The Panama Papers revelations - Morality versus Legality

8 April 2016

This week our somewhat more shady cousins of the offshore wealth management sector grabbed most of the headlines. We have therefore dedicated a separate article to the background of the so called '˜Panama Papers' affair and the impact it may have on this part of the finance world. I personally believe that this may well be the beginning of the end of the large scale private client offshore sector.

This is because now even those investors who thus far didn't have to fear the investigation and payment tracking efficiency of their home country tax and legal authorities or had perfectly legitimate accounts and motives will from now on have to fear that their financial affairs can very quickly be dragged into the public domain. This is particularly true for the Middle American offshore centres, which have lower governance and oversight standards than the European offshore industry of the Channel Islands and Switzerland.

If the Panama Papers were last week's Waterloo moment for private tax dodgers and money launderers, then a US government ruling against so called corporate tax inversion schemes became the same for US companies. US firms felt increasingly obliged towards their shareholders to use a loophole between corporate US tax law and that of Ireland and the Netherlands to set up a construct which redirected revenue flows towards the latter countries with more preferential tax rates. This not only deprived US fiscal authorities of their tax revenues, but also meant that ever increasing amounts of cash reserves accumulated in jurisdictions where these companies had little use for them. The global economy was thus deprived of productive use of vast amounts of capital - not dissimilar perhaps to private wealth parked in offshore tax havens.

From a purely economic point of view, both developments should therefore be welcomed. However, the revelations of the offshore accounts are potentially going to have a negative near-term impact on global politics and industry as many politicians and business leaders will be forced to divert their attention from their real jobs to deal with damage limitation around their private financial affairs.

Stock markets seem to have completed their recovery from the February lows and over the past week once again followed the yo-yo of the oil price, even if less closely than they did a few weeks ago. The oil price lost and gained on the ebb and flow of rumours around production volume concessions different oil producers may be willing to agree to when OPEC and some non-OPEC oil producing nations meet on 17 April in Doha.

Bond markets on the other hand recorded further gains as yields in government bonds of the western world fell once again towards their previous record lows. Just as last year, this was not as a result of a flight to safety, but in the expectation that central banks will keep interest rates low for longer than previously anticipated. This sentiment was further fuelled by the March meeting minutes of the last US central bank's rate setting committee and hints by the Eurozone's ECB.

Away from the main headlines, the concerns that had fuelled the Jan/Feb stock market correction continued to dissipate. China recorded a surprise increase of their foreign currency reserves during March which should put an end to concerns over systemic capital flight from China. US employment data continued to surprise on the upside and the slowly weakening US$ is beginning to offer a more upbeat perspective to US corporate earnings, both domestically and from their overseas activities.

Nevertheless, there are also some signs that economic growth concerns may flare up again in the near future, because the negative feedback loop effects from the market turmoil of Jan/Feb to industry and economic growth are now slowly filtering through. This could cause increased market volatility in the near term as the new levels may get tested for resilience to the downside. Over the medium term however, that is for all of 2016, there are increasingly strong signs that the hiatus since last September may prove to have been yet another mini-cycle as we have now witnessed at least three since the 2008/2009 Great Global Recession.