The big squeeze on financial services: How long can it last?

Economic Perspectives

The dynamics of the financial services industry’s role in the Cayman Islands has changed significantly and warrants a completely new approach to the government’s policy on matters such as fees and immigration. 

By any reasonable estimate, the financial services industry contributes at least 50 per cent of the Cayman Islands economy. Previous studies, data from the government’s annual budgets and even causal observations supports this conclusion. 

As a major economic sector the industry is also often subjected to large increases in fees and more often than not the industry has maintained its success even in the face of these increases. 

 

Financial services 

Furthermore, while most businesses complain about increases in fees it is usually the financial services industry that “comes to the rescue” when successive governments have faced challenges with balancing their budgets year on year.  

There is nothing new about this phenomenon: it has been occurring for the best part of two decades. The FCO has suggested repeatedly that the Cayman Islands is too reliant on this industry and that revenues from the financial services industry are not sustainable. That there is heavy reliance cannot be argued; clearly the country needs to work harder at diversifying the economy. 

 

Sustainability 

The traditional argument regarding sustainability has been that the heavy reliance on the industry coupled with the global developments which put increasing pressure on offshore financial services, places the country’s economy and fiscal balances at risk. Up to now the most effective rebuttal of that argument has been that despite the various regulatory and international initiatives the industry has continued to hold up fairly well and its revenue contribution to the government remained very strong. 

But a closer examination of the industry’s success and the role of domestic policies puts that rebuttal in a different light.  

While the industry may have survived international developments it is less clear that it is surviving changes to the domestic policy environment over the past 12 years or so. 

When fees are increased on the industry or immigration policies attempt to intervene in firms’ recruitment strategies, these firms, whose objective is maximising returns to shareholders, must respond. It should be clear that while many firms are good corporate citizens they are not in fact in the business of community service. In fact to a large extent profitability is the very platform which enables them to continue to be good corporate citizens. 

Traditionally, firms were not in a position to react easily to such domestic policy changes because they were in effect far less globalised than they are today.  

Now many of the major firms have a presence in at least five other jurisdictions.  

In addition an increasing number of firms have back office support teams strategically located in countries with large pools of qualified mid-level workers in a convenient time zone. 

The actual number of financial services entities in the industry has suffered a consistent average decline between 2003 and 2010 and seems to be recovering in recent years. But these often cited trend lines are an overly simplistic way to assess the industry’s role and tell us only half of the story.  

 

Outsourcing 

While firms may have a license some are demonstrating lower levels of local employment, while growing employment in other countries, and therefore less economic contribution, both due to their increased global presence. Looked at this way the situation is potentially a lot worse than the trend lines suggest. 

The immediate reaction to firms outsourcing may be to ‘legislate’ that they carry out certain economic activities in Cayman.  

The objective behind this way of thinking seems sensible enough; the more activities carried out on the ground the larger the economic impact of such firms.  

But restricting firms’ ability to use their global presence or to legislate local economic activity would be the wrong way to achieve this objective.  

Encouraging firms to establish themselves with a physical presence through lower fees and less intervention in their recruitment practices is the way to entice them to do more locally. Otherwise these firms may find that the benefit associated with a Cayman presence, even a minimal physical presence, is simply no longer worth it. 

 

Decline 

Some firms have already contracted their operations locally through outsourcing and if the squeeze continues the industry will face a severe decline, which will have a devastating economic effect.  

There appears to be continuing misperception that the financial services industry needs the Cayman Islands more than the Cayman Islands needs this important economic sector (things may have started this way but significant leverage has been lost by the jurisdiction over the years).  

To date as a result of the industry’s success, the government has been able to secure substantial revenues, jobs for Caymanians and some local economic activity, albeit the latter has been quietly on the decline due to the globalisation of firms and domestic policies.  

But if the squeeze continues the alternative scenario is that the country will lose the so called golden goose entirely.  

For years this ‘golden goose’ argument has been dubbed the bogeyman, nothing more than a false threat raised only when the industry wishes to use some leverage against policymakers.  

Recent trends and the new global dynamics of how firms operate demonstrate that not only is this threat real, it has been manifesting itself for several years now. 

 

Paul Byles is CEO and partner of First Regents Bank & Trust. He is an experienced economist and finance professional. 

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