in and encourage risky mortgage lending.

These elements are included in the president’s memorandum, but their ultimate effects are well-known because of the sad history of the US housing finance system. The president’s memorandum seems to acknowledge these dangers, but suggests that they will be mitigated by better regulation, more capital for the GSEs, and some form of compensation for the US taxpayers who will have to assume the risks of another GSE financial collapse – brought on, as it was in 2008, by the risky lending policies that GSEs will be expected to pursue.

Past experience with these “protections” has shown them to be worthless; Congress, responding to the demands of the housing lobby, will push the GSEs take increased risks, intimidate their regulator, and encourage the GSEs to lower their capital levels. The administration then in office will concur, realising that a strong capital position makes their mortgage loans too expensive for homebuyers. Investors in their debt securities will not be troubled, because they will be relying on the government guarantee and not on the GSEs’ capital position.

It is not as though a better policy was difficult to achieve. With its control over the Federal Housing Finance Agency, the regulator and conservator of the GSEs, the administration could have gradually withdrawn them from the housing finance market through administrative action alone, without consulting Congress.

This would be done by gradually reducing the size of the mortgages the GSEs could purchase and guarantee, opening larger and larger portions of the housing finance market to the private sector. At the moment, only US banks are significant private sector investors in whole mortgages, holding roughly $3 trillion in private mortgage debt. The GSEs hold most of the balance, about $2.4 trillion, through mortgage-backed securities they have issued and the portfolios of mortgage debt and whole mortgages that they still retain. FHA has insured the balance, which were securitised through Ginnie Mae.

As a result, there is little space in the US today for the development of a robust private securitisation market. However, if the GSEs were to be gradually removed from the market, a private securitisation market would be able to develop. Eventually, as the GSEs are withdrawn, most of the market would be managed by the private sector.

The traditional argument against private securitisation is that it could not supply the 30-year fixed rate mortgages that American home buyers want. But this is false. Contrary to the housing lobby’s claims, private lenders and securitisers offer 30-year fixed rate loans at rates competitive with the GSEs, and in some case rates that are even lower.

After the GSEs’ withdrawal, the government’s remaining role would be carried out through a reformed FHA, which would offer mortgage insurance only to lower income first time home buyers who need government assistance and have the credit scores to show that they meet their obligations.

It is difficult to understand why an administration that claims to believe in deregulation and reducing the government’s footprint in the economy would find this policy difficult to conceive and implement. Most of the US economy – food production and distribution, retailing, construction, manufacturing and services – is open to the innovation and competition of the private sector. To this we owe the vigorous economy we have today.

Yet the US housing market, for no discernible reason, is and has been historically controlled by the government to an extent far greater than in any other developed country. The low down-payment and high debt ratios that the GSEs have followed over many years produced a highly volatile market, subject to massive booms and busts, finally culminating in the 2008 financial crisis.

That debacle had disastrous political as well as financial consequences. It resulted in the 2008 election of Barack Obama and the subsequent enactment of the Dodd-Frank Act, which stifled the US economy for the eight years of the Obama administration. Now that the US is finally throwing off the consequences of this period, we are in danger of authorising another housing finance structure that will reproduce the same effects.

Although they remain in a government conservatorship, the GSEs are pursuing the same housing finance policies, low down-payments and high debt-to-income ratios for borrowers, that caused the 2008 debacle. It should not be a surprise, then, that current market data clearly show that housing prices for low- and moderate-income families are increasing at roughly the same rate as they did before the 2008 collapse. This is the inevitable result of the government’s intervention, using the GSEs and the Federal Housing Administration (FHA), to pursue the misconceived idea that low down-payments and high borrower leverage will make homes more affordable.

In reality, the opposite is true. These policies increase credit leverage and drive up home prices. And when these families do buy an overpriced home, with little equity in the transaction, they will again find themselves unable to sustain their ownership when the government-induced boom reverts to the mean and collapses.

During the Trump administration, the Treasury has consistently argued that reform should be achieved through negotiation with Congress, and not through administrative action. This is a prescription for political failure, especially when the House of Representatives is now under the control of the Democrats. Affordable housing, as much as possible, is the sine qua non of the Democrats’ caucus and of House Financial Services Chair Maxine Waters. It is unlikely that they will settle for less before the 2020 election.

Another stab at affordable housing will be a nonstarter for Republicans, especially in the Senate, who will almost certainly oppose a government guarantee that requires the taxpayers once again to bear the resulting losses of the GSEs. They are unlikely to be fooled again by promises of adequate compensation for this risk or better regulation to prevent failure. With assets equal to the nation’s three largest banks combined, the GSEs are too big to fail, and will always be saved. The result: legislative stalemate.

Thus, the most serious problem is that, at the end of President Trump’s first term, the opportunity to substantially privatize one-sixth of the US economy will have been squandered, and policies will remain in place that will lead ultimately to another housing market bust – all to be blamed, for good reason, on President Trump.

Peter J. Wallison is a senior fellow at AEI and co-director of its programme on financial market deregulation. His most recent book is ‘Judicial Fortitude: the Last Chance to Rein in the Administrative State’.

Are Brexit fears exaggerated?

Scissors cutting UK and Euro flags that are currently joined together

This year, over 1 million people from across the UK marched to central London to demand a second vote on whether the UK should leave the EU. That is a drastic shift from just three years earlier, when over half of all UK voters (17 million people) voted in favour of the United Kingdom leaving the European Union in what became known as the Brexit referendum.

Millions of people have also signed an online petition calling for a Brexit referendum do-over since the original vote.

But what led to Brexit in the first place was public discontent with policy decisions coming out of Brussels. The 2016 vote signalled a desire on the part of UK residents to have more autonomy over their country’s governance and finances.

According to economic theory, had a pro-EU government sufficiently compensated (represented) the policy preferences of the 17 million individuals from the UK who voted to leave the EU, the UK majority may have opted to stay in the EU. Years of EU membership may have created winners and losers, and many Brits are hoping that Brexit could restore the balance.

On one hand, if a political jurisdiction is too large, a smaller jurisdiction can improve the welfare of those whose policy preferences differ greatly from the law of the land. On the other hand, the average cost of government increases, as a jurisdiction gets smaller. The efficient size of nations optimizes this trade-off.

Brexit is far from an isolated event. National borders are forever changing and while some political jurisdictions are created, others are being dissolved. Economists Alberto Alesina and Enrico Spolaore claim that political separatism could be a good thing. In their book ‘The Size of Nations’, they argue that political separatism is the result of more democratisation and more economic integration.

In 2017, the Catalan independence referendum was declared a breach of the Spanish constitution, therefore silencing over 2 million voters (92% of those who voted) who had expressed their desire to see Catalonia become an independent state. In 2014, Scots headed to the polls to decide whether to remain part of the United Kingdom and Northern Ireland or to become an independent sovereign state. The majority rejected Scottish independence with over 2 million voters (55.8% of voters) expressing their satisfaction with the London-based government.

Brexit, Catalonia and Scotland were peaceful and democratic examples of individuals choosing to join or to break away from a central unit of government. Unfortunately, our known history is also full of less democratic examples of new country formation.
It took multiple civil wars for South Sudan to become an independent state in 2011.

Territorial disputes in the Balkan Peninsula eventually led to the formation of the Republic of Kosovo in 2008. The single nation of Serbia and Montenegro, formed after the collapse of Yugoslavia in 1991 also led to two separate independent states in 2006.

Others such as Palau became independent on Oct. 1, 1994, 15 years after it had decided against becoming part of Micronesia due to cultural and linguistic differences. It is clear that the more recent trend towards peaceful, democratic secession movements is far more preferable than the way most borders were redrawn in the past.

Why are the world’s political jurisdictions constantly being redefined?

Country formation and secessions depend on a large and complex mix of factors such as geography, history, ethnicity, ideology, politics and economics. However, Alesina and Spolaore illustrate that a simple story of trade-offs between the benefits of large political jurisdictions and the costs of heterogeneity in a large population can explain the size of nations. In their book, they show that political separatism was caused by widespread democratisation and an increase in global economic integration.

The per capita cost of any non-rival public good decreases with the size of a political jurisdiction. However, since a large population is likely to be less homogenous, policy decisions may be less correlated with the preferences of the average constituent in large political jurisdictions. When policy decisions are not congruent with constituent preferences, these constituents have an incentive to secede.

Geography, linguistic and cultural differences could result in a set of policy outcomes that may benefit a majority but differ greatly from the preferred policy choices of a large number of constituents that are far from the place where most policy decisions are made – the political capital. It is easy to see why geographical, cultural differences and policy preferences may coincide. Individuals similar in ideology and policy preferences have an incentive to form a country together. It is also true that individuals choose to live in regions inhabited by people of similar ethnicity, language, beliefs, ideology, etc.

A recent report published by the Pew Research Center shows a link between geography and the growing partisan divide in US states. Pew data indicate that Republicans prefer to live in rural areas, while Democrats prefer urban living. Sixty-five percent of Republicans say they would rather live in communities where “houses are larger and farther apart” and “schools, stores and restaurants are several miles away”. In contrast, 61% of Democrats said they would prefer to live in a place where the homes are smaller and more densely packed into neighbourhoods, and stores, schools and restaurants are in walking distance. Those preferences line up with the urban-rural divide that showed up in the results of the 2016 presidential election.

This evidence illustrates how geographical location and policy preferences coincide. There are huge costs associated with distance from where policy decisions take place, and unless these constituents are well represented and compensated by the appropriate redistributive scheme, the likelihood of discontent and secession increases. These costs could certainly explain why nations are bound together by geography.

Democratisation leads to secession

The efficient number of countries increases with the costs of distance (preference heterogeneity and geography) and decreases in the cost of government (taxes). This is because the efficient number of nations optimises the trade-off between average taxes and heterogeneity in policy preferences (i.e., the average distance from each government’s policy choices).

The efficient number of countries is not stable. When everyone faces the same tax burden, whether or not they agree with policy decisions, then not everyone achieves the same level of welfare. It would be unfair for those who benefit least from the public good to be taxed at the same level as those who benefit most. Government benefits some more than others, but there have to be counterbalances – a redistribution scheme – to keep those who do not come out on top in the game satisfied, otherwise they will leave. However, the redistribution scheme that restores efficiency is difficult to implement because the scheme must be linked to individual preferences. This is why allowing individuals to vote on whether or not to secede via a democratic majority-rule referendum can lead to an inefficiently high number of more stable countries.

When a democratic referendum is not an option, more economic integration and free trade across borders makes unhappy residents of a large country better off and reduces the incentive to secede. Free trade also increases the welfare of residents in small countries. As a result, in the absence of democratic referenda, higher economic integration is always welfare improving.

Large nations are large economies. Relative to smaller economies, they have access to more human capital, which improves living standards. More economic integration makes breaking up large nations less costly. The benefits of large nations become less important if trade barriers are removed and small nations can freely trade with each other. For that reason, democratisation coupled with economic integration leads to more political separatism. A higher degree of economic integration can cause both the efficient and the stable number of nations to increase.

If higher economic integration makes countries smaller, welfare could decrease if a country is already “too small”. Relative to the efficient country size that maximises welfare, the average cost of public goods will be too high in the more stable, smaller country. Since more economic integration makes countries smaller, average welfare will decrease if a small country breaks up below the efficient size.

On one hand, the smaller size leads to more congruence between policy choices and voters, and greater economic integration increases income. On the other hand, a smaller country faces a higher average cost of government. When a country becomes “too small”, the cost of government can begin to outweigh the benefits of integration resulting in lower welfare.
Political separatism is linked to higher living standards

History largely agrees with economic theory. As the number of absolute monarchies and authoritarian regimes decreased, the number of nations increased. Democratisation and economic freedom that led to the creation of more (smaller) countries are positively linked to higher living standards.

Empirical evidence from a panel of around 100 countries form 1960 to 1990 suggests that economic freedom improves living standards regardless of country size. However, the relationship between political freedom and economic growth is more complex. Some political freedom is good for growth but too much can harm welfare. There exists a growth maximising level of political freedom and once a moderate amount of democracy has been attained, a further expansion can reduce living standards. In contrast to the weak causal effect of democracy on living standards, there is a strong positive influence of the standard of living on a country’s propensity to experience democracy.

Political freedom, economic freedom and Brexit go hand in hand

Although political and economic freedom could lead to countries that are too small and too inefficient, there is enough evidence to suggest that Brexit falls on the right side of history. Large heterogeneity within the EU block has already led to severe economic pain for some of the member countries.

A globally integrated economy means that fears of a decline in economic activity surrounding the break-up may be exaggerated. Globalisation means that the UK should be just fine without Brussels and the one thing that remains certain: a smaller political jurisdiction will lead to better representation for all.

Promoting Cayman

With a focus on promoting the Cayman Islands as a leading jurisdiction for private clients, wealth management, and the administration of trust and estates, the Cayman Islands Branch of the Society of Trusts and Estates Practitioners recently held its second international wealth structuring forum. Over 280 local and international attendees convened at the Kimpton Seafire on Jan. 31 and Feb. 1 to learn more about the sophistication of the jurisdiction and the depth of expertise available within it. As was the case in 2018, the Forum was once again widely recognised as a huge success and was supported by a record crowd of local and international sponsors.


STEP, a global network of professionals who specialise in family inheritance and succession planning, has a significant membership base in the Cayman Islands comprising lawyers, accountants, fiduciaries and other wealth structuring specialists. From that membership base, and via STEP’s global network, delegates from the STEP Cayman branch joined attendees from other jurisdictions including London, New York, Beijing and Texas to take advantage of the extensive networking opportunities among fellow experts from the wealth management industry and to hear and engage with respected speakers with a wide range of experience.

The Forum

The conference retained the same two-day format as the inaugural 2018 Forum, and included speakers addressing a number of interesting topics, including how trustees are responding to the growing demand to hold digital assets, notable developments in trust litigation, a review of the success of Cayman’s introduction of its Foundation Companies Law and the challenges faced by international financial centres, which might well now include the United States of America. Speakers took deep dives into recent case law affecting trustees and beneficiaries alike, including the judgments in important trusts law cases such as Mezhprom v Pugachev and Investec v Glenalla, and explored issues including the confidentiality of trust documentation and the proper litigation of family disputes. A mock court application and wealth structuring tips for PRC families and philanthropists rounded out the agenda.

STEP Cayman also showcased an array of domestic and internationally renowned speakers. These included Tara Rivers, Minister of Financial Services and Home Affairs, who provided an opening address, and keynote speakers Justice of the Grand Court Ian Kawaley and Mary Duke TEP. Highly regarded experts from the UK, Switzerland, China and the US joined speakers from local law firms and on-island trust companies to delve into other hot topics in the trusts and estates arena.

Plans for the future

Given the success of the Forum in 2018 and 2019, and with the immensely positive feedback received from delegates and sponsors at front of mind, planning for the 2020 Forum is already well under way. The Forum’s Steering Committee hopes to present a refreshed and topical agenda to potential delegates in due course, and is committed to not only continuing to present the Cayman Islands as a jurisdiction of choice but to educating branch members and other delegates about innovation, change, and issues of note for trusts and estate practitioners worldwide. Further feedback, and suggestions and contributions from branch members is always welcome.

Promoting Cayman

Thanks to the ongoing efforts by STEP Cayman, and the support of sponsors, the conference continues to be a key component of the international private wealth calendar and the jurisdiction’s wider marketing efforts. Promoting Cayman via the Forum has been a successful endeavour to date, and STEP Cayman continues to work on attracting an even greater range of delegates to the island. It is already anticipated that the delegate numbers for the third year of the Forum will exceed those of 2018 and 2019. The 2020 dates, and initial programme, will be announced in the coming weeks, and potential delegates are encouraged to reserve their space as soon as possible to ensure attendance.

Further information about STEP Cayman is available online at and further enquiries can be directed to
[email protected].

Monetary policy at the edge of QE

The world of economic policy, monetary and fiscal, is the realm of fooling ourselves into believing that, when everything else fails, there is a saviour of last resort, a sort of higher power available to those willing to deploy it for common good. This power, per textbooks on economics, can break recessions, bend deflationary dynamics, and will the laws of social evolution. It is a powerful illusion, capturing the minds of policymakers (from the US President and a score of the 2020 presidential hopefuls, to cohorts of European apparatchiks and parliamentarians), of markets analysts and investors (from hedge funders to cut-throat vulture funds managers), and of academic economists (including those advocating Washington’s flavour-of-the-day Modern Monetary Theory).

This belief is currently at play across the advanced economies, gripped by the long-run crisis of twin secular stagnation: anaemic growth on both the demand and supply sides of private consumption, investment and productivity.

Driven by adverse demographics, falling real impact of technological progress and decades of manipulation of the markets to the will of central planners, the secular stagnation is a structural phenomenon. As such, it renders traditional policy tools, such as increased government spending and money printing, powerless, challenging the very notion of an economic panacea of last resort.

Look no further than the current path of the monetary policy in the advanced economies. At the peak of Quantitative Easing (QE) in the second quarter of 2018, the US Federal Reserve, the European Central Bank and the Bank of Japan, collectively held just below US$15 trillion worth of assets. One year later, after months of synchronised ‘tightening’ by the central banks, cumulative assets held by the same big three monetary authorities are at $14.2 trillion, a drop of just 5% on the peak. In other words, for all the buzz in the markets and the media about quantitative tightening (QT), the central bankers have managed to unwind only five months-worth of QE over the period of twelve months of QT. During the same period, the unweighted average of the key policy rates set by the big three has moved only 25 basis points, from 0.51% in March 2018 to 0.76% a year later.

Put differently, anyone believing that the central bankers’ new monetary ‘normal’ does not involve endless support for low interest rates and virtually unlimited banking and financial markets liquidity is doing exactly what Richard Feynman warned us not to do: fool ourselves.

The news flow from the Western front of battling for monetary normality is also telling us not to buy into the powers of the printing press. In recent months, the Fed effectively paused interest rates hikes, and the markets are now pricing a substantial likelihood of a 25 basis points rate cut for 2019. Just two months ago, the consensus was for a 50 bps hike over the same time, providing for the monetary conditions easing of 75 basis points over the duration of this year alone. The most recent additions to the Fed Governing Board are signalling the end of the fragile attempts at brining the cost of capital in line with historical norms. These changes in the Fed policy positioning are reflected in ever-accelerating calls from financial markets for the Fed to re-engage in a QE 5 programme, with some analysts going as far as suggesting that this time around, the Fed should be buying not only US government bonds, but also corporate bonds and equities.

The same dynamics are evident in the calls for ECB to continue pausing interest rates hikes beyond December 2019. Most recent poll by Reuters found that 51% of Wall Street economists are expecting the first hikes in ECB rates by the end of the third quarter 2020, while 45% expect no rate rises through 2020. Markets analysts are currently expecting the ECB refinancing rate to remain at zero through 2020, against the consensus expectation of at least one rate hike in 2020 just a month ago. For the first time since 2016, analysts’ consensus has shifted toward an expectation that Frankfurt will re-engage its printing press.

More than that, the ECB is also considering a new twist on the already expansionary monetary policy. Per recent reports, the ECB is studying the option of creating a tiered deposit rate system in order to recycle back into the financial system some EUR7 billion in annual interest charges it collects from bank deposits.

The problem with the latest developments is that more than a decade-long experiment with the monetary easing on an unprecedented scale has left the advanced economies in exactly the same predicament as they were at the tail end of the global financial crisis. While economic growth uncertainty remains high, official inflation is running well below central banks’ policy targets, and real productive non-financial investment tracking well below its past historical levels. In other words, monetary policy has not worked, is not working, and is not about to start working.

At the end of 2018, the Fed’s combined holdings of government and private securities amounted to 19.6% of the US GDP, ECB’s balance sheet was at 39.8% of the euro area GDP, and Bank of Japan’s holdings were at 100.6% of the country annual output. Virtually all of this money went to fund government spending and investment, and to beef up the valuations of financial assets. The result is a blowout in private and public and private debt, plus a massive bubble in financial markets.

Meanwhile, US total productivity in the non-farm private sector expanded at an average annual rate of 1.3% over the period of QE, less than half the rate of growth from 2000 to 2007, and 0.9 percentage points below the 1990 to 2000 average, based on the data from the Bureau of Labor Statistics. In the euro area, annual labour productivity growth averaged over 1.14 % over the 1990s, falling to 0.97% in the period 2000 to 2007 and to 0.41% during the QE period, based on ECB data. Productivity growth in terms of GDP per hour worked has followed exactly the same trends, as Chart 1 illustrates.

Despite low unemployment (in part due to collapsed labour force participation rates post-global financial crisis, and lower wage jobs creation in the services sectors over 2010-2016), and booming financial markets, consensus forecasts now indicate high (and rising) probability of a US recession by the end of 2020, and a growing view that a Eurozone recession is becoming increasingly likely in late 2019 or early 2020. Euro area leading growth indicators (from eurocoin to purchasing managers indices) are currently showing significant slowdown in core economic activity across the common currency’s largest economies. Inflation remains stubbornly anchored at around 1%. Thus, in a recent note, Fitch Ratings projected that the ECB will restart asset purchases at the end of 2019.

Investment contribution to GDP growth has virtually collapsed. In the 1990s, net of M&As and shares buybacks, it averaged over 0.68% annually across the advanced economies, based on the data from IMF and Factset. In the 2000s, average contribution from investment to GDP was running at over 0.67 percent. Since the start of the global QE programmes, the same figure through the third quarter of 2018 was below 0.349%. Chart 2 shows the trend.

As illustrated in Chart 3, over the same time horizon, relative price of capital goods – a measure of tangible investment costs – has fallen almost 55%. In simple terms, therefore, cheaper capital is yielding less investment – a scenario that can only be accounted for by the non-financial (and non-monetary) drivers for slower growth and, thus, lower investment opportunities, and lower investment demand.

The truth is: no matter how much we wish for the reality to be different, the idea that monetary policies of the past can be made to work in the age of structurally slower growth is an illusion, a myth we perpetuate for the lack of any alternatives. Come the next crisis, the central banks will not only be out of the proverbial bullets, but their guns will be about as effective as a water pistol at a pub fight.

At the edge of the QE decade, we are left with two lessons worth learning.

The first one is that in the age of the demand- and supply-side secular stagnation, monetary policy, no matter how expansionary (Bank of Japan) or inventive (ECB) or timely (the Fed) holds no promise of a structural recovery. This, in turn, implies that the economy’s leveraging capacity, the effectiveness of debt as a driver for growth, is now smaller than in the past.

Future growth, therefore, will have to come from drivers other than demographics, debt and fiscal or monetary spending. In other words, to continue thriving, the West must return technological and labour productivity growth rates to pre-crisis levels.

The second one is that dealing with secular stagnations will require a painful restructuring of the entire economy. The West needs large scale private investment in productivity growth, not a monetary stimulus-induced M&A and shares buybacks binge. These investments have to be organic – originating from the market participants, and not from the state-sponsored investment funds. This means we need aggressive deployment of new incentives for entrepreneurship and real investment: reduced tax burden on early stage finance, capital gains from equity investments, elimination of asymmetric incentives for debt financing over equity and improved incentives for employee share ownership (as opposed to executive compensation). In addition, it requires improved incentives for human capital investments, such as restructuring of the student loans to reduce the level of financial burden arising at the early stages of professional careers, and full tax deductibility of professional and STEM (Science, Technology, Engineering and Maths) degrees tuition.

Financial institutions and dishonest assistance

As the quintessential deep-pocket defendant, financial institutions are often a target of litigation when victims of fraud are casting around to seek to recoup their losses. In 2017 and 2018 there have been a series of attempts to make financial institutions liable, in three common law jurisdictions (England, Cayman and Gibraltar), for dishonestly assisting in frauds. This article considers this unusual spate of recent cases, why they are generally unsuccessful, and the key lessons from the case law for financial institutions and their advisers.

The three relevant frauds were:

(1) In the English case of Singularis v. Daiwa [2018] EWCA Civ 84, as the well-known frauds involving AHAB and the Saad group were being exposed by the credit crunch, the man at the centre of those allegations, Maan Al-Sanea, defrauded Cayman company Singularis of US$204 million, by instructing (as one of its directors and its sole beneficial owner), its brokerage, Daiwa, to pay Singularis’ funds to other companies in the Saad Group, in eight transfers over a period of six weeks. One of the transfers alone was for the sum of US$180 million.

(2) In the Cayman case of Ritter v. Butterfield, Grand Court, before Justice Williams on May 29, 2018, a local Cayman director, Mr. Self, had stolen US$875,000 from a captive insurance company’s bank account by forging his co-director’s signature on wire transfers on eight occasions over a period of two years. Mr. Self was subsequently convicted and imprisoned for theft for five years.

(3) In the Gibraltarian cases of Jyske and RBSI (Gibraltar Court of Appeal, Jan. 15 and June 12, 2018), the relevant fraud was that of the partners in a formerly well respected law firm, Marrache & Co. The three brothers who were principals in the firm had conspired to defraud clients by misusing their monies (which ought to have been segregated and held on trust in client accounts in the usual way) by treating those funds as the firm’s funds, or even the brothers’ own personal funds. Total losses as a result of the fraud were estimated to be GBP 28.4 million. The firm was quickly wound up, the three brothers were made bankrupt, and were each convicted and sentenced for terms of imprisonment of between 8 and 11 years.

In each case, the victims of the fraud or their representatives claimed that employees of financial institutions used by the company or partnership were sufficiently aware of a range of suspicious features of the various transactions such that they were acting dishonestly, and through them the financial institution was (vicariously) liable to account to the victims as a constructive trustee for this dishonest assistance.

Although, as is well known, that cause of action requires three elements to be satisfied: (1) breach of a fiduciary obligation or trust by the fraudster (2) assistance of the fraudster by the defendant and (3) that the assistance was dishonest in the way explained and developed in the leading cases of Tan, Twinsectra and Barlow Clowes; in reality, the battleground in all of these cases is whether anyone at the relevant financial institution had acted dishonestly.

In each of the four recent cases, the dishonesty claim ultimately failed.

(1) In Singularis, two employees of Daiwa were said to be dishonest, Mr. Metcalfe and Mr. Hudson, working in the brokerage’s credit risk and compliance departments respectively. It was said they had approved payments dishonestly by ignoring the many red flags on the account at the time, and without proper enquiry. The red flags included: a freezing order against Mr. Al-Sanea, the removal of the Saad Group’s credit ratings by the leading agencies, US$80 million having been received into the account days after the freezing order with no explanation, as well as deeply suspect documentation produced like “a rabbit out of a magician’s hat”. There was a suggestion they had dishonestly ignored all this as Singluaris was Daiwa’s most profitable relationship between 2007 and 2009. Despite approving the payments without inquiry in these circumstances, Messrs Metcalfe and Hudson were not held to have been dishonest: Mr. Hudson had not had it explained to him by management what other checks he ought to be performing other than working through his standard AML/terrorist financing and sanctions list queries. As for Mr. Metcalfe, concerns held by management in respect of the Singularis account had not been passed on to him, he was relatively inexperienced, he had no motive to act dishonestly, he reasonably trusted Mr. Al-Sanea and his advisers as honest and reputable people, and he had sought to involve others in the decision to approve the payments, such action being inconsistent with any dishonest intention.

(2) In Ritter, no individual employee of Butterfield was identified as having been dishonest. The implication, however, was that the Bank’s various payment processing staff who had approved each of the eight forged payment transfer requests had all acted dishonestly by ignoring the alleged suspicious nature of the payments, which included what were said to be obviously forged signatures and suspicious payment descriptions. At trial, a further and wider claim was added: that the Bank itself was structurally or systemically dishonest. The Court dismissed the dishonesty claim in its entirety as it had been defectively pleaded by not identifying who was alleged to have been dishonest, and on what particular basis, as well as for not following the strict guidance to pleading such claims set out in the leading case of Lipkin Gorman [1989] 1 WLR 1340 (CA) (dishonesty to be pleaded as the primary not alternative claim, with distinct and separate pleading). This was held to be in breach of basic procedural fairness. Having dismissed the claim on this basis, the Court went on to record that there was no evidence of dishonesty in any event, relying on the principle from Re H [1996] AC 563 (HL), that since dishonesty allegations are more serious, more cogent evidence is required in support to establish them to the civil standard on the balance of probabilities. Specifically, the Court held that there was no reason to doubt the honesty of Mr. Self, who was thought to be a reputable insurance manager; that it was exceptionally rare for there to be fraud between two authorised signatories on an account; that none of the signatures were obvious forgeries once hindsight was stripped out; and that none of the payment descriptions were unusual. The Court accepted evidence from Mr. Skinner, the Bank’s Head of Corporate Banking, reliable as to banking practice, when he said that if he had been asked to approve any of the payments at the time, he would have done so. The context of the approval of the payments was also held to be of importance when assessing whether the Bank’s employees had acted improperly, viz. “where the staff members at the Bank have to process around 20-30 transfers per day for corporate clients and around 8,000 wire transfers per month for clients in all divisions of the Bank … appropriate validation enquiries cannot and do not require a detailed review and cross-reference of each and every transaction.”

(3) In Jyske, it was alleged that the account manager for the accounts of Marrache & Co and its associated companies was dishonest by being sufficiently on notice that the brothers were misusing client funds by paying client monies into the firm’s office account, by transferring sums from the office account to the client account, by ignoring large transfers from the client account to the office account to keep the latter within overdraft limits (putting client accounts into overdraft which were then brought into line by payments from a different client account); and by being aware of payments from client accounts to the Marrache brothers’ personal accounts and credit cards ranging from GBP 5,000 to 350,000. Although Mr. Bishop was held dishonest at first instance by Justice Jack, this was overturned on appeal as the judge had imposed monitoring expectations which went beyond the expert evidence of banking practice (generally to confirm proper authority, and review transfers for AML concerns). It was also held that the bank was entitled to trust a highly rated, respectable firm of lawyers, it being “virtually unthinkable” that a partner of law firm would be misappropriating client funds. The Court again referred to the “practical realities” facing Mr. Bishop in conducting his business (20-30 transfers a day, responsible for more than 250 customers with 300 separate accounts, with the impugned transactions being only 70 over a six-year period). Finally, it was held (1) that Justice Jack at first instance had ignored the “inherent improbability of Mr. Bishop having acted dishonestly, coupled with a complete lack of motive to do so”; and (2) that bank employees are not expected to act as policemen, forensically checking across multiple accounts for suspicious patterns.

(4) In RBSI, seven bank employees were alleged to be dishonest: three relationship managers, three credit managers and the Head of Corporate and Financial Institutions. Justice Jack held at first instance that one relationship manager, Mr. Shaw, had been dishonest as he had actually identified a need to investigate potential cross-firing of cheques and misuse of client funds, and had conducted an investigation which the judge held must have revealed the fraud, notwithstanding Mr. Shaw’s denials. The judge found that the reason Mr. Shaw did not report what he found, was in order not to “open a can of worms” for RBSI, and because he lacked the courage to act as a whistle-blower. On appeal, however, all of these findings were overturned. It was held that the basis upon which Mr. Shaw had been found to be dishonest had not been pleaded; and that the findings that Mr. Shaw had lied about deriving comfort in respect of the Marrache accounts from a previous internal investigation, as well as a meeting with the firm’s accountants, had been made on a demonstrably incorrect factual basis. The Court of Appeal also (1) held that Justice Jack had wrongly identified suspicious features on the account (bunching of payments) which neither of the banking experts had considered material (2) accepted Mr. Shaw’s evidence that he was under no obligation to continually monitor his customers’ accounts for suspicious activity (3) referred to the fact Mr. Shaw trusted the Marrache brothers as a respectable firm of solicitors and (4) held that it was an application of hindsight to say that his investigation should have been conducted more widely. Finally, the Court of Appeal found Justice Jack’s case theory on Mr. Shaw’s motive “surprising and implausible”, as “he had nothing to gain … [but] plenty to lose: his job, his reputation and his career.”

The real principles of importance in these claims are not the precise content or definition of the legal test for dishonesty (the subject of debate in extenso in the leading appellate cases concluding with Barlow Clowes). On any analysis, the most important principles guiding the ultimate results are the legal requirements for (1) proper pleading to give fair warning of the nature of the serious case being made against the employee and the financial institution, without which there will be fundamental procedural unfairness, and (2) suitably cogent evidence to establish such serious allegations against employees in financial institutions, who are in all probability not going to have acted dishonestly.

Well-known exceptional examples of staff at financial institutions actually acting dishonestly are not hard to bring to mind (e.g., Nick Leeson at Barings, Jerome Kerviel at SocGen and Kweku Adoboli at UBS). They invariably involve a combination of a clear personal financial motive and wholesale concealment by the rogue employee, features that were notably absent in the cases discussed above. For a recent decision in which the English Courts upheld a dishonest assistance claim against a financial institution, see Group Seven v Notable Services LLP [2019] EWCA Civ 614; [2017] EWHC 2466 (Ch) (in the High Court judgment in that case, Justice Morgan found the relevant banker to have been dishonest in providing misleading banking references in respect of an individual later convicted of money laundering offences. Following the analysis above of the factors which are usually present in successful claims, but absent in claims which fail, Justice Morgan found that the banker (1) was personally financially motivated to act in the way he had (noting that during cross-examination, he “accept[ed] that he expected to benefit financially” [511] and held that he acted as he did “with a view to receiving a substantial payment” [512]) and (2) had engaged in concealment from colleagues (the banker accepted at trial that he had mislead his colleague into believing that he had discontinued contact with the individual later found to have been engaged in money laundering, and for whom the banker had provided the dishonest references).

There are some key lessons for both financial institutions and their advisers from these recent cases:

First, whilst the dishonesty risk is usually negligible, there is still – in cases where the claimants include the client of the financial institution – a risk of negligence liability for allowing payments to be made where the Bank was on enquiry as to possible misappropriation (the “Quincecare duty”). Liability was established on this basis for the first time in Singularis (per Vos LJ), even though the dishonesty claim was dismissed. The negligence risk can be minimised by ensuring any concerns in respect of clients are shared amongst all relevant employees, and by training staff on the Quincecare duty and what it requires of them (as seems not to have been done at Daiwa in Singularis). One way to seek to further build on that awareness by using financial institutions’ existing systems is to make clear (e.g. on the relevant reporting form) that when an employee makes an internal SAR to the MLRO, that if there is anything in the report which suggests there might be misappropriation by an authorised party from a corporate, partnership or trust account, payments from the relevant account must be stopped while inquiries are made.

Secondly, where staff have determined to investigate possible misappropriation (as did Mr. Shaw in RBSI) it is advisable for the legal and compliance function to be informed and involved, supported by external advice where justified in the circumstances, to ensure any investigation is conducted with a proper scope and with the relevant legal obligations clearly in mind.

Thirdly, brokerages have more risk than banks as they cannot plead the “practical realities” of the level of transactions that have to be processed, in the same way a bank can (per Singularis).

Finally, whilst it is accepted in the case law that financial institutions are not “detectives” or “policemen”, and that they are not expected to continually monitor across multiple accounts for signs of fraud, as automated systems are increasingly used to perform a wider kind of monitoring than was possible hitherto (say than in the 1980s when these principles were first established in the case law), this has the potential to increase the risk of liability, in particular if such reports are notified to relationship managers, or account managers (the employees who are most typically the target of these claims).

Sebastian Said is a Partner in the Dispute Resolution Practice Group of Appleby (Cayman) Ltd). He appeared as advocate for Butterfield in its successful defence in Ritter.

Cayman already geared up to take on board new economic substance rules

George Town seen from above

The issue of economic substance is not a new one for the Cayman Islands, as the subject was much talked about some years ago and this was a motivating factor in the development of the Cayman Enterprise City project. As a result, Cayman passed its Special Economic Zones Law in 2011. Businesses located within CEC have been growing steadily in numbers since it first opened its doors to the likes of technology, media, intellectual property, shipping, aviation, commodities and derivatives trading businesses that wanted to establish a physical presence in a tax-neutral jurisdiction such as ours, while meeting globally recognised economic substance requirements.

Last year, the government passed new economic substance rules so that Cayman would comply with European Union ruling requiring Cayman-registered companies to show that they had adequate economic activity within the Cayman Islands (i.e., staff and offices) which would be a true reflection of the profits they were making.1

The question is, as far as the real estate industry is concerned, how will enacting these laws impact our industry? I believe that this latest focus by the European Union to have Cayman adopt further economic substance legislation is just taking what we have already established one step further.

The Cayman Islands has already benefitted from that original push for companies to show a commitment to more staffing. One has only to look at the population figures for the Cayman Islands to see incredible growth in people wishing to live and work here, with a population of 64,420 persons as at Spring 2018.

Quantifying the amount of ‘economic substance’

When we talk about growth in population, the real estate industry reaps the benefits of that increase. This is reflected in the huge growth in the construction and development industry in Cayman over the last year. So, the real question in my mind is just how much of an economic substance do companies registered in Cayman have to show in order to comply with these new rules. That, in turn, will impact how many people will need to move to Cayman, which will then impact our real estate industry.

Earlier this year, the Cayman Islands government published a guidance booklet to help companies comply with this new legislation, explaining just what the term adequate economic activity really means in terms of a physical presence and staffing.2 Cayman Enterprise City appears to be a sensible solution to these issues, as it touts itself as a solution for offshore intellectual property businesses, allowing them to set up a physical presence in the Cayman Islands by working within CEC’s special economic zone.

But if there is a really significant push for increasing the number of people living here, there will be a need for even more services and an increased strengthening of infrastructure, such as in transportation, communications and bandwidth services. I foresee significant numbers seeking to make Cayman their home, perhaps as many as 100,000 people living here in just a decade or so.

If the EU’s requirements mean more workers on island, then that can only be a good thing for Cayman. With Cayman Enterprise City, we have already proved we can accommodate such legislation and, in fact, it has already been done.


1 Read more on this subject in an article published in the Cayman Compass dated Dec 18, 2018.
2 Also read the article published in the Cayman Compass on Feb. 26 this year for more detailed information on this topic

Opportunities for President Trump to lead on trade

Container ship

The 2019 Economic Report of the President reiterated President Trump’s goal of “zero tariffs, zero non-tariff barriers, and zero subsidies” for international trade. This is a goal that deserves bipartisan support. A good start would be for Congress and the administration to work together to achieve passage of the United States-Canada-Mexico Agreement (USMCA).

Canada and Mexico represent our nation’s two largest export markets. As the President’s Economic Report pointed out, nearly 25% of US trade is accounted for by Canada and Mexico. Per capita gross domestic product of all three countries has soared under free trade.

After adjusting for inflation, per capita US GDP is up nearly 40% under the North American Free Trade Agreement (NAFTA). US manufacturing output has increased by a similar amount.

The bottom line is that the USMCA preserves NAFTA’s core intent of liberalising trade in North America, and a modernised USMCA agreement would allow this progress to continue. With such stark consequences attached to the fate of the USMCA, Congress and President Trump should work together to ensure the trade deal is passed as early in 2019 as possible.

President Trump also has an opportunity to improve US trade with China. US tariffs on imports from China were supposed to force China to change its economic policies, but as the President’s Economic Report noted, “Rather than changing its practices, China announced retaliatory tariffs on US goods.” Predictably, other countries did the same.

It is time to try something new instead of doubling down on a tariff policy that is not working. Fortunately, President Trump says he never gets too attached to one negotiating approach.

A bilateral agreement that encourages market-oriented reforms and allows both countries to claim victory would be far preferable to another round of mutually destructive tariff increases.

Finally, the Trump administration may impose a massive tax hike on imported cars and parts.

Such a move would be incredibly costly for both car buyers and autoworkers across the United States. A study from the Center for Automotive Research calculated that a 25% tariff on motor vehicles and parts from countries other than Canada and Mexico would cost more than 197,000 American jobs while increasing average car prices by $2,450.

A better approach would be to learn from Canada and Mexico. Companies that manufacture in those countries can export their cars to Japan and the European Union duty-free thanks to zero-tariff free trade agreements, like the one the Trump administration claims to want.

If the administration has learned anything from last year’s trade actions, it should be that higher tariffs here do not lead to lower tariffs there – instead they provoke retaliation against US exporters.

President Trump’s Economic Report includes a chapter on markets versus socialism, with a discussion of the costs imposed when governments adopt central economic planning. The costs of central planning apply to trade policy as well. Countries where powerful central governments pick winners and losers by imposing restrictive trade barriers are much poorer than those that embrace free trade.

President Harry S. Truman referred to this following World War II: “But if controls over trade are really to be tight, tariffs are not enough. Even more drastic measures can be used.

Quotas can be imposed on imports, product by product, country by country, and month by month. Importers can be forbidden to buy abroad without obtaining licenses. Those who buy more than is permitted can be fined or jailed. Everything that comes into a country can be kept within limits determined by a central plan …. This is precisely what we have been trying to get away from, as rapidly as possible, ever since the war. It is not the American way.”
Since World War II, treating our trading partners as allies rather than adversaries has paid enormous dividends for Americans. Just since 1990, world tariffs fell by nearly two-thirds as US exports more than doubled, even after adjusting for inflation.

Unfortunately, President Trump has endorsed legislation called the ‘Reciprocal Trade Act’ that would turn this successful approach to trade on its head. In a 2018 tweet, President Trump defined reciprocity this way: “When a country Taxes our products coming in at, say, 50%, and we Tax the same product coming into our country at ZERO, not fair or smart. We will soon be starting RECIPROCAL TAXES so that we will charge the same thing as they charge us. $800 Billion Trade Deficit – have no choice!”

The handful of proponents who endorse this approach often argue that tariff reciprocity is needed to as a lever to reduce foreign trade barriers. But the White House’s own case studies show this is untrue. For example, the White House produced a chart with tariffs on selected cherry-picked products from Japan, China, Thailand, Turkey, and the European Union attempting to show ‘unfair’ examples of non-reciprocal tariffs.

But each of those trading partners has lowered its average tariff on US exports significantly, without the need for blunt instruments like the Reciprocal Tariff Act. President Trump wants to replace a successful post-World War II policy based on the understanding that trade is win-win with one that is likely to encourage foreign governments to retaliate against Americans.

One US legislator contended: “Well, we’ve got to have an Old Testament approach to trade, an eye for an eye.” But this approach to tariff policy has been tried before, with results that were often disastrous. President Ronald Reagan described the risks involved in eye-for-an-eye tariff reciprocity: “I think you all know the inherent danger here. A foreign government raises an unfair barrier; the United States Government is forced to respond. Then the foreign government retaliates; then we respond, and so on. The pattern is exactly the one you see in those pie fights in the old Hollywood comedies: Everything and everybody just gets messier and messier. The difference here is that it’s not funny. It’s tragic.”

Recent US tariffs have led to retaliatory tariffs on $121 billion of exports ranging from lobster (25% additional tariff imposed by China) to pork (25% additional tariff imposed by China) to bourbon (25% additional tariff imposed by the European Union). The Trump administration calls this foreign retaliation “unfair”. Whether it is fair or not, the costs imposed on American exporters continue to mount.

History shows trade policy is more likely to succeed if it is based on the Golden Rule instead of on hostile eye-for-an eye reciprocity. It turns out that the United States benefits when we treat our trading partners the way we would like them to treat us.

US trade agreements are based on a mutually beneficial form of reciprocity with both countries reducing most trade barriers to zero. In almost every free trade agreement, the United States has signed, foreign barriers have fallen by more than US barriers. For example, prior to NAFTA, Mexico’s average tariff on US exports was about 10% while the average US tariff on imports from Mexico was just 2%. Zero-tariff reciprocity remains a desirable goal for US trade policy.

Attempting to mirror foreign tariffs is the opposite of an America First trade policy, because it would result in the US government copying bad policies from other governments instead of pursuing policies that would benefit Americans. As economist J. Laurence Laughlin asked in 1903: “But, should we desire reciprocity? … Certainly, there is no reason why we should deprive ourselves of the immediate benefit of cheaper goods because we feel that we must wait until other countries are willing to get our goods as cheaply.”

Instead of copying bad trade policies from other countries, some legitimate America First trade policies the Trump administration could undertake include:

Phase out all tariffs on imports used by Americans to compete in the global economy, including taxes on imported automobile parts along with steel and aluminium tariffs that were imposed last year for dubious “national security” reasons. These changes would encourage more companies to manufacture in the United States.

Eliminate regressive taxes on imported shoes and clothing, which average more than 13% and disproportionately burden low-income Americans.

End restrictions on sugar imports. US barriers force Americans to pay nearly twice as much for sugar as people in the rest of the world, encouraging sugar-using industries to relocate to other countries.

Allow Americans to use foreign-built ships for domestic transportation, making it more affordable to ship goods to Hawaii or Puerto Rico and reinvigorating a domestic cruise industry.

All trade is reciprocal, consisting of mutually beneficial transactions where each party willingly agrees to trade. The goal of the Trump administration’s trade policy should be to promote reciprocal trade, not reciprocal taxes. If the Trump administration really wants to open foreign markets instead of just hiking tariffs, history demonstrates that leading by example would be a good place to start.

As President Reagan explained: “[T]he future belongs to those who lower trade barriers. These are the countries that will be in the forefront of technology. These are the countries that will see their living standards rise most quickly. And these are the countries that will lead the world in the years ahead.”

There’s also an important role for Congress to play in trade policy. After World War II, Congress delegated much of its tariff authority to the executive branch. It is time for Congress to reclaim this authority.

For example, bipartisan legislation has been introduced that would remove the president’s power to impose tariffs for ‘national security’ reasons without first getting congressional approval.

According to Sen. Pat Toomey (Republican, Pennsylvania): ““Over recent decades, Congress has ceded its constitutional responsibility to establish tariffs to the executive branch. This measure reasserts Congress’s responsibility in determining whether or not to impose national security-based tariffs. I urge all of my colleagues to join this bipartisan effort.”

For success in 2019 and beyond, the Trump administration needs to reject a trade policy based on central planning. The president’s critics have said his “zero tariff” rhetoric is an empty promise. By implementing the United States-Canada-Mexico Agreement, pursuing a trade policy designed to encourage market-oriented reforms in China instead of haphazardly slapping on more tariffs, and rejecting new taxes on vehicle imports, the Trump administration can show it means it when it says its goal is zero tariffs, zero nontariff barriers and zero subsidies.

Security token offerings in the Cayman Islands

An increasing number of businesses are concluding that a security token offering (STO) is now the preferred approach to raise funds for their project, product or platform. Whereas a traditional initial coin offering (ICO) seeks to raise funds through the issue of a non-asset backed cryptocurrency or digital token which is designed to be utilised in an ecosystem or platform, an STO typically links tokens to either profits, assets or both (referred to herein as a security token).

As an STO therefore offers a token with the promise of a return as opposed to the promise of utility, many consumers are now looking to security tokens for their digital investments – a trend that has not been lost on those businesses competing or starting out in the blockchain space. In the Cayman Islands we are starting to see companies issuing security tokens that are backed by assets such as real estate or physical commodities such as gold.

However, the issuance of security tokens and the distribution of profits raises several questions from a legal and regulatory perspective. This article considers a few of the common questions facing security token issuers incorporated or established in the Cayman Islands.

Is a security token a security?

As with ICOs and the issuance of utility tokens, it is imperative that a full analysis on the characteristics of the security token be conducted to determine whether or not such token is in fact a “security” for the purposes of the Securities Investment Business Law (Revised) (SIBL).

Notwithstanding the nomenclature, it is possible that some security tokens will not actually be considered as securities under Cayman law. However, where the token is backed by profits or is redeemable for an asset, consideration must be given as to whether such token would be regarded as a debt instrument or an option and therefore a security.

Alternatively, where the security token possesses all the rights of a typical share and such rights are acknowledged in the issuer’s memorandum and articles of association, it is arguable that such token actually represents a share in the issuer, much like a share certificate albeit in digital form.

Under Cayman law, a token issuer may not be carrying on ‘securities investment business’ despite issuing securities. Where a token issuer is issuing its own securities, such activity would typically be regarded as an excluded activity under SIBL in which case the issuer would not be required to be registered or licensed with the Cayman Islands Monetary Authority (CIMA).

As several such exclusions or exemptions apply, the token issuer can therefore take steps to structure the STO so that licensing and registration is not required in the Cayman Islands.

However, the same may not be true in any or all jurisdictions where the issuer proposes to market or sell such tokens and local legal advice should be sought before the issuer sells any tokens in such jurisdictions.

Anti-money laundering

It is now well known that, for an ICO in any jurisdiction, a token issuer must have the prevention of money laundering and terrorist financing at the forefront of its priorities. It is no different for an issuer conducting an ICO from the Cayman Islands.

However, in many utility token ICOs, the issuer’s anti-money laundering (AML) obligations often only extend to direct purchasers of tokens, such purchasers being characterised as the issuer’s clients or customers. However, in the case of a security token issued as part of an STO, the relationship with the token holder often extends beyond the initial sale of the token, potentially resulting in further AML compliance required by the issuer. The extent of these obligations will depend on the rights attached to the security token itself.

For example, where a security token entitles the holder to rights in a dividend or distribution, the holders of tokens at the time of the distribution may be considered as customers and the issuer may therefore be expected to gather ‘know your customer’ (KYC) documentation and carry out AML checks on each such holder at the time of the distribution.

A large part of the attraction of digital tokens is that they may be listed on cryptocurrency exchanges and therefore become tradeable on secondary markets. Accordingly, listing security tokens on a cryptocurrency exchange may create additional AML obligations for issuers. Ultimately, an issuer’s compliance with AML obligations should follow a risk-based approach, so it will be for each issuer to determine its own compliance strategy.

This could include policies whereby (a) redemptions or distributions are not processed until a token holder has supplied adequate KYC, (b) KYC information is collected and exchanged on token holders as between the issuer and the cryptocurrency exchange, or (c) the issuer conducts due diligence on the AML policies and procedures of the cryptocurrency exchange and relies on those policies and procedures for the purposes of its own compliance.

The considerations above are not unique to the Cayman Islands and it is likely that most issuers of security tokens will need to consider their AML obligations.

Tax reporting

Like many other jurisdictions, the Cayman Islands has adopted tax information reporting regimes like FATCA and CRS. Accordingly, where an entity is classified as a reporting financial institution under these regimes, it will be required to collect tax information on its account holders and report to the Tax Information Authority of the Cayman Islands.

An in-depth, fact specific analysis for the purposes of FATCA/CRS will be required for each and every STO. As security tokens often allow for a return of value to the token holder in a similar manner to share- or equity- holders, the relationship between token issuer and token holder is significantly different than under a utility token ICO and much closer to a relationship covered by FATCA and CRS.

This relationship depends on the activities of the token issuer and the means through which its profits are derived and paid to token holders, possibly bringing the STO within scope of these tax reporting regimes. If an STO is in scope, the collection of information and reporting on token holders becomes difficult where the issuer intends to list the tokens on cryptocurrency exchanges where the persons holding tokens may change minute-by-minute.

While it is possible that not all token holders would be regarded as account holders for FATCA/CRS purposes, the administrative burden on the issuer to monitor, collect and report for tax purposes on any of its token holders could prove decisive. If adequate consideration has not been paid to its tax information reporting obligations at the very start of the STO, an issuer could find itself stuck with obligations it cannot, or is not willing, to perform.


In short, an STO cannot be treated like an ICO, and each project will require a fresh look from a legal and regulatory perspective in the Cayman Islands. In addition to the above, security token issuers must also be cognisant of a number of other structuring concerns, including the type of corporate structure to use for the STO, whether the STO engages with the Mutual Funds Law (Revised) of the Cayman Islands, whether the rights of token holders are included in constitutional documents, whether the rights of token holders, shareholders or ultimate beneficial owners are in conflict and whether the structure ultimately achieves the objectives of the STO.

Modern Monetary Theory — a critique

Helicopter dropping money

So called Modern Monetary Theory (MMT) has become popular with Green New Dealers because it claims to remove or at least loosen traditional constraints on government spending. MMT offers unconventional ideas about the origins of money, how money is created today, and the role of fiscal policy in the creation of money. It argues that government can spend more freely by borrowing or printing money than is claimed by conventional monetary theory.

As columnist James Mackintosh noted in the Wall Street Journal, “The most provocative claim of the theory is that government deficits don’t matter in themselves for countries – such as the US – that borrow in their own currencies …. The core tenets of MMT, and the closest it gets to a theory, are that the economy and inflation should be managed through fiscal policy, not monetary policy, and that government should put the unemployed to work.”1

In fact, despite its efforts to change how we conceive and view monetary and fiscal policies, MMT abandons market-based countercyclical monetary and fiscal policies for targeted central control over the allocation of resources. It would rely on specific interventions to address ‘road blocks’ upon the foundation of a government guaranteed employment programme.

MMT is an unsuccessful attempt to convince us that we can finance the Green New Deal and a federal job guarantee painlessly by printing money. But it remains true that shifting our limited resources from the private to the public sector should be judged by whether society is made better off by such shifts. Printing money does not produce free lunches.

Where does money come from?

It has been almost 50 years since the US dollar, or any other currency for that matter, has been redeemable for gold or any other commodity whose market value thus determined the value of money. It remains true, however, that money’s value depends on its supply given its demand. The supply of money these days reflects the decisions of the Federal Reserve and other central banks.

The traditional story for the fractional reserve banking world we live in is that a central bank issues base or high-powered money (its currency and reserve deposits of banks with the central bank) that is generally given the status of ‘legal tender’. You must pay your taxes with this money. We deposit some of that currency in a bank, which provides the bank with money it can lend. When the bank lends it, it deposits the loan in the borrower’s deposit account with her bank, thus creating more money for the bank to lend. This famous money multiplier has resulted in a money supply much larger than the base money issued by the central bank. In July 2008, base money (M0) in the United States was $847 billion dollars while the currency component of that plus the public’s demand deposits in banks (M1) was almost twice that – $1,442 billion dollars. Including the public’s time and savings deposits and checkable money market mutual funds (M2) the amount was $7,730 billion. I am reporting data from just before the financial crisis in 2008 because after that the Federal Reserve began to pay interest on bank reserve deposits at the Fed in order to encourage them to keep the funds at the Fed rather than lending them and thus multiplying deposits. This greatly increased and distorted the ratio of base money to total money, i.e., reduced the multiplier. In October 2015 at the peak of base money M0 = $4,060 billion, of which only $1,322 billion was currency in circulation.

The neo Chartalists, now known as MMTists, want us to look at this process differently. In their view banks create deposits by lending rather than having to receive deposits before they can lend. While a bank loan (an asset of the bank) is extended by crediting the borrower’s deposit account with the bank (a liability of the bank), the newly created deposit will almost immediately be withdrawn to pay for whatever it was borrowed for. Thus, the willingness of banks to lend must depend on their expectations of being able to finance their loans from existing or new deposits by borrowing in the interbank or money markets or by the repayment of previous loans at an interest rate less than the rate on its loans.

The money multiplier version of this story assumes a reserve constraint, i.e., it assumes that the central bank fixes the supply of base money and bank lending and deposit creation adjust to that. The MMT version reflects the fact that monetary policy these days targets interest rates leaving base money to be determined by the market. Traditionally the Fed set a target for the over-night interbank lending rate – the so-called Fed Funds rate. In order to maintain its target interest rate, the central bank lends or otherwise supplies to the market whatever amount of base money is needed to cover private bank funding needs at that rate. The market determination of the money supply at a given central bank interest rate is, in fact, similar to the way in which the market determines the money supply under currency board rules under which the central bank passively supplies whatever amount of money the market wants at the fixed official price (exchange rate) of the currency. With the Federal Reserve’s introduction of interest on bank reserve deposits at Federal Reserve Banks, including excess reserves (the so-called Interest On Excess Reserves – IOER), banks’ management of their funding needs for a given policy rate now involve drawing down or increasing their excess reserves.

According to MMT proponents, loans create deposits and repayment of loans destroys deposits. This is a different description of the same process described by the money multiplier story, which focuses on the central bank’s control of reserves and base money rather than interest rates. It is wrong to insist that deposits are only created by bank lending and equally wrong to insist that banks can only lend after they receive deposits.

How is base money produced?

MMT applies the same approach to the creation of base or high-powered money (HPM) by the government as it does to the creation of bank deposits by the private sector:

“It also has to be true that the State must spend or lend its HPM into existence before banks, firms, or households can get hold of coins, paper notes, or bank reserves …. The issuer of the currency must supply it first before the users of the currency (banks for clearing, households and firms for purchases and tax payments) have it. That makes it clear that government cannot sit and wait for tax receipts before it can spend—no more than the issuers of bank deposits (banks) can sit and wait for deposits before they lend.”2

This unnecessarily provocative way of presenting the fact that government spending injects its money into the economy and tax payments and t-bond sales withdraw it does not offer the free lunch for government spending that MMT wants us to believe is there.

Central banks can finance government spending by purchasing government debt, but this does not give the Treasury carte blanche to spend without concern about taxes and deficit finance. This is the core of MMT that we must examine carefully.

MMT claims that:

“(i) the government is not constrained in its spending by its ability to acquire HPM since the spending creates HPM …. Spending does not require previous tax revenues and indeed it is previous spending or loans to the private sector that provide the funds to pay taxes or purchase bonds ….

“(iii) the government deficit did not crowd out the private sector’s financial resources but instead raised its net financial wealth.

“Regarding (iii), the private sector’s net financial wealth has been increased by the amount of the deficit. That is, the different sequencing of the Treasury’s debt operations does not change the fact that deficits add net financial assets rather than ‘crowding out’ private sector financial resources.”3

MMT is correct that federal government spending does creates money. But what if the resulting increase in money exceeds the public’s demand (thus reducing interest rates), or the destruction of money resulting from tax payments or public purchases of government debt reduces money below the public’s demand (thus increasing interest rates)? MMT claims to be aware of the risk of inflation and committed to stable prices (an inflation target) but ignores it most of the time.

If the central bank sets its policy interest rate below the market equilibrium rate, it will supply base money at a rate that stimulates aggregate demand. If it persists in holding short-term interest rates below the equilibrium rate, it will eventually fuel inflation, which will put upward pressure on nominal interest rates requiring ever increasing injections of base money until the value of money collapses (hyperinflation). If instead the central bank money’s price is fixed to a quantity of something (as it was under the gold standard, or better still a basket of commodities) and is issued according to currency board rules (the central bank will issue or redeem any amount demanded by the market at the fix price), arbitrage will adjust the supply so as to keep the market price and the official price approximately the same.4

Unlike an interest rate target, a quantity price target is stable.

Does the story matter?

But does the MMT story of how money is created open the door for government to spend more freely and without taxation, either by borrowing in the market or directly from the central bank? According to MMT, “One of the main contributions of Modern Money Theory (MMT) has been to explain why monetarily sovereign governments have a very flexible policy space that is unencumbered by hard financial constraints. Not only can they issue their own currency to meet commitments denominated in their own unit of account, but also any self-imposed constraint on their budgetary operations can be by-passed by changing rules.”5

MMT maintains that: “Politicians need to reject the urge to ask ‘How are we going to pay for it?’… We must give up our obsession with trying to ‘pay for’ everything with new revenue or spending cuts …. Once we understand that money is a legal and social tool, no longer beholden to the false scarcity of the gold standard, we can focus on what matters most: the best use of natural and human resources to meet current social needs and to sustainably increase our productive capacity to improve living standards for future generations.”6

MMT proclaims that a government that can borrow in its own currency “has an unlimited capacity to pay for the things it wishes to purchase and to fulfil promised future payments and has an unlimited ability to provide funds to the other sectors. Thus, insolvency and bankruptcy of this government is not possible. It can always pay …. All these institutional and theoretical elements are summarised by saying that monetarily sovereign governments are always solvent, and can afford to buy anything for sale in their domestic unit of account even though they may face inflationary and political constraints.”7

But inflating away the real value of obligations (government debt) is economically a default.

Moreover, debt cannot grow without limit without debt service costs absorbing the government’s entire budget and even the inflation tax has its hyperinflation limit (abandonment of a worthless currency).

MMT advocates do acknowledge that at some point idle resources will be used up and that this process would then become inflationary, but this caveat is generally ignored. But if MMT is serious about an inflation constraint, we must wonder about their criticism of asking how government spending will be paid for. In this regard MMT is a throwback to the old Keynesianism, which implicitly assumed a world of perpetual unemployment.

Is there a free lunch?

MMT states that when the government spends more than its income (and thus must borrow or print money) private sector wealth is increased “because spending to the private sector is greater than taxes drawn from the private sector, the private sector’s net financial wealth has increased”. As explained below this deficit spending increases the private sector’s holdings of government securities, but not necessarily its net financial wealth.

Whether we take account of the future tax liabilities created by this debt in the public’s assessment of its net wealth (Ricardian equivalence) or not, we must ask where the public found the resources with which it bought the debt. Did it substitute T-bonds for corporate bonds, i.e., did the government’s debt (or monetary) financing of government spending crowd out private investment thus leaving private sector wealth unchanged, or did it come from reduced private consumption, i.e. increased private saving.

Any impact on private consumption will depend on what government spent its money on. MMT claims that “the government deficit did not crowd out the private sector’s financial resources but instead raised its net financial wealth”, is simply asserted and is unsupported.

Whether the shift in resources from the private sector to the public sector is beneficial depends on whether the value of the government’s resulting output is greater than is the reduced private sector output that financed it.

One way or another, government spending means that the government is commanding resources that were previously commanded by or could be commanded by the private sector. If the government takes resources by spending newly created money that the central bank does not take back, prices will rise to lower its real value back to what the public wants to hold. This is the economic equivalent of the government defaulting on its debt, contrary to MMT’s claim that default is impossible. This inflation tax is generally considered the worst of all taxes because it falls disproportionately on the poor. In fact, MMT proponents rarely mention or acknowledge the distinction between real and nominal values that are, or should be, central to discussions of monetary policy. The exception to the inflationary impact of monetary finance is if the resources taken by the government were idle, i.e., unemployed, which, obviously, is the world MMT thinks it is in.

MMT claims to have exposed greater fiscal space than is suggested by conventional analysis. They claim that government can more freely spend to fight global warming or to fund guaranteed jobs or other such projects by printing (electronic) money. However, the market mechanism they offer for preventing such money from being inflationary (market response to an interest rate target that replaces unwanted money with government debt), implies that such spending must be paid for with tax revenue or borrowing from the public. Both, in fact all three financing options (taxation, borrowing and printing money), shift real resources from the private sector to the public sector and only make society better off if the value of the resulting output is greater than that of the reduced private sector output. There is nothing new here.

Fiscal policy as monetary policy

Government spending increases M and the payment of taxes reduces it. MMT wants to use taxation to manage the money supply rather than for government financing purposes. MMT wants to shift the management of monetary policy from the central bank to the finance ministry (Treasury). The relevant question is whether this way of thinking about and characterising monetary and fiscal policy produces a more insightful and useful approach to formulating fiscal policy. Does it justify shifting the responsibly for monetary policy from the central bank to the finance ministry? Should taxes be levied so as to regulate the money supply rather than finance the government (though it would do that as well)?

In advocating this change, MMT ignores the traditional arguments that have favoured the use of central bank monetary policy over fiscal policy (beyond automatic stabilisers) for stabilisation purposes. None of the challenges of the use of fiscal policy as a countercyclical tool (timing, what the money is spent for, etc.) established with traditional analysis have been neutralized by the MMT vision and claim of extra fiscal space. In fact, as we will see below, despite their advocacy of fiscal over monetary policy for maintaining price stability, MMT supporters have little interest in and no clear approach to doing so as they prefer to centrally manage wages and prices in conjunction with a guaranteed employment programme.

But the arguments against MMT are stronger than that. The existing arrangements around the globe (central banks that independently execute price stability mandates and governments that determine the nature and level of government spending and its financing) are designed to protect monetary stability from the inflation bias of politicians with shorter policy horizons (the time inconsistence problem). The universal separation of responsibilities for monetary policy and for fiscal policy to a central bank and a finance ministry are meant to align decision making with the authority responsible for the results of its decisions: price stability for monetary policy and welfare enhancing levels and distribution of government spending and its financing.

It is the sad historical experience of excessive reliance on monetary finance and the costly undermining of the value of currencies that resulted that have led to the world-wide movement to central bank independence.

MMT is silent on this history and its lessons. As pointed out by Larry Summers in an op-ed highly critical of MMT, the world’s experience with monetary finance has not been good.8

The establishment of central bank operational independence in recent decades is rightly considered a major accomplishment. MMT advocates bring great enthusiasm for more government spending – especially on their guaranteed employment and green projects, which will need to be justified on their own merits. MMT’s way of viewing money and monetary policy adds nothing to the arguments for or against these policies.

The bottom Line

To a large extent, most of the above arguments by MMT are a waste of our time as MMT advocates actually reject the macro fine tuning of traditional Keynesian analysis. “This approach of government intervention aims at avoiding direct intervention to achieve the goal (e.g., hiring to achieve full employment, or price controls to achieve low inflation), but rather using indirect ‘tools’ while letting market participants push the economy toward desired goals by tweaking their incentives. MMT does not agree with this approach. The government should be directly involved continuously over the cycle, by putting in place structural macroeconomic programmes that directly manage the labour force, pricing mechanisms, and investment projects, and constantly monitoring financial developments …. But MMT goes beyond full employment policy as it also promotes capital controls for open economies, credit controls, and socialisation of investment. Wage rates and interest rate management are also important.”9

No wonder Congresswomen Alexandria Ocasio-Cortez is excited by MMT.

MMT attempts, unsuccessfully in my opinion, to repackage and resurrect the empirically and theoretically discredited Keynesian policies of the 1960s and ‘70s.

A 2019 survey of leading economists showed a unanimous rejection of modern monetary theory’s assertions that “Countries that borrow in their own currency should not worry about government deficits because they can always create money to finance their debt,” and “Countries that borrow in their own currency can finance as much real government spending as they want by creating money.”10

Both the excitement and motivation for MMT seem to reflect the desire to promote a political agenda, without the hard analysis of its pros and cons – its costs and benefits.


  1.  James Mackintosh, “What Modern Monetary Theory Gets Right and Wrong’ WSJ April 2, 2019.
  2.  Fullwiler, Scott, Stephanie Kelton & L. Randall Wray (2012), ‘Modern Money Theory: A Response to Critics’, in Modern Monetary Theory: A Debate, Modern Monetary Theory: A Debate,, 2012, page 19
  3.  Ibid. page 22-23.
  4.  for a detailed explanation see my article: “Real SDR Currency Board”, Central Banking Journal (2011),
  5.  Tymoigne and Wray, 2013
  6.  Stephanie Kelton, Andres Bernal, and Greg Carlock, “We Can Pay For A Green New Deal” cost_n_5c0042b2e4b027f1097bda5b 11/30/2018
  7.  Tymoigne and Wray, op cit. p. 5
  8.  Lawrence H. Summers, Modern Monetary Theory-a-foolish-pursuit-for-democrats, The Post and Courier, March 5, 2019
  9.  Tymoigne and Wray, op cit. pp. 44-45