No desks. No staff. No tax. Ireland’s shadow banks

Ireland’s unregulated and barely visible ‘shadow banking’ industry is 10 times the size of our GNP. Is it a benefit or a threat to the economy?

So many companies are listed in the marble-tiled, plant-filled foyer that there are no brass plates or printed guides. Instead, it takes a computer to search through them all. This is 5 Harbourmaster Place, a Celtic Tiger-era chrome-and-glass building at the edge of the International Financial Services Centre, in Dublin.

It might not look big enough to house them all, but this modest-sized building is home to about 250 companies. One is Orpington Structured Finance I. It has gross assets of €1.7 billion, which would make it one of the most valuable firms in Ireland. Except it has no employees. It has no buildings or machinery. Nor does it pay any tax.

It is one of hundreds of so-called financial-vehicle corporations, which are companies set up to house or trade in securitised investments, in other words to package and resell loans.

It’s part of a much wider area of financial activity known as shadow banking, a term coined five years ago when the US economist Paul McCulley defined the area as the “whole alphabet soup of levered-up non-bank investment conduits, vehicles and structures”.


The term spread almost as fast as the financial crisis, and regulators and governments have been mobilising ever since to try to map this largely uncharted world.

It’s big business: the total value of assets in the Republic’s shadow-banking sector, at €1.7 trillion, is almost 11 times the State’s gross national product, which is the total value of all products and services produced in a single year.

Supporters of low taxes and multinational-friendly policies say these companies help create much-needed jobs in a country with 14 per cent unemployment and stagnant growth. The wider IFSC employs an estimated 32,000 people, for example, and contributes about €1 billion in corporation tax. Of those employees, about 1,000 work in companies linked to the securitisation industry. If Ireland weren’t courting this kind of business, the argument goes, it would end up in rival jurisdictions, such as the UK or the Netherlands.

But detractors question whether the benefits really stack up.

Much shadow-banking activity is set up to attract little, if any, tax. This reliance on aggressive tax avoidance, critics say, distorts the country’s industrial policy and leaves it vulnerable to appealing changes in tax rates around the world.

Moral argument
There is also a moral argument: companies and people who don't pay a fair proportion of tax shift the burden on to those who do. At a time when PAYE workers and the middle classes are bearing the brunt of tax increases, many grumble that corporations are able to escape without paying their share.

On Tuesday, at a meeting of the EU’s finance and economics ministers, issues such as aggressive tax avoidance and profit-shifting across borders will be out of the shadows and in the spotlight.

In its role as president of the council of the European Union, the Government says it is leading efforts to tackle this area.

Yet Ireland has been under pressure from some of its neighbours to tackle its low-tax regime and plug loopholes such as the “double Irish”, which allow Google and other US multinationals to lower their tax liabilities dramatically.

Although Ireland has avoided being labelled a tax haven by international bodies such as the Organisation for Economic Co-operation and Development, some academics say it deserves the name.

Nicholas Shaxson, an associate fellow of the UK think tank Chatham House and the author of Treasure Islands , a book about the offshore system, says Ireland is a tax haven by his definition in light of the country's regulation of financial services.

“What I have seen in Ireland does fit so closely the pattern I’ve seen again and again in tax havens, which is this willingness to do what the financiers want, really not ask any questions, and to have all sorts of measures for keeping Irish democracy out and keeping debate out of the way,” he says.

“That’s by either doing things behind closed doors and the shaping of a national consensus that ‘this is the goose that lays the golden egg and we mustn’t do anything to trouble it’ . . . to arguments that all this stuff is going to go overseas if we touch it, so let’s not rock the boat.”

Shaxson calls this “the captured state”: a world in which policymaking has been largely taken over by financial interests that can pick and choose between jurisdictions and in effect write the laws they need. “That happens in its purest form in the very small tax havens where there is just no local democracy to do anything. There is a little bit of a counterweight but it isn’t very strong in Ireland.”

Others go further still. Dr Conor McCabe of the Equality Studies Centre at University College Dublin, who is a campaigner in the area of tax justice, says companies can ride roughshod across competing jurisdictions, extracting what they want and contributing little. “They want all the pluses of a modern democracy while seeking to reduce their obligations to zero. They are behaving like parasites,” says McCabe.

The financial services sector insists Ireland has benefited hugely from its competitive tax regime through large-scale employment and investment.

“Ireland is not a tax haven. It has an excellent network of treaties with other jurisdictions and operates a simple and transparent corporation-tax system,” says Fergal O’Brien, the chief economist with the employers’ group Ibec, which represents financial services.

He says Ireland is simply competing with other countries for business, and one of the key reasons our low-tax regime attracts comment from our neighbours is because it has nothing to hide.

“In many ways, the very transparency of Ireland’s corporation tax regime has meant that it attracts such attention. Many other jurisdictions compete more aggressively on allowances and write-off, but have a higher headline tax rate.

“A number of studies have shown that Ireland’s effective tax rate is fairly close to its headline 12.5 per cent rate, whereas in many other jurisdictions the effective rate is substantially lower than the headline rate.”

Minister for Finance Michael Noonan has also insisted that Ireland has always been above board in how it operates. He says the issue of tax avoidance is an international one rather than an Irish question.

“The ability of companies to lower their effective rate of tax using international structures reflects the global context in which Ireland, and indeed all countries, operate,” he said recently.

“The tax system in Ireland has a positive international reputation based on transparency and on the fact that it is applied equally and openly to all corporate taxpayers. Ireland has an extensive tax-treaty network, which confirms our international standing.

Orpington Structured Finance I
Orpington Structured Finance I is set up like many financial-vehicle corporations based in Ireland. It has two named directors, David McGuinness and Eimir McGrath, who are employees of a management company – in this case Deutsche International Corporate Services, a division of Deutsche Bank that provides corporate and secretarial services to a range of companies.

In fact, both individuals are also directors of hundreds of other companies: McGuinness is listed as a director or former director of 167 firms; McGrath is a director or former director of 183. This is not improper or unusual. Many directors in this sector are linked to large numbers of companies.

Most of these companies are involved in what appear to be financial services. Although the company is registered and domiciled in Ireland, the investments appear to be managed from the UK. Its “banker and custodian” is listed as the London-based RBC Dexia Investor Services Trust.

It is unclear who owns Orpington Structured Finance I. It has close links to HSBC Bank, one of the world’s largest financial institutions. Orpington’s company accounts and annual report show that all administrative and other expenses, such as the company audit and tax fees, were paid by the bank. HSBC declines to comment on its relationship to the firm, citing “client confidentiality”.

Deutsche International Corporate Services says its business is not to help companies with “aggressive tax planning”. It says any companies it is linked with are obliged to comply with Irish company law and Irish tax law.

As for the number of companies listed to directors, it says Irish law specifically permits individuals to hold multiple directorships. “All directors of Irish companies are obliged to comply with their legal obligations and responsibilities in carrying out their role as directors. There is no concept of nominee directorships in Irish law,” the company says in a statement.

Debt securities
Ireland has more of these types of companies than any other EU country. We have 27 per cent of them; Spain, the Netherlands and Luxembourg come next. Typically, the firms are set up so that debt securities – the packaging and reselling of loans – can be issued and controlled through a financial vehicle that has the legal form of a public limited company. They file accounts, and most have debt securities that are quoted on the Irish stock exchange. They are often owned by trusts, but many are linked to larger financial institutions or investment pools.

Jim Stewart, associate professor of finance at Trinity College Dublin, is trying to map shadow banking in Ireland. Part of his work has involved peering into the accounts of dozens of financial-vehicle corporations. He has examined 80 of the estimated 700-plus firms, which, in turn, are linked to about 4,000 securitised funds.

There are some striking similarities: all the corporations he studied, he says, had zero employees. All had administrative services performed by management companies in Ireland, and all tended to be managed from centres such as London or New York. Many had links with advisory firms in other low-tax centres, such as Luxembourg and Jersey; others were based in the Cayman Islands, Bermuda or other tax havens. There is no evidence that this is the case with Orpington.

Stewart says many of them are a way of removing assets or liabilities from a parent company’s balance sheet and escaping the regulatory requirements that come with this. Again, there is no evidence this is the case with Orpington.

These companies, which are classified as nontrading firms, have a theoretical tax rate of 25 per cent. In reality, they are able to use write-offs in Irish legislation to ensure they make no profits and so have no tax liabilities. Overall, Stewart is sceptical about the benefits of shadow banking to Ireland. “As far we’re concerned, we don’t get much out of this,” he says. “There might be modest fees for company secretarial services or Irish auditors. But the real work is done abroad.”

Gary Palmer, the chief executive of the Irish Debt Securities Association, an industry representative group, would like to see Ireland take the lead in the area. “It’s a well-known fact that some securitisations performed incredibly badly during the financial crisis, but not all performed badly and some performed very, very well,” he says. He believes more people could one day work in the securitisation industry in Ireland.

As for tax benefits, although the financial services are done on a “fairly tax-neutral basis”, the jobs they create provide taxes for the State, he says. “The entity doesn’t do anything, and doesn’t do anything here. It doesn’t do anything anywhere, but the moving parts are the servicing, support and the management, and they are all done here in Ireland, and that’s where the tax take is.”

Some in the industry believe the term “shadow banking” unfairly implies some sort of furtive or sinister activity. Instead, they point out, governments use it to invest sovereign wealth funds, and state agencies in areas such as oil, gas and mining make legitimate transactions across borders.

But Stewart warns that the much wider world of shadow banking carries risks. He says financial products played such a direct role in the financial crisis that we should be wary about seeking to attract more of this industry to Ireland.

Bear Sterns, whose collapse in 2008 heralded the beginning of the financial crisis, had several investment vehicles listed in Ireland, with gross assets at one point valued at close to €50 billion. Lehman Brothers, too, had debt securities, with €20 billion issued, along with funds administered from Dublin and quoted on the Irish stock exchange.

The largest and potentially most serious losses occurred at Depfa Bank, an Irish-registered bank, located in the IFSC, that became a subsidiary of Hypo Real Estate in 2007. Losses at these banks required billions in state aid from the German government. It has been reported that it led to a request from the German government to the Irish Government to assist in the bailout of Depfa Bank.

With so much money, and given the role shadow banking played in the financial crisis, many assume this is now a tightly regulated area. But financial-vehicle corporations are not regulated by the Central Bank of Ireland. It says its role is to regulate firms rather than specific financial products. It started keeping figures on the number of these vehicles based in Ireland only from 2008 onwards. Today, a total of two employees in the Central Bank oversee the industry.

Next Tuesday’s meeting of finance ministers appears to be one step in a much longer-term EU-wide bid to tackle aggressive tax planning. It’s unclear at this stage what impact, if any, these moves will have on Ireland. Initial indications are that it is unlikely to focus heavily on so-called shadow banking, at least for now.

The financial-services industry says that because the clampdown is on tax havens and tax evasion, it has nothing to worry about. "None of the measures identified in the action plan are likely to have a significant impact on Ireland," says Fergal O'Brien of Ibec. He reiterates that Ireland's network of treaties with other jurisdictions means that it operates a simple and transparent corporation-tax system. "The European Commission is predominantly targeting tax evasion in its work at both the business and personal level."

On the issue of companies being able to trim their tax bills well below corporation-tax rates, O’Brien says there are many legitimate reasons companies are able to do so. Tackling tax evasion, on the other hand, requires an international response.

“There are various reasons some companies might pay an effective rate which is lower than the headline rate: allowances for research and development investment or timing issues. The globalised nature of modern businesses and their presence in multiple tax jurisdictions also clearly complicates tax systems.

“Tax evasion must be fought on a co-ordinated basis by governments, and it is positive to see that both the EU Commission and the OECD have recently placed more attention on the issue. Tax evasion of any form is totally unacceptable.”

Erosion of tax
It remains to be seen just how the EU's attempts to tackle the erosion of tax will affect Ireland.

What is clear is that European governments, at a time of austerity, are less likely to put up with potential tax revenue being shifted outside their jurisdictions.

“Let’s remember what the battle against tax evasion is really about,” Algirdas Semeta, the European Commissioner for taxation, said recently. “It’s about protecting the fairness of our tax systems, so honest taxpayers don’t pay for the deeds of the dishonest. It’s about protecting our competitiveness, so that our free markets and open economies are not left vulnerable to abuse.

"The tide has turned towards greater information exchange," and tax evaders "must know that this current is too strong to swim against."

Shadow banking: A glossary

Shadow banking: Generally describes nonbank entities involved in the creation of credit across the global financial system. They tend not to be subject to regulatory oversight. Regulators are worried about the role they played in the financial crisis.

Financial-vehicle corporation: A company can use such a vehicle to finance a large project without putting the entire firm at risk. Accounting loopholes means they are often a way for large firms to hide debt, so it looks as if a company doesn't have a liability when, really, it does.

Hedge funds: These are aggressively managed pools of assets that use a variety of investment strategies to make money. They play a big role in debt markets. Globally, they are largely unregulated, causing concern that they could destabilise bank lenders.

Securitisation: This involves the pooling of assets such as mortgages into securities, or tradeable assets. These are combined into pools that can be divided and sold to investors in smaller pieces. The price depends on the level of the risk of default of different types of mortgage.

Clearing house: This is a third party responsible for processing trades that uses capital from its members to guarantee deals, even if one of them defaults. There is some concern among regulators about whether these agencies could withstand multiple defaults.

Money-market funds: The aim of a money-market fund is to give investors a relatively safe place to invest easily accessible assets at a low risk and for a low return. During the financial crisis, many of these funds dumped their assets and stopped purchasing, causing problems for some investors.Generally describes nonbank entities involved in the creation of credit across the global financial system. They tend not to be subject to regulatory oversight. Regulators are worried about the role they played in the financial crisis.