US, European banks divided over 'high-risk jurisdiction' list of nations

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Global custodians are at loggerheads among themselves over preparing a list of nations that should be classified as “high-risk jurisdictions”. Sources said US-based banks had pushed for the inclusion of Mauritius in the list, but a few European ones are opposed to it. There have also been disagreements over other jurisdictions, such as the United Arab Emirates, Cayman, and Saudi Arabia, in the absence of standard rules.

Investments from destinations tagged as “high-risk” are subject to stricter regulations, which include lower investment ceiling. Typically, any entity which owns 25 per cent or more in a fund is considered to be a beneficial owner (BO). However, if the fund operates from a high-risk jurisdiction the applicable threshold is 10 to 15 per cent, depending on how the fund is structured. Hence, some of the strategic investors might end up being end-beneficiaries, leading to higher compliance. 

Even though the basic idea behind the list is same across market participants, interpreting the financial risk of a jurisdiction varies from custodian to custodian and is based on several factors including the stance of banks, geo-political factors and tax implications. 

Following the April 10 circular on offshore funds, Sebi asked global custodians to draft a list of high-risk jurisdictions. 
Industry observers have questioned the authority given to custodians — essentially global banks — to draw up this list. There is an inherit conflict of interest among custodians, with each favouring jurisdictions based on, its business interests, they add.

“The disagreement in the Mauritius case was because several vested interests were at play. The custodians who wanted Mauritius on the list were the ones who had substantial interests in other Asian investment destinations. The perception of risk is also very different between US and European institutions. Some of them might find lax in law enforcement a risk while others might find financial secrecy a key risk,” said a source.

A similar disagreement occurred in the case of Cayman, wherein a US custodian had opposed its inclusion in the list. Cayman is amongst the most popular investment destinations for US-based investors and banks have scores of clients who route their investment through the jurisdiction.

“Such differences don’t augur well for the image of Indian markets.  Although there is a need for such a list, it cannot be designated to custodians who have conflict of interest.  Rather than putting out a blanket list, Sebi in concert with custodians could examine the requirements on a case to case basis,” said Tejesh Chitlangi, partner, IC Universal Legal.

Experts say each custodian having a separate list could also led to unintended consequences such as custodian shopping. For instance, if custodian X has Mauritius in his list while custodian Y doesn’t, a Mauritius-based investor will switch custodian from X to Y so that he is not subject to any restrictions. This could defeat the purpose of the move.

The idea behind Sebi’s move to maintain such a list is to place additional safeguards on flows coming from destinations that have lax money-laundering laws. However, Sebi did not come up with a list on its own owing to diplomatic considerations. Instead it got authorised custodian to do it.
Stricter regulations

What is a high-risk jurisdiction? 

An investment region where tax and money- laundering laws are not on a par with international standards

Who is preparing this list?

Sebi has asked global custodians to come up with a list of high-risk jurisdictions

What will be its impact?

Stricter compliance requirements applicable for investments coming from these destinations