Bershidsky: The risky mix of politics and offshore finance

Ramon Fonseca, a founding partner of Mossack Fonseca, the Panamanian offshore incorporator that has suffered the biggest leak of privileged information in history, has told the Financial Times that the investigations stemming from the leak are an attack on the basic human right to privacy.

The investigative journalists themselves see their effort as strike against corruption and money-laundering. So what purpose do the Panama Papers investigations really serve?

To me, they highlight the gaping disconnect between the world of global money and that of traditional nation states. This is a gap that has begged for years to be addressed without destroying either concept, and the debate about the acceptability of offshore operations reignited by the Panama affair should serve that useful purpose.

The Boston Consulting Group estimated the global wealth management market at US$40 trillion in 2001; last year, it put global private financial wealth at US$155.7 trillion. A surprisingly small share of these assets is booked in offshore finance centers: According to the BCG’s Global Wealth 2015 report, the most popular of these centers account for US$9.7 trillion in assets.

That, however, is still an enormous amount of money. The Panama Papers have exposed only a tiny bit of the industry, a fraction of the US$1.3 trillion parked in Panama and the Caribbean, Mossack Fonseca’s main area of operation.

All that money is subject to less taxation than the countries where these fortunes are made would like to impose. In principle, there is nothing wrong with that: Everyone is entitled to create a legal tax structure to minimize those payouts. If governments cannot stop other governments from setting up light fiscal regimes – by diplomacy, sanctions or other means – money will naturally flow to the tax havens. And some of these havens are in the world’s biggest and economically most powerful countries, such as the U.S., the U.K. and China, so it’s hard to imagine who might stop them. Scaling back the offshore industry would mean creating artificial borders in a globalized financial world.

The Panama Papers have revealed the offshore companies of soccer star Lionel Messi, action film hero Jackie Chan and art house film director Pedro Almodovar and lots of other high-earning individuals.

It’s likely these people did nothing wrong and their tax structures were perfectly legal (though Messi is under indictment in Spain for tax dodging). They are being dragged into the scandal unfairly. They are, after all, private citizens, under no legal or ethical obligation to pay the highest taxes possible or to reveal more than a government should know about their business. It’s natural for them to seek greener financial pastures – provided they don’t break the laws of the lands where they earn their money.

Politicians and politically connected individuals are a different matter. They embody the nation states they serve. Take Ukrainian President Petro Poroshenko: As a wealthy businessman, he had every right to set up an offshore structure as he prepared to sell his confectionery company, Roshen. But as his country’s leader, he’s supposed to set a patriotic example. And he’s not supposed to be focusing on deal structures when his country’s army is suffering heavy losses, as the Ukrainian army was in 2014 when Poroshenko became a Mossack Fonseca client.

Or take the Russians from Vladimir Putin’s inner circle. Most of them are businessmen, not politicians, but they have publicly proclaimed loyalty to Putin’s patriotic platform of imperial revival and gotten rich thanks to the president. Their offshore activities cast a shadow over Putin, even if they are not conducted for his financial benefit. If the president’s friends don’t believe in the Russian system, it’s unlikely that he believes in it himself – and probable that he’s setting up one system for his cronies and another, tougher one, for other Russian citizens.

Politicians, officials and other “politically exposed persons,” or PEPs, shouldn’t be using the offshore industry. It’s not even a matter of keeping their hands clean of corruption: These people are supposed to fix their own countries so that citizens don’t have to go offshore for tax benefits or better legal protections.

The difficulty, of course, lies in determining who is a PEP and who isn’t. Sergei Roldugin, one of Putin’s closest friends, was asked on a Mossack Fonseca questionnaire whether he was one – and got away with just saying no. Offshore incorporators should bear legal responsibility for fact-checking such claims; Roldugin meets the Financial Action Task Force’s definition of a PEP because of the close social relationship he maintains with Putin. Mossack Fonseca could have determined that in just a few minutes using Google.

It should be obligatory for anyone defined as a PEP to have to apply to an international body, such as FATF, for clearance before opening an offshore account. Failure to file such an application should be illegal a priori, regardless of what the PEP intends to do with the offshore firm. And such a stricture wouldn’t violate ordinary citizens’ right to privacy.

Keeping public servants and politically connected individuals out of the offshore industry is more important than blanket measures against tax avoidance, money laundering and other sins of which the industry is accused. If those havens aren’t available, they may be more mindful of their countries’ failings, and more inclined to put them right. Eventually, that should turn offshores into a non-issue.

© 2016, Bloomberg View