## 1. OFC Definitions

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### Introduction and Rationale
- Increasing recognition of the need to improve understanding of the activities of offshore financial centers (OFCs) because these centers have captured a significant proportion of global financial flows.
- A clear definition of what constitutes an OFC would be useful to the IMF in the context of its assessment program of the centers.
- Following concerns expressed by the Financial Stability Forum (FSF) in 2000, the Executive Board mandated the IMF to enhance OFCs’ adherence to internationally accepted prudential and supervisory standards.
- IMF interest areas:
  - Impact on the national economies of member countries from operations undertaken in OFCs, within IMF surveillance of economic and financial policies.
  - Specific vulnerabilities to financial system stability in countries operating OFCs, including risks from anonymity, opacity of financial operations, and legal protection in some OFCs that heighten potential for financial abuses.
  - Competitive pressures in OFCs that may create incentives for profitability at the expense of regulatory and supervisory standards.

### Proposed Definition and Conceptual Basis
- Verbatim proposed definition:
  - "An OFC is a country or jurisdiction that provides financial services7 to nonresidents on a scale that is incommensurate with the size and the financing of its domestic economy."
- Three recurrent characteristics in conceptual definitions:
  - (i) primary orientation of business toward nonresidents;
  - (ii) favorable regulatory environment (low supervisory requirements and minimal information disclosure);
  - (iii) low-or zero-taxation schemes.
- Emphasis: OFC raison d’être is the provision (exports) of financial services to nonresidents; specialization in export of financial services may generate revenues that often constitute a critical proportion of national income.
- Typical receipts of these exports:
  - financial services billed to nonresidents by domiciled entities (examples enumerated in source);
  - registration/renewal fees for licensed entities (offshore banks, insurance companies, collective investment vehicles, international business companies, trusts and estates, etc.).
- Note: Definition ideally would include insurance services (excluding freight insurance) per United Nations et al. (2002), but data limitations prevented inclusion of insurance services in analysis.
- Order-of-magnitude examples:
  - British Virgin Islands: fees accounting for almost 55 percent of government revenue, or 13 percent of GDP (at end-2000).
  - Cayman Islands: fees accounting for 14.5 percent of government revenue, or 4.1 percent of GDP.

### Indicators and Measurement Strategy
- Primary flow-based indicator:
  - Ratio of net financial services exports to GDP.
  - Measurement challenges: omissions in reporting of financial services entries; many jurisdictions (especially OFCs) do not collect or disseminate balance of payments statistics.
- Stock-based proxy indicators (rationale: exports of financial services generally matched by underlying capital flows):
  - CPIS Assets: ratio of CPIS Portfolio Assets to GDP (CPIS = Coordinated Portfolio Investment Survey data on cross-border holdings of portfolio investment assets by residence of the issuer).
  - Filtered IIP Assets: ratio of filtered IIP assets to GDP, where filtered IIP assets = total IIP assets excluding foreign direct investment, reserve assets, and all assets belonging to general government and monetary authorities (includes financial derivatives).
- Combined-data coverage:
  - Use of financial services (current account), CPIS, and IIP expands coverage from 77 to 104 countries/jurisdictions.
- Historical stock-based IMF working criteria cited:
  - "close to or more than 50 percent of GDP and in absolute terms more than $1 billion."
  - "at least three times the world average" (Landell-Mills, 1986) cited as operationalization of "significantly larger than the world average".

### Data Strengths and Weaknesses
- Financial services approach:
  - Good coverage overall; many OFCs do not compile a balance of payments or exclude offshore sector; weak coverage of insurance services; implicit pricing may distort reporting.
- Filtered IIP approach:
  - Adequate coverage for onshore middle-income jurisdictions; many OFCs do not compile IIP; difficulties in stock valuations; poor submission on financial derivatives.
- CPIS Assets approach:
  - Best coverage of offshore jurisdictions and sometimes the only data available for OFCs; data quality and collection methods vary; substantial underreporting in some jurisdictions due to confidentiality/practical reasons.
- CPIS and IIP handling:
  - Combined series constructed as Max(CPIS, IIP) by taking CPIS where only CPIS was submitted, IIP where only IIP was submitted, and the highest of the two where both were submitted with different values.
- CPIS limitations:
  - CPIS relatively new; participation voluntary; many 2003 submissions their first portfolio data collection; coverage and collection methods vary.
- IIP limitations:
  - Valuation and reconciliation challenges; many submitters leave financial derivatives line blank.

### Econometric Estimations (Estimating Missing Flow Ratios)
- Strategy:
  - Assemble Max(CPIS, IIP) = higher of CPIS total assets and IIP portfolio investment asset position for sample countries with both series.
  - Run OLS regressions to estimate ratio of net financial services exports where flow data missing.
- Regression equations:
  - Equation (1): Ratio of net financial services exports = α + β (Ratio of Max (CPIS, IIP)) + μ
  - Equation (2): Ratio of net financial services exports = γ + δ (Ratio of filtered IIP) + ε
- Regression summary results (preserved exactly):
  - High income, Max(CPIS, IIP), Equation 1:
    - Coefficient on Max(CPIS, IIP) ratio = 0.0038605, "t" statistic = 3.53***.
    - Intercept = 0.0000416, "t" statistic = 0.00.
    - R-squared = 0.3416.
    - Number of observations = 26.
    - *** statistical significance at the 99 percent level or greater.
  - High income, filtered IIP, Equation 2:
    - Coefficient on "Filtered" IIP ratio = 0.0028953, "t" statistic = 4.91***.
    - Intercept = -0.1297243, "t" statistic = -0.90.
    - R-squared = 0.5231.
    - Number of observations = 24.
    - *** statistical significance at the 99 percent level or greater.
  - Low and middle income, Max(CPIS, IIP), Equation 1:
    - Coefficient on Max(CPIS, IIP) ratio = 0.0081085, "t" statistic = 1.76**.
    - Intercept = -0.0672926, "t" statistic = -1.39.
    - R-squared = 0.0814.
    - Number of observations = 37.
    - ** statistical significance at the 95 percent level or greater.
  - Low and middle income, filtered IIP, Equation 2:
    - Coefficient on "Filtered" IIP ratio = 0.0050788, "t" statistic = 4.26***.
    - Intercept = -0.1464467, "t" statistic = -3.16.
    - R-squared = 0.3615.
    - Number of observations = 34.
    - *** statistical significance at the 99 percent level or greater.
- Interpretation:
  - Equations using filtered IIP (eq. 2) are more robust than those using Max(CPIS, IIP) (eq. 1) for both income groups.
  - Regressions for high-income group present better fit than low-and middle-income group, reflecting better data quality for high-income countries.
- Construction of final series:
  - For each income group, final ratios combined:
    - (i) observed financial services exports value;
    - (ii) estimated value from filtered IIP regression (eq. 2) when available;
    - (iii) estimated value from Max(CPIS, IIP) regression (eq. 1) when filtered IIP estimate not available.
  - In high-income group: 29 observed values and 11 estimated (4 via eq. 2; 7 via eq. 1).
  - In low-and middle-income group: 51 observed values and 13 estimated (9 via eq. 2; 4 via eq. 1).
- Role of regressions: instrumental/constructive (not behavioral causal equations) confirming positive correlation between flows and stocks.

### Empirical Identification Methodology and Results
- OFC identification rule:
  - Compute ratio of net exports of financial services to GDP for each country in each income group.
  - Calculate mean and observed standard deviation for each group.
  - Use observed standard deviation as threshold: ratios above the standard deviation considered atypical and indicative of OFC status.
- Observed standard deviations used:
  - High-income observed standard deviation (excluding Luxembourg) = 0.667 (Table 8).
  - Low-and middle-income observed standard deviation = 0.217 (Table 9).
- High-income group results:
  - Luxembourg identified as outlier (five standard deviations above the mean) and excluded from regression of equation (1) and statistical moments.
  - Aruba metadata: offshore activity excluded from CPIS and balance of payments, making data irrelevant for selection criteria.
  - Of roughly 40 countries in the high-income category, 16 identified as OFCs. The text lists 16: The Bahamas; Bahrain; Bermuda; Cayman Islands; Cyprus; Hong Kong; Guernsey; Ireland; Isle of Man; Jersey; Luxembourg; Malta; Netherlands Antilles; Singapore; Switzerland; United Kingdom.
  - Stricter threshold (two standard deviations) yields greater certainty for Bahrain, Bermuda, the Cayman Islands, Hong Kong, Guernsey, Isle of Man, Jersey, Luxembourg, Netherlands Antilles, Singapore, and Switzerland as OFCs.
- Low-and middle-income group results:
  - Of more than 60 members, 6 qualified as OFCs: Barbados, Latvia, Mauritius, Panama, Uruguay, and Vanuatu.
  - Notes and caveats:
    - Latvia: hosts numerous offshore banks and companies serving mainly nonresident CIS clients; more than half of bank total deposits in Latvia are of nonresident origin (IMF, 2005).
    - Uruguay: operations of some 12 offshore banks and about half a dozen offshore mutual fund companies; under consideration for IMF OFC program participation.
    - Mauritius: CPIS assets ratio an outlier (6 standard deviations above mean) with CPIS assets to GDP over 470 percent (average of 7 percent for the group); CPIS-based ratio treated as outlier.
- Overall findings:
  - Majority of low-and middle-income countries are net importers of financial services; majority of high-income countries are net exporters.
  - Study identified 22 countries and jurisdictions as offshore or international financial centers, of which 16 belong to high-income group.
  - The approach identified 80 percent of the OFCs in the study sample that also appear in the a priori IMF list used for the OFC program.
  - Empirical identification singled out Latvia, the United Kingdom, and Uruguay as OFCs based on the defined criteria.

### Appendix I — Origins, Scale, and Activities of OFCs
- Origins and historical drivers:
  - OFCs described as geographical extension of the Eurocurrency market outside Western Europe.
  - Four factors explaining creation and growth: capital controls to reduce balance of payments deficits; high taxes and tightened monetary policy; removal in 1958 of foreign exchange restrictions on conversion by nonresidents in Western Europe; U.S. banks' response to Glass-Steagall Act of 1933.
  - Historical market growth:
    - During 1966-77, the gross size of the Euromarket grew 17-fold, from US$18 billion at end-1966 to US$310 billion at end-1977.
- Significance and selected quantitative indicators (preserved exactly):
  - By end-December 2003, the external position of offshore banks in terms of assets (in accordance with the BIS list) had reached US$1.9 trillion, compared with US$16 trillion of total bank assets.
  - By the same date, external loans (i.e., claims of OFCs on the rest of the world) had reached US$1.5 trillion or 13 percent of the world cross-border bank claims, as reported to the BIS (US$11.9 trillion).
  - Assets under management in OFCs are estimated at around US$400 billion, compared with assets managed worldwide estimated at US$12 trillion.
  - Bermuda reported in 2001 some 1,600 insurance and reinsurance companies totaling $172 billion in assets, and underwriting over $48 billion in annual gross premiums.
  - In 2004, Bermuda became the fourth-largest reinsurance market in the world, after the United Sates, Germany, and Switzerland (in terms of total net written premiums).
  - Historical BIS-based on-balance-sheet figure cited elsewhere: on-balance-sheet OFC cross-border assets reached US$4.6 trillion at end-June 1999 (about 50 percent of total cross-border assets), of which US$0.9 trillion in the Caribbean.
- Measurement caveats:
  - Balance of payments records for financial services face complications due to “invisible trade,” absence of explicit prices for many services, and imputed financial intermediation services indirectly measured (FISIM) in SNA 1993; BPM5 does not require estimation of FISIM.
  - Understatements may be more pronounced in low-and middle-income countries with weak data collection capabilities; most of these countries do not compile FISIM.

### Conclusions and Suggested Refinements
- Paper contributions:
  - (i) Proposed an alternative definition of OFCs based on exports of financial services to nonresidents.
  - (ii) Developed a statistical method to distinguish OFCs from non-OFCs using ratio of net financial services exports to GDP and stock-based proxies (CPIS Assets and filtered IIP assets).
- Validation and findings:
  - Identified 22 OFCs in the sample; 16 in high-income group.
  - Identified 80 percent of OFCs that also appear in IMF's prior OFC list.
  - Differentiated OFCs strictly on distinctive macroeconomic features, avoiding subjective presumptions.
- Suggested avenues for refinement:
  - Construct sectoral proxies to examine OFC activity by sector (banking, insurance, securities).
  - Use BIS locational banking statistics to supplement CPIS and IIP and to identify minor centers with significant offshore banking components.

*Source: _wp0787 - 1. OFC Definitions (IMF PDF).*

### 1. OFC Definitions......................................................................................................

### 1. OFC Definitions

### Introduction and Rationale
- Increasing recognition of the need to improve understanding of the activities of offshore financial centers (OFCs) because these centers have captured a significant proportion of global financial flows.
- A clear definition of what constitutes an OFC would be useful to the IMF in the context of its assessment program of the centers.
- Following concerns expressed by the Financial Stability Forum (FSF) in 2000, the Executive Board mandated the IMF to enhance OFCs’ adherence to internationally accepted prudential and supervisory standards.

### IMF Concerns and Remits Regarding OFCs
- OFCs provide financial services predominantly to nonresidents.
- IMF interest areas:
  - Impact on the national economies of member countries from operations undertaken in OFCs, within IMF surveillance of economic and financial policies.
  - Specific vulnerabilities to financial system stability in countries operating OFCs, including risks from anonymity, opacity of financial operations, and legal protection in some OFCs that heighten potential for financial abuses.
  - Competitive pressures in OFCs (which depend on attracting global financial business) that may create incentives for profitability at the expense of regulatory and supervisory standards.
- Multilateral initiatives are minimizing the scope for regulatory arbitrage, but challenges remain.

### Global Initiatives and Mandate
- Concerns about risks posed by OFCs to the international financial system have resulted in a number of global initiatives to improve oversight.2
- Motivated by its mandate to promote financial stability, the IMF, in 2000, embarked on an assessment program aimed at:
  - Determining the extent to which OFCs met the standards advocated by international standard setters3 in banking, insurance, securities and anti-money-laundering regimes.
  - Helping to strengthen OFCs’ financial supervision.

### Conceptual and Empirical Challenges
- No unanimity exists on what constitutes an OFC.
- While authors have proposed various lists of OFCs, an empirical framework for uniform classification does not exist.

### Objectives of This Paper
- The paper proposes a framework for a uniform classification of OFCs.
- The paper develops operational and measurable indicators of the OFC status of any given economy.
- The paper derives a list of countries/jurisdictions4 that could be classified as OFCs.

### Terminology Note
- The term “jurisdiction” is used to designate any territorial entity that is not a “country” or a “state” as commonly understood by international law and practice.
- In most cases, a jurisdiction refers to an overseas territory under the sovereignty of another state (typically a former colony or dependency).
- In other cases, jurisdiction refers to an enclave within a given country.

*Source: _wp0787 - 1. OFC Definitions (IMF PDF).*

### Section IV proposes a definition, as well as empirical indicators, and section V concludes the paper.

### _wp0787 - Section IV proposes a definition, as well as empirical indicators, and section V concludes the paper.

### II. Definitions of an OFC: A survey of the literature
- No consensus exists on what constitutes an Offshore Financial Center (OFC); multiple synonymous terms used include International Financial Center (IFC), International Banking Center (IBC), International Banking Facilities (IBFs), and Offshore Banking Center.
- Two groups of definitions identified:
  - Conceptual definitions (mostly academic).
  - Operational definitions (mostly IMF/practical).
- Three recurrent characteristics in conceptual definitions:
  - (i) primary orientation of business toward nonresidents;
  - (ii) favorable regulatory environment (low supervisory requirements and minimal information disclosure);
  - (iii) low-or zero-taxation schemes.
- Historical IMF/operational definitions cited:
  - IMF (1995) alternative definition: banking system acting as financial entrepôt with substantial external accounts beyond domestic economic activity; or ratio of deposit banks’ external assets to exports of goods and services at least three times the world average (Landell-Mills, 1986).
  - IMF Statistics Department (IMF, 2002) working definition: jurisdiction in which international investment position assets (including all resident entities) are close to or more than 50 percent of GDP and in absolute terms more than $1 billion.

### III. Limitations of previous definitions
- Prior definitions tend to equate OFCs with regulatory/tax phenomena and do not differentiate OFCs by measurable macroeconomic features resulting from cross-border financial intermediation.
- Objective definition is important for IMF OFC assessments to promote participation and ownership in voluntary assessment programs.

### IV. Definition of OFCs and empirical indicators
A. Proposed definition
- Proposed definition (verbatim): "An OFC is a country or jurisdiction that provides financial services7 to nonresidents on a scale that is incommensurate with the size and the financing of its domestic economy."
- Emphasis: OFC raison d’être is the provision (exports) of financial services to nonresidents; specialization in export of financial services may generate revenues that often constitute a critical proportion of national income.
- Typical receipts of these exports:
  - financial services billed to nonresidents by domiciled entities (examples enumerated: bank fees for advisory services and financial engineering; intermediary service fees related to lines of credit, financial leasing, and foreign exchange; commissions on funds administration and securities transactions including brokerage, placements of issues, underwritings, arrangement of swaps, options, and other hedging instruments; services related to asset management; security custody services, etc.); and
  - registration/renewal fees for licensed entities (offshore banks, insurance companies, collective investment vehicles, international business companies, trusts and estates, etc.).
- Note: Definition ideally would include insurance services (excluding freight insurance) per United Nations et al. (2002), but data limitations prevented inclusion of insurance services in analysis.
- Order-of-magnitude examples cited:
  - At end-2000, British Virgin Islands collected fees accounting for almost 55 percent of government revenue, or 13 percent of GDP.
  - Cayman Islands collected fees accounting for 14.5 percent of government revenue, or 4.1 percent of GDP (Suss E. et al, 2002).

B. Indicator of OFC status (flow concept)
- Primary indicator proposed: ratio of net financial services exports10 to GDP.
- Measurement challenges: omissions in reporting of financial services entries; many jurisdictions (especially OFCs) do not collect or disseminate balance of payments statistics.
- Flow concept can be supplemented by stock concept.

C. Proxy indicators of OFC status (stock concepts)
- Rationale: exports of financial services from OFCs are generally matched by underlying capital flows that affect assets and liabilities positions (stocks).
- Two stock-based proxy indicators constructed:
  - CPIS Assets: ratio of CPIS Portfolio Assets to GDP (CPIS = Coordinated Portfolio Investment Survey data on cross-border holdings of portfolio investment assets by residence of the issuer).
  - Filtered IIP Assets: ratio of filtered IIP assets to GDP, where filtered IIP assets = total IIP assets excluding foreign direct investment, reserve assets, and all assets belonging to general government and monetary authorities (includes financial derivatives).
- The stock proxies rest on positive correlation between exports of financial services and accumulation of assets domiciled in offshore jurisdictions.

D. Data description and issues
- Combined use of financial services (current account), CPIS, and IIP expands coverage from 77 to 104 countries/jurisdictions.
- Countries classified into two income groups using 2003 World Bank classification consolidated into:
  - low and middle income; and
  - high income.
- Summary of data strengths and weaknesses (Table 2, key points):
  - Financial services approach: good coverage overall; many OFCs do not compile a balance of payments or exclude offshore sector; weak coverage of insurance services; implicit pricing may distort reporting.
  - Filtered IIP approach: adequate coverage for onshore middle-income jurisdictions; many OFCs do not compile IIP; difficulties in stock valuations; poor submission on financial derivatives.
  - CPIS Assets approach: best coverage of offshore jurisdictions and sometimes the only data available for OFCs; data quality and collection methods vary; substantial underreporting in some jurisdictions due to confidentiality/practical reasons.

E. Econometric estimations (estimating missing flow ratios)
- Strategy:
  - Assemble Max(CPIS, IIP) = higher of CPIS total assets and IIP portfolio investment asset position for sample countries with both series.
  - Run OLS regressions to estimate ratio of net financial services exports where flow data missing.
- Regression equations:
  - Equation (1): Ratio of net financial services exports = α + β (Ratio of Max (CPIS, IIP)) + μ
  - Equation (2): Ratio of net financial services exports = γ + δ (Ratio of filtered IIP) + ε
- Regression summary results (Tables 3–6):
  - High income, Max(CPIS, IIP), Equation 1:
    - Coefficient on Max(CPIS, IIP) ratio = 0.0038605, "t" statistic = 3.53***.
    - Intercept = 0.0000416, "t" statistic = 0.00.
    - R-squared = 0.3416.
    - Number of observations = 26.
    - *** statistical significance at the 99 percent level or greater.
  - High income, filtered IIP, Equation 2:
    - Coefficient on "Filtered" IIP ratio = 0.0028953, "t" statistic = 4.91***.
    - Intercept = -0.1297243, "t" statistic = -0.90.
    - R-squared = 0.5231.
    - Number of observations = 24.
    - *** statistical significance at the 99 percent level or greater.
  - Low and middle income, Max(CPIS, IIP), Equation 1:
    - Coefficient on Max(CPIS, IIP) ratio = 0.0081085, "t" statistic = 1.76**.
    - Intercept = -0.0672926, "t" statistic = -1.39.
    - R-squared = 0.0814.
    - Number of observations = 37.
    - ** statistical significance at the 95 percent level or greater.
  - Low and middle income, filtered IIP, Equation 2:
    - Coefficient on "Filtered" IIP ratio = 0.0050788, "t" statistic = 4.26***.
    - Intercept = -0.1464467, "t" statistic = -3.16.
    - R-squared = 0.3615.
    - Number of observations = 34.
    - *** statistical significance at the 99 percent level or greater.
- Interpretation:
  - Equations using filtered IIP (eq. 2) are more robust than those using Max(CPIS, IIP) (eq. 1) for both income groups.
  - Regressions for high-income group present better fit than low-and middle-income group, reflecting better data quality for high-income countries.
- Construction of final series:
  - For each income group, final ratios combined: (i) observed financial services exports value; (ii) estimated value from filtered IIP regression (eq. 2) when available; (iii) estimated value from Max(CPIS, IIP) regression (eq. 1) when filtered IIP estimate not available.
  - In high-income group: 29 observed values and 11 estimated (4 via eq. 2; 7 via eq. 1).
  - In low-and middle-income group: 51 observed values and 13 estimated (9 via eq. 2; 4 via eq. 1).
- Regression role: instrumental/constructive (not behavioral causal equations) confirming positive correlation between flows and stocks.

F. Empirical results and OFC identification methodology
- Method:
  - Compute ratio of net exports of financial services to GDP for each country in each income group.
  - Calculate mean and observed standard deviation for each group.
  - Use observed standard deviation as threshold: ratios above the standard deviation considered atypical and indicative of OFC status.
- Results — high-income group:
  - One jurisdiction (Luxembourg) identified as outlier (five standard deviations above the mean) and excluded from regression of equation (1) and statistical moments.
  - Metadata for Aruba shows offshore activity excluded from CPIS and balance of payments, making data irrelevant for selection criteria.
  - Of roughly 40 countries in the high-income category, 16 identified as OFCs (the text lists 16 among which: The Bahamas; Bahrain; Bermuda; Cayman Islands; Cyprus; Hong Kong; Guernsey; Ireland; Isle of Man; Jersey; Luxembourg; Malta; Netherlands Antilles; Singapore; Switzerland; United Kingdom). (Text also notes that, save for the United Kingdom, all these centers are already on IMF OFC list.)
  - Stricter threshold (two standard deviations) yields greater certainty for Bahrain, Bermuda, the Cayman Islands, Hong Kong, Guernsey, Isle of Man, Jersey, Luxembourg, Netherlands Antilles, Singapore, and Switzerland as OFCs.
- Results — low-and middle-income group:
  - Of more than 60 members, 6 qualified as OFCs: Barbados, Latvia, Mauritius, Panama, Uruguay, and Vanuatu.
  - Notes and data caveats:
    - Latvia: hosts numerous offshore banks and companies serving mainly nonresident CIS clients; more than half of bank total deposits in Latvia are of nonresident origin (IMF, 2005).
    - Uruguay: operations of some 12 offshore banks and about half a dozen offshore mutual fund companies; under consideration for IMF OFC program participation.
    - Mauritius: reported balance of payments do not presently cover offshore financial transactions (GDDS metadata); CPIS assets ratio for Mauritius was an outlier (6 standard deviations above mean) with CPIS assets to GDP over 470 percent (average of 7 percent for the group), implying CPIS-based ratio treated as outlier.
- Overall counts and observations:
  - Majority of low-and middle-income countries are net importers of financial services; majority of high-income countries are net exporters.
  - Study identified 22 countries and jurisdictions as offshore or international financial centers, of which 16 belong to high-income group (Table 7 summary referenced).

Key numerical thresholds and empirical parameters used
- Stock-based IMF working criteria cited historically: "close to or more than 50 percent of GDP and in absolute terms more than $1 billion."
- Historical statistical rule cited: "significantly larger than the world average" operationalized as "at least three times the world average" (Landell-Mills, 1986).
- Regression coefficients and statistics (see Econometric estimations section for exact entries).
- Observed standard deviations used as OFC thresholds: high-income observed standard deviation (excluding Luxembourg) = 0.667 (Table 8); low-and middle-income observed standard deviation = 0.217 (Table 9).

### V. Conclusion
- Paper contributions:
  - (i) Proposed an alternative definition of OFCs based on the nature of their trade (exports of financial services to nonresidents).
  - (ii) Developed a statistical method to distinguish OFCs from non-OFCs using ratio of net financial services exports to GDP and stock-based proxies (CPIS Assets and filtered IIP assets).
- Validation and findings:
  - The approach identified 80 percent of the OFCs in the study sample that also appear in the a priori IMF list used for the OFC program.
  - Differentiated OFCs strictly on distinctive macroeconomic features, avoiding subjective presumptions.
  - Identified Latvia, the United Kingdom, and Uruguay as OFCs based on empirical criteria.
- Suggested avenues for refinement:
  - Construct sectoral proxies to examine OFC activity by sector (banking, insurance, securities).
  - Use BIS locational banking statistics to supplement CPIS and IIP and to identify minor centers with significant offshore banking components.

*Source: IMF working paper content provided in the supplied PDF excerpt.*

### APPENDIX I: OFCS—THEIR ORIGINS AND ACTIVITIES

### APPENDIX I: OFCS—THEIR ORIGINS AND ACTIVITIES

### A. The Origins and Rationale of OFCs
- OFCs are described as the geographical extension of the Eurocurrency market outside Western Europe; both share a common history.
- OFCs and Eurocurrency centers emerged as an efficient market response by international banks to restrictive domestic regulations on capital flows in many advanced countries in the 1960s and 1970s.
- Restrictions intended to strengthen domestic monetary policy encouraged a shift of deposits and borrowing to less regulated institutions—banks in OFCs and Eurobanks—that were exempt from such restrictions.
- Four factors offered by practitioners and academics to explain the creation and growth of present-day offshore centers:
  - the establishment of capital controls with a view to reducing unsustainable balance of payments deficits recorded primarily by the United States in the late 1950s and also, by many OECD countries in the 1960s;
  - the imposition of high taxes, coupled with a tightening of monetary policy, in an attempt to curb balance of payment deficits resulting from fiscal imbalances, particularly in some OECD countries;
  - the removal in 1958 of foreign exchange restrictions on the conversion by nonresidents of current earnings in Western Europe (Johnston, 1982);
  - the fact that U.S. banks’ interest in conducting business transactions in foreign currencies and to extend their reach to new territories was spurred by the Glass-Steagall Act of 1933, which barred commercial banks from entering the investment banking business.
- The combined effect of increasingly restrictive onshore regulatory regimes and new offshore business opportunities (notably the return to full convertibility of nonresident assets in Europe) drove financial delocalization and broadened the Eurocurrency market.
- Historical growth highlights:
  - After 1966, U.S. money market rates rose above the interest rate ceilings on dollar deposits allowed by Regulation Q, producing a credit crunch that forced U.S. banks to seek funds in the Eurodollar market.
  - During 1966-77, the gross size of the Euromarket grew 17-fold, from US$18 billion at end-1966 to US$310 billion at end-1977.
- In the early 1970s the market’s geographical location shifted from mainly Western Europe to worldwide, with banks and later securities and insurance firms establishing offshore branches in jurisdictions in the Caribbean, Latin America and Southeast Asia—these jurisdictions became known as offshore financial centers.

### B. Significance of OFC Activities in the International Financial System
- Data limitations and coverage caveats are emphasized: statistics are incomplete, and OFC reporting to BIS and other sources is not universal; available statistics nevertheless indicate sizeable offshore banking business.
- Selected quantitative indicators (preserved exactly as reported):
  - By end-December 2003, the external position of offshore banks in terms of assets (in accordance with the BIS list) had reached US$1.9 trillion, compared with US$16 trillion of total bank assets.
  - By the same date, external loans (i.e., claims of OFCs on the rest of the world) had reached US$1.5 trillion or 13 percent of the world cross-border bank claims, as reported to the BIS (US$11.9 trillion).
  - Assets under management in OFCs are estimated at around US$400 billion, compared with assets managed worldwide estimated at US$12 trillion.
  - Bermuda (leading OFC and the world’s largest captive insurance center) reported in 2001 some 1,600 insurance and reinsurance companies totaling $172 billion in assets, and underwriting over $48 billion in annual gross premiums.
  - In 2004, Bermuda became the fourth-largest reinsurance market in the world, after the United Sates, Germany, and Switzerland (in terms of total net written premiums).
- Note on underestimation: because not all banks or OFCs report to the BIS, the stated BIS-based figures are likely underestimated.
- Historical BIS-based on-balance-sheet figure (cited elsewhere in appendix): on-balance-sheet OFC cross-border assets reached US$4.6 trillion at end-June 1999 (about 50 percent of total cross-border assets), of which US$0.9 trillion in the Caribbean.

### Data and measurement considerations relevant to OFC activity assessment
- Measurement challenges:
  - Balance of payments records for financial services face complications due to “invisible trade,” absence of explicit prices for many services, and imputed financial intermediation services indirectly measured (FISIM) in SNA 1993; BPM5 does not require estimation of FISIM, so BOP records tend to underestimate trade in financial services and banking services in particular.
  - Understatements may be more pronounced in low-and middle-income countries with weak data collection capabilities; most of these countries do not compile FISIM.
- CPIS and IIP data handling:
  - A combined series (Max of (CPIS, IIP)) was constructed by taking CPIS Assets where only CPIS was submitted, IIP where only IIP was submitted, and the highest value of the two where both were submitted with different values.
  - Rationale: CPIS is compiled on a market-value basis and may be higher than IIP when IIP uses “book value”; conversely, IIP may exceed CPIS when CPIS coverage is limited for confidentiality reasons.
- CPIS limitations:
  - CPIS is relatively new (four years old at the time) and participation is voluntary; many countries’ 2003 submissions represented their first portfolio data collection.
  - CPIS coverage is incomplete in countries and institutional sectors; massive underreporting can occur when participants omit sectors (e.g., Caymans reporting only banking sector holdings).
  - Data collection methods vary across countries (aggregate vs security-by-security, end-investors vs custodians, optional vs mandatory participation), affecting accuracy.
- IIP limitations:
  - Valuation: stocks derived from flows require revaluation for exchange rate and price changes; reconciling flows valued at transaction-time market value with end-period market-price stocks is sensitive and difficult, especially in volatile markets.
  - Financial derivatives stocks are contingent claims whose values and ledger positions can change over time; many IIP submitters leave the financial derivatives line blank.

*Source: APPENDIX I: OFCS—THEIR ORIGINS AND ACTIVITIES (excerpt).*/*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2007/_wp0787.pdf_