It says that dedicated financial crime units should be set up on Guernsey, Jersey and the Isle of Man to investigate fraud, money laundering, tax evasion and other criminal activity.
Senior Treasury official, Andrew Edwards, said in a 175-page report that 20 new professional financial crime investigators needed to be recruited to work on the islands.
In his report, Mr Edwards conceded that the battle against financial crime "is not being convincingly won anywhere". He stated that professionals were increasingly anxious for the United Kingdom to set up its own National Fraud and Financial Crime Squad to fight the problem.
His three-month review gives an insight into the astonishing growth of Britain's offshore financial centres, which have a combined population of only 217,000 but now have assets and liabilities of between pounds 300-pounds 350bn. Total bank deposits amount to pounds 170bn, with pounds 100bn in Jersey, pounds 50bn in Guernsey and pounds 20bn on the Isle of Man.
There are 90,000 companies on the islands and many more are administered from the islands but incorporated elsewhere, to give greater secrecy. The majority of companies on the islands are tax exempt or have special tax status.
During his review, Mr Edwards said that concerns were expressed that too little was known about many companies operating on the islands and that some with "questionable track records" were being allowed to continue in business. He called on the authorities in Jersey to take greater action to co-operate with other countries in the pursuit of financial crime and money laundering.
Mr Edwards said the authorities on the islands of Guernsey, Alderney and Sark should introduce a system of licensing and registering directors and bring in a code of conduct governing the standards expected from directors and trustees.
He also called for a limit to be set on the number of directorships held by individuals, suggesting a ceiling of five trading companies or 30 asset- holding companies. But he stopped short of calling for the publication of the accounts of companies on the islands, on the grounds that this would simply drive away business to other offshore financial centres.
Overall, Mr Edwards's report was seen as far more favourable than had been expected from copies of a draft which were leaked last September. Suggestions that he was bringing pressure on Jack Straw, the Home Secretary, to introduce a major overhaul of the offshore financial centres had prompted the islands to initiate frenzied lobbying activity.
At a press launch yesterday, Mr Edwards said: "As I see it, the islands are definitely right in the top division of offshore centres. In all sorts of ways, they compare very favourably with the onshore centres which I am familiar with."
Guernsey's capital, St Peter Port, with its attractive Napoleonic architecture, is crammed with the offices of world-famous financial institutions, including Rothschild's and Barings.
In Christie's, a bar bistro, the business pages of The Daily Telegraph are posted on the wall of the men's lavatories. There are not many places where you can read that the Treasury has issued a 2.5 per cent index-linked bond while attending to the call of nature.
The official response to the report is one of quiet welcome. Laurie Morgan, Guernsey's most senior parliamentarian and chairman of the key finance advisory committee, says it has given them "a clean bill of health". Is that not a little nonchalant? "We were always quietly confident that we were not likely to be held up as crooks and thieves," Mr Morgan replied.
Richard Tee, chairman of the Guernsey International Business Association, agrees. "Overall, we welcome this report. It does highlight areas where we could do better."
The offshore havens with their local laws first became major financial centres in the Seventies when many rich people put their money out of reach of the Labour government's high taxes. As a result, islanders enjoy a standard of living 30 per cent above the United Kingdom mainland. When asked if Guernsey thrived on tax avoidance, Mr Tee said: "I would certainly accept the charge, but we prefer to call it tax planning."
For the best scam of all, go to the Tower Steps in the main harbour and take a ferry to the island of Sark. A strange feudal island with a population of just 575, it is home to the notorious "Sark lark". It may have no cars but it has 23,000 companies. The Sark lark is the provision of nominee directors for companies registered elsewhere. This recently reached its apogee as a few residents were found to be directors of up to 3,000 companies, in return for payments for holding the posts.
The Edwards report is scathing about the practice. "The reputation of all the islands has suffered from the presence on the islands, especially Sark, of so-called `nominees' - directors of companies."
The Department of Trade and Industry (DTI) has finally taken action. Sark resident Philip Crowshaw, 42, who is in the Guinness Book of Records for his 3,000 British, Irish and Manx directorships, faces charges of failing to carry out his responsibilities as a director in the case of one company. The civil hearing in front of a judge will take place next February.
Another Sark multi-director, John Donnelly, said he was not commenting on the report until he had had time to read it. Mr Donnelly and his father were nominee directors of an Isle of Man company Miltech, which was accused of supplying weapons during the Rwandan civil war. Mr Donnelly has admitted that he did not know what the company did, and yesterday said he was still not convinced it had dealt in arms.
Although it has its own feudal legislature, Sark comes under Guernsey regulation. The businessmen on the latter are embarrassed by the high profile the Sark lark has had in the media. Mr Tee said he thought the matter was coming under control: "I think the DTI action has made some people think." Guernsey is introducing a law to stop the Sark lark by the end of 1999.
As Mr Edwards said yesterday: "The perception has arisen that many of the directors on Sark are directors in name only, not in substance, and that the real directors... are other people altogether."
Guernsey*: Famous for its tomatoes, sweaters and creamy milk
No of companies 16,204
GDP per head pounds 15,615
No of banks 76
Bank staff 2,688
Investment funds 381
Insurance companies 354
Employees in finance 6,066
*Inc Sark and Alderney
Jersey: The island of new potatoes, cows and television's Bergerac
No of companies 32,272
GDP per head pounds 15,854
No of Banks 80
Bank staff 4,700
Investment funds 335
Insurance companies 13
Employees in finance 7,600
Isle of Man: Famous for its TT races, cats with no tails, and its tough stance on law and order
No of companies 41,980
GDP per head pounds 8,931
No of banks 1,781
Bank staff unavailable
Investment funds 102
Insurance companies 192
Employees in finance 5,406Reuse content