INTERNATIONAL TAX PLANNING ASSOCIATION
Cayman Islands 7th December 2009
THE FUTURE OF THE CAYMAN ISLANDS AS A FINANCIAL SERVICES CENTRE
by Timothy Ridley
Introduction
• We have recently endured some very turbulent times for the financial industry and its service providers. And there may still be bumps along the road to recovery, as recent events in Dubai have shown.
• We are also now in an era of heightened initiatives both international and onshore that are likely to change the shape of the industry. The financial crisis significantly added to this momentum, certainly in terms of rhetoric, but with something of a welcome slowdown recently as greater maturity has returned to the debate.
• Many offshore centres, and perhaps the Cayman Islands more than many, have experienced significant drops in their key industries, tourism and financial services, and thus also general local business activity and Government revenues. This is turn has caused budgetary problems for Governments.
• Reports of the impending death of the offshore industry are exaggerated (pace Mark Twain). I believe there will continue to be a place for high quality, innovative and adaptive offshore financial centres (OFC’s), unless the world is prepared to go back to the days of strict exchange controls, fixed exchange rates and restricted global trade and investment. This I think is unlikely in the long term, although there are some short term signs to the contrary (e.g. Brasil’s imposition of an inward investment tax to limit the appreciation of the real). Assuming I am correct, there will equally be a place and need for high quality service providers in those OFC’s.
Let us now look in more detail where the Cayman Islands stands in all of this.
Constitutional advancement and the UK-Cayman relationship
After false starts over several decades, the Cayman Islands finally adopted a new constitution that, with some transition features such as the Bill of Rights and the increase in the number of Members of the local Legislative Assembly and Cabinet, came into effect in early November 2009. This is not part of a set timetable to independence (with one more small red dot on the map disappearing), but rather a modernisation with greater autonomy given to the locally elected politicians lead by a Premier.
The Governor (typically a career FCO diplomat appointed by London) and the UK still have very extensive reserved powers (albeit with greater local consultative obligations than before). In particular, the UK may still legislate by Order in Council and disallow locally enacted legislation. The Governor continues to be responsible for defence, external affairs, internal security and the appointment of public officers such as the judiciary, senior civil servants (e.g. the Attorney General) and other senior appointments such as the Auditor General and Complaints Commissioner. Of particular note for the financial services industry are the following:
• The elected position of Minister of Finance is created and the Financial Secretary ceases to be a Cabinet post.
• The Governor may not enter into international agreements for Cayman without the approval of Cabinet (unless the UK otherwise directs).
• The Governor must delegate to the Premier (or another Cabinet member) responsibility for external affairs such as financial services, taxation and EU matters.
• Provision is made for various bodies to ensure good governance and transparency, such as the national security council, the judicial and legal services commission and the commission for standards in public life.
• The UK still exercises oversight of budgetary matters, as evidenced recently in the need for the UK’s consent to the US$312 million bond issue since Cayman was in breach of certain ratio requirements under the Public Management and Finance Law.
International Initiatives and Implications for Cayman
So what is driving much of this international activity? Fundamentally it is a battle to retain control the world’s capital and thus the ability to tax it. The old guard (the G7-8-9) is fighting hard to maintain the status quo under the guise of financial stability, propriety, integrity and transparency (being the latest favoured buzzwords).
• Most major jurisdictions publicly support open and competitive global markets between which capital can freely move. There is a growing body of academic studies that argues that OFCs can and do enhance competition in onshore markets and facilitate foreign investment into onshore jurisdictions that might not otherwise be made due to domestic constraints in those jurisdictions. After all, the funds do not remain in the OFC’s. Their domestic markets are far too small and undeveloped to absorb the capital flows.
• In reality, many jurisdictions that claim to support free markets principles and the unrestricted flow of capital do so only as long as this system works in their favour. Behind the façade, they actually pursue self interested financial imperialism and protectionism.
• For example, in financial services and products and in facilitating the global allocation of capital, OFCs pose a major competitive and potentially uncontrolled challenge. Thus, the UK and the US in particular are not keen to see OFCs thrive too much, but they have traditionally recognised that, for their own financial service industries and multinationals to be competitive, they must allow them to use OFC domiciled structures. Further, they recognise that such structures are also often the conduit for valuable inward investment from foreign investors. This traditional position is now under serious pressure as many politicians see more downsides than upsides in the continued symbiotic relationship between onshore and offshore.
• Other major European nations with growing and unfunded entitlement programmes and ageing populations fear loss of capital to OFC’s and reduced tax revenues. And they wrongly see OFC’s (as opposed to their own domestic policies) as the cause. So, while voicing their commitment to open markets for (their own) financial services and products, they continue to impose burdensome and anti competitive regulation on OFC’s and to raise barriers to their residents investing in or using OFC financial products or services. Again, protectionism in all but name, despite protestations to the contrary.
• The international standard setters mandated to execute the various initiatives are the creatures of and funded by the very same major countries that have no real interest in a level playing field open to OFC’s or to anyone else threatening to deprive them of control of the world’s capital.
Current position
Let us now look briefly how this is playing out in the various important international and domestic initiatives that are underway or threatened. These initiatives have been significantly energised by broad political support at the highest level in the major economies of the world as a result of the financial crisis. At the very top are the G8 and the G20 policymasters leapfrogging each other every few months in producing macro statements, followed up by often overlapping reports, although the G20 now seems to be the preferred leader. In no particular order of merit, the more significant are as follows:
• The UN held a summit to tackle the global economic crisis in June 2009. The communiqué specifically stressed the need for transparency, cooperation in tax matters and combating illicit financial flows. There have been various suggestions (principally from some European nations) that the UN become the global tax collector and regulator (combined with a global tax on financial transactions). Given the UN’s record, one might be forgiven for using Mr. McEnroe’s comment “you cannot be serious”.
• The G8 and G20 have been laying out the “big picture” framework for global standards on issues such as corruption, banking, corporate governance, taxation, financial markets and executive pay. The latest G20 Finance Ministers’ November 2009 communique specifically endorsed the work of the Global Forum (an OECD subset) on tax transparency and exchange of information and urged completion of the peer review of effective implementation and adherence to international standards and preparation of countermeasures against non compliant countries.
• The OECD has for over ten years been pursuing its global tax initiative, that has been chameleon like in its changes during the period. Having been beaten back (principally by the Bush Administration) on tax harmonisation (i.e. everyone should adopt French and German tax rates), the programme is presently focused on tax information exchange and transparency and their effective implementation. In concert with (or under the direction of their political masters) the G8 and G20, the OECD has recently been playing the “name and shame” card to remarkably good effect.
• OFC’s have been scrambling to sign up at least 12 double tax agreements or tax information agreements (TIEA’s) that meet the OECD standards and thus secure a place on the favoured white list (although it is not clear what specific reward that actually brings). Cayman initially missed the white list by a narrow margin (having been slow to build on both its early TIEA with the USA in 2002 and its implementation of the automatic reporting under the EU savings directive in 2005), but made it in quick order during the summer of 2009 by signing a plethora of TIEA’s. The next steps will be “peer review” of effective implementation. And possibly moves to sign multilateral agreements. And not so far over the horizon, automatic/spontaneous exchange of tax information.
• IOSCO (the international organisation of securities commissioners) has published six high level principles with respect to hedge funds, that in particular recommend that all hedge funds and/or managers/advisors and prime brokers and banks that lend to hedge funds should be subject to registration, there should be regular reporting to regulators to protect against systemic risk and better cooperation between regulators. I doubt that the IOSCO principles will be overly problematical for the major offshore hedge fund domiciles such as Cayman.
• IAIS (the international association of insurance supervisors) is now actively working on the first common rules on solvency requirements (margins etc) for international insurance and reinsurance companies. It may be early days but is a sign that the insurance regulatory environment is at long last going global. I do not think that these standards will cause any real problems for Cayman’s captive market.
• The Basel Committee on Banking Supervision, having only recently finished Basel II, is busy working on what will probably be called Basel III to apply the lessons coming out of the recent crisis. There will be much focus on the issue of on and off balance sheet transactions and structures, related capital requirements, risk management and stress testing. I do not see this as troubling Cayman’s banking industry (other than increased compliance costs).
• The UNODC and the World Bank are actively pursuing a (welcome) programme (the StAR project) to assist developing nations stamp out official corruption and to trace and recover stolen assets in financial centres (onshore and onshore).
• Lurking in the wings are the other usual players such as the IMF, the Financial Stability Group (essentially the policy implementer of the G20) and the FATF (Financial Action Task Force, a subset of the OECD), expanding their oversight and assessments and developing new policies and rules as they go along.
• The international activity is complemented by proposals in the US, UK and the EU for domestic/regional legislation to limit and make the legal use of offshore centres by individuals and corporations increasingly difficult, burdensome and costly and to enhance the regulation and taxation of onshore hedge fund managers and, if they can find a way to do it, the offshore funds themselves. The proposed EU Directive on Alternative Investments is being particularly hotly debated. This, combined with UCITS III, could lead to European investor focused funds being formed within the EU rather than offshore, with Luxembourg and Ireland being the principal beneficiaries.
• The UK and the US have also indicated a wish to punish so called vulture funds that they perceive prey on poor countries’ debt.
• The EU proposes that the automatic reporting of interest income EUSD (savings directive) be greatly expanded to include different types of income and gains and cut through provisions to the beneficial interests behind companies, partnerships and trusts.
• The US proposes to tighten up the QI (qualified intermediary programme) to reduce abuse by US taxpayers through offshore vehicles, to expand the reporting requirements by US taxpayers regarding offshore accounts and investments, to introduce withholding taxes for non QI compliant foreign financial institutions and to limit the ability of US multinationals to utilise OFC’s to avoid or defer US taxes and to manipulate transfer pricing (the US multinationals seem to have beaten back much of the last two for the moment anyway). Some of these proposals if enacted may also impact the captive insurance industry.
• The UK Foot Report has raised various issues of good governance, regulation, tax transparency, financial crime and the UK’s contingent liability with respect to the UK OFC’s and the Crown Dependencies.
• All the various current proposals are still very fluid with much lobbying and backroom negotiation before the fat lady sings.
Price of not playing the game
So why do OFC’s like Cayman take any notice of these issues? Why not ignore them and carry on a before? This is not a sensible long term option for those OFC’s that wish to participate in global financial markets. Perception is very important. And uncertainty and delay are not good for the reputations of or the development or retention of quality business by OFC’s. So let us look at some of the things that are happening:
• There are heightened threats of meaningful sanctions (e.g. increased withholding taxes) against non compliant OFC’s and those that use them. Germany has been considering specific legislation, and France has recently announced the establishment of Evafisc a Big Brother database to monitor offshore accounts. And it is by no means clear that inclusion in the OECD white list will necessarily give OFC’s a “get out of jail” card. For example, the list appears to cut no ice with the US Administration or Congress, even assuming they are aware of it.
• The UK Revenue has issued a proposed code of conduct for UK banks under which they will (voluntarily) commit to meeting the spirit and not just the letter of UK tax laws. It aims to limit the banks’ use (for themselves and their clients) of offshore structures that do not support genuine commercial activity and that, while legal, offend the spirit of UK tax laws as intended by Parliament. The final code has not yet been issued.
• The European Investment Bank (EIB) has amended its lending policies so that loans will not be signed with entities domiciled in jurisdictions that do not meet international standards on tax information exchange.
• US citizens working overseas are finding it increasingly difficult to open, operate and maintain normal banking relationships. Banks are finding the compliance costs and risks are not worth it.
• A number of publicly quoted non-financial companies domiciled in Bermuda and the Cayman Islands and with strong US connections (so far principally reinsurance and oil services companies) have already elected to transfer their domiciles to jurisdictions with established (and protective) double tax treaty networks and attractive corporate tax regimes. To-date Ireland and Switzerland have been the preferred domiciles.
Domestic Imperatives and Initiatives - Actions Cayman is taking
In light of this, let us now look specifically at what Cayman is doing. The Government elected in May 2009 is showing a renewed commitment to protect, support and enhance the financial services industry and thus benefit the local economy and Government revenues. Given the recent severe budget crisis that highlighted Cayman’s total dependency on financial services and tourism (and their respective support services), it is imperative that Cayman has the right platform to renergise its financial services industry (and tourism industry). The list of what I think needs to be done is lengthy but an encouraging start has been made by the new Government (in fairness some of the matters were already underway under the previous Governments), and the private sector is also showing praiseworthy energy at long last with a number of major international lobbying and public relations initiatives:
• There is now dedicated and focused political and executive leadership for finance and financial services under the Premier, Mr. Bush. A separate financial services division has been created within the Finance Ministry with a new Chief Officer in charge.
• The Government has prepare a balanced budget for the current fiscal year requiring increases in a wide range of indirect fees and duties, asset sales and cost containment) and successfully sold US$312 million in ten year bonds to solve the immediate and hopefully short term cash flow problems.
• The Government has commissioned a study to review public revenues and expenditures, the budgetary processes and revenue base and to report back with recommendations in February 2010. The principle goal is to explore cutting government expenditure, selling suitable assets, disposing of non core government activities, developing a more sustainable revenue base for the long term. My personal view is that existing revenue sources are probably maxed out and that, at some point, new forms of revenue will be needed. Examples could be a community service charge tied to property, levies on utility bills (a form of sales tax/VAT) and even casino licences.
• There has been greatly increased action and engagement to secure compliance with and effective implementation of relevant international standards and cross-border assistance through tax information exchange agreements thus to secure admission of Cayman’s to the OECD white list. Cayman now has signed 14 TIEA’s and reached technical agreement with 5 other major countries. This is in addition to the previous implementation of the EU Savings Directive and the unilateral measures to allow tax information exchange with qualified countries (12 have been so far been designated).
• Cayman is also doing much better at getting a seat at the international standard setters’ tables. It is now a member of the OECD Global Forum Peer Review Group. The Monetary Authority achieved full IOSCO membership in June 2009, is an active participant in the development of IAIS multilateral memorandum of understanding and international standards for the insurance and reinsurance industry and a long standing member of the Offshore Banking Supervisors Group. It is also expanding its Memoranda of Understanding for exchange of information with fellow regulators. The Cayman Stock Exchange (CSX), the Civil Aviation Authority (CAA), the Marine Authority of the Cayman Islands (MACI) and the Financial Reporting Authority (FRA) have all made good progress in achieving international recognition in their respective fields over the past few years.
• There have been welcome trips by the Premier, senior Government officials and private sector representatives to key global financial centres such as London, New York, Hong Kong and Singapore to explain and promote the Cayman Islands to the political, public and private sectors and the media. These should be continued on a regular basis.
• Major policy statements have been made by the Premier to encourage and welcome new financial and other international businesses to establish in Cayman with meaningful physical presences and also to encourage much greater decision making and economic activity within the jurisdiction by the entities domiciled here. This is particularly directed to the hedge fund and reinsurance market.
• Equally the Premier has made major policy statements to encourage wealthy people to take up physical residence, buy houses and invest locally.
• In order to bring reality to these policy statements active steps are underway to reinvent a sensible and welcoming immigration regime and policies and procedures to attract and keep the top quality professionals and their families to Cayman and to encourage and nurture a well educated, motivated and participating local professionals and staff working alongside them. It is imperative that this new regime be delivered in daily practice and not just in words.
• The Anti-Corruption Law and the Anti-Corruption Commission will go live in January 2010. This, and the work of Complaints Commission, Freedom of Information Office, the Auditor General and the Economic and Statistics Office (ESO), demonstrates a real commitment to greater good governance, transparency and accountability in government and the public sector.
• The specialist financial services court has recently been established to handle commercial cases with a roster of experienced commercial/financial judges.
Now let us look at what more needs to be done:
• Cayman needs to improve the delivery of legislation and regulation that relates to financial services. It simply takes too long for ideas to move to formal action. Examples are the length of time it took for the new insolvency regime and deregulation of private trust companies to go into operation. And where are the updated Insurance Law, the new Arbitration Law and the much mulled on Foundations Law? The ability to move quickly to take advantage of new opportunities as they arise is critical. Discussions of possible streamlining and specialist draftspersons need to move to implementation.
• We need increased transparency in the private sector by enactment of holistic data privacy laws in place of the Confidential Relationships (Preservation) Law, by increasing the publicly available information regarding both regulated and unregulated entities and by increasing the statistical information obtained and published by the Monetary Authority and the ESO.
• We need greater and more effective enforcement of our existing financial services laws and regulations by the regulators and law enforcement. That means more and better resources for those agencies.
• We need better targeted and effective intelligence gathering, lobbying and media relations, particularly in key centres such as Washington, London, Brussels and Paris to influence political and media perceptions, opinions and outcomes. I believe the commitment is there but more effective outcomes are needed.
• The Government London office should be greatly strengthened and include the ability to effectively cover Brussels, Paris and other key European centres.
• Government offices (with the right staff) are needed in key centres such as Washington DC and possibly the Far East.
• Cayman should develop better governmental contacts and business promotion in Asia, Latin America and the Middle East.
• The Government and the private sector should support think tanks, symposia/fora/conferences and the research, publication and dissemination of quality academic studies analysing the (beneficial) role of OFC’s. The recent STEP Report “International Financial Centres and the World Economy” by Professor James Hines is a good example of what I have in mind. And I would like to see the Government and/or private sector hosting high profile conferences where these issues can be debated by recognised academics.
Winners and Losers
So what might OFC’s, like Cayman, expect for the future?
• The pendulum is still swinging against OFC’s for the moment. But unless the world goes back to the dark economic ages, the rhetoric (even from the French and Germans) will reduce and some semblance of balance will return.
• The world is full of global businesses and families. And their number and wealth (pace Bernie Madoff and Allen Stanford) should increase over time. The real growth will probably be in the new BRIC worlds and not so much the traditional world of the G7, 8 and 9.
• Increased rates of taxation will make proper tax and estate planning for wealthy families even more important and also lead to greater demand for tax advantaged and good places to live where there is access to quality professional services and advice.
• Global economic competition inevitably means tax and regulatory competition. No-one has yet created the perfect tax or regulatory regime, so competing regimes (within broad agreed norms) are perfectly proper, just as there are many ways to make a safe automobile. Individuals and corporations are still entitled legally to maximise their wealth. Indeed, corporations have an obligation to their shareholders to do so.
• Legitimate tax and regulatory planning will always have a place. OFC’s with high standards of sensible regulation, appropriate transparency, cross border assistance arrangements and good infrastructure and providing quality value-added service have a valuable and vital role to play in this scenario.
• The barriers to entry as an OFC are ever increasing. The cost of developing the infrastructure and meeting international standards is significant and success cannot be achieved overnight or guaranteed. There are some who are doing it nevertheless, such as Dubai and more recently Ghana and Botswana. Whether they will succeed for the longer term is still an open question.
• There are probably now too many OFC’s. Competition is increasingly fierce, and jurisdictions and structures are increasingly fungible.
• I firmly believe in the Darwinian principle of survival of the fittest. The survivors will be those who meet international standards, have an established infrastructure and track record (in all its aspects), tax efficiency, professional expertise and support services, a solid and diverse base of business, and the ability quickly to adapt and innovate in the ever changing global environment and to add real value to international transactions and capital flows in an efficient and cost effective way. Sitting and saying “we are here, the business will come, just show me where I sign” will not cut it.
Rosy v Doomsday Scenario for Cayman
So applying all this, what is the future for Cayman? Do we thrive as a financial services centre and tourism destination or do we go back to fishing, rope making and the “Islands that time forgot” (with meager handouts from the UK and EU?) until global warming finally sinks us?
Why Cayman should survive and can thrive
I believe Cayman meets the foregoing tests for being a survivor and need not suffer death by a thousand cuts. But to really thrive as a financial services centre, it must learn better from history and from its mistakes and work more effectively to be fully accepted as a legitimate participant in the global financial world and to continue to be one of the preferred OFC’s for both businesses and individuals.
© Timothy Ridley 2009