It should come as no surprise that China and Hong Kong have been revealed in the Panama Papers as being among the most prolific in hiding entities that use offshore financial centers and tax havens. This partly stems from the fact that Hong Kong was a British territory for most of the past 150 years, and it was the U.K. more than any other country that saw the economic opportunity in providing financial and professional services to those seeking a favorable tax or legal environment.
It is also no coincidence that British territories over the past 75 years have dominated this offshore space, and why increasingly, corporate profits are parked overseas in low-tax jurisdictions with double tax-avoidance treaties. Laws in Panama and in many popular offshore jurisdictions are specifically tailored to circumvent the regulatory and disclosure burdens that exist in many developed economies. As often as not, English law forms the legal basis of many offshore jurisdictions, which is why Hong Kong, as China's gateway to the world, has so many Chinese nationals owning offshore holding companies and accounts.
There are many legitimate reasons why the wealthy and businesspeople take advantage of the services and products offered up by offshore centers such as Panama. Apart from this cyber breach, resulting in the leak of 11.5 million files, offshore centers had been relatively risk-free. They offer greater personal privacy and lower taxes, and they are loosely regulated, if at all.
For those who conduct multiple transactions, using an offshore entity limits downside risk in terms of potential litigation or legal contamination from unrelated parties or transactions. Some high-profile Asians, including actor Jackie Chan and the daughter of former Chinese Premier Li Peng, Li Xiaolin, have been identified as clients of Mossack Fonseca, the Panamanian law firm at the center of the media storm.
Many named in the Panama Papers have not broken laws. They are simply using what is legally available to them. Neither Chan nor Li created any of the legal or tax-friendly structures that were allegedly set up for them. Hence, moral outrage should also be directed at the politicians and third-party professionals that made all this possible.
Backing property booms
The Panama disclosures are pretty definitive in demonstrating the massive use of offshore facilities by the Chinese. It is no coincidence that London, in particular, has enjoyed a dizzying real estate boom over the last few decades. It is widely acknowledged that normal people have been priced out of central London as Russian oligarchs, African despots, autocratic Middle Eastern rulers and criminals have made the city their financial home. In the past 15 years, it has also become a safe haven for China's elite -- corrupt government officials and tax-evading businesspeople -- to park their ill-gotten gains.
In 2015 alone, $1 trillion flowed out of China, according to Bloomberg News. A large part of this did not leave via official channels, and the ownership and control of these untold billions have to be hidden. The Chinese favor had brick-and-mortar in which to park their wealth, typically in English law jurisdictions.
This is how it works: A corrupt Chinese government official makes a deal with a large real estate developer in Shanghai who already has assets in London. The developer buys a large plot of cheap land around Shanghai, which is then rezoned in his favor. Say this results in a $500 million profit for the developer.
Then imagine that the official has a family member or trusted friend who owns a British Virgin Islands holding company and enjoys U.K. residency. The developer also owns an offshore company incorporated in Panama whose sole asset is a $50 million property. The Panamanian company then "sells" its shares in bearer form to the BVI entity for $1 and other consideration. The control and ownership of this $50 million property will now have been transferred to the government official or his proxy. Yet on the deed registry in London, the property will not reflect a sale or a change of ownership and hence, no stamp duty will be paid.
Furthermore, a proper loan agreement between the Panamanian company and the BVI company on normal commercial terms can be drafted, but who says a loan has to be paid back? The property acquired under this transaction can then be used to launder Chinese outflows by being rented out at an inflated rate to another associate seeking to "wash" his cash. All of these machinations can be buttressed by simply adding more legally created offshore structures so that the paper trail is completely obfuscated. For the same reason, many luxury yachts and private jets are held by offshore corporate entities.
I have 30 years of firsthand knowledge of many of these offshore money laundering techniques and the flow of these funds back into the public capital markets to facilitate other fraud against the public, dealing with the lawyers and professionals who willfully turn a blind eye to the source of such funds. I worked undercover for almost 20 years for various government agencies combating organized crime and terrorist financing. One three-year undercover project between the U.S. Federal Bureau of Investigation and the Royal Canadian Mounted Police revealed for the first time the extent to which offshore financial centers had come to provide shelter for criminal activity. Money, drugs, rogue states, murder, organized crime, banks, brokerages, capital markets, lawyers and accountants came together, with offshore markets and tax havens as their common ground.
It was Meyer Lansky who conceived of the idea of money laundering and tax evasion. Lansky was effectively the chief financial officer for the Mafia in the early to mid-20th century. He learned from the experience of Chicago gangster Al Capone, who was convicted in 1931 for tax evasion. Realizing that the money trail caused Capone's downfall, Lansky took advantage of the 1934 Swiss Banking Act that enshrined his right under Swiss law to use numbered Swiss bank accounts, with guaranteed anonymity. Lansky also understood that investigators would have a difficult time obtaining information across multiple jurisdictions, especially as bilateral legal treaties on information-sharing did not exist.
It can be a painfully slow and expensive exercise for overseas investigators to obtain necessary evidence today. Many Asian countries, including China, do not have treaties with popular offshore centers, and this is a factor in why elite Chinese use the services provided in places such as Panama or the BVI.
It should be especially worrisome for regulators and investor advocacy groups that so many shareholders of public companies in Hong Kong are not individuals, but offshore holding companies. There is a risk of a single entity coordinating multiple shareholdings in secret for its own benefit. This destroys the concept of minority shareholder rights and underpins the notion that Hong Kong does not provide a level playing field. Hong Kong and Singapore are important financial centers in Asia, but they also play a large part in the shady world of offshore vehicles and structures. It would be foolish to think that it is only clean money and real deals flowing through those offshore vehicles. Tax evasion, money laundering, sanctions violations, bribery and corruption and good old-fashioned white-collar crime are thriving in those jurisdictions where secrecy and financial engineering, rather than good governance, are the legal and political imperatives.
Bill Majcher heads EMIDR, a cybersecurity and corporate risk advisory in Hong Kong, and investigated money laundering and other crimes as a Royal Canadian Mounted Police inspector between 1985 and 2007.