Piketty, transparency and financial crime

Thomas Piketty’s Capital in the 21st Century addresses questions of inequality and wealth across three hundred years of economic history. Piketty spends little time on financial crime. The intricacies of scams, fraud, placement, layering and integration are not germane to his themes. However, he does mount a strong argument for financial transparency and information-sharing as part of his case for a global tax on capital. Piketty acknowledges the obstacles to introducing such a tax, and his proposals for financial transparency would face similar challenges. They require a level of international co-operation that seems an unlikely prospect, given the current climate of competition between nation states for global capital. However, Piketty argues persuasively for the economic benefits that increased information-sharing would deliver.

The worth of data on wealth

An impressive aspect of Piketty’s work is his ingenious use of data to answer economic questions. Where possible, he uses national accounting data published by government treasuries and revenue agencies. However, when Piketty attempts to measure the fortunes of the very wealthy, he is forced to rely on unsatisfactory sources; mainly the Forbes magazine global list of billionaires and the annual wealth report produced by Credit Suisse bank. These reports, with their piecemeal data and ‘heroic assumptions,’ are the best available. Piketty challenges economists and international organisations to do this work in a more systematic way because:

“..democratic transparency requires it; in the absence of reliable information about the global distribution of wealth, it is possible to say anything and everything and to feed fantasies of all kinds (1).”

The solution is the automated collection and exchange ?of data on wealth and asset ownership amongst nation-states. The underlying principle here is that national tax authorities should receive the information they need to calculate the net wealth of taxpayers, even if that necessitates collecting information from other jurisdictions. Piketty argues that data-sharing requirements should have been incorporated into the many international free trade agreements negotiated in the last forty years, and sees no reason to perpetuate this oversight (2).

The costs of opacity

In Piketty’s view, the opacity of data on global wealth has a practical cost to the global economy, and can amplify the impact of economic shocks. This is because international monetary authorities, which play an important role in maintaining stability, have only a rough idea of the global distribution of financial assets. Visibility of wealth held in tax havens is particularly limited. "Navigating our way through a global financial crisis blanketed in such a thick statistical fog," Piketty states, "is full of peril." He cites the example of the 2013 Cypriot banking crisis, where European authorities and the IMF were in the dark about the true ownership of financial assets in Cyprus, and proposed ineffective solutions as a result (3).

'Birmingham Northern Rock bank run 2007' by Lee Jordan is is licensed under CC BY-NC-ND 2.0 via Wikimedia Commons.

It is also relevant to consider the cases of Northern Rock and HBOS, two British banks which collapsed in 2007. Both set up Special Purpose Vehicles (SPVs) in the tax haven of Jersey to borrow money via short-term loans, using the borrowed funds to buy mortgage debt. The banks then securitised and sold these mortgages to pay back the loans, before borrowing more. The SPVs were set up as charitable trusts, meaning that the banks controlled but did not own them. This enabled the banks to keep the SPVs off their balance sheets, freeing up capital and masking their exposure to the US subprime market. This concealment, which inflated profits in the good times, worsened the impact of the subprime crash on their shareholders and depositors (4). Jersey is now obliged to exchange information with the US, UK and the EU on the use of its banks by their citizens.

Financial crime investigators would be familiar with the toll financial opacity takes on their work. The time taken to trace assets concealed in secrecy jurisdictions can make evidence-gathering and asset confiscation unfeasible. In 2010, Australia’s corporate regulator, ASIC, finally abandoned its investigation into the ownership of a secret parcel of shares linked to a 1993 insider trading scandal. The shares had soared in value after a suspicious fire at the Offset Alpine printing firm’s headquarters led to an inflated insurance payout to the company. ASIC gave up after fighting a legal battle for over a decade to obtain evidence of corporate ownership from jurisdictions including Switzerland and the Isle of Man.

Clearly financial opacity does not assist financial crime investigations. Piketty argues convincingly that it does not serve the interests of the global economy either. It only benefits the secrecy jurisdictions which bleed the tax base of their neighbours to enrich themselves. Automated information-sharing arrangements might not have prevented the alleged insider trading in the Offset Alpine case. However they would have enabled the Australian government to resolve the ownership question and move to a decision about the prospects of prosecution and civil action. The same arrangements would give regulators visibility of high-risk financial strategies likely to lead to market failure, like the use of Jersey-registered SPVs by Northern Rock and HBOS. For these reasons, financial transparency is not just important to law enforcement, but is ‘a crucial matter for the modern fiscal state across the board (5).’

This importance is equally clear when it comes to tax evasion. In a sense, the Pandora Papers, Lux Leaks and other scandals of the last decade are a public response to the onward march of offshore tax havens. Each leak sent revenue authorities scrambling to match data to their holdings, as the data revealed how commonplace the offshore concealment of wealth had become. Leaks have been a valuable source of leads for governments and tax authorities, and help make the public aware of the scale and nature of global tax evasion. However leaked information may be incomplete or out of date. It is unlikely to satisfy the evidentiary standards required for criminal or civil enforcement action. Furthermore, the continued emergence of leaks points to a troubling gap in the information-gathering activities of nation-states.

Again and again the International Consortium of Investigative Journalists (ICIJ) has co-ordinated a formidable global intelligence and investigative effort, transforming multiple data sources into a single knowledge base which provides a foundation for action. But something is amiss when government and international organisations wait to receive and react to this information, rather than leading the co-ordination themselves. The ICIJ have grasped Piketty’s point that transparency is a crucial matter for the modern fiscal state, but states themselves hesitate to commit to this objective.

Piketty's views highlight how information-sharing measures which support the investigation of financial crime would also have broader economic benefits. This is unsurprising. Ultimately, the investigation of fraud, corruption and money laundering supports the stability of both global financial markets and democratic states. Opacity of information about global assets and wealth makes it difficult to differentiate between illicit and legally acquired wealth. It also prevents early diagnosis of market risks and makes it harder for regulators to mitigate these risks. As we move into a period of increased global instability and conflict, we are unlikely to see a true global consensus on financial information-sharing. However, governments with shared interests in democracy, stability and the rule of law should pursue it, even if that means progressing smaller-scale regional initiatives to build momentum. The economic cost of leaving governments and monetary authorities in the dark becomes apparent only when they need to act fast, and lack the necessary information.

The views and opinions expressed in this article are solely my own and do not represent the views of my employer.

(1) Capital in the Twenty-First Century, Thomas Piketty, 2014, pp. 552-53.

(2) Ibid, pp. 674-675.

(3) Ibid, pp. 668-669.

(4) For a good summary of the structures used by Northern Rock, see The Finance Curse: How Global Finance is Making Us All Poorer, Nicholas Shaxson, 2018, pp. 169-170.

(5) Piketty, pp. 674-675.

?