Law firms: Regulation, cost and competition remain top issues in 2015

Law firms rarely confess to being “happy,” “content” or “entirely satisfied,” but that is the nature of the business; they are employed to worry so that clients don’t have to. 

Make no mistake: They are paid well for their trouble, and the 2015 “mood of the boardroom” is broadly – if guardedly – optimistic and acutely aware of the challenges the profession faces this year. 

Those challenges vary, although similarities exist. 

At Walkers, partners are worried about the U.S. Foreign Account Tax Compliance Act, regulatory compliance with Organization of Economic Cooperation and Development directives, and other European directives, the public listing of beneficial ownership in private companies, and the Directors Registration and Licensing Law, which requires registration of fund directors. 

At Maples and Calder, the boardroom is also pondering FATCA and its European analogues, profound changes involved in U.K. proposals to list beneficial ownership, and the burdens of fast-changing compliance regulations, both locally and internationally. 

At HSM Chambers, founder and managing partner Huw Moses says the firm, founded in 2012, has grown quickly, and while it is more of a subtext in his thinking, managing that growth has presented its own difficulties. 

He also worries about FATCA and what it means to the business environment, training Caymanian talent, regulation of intellectual property and the ongoing, local financial fallout from the recession. 

Ingrid Pierce, Global Managing Partner at Walkers, says costs and competition, both offshore and onshore, remain on the list of 2015 concerns, mirroring 2014. 

“The market for legal services is still as competitive offshore as it is for our onshore counterparts,” she says, “so it has been a challenge to continue to grow and increase our revenue in this environment. 

“Our clients faced further significant regulatory changes last year, with the introduction of FATCA in the U.S. and U.K., and the implementation of the Alternative Investment Fund Managers Directive in Europe.” 

The AIFM Directive regulates hedge funds and private equity funds wherever they are based. It also regulates fund managers and anyone who markets the funds.  

Prior to the financial crisis, those funds – and their managers – were not subject to the same rules as mutual and pension funds. Much of the severity of the financial crisis was – rightly or wrongly – attributed to that lack of regulation, sparking the directive, which was intended to address the gap. 

Pierce says costs of regulatory compliance have “dramatically escalated” in the last year, meaning the price of participating in the hedge fund market is, if not prohibitive, at least significantly higher than previously. While that may help protect investors, the concern is that it may impede the conduct of open markets and discourage investors and managers. 

“The infrastructure required has raised barriers to entry,” Piece says, “especially for new investment managers that cannot easily absorb these costs.” 

Maples also worries about compliance costs, particularly in regard to the U.K.’s proposed Companies Law, which will require British-based firms to keep public registers of their beneficial ownership posted on a central database. 

“This is a fundamental change and has drawn a fair amount of criticism from U.K. industry bodies who worry that the cost of the introduction of such a register will make the U,K, uncompetitive,” says Henry Smith, Maples global managing partner. 

The new law may “constitute a serious erosion of the right to privacy and leave citizens open to those who might abuse any such information for criminal or fraud purposes,” he says. 

Maples has doubts regarding the law, suggesting it may not be proportional to its aims – and that a better idea may be available: “The proposal also is flawed in several ways as it relies on self-reporting and it is thought that it is unlikely to achieve its goals. 

“As an alternative approach, the Overseas Territories have suggested that the U.K. follow the lead of introducing a licensing regime which requires U.K. corporate service providers to be licensed and to maintain certain Know Your Customer information about those who use [these] companies. 

“This has proved to be helpful to authorities seeking to ascertain the ownership of Cayman companies, where corporate service providers are already licensed,” he says. 

Pierce says, “The Cayman Islands government’s position is the right one.” 

In mid-February, Premier Alden McLaughlin told BBC’s “Hard Talk” that he had “no difficulty” introducing a public registry for beneficial ownership as long as the G8 nations and the G20 nations and the United States moved first. 

“The playing field must be level,” Pierce says, “and while the mechanisms exist to provide overseas authorities timely access to beneficial ownership information, Cayman should not introduce a public register without a similar move across the G20.” 

HSM’s Moses is not embroiled so much in compliance issues and costs as he is in developing a clear path at the firm, and helping local businesses navigate a volatile economic environment. 

“We continue to grow at a rate that was not envisaged when we first opened our doors. It has restored my belief that any business can still flourish and grow despite the challenges of doing business in the Cayman Islands,” he says. 

“Several attempts at a business plan for the next [five] years have ended up abandoned as we have reacted to change and opportunities for growth,” he says. “If there w[ere] a strategy that I would recommend to any business at this time, whether a new or old business, it would be ‘be flexible,’” he says. 

Pressures on local business are already severe, he says. FATCA and its European equivalents only exacerbate the problem. 

“We have already seen some retraction of business in the areas of wealth management and private trusts. Further adjustments,” he suggests, “are inevitable in 2015. 

“A balance has to be struck between having a modern set of laws and business being overburdened trying to comply with new legislation. 

“Strong cooperation is needed between central government and the private sector. Cayman was traditionally built on that relationship and it is as much needed today as it was in the 1970s,” Moses says. 

Elsewhere, the specter of competition from other jurisdictions leaves Maples’s Smith largely unmoved; Pierce declined to address the question. 

“Competition is always a reality,” Smith says. “Many jurisdictions view the Cayman Islands as the leader and attempt to fashion themselves in our image in an effort to knock us out of the top position. Fortunately, the Cayman Islands has a solid foundation with decades of experience.” 

McLaughlin also told the BBC that the more international regulation the local financial industry embraced, the more the business environment improved, and the more business was attracted to the jurisdiction. 

Smith agrees: “By embracing transparency, good governance and proportionate regulation, the Cayman Islands has been recognized by the international business community, and this is reflected by the increased numbers of new Cayman Islands companies and partnerships being formed in the jurisdiction [in 2014].” 

He dismisses suggestions of over-regulation: “International regulatory bodies have leveled the playing field across the global jurisdictions,” he observes, suggesting that at its worst, Cayman is little different from any other place. 

“The Cayman Islands has benefited from a stable regulatory environment, giving us an edge in the transitional stages of such changes,” as FATCA, European directives and U.K. laws, which Smith describes essentially as “par for the course.” 

Driving the point home, he says Cayman is “comparable to other similar jurisdictions in terms of fees and costs of doing business.” 

Moses expresses greater concerns about local business owners, entrepreneurs buffeted by the financial downturn, shrinking capital and declining profits. 

“The volume of work we have for clients seeking to recover, in one way or another, monies lent to individuals and local businesses is worrying from a social [and] economic standpoint,” he says. “We have not yet seen the end of mortgage repossessions, recovery of credit-card debt and car loans, recovery of strata arrears and a growing need by businesses to collect money where customers have run up store credit and then failed to pay.” 

The situation feeds a long-term cycle. Failed repayments mean tighter credit, making it harder to borrow. As such, borrowing requires greater collateral, increasing pressure on business, ultimately making it harder to repay loans, which tightens credit. 

In September, consultant Ernst & Young underlined the situation, documenting the virtual bankruptcy of the Cayman Islands Development Bank, created in 2002 to offer low-cost mortgages and loans to small businesses and students. 

The bank, said the consultant, faced a $30.5 million debt, due this year. Between 60 percent and 70 percent of its business loans were delinquent as of mid-June; 90 percent of the companies missing payments were small startups. 

Meanwhile, delinquency rates for student loans and home mortgages were somewhere between 30 percent and 32 percent. 

Moses is acutely aware of the problem. Part of the solution, he proposes, is debt counseling and improved consumer protection laws to counter high interest rates. 

“However,” he says, ”this must be balanced with easier ways for banks, businesses and stratas who are owed money to collect what is due to them or realize the security they hold.” 

The 2015 challenge to local government , he says, is “resolving longer-term infrastructure challenges – the [George Town] dump being just one, whilst being reactive to private-sector needs to attract new business. 

“The balance between the need to achieve full employment of Caymanians and manage the levels of skilled imported labor have always been a challenge for the government of the day, but we must remain able to attract new investment if we are to survive in the longer run as more traditional sources of employment and wealth are challenged by technological advances and global fiscal policy,” Moses says. 

Looking farther ahead, Pierce, of Walkers, anticipates the 2017 inspection tour by a team from the 36-jurisdiction Financial Action Task Force, scrutinizing increased demands for compliance with its “40+9” regulations regarding money laundering and counter-terrorism financing. 

The visit, she notes, “will be 10 years on from our last assessment. At that time, we expect Cayman will participate fully … and there is no reason to suggest that Cayman will not perform strongly as it has done in the past. 

“The OECD will no doubt be keenly watching how Cayman is ranked on the Transparency and Beneficial Ownership standard, which is part of the revised 40 recommendations issued in 2012.” 

The international challenge, she says, is, really, Cayman’s perennial challenge: “To counter any misconceptions regarding the levels of transparency here in Cayman and the degree to which our authorities exchange relevant tax information with overseas tax officials.” 

Left unchecked, she warns, the misconceptions “could result in legitimate business being diverted away from Cayman.” 

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Ingrid Pierce

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Henry Smith
BLOOMBERG NEWS

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Huw Moses

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