Cook Islands
Assessment of the Supervision and Regulation of the Financial Sector Volume II—Detailed Assessment of Observance of Standards and Codes

This paper focuses on key findings of the detailed assessment of observance of standards and codes in the financial sector of the Cook Islands (CI). The new legal framework in CI represents an important first step in correcting deficiencies, as they are all addressed in the new set of laws. The framework empowers the Financial Services Commission to license, supervise, and regulate the financial sector. It also provides it with enforcement authority in the event of noncompliance with the law, and to cooperate with foreign supervisors where necessary for implementation of comprehensive supervision on a consolidated basis.

Abstract

This paper focuses on key findings of the detailed assessment of observance of standards and codes in the financial sector of the Cook Islands (CI). The new legal framework in CI represents an important first step in correcting deficiencies, as they are all addressed in the new set of laws. The framework empowers the Financial Services Commission to license, supervise, and regulate the financial sector. It also provides it with enforcement authority in the event of noncompliance with the law, and to cooperate with foreign supervisors where necessary for implementation of comprehensive supervision on a consolidated basis.

I. Assessment Of Observance Of The Basel Core Principles For Effective Banking Supervision

A. Overview

General

1. This assessment of the Cook Islands’ current state of compliance with the Basel Core Principles for Effective Banking Supervision was conducted as part of the IMF Module 2 Offshore Financial Center (OFC) assessment program. This report provides a key input for the development of an action plan to move toward full compliance with the Core Principles. The assessors were Desiree Cherebin and Joel Shapiro, banking supervision consultants.

Information and methodology used for assessment

2. The assessment followed the core principle assessment methodology approved by the Basel Committee and was based on extensive discussions with the recently established Financial Supervisory Commission (FSC), primarily the recently appointed Commissioner. The mission reviewed the core principle self-assessment undertaken by the FSC immediately preceding this assessment. The mission held meetings with the Prime Minister, representatives of the Board of Directors of the FSC, officials of the Financial Intelligence Unit (FIU), and senior officers of the three domestic banks and one offshore bank. Discussions were also held with representatives of two audit firms, the Trust Companies Association, and the management of two trust companies offering offshore financial services. The mission also reviewed the Banking Act 2003 (BA) and three prudential statements issued under this statute in February 2004, the Financial Supervisory Commission Act 2003 (FSA), the Financial Transactions Reporting Act 2003 (FTRA), and regulations issued in February 2004, as well as other laws relevant to the operations of financial institutions licensed by the FSC. With the exception of one on-site examination report of the local domestic bank, no prudential information exists on any licensed financial institution, as the FSC has yet to implement supervisory policies and procedures.

Institutional and macroprudential setting, market structure overview

3. The Cook Islands is a small offshore center by international standards, but the sector makes a relatively significant contribution to government revenues and to GDP. Registration and license fees represent about 4 percent of government revenues, and industry estimates put the total contribution of the offshore sector in the range of 8 percent of GDP. Actually, the contribution of the offshore sector relative to GDP may have peaked with the establishment of a legal framework that requires the offshore sector to have a physical presence in the Cook Islands, and to be subject to a vigorous bank supervision regimen similar to traditional commercial banks, as some offshore institutions have indicated they do not intend to apply for a new license to conduct a banking business.

4. In June 2000, the Cook Islands were placed on the Financial Action Task Force (FATF) list of non-cooperative countries and territories based on the absence of effective supervision of the offshore sector, the lack of an adequate infrastructure to combat money laundering, and excessive secrecy provisions. The government made some early progress in addressing the FATF’s concerns, with the impetus fueled by the possibility of additional countermeasures by the FATF. More recently, the Government has refocused on initiatives to upgrade its financial sector supervision and anti-money laundering infrastructure in its efforts to be removed from the FATF “blacklist,” which is a high priority for government.

5. As part of this effort, in May 2003 the Government of the Cook Islands enacted a suite of legislation to establish a sole regulator of the financial sector and strengthen its supervision. The FSC, which is the regulator, is empowered, inter alia, to license, regulate, and supervise the business of banking. One effect of the legislation is to require offshore banks to have a tangible physical presence in the Cook Islands (the “mind and matter” principle), transparent financial statements, and adequate records prepared in accordance with consistent accounting systems. All banks will be subject to a more vigorous and comprehensive regulatory process, including on-site examinations and supervision of their activities on a consolidated basis. The effect of the legislation and the supervisory processes to be implemented by the FSC may be to discourage some offshore entities from maintaining their operations in the Islands due to the cost of regulation, issues of transparency, the extent of their banking business and other factors.

6. The FSC was established in June 2003 shortly following enactment of the new legislation, and the first Commissioner was appointed in September 2003. With the exception of a Deputy Commissioner, the agency is fully staffed. The FSC is currently in the initial stages of developing systems and procedures for reviewing licensing applications. No prudential data or other supervisory information on licensees has yet been collected, with the first to be filed by licensees in connection with their application for a license under the new legislation. The FSC has not yet developed prudential returns, procedural manuals or other supervisory tools, nor developed a training program for staff. Creation of the FSC is at a start-up stage in every sense of the word, and the Commissioner’s mettle as a supervisor and administrator clearly will be tested.

7. The domestic banking system is comprised of branches of major Australian banks (ANZ and Westpac), and the indigenous Bank of the Cook Islands (BCI). The latter is the result of the merger, in 2001, of the government-owned Cook Islands Development Bank and the Post Office Savings Bank. While the bank will continue to be a stand-alone institution competing against the two Australian banks, it will no longer engage in development lending. The development lending and problem loan portfolios will be transferred to companies owned by the Cook Islands Government Property Corporation.

8. The offshore financial center (OFC) was established in 1981 through the enactment of several laws which provided exemption from all forms of tax as a major inducement for all registered offshore entities There are currently sixteen international banks licensed in the Cook Islands, which were granted offshore banking licenses under the Offshore Banking Act 1981, which was repealed with the Banking Act 2003. In addition, the Island hosts some 800 international companies, and six trust companies that administer 2,100 international trusts. The trust companies act as representatives of some of the offshore banks. There are approximately 20 offshore insurance companies as well.

9. The primary business of the domestic banks operating in the Cook Islands is traditional deposit taking and lending. Current data on total deposits and loans was not available from the FSC during the mission, but based on information provided by the three banks at meetings held with them, it is estimated that total assets in the domestic system aggregate approximately $NZ 180 million, of which roughly $NZ 150 million represents loans to commercial enterprises and consumers.

General preconditions for effective banking supervision

10. Prior to enactment of the Financial Supervisory Commission Act, there was in practice no meaningful oversight and supervision of the financial sector. The Monetary Board, the predecessor to the FSC, had long ceased to function as the regulator of the domestic banks, while the Offshore Financial Services Commission viewed its principal role relative to the offshore community as a collector of license and registration fees.

11. The inadequate legal framework and the low level of resources devoted to bank supervision reinforced the conventional view that the banking system, especially offshore institutions, had free reign. There were no meaningful legal requirements pertaining to transparency, accounting standards, corporate governance or safe and sound banking practice. There was no active on-site/off-site supervision program.

12. The new legal framework represents an important first step in correcting these deficiencies, as they are all addressed in the new set of laws. The framework empowers the FSC to license, supervise and regulate the financial sector. It also provides it with enforcement authority in the event of noncompliance with the law, and to cooperate with foreign supervisors where necessary for implementation of comprehensive supervision on a consolidated basis. The second and more difficult task is implementation of these laws, and creating the appropriate supervisory infrastructure, and that is the challenge that lies ahead.

13. In addition, two specific areas not covered adequately in existing legislation must be confronted. One is that the legal framework must be strengthened for resolving problem banks, including development of procedures for receivership and liquidation. The other issue is that of a public safety net. For now, the issue revolves principally around the government’s approach to rescuing depositors at BCI in the event of a financial crisis.

B. Detailed Assessment

Table 1.

Detailed Assessment of Compliance of the Basel Core Principles

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C. Summary Compliance of the Basel Core Principles

Table 2.

Summary Compliance of the Basel Core Principles

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C: Compliant.

LC: Largely compliant.

MNC: Materially noncompliant.

NC: Noncompliant.

NA: Not applicable.

D. Recommendations

Table 3.

Recommended Action Plan to Improve Compliance of the Basel Core Principle

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II. Detailed Assessment Report on Anti-Money Laundering and Combating the Financing of Terrorism

A. General

Information and methodology used for the assessment

14. A detailed assessment of the anti-money laundering (AML) and combating the financing of terrorism (CFT) regime of the Cook Islands was prepared by a team of assessors that included staff of the International Monetary Fund (IMF), an expert under the supervision of the IMF, and another expert not under the supervision of IMF who was selected from a roster of experts for the assessment of criminal law enforcement and nonprudentially regulated activities, provided by the Asia Pacific Group on Money Laundering. IMF staff and the expert under staff supervision reviewed the relevant AML/CFT laws and regulations, and supervisory and regulatory systems in place to deter money laundering (ML) and financing of terrorism (FT) among prudentially regulated financial institutions as well as with regard to nonprudentially regulated activities that are macroeconomically relevant, specifically trust and company service providers. The expert not under the supervision of IMF staff reviewed the regulatory systems in place for other nonprudentially regulated sectors, specifically money exchange and transmission services, as well as the capacity and implementation of criminal law enforcement systems.

15. A broad range of legal, regulatory, and supervisory materials were examined in the context of the assessment, including:

  • Various statutes, including the Banking Act 2003 (BA), International Companies Act 1981-82 (ICA), Trustee Companies Act 1981-82 (TCA), the Financial Supervisory Commission Act 2003 (FSCA), the Financial Transactions Reporting Act 2003 (FTRA), the Proceeds of Crime Act 2003 (POCA), the Mutual Assistance in Criminal Matters Act 2003 (MACMA) and the Mutual Assistance in Criminal Matters Amendment Act 2003 (MACMAA), the Extradition Act 2003 (EA), the Criminal Procedure Amendment Act 2003 (CPAA), the United Nations (Security Council Resolutions) Act 2003 (UNSCRA), the Crimes Act 1969 (CA), the Criminal Procedure Act 1980-81 (CPA), etc.;
  • Other enforceable legal materials, such as the set of specific regulations issued under the FTRA, covering respectively offering companies, forms, and customer identification, (a.k.a. the Financial Transactions Reporting Regulations 2004—FTRR) as well as the Extradition Regulations 2004 (ER), Proceeds of Crime (Border Currency Report Form) Regulations 2004 (PCR), International Companies (Evidence of Identity) Regulations 2004 (ICR), Qualifications for Compliance Officers pursuant to the FSC Act 2003, etc.; and
  • Nonbinding legal materials, such as the Prudential Statements of the FSC. Since the draft Guidance Notes on the Prevention of Money Laundering and Terrorist Financing in the Cook Islands (March 2003) are not yet effective and are subject to further review, they were not considered in conducting the assessment.

16. The AML/CFT team consisted of Mr. Peter Csonka (Senior Counsel, LEG), Mr. Steven Gilbert (Consultant, MFD) and Mr. Simon Leung (Senior Inspector of Police, Hong Kong China), who conducted an assessment of the implementation of the criminal law enforcement elements of the AML/CFT Methodology as Independent AML/CFT Expert (IAE)1 as well as of the arrangements applicable to money exchange and transmission services in the Cook Islands.

17. To conduct the assessment, the team visited Rarotonga (the main island of Cook Islands) from February 16 to February 27, 2004, and held discussions with officials of the Cook Islands Working Group on NCCT issues, the Ministry of Justice, the Crown Law Office (Solicitor-General), the Financial Supervisory Commission (FSC), the Financial Intelligence Unit (FIU), the Police, the Customs, as well as with representatives of the private sector, including the Law Society, the Trust Company Association, domestic banks, trust companies, external auditors, and a company providing money transmission services.

18. The assessment team is grateful for the high degree of cooperation and warm hospitality received from all the participants during its visit and especially expresses gratitude to the FSC and the FIU for the excellent organization of the visits and the substantial time they devoted to the completion of the self-assessment questionnaire.

19. The following categories of regulated financial institutions were included within the scope of the AML/CFT assessment: banks, insurance companies, and trustee companies.

General situation of money laundering and financing of terrorism

20. The Financial Intelligence Unit (FIU), the Cook Island Police (CIP), and the Crown Law Office (CLO) are the authorities directly involved in collecting intelligence, investigating, and prosecuting money-laundering related offenses. While the CIP and the CLO are respectively the principal law enforcement and prosecution agency in the Cook Islands, Customs, Immigration, and Revenue Management departments also play minor investigative and prosecution roles in their respective field. They shall play the same role in combating the financing of terrorism when the proposed Suppression of Terrorist Financing Act is passed in the near future.

21. The general crime rate of the Cook Islands remains low. General crimes are burglary, petty theft and low-level fraud with an insignificant amount of property involved. There is no evidence suggesting that the Cook Islands has problems of any major organized crime, drug trafficking or serious fraud, crimes which would generate large amount of revenue and create a domestic demand of money laundering services.

22. While the risk of domestic money laundering is small, there is a potentially significant risk of the Cook Islands offshore banking sector and trustee companies being abused by criminal elements.

23. There is yet no successful investigation and prosecution of money laundering in the Cook Islands and thus there are no statistical data on the estimated volume of proceeds of crime. It is therefore not possible to estimate the amount of money laundering, if any, which might take place in or through the Cook Islands. The insignificant number of suspicious transactions reports made to the FIU is also insufficient to indicate any particular money laundering trend or typology.

Overview of measures to prevent money laundering and terrorism financing

24. The Cook Islands remains on the FATF’s list of Non-Cooperative Countries and Territories (NCCT) since June 2000. FATF’s concerns included that the Cook Islands Government (CIG) held no relevant information on approximately 1,200 international companies it had registered and that the country licensed seven offshore banks that took deposits from the public, yet were not required to identify customers, nor keep records. Excessive secrecy provisions guarded against the disclosure of bank records and relevant information about the international companies. Further, the International Companies Act of 1981 (ICA), permitted issuance of bearer shares and the marketing of shelf companies. The ICA also prohibited public access to registers of corporate directors or managers or the disclosure of beneficial owners. While corporate directors were not required to be residents, companies had to maintain a registered office and company secretary in the Cook Islands and file annual reports, but were not required to have their accounts audited.

25. The Cook Islands has enacted several legislative reforms to address the deficiencies identified by the FATF. The first set of measures were taken in August 2000, when the Cook Islands enacted the Money Laundering Prevention Act 2000 (MLPA), but given continued FATF concerns over the adequacy of the AML framework, an entirely new AML-suite came into force in June 2003, superceding the previous legislation and regulations. The new AML suite included new acts on proceeds of crime, mutual legal assistance, extradition, and financial transactions reporting. It has also amended the Crimes Act 1969 (CA) to introduce a new ML offense through Sections 280A and 280B. The new ML offense extends to all predicate offenses that are “serious offenses” and applies to both physical and corporate persons. “Serious crimes” were defined by threshold, as a result of which any offense punishable under Cook Islands law by imprisonment of not less than 12 months or a fine of more than $NZ 5,000, whether committed in the country or overseas, so qualifies. However, at present FT is not criminalized, and it is not a predicate offense for ML. A new Banking Act was also enacted in 2003.

26. Under the Proceeds of Crimes Act 2003 (POCA), provisions were made to the effect that tainted property and benefits derived from crime can be recovered through two different types of legal action, i.e., forfeiture orders and pecuniary penalty orders. Both are discretionary criminal penalties and require conviction of a serious offense. Forfeiture can be applied also against tainted property where the accused has absconded or died. Under the POCA, law enforcement authorities can use production orders, monitoring orders and search warrants for tracing assets, and seizure and restraining orders can be used to secure them.

27. As part of the 2003 AML-suite, the Financial Transactions Reporting Act 2003 (FTRA) redefined obligations and procedures related to customer identification, record-keeping, internal controls and reporting of suspicious or other types of transactions. It has also reorganized the supervisory structure, by allocating compliance checking functions for licensed entities to the Financial Supervisory Commission (FSC) and set up an independent administrative-type FIU, with responsibility for the supervision of non-licensed entities as well as the collection, analysis, and dissemination of financial intelligence. Under Sections 10 and 11 of the FTRA, a broad range of financial institutions are required to submit ML-related reports to the FIU on suspicious transactions and cash or electronic transactions above $NZ 10,000. The FIU has the authority to require reporting parties to supplement reports and has broad powers to obtain relevant information needed to combat ML, but it does not have FT-related functions at present. The FIU has been also charged with the exchange information with counterpart FIUs and training. Its Egmont Group membership is expected to be granted in June 2004.

28. The Cook Islands is not a party to the Vienna Convention and it has not signed, nor ratified the Palermo Convention. The Cook Islands signed the UN International Convention for the Suppression of the Financing of Terrorism on December 24, 2001, but has not ratified it yet. The Cook Islands enacted the UNSCRA to give effect to UN Security Council Resolutions on FT, including Resolution 1373, but has not yet issued any implementing regulations under the Act.

29. The Mutual Assistance in Criminal Matters Act 2003 (MACMA) and the POCA made provisions for enabling the Cook Islands to provide a broad range of types of assistance without formal treaty or similar arrangements subject to dual criminality. The Extradition Act 2003 (EA) sets forth similar provisions to enable extradition, though the absence of criminalization of FT prevents the Cook Islands from extraditing persons sought for FT. This shortcoming has already been identified and the authorities are planning to correct with the proposed draft Terrorism Suppression Bill.

30. The Cook Islands is a member of the Asia/Pacific Group on Money Laundering and was subject to a mutual evaluations conducted by that Group jointly with the Offshore Group of Banking Supervisors in October 2001.

B. Detailed Assessment

31. The following detailed assessment was conducted using the October 11, 2002 version of Methodology for assessing compliance with the AML/CFT international standard, i.e., criteria issued by the Financial Action Task Force (FATF) 40+8 Recommendations (the Methodology).

Table 4.

Detailed Assessment of Criminal Justice Measures and International Cooperation

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Assessing preventive measures for financial institutions

Table 5.

Detailed Assessment of the Legal and Institutional Framework for Financial Institutions and its Effective Implementation

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