Brian Fallow on the economy

Brian Fallow is the Herald's Economics Editor

Brian Fallow: Financial hub is a distant dream

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'Hub' is the last word that springs to mind when looking at New Zealand on a map. Photo / Google Earth
'Hub' is the last word that springs to mind when looking at New Zealand on a map. Photo / Google Earth

On the face of it there is something risible, if not absurd, about any sentence with "New Zealand" and "financial hub" in it.

Glance at a globe or map of the world and "hub" is the last word that is likely to spring to mind.

So some obvious questions confront the Prime Minister and other enthusiasts for the idea that we have a glittering future as a financial hub, even in the limited sense of being a legal domicile for fund managers and providers of book-keeping services to them.

They are not rhetorical questions. They may well have convincing answers. It is just not immediately apparent what they are.

The most important one is: What is New Zealand's comparative advantage in this area supposed to be? What can we offer that others cannot?

Our time zone is often cited as an advantage, but compared to whose?

Tokyo, Singapore and Hong Kong are already wide awake while London and New York sleep. Financial services account for a fifth of Hong Kong's GDP and an eighth of Singapore's, and in both cases their GDP is a whole lot bigger than ours.

Even if there is some vacant niche between those Asian centres and New York, it is still not obvious what advantage Auckland would have over Sydney - already a sophisticated financial centre - or, say, Honolulu, which of course is in the United States.

What about "our well educated and mobile workforce, along with our political stability, the proven success of our macro-economic policy framework, our sound legal and regulatory framework and our quality of life"?

Oh sorry, that was from the Johnson report, delivered to the Australian Government late last year about how Australia could expand its role as an exporter of financial services. It already has a huge scale advantage. Thanks to its compulsory superannuation policy, the Australian funds management industry has A$1.2 trillion ($1.57 trillion) under management - more than 25 times as much as its New Zealand counterpart. But only 11 per cent of that was sourced offshore, a proportion the Australians seem keen to expand.

Can we match their claim to have a "sound legal and regulatory framework" when it comes to securities law?

Quite a few local investors would answer with a bitter no and it seems even the head of the Securities Commission, Jane Diplock, is a lot less than sanguine on this point.

Asked on last Sunday's Q+A programme if New Zealand's regulations are good enough for it to be a capital markets hub, she said no.

"Part of the Securities Act review which is coming up this year is going to address that particular point," she said, but "at the moment investors in Hong Kong and in Singapore have a better regulatory framework of managed funds than we do, and they won't recognise our managed funds framework".

That leaves the issue of taxation.

A hospitable tax regime for funds en route from foreign savers to foreign investment destinations (selected by asset allocation decisions made offshore) is under development.

It is outlined in an official issues paper released last week entitled "Allowing a zero per cent tax rate for non-residents investing in a PIE [portfolio investment entity]".

But before turning to the details of the proposal it is important to note that tax concessions are not a durable source of comparative advantage. They can easily be competed away.

The most the tax laws can offer is the absence of an impediment to the development of this activity.

That might still be worth doing, though, depending on how much activity this fund domicile/back office plan generated. The IRD paper asserts, citing only "financial services industry estimates", that after 10 years it "could create approximately $1 billion of profits and approximately $300 million in taxes".

The proposed change sounds simple enough. When non-resident investors earn, via a New Zealand PIE, income from investments outside this country, it should incur no New Zealand tax.

At the moment non-residents investing in foreign assets through a PIE are taxed on income from the PIE as if they were residents.

This is inconsistent with New Zealand's approach to international taxation, which is source-based rather than residence-based, tax officials say, and is inconsistent with how the same investors would be taxed if they invested directly in the assets.

Intuitively the idea is that as things stand neither the flow of money from the foreign savers to the foreign investment destinations, nor the returns on that investment flowing back, would come anywhere near NZ.

The law change, it is argued, might bring some employment our way and some taxable profits for New Zealand-domiciled fund managers intermediating the flows, and that would be all upside compared with the status quo.

But the issue paper acknowledges risks associated with this approach.

One risk is that New Zealand investors will find ways to take advantage of the exemption.

The issues paper's brief discussion of one way that might be attempted and what might be done to address it, but the undesirable side effects that patch might give rise to, illustrates that making this apparently simple policy work gets very complicated very quickly.

It is debatable how many jobs the policy might give rise to in the funds management sector, but it is a certainty there will be plenty of work for inventive tax accountants and for officials hammering bungs into the loopholes as they emerge.

The last time this kind of "conduit" tax rule was introduced it ended in multibillion-dollar tax disputes between the Inland Revenue and the Australian-owned banks.

Another danger officials allude to is the possibility that it will fall foul of OECD concerns about "harmful tax competition".

Two of the tests of that are a low or zero tax rate on the relevant income, and ring-fencing to restrict the tax benefits to non-residents.

Officials say the boundaries of what is harmful tax competition are not clear-cut but in any case "the proposals raise concerns about New Zealand's ability to meet its disclosure of information obligations".

For a while in the 1980s there was gung-ho talk of New Zealand becoming the Switzerland of the South Pacific. The Liechtenstein of the South Pacific now looks more like it.

Contrast the prime ministerial enthusiasm for the financial hub project with the response to proposals to explore the country's potential in the clean technology space.

If the International Energy Agency is in the ball park about how much the world will need to spend on that technology over the next 20 years, and if New Zealand could capture just 1 per cent of that business, it would be worth $5 billion a year.

Yet that proposal, from business heavyweights, has elicited only an indolent silence.

- NZ Herald

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