Texas A&M University School of Law Texas A&M Law Scholarship Faculty Scholarship 1-2009 Change, Dependency, and Regime Plasticity in Offshore Financial Intermediation: The Saga of the Netherlands Antilles Craig M. Boise Andrew P. Morriss Texas A&M University School of Law, [email protected] Follow this and additional works at: https://scholarship.law.tamu.edu/facscholar Part of the Law Commons Recommended Citation Craig M. Boise & Andrew P. Morriss, Change, Dependency, and Regime Plasticity in Offshore Financial Intermediation: The Saga of the Netherlands Antilles, 45 Tex. Int'l L. J. 377 (2009). Available at: https://scholarship.law.tamu.edu/facscholar/265 This Article is brought to you for free and open access by Texas A&M Law Scholarship. It has been accepted for inclusion in Faculty Scholarship by an authorized administrator of Texas A&M Law Scholarship. For more information, please contact [email protected]. Change, Dependency, and Regime Plasticity in Offshore Financial Intermediation: The Saga of the Netherlands Antilles CRAIG M. BOISE* & ANDREW P. MORRISS** Abstract The legal regimes of offshore jurisdictionshave historically differed in significant ways from those applicable in onshore jurisdictions. Inevitably, legal and financial professionals have seized upon these differences to develop strategies for reducing transactions costs. A prominent example of such cross-border arbitrage was the routing of Eurodollarloans through a small group of former Dutch island colonies in the Caribbean,a practice which peaked in the mid-1980s, when virtually every major U.S. corporation made interest payments to a Netherlands Antilles finance subsidiary. The "Antilles sandwich" strategy exploited the difference between high U.S. withholding tax rates that applied to interest payments made to most foreign lenders, and the zero rate of tax that applied to U.S. interest payments made to residents of the Antilles under the United States-Netherlands Antilles double taxation treaty. Both jurisdictions reaped significant benefits from the strategy until the United States unilaterally terminated the tax treaty in 1987, virtually wiping out the Antilles offshore financial sector overnight. Unfortunately, because of rigidity in its governance structure, the Antilles failed to develop alternativefinancial intermediationstrategies to replace the Antilles sandwich structure before its demise. The rise and fall of the Antilles' offshore financial sector provides insight into the current debate over the role of offshore financial centers like the Antilles within the global economy. Concerned about tax evasion by their residents, onshorejurisdictions * Professor of Law, Director of Tax Programs, and Director, Institute for Offshore Financial Studies, DePaul University College of Law. B.A., University of Missouri-Kansas City; J.D., University of Chicago Law School; LL.M (Taxation), New York University School of Law. We thank the Mercatus Center at George Mason University for financial support for travel to Curaqao, Claire Morgan at Mercatus for her support, and the numerous people in Curaqao who took time from their schedules to talk to a couple of American law professors. In particular, Phyllis van den Hout of CIFA generously opened doors for us with many people. Eric Andersen, Hermann Behr, Felipe Croes, Gregory Elias, Errol Gova, Zuleika S. Lasten, Edgar Nunes, Shulaika Paassen-Delsol, Eric Passen, and Guiveron T. Weert graciously spent time with us, as well as others who asked not to be named. Matthew Brown, Justin Cook and Cyrus Sachinvala provided able research assistance. Thanks for helpful comments are owed as well to the participants in the faculty workshop in 2008 at George Mason University School of Law, particularly Eric Claeys, and to Allison Christians. As always, Andrew Dorchak and Stephanie Davidson cheerfully provided invaluable reference assistance that made our lives easier and improved the content immensely. Of course, all errors remain our own. ** H. Ross & Helen Workman Professor of Law & Professor of Business Administration, University of Illinois; Senior Scholar at the Mercatus Center at George Mason University, and Senior Fellow, Property & Environment Research Center, Bozeman, Montana. A.B. Princeton University; J.D., M.Pub.Aff., University of Texas; Ph.D. (Economics) Massachusetts Institute of Technology. TEXAS INTERNATIONAL LAW JOURNAL [VOL. 45:377 including France, Germany, and the United States are pressing for major changes in offshore jurisdictions' legal and regulatory regimes that may eliminate legitimate opportunitiesfor internationalarbitrage. In such an environment, offshore financial centers may find it difficult to survive. In this article, we distill from the Antilles experience a theory of "regime plasticity" and examine the role that it plays in allowing offshore financial centers to adapt to changes in the legal and political environments within which they operate. How offshore financial centers react and whether they have learned the lessons of the Antilles' experience will play a major role in determining the future of the global offshore financialsector. SUMMARY I. INTRO D U CTIO N ................................................................................................... 379 II. ECONOMIC UNDERPINNINGS ............................................................................. 384 A . "A L onely Island"...................................................................................... 384 B. The Impact of the Second World War ....................................................... 391 C. JurisdictionalFoundations ......................................................................... 396 II. THE ARC OF ANTILLEAN FINANCIAL INTERMEDIATION ............................... 401 A. The Economic Need to Create an Offshore Sector................................... 401 B. The Beginnings of Offshore Activity ......................................................... 404 C. "L ike Finding G old".................................................................................. 406 D. Expanding the Franchise............................................................................ 410 E. Trouble on the H orizon .............................................................................. 414 F. "Then Disaster Struck". .............................................................................. 419 III. REGIME FLEXIBILITY, THE ANTILLES, AND THE FUTURE OF OFFSHORE FINANCIAL INTERMEDIATION ........................................................................... 426 A. A Theory of Regime Plasticity.................................................................... 427 1. The Persistence of Difference ............................................................. 427 2. The Challenge of Change .................................................................... 430 3. The Imperative of Legislative Agility ................................................ 431 4. C onstitutional C oncerns ...................................................................... 434 B. The NetherlandsAntilles in the Aftermath of Treaty Repeal................... 435 1. The Post-Treaty Antilles and Legislative Flexibility ........................ 436 2. The Post-Treaty Antilles and Constitutional Concerns ................... 437 IV. LESSONS FOR THE FUTURE OF OFFSHORE FINANCIAL INTERMEDIATION...441 A. The Prospectsfor the Antilles ..................................................................... 441 B. Other Offshore Jurisdictions...................................................................... 447 C. O nshore Competitors .................................................................................. 44 9 D. The Impact of MultilateralInstitutions ...................................................... 453 E. The Changing Clim ate ................................................................................ 454 V . C ONCLU SIO N ....................................................................................................... 455 2009] OFFSHORE FINANCIAL INTERMEDIATION I. INTRODUCTION In the immediate aftermath of World War II, world markets were littered with protective measures, exchange control regimes, tariffs, and endless quantitative trade restrictions.! As the decades following the war passed, barriers to trade in goods gradually fell and, as trade grew, global capital markets also began to open.2 The pace of that opening varied considerably across jurisdictions around the globe, however, leading to significant differences among the legal regimes within those jurisdictions. It was virtually inevitable that legal and financial professionals would seize upon these differences to develop strategies for reducing transaction costs (including taxes and regulatory expenditures) through international arbitrage. One of the most prominent examples of this was the use of Netherlands Antilles international finance subsidiaries by U.S. companies to tap into the Eurodollar markets.' This practice peaked in the mid-1980s, when virtually every major U.S. corporation had at least one Antilles finance subsidiary.4 The "Antilles sandwich" financing strategy was not a result of competitive or opportunistic lawmaking by an offshore financial center. Rather, it exploited the then-existing difference between high withholding tax rates that applied to interest 1. KEETIE E. SLUYTERMAN, DUTCH ENTERPRISE IN THE TWENTIETH CENTURY: BUSINESS STRATEGIES IN A SMALL OPEN ECONOMY 166 (2005). 2. See JOOST JONKER & KEETIE