Latvia - like a Virgin island

By bne IntelliNews July 24, 2013

Mike Collier in Riga -

If you've ever wondered what sort of tax dodges they get up to in the British Virgin Islands, take a trip to Latvia and speak with Kristaps Zakulis, chairman of the country's financial regulator, the Financial and Capital Markets Commission (FKTK). Zakulis displays impressive knowledge of and enthusiasm for talking about the Caribbean archipelago whenever Latvia's own offshoring industry is mentioned.

During the course of an interview lasting less than an hour, he racks up a couple of dozen uses of the words "British Virgin Islands", "former British colony" and "John Smith" - all the more impressive when the conversation was supposed to be about his agency's investigation into the links between Latvian banks and the notorious Magnitsky affair in Russia.

The annoyance Zakulis expresses over anything bearing a Union Flag was clearly supposed to provoke your correspondent into a fit of patriotic indignation, yet never having been to the Caribbean archipelago or of a high enough net worth to open any tax-efficient account more impressive than a Post Office savings book, it was a wasted expenditure of energy.

But Zakulis' probable point is that whatever is happening in Latvia is happening elsewhere too - which is certainly true as far as offshoring goes. To an extent the point could also be applied to the Magnitsky case, as banks in Moldova, Lithuania, Estonia and Cyprus holding accounts from the UK, Belize and - you guessed it, the British Virgin Islands - have been named by lawyers representing Hermitage Capital Management of laundering $230m in the case that led to the death in detention of their lawyer Sergei Magnitsky. According to the lawyers, around $63m of that total was laundered via six Latvian banks in 2007 and last year, Hermitage filed a complaint in Riga demanding the authorities look into its allegations.

Latvia's Economic Police initially seemed disinterested, but did eventually open an investigation that is ongoing though yet to bring any criminal charges.

To its credit, FKTK was much more active in conducting an investigation and even found one bank culpable enough to impose the maximum fine it is allowed by law, LVL100,000 (€142,000). But the Magnitsky case has a way of making everyone it touches look absurd, from the ridiculous contradictory accounts of how the lawyer met his death in the first place to his ludicrous posthumous conviction pushed by the Kremlin. The Latvian connection does not disappoint in this regard either, for FKTK refuses to say not only when the fine was imposed, but even the name of the bank that is supposed to pay it.

In so doing, the Latvian authorities seemingly spurned an easy chance to prove how transparent they are, how well Latvian banks are regulated and above all, how the Latvian financial system has nothing to hide. "The media and the general public in other countries is used to weekly press releases with some fines and the names, like Barclays. It depends on the country, on the jurisdiction, on the system, how this supervisory system works, how the penalties are applied and are they published or not," Zakulis tells bne in his Riga office.

"The [Latvian] legal framework is that that is restricted information. How it usually works and how it has worked until now is that it is restricted information. The basis for that is related with financial stability issues," he explains. "When we look at the Latvian legal framework, historically it was developed so that those penalties are reported at the end of the year in an overall picture, totalling the penalties but not naming the banks."

But pressed on the issue, he admits that FKTK does have the power to name the bank if it so desires. "Technically, there is a part in the credit institution law [that would allow naming], but everyone is a little bit confused because the wording is maybe not exactly the best we would like to have right now," Zakulis says.

However, he denies that the huge international interest in Magnitsky is enough to justify disclosure. "I understand that in your eyes it might look like an extraordinary case. In our eyes it is a possible money-laundering case where we as the supervising institution and go in - okay we are changing our inspection schedule and our resources, but that's the only extraordinary thing for us."

"You are jumping too far," he goes on. "We are not saying the bank was involved in IML (international money laundering) activities in an active way. We are looking at how the IML prevention system was working, how much information the bank has collected regarding the principle of 'know your customer'. We are not coming with judgments that if they had been going two steps further that it would have been prevented or stopped or would have saved someone's life."

Preaching transparency

The fug surrounding the decision is all the stranger seeing as Zakulis himself wrote a forceful letter to the Financial Times in April claiming the authorities relished international scrutiny, in the wake of the newspaper asking whether Latvia could soon be the new Cyprus, thanks to its similar combination of non-resident deposits, offshore agencies and boutique banks.

"As the person whose office is responsible for regulating and supervising the financial institutions in Latvia held up for inspection today, I welcome the scrutiny," Zakulis wrote. "Latvia's banks go to extraordinary lengths to avoid even the appearance of impropriety across all accounts, particularly those that originate from the former Soviet Union... We welcome sceptics."

A similar piece titled "Latvia - Meet the EU's newest tax haven" appeared in the prestigious German news weekly Der Spiegel on July 11, but Zakulis doesn't seem to welcome it much, dismissing it with a wave of the hand as "yellow press" - presumably alongside the FT, Wall Street Journal, Guardian, Bloomberg and Reuters, which have all published similar features. Plus of course one by this correspondent in bne, which Zakulis has on the desk in front of him, meticulously highlighted and annotated, eyeing it with the mixture of lust and loathing of someone on a diet looking at a piece of chocolate cake they have been saving in the fridge for three months.

Making the secrecy situation sillier, even the Association of Latvian Commercial Banks would prefer it if the bank in question was named, undercutting Zakulis' argument that FKTK has to consider if full disclosure might lead to a bank run or lack of confidence in the banking system. Failure to disclose leaves the cloud of suspicion hanging over all six banks named by the Magnitsky lawyers, none of which could be regarded as having systemic importance for the economy as a whole.

Martins Bicevskis, head of the Association of Latvian Commercial Banks (ALCB), said he would prefer it if the bank was named. "I think the best way would be to give clear information to the market," he tells bne. "That would give us a clear answer for the other members of the system," adding that ALCB will use its place on FKTK's consultative council to press for full disclosure in future.

bne has ascertained that FKTK's investigation started in August 2012 and was completed by the end of March 2013. The decision to fine the mystery bank was taken in May, Zakulis said in the interview, adding somewhat testily that, "We are not so much focusing on whether it was May or whether it was a sunny day outside. Actually we are doing our work whether it's snowing, whether it's raining or whether the sun is shining." The next day his office described bne's request to supply the date as promised as an "assumption" that was "not going to be revealed".

Whatever the exact date, the general public, including account holders at the bank in question, did not get the chance to discover that anything had happened until a release dated June 14, and then only thanks to a media enquiry asking what stage the investigation had reached. "We were not delaying. Those are not public decisions. It is not a public decision because there is not a name in this decision. It is restricted information. Somebody asked how things were going and we just replied with this part which is not so restricted," Zakulis says.

The resulting press release - never published on FKTK's website - said it had "adopted a decision to impose [an] administrative penalty for deficiencies in internal control system on one occasion, ie. customer due diligence. A maximum fine of 100,000 lats is imposed for violations in the area of laundering the proceeds from criminal activities and terrorist financing."

"In most cases, banks were unable to identify Magnitsky-related transactions as suspicious and report them... because the performed transactions did not differ from other payments and constituted an insignificant amount of total turnover... it is known that several dozens of banks were involved in huge transactions not only in the Baltic States but also in Europe," the statement said. "Considering information disclosure restrictions, FKTK is not authorised to disclose the name of the bank," FKTK added, though as has already been established, that was not strictly true.

Coincidentally, during April and May, Latvia was awaiting crucial verdicts from the European Commission and European Central Bank (ECB) on whether it would be allowed to join the Eurozone next year - an aim that was the number one priority of both the government and the central bank. Commission and ECB staff were in Riga throughout April going through the country's books, compiling the convergence reports that would decide Latvia's fate.

That was also the time when the "new Cyprus" stories were at their peak and officials were becoming increasingly worried by the effect of such negative publicity, prompting Zakulis' counter-blast to the FT published on April 24 and a speech by the central bank governor, Ilmars Rimsevics, on April 18 in which he said: "We're working day in and day out in order to prove that we're not Cyprus two, we're Latvia one."

The Commission and ECB gave the thumbs-up to Latvian Eurozone membership with the release of their reports on June 5. The first news stories about the Magnitsky fine appeared June 18. The final rubber stamp on Latvia joining the Eurozone took place at a July 5 meeting of European finance ministers following on from a June 21 meeting at which the decision was agreed in principle.

The delay in releasing details of the Magnitsky fine certainly helped Latvia avoid some unpleasant headlines at a sensitive time, but Zakulis is adamant that the timings are purely coincidental, as the rules dictate a complex sequence of to-and-fro between FKTK and the bank in question before a decision is made.

He denies any suggestion that the central bank, finance ministry or any other agency applied pressure to delay disclosure. "We did our job and they are not involved in the Magnitsky case. Everyone in the Magnitsky case is doing what they are doing. The Economic Police is investigating possible money laundering. We are going and looking at how the bank used IML systems and the prosecutor's office was once involved because there was initially a criminal investigation started. The central bank is not involved," he says.

For its part the central bank tells bne: "There is no obligation on the part of the market supervision institution to inform the central bank on such decisions - whether and when taken. Consequently - Latvijas Banka has not received information from FKTK on this issue."

Yet, when essential (name of bank) and even trivial (date of fine) facts are routinely withheld from the public, it is not surprising that imagination will tend to fill in the gaps. Until disclosure rather than secrecy becomes the norm, speculation about Latvia's banking sector will continue and its criticism of Russia over putting the deceased Sergei Magnitsky on trial will ring hollow.

Ironically, the move to a regime of full disclosure should come when Latvia's banking system is absorbed into the Eurozone on January 1, 2014.

Nevertheless, when the British Virgin Islands needs a new governor, they could do a lot worse than appoint the knowledgeable Mr Zakulis. Your correspondent would welcome the chance to see him take up residence on any one of the 60 sun-baked islets and rocks (15 of which are inhabited) with a remit to clean up the tax-dodging British overseas territory.

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