Former CIMA Chairman Timothy Ridley gives The Journal his insights to the challenges and opportunities ahead for the Cayman Islands, as presented to a Forum produced by Stuarts Walker Hersant attorneys and RBC Wealth Management held in New York on 30 June, 2009.
We are passing through some of the most turbulent times the financial services industry has ever seen. This comment applies to the industry onshore and offshore and around the globe.
We are also in an era of heightened initiatives both international and domestic that are rapidly changing the shape of the industry. The financial crisis has significantly added to the momentum.
Reports of the impending death of the offshore industry are exaggerated. I believe there will continue to be a place for high quality offshore financial centres, unless (unlikely I think) the world is prepared to go back to the days of strict exchange controls and restricted global trade and investment. Assuming I am correct, there will also be a place for high quality banks and service providers in those OFCs.
Battle for control of global capital
Let us first consider what is behind all this activity. It is a question of who will control the world’s capital. And the old guard of rich countries (the G7-8 et al) is fighting hard to maintain the status quo, that is very much in their favour, under the guise of sorting out the financial crisis and bringing to book wayward offshore financial centres. Financial imperialism and protection is alive and well!
The various important international and domestic initiatives that are underway or threatened have been significantly energised by broad political support at the highest level in the major economies of the world (G20 et al) as a result of the financial crisis. In no particular order of merit, the more significant are as follows:
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. In concert with the G20 and G8, the OECD has recently been playing the “name and shame” card to remarkably good effect;
OFCs are scrambling to sign up at least 12 double tax agreements or tax information agreements (TIEAs) 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 missed making 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 has recently signed with the Netherlands, the UK, Ireland and the seven Nordic countries, with more to come, and adopted locally enacted unilateral measures that will allow it to exchange tax information with designated countries (currently 12 countries have been so designated);
Recent statements from the OECD and leading members now make it clear that simply signing 12 agreements is not necessarily sufficient. The requirements now seem to be agreements with the major players, effective implementation and satisfactory peer review of implementation. This may further delay Cayman’s promotion to the white list;
IOSCO (the international organisation of securities commissioners) has recently 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;
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 UN held a summit to tackle the global economic crisis last week. The communiqué specifically stressed the need for transparency, cooperation in tax matters and combating illicit financial flows;
The UN 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);
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. Both the UK and the US also wish to punish so called vulture funds that 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 prevent perceived abuse by US taxpayers hiding behind offshore vehicles, to expand the reporting requirements by US taxpayers regarding offshore accounts and investments and to limit the ability of US multinationals utilise OFC’s to defer US taxes and to manipulate transfer pricing;
All the various current proposals are still very fluid with much lobbying and backroom negotiation before the fat lady finally sings.
Price of not playing the game
So why do OFCs 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 OFCs that wish to participate in global financial markets. Uncertainty and delay is not good for the reputations of or business retention and development by OFCs. So let us look at some of the things that are happening:
Heightened threats of meaningful sanctions (e.g. increased withholding taxes) against non compliant OFCs and those that use them;
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;
The UK has announced a 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. As yet unpublished, it will surely limit the banks’ use (for themselves and their clients) of offshore structures that, while legal, may be seen to offend the spirit of UK tax laws;
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;
There is anecdotal evidence that some international financial institutions are becoming concerned about the heightened reputational issues raised by their conducting business through or with offshore jurisdictions and certainly with those not on the whitelist. Some of Cayman’s key competitors have been ‘whitelisted” and are ramping up their marketing on this basis.
Actions Cayman is taking
Cayman recently elected a new Government and approved a new constitution. With that has come a renewed commitment from the political leadership to support, enhance and protect the financial services industry and thus benefit the local economy. And to do what it takes to make that happen. I am pleased to report that some of that is under way.
Some crystal-ball gazing
So what might we expect?
The pendulum is swinging against OFCs for the moment. But unless the world goes back to the dark 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 should continue to grow over time. The real growth will 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;
In tax matters, the rule of law requires the legislation to be clear. Broad anti-avoidance wording can go a long way towards discouraging too much envelope-pushing, but subjective statements like “paying your fair share” are on their own unhelpful in the extreme. The fair share is in the eye of the beholder. To be meaningful, the statement must be converted into legislation and regulations that can be understood and applied consistently by tax departments and courts;
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. Individuals and corporations are entitled legally to maximise their wealth. Indeed, corporations have an obligation to their shareholders to do so. Thus, legitimate tax and regulatory planning will always have a place, and OFCs with high standards of sensible regulation and quality value-added service have a valuable role to play in that scenario.
The challenge for OFCs and their service providers will be to maintain their competitive advantage in the face of inevitable increase in the cost of doing business. So I expect the required minimum net worth of clients and size of transactions will likewise increase. That may be no bad outcome.
Government controlled banks in the UK and the US may feel obliged to pull back from the offshore market; if so, that leaves greater opportunities for those banks and others that are not so constrained.
I do not believe legitimate quality offshore centres, such as Cayman, need suffer death by a thousand cuts; if the lessons are learned and applied, they can and will survive and thrive.