Ethics and governance in the European Financial centers

Investors in Ucits funds will face possible higher fees if European Union plans to tighten up rules surrounding safekeeping of fund assets become law, reported the Financial Times.

Bloomberg recently quoted Luc Frieden.

 

What he said is worth commenting. 

 

 

“The principle is very clear: the custodian bank has to indemnify (…) Regarding the law, the situation is not that difficult: the custodian bank has a responsibility to make restitution for these assets”, Luc Frieden said.

 

Yes the principle is clear, but it is as well pragmatic, word that Luc Frieden is no longer saying. Let’s read again what Luc Frieden wrote five years ago:

 

“I want to ensure that Luxembourg remains a leading player in the world of investment funds. Based on clear and pragmatic legal rules that are fully compliant with the EU legal framework as well as on the unique international experience built up over the past decades, the Grand-Duchy of Luxembourg will continue to undertake every effort to develop Luxembourg as the European hub for investment funds both for European and non-EU financial operators. » (Fundlook, July-September 2004, page 3)

 

What do pragmatic legal rules mean?

 

Article 10 of the UCIT directive states that “ 1. No single company shall act as both management company and depositary”. This paragraph was purely removed to only transpose literally paragraph 2 that states that “2. In the context of their respective roles the management company and the depositary must act independently and solely in the interest of the unit-holders.”
What is not prohibited by the law is possible. When one knows that Luxembourg is a small jurisdiction where there are many conflicts of interests, requiring acting independently and solely with no requirement of being distinct legal entities is a beginning of problem. It is exactly like the law firm in Luxembourg that is both UBS’ and HSBC’s lawyers, provides the Chairman of ALFI, members in CSSF committees (e.g. Banks Committee or Lawyers Committee) , and takes part in the writing of the legislation in Luxembourg.

 

I will quote again Circular IMS 91/75 (as amended by Circular CSSF 05/177) dated 21 January 1991 that states that “The concept of custody used to describe the general mission of the depositary should be understood not in the sense of “safekeeping”, but in the sense of “supervision” (…) The depositary has discharged its duty of supervision when it is satisfied from the outset and during the whole of the duration of the contract that the third parties with which the assets of the UCI are on deposit are reputable and competent and have sufficient financial resources. “ Such provisions does not comply with article 7 of the UCITS directive that states that “A unit trust's assets must be entrusted to a depositary for safekeeping”

 

 

Madoff did not happen by chance in Luxembourg as the pragmatic legal and regulatory framework opened the drift.

 

It seems that nobody in Luxembourg, Frieden included, commented Commissioner McCreevy’s statement that “the minimum high level principles of the UCITS Directive have been transposed in very diverging ways by Member States, which means that some EU investors in UCITS funds are better protected than others”.

 

 

 “An international arbitration will be a more professional and fast solution that is probably more satisfactory to all (...) I prefer an arbitration of two, three years than having 100 court cases decided in 10 years”, Luc Frieden said.

 

Is the Luxembourg justice not reliable?

Who would pay for such international arbitration? Investors, who already lost money?

 

As I said, it is morally up to the Luxembourg state to pay for the Luxalpha disaster. The only way for investors who are victims of the pragmatic legal and regulatory framework to be respected would be a payment by the Luxembourg State that would go later before the court for the refund in the legal and regulatory framework it enforced.

 

Should this simple solution had been implemented when I stated it, early this year, the Madoff story would be over in Luxembourg.

 

It is now only beginning after what stated the CSSF in its latest press release.

 

 

 

Have in the future “Luxembourg as the European hub for investment funds both for European and non-EU financial operators”, Luc Frieden said.

 

I am afraid it will no longer be the case unless leaders are changed.

 

They are not. For the moment…

 

 

In a recent press release Angel Gurria from the OECD stated that “agreements with six of its key economic partners show that Luxembourg has joined the international drive to combat tax havens and is moving swiftly towards substantial implementation of the OECD standard.”

 

Considering that the agreements do not have as an aim an automatic exchange of banking information and do not authorize general requests i.e. fishing expeditions as confirmed by Mr Angel Gurria in a letter to Luc Frieden that the Luxembourg Government published ;

Considering that only accurate requests will be satisfied: “where information is requested, it must be exchanged only where it is "foreseeably relevant' to the administration or enforcement of the domestic laws of the treaty partner. Countries are not at liberty to engage in 'fishing expeditions" or to request information that is unlikely to be relevant to the tax affairs of a given taxpayer. In formulating their requests, competent authorities should demonstrate the foreseeable relevance of the requested information” (A. Gurria to L. Frieden, 13 March 2009);

Considering that it will be a long shot for competent tax authorities to demonstrate the foreseeable relevance of the requested information;

Considering that the "foreseeable relevance" of the requested information will be at the discretion of country where the evasion take place;

Considering that in any event for accepted requests there will be delays for foreign tax administrations to obtain the requested data, like it is for the “letters of request” (to foreign courts);

Considering that in Luxembourg bankers welcome tax evasion that is not repudiated all the more than they consider that it is not their duty to control if the taxpayer was honest (Cf. Lucien Thiel’s doctrine: he is the former chairman of the Luxembourg Bankers’ association, and one of the founders of the LIGFI);

Considering that Swiss professional recently admitted the OECD tax model is a charade to counter tax evasion (According to Thomas Kalbermatten, bank Analyst at Credit Suisse, quoted by Le Temps, "Il sera, en pratique, très difficile pour les autorités fiscales étrangères qui appliquent les standards de l’OCDE de fournir ce degré de details" (free translation: “It will be, in practice, very difficult for the foreign tax authorities which apply the OECD standards to provide this degree of details”; according to Didier de Montmollin, partner at Secretan Troyanov, quoted by Le Temps, "Si la Suisse va dans la même ligne que le Luxembourg, le résultat ne sera pas du tout si problématique pour la Suisse. Le secret bancaire sera relativement préservé, et le client restera maître de son éthique fiscale". (free translation: “If Switzerland goes in the same line as Luxembourg, the result will not be so problematic  at all  for Switzerland. Banking secrecy will be relatively preserved, and the client will keep his/her tax ethics under control”)  

Considering that it result from the above that many tax payers that commit fraud neither will be dissuaded nor will be detected

 

The international drive to combat tax havens, as promoted by the OECD, and the swift move towards substantial implementation are a charade, so was the OECD list.

 

 

Luxembourg, and every jurisdiction, will be credible in their will to combat tax evasion when they vote at least a legal and regulatory framework to criminalise tax evasion, like AML legal and regulatory framework, with dissuasive sanctions.

Such framework would make useless the automatic exchange, provided that the sanctions are both dissuasive and effective, and are not made difficult even impossible in practice by a subtle formulation (like “knowingly”, added to the Luxembourg AML law).

 

Subsidiary questions:

-         By the way, what about Luxembourg’s situation in the international drive to combat corruption especially, with the criminal liability of legal persons and in general in the implementation of OECD or GRECO Recs?

-         By the way, what about Luxembourg’s actual framework on the depositary’s liability regarding the UCITS directive despite a misleading communication on the “faithful transposition” (I know that the OECD did not communicate on Madoff despite it is a very interesting case study of the perfectible governance in Luxembourg where EVERYONE - leaders and powerhouses, politicians and professionals, regulator - did not tell the truth. Why would they be trusted in their move towards substantial implementation of the OECD standard? Once a liar always a liar…