Monday, February 27, 2017

Global implosion of trust

Public trust in the institutions of government, business, the media and nongovernmental organizations is in freefall, according to a survey in the 2017 Edelman Trust Barometer.

In two-thirds of the 28 countries surveyed, more than half of the public no longer trusts mainstream institutions to do what is right. Trust in the media, especially, has fallen dramatically and is at an all-time low in 17 countries, the survey found.

Trust in government fell in 14 countries, making it the least trusted institution in half of the countries.

The credibility of leaders has also taken a hit. CEO credibility plummeted in every country and is at an all-time low. Government officials remain the most distrusted overall.

Most significantly, more than half of those surveyed worldwide believe that the current system has failed them, is unfair and offers little hope for the future. Only 15 percent are confident it is working.

Even half of the top earners and the college educated have lost faith in the economic and political system and agree that it has failed.

Three major European countries – France, Italy and Spain – are in the top five countries where the public has the least faith in the current system, together with Mexico and South Africa.

“The implications of the global trust crisis are deep and wide-ranging,” said Richard Edelman, CEO of public relations firm Edelman. “It began with the Great Recession of 2008, but like the second and third waves of a tsunami, globalization and technological change have further weakened people’s trust in global institutions. The consequence is virulent populism and nationalism as the mass population has taken control away from the elites.”

Shrinking middle class

One indication of the perceived “system failure” in the United States is the shrinking of the middle class during the past four decades.

A 2015 Pew Research Center study noted that for the first time, more Americans are in the upper and lower income brackets than in the middle class. The share of the American adult population that lives in middle income households has fallen as middle income earners moved to both upper and lower income tiers.

The share of Americans who are classed as upper income increased more than the share of lower income Americans. But in almost half the metropolitan areas examined by the study, “There has been more movement down the ladder than up.”

This shift is partly explained by a decline in the median household income in the U.S. from $67,673 in 1999 to $62,462 in 2014, after the data is adjusted for household size and scaled to a household of three.

Likewise during that period, the amount required to be classified as middle income or upper income households also fell, from $45,115 to $41,641 and $135,346 to $124,924, respectively. At the same time, the upper income tier benefited from rapid income gains.

In addition to a 4 percent income decline for middle income Americans, their median wealth assets fell by 28 percent between 2001 and 2013.

Weaknesses in Europe

In Europe, meanwhile, the financial and government debt crisis combined with structural weaknesses have caused rising unemployment and slow economic growth, which in turn put a greater strain on the public purse. EU political leaders have been unable to agree to compromises on debt relief, structural reforms, monetary policy or the level of government spending.

Not surprisingly, the belief in political and economic leadership has waned. More than two-thirds of the general population worldwide have no confidence that current leaders can address their country’s challenges.

The liberalization of financial markets and the globalization of trade and supply chains has produced winners and losers. While this may have still benefited economies as a whole, the anticipated losers have not been sufficiently compensated to avoid a palpable rise in inequality.

In many countries, the advocated solution is now not greater wealth redistribution to redress the imbalance but more nationalism and protectionism.

“Business has much to fear in this context,” said Edelman.

Almost half of the general population now believes that free trade agreements hurt a country’s workers and nearly three quarter favor government protection of jobs and local industries even if that leads to slower growth for the economy in general.

“Populist-fueled government could implement harsh regulation of specific industries such as manufacturing and technology, and a ban on immigration, even of skilled workers,” Edelman wrote in his analysis.

Media

The level of distrust is intensified by media and social media echo chambers which reinforce personal beliefs and block opposing points of view, the survey noted.

This confirmation bias is strengthened as most people favor search engines (59 percent) over human editors (41 percent) and are nearly four times more likely to ignore information that supports a position they do not believe in.

At the same time, the gap between the informed public ‒ defined as college educated, top earning, regular consumers of news media ‒ and the general population in terms of trust has widened considerably with the biggest disparities in the U.S., the U.K. and France.

“People now view media as part of the elite,” said Edelman. “The result is a proclivity for self-referential media and reliance on peers. The lack of trust in media has also given rise to the fake news phenomenon and politicians speaking directly to the masses.”

Trust in traditional media fell 5 points to 57 percent, the steepest decline among media platforms since 2012, followed by social media (41 percent), which dropped three points. By contrast, online-only media (51 percent) received the biggest bump in trust up five percentage points.

For Edelman the solution is that “media outlets must take a more local and social approach.”

Businesses could make a difference

Although trust in business has dropped in 18 countries to 52 percent overall, the Trust Barometer noted that business is viewed as the only mainstream institution that could make a difference.

About 75 percent of respondents think that a company has the ability to grow profits and improve economic and social conditions in the community where it operates. Especially the respondents who are uncertain whether the current system is working for them trust businesses most.

Still, globally a majority of respondents are concerned that they might lose their job because of the impact of globalization (60 percent), lack of training (60 percent), immigrants who work for less (58 percent), outsourcing of jobs to cheaper countries (55 percent) and automation (54 percent).

“Business is the last retaining wall for trust,” said Kathryn Beiser, global chair of Edelman’s Corporate practice. “Its leaders must step up on the issues that matter for society. It has done a masterful job of illustrating the benefits of innovation but has done little to discuss the impact those advances will have on people’s jobs. Business must also focus on paying employees fairly, while providing better benefits and job training.”

If more than half of the population believes the current system is not working, Beiser said, businesses should assume that their employees are a subset of that population.

“In a climate of disillusionment, remaining connected to the mood and concerns of the workforce becomes increasingly important.”

Businesses are also at odds with a public that is keen to see more rather than less regulation on business, because it believes the pace of change in business and industry is happening too fast.

A push for further deregulation could in fact lead to a greater erosion of trust.

“It would be the greatest folly for CEOs to press populist leaders for less regulation, particularly in the environmental arena,” Edelman said. “Fifty-two percent of the general population say a company’s effort to protect and improve the environment is important for building their trust.”

Cayman retailers turn focus to local shoppers amid dampened tourism sales

Improvements in tourism infrastructure, including a cruise ship berthing facility and a new airport, would bring a boost in 2017 and encourage greater foot traffic.

Kayla Young

Tumultuous politics and competitive pricing spelled a difficult year for Cayman retailers focused on tourist foot traffic in 2016.

While cruise ship and stay-over arrivals held steady with around 2 million visitors, retailers felt the effects of depressed exchange rates out of Europe and uncertainty created by the U.S. elections.

Chris Kirkconnell, vice president of operations for Kirk Freeport, said he noticed a slowdown last summer that has carried over into the new year.

“When we look at any U.S. election, you do see people hold back on consumer spending,” said Kirkconnell, who manages duty-free shops, jewelry stores and boutiques on Seven Mile Beach and at Bayshore Mall, among other locations in Grand Cayman.

“With a new U.S. administration that is only days in, we’re still waiting to see how that affects consumers out of North America,” he said.

He hopes planned improvements in tourism infrastructure, including a cruise ship berthing facility and a new airport, will bring a boost in 2017 and encourage greater foot traffic.

Phuong Buettner, Cayman retail manager of Penha Freeport, said marketing to cruise ships and hotels can be difficult.

While she has seen Penha’s cosmetics and perfume shops increase in popularity among local shoppers, the tourist segment remains difficult. Shopping opportunities on ship and loyalty shopper programs make for strong competition with cruise ships.

“They are selling the same products, fragrances, cosmetics, etc., and they also give a very deep discount to their customers,” she said.

Ships carrying Latin American and European passengers typically produce better sales than those from the U.S., she said. In January, she noticed particular interest from passengers from Spain, Costa Rica, Venezuela and Brazil, drawn in by competitive prices compared to shopping back home.

Kirkconnell pointed out that one benefit of duty-free shops on Grand Cayman is the wider product variety they offer compared to stores on ship.

While new hotels like the Kimpton Seafire Resort also create opportunity [for marketing], Buettner said, she will keep her focus on local shoppers. Unless stay-over tourists see an ad in a local magazine or get a tip from a hotel concierge, she said, it can be difficult for them to find shops in town.

Despite barriers, Cayman’s wholesale and retail trade grew 7.6 percent in the first half of 2016, according to the Cayman Islands Economics and Statistics Office. Buettner attributes this growth to local shoppers rather than to tourism.

A strong local economy and low unemployment have Buettner anticipating 5 percent sales growth or greater for 2017.

Island Companies CEO Matthew Bishop said retail in Cayman remains challenging. Difficulties arise as a result of high operating costs and market volatility, at times linked to bad weather that can dampen tourist shopping opportunities.

“We are also operating in an increasingly competitive space, not just from other on-island entities, but increasingly also from the internet,” Bishop said.

Traditionally the cruise ship segment has been the focus of his shops in Island Plaza, Camana Bay and the airport. He saw muted growth from this sector in 2016, however, and anticipates it to remain slow in 2017.

Local sales will also drive his focus for the year, in addition to stay-over tourists.

Bishop suggested a two-tiered duty approach to support local retailers. He proposed government offer lower tariffs for locally owned companies.

“This might help reduce the cost of living while also protecting jobs,” he said.

Bon Vivant owner Cynthia Hew said she also depends on local shoppers for her luxury kitchen retail shop. She hopes to better target client needs and improve marketing channels to increase sales in 2017.

“Our customers want to have an experience, so our focus in 2017 will be to make shopping with us an experience where they learn about us and our product through other methods and not just when they stop in to the store. If they can’t come to us, we will go to them,” she said.

For a strong sales year, she recommends stores take the time to train staff and deliver on promises.

She suggested, “Making promises that you can keep, knowing your product better than anyone so you can educate the end user and training staff to lead with your brand values and responsibilities. Sometimes it’s hard to do all of these at once, but deliver on these three things and you will have a customer for life.”

Expect the unexpected

Francois Fillon, with his wife Penelope, during a recent rally in Paris. - Photo: AP

The Cayman Islands Journal, Feb. 1, 2017: By the time you read this, one of the most unlikely events that could have been imagined one year ago will have happened – Donald Trump will have been inaugurated as the 45th president of the United States of America. We are not here to sit in judgment of this fact, but simply to point out that in January of 2016, very few people anticipated this outcome, least of whom were the experts and pundits that make a living out of their predictive abilities.

It is with this in mind that we would like to look forward and try to think through two possible outcomes for financial markets in 2017; outcomes that financial markets currently price as improbable. Call it the list of “the most likely of the unexpected” events to occur. Everyone has a prediction for what WILL happen in 2017 and most of those will be wrong (refer to the Federal Reserve’s economic forecasts in December of every year since 2011), so here are two things the market has definitely not counted on, but which could actually occur.

  • The triggering of Article 50 of the Lisbon Treaty, or the official Brexit, does not turn out to be the most important political event of the year.

The entire world will most assuredly be watching when Theresa May gives her speech and signs whatever needs to be signed, in triplicate no doubt, to trigger the U.K.’s exit from the Eurozone. This event is due to occur sometime in March. There will be an active betting market on which day it will be, and surely an estimate from the punditry of how many times Mrs. May utters “the British people.” This may not, however, turn out to be a market-moving event. Why should the symbolic signing of a piece of paper cue market volatility? There should be countless opportunities over the next two years (or more) of negotiations for volatility associated with this divorce, and we frankly see little reason for it to happen immediately at, or directly after, the event.

The real political market-moving event may be the presidential elections in France. We already know there is likely to be no Socialist candidate, so the government is changing. The election will almost certainly be contested between two conservative parties, one of a “center-right” disposition and the other very far to the right indeed. A panoply of polls has Marine Le Pen’s Front National scoring no better than between 32 percent and 37 percent in the last run-off of the election whether she faces Alain Juppe or Francois Fillon. Do you trust the polls after what happened in the U.K. and the U.S. in 2016? Or rather, do you trust them enough to believe that the unlikely simply cannot happen?

  • U.S. Treasury bonds will not be the worst performing asset class in 2017, as the markets expect.

First, to be clear, we are among those who believe inflation will rise in the U.S. this year. If any, or most, of President Trump‘s policies are enacted into law, or decreed, as is his right in some cases, most of the policies are inflationary. If U.S. inflation is set to rise then, how is it possible for the Treasury market to perform well? Easily. Financial markets are giving a “huuuge” benefit of the doubt to Trump and the potential for his policies to be supportive of growth. More sensible forecasters, that we happen to agree with, have added only marginally to forecasts for measured GDP in 2017. Recall that in the end of 2015, GDP growth was forecast to be nearly 3 percent; 2016 was going to be the year that growth broke out of its “new moribund,” but it didn’t happen. GDP growth forecasts for 2017, even with the Trump bounce in sentiment are 2 percent to 2.5 percent, which, while better than 2016, is not much higher than estimated potential growth for the U.S. economy. U.S. 10-year rates finished at 2.45 percent, not materially higher than at the end of 2015. Therefore, if expansionary fiscal policy or tax cuts take longer than expected or growth negative policy takes priority, there is potential for GDP to disappoint and for rates to remain much more range-bound than recent price action would predict.

In conclusion, one does not have to truly believe that a far right candidate will win the French presidency, or that Trump’s policies will fail, to engage in an exercise questioning what is possible in 2017, even if it is not the most probable outcome. Thinking about how markets are valued based on the probable outcome does little to protect you from the potential downside of being wrong. One must assume some level of humility and test assumptions (both one’s own and the market’s) in order to ensure that if the unlikely occurs, your portfolio is protected from irreparable damage.

The views expressed are the opinions of the writer and while believed reliable may differ from the views of Butterfield Bank (Cayman) Ltd. The Bank accepts no liability for errors or actions taken on the basis of this information.

Reflation causes rotation

Inflation is coming! At least that is the warning from prophets of doom since the central banks began to react to the credit crisis of the years 2008/09 with an unprecedented expansionary monetary policy. Until now, however, these warnings have always proved to be false alarms. Instead, deflationary or at least disinflationary tendencies were felt virtually worldwide in previous years. Only in the course of last year have the winds on the inflation front slowly started to change.

Recently, the inflation rate is picking up again, at least slightly. In the Eurozone the annual rate of consumer prices rose from 0.6 percent in November to 1.1 percent in December. On the one hand, this is still below the inflation target of almost 2 percent the European Central Bank has for the Eurozone, but on the other hand, it is the highest number since September 2013. In the U.S., prices were up 2.1 percent in the past year. That means annual inflation hit a 2-½ year high in December.

As in the case of almost all recent developments in the financial markets, it is said that the election of President Donald Trump has had at least a reinforcing effect. That has to do with his plans for a more expansive fiscal policy and the creation of millions of jobs. It is not only the U.S. national bank that thinks these proposals carry potential inflation risks. In fact, the economists at Capital Economics, not least for these reasons, expect that the headline and core CPI inflation in the U.S. will move up toward 3 percent this year.

Markets have already started to play the topic

Since it is not clear what will happen after one-time statistical base effects like a higher oil price run dry, it remains to be seen whether the outlined trends will really continue in 2017. It is striking, however, that over the past weeks and months, leading investment banks repeatedly published reports which contained reflation forecasts for the global economy. What is important here is that these predictions are not about strong inflation. Instead, according to Morgan Stanley Europe’s chief economist Elga Bartsch, the term “reflation” means a phase in which both growth and inflation are approaching their long-term trends again.

Noteworthy in this respect is the fact that the analysts’ forecasts are in line with recent developments in the financial markets. Consistent with the change in mood among investors and the rising inflation figures, particularly in the U.S., bond yields have risen. Bolstered by the key interest rate reversal in the U.S., the U.S. dollar is also showing continued strength.

In addition, strategists also link the stock market rally at the end of the year with the outlined development. According to Morgan Stanley, based on historic experiences, a reflation scenario is connected with the following scenario: Economic growth is recovering, policy rates remain relatively low, bond spreads are narrowing, and stock prices are picking up.

As Blackrock reported, at the turn of the year the accelerating reflation trend in the U.S. was the main theme with customers. In the discussions, the world’s largest asset manager held the view that reflation worldwide will accelerate in 2017, led by the United States and accompanied by rising nominal growth, wages and inflation rates. This theme also plays a central role in how Blackrock suggests positioning portfolios for the current year.

“With inflation taking root and growth picking up, we believe bond yields have bottomed, and yield curves are likely to steepen further in 2017. This environment should support reflationary beneficiaries, such as value stocks. Higher long-term rates drove a rotation within equities during the second half of 2016. Reflation contributed to value shares outperforming the broader market, as bond-like equities suffered. We expect more of this rotation in 2017, and see the stock market beneficiaries of the post-crisis low-rate environment further underperforming over the medium term,” says Richard Turnill. And the BlackRock global chief investment strategist adds, “We generally prefer stocks over bonds and are optimistic about further upward revisions to earnings estimates.”

Prefer real assets and stocks

In addition, fund manager Jupiter Asset Management believes that an environment with rising interest rates and higher inflation has a favorable effect on the prices of global financial stocks. This is also in line with the recent price movements on the stock market. Another interesting aspect is pointed out by Edith Southammakosane. Based on data since 1991, real assets tend to perform well during months of rising inflation in the U.S., with similar results also for Europe. According to Southammakosane, a multi-asset strategist at ETF Securities, the analysis shows that commodities are the best performer, followed by infrastructure, real estates and then inflation-linked bonds.

Bank of America Merrill Lynch also bets on real assets. In explaining that call, Chief Investment Strategist Michael Hartnett states that real assets were historically positively correlated with inflation and interest rates. Furthermore, real assets traditionally benefited from fiscal stimulus and protectionism. He also thinks real assets are cheap, since the long-run price relative of real assets to financial assets is at its lowest level since 1926. To implement the real asset theme, Hartnett recommends owning real estate, commodities and collectibles, either directly or through financial products like ETFs and specialized funds focusing on infrastructure, home building, precious metals, farmland, timber, wine, etc.

As far as stocks are concerned, this asset class is doing well as long as inflation does not get out of hand. This is shown in an empirical study by Sal. Oppenheim. Based on U.S. data, the capital market experts at the German private bank analyzed the real annual performance of six asset classes from 1900 to 2015. The aim was to find out whether equities, bonds, real estate, oil, cost and cash provide adequate protection against inflation and/or deflation. According to the results, investors lost money with stocks only in periods of inflation rates above 8 percent.

Taking these findings into account, it makes sense to incorporate the reflation theme when attempting to develop the appropriate investment strategy for 2017, especially since the financial markets have already started to play the reflation topic. However, in order for these trends to continue, the reflation scenario must actually unfold. For this reason, it will be even more important than usual for investors to pay close attention to the inflation data in the course of the current year.

OECD’s reporting standard: Collateral damage

Ashley Fife
Ashley Fife

The elimination of tax evasion is a laudable objective. Governments miss out on revenue if assets are moved to other jurisdictions to evade taxes, and the impact is greater in poorer countries.

However, it is reasonable to ask whether international efforts for the automatic exchange of information (AEOI) strike an appropriate balance between the objective of eliminating tax evasion and the legitimate concerns of individuals concerning their privacy and safety.

The use of planning techniques to lawfully minimize taxation, combined with honest tax reporting, is very different from illegally hiding assets and income to avoid accurately reporting to tax authorities. However, those who pay higher tax rates may be forgiven for begrudging those with the resources to structure their affairs utilizing lower tax jurisdictions, potentially only further increasing the substantial proportion of global wealth held by a tiny proportion of the population.

The Tax Justice Network, a tax research and advocacy group, estimates that offshore financial centers (OFCs), many of which are United Kingdom dependencies or territories, hold US$21 trillion to US$32 trillion of individuals’ financial assets. Governments and media have described tax avoidance as a moral evil, often distinguishing between aggressive and ordinary tax planning. However, taxpayers cannot be expected to comply with subjective notions of morality. Rather, the imposition of tax through application of clear laws should be the objective.

In order to implement appropriate tax laws, governments may require information regarding the transactions and entities that their residents benefit from locally and abroad. The Organisation for Economic Cooperation and Development (OECD) and many governments are concerned that OFCs attract foreign investment by: imposing low, or no income or corporate taxes on foreign investors; and facilitating foreign investors to keep their identities and financial affairs private.

Since the financial crisis began, the OECD has escalated global initiatives against harmful tax competition, focusing on OFCs. However, OFCs may facilitate investment into poorer jurisdictions and help avoid the imposition of double or triple taxation on workplace pensions and other investments. Many OFCs impose customs and probate duties, annual fees on entities and other taxes to generate revenue. Should OFCs be criticized for not introducing taxes that are not appropriate for their economic circumstances?

OFCs are not the only jurisdictions whose tax systems and laws attract foreign investment. Many U.S. jurisdictions, including Delaware, Nevada, Wyoming and South Dakota impose little or no income or corporations tax and restrict disclosure of the identities of beneficial owners of entities established there. Foreign investment into the U.K. is facilitated by the U.K.’s relatively low corporation tax rate and a preferential tax regime for individuals who are resident but not domiciled there.

The OECD has used blacklists and other measures to compel OFCs to enter into tax information exchange agreements (TIEAs) with higher tax jurisdictions. The Model TIEA requires an applicant to demonstrate that the information requested from the partner jurisdiction is “foreseeably relevant” to a tax investigation. Critics consider the TIEA process too difficult and cumbersome to significantly reduce tax evasion.

Following the U.S. Foreign Account Tax Compliance Act (FATCA) 2010, the OECD developed the Common Reporting Standard (CRS). There are more than 100 CRS participating jurisdictions. Unlike TIEAs, CRS essentially operates on a multilateral basis requiring participating jurisdictions to disclose information received from resident reporting financial institutions (RFIs) in bulk to other participating jurisdictions, where RFI “account holders” are resident. The information need not be relevant for a tax investigation. In some instances, CRS requires exchanging information about persons who cannot even benefit from “accounts.”

FATCA is generally limited to non-U.S. financial institutions disclosing financial information on accounts held by “U.S. persons.” FATCA does not require any meaningful reciprocal disclosure by U.S. financial institutions about non-U.S. residents to non-U.S. governments. The U.S. does not presently participate in CRS. Consequently, in some cases, non-U.S. persons may hold accounts in financial institutions in the U.S. without being subject to FATCA or CRS reporting obligations. The compliance costs on financial institutions and the costs on governments to collect, disclose and review disclosed information are huge. Poorer governments may not have the resources to effectively create such infrastructure. It is also questionable whether any additional taxes collected from CRS will justify these costs. Aside from philosophical or constitutionally enshrined entitlements to privacy, many individuals legitimately fear that disclosure of financial information may increase their exposure to kidnapping, extortion or blackmailing by criminals or confiscation of assets by corrupt governments.

Given the recent data breaches associated with the U.S. election, Panama papers and The Bahamas, can we conclude that existing global technology and systems are sufficient to prevent unauthorized access and disclosure of the information reported under CRS? Should international efforts focus instead on preventing corruption and tax evasion through ongoing anti-money laundering measures, general anti-avoidance legislation, continued development of robust and efficient TIEAs, voluntary disclosure programs and initiatives to improve national governance in poorer countries? Despite the OECD’s safeguards, CRS may presently be unable to adequately address legitimate privacy and safety concerns of tax compliant individuals.

Ashley Fife is a senior associate in Appleby’s Private Client & Trusts Practice in Bermuda. This article first appeared in Bermuda’s Royal Gazette.

‘Year for Tourism’ celebrates record prices and rebuilds

The Cayman Islands Tourism Association has declared 2017 “The Year for Tourism,” a declaration that comes in the wake of improving economies in Cayman’s North American markets and a long-awaited recovery at home, boosting arrivals, room inventories, new flights by Southwest Airlines, a new Ministry of Tourism outreach to South America, a residential building boom and plans for at least five new hotels.

CITA is excited. Executive Director Tiffany Dixon-Ebanks says November’s launch of Cayman’s newest top-rated hotel is only the start.

“Opportunities stem from the November 2016 opening of the Kimpton Seafire,” she says, the first overseas effort by the San Francisco-based chain.

Dixon-Ebanks said the five-star resort, owned by Dart Enterprises, added “some 266 rooms to the island’s room stock, and reported a 75 percent occupancy rate [during] the first few months of operation.”

Occupancy rates are normally closely guarded, but the Kimpton’s successful launch and the much-anticipated addition of fresh room inventory appeared to galvanize the industry.

“There are also additional properties such as the Margaritaville, which are scheduled to be open, and others on the horizon for the eastern side of Grand Cayman,” Dixon-Ebanks said.

Renovations are under way on the $70 million conversion of the former Treasure Island Resort on West Bay Road into the 285-room Margaritaville Beach Resort Grand Cayman. A March opening has been set for the rebuilt complex, which will include three pools, a swim-up bar, a fitness center, retail shops and function spaces.

Owners Howard Hotel Group announced in October plans for a three-story, 42-room boutique hotel on West Bay Road near Lawrence Boulevard.

Other hotel plans include a second Dart Enterprises five-star project on Seven Mile Beach, scheduled to open in 2018, plus the company’s rebuild of the old Hyatt hotel. Managing Director of Beach Bay Land John Layton has signed an agreement with government for a $250 million, five-star, 10-story development, with 200 rooms and 75 residences, on 16 acres at St. James Point in Bodden Town, scheduled to open in late 2018.

The $365 million, 600-acre Ironwood Development, another mixed-use residential, tourist and recreational project – including a hotel, conference center, Arnold Palmer golf course, beach club, town center and homes for 2,000 – is planned for Frank Sound.

Ground-breaking at Cayman Enterprise City and accommodations at Health City Cayman Islands are also on the docket.

Theresa Leacock-Broderick, CITA vice president and condominiums director, said 2016 changes were “by far positive, from progress on the airport expansion, increased airlift and [a] new fleet for the national airline to new hotel openings, all contributing to future success.”

She added, however, that “One of the challenges for Cayman’s tourism continue to be related to managing growth without compromising our visitors’ experience. We are fortunate to have growing demand, but we have to be mindful of our infrastructure, congestion or unregulated services that could potentially detract from our overall successes.”

Final numbers for 2016 from the Department of Tourism reveal 385,451 air arrivals, a 0.02 percent increase from 2015, and 1.7 million cruise arrivals.

Both the Westin and The Ritz-Carlton, Grand Cayman, the island’s two biggest hotels, indicate solid profitability, but flat occupancy rates.

In its 2016 year-end report, tourism watchdog New York-based Integra Realty Resources says regional hotel performance has declined slightly after “several years” of improvement, but says Cayman was displaced at No. 15 on the list of high-growth destinations by Turks and Caicos, which registered a 19 percent improvement.

At the same time, IRR says, Cuba, newly opened to visitors, reports 11.7 percent growth through August, a “significant improvement,” and “is expected to top 3 million visitors in 2016 for the first time,” although those numbers come from a base both low and difficult-to-measure.

Dixon-Ebanks says Cayman is not competing with Havana – at least not for the foreseeable future: “The Cayman Islands visitor target is for the most part that of the affluent, and focused on a high-quality visitor experience, providing a cosmopolitan atmosphere with access to all the comforts of home.

“With the progress made in both the product offering as well as the new accommodations and developments coming online in 2016 and those to continue in 2017, the destination is poised for continued growth,” she says.

IRR says the Kimpton Seafire added 7 percent to Cayman’s room stock, but notes that 22 hotel projects in the Caribbean will add 4,356 rooms, fewer than 250 of which are “in the pipeline” in Cayman.

In fact, the three largest projects pending in the Caribbean are 2,850 rooms in two Jamaican resorts, and another 512 in the Dominican Republic. Those figures, IRR notes, do not include the stalled 2,173-room Baha Mar mega-hotel in the Bahamas – which may be about the resume.

Nonetheless, Dixon-Ebanks anticipates increases – if modest – in local room stock, saying, “The condo sector is optimistic, and some are putting more stock into short-term rentals. Airbnb and VRBO [Vacation Rentals By Owner] may likely also have an impact on increasing short-term rentals.”

IRR figures support the upbeat mood: “The market for resort condominium projects appears to be relatively stable in established markets such as the Cayman Islands and Turks and Caicos Islands.

“On Grand Cayman’s Seven Mile Beach, volume of sales of oceanfront condominiums has been steady and the average price per square foot is on the increase,” the report says, noting 2014 peak sales of 72 condos at an average price of nearly $850 per square foot, and 2016 sales of just 20 condos, but with an average price of $1,002 per square foot.

“It should be noted that the 60-unit Watercolours project was completed in 2014,” the report says, “which explains the large increase in volume of sales that year. The remaining Watercolours units have continued to sell in the last two years … .”

Morty Valledejuli, general manager at The Westin, says his hotel’s biggest challenge in 2016 was not from competing destinations, but the multimillion-dollar renovations that disrupted daily operations.

“The renovation displaced revenues for five months,” he said, meaning “we had to lead the resort in adversity and think about how to overcome [the] drop in revenues, keep as many associates employed and keep a budgeted and renovation time line on schedule so we could open the hotel on time – during Christmas season.”

That was just the initial phase of a two-part $50 million renovation, he said, which followed a 2013, $10 million re-build that “paid major dividends and added incredible value to the asset.”

The 2016 project – “a full re-imagination of our public spaces and pool deck area” – was finished on Jan. 5.

The $30 million phase 2 – re-building the hotel’s 343 rooms – will start in May, and is expected to be completed in August.

“The Westin will have the newest hotel guest rooms in the market – that makes us the preferred destination in Cayman,” Valldejuli said.

The Cayman market is the highest priced in the Caribbean. IRR pegged 2016 average daily room rates, at US$356, trailed by the U.S. Virgin Islands at $331 and Barbados at $283.

Valldejuli said Westin average daily room rates may rise after August.

“Our rates and that of the market will drive rates up as long as there is demand – as long as flights keep coming and airfares are competitive with other islands – and we continue to have a great property, great service that will add value to that rate.

“Our rates are seasonal – our BAR (Best Available Rates) can start from $589 per night and go up from there pending on room type, view, etc.,” he said. “After the remodel – we’d like to see a 15+ percent in our ADR.”

CITA’s Dixon-Ebanks is  not worried about Cayman’s high average daily rate, saying, “We believe hotels are in tune with supply and demand and will adjust strategies accordingly for success. Currently, persons visiting the Cayman Islands are looking for that incredible experience and individual properties.”

Valldejuli pointed to one “dangerous trend”: “If one of the ‘big four” hotels starts lowering rates to gain occupancy – that creates a bad domino effect that devalues the market. Not a good strategy.”

Ritz-Carlton Director of Sales and Marketing Heidi Nowak, while declining to discuss ADRs or any financials, said the “most immediate threat to our destination is the current state of the airport and its ongoing construction.”

A $55 million expansion of the terminal at Owen Roberts International broke ground in late 2015. Workers have completed a new baggage-claim area and luggage-screening room. New arrival and departure halls, scheduled to open in mid-2018, will boost the facility from 77,000 square feet to 200,000 square feet, improving passenger throughput from 500,000 per year to 2.5 million per year.

Valledejuli looks forward to the opening, saying the terminal “will definitely enhance the customer experience on the arrival/departure side of things – more customs and immigration officers, larger baggage claim and handlers, etc.”

Nowak, of The Ritz-Carlton, says Cayman’s strength as a destination “is driven by flight capacity, frequency, change in seasonality of lift, and originating cities. Any changes to those can impact the hotel both positively and negatively.”

She pointed to “new direct flights last summer, which boosted our level of occupancy, [and] demonstrated that there is room for more arrivals.

“The destination is highly recognized and with additional capacity, [the Ritz is] ready to welcome more guests,” she said.

In early January, Dallas-based Southwest Airlines announced daily service between Fort Lauderdale and Grand Cayman starting June 4, increasing airlift from the U.S., the source of 78 percent, 300,571, of the islands’ visitors in 2016.

Also in early January, Minster of Tourism Moses Kirkconnell and the Department of Tourism renewed efforts to gain traction in Central and South American markets, targeting affluent Brazilians, Argentinians, Colombians and Panamanians.

DoT arrival figures suggest ample room for improvement in those areas. In 2016, there were 743 visitors from Brazil; 711 from Argentina; 182 frp, Panama; and 169 from Colombia. Similarly, Mexico registered 559 visitors and Costa Rica only 198.

Kirkconnell said the latest effort might fill 20 percent more hotel rooms expected in the next two to three years. Bids for the consultancy closed Jan. 13.

CITA said talks are in progress with other carriers, while Cayman Airways announced on Jan. 19 the inauguration of twice weekly flights to Roatan, Honduras.

CITA’s Krug said there are discussions from other carriers involving new routes, and “with a new [airport terminal] that is more than double its current size, passengers will certainly have a much more pleasant experience.

“The ability to handle passengers more efficiently and the prospect of new hotels are both matters that airlines take into consideration when looking at additional airlift.”

The Ritz, says Nowak, is poised to take advantage of the opportunities. In 2015 the Marriott-managed hotel completed a three-year multimillion-dollar “aggressive renovation/rejuvenation program,” which had “strengthened its position in the market to face any upcoming challenges.

The re-build reconfigured the hotel’s fifth floor into meeting rooms, and created an interactive culinary studio, the “Starfish Cay” splash park, expanding outdoor seating and opening a high-end retail shop – while announcing 2016 plans for another $100 million in renovations of 100 suites and residences.

“The way we best meet challenges,” she said, “is truly by delivering the best possible guest experience … Our team is … engaged in adapting to guest needs and, therefore, in applying innovation to our thinking and to all of our processes, so as to ensure we always stay ahead.”

Finally, CITA’s Leacock-Broderick touched on a handful of smaller, if related, issues regarding infrastructure and legislation likely to affect the numbers and enthusiasm of tourists in the immediate future.

“We would like to have greater confidence in a resolution for solid waste management and see workable steps for the revitalization of George Town,” she said.

“Regulations related to the use and management of public beaches and vendors continues significantly to impact the visitor experience as well as those related to taxi, water sports and tour operators.

“In as much as there could be far greater integration and collaboration amongst governmental fractions, we need to be particularly supportive of the development of a National Tourism Plan that has the potential of being instrumental in creating a shared vision and pathway for optimally managing our current position while developing strategically and proactively in a balanced, sustainable manner for the future of Cayman’s tourism,” she said.

Financial services: regulation, costs and maybe fintech

In a briefing to financial services chiefs in New York last month, Cayman Finance CEO Jude Scott offered a modest headline: The jurisdiction is looking at streamlining compliance issues using fintech, a software-based financial-tracking system.

Along the way, Scott also announced formal elevation of the reinsurance industry to Cayman’s formal industry sector – the sixth alongside banking, investment funds, insurance, corporate services and trusts, reflecting its growth in the last year, and hopes for greater 2017 development.

“The development of our reinsurance sector is just one area of innovation that we have been focusing on over the past 12 months,” Scott said.

“We have also been looking very closely at the fintech industry and specific aspects of fintech that fit synergistically with the overall Cayman business model.”

A rapidly growing sector in itself, fintech refers to software-based applications that streamline numerous financial transactions including stock trading, investment, peer-to-peer lending and standard retail banking functions such as traditional lending and management of portfolios and personal finances. Fintech is used among banks and their business and retail clients, and small businesses and their clients.

Fintech can also be used to streamline compliance, although “blockchain” a potential regulatory boost, has created a host of problems by making possible the unregulated, extra-institutional spread of bitcoin currency, which is sometimes associated with criminal activity.

A Wall Street Journal analysis notes that blockchain renders bitcoin transactions and peer-to-peer lending anonymous and outside any global standards or certification, “a regulators worst nightmare.”

A framework of laws, developed under both Cayman Finance and the Cayman Islands Monetary Authority, might direct fintech toward a more institutionally based market, a “system based on entities,” Scott said earlier.

Informal conversations have started, Scott told the Wall Street Journal.

Blockchain, an “open, distributed ledger” (also called a “common ledger”) “can record transactions between two parties efficiently and in a verifiable and permanent way,” according to January’s Harvard Business Review, and thus could become a “standard place for verifying the credentials of customers.”

“With blockchain, we can imagine a world in which contracts are embedded in digital code and stored in transparent, shared databases, where they are protected from deletion, tampering and revision,” the Business Review says. “ … Every agreement, every process, every task and every payment would have a digital record and signature that could be identified, validated, stored, and shared … This is the immense potential of blockchain.”

“To ease the way to that future,” the Wall Street Journal reported, “[Scott] advocates global standards for key areas of compliance such as money laundering.”

Regulatory compliance

Regulatory compliance regarding anti-money laundering will raise its head again later this year, Cayman Islands Attorney General Sam Bulgin told an audience at the Jan. 11 opening of the court year. The Trinidad-based Caribbean Financial Action Task Force, he said, would visit Cayman for a “mutual evaluation” of the long-standing 40 AML recommendations made by the organization’s FATF Paris-based parent – a division of the Organization for Economic Cooperation and Development.

The timing of the visit is of particular interest to local bankers, who are worried about the detailed preparations it entails. Fidelity CEO Brett Hill said he was aware of the “upcoming review,” but didn’t know which banks would be selected … if any.

A visit from the International Monetary Fund also looms this year, “but at this stage this has not involved Fidelity,” he said.

In 2015 and 2016, Fidelity undertook “a full AML/CFT [combatting financing of terrorism] review, including a review of all client files” which Hill described as “an extremely costly and time-consuming exercise.”

Fidelity also completed a formidable list of additional surveys, he said, including the Foreign Account Tax Compliance Act; United Kingdom, Crown Dependencies and Overseas Territories international tax compliance regulations; implementation of Common Reporting Standards; the Basel II Internal Capital Adequacy Assessment Process, requiring minimum liquidity requirements; and a series of risk assessments.

“The overall direct and indirect costs have been substantial,” Hill said.

Fidelity was not alone in navigating stiff regulatory challenges. Bulgin’s Jan. 11 address came immediately after meeting a three-member OECD panel from the Global Forum on Transparency and Exchange of Information for Tax Purposes.

The meeting marked the end of a 72-hour visit assessing Cayman’s implementation of international standards for sharing tax information formally sought by other jurisdictions.

Minister of Financial Services Wayne Panton said the results are due later this year. “We now look forward to working with the Global Forum over the coming months to finalize the report. Given our track record on tax cooperation over the years, we remain optimistic that our regime is in line with global standards,” he said.

Bulgin noted, however, the ongoing battle to establish “the continuing excellent reputation of Cayman’s international financial services industry.”

“Notwithstanding the numerous confirmations and validation of the soundness of our regulatory standards, there are still some foreign organizations that continue to perpetuate their jaundiced criticisms about our regulatory framework,” he told the courtroom gathering.

“Most of the critics are persons or entities who are just not familiar with the nature of the industry. But … we will continue to highlight the fact that our standards are consistent with, and in some cases, exceed international thresholds,” he said.

Just two weeks ago, in U.S. Senate hearings, legislators accused Treasury Secretary-designate and former Goldman Sachs partner Steve Mnuchin, of sheltering money in the Cayman Islands “tax haven.”

“As Treasury Secretary … would you support closing tax loopholes in the tax code that … extremely wealthy people … – such as yourself – have used to avoid paying taxes?” Sen. Deborah Stabenow asked.

“I would support changing the tax laws to make them simpler and more effective, yes,” Mnuchin answered, saying he “did not use a Cayman Islands entity to avoid paying taxes for myself.”

“So you helped others avoid paying?” Stabenow replied.

Ingrid Pierce, Walkers Global Managing Partner, echoed Bulgin’s sentiments: “The role of international financial centers continues to be misunderstood or misreported in certain quarters, so the efforts of governments, financial services industry groups and the IFC Forum are key [to] bringing balance and fairness to the debate.”

New financial services laws

Bulgin’s legal acumen is likely to be instrumental in the introduction next month of new financial-services laws into the Legislative Assembly.

Starting on Feb. 22, the roster includes amendments to the 2003 Companies Law, requiring firms to create internal beneficial ownership registers, and concomitant changes to the 2016 Limited Liability Companies Law, which will also require local firms to “establish and maintain” registers of beneficial ownership.

Other financial services legislation will allow “formation and registration” of limited liability partnerships, and “a bill for a law to amend the Trusts Law (2011 Revision).”

Beneficial ownership has loomed as a global issue for years as regulators have sought to eliminate “secret” rosters of company owners, seeking to preserve privacy, anonymity and even protection from taxation and legal inquiry.

In early 2014, Premier Alden McLaughlin appeared on BBC’s “HARDtalk,” defending Cayman’s regulatory regime, telling host Stephen Sackur that he would embrace a public ledger of beneficial ownership when other jurisdictions did.

Since then, negotiations have slowly eroded fierce resistance to a public account, arriving at a compromise whereby beneficial owners will be named on a centralized list, searchable only by a local “competent authority,” and released only to U.K. law enforcement.

“The proposals are to be welcomed as constructive and positive and would strike a sensible balance by enabling law-enforcement authorities to have access to the information they need in cases where people abuse the corporate veil, while continuing to protect the privacy of legitimate commercial interests and individuals,” said Harneys Managing Partner Jonathan Culshaw, writing with partners Ian Gobin and Sean Scott.

Harking to Cayman Finance fintech proposals, the authors observed that a timetable for implementation was unclear: “As the platform will require a new, secure IT system to be developed by the government, and corporate service providers [must] develop their IT systems to allow the platform to connect to the beneficial ownership registers they maintain, this timetable could be challenging.”

Further delays may result as “secondary legislation is also expected to be published to expand on some aspects of the proposals,” the trio wrote.

Walker’s Partner Lucy Frew said the U.K. had accepted Cayman counter-proposals “to establish a centralised platform of non-public beneficial-ownership information.

“The platform … will enable a senior official designated by the Cayman Islands ministry to access [the] information – already collected and held by corporate services providers in the Cayman Islands – and to provide it to the UK’s National Crime Agency following a lawful request by the latter.”

Both Frew and the Harneys trio named June for implementation.

“The platform is intended to facilitate expedited access from June 2017,” Frew said, with Cayman required to respond within 24 hours.

“Having invested in state-of-the-art technology and infrastructure in order to maximise the efficiency, speed and quality of our services, we are perfectly placed to facilitate clients’ compliance with the proposed legislation on a cost-effective basis,” she said.

Intimately related are the amendments to the 2016 Limited Liability Law – modeled on legislation in the U.S. state of Delaware – which created a hybrid of Cayman Islands exempted companies and Cayman Islands exempted limited partnerships, and mostly employed as holding companies and both special-purpose and joint-venture vehicles.

Since introduction of the law last year, investors have formed more than 200 LLCs, according to Walkers Partner Melissa Lim, who said advantages “included flexibility in terms of modifying the applicable fiduciary standards … the ability to create sole-member-managed LLCs … The organisational documents may also be simplified.

“Accordingly,” she said, “we expect that the use of Cayman LLCs will increase over time.”

The 2017 amendments will ensure LLCs abide by emerging beneficial ownership standards. The tightening regulation in aid of global tax compliance creates a kind of “approach-avoidance” dilemma for the financial-services industry – which craves international approval, yet resists attendant restrictions.

More regulation

Yet, more regulation is in prospect, underlined internationally by fresh changes to OECD common reporting standards.

The move toward CRS only came in 2013 when G-20 leaders endorsed OECD proposals for automatic, standardized, annual exchanges of information among tax jurisdictions.

Approved in mid-2014, the standard, according to the OECD website, “calls on jurisdictions to obtain information from their financial institutions and automatically exchange that information with other jurisdictions … It sets out the financial-account information to be exchanged, the financial institutions required to report, the different types of accounts and taxpayers covered, as well as common due diligence procedures to be followed by financial institutions.”

Last year was the first for CRS for Cayman financial institutions, according to Harneys Partner Matt Taber, who says certain information is due at government’s Department of International Tax Cooperation by May 31.

The changes are complex but fall in four broad areas: Registration requires all local financial institutions to register with the DITC, providing “certain information” by April 30, including contact details for an individual designated as the principal point of contact; nil returns require financial institutions to file tax returns for all reportable jurisdictions even if they have no reportable accounts in those jurisdictions; a clear requirement for written policies and procedures requires financial institutions to “establish, implement and comply with written policies and procedures to cover all of their obligations under the regulations,” meaning the DITC expects complete documentation when it takes compliance or enforcement action; and new offenses and penalties introduces such offenses as “providing materially inaccurate information, tampering with information and hindering the Tax Information Authority in its functions.” Criminal liability can result, accompanied by fines as high as US$60,975.

The DITC has pledged to issue guidance notes by March for the changes, which Taber says demonstrate “Cayman Islands’ continued commitment to implementing international transparency standards as well as their willingness to legislate in order to maintain Cayman’s position as a leading international finance center.”

The regulations, he says, will allow Cayman to meet its CRS obligations, but Walkers’ Pierce notes that the costs of compliance with growing regulation continue to escalate.

“Clients are responding in different ways,” she says. “Established managers with good infrastructure are usually able to defray these costs and have either built their systems or are in the process of improving their systems to cope with new regulations and best practices.

“Smaller or newer managers may need seed capital or to join forces with a larger platform through which they can offer their product. We have also seen clients outsourcing various roles which they cannot realistically take on full-time in house.”

She said the advent of CRS – and FATCA and the Alternative Fund Managers Directive – proved to be major issues in 2016.

“Another big driver,” she said, “is market expectation around best practices, driven in large part by institutional investors. This, coupled with an overall increase in regulation, means there is probably more focus on regulatory compliance than ever before.”

Meanwhile, the legislature is scheduled to grant new enforcement powers to the Cayman Islands Monetary Authority, allowing it to impose fines for the first time.

Under the Banks and Trust Companies Law, the Companies Management Law, the Mutual Funds Law, the Securities Investment Business Law and the Directors Registration and Licensing Law, CIMA will be able to impose fines, ranging from $1 million to spot fines, to ongoing daily penalties of $5,000, for breaches of money-laundering regulations or violation of any of the five related laws.

Fidelity’s Hill laments regulatory growth if only because of compliance costs – and observed that the new U.S. president has pledged to slash bureaucracy.

“Depending of course on what steps Mr. Trump takes, we believe that regulation is likely to continue to increase and therefore the cost of doing business will rise,” he said.

“Having said that, we’re hopeful that profitability will increase with the economic recovery and growth of our business.”

Pierce agreed: “The cost of infrastructure and regulatory compliance continues to hamper the start-up environment,” noting “the funds market is more competitive and in a low-growth environment there is continued pressure on fees. This means that managers are looking at non-traditional structures and strategies and in some cases taking more risk in order to increase the chances of higher returns.

“In terms of growth areas, we continue to see credit funds and managers looking more towards emerging markets. We are also starting to see the resurgence of an appetite for distressed or otherwise illiquid assets,” she said.

Hill pointed to a looming, if under-reported problem: “Don’t forget correspondent banking. That is a major threat to the region, but the financial sector, including [Cayman’s] Ministry of Finance, is aware of it and is taking steps to deal with it before it becomes a problem for Cayman.

“The reality is that such bodies as the IMF, FSB and FATF understand the need [for] large U.S. banks to continue to offer correspondent banking services and have publicly stated this position. However, some of the large correspondent banks have been hit with significant fines by the Department of Justice and are seeking to de-risk.

“There is also a compliance cost associated with offering these services, so it’s not just about de-risking; it’s also a business decision,” Hill said.

“We’re rather hoping that regulatory burdens will decrease somewhat under President Trump, but we’ll have to wait and see. We’re not counting on it.”

Construction industry reports recovery, cautious optimism

Residential construction has dominated the market since Hurricane Ivan in 2004. – Photo: Taneos Ramsay

The construction industry has rarely been acknowledged as the third pillar in a market driven by financial services and tourism, but Ian Pairaudeau, general manager at McAlpine Ltd., has little patience with that idea.

“The construction industry has a much wider impact on Cayman’s economy than it’s given credit for,” says Pairaudeau.

“Many Caymanian households have at least one family member either directly employed in the industry or employed in an associated industry … [and] when the industry is active, everyone benefits,” he says.

No one need look beyond Hurricane Ivan in 2004 to imagine what Cayman might look like without the construction industry. The island recovered from the category 5 storm – which damaged 80 percent of the buildings and did a billion dollars’ worth of damage – because the builders set to work.

In fact, the demand for post-Ivan construction services was so overwhelming that it spurred dozens of fly by-night operators who were under-financed, under-qualified and unable to meet baldly unrealistic deadlines and abandoned families and homeowners mid-project.

Ultimately, the Ivan re-builds, fueled by insurance payouts, worked through the system, restoring a measure of equilibrium to the industry – just in time for the worst recession in decades in 2007/2008. Investment dried up, unemployment soared, and the construction industry was \another casualty.

Only now, after weathering some lean years, is recovery evident, and it’s been a long haul for Cayman’s largest builders, McAlpine and Phoenix Construction.

“Construction,” says Phoenix general manager Barbara Anley, “is not for the faint of heart.”

She should know, having navigated the company through some of its toughest times. “The economy has been improving painstakingly slowly for the building sector since 2011 and, with gratitude, 2016 was the first year that builders could say with a degree of certainty that we were finally seeing consistent growth since the recession.”

Pairaudeau echoes the sentiment: “We have had several profit-neutral years since 2012, but with the industry picking up, we hope to improve that situation. That being said, construction is not a significant profit-making business, and generally, annual profit percentages are in the mid-single to low digits.

“Historically, McAlpine has been the primary contractor for large commercial projects,” he says. “Over the last few years, this sector of the construction market has been relatively stagnant. Our challenge has been to find suitable projects outside of the home residential market.”

Traditionally, McAlpine has stayed away from home building, preferring that “the country’s small and medium-sized contractors undertake this work,” Pairaudeau says. “we really only do very large homes or homes for selected clients.”

A stagnant commercial sector, in 2012, for example, forced McAlpine to lay off at least 90 staff locally, while work continued on a hospital in Bermuda and the company bid for a $100 million airport and runway expansion in the British Virgin Islands.

At the time, Pairaudeau pegged McAlpine’s workforce at “about 60 percent to 70 percent Caymanians,” out of a peak of 180, but estimated post-layoff numbers between 20 employees and 30 employees.

Those figures have since recovered, however, and, and as the economy strengthens, he says, “We will increase our workforce as our workload increases.”

Residential construction

Currently, Anley, of Phoenix, says residential construction dominates the market, underlining realtors’ recent observations that the sector – particularly in South Sound and Seven Mile Beach – “is on fire.”

“The biggest increase in the construction industry post-recession is in residential construction,” she says. “There are numerous new homes going up all over the Island, with the coastal areas being the most popular.

“Many of the clientele are wealthy professionals seeking to build the home of their dreams, to raise their families in a safe environment, with the reassurance that the education and health amenities are of a high caliber, with the added benefit of numerous options for extracurricular activities for all age groups.”

Pairaudeau agrees: “The residential boom is driven mainly by professionals in the finance industry and wealthy families relocating to Cayman. This market has been booming over the past few years, and many architectural and quantity surveying firms have expanded into construction management due to the demand. I think the trend will continue, but maybe not at the same pace.”

Commercial projects

McAlpine does not lack for work, however. He lists some of the company’s heavyweight projects: a new office building at Cricket Square and a $20 million private office building for the Flowers family.

“Earlier in 2016 we won the Owen Roberts airport expansion and John Gray High School gym contracts … [and] we recently completed the concrete frame on block 5 south at Camana Bay for DECCO,” Dart Enterprises’ construction outfit.

“In 2015/16,” Pairaudeau says, “we completed the concrete frame, site utilities and roof at the Kimpton hotel,” which opened in November. “We completed the Tomlinson Building, the civil work for the new Caribbean Utilities Company generator and several fit-out projects at Willow House,” the Shedden Road Cricket Square office block.

He says McAlpine will seek similar work in the coming year.

Anley lists a dozen Phoenix projects, and predicts growing competition in 2017.

“We have built numerous projects for various government departments, built a good majority of our grocery stores, built and/or renovated corporate offices, retail spaces, constructed distribution facilities, gas stations, sports fields, condominiums and completed wonderful homes for our clients,” Anley says.

“We’ve achieved great success in completing major hotel renovations while they remained operational, built award-winning restaurants, medical clinics, and just about everything in between.”

Anley notes that “The industry still faces strong competition, with both large and small contractors all vying for the same projects. As should be evident (but often isn’t), the large contractors offer greater assurance that the projects will be completed and not left abandoned due to lack of funding.”

That security has a cost, however, “a higher cost than the smaller one-to-two-man companies,” she says. “Most clients would like a $3 million project for a $1 million budget. So, a few less-reputable builders will take on the project, [but] end up running into financial difficulties once they realize they cannot complete what the client wants for the sum they have agreed to do it for.

“This results in their workers not getting paid and the client left with an unfinished project and very little recourse because the builder closes his door and opens up a new one the next day under a different name.”

The Builder’s Bill, legislated exactly one year ago, creates a 10-member board to license builders and contractors in five categories: general contractor; building contractor; residential contractor; sub-trades contractor; and civil contractor.

The law also seeks to counter abuses such as non-payment of health and pension benefits and hiring unqualified personnel.

“It will be a requirement for all builders and contractors to qualify at their appropriate level, then be registered through the Builder’s Board,” Anley says. “The Builders Board and members of the Contractors Association will continue to encourage all contractors, large and small, of the need to have project insurance to protect themselves and their clients and to purchase workers compensation insurance in the event of an accident on their sites.

“Those of us who have been playing by the rules for many years will be grateful to have a more level playing field,” she says.

Pairaudeau is upbeat, if guarded, about 2017. A strong economy is never guaranteed.

“An improving economy means more business activity, which will require more employees, which increases the need for new accommodation for both expanding businesses, new businesses and employees of these businesses,” he says, but “expansion must always be looked at from a long-term perspective, not for short-term profitability or short-sighted political reasons.

“[I’m] not sure we will ever have a non-shaky economy in the current worldwide climate,” he added.

“When the industry is active, everyone benefits. The difficulty is the balance between new developments, the environment and the effects it will have on the current business operating in Cayman.”

Hedge funds more bullish on 2017

Although 2016 was far from a breakout year for hedge funds, performance improved over a lackluster 2015, and managers have a more positive outlook for 2017 as stock markets are boosted by President-elect Donald Trump’s plans to lower taxes, deregulate and spend on infrastructure.

Data provider Eurekahedge reported hedge funds were up 3.53 percent through November 2016, double the modest gains of 1.73 percent over the last year.

But fees and performance remained at the top of the list of investors’ concerns for the industry as the sector continued to trail the equity markets.

Cheaper passive investments have made inroads into the alternatives market by replicating some hedge fund strategies at a fraction of the cost.

Whether these smart beta exchange traded funds can fare in the same way in the choppier weather of more volatile markets remains to be seen. But alternative beta, in combination with the relatively modest performance of hedge funds, have raised the question of costs for institutional investors.

Pensions funds that made up a growing share of hedge fund investors over the past decade now set the tone. They put pressure on fees and demand customized investment structures and more detailed reporting on the funds’ positions to better align the hedge fund investment with their overall portfolio.

Others have scrutinized their allocations more critically after the unimpressive performance of hedge funds overall.

In a year when the S&P 500 gained 9.8 percent through Nov. 30, equity hedge funds returned a meager 4.9 percent, according to data provider Hedge Fund Research.

As a result, some investors have taken their money out of hedge funds altogether, pushing into better performing alternatives like private equity, real estate and infrastructure funds.

Hedge Fund Research predicts that 2016 could be the first year of net withdrawals from the sector since 2009. The number of hedge funds has also declined and is lower than in the past three years.

MetLife is one of the institutional investors that plans to radically reduce hedge fund investments in 2017. The firm said in December that it will bring down its hedge fund allocations from $1.8 billion to $800 million. This followed moves by CalPers, America’s largest public pension fund, which announced two years ago that it was eliminating its $4 billion hedge fund program. The New York City Employees’ Retirement System followed suit in April last year, along with a slew of smaller U.S. pension funds.

Fees

Institutional investors named cost and complexity as two of the main criticisms of their hedge fund investments. High fees and restrictive terms are less of a concern when the asset class produces outsize returns but amplifies once performance wanes.

“Allocations are hard to come by, so investors are really driving the fees,” said Dennis Westley, managing director, North America, Apex Fund Services, at the Campbells Fund Focus conference in December.

To attract further capital in a difficult fundraising environment, hedge funds had to respond.

Fee cutting and flexibility around incentives have become the norm in the industry.

Most funds used to command a management fee of 2 percent of assets under management and a performance fee of 20 percent of the profits. On average, this has come down across the board to about 1.65 percent and 18 percent, respectively. But depending on the size of the fund or whether it is a startup or established fund, fees can come down much lower. About two-thirds of funds offer some type of fee discount.

Managers give discounts depending on assets under management or time invested to reward early investors. Other structures use crystallization periods for performance fees, minimum return thresholds or hurdles for incentive fees, or they tie performance fees to the size of the return.

Managers are also looking for stickier capital and apply discounts for longer lock-up periods or reward particularly large investments.

“The most obvious one is longer lock-ups for lower fees,” said Westley. “We have seen that over and over again in the past months.”

In addition, founders’ shares, which incentivize early investors with discounted fees, have become more widespread.

For fellow panelist John McCann, CEO of Trinity Fund Administration, the convergence of the sector is part of the problem. Since hedge funds went mainstream, institutional investors have come in and set the scene.

“You have got pressures on fees, you have got hurdles, benchmarking. And yet performance is still not there. Ninety percent of the assets in the industry are controlled by 10 percent of the managers. And they are average,” he said. “Where are the alpha pickers? If they are vanilla strategies pretending to be hedge funds, I think that’s the problem. They lost their way.”

Looking at the industry’s average returns collated by data provider Prequin, large funds have indeed been the problem of the industry as small funds have shown the best returns, and emerging funds also performed better than institutional players.

This can still be an opportunity for the industry going forward, noted Ronan Guilfoyle, founder of Calderwood, an asset management fiduciary firm that offers directorship services.

“If you are diversifying your portfolio, you are going to allocate to emerging managers, emerging markets, as well as having your private equity and hedge piece. That’s traditionally where a lot of the best returns have been: the small nimble managers who have to do well,” he said. “The new managers that we are talking to are saying there is some excitement out there, some interest.”

However, he acknowledges that it will take time for these startups to get past the $100 million hurdle required to develop a critical mass in today’s market.

“You have to make significant investment in infrastructure up front on top of that outperformance for investors to take notice. The days with two guys and a Bloomberg and friends and family money are long gone,” he said.

Institutional investors are now demanding detailed information from managers similar to the reporting required by regulators.

While investors do not want to invest blindly, and ensure they know the risk characteristics of their investment, it puts them at odds with managers who want to protect their intellectual property.

Still, the volume and velocity of reporting of risk metrics has exploded, McCann said. In Europe, this is largely due to regulation, but the U.S. is seeing the same trend, according to Westley.

In any case, the infrastructure needed to report the vast amounts of data and analytics is costly. Managers must choose between adding staff and outsourcing.

Investors also demand more customized investments. EY’s annual survey of the hedge fund industry found that 42 percent of investors aim to shift from commingled hedge funds to customized vehicles and segregated accounts.

The move to customization is prompted by the desire to gain more control, flexibility and a more intimate understanding of the investment strategy.

Many institutional investors will turn to hedge funds only to achieve specific exposures, noted EY partner Jeff Short at the firm’s Hedge Fund Symposium in Cayman in December.

Top risk for the industry

Yet, EY’s survey showed only 8 percent of investors believe hedge funds can offer strategies or exposures that cannot be obtained elsewhere. Changing investor demands were thus the top risk for the hedge fund industry, the survey found. About half of all investors said they expect to shift their hedge fund investments to other alternative investments such as private equity, real assets and venture capital over the next three to five years.

Family offices and sovereign funds have already moved significant capital out of hedge funds, some of it going into private equity and real assets, said McCann.

“That may pause now because of Trump,” he said.

Although President-elect Trump said he would repeal the carried interest benefit for hedge funds and private equity funds, industry insiders are not sure whether he is going through with the proposal, nor whether he is bluffing with his stance on trade.

The stock market, however, has reacted positively to the prospect of large-scale deregulation, tax reform and a general pro-business stance of the new administration.

Banking stocks surged 20 percent since the U.S. presidential election. For McCann there are obvious sectors that should benefit. With a divergence of interest rates and the strengthening of the U.S. dollar, investors are showing strong interest in U.S.-centric businesses, he said.

“We have had many board meetings where certain sectors are anticipating to benefit. Everybody is anticipating deregulation. I think U.S.-centric will do very well. I think infrastructure sectors will do very well, certain parts of energy.”

Guilfoyle said he is not convinced that a lot of capital went from hedge funds into private equity.

“A lot of the money will be sitting on the sidelines. If you are diversifying your portfolio, you are already allocating to private equity. You don’t want to be overweight. So, it is a question of the mix. Maybe there is a bit of cash on the sides and that will come back into the hedge fund space in two years.”

Guilfoyle is also upbeat about the industry’s prospects in the near term.

“We have seen a lot of activity and out of the U.K. and Switzerland. We see new launches all the time and that has steadily increased as the year has gone on,” Guilfoyle said. “I think we will see more launches and more spinoffs from the larger managers.”

Westley agreed. “The last several months we have seen an uptick, not just in the U.S., but in the Asia Pacific region.”

Whatever direction the Trump presidency is going to take, panelists agreed, the uncertainty created by the political situation and the volatility from rising interest rates will form an environment with many opportunities for hedge funds.

RBC economist: Inequality drives the economy and politics

2016 has been a tumultuous year. Democracy itself has faced a crisis, and the political establishment has been shaken. Voters in the U.S. and the U.K. expressed their desire for change, regardless of the form this change is going to take and at times fueled by xenophobic sentiment.

Worldwide economic and political freedom has declined.

The Global Freedom Report, published by Freedom House, which promotes democracy and human rights, noted a 10th consecutive year of decline of political rights and personal liberties in countries around the world.

Last year, freedom diminished in 72 countries, the largest number during that period. Over the past 10 years, 105 countries have seen a net decline, and only 61 have experienced a net improvement, Freedom House noted.

The numbers indicate that democracy is under threat. The outcome of the British referendum to leave the European Union and the election of Donald Trump to become U.S. president are seen by some as symptomatic.

Inequality

Political commentators have ascribed the current sentiment to xenophobia, automation causing job losses and the middle classes in developed countries being left behind amid the rapid change of a more globalized world.

“But I think underlying all those things is inequality,” Royal Bank of Canada group economist Marla Dukharan said during a Global News Matters webinar on the economic outlook for the  Caribbean region in December.

“If you look at how inequality has been trending since the financial crisis, the richest 1 percent of the world has more wealth than the rest of the world combined,” she said, citing a report by aid agency Oxfam.

The same report notes that 62 individuals have the same wealth as the bottom half of the population.

“That extensive inequality is unprecedented,” said Dukharan. “This rise in inequality has been exacerbated by the policy response to the financial crisis.”

The policy response of monetary fiscal stimulus to generate economic activity was somewhat successful, but it has been far more effective at driving up asset prices. “So the 1 percent have seen their wealth increase significantly as a direct result of the policy response to the financial crisis.”

The resulting rise in inequality is more than a political problem. It is an economic one.

A 2015 study by the International Monetary Fund determined that increasing the share of income of the top 20 percent results in lower economic growth, whereas rising incomes for the lower and middle classes increases growth.

In other words, “when the rich get richer, benefits do not trickle down,” the report concluded.

“Causes and Consequences of Income Inequality” thus recommended country-specific policies with a focus on raising the income share of the poor and preventing the hollowing out of the middle classes.

The answer in advanced economies, the authors said, has to be to raise human capital and skills and to make tax systems more progressive.

Inequality in the Caribbean, measured by the Gini coefficient, is even higher than in the U.S.

“We need to fix that inequality problem in the Caribbean and on a global scale,” Dukharan said.

But she concedes that although global growth is at 3.1 percent, only slightly above the level of 3 percent which the IMF considers to be a recession, “nobody sees a need for a coordinated response.”

Globalization

Just like democracy, globalization has faced a backlash in the current political climate. Not only have trade flows dropped significantly, the flow of capital between countries has dried up.

Cross-border capital flows, measured as a percentage of gross domestic product, are at the lowest level since 1989. Current levels of 2.6 percent are down from 20.7 percent just before the financial crisis.

Dukharan says this suggests that the Caribbean will see similar patterns, for example in the form of lower foreign direct investment.

“That is a challenge in two terms: with infrastructure and to help us with our productive capacity. In the Caribbean we have a current account deficit in most countries, we import more than we export. And we finance the deficit through inflows on the capital account. That means we borrow U.S. dollars or we get FDI inflows,” she explained.

“If they are declining, we are challenged to balance our current accounts. We will face diminishing reserves, which we have seen in some countries.”

China, she added, will reduce its outflow of U.S. dollars to hold on to its reserves. The Chinese government recently issued a directive that state-owned enterprises will not be allowed to invest more than $1 billion on any single overseas transaction.

“That is going to have implications for the Caribbean. We have relied very heavily on Chinese capital inflows and direct investments,” the RBC economist said. “It has implications for refineries in Curacao and the Baha Mar project in the Bahamas as far as that they need more capital to finish that project.”

Commodity prices, currencies

Meanwhile, most Caribbean economies must likely deal with the challenge of rising oil prices. RBC Capital Markets is expecting West Texas Intermediate crude oil to average US$56.40/bbl in 2017, reaching the US$60/bbl range by late 2017.

This is not even a positive for oil producers like Trinidad and Tobago, which generates 75,000 barrels a day but imports 100,000 barrels a day.

“So higher oil prices can put a strain on the raw materials for running the refineries,” Dukharan said.

Guyana, Suriname, and Dominican Republic will also be impacted by an anticipated decline in the price of gold. And due to a strong correlation between the one-month gold and three-month natural gas prices, natural gas should soften as well, she added.

The strengthening U.S. dollar, on the other hand, can affect the exports and tourism competitiveness of Caribbean countries whose currencies are pegged to the U.S. dollar and have appreciated against major currencies like the Canadian dollar, the euro and the sterling.

A tale of two countries

Demonstrators wave flags from the top of a bus last month outside the Supreme Court in London where Prime Minister Theresa May's government asked the court to overturn a ruling that Parliament must hold a vote before Britain's EU exit negotiations can begin. - PHOTO: AP

Brendalee Scott-Novak,
Butterfield

2016 heralded unprecedented shifts in our global political landscape. The watershed moment, it can be argued, was Britain’s vote to abandon the 23-year-old European Union. As news reports of this historic vote surfaced, shock waves ricocheted across global financial markets, sending all the major indices into tailspins.

This unprecedented move by the euro area’s second-largest economy drove down the British pound more than 18 percent, caused the FTSE 100 Index to plunge more than 15 percent and pushed down GDP growth estimates to merely 1.4 percent for 2017.

Analogous to the shock of a Brexit reality was the striking defeat of Democrat Hillary Rodham Clinton in the U.S. presidential election, giving the presidency of the world’s super power to the populist, anti-establishment candidate Donald Trump.

Prior to the election, forecasts of a Trump victory suggested a sharp selloff in markets similar to the aftermath of Brexit. While equity markets did experience a brief selloff at the opening, as the initial shock wore off, investors began dissecting the reality of Trump’s policy initiatives. U.S. equity markets then rose in spectacular fashion on speculation that the president-elect will introduce fiscal stimulus, boost infrastructure spending and tackle deregulation, boosting the economy and spurring inflation. The sanguine mood in markets drove the Dow Jones Industrial average to new highs inching closer to a record 20,000. Fixed income markets, on the other hand, spun into a nosedive, pushing rates higher across the entire curve. The move dealt a crushing blow to bond holders, driving 10-year U.S. Treasuries up more than 94 basis points.

In the months leading up to the election, analysts and the media alike touted a Trump victory and Brexit as two sides of the same coin. But what exactly caused the euphoria in U.S. equity markets following Trump’s victory versus the flight to safety and free fall in British markets from a Brexit vote?

Admittedly, the referendum in Britain was the first in the sequence of political shake-ups our modern world has experienced. Italy’s vote to reject the referendum on constitutional reform and subsequent resignation of Prime Minister Matteo Renzi (increasing the probability for early elections this year) has left many concerned about the wave of populist sentiments and its potential impact on Europe.

While most of Europe’s populist parties are hoping to ride the wave of revolution taking place, the recent defeat of far-right anti-immigration Freedom Party’s Norbert Hofer in Austria means a sweeping move by anti-establishment ideologies is not a foregone conclusion. With elections in the Netherlands in March, France in May, and Germany in the fall, all eyes will be on the euro area as they navigate a new year riddled with political uncertainty.

As we usher in 2017, we are left to wonder if the shifting political dynamics and market euphoria around a Trump presidency have been miscalculated.

Adopting President-elect Trump’s policy initiatives in part or the whole can easily swing the pendulum from a country operating at or near the natural rate of full employment into a deep rooted recession. A large surge in activity when the economy is close to its full employment rate could bolster wage pressures, the most significant contributor to inflation. Current initiatives by states to increase the minimum wage, coupled with anti-immigration policies of the president-elect — specifically around the deportation of illegal immigrants — could further reduce the labor force, making the environment ripe for additional wage pressures.

The levying of steep tariffs on goods produced abroad by U.S. corporations, a major campaign theme of the president-elect, will make U.S. corporations less competitive, whilst driving imports of cheaper alternatives higher. A rising trade deficit and debt burden from large-scale fiscal stimulus and infrastructure spending will undoubtedly add to inflationary pressures, bringing the integrity of the U.S. balance sheet into question.

While Trump’s victory was met with much jubilation in the streets, the longer-term impact of his combined policies, if passed by Congress, may not bode so well for the U.S. economy. Paradoxically, the U.K.’s decision to exit the EU has resulted in short-term pain, but it could effectively serve to undergird an even stronger economy in the not so distant future.

Statistics and Data Source: Bloomberg LP., BCA Research, Federal Reserve

Disclaimer: The views expressed are the opinions of the writer and while believed reliable may differ from the views of Butterfield Bank (Cayman) Ltd. The bank accepts no liability for errors or actions taken on the basis of this information.

Wall Street starts 2017 with tailwind

Thanks to a series of new record highs, the leading U.S. stock market indices had a very successful end of the year. The recent momentum also puts the market in a good position heading into 2017.

The Journal looks ahead and names some favorites.

Time magazine named President-elect Donald Trump as “Person of the Year” for 2016. Though he does not take office until Jan. 20, Trump’s promises and policies have already captured the attention of stock market investors. Trump was not only deemed responsible for the push forward to new record highs in the market (the Dow Jones Industrial Average was close to 20,000 as of this writing), but also for the sector rotation, through which long-neglected parts of the market like financials or cyclical and value stocks have emerged as the new favorites.

In the most significant event, the sellout in the bond market, Trump was also considered to be partly responsible, largely attributed to the fact that the growth-promoting economic policy he strives for would presumably increase inflation as well.

If Trump’s plan proves to be successful, it could create further stock price momentum. After all, in recent years a lot of money went into bonds and comparatively little into equities. Should this trend reverse, it could turn out to be an important price support for equities.

Corporate tax reduction

The importance of Trump’s plan to reduce corporate taxes should not be underestimated. Strategist Ed Yardeni from Yardeni Research has already significantly increased his earnings estimates for the S&P 500 index. In 2017, aggregated earnings are expected to jump to $142 instead of $129, an increase of 20 percent, and in 2018 he expects $150 instead of $136.75. Apart from the expected positive outcome for corporate earnings, Yardeni says it is “important to see if Trump’s tax cuts really do benefit middle-class families and small business owners.”

It remains to be seen, however, which of Trump’s ambitious plans will be realized, since even in his own Republican ranks not everyone shares great enthusiasm for all of his ideas.

Finally, all policies that increase debt significantly or all protectionist measures, which ultimately turn out to be a boomerang, should be viewed with skepticism.

Recession unlikely

Although the trend on Wall Street in 2017 will, to a large extent, depend on what Trump will do, many of the most recent trends were already apparent before his election, including the rise of the inflation expectations and the upturn in the economy. Wall Street may even have headed for new records had there been a different election outcome simply because of the relief connected with the end of the political uncertainty.

That said, the valuation of the stock market can be considered a burden, since the P/E ratio of the market is above average in historical comparison. This should only backfire if there is a recession, a view shared by Sam Stovall, chief investment strategist at CFRA Research. He notes that this bull market is three months from its eighth birthday, a milestone reached by only one bull market since World War II.

“Bull markets don’t die of old age,” he says. “They die of fright. What are they most afraid of? Recession.“

Therefore, it is encouraging that economic models suggest the likelihood for such an event is still relatively low. Based on the recent development of the Philly Fed State Coincident Indexes, that is also the verdict of Veneta Dimitrova, senior U.S. economist at Ned Davis Research.

“Economic growth has broadened across more states, and the improvement has been sustained over the past several months,” Dimitrova says. “Our Recession Probability Model, based on state coincident indexes, edged down to 0.7 percent, indicating practically no odds of recession at this time.“

Bull trend

The Conference Board’s Consumer Confidence Index surged in December as the stock market reached record highs. The Conference Board said last week its consumer confidence index increased to 113.7 in December from an upwardly revised 109.4 in November. There is still plenty of room to run until the overbought 140+ levels (view graph). Bank of America Merrill Lynch views this as bullish in terms of secular sentiment. From this points of views, the road signs on Wall Street are still green. At least the completely intact long-term uptrends in the chart of the leading stock market indices allow no other conclusions.

Bank of America Merrill Lynch even speaks about a secular market trend like that of the 1950s. Technical Research Analyst Stephen Suttmeier continues to view the S&P 500 April 2013 breakout from the 2000-2013 trading range as a secular bull market breakout similar to those from 1980 and 1950, which lasted until 1966 and 2000, respectively. According to him, this means that the secular bull market triggered on the 2013 breakout remains at an early stage, with at least a decade more to run, in our view.

Apart from betting on the U.S. stock market as a whole in 2017, it should again prove to be particularly rewarding to invest in single stocks. In this case, it is important, as always, to pay attention to an advantageous combination of technical patterns, valuation and investment story. Stocks that have met these qualifications include UnitedHealth Group, Altria, General Dynamics, Citigroup, Boeing, Fedex, John Deere, Berry Plastics, Broadcom and Amazon.

As far as sectors are concerned, CFRA Research recommends overweight positions for consumer discretionary, industrials and materials. CFRA also suggests underweighting energy, consumer staples, real estate and utilities.

Analysts at investment bank Jefferies share the positive view of discretionary and industrials. In their opinion, given the dollar’s strength, it makes sense to focus the sector allocation more domestically.

Court of Appeal restores developers’ power to amend strata by-laws

Hector Robinson and Nicosia Lawson,
Mourant Ozannes

The Cayman Islands Court of Appeal has recently confirmed that the proprietors of a strata corporation registered under the Strata Titles Registration Law (STRL) have the power to govern, control and manage the strata through by-laws adopted in accordance with the STRL.

If a developer controls all the voting rights of the strata corporation, there is no limit to the power of the developer to adopt by-laws which confer enhanced voting rights at general meetings, and control of the executive committee, as long as such by-laws are adopted by a resolution passed with the requisite majority in accordance with the law, and the amended by-laws do not otherwise infringe the STRL.

On Nov. 4, 2016, the Court of Appeal handed down its judgment on the appeal in Thompson Resorts Ltd. and Castaways’ Timeshare Ltd. v Carl Clappison & Others. The court set aside the declaration of the trial judge that one of the by-laws of the Castaways’ Cove strata plan was ultra vires the STRL. The by-law had granted the developer enhanced voting rights and control of the executive committee for a period of 50 years.

In determining whether the by-law was contrary to the Strata Titles Registration Law, the court considered section 15 of the STRL, 1973, which was in effect at the time the impugned by-law was adopted (now section 21 of the 2013 Revision).

This judgment makes it clear that: (1.) The STRL expressly allows strata corporations to amend the default by-laws set out in Schedule 1 of the Law; (2.) There are no limitations on a strata corporation adopting, amending or varying the by-laws set forth in Schedule 1 of the law if the amendment is made in accordance with section 15 of the STRL, 1973 (section 21 of the 2013 Revision); (3.) The requirement for unanimity (now a super-majority) on the resolution amending the Schedule 1 by-laws is a legal imperative, rather than a procedural requirement; and (4.) It is for the legislature, not the judiciary, to amend a law which is governed by statute.

The Grand Court proceedings

In the case, two owners of unit entitlements in Castaways’ Cove brought proceedings in the Grand Court. They sought a declaration that the by-law in question was ultra vires the powers and duties of Castaways’ Cove and inconsistent with the strata law, as well as an order removing the by-law from the Castaways’ Cove by-laws.

By-law 2 was adopted in October 2003 by a unanimous resolution amending the default by-laws in Schedule 1 of the STRL.

At the time, the developer, Thompson Resorts Ltd., owned 100 percent of the unit entitlement within Castaways’ Cove and, under a Strata Management Agreement, was also appointed as the exclusive manager of the property for the period ending June 2050, with rights of renewal for subsequent five-year periods.

The amended by-laws and the Strata Management Agreement created a governance and management structure under which Castaways’ Cove would be managed together with, and as part of, the Reef Resort (now the Wyndham Reef Resort), for a period of 50 years ending in June 2050.

By-law 2 conferred on Thompson Resorts the power to call extraordinary general meetings at its sole discretion; the entitlement on a poll taken at a general meeting to such number of votes equal to all the votes cast at the meeting, plus two additional votes; and the power to appoint at least two out of five members of the executive committee.

The trial judge, Justice Ingrid Mangatal, held that by-law 2 was ultra vires the strata law, and ordered that the executive committee of Castaways’ Cove amend by-law 2 and file the re-amended by-laws with the Registrar of Lands.

Agreeing with Justice Alex Henderson (retired) in Keim v Proprietors, Strata Plan No. 275 (Ocean Pointe Club), the trial judge held that the intent of the Strata Titles Registration Law was that a strata corporation be run on democratic lines, and that the voting structure embodied in the model Schedule 1 by-laws was designed to be a democratic, inclusive process, enabling majority rule and allowing the proprietors to make collective decisions. The judge concluded that by-law 2 was repugnant to the structure and scheme of the legislation.

The Court of Appeal’s judgment

The Court of Appeal overturned the decision. The court held that notwithstanding what the trial judge described as its apparently undemocratic characteristics, by-law 2 would be valid so long as the amending resolution was passed unanimously (as was the requirement at the time), and the amended by-laws did not breach any provision of the strata law. This included, for example, section 15(4) of the STRL, 1973 (now section 21(4)), which provides that no by-law shall operate to restrict the devolution of strata lots or any dealing therewith, or any easement implied or created by the STRL; and section 15(5) [now section 21(5)], which provides that no amendment or variation of the by-laws shall be effective until they have been filed with the Registrar of Lands.

Sir George Newman, who delivered the judgment of the Court, stated that “it is impossible to see how the clear meaning of section 15(2) can be cut down by an implied reservation or limitation upon the validity of a duly passed unanimous resolution.” He noted that the STRL created no sub-class of resolutions which, if duly passed, lose validity, as the trial judge held, when proprietors other than the developer subsequently purchase units within the strata development. He further held that resolutions duly passed take effect after due notification, and bind the corporation and every member.

Conclusion

The Court of Appeal’s decision should come as welcome relief to a vast number of developers of strata developments in the Cayman Islands. It is common practice for developers, upon registration of a strata plan, to adopt and register amended by-laws replacing the default Schedule 1 by-laws. Typically, a developer will adopt some variation of by-law 2, at least, for example, to secure control over the development during the construction stage, or until all units in the development have been sold.

Developer control takes on added importance where the development is operated as a resort, or as part of a resort. In such cases, consistency in appearance and management standards is critical, more so where the resort is managed under a management agreement with an established international brand. Had the Court of Appeal not set aside the Grand Court’s judgment, all by-laws adopted since 1973, which contain provisions similar to the Castaways’ Cove by-law 2, would also be ultra vires the STRL. This would have given proprietors of those strata corporations the right to have such by-laws set aside. The difficulties which would have been caused by such an eventuality are not difficult to imagine.

The STRL has been the subject of review and consideration for reform for a number of years. The issue of a developer’s ability to amend the default Schedule 1 by-laws has been recognized and discussed in a report of the Law Reform Commission but, to date, there has been no proposal to limit or restrict that power, as has been done in other jurisdictions which have adopted legislation similar to the STRL.

There is no reason to believe that the current state of the law does not reflect the desired policy. In any event, whether or not that policy changes is, as the Court of Appeal has pointed out, a matter for the legislators, not the judiciary.

Facts in the age of post-truth, truthiness and Trump

The year 2016 will be remembered for Brexit and for the election of Donald Trump to become the 45th president of the United States, for the media and pollsters getting it wrong, for experts being out of touch with “regular” people and for the establishment being oblivious to the extent of public discontent.

Perhaps 2016 will also be remembered as the year that facts ceased to matter.

In November, Oxford Dictionaries chose “post-truth” as its international “Word of the Year.” The term is defined as an adjective “relating to or denoting circumstances in which objective facts are less influential in shaping public opinion than appeals to emotion and personal belief.”

Casper Grathwohl, the president of Oxford Dictionaries, said it was not surprising that “post-truth” was selected to define 2016, given it has been a year “dominated by highly charged political and social discourse.”

“Fueled by the rise of social media as a news source and a growing distrust of facts offered up by the establishment, post-truth as a concept has been finding its linguistic footing for some time,” Grathwohl said in a statement.

The use of “post-truth” spiked in June with buzz over the Brexit vote and again in July when Donald Trump secured the Republican presidential nomination.

The post-truth campaign

Trump’s U.S. presidential campaign and the Leave.EU campaign in the U.K. succeeded with a deliberate strategy not to engage in a debate based on facts and to focus solely on winning the emotional argument.

Businessmen Arron Banks, who funded the Leave.EU campaign, said he relied on the explicit advice of U.S. political consultancy and public relations firm Goddard Gunster that “facts don’t work.”

“The remain campaign featured fact, fact, fact, fact, fact. It just doesn’t work,” Banks said earlier this year. “You have got to connect with people emotionally. It’s the Trump success.”

The Trump and Brexit campaigns were particularly effective in appealing to voter emotions with their slogans “Make America great again” and “Let’s take our country back.”

The messages tapped into the dissatisfaction of people who feel they have no control over their lives, which, seen through the proxy of their country, are heading in the wrong direction.

Modern campaigns no longer attempt to offer plausible policy solutions. Engagement on an emotional level is much more important.

The Brexit campaign communicated with short video clips shared on social media asking, “Are you concerned about the amount of crime being committed in the U.K. by foreign criminals?” or “Are you worried about the overcrowding of the U.K. and the burden on the NHS [National Health System]?” The supposed answer came in the form of another question: “Isn’t it time to take back control?”

Trump followed a similar strategy.

Political theorist Danielle Allen, who directs the Edmond J. Safra Center for Ethics at Harvard University, says the U.S. has split into a culture that reads and a culture that watches.

Most of Trump’s campaigning was directed at people who watch and do not read, she said, which is one of the reasons why he could ignore the press. Instead of policy papers, Trump’s campaign website featured short videos expressing his attitude on specific topics.

“The old-fashioned read-a-lecture-from-a-text does not meet audiences where they are right now. And Trump gets that,” Allen told the Harvard Gazette in June. Trump appreciates the new culture, the changes in news consumption, and he knows how to amplify conversations through social media more than any other political actor.

“The communications marketplace has been transformed, and Trump is the only candidate in either party who understands the new architecture,” Allen said. “Any candidate could actually master the communications architecture just as well as Trump has and fill it with positive content. We’re in the very unlucky situation that the first person who happens to have mastered the new communications architecture is also filling those channels with junk.”

Trump, who says he has more than 10 million people following his social media accounts, is fully aware of the effectiveness of communicating on these platforms. In 2012, he tweeted, “I love Twitter … It’s like owning your own newspaper – without the losses.”

Lies do not matter

Yet, owning a newspaper, unlike Twitter, comes with the added responsibility of being bound by reporting facts. Newspapers can certainly be biased by omitting information and emphasizing certain facts over others. However, telling inaccuracies or even lies is much harder to do in traditional news media than in social media.

In his public statements, Trump often contradicted the established record, the facts and even himself without the negative consequences typically attached to outright lying.

PolitiFact, a nonpartisan fact-checking organization, verified more than 300 of Trump’s statements since 2011 and found 70 percent of his claims were “mostly false,” “false” or “pants on fire.” About 15 percent of his statements were “half true” and the remaining 15 percent rated “mostly true” and “true.”

By comparison, PolitiFact verified nearly 300 of Democratic opponent Hillary Clinton’s statements since 2007 and found 26 percent of her claims were “mostly false,” “false” or “pants on fire.” About 24 percent of her statements were “half true” and 51 percent rated “mostly true” and “true.”

During the presidential campaign, both Trump and Clinton tried to taint each other as untrustworthy, habitual liars. In previous elections, this would have damaged the candidate who made the allegations. Not so in 2016.

“This has just been a clinic on the post-truth age of politics, Trump in particular. It’s performance art at this point,” Christopher Robichaud, a lecturer in ethics and public policy at Harvard said in the university’s Gazette. “It’s true that what Trump is saying is false, it’s just that in the post-truth age of politics, we’re beyond criticizing someone for that. It’s like criticizing an actor for saying a lot of false things. He says whatever he needs to say to move people emotionally.”

The media called this practice, rightly, populism and reported on Trump’s inaccuracies, putting the president-elect on a war footing.

The logical response for Trump, in dealing with organizations that trade in facts, was to deride the news media as elitist and partisan, and to brand them as part of the establishment that is, according to him, the real problem.

Reporters were singled out for abuse at Trump rallies and blacklisted for critical stories. Trump threatened to sue the New York Times for reporting on his taxes and NBC for the release of the “Access Hollywood” tape from 2005. In the video, he bragged about grabbing women by their genitals and getting away with it because he is famous. On “Fox News,” he threatened to go after Amazon for unpaid taxes. Amazon founder and CEO Jeffrey Bezos owns The Washington Post.

To do so, Trump advocated the introduction of tougher libel laws.

When the New York Times reported on the infighting in Trump’s transition team in November, the president-elect tweeted the Times “is just upset that they looked like fools in their coverage of me.” He claimed that the newspaper “is losing thousands of subscribers because of their very poor and highly inaccurate coverage of the ‘Trump phenomena.’” The Times responded by saying its subscriptions are surging.

The media struggle

Post-election, media critics called news organizations “smug” and out of touch with ordinary people, in line with Trump’s allegations of an “elitist” and “establishment” media.

Conversely, it can be argued that ordinary people have become out of touch with traditional news media.

Since the advent of social media, the lines between reporting and opinion are increasingly blurred.

Traditional media not only have to fight free-falling advertising revenues, they also are no longer an authoritative voice. Newspapers, unsure about how to react to their diminishing influence and how to embrace digital media in a way that makes money, are now just one of many voices in the media landscape.

Media consumers have changed their behavior accordingly.

A 2016 Pew Research report on the modern news consumer confirmed a trend away from traditional news media. Although local and national news organizations remain the most trusted, only 20 percent of adults regularly get their news from print newspapers, down from 27 percent in 2013. And of those 20 percent, 85 percent are over the age of 50.

The same age group drives TV news consumption, which is still the most prevalent news platform. However, half of all news consumers under 50 receive their news online. Those who prefer digital news have a more negative view of the news media overall. They trust it less and sense more media bias, the research found.

In January, in another survey by Pew, more people under 50 reported that they get their news from late-night comedy programs than from local and national newspapers.

Ironically, it is comedian Stephen Colbert, who more than 10 years ago coined the term “truthiness” in “The Colbert Report,” a satirical mock news show on Comedy Central, in response to the increasing number of lies told on regular TV news channels. The term denotes that something is true because it comes “from the gut” or “feels right” regardless of evidence, reason or facts.

Media and ‘anti-media’

Meanwhile, the proliferation of partisan media has led to a rising polarization that reinforces bias and has made political dialogue and problem solving more difficult.

Following the U.S. presidential election, CNN’s Brian Stelter said traditional news media reporting still mattered to some people. “But maybe something else mattered even more, something I would call anti-media. Breitbart is anti-media. Much of ‘Fox News’ is anti-media. Fake news websites and some right-wing blogs are anti-media.

“These outlets provide a different audience with a different set of facts about the world, but too often what they’re really selling are opinion and conspiracy theory masquerading as fact.”

All journalists have a responsibility to the truth, he said.

“The truth is not in a bubble. It is not elitist to reject conspiracy theories or fact-check obvious falsehoods. It should be done equally, but truth is the word we can keep coming back to. Don’t cower before the truth. Don’t tell half-truths, don’t shade the truth. Don’t fear the truth. And then we can focus on the other “t” word – trust. Winning back the trust of people who right now prefer anti-media.”

This will be a difficult task.

The internet and social media have democratized the news by giving everyone with access to a computer or cellphone a voice. They have brought about new forms of journalism like citizen reporting. They have also created an enormous amount of noise.

Social media sites like Facebook, through which most millennials receive their news, even call their main messaging boards “news feeds.” On this social media news feed, links to traditional news reports compete for attention with news from family and friends, entertainment, puppy and cat videos, food photos, conspiracy theories, fake news and well-packaged misinformation.

An analysis by BuzzFeed News found that in the final three months of the U.S. presidential campaign, the top-performing fake election news stories on Facebook generated more engagement in the form of shares, reactions and comments than the 20 top stories from major news outlets like the New York Times, Washington Post, Huffington Post or NBC News.

Google faced similar criticism when after the election its top search result featured a fake news blog claiming, with detailed results, that Trump had won the popular vote.

Facebook CEO Mark Zuckerberg rejected the allegations that fake news on the social network could have swayed voters in the U.S. presidential election as a “crazy idea.” He added that Facebook does not want to become an “arbiter of the truth.”

Facebook and Google nevertheless announced they will stop placing their advertising on sites that present fabricated news. Facebook later outlined plans to combat misinformation.

Changing and hidden values

The relative anonymity of the internet has brought about increasingly coarse language in the public discourse that is now even mirrored by mainstream political candidates. Traditional fact-based reporting is countered with a permanent diet of “crisis mode” talk, needed to make the new radicalized rhetoric more palatable for the disoriented, dissatisfied voter.

More than just a changing culture of language, the diminution of fact reveals a fundamental shift in the basic common value of honesty and a growing tolerance for divulging opinions and core values that in the past remained hidden.

“Telling it like it is” no longer means disclosing a hitherto little shared fact. It has become uttering something that until now was unacceptable because it is, at the very least, bordering on the obnoxious.

This is also reflected by the inability of surveys and opinion polls to get a correct handle on the true beliefs of their focus groups in the run-ups to Brexit and the U.S. election.

It is a valid criticism that the media, in an effort to supplement the reporting of campaign slogans with fact, overly relies on polls and surveys without the disclaimer that they have a considerable margin of error.

The limitations of surveys have been known for decades. One factor is the spiral of silence theory, which has provided numerous examples since the 1970s showing that people remain “silent” in surveys when they believe their views are in opposition to the majority. Or they plainly lie if they feel their views are socially unacceptable, for example because they might be perceived as sexist or racist.

Other sources of potential inaccuracy in surveys include poor sampling of a population, not weighting data properly in a “non-random” sample, and bias on the part of researchers asking the questions and interpreting the results.

The danger is that disregarding facts has wider consequences for everyone.

“If we are not serious about facts and what’s true and what’s not, if we can’t discriminate between serious arguments and propaganda, then we have problems,” President Barack Obama said in November.

“If everything seems to be the same and no distinctions are made, then we won’t know what to protect. We won’t know what to fight for. And we can lose so much of what we’ve gained in terms of the kind of democratic freedoms and market-based economies and prosperity that we’ve come to take for granted,” he said.

Mid-level rental market heats up, hits constraints

A surge in demand in the most popular segment of Cayman’s rental property market has caused prices to rise by more than 10 percent in the last 12 months, real estate experts say.

Following the financial crisis, the rental market in the Cayman Island was characterized by falling prices in line with the drop in demand as work permit numbers plummeted.

In September 2011, then-Premier McKeeva Bush told the Legislative Assembly, “My information is that there are over 2,200 rental apartments currently empty.”

Since then, both the economy and demand for rental properties have experienced a considerable turnaround. So much so that mid-level rental properties for up to $2,000 are now in short supply.

Websites of local real estate agents and property managers show few listings, particularly in the mid-price segment.

Amber Yates, a realtor at Century 21 says, “I can list a rental under $2,000 and it is gone that day.”

The current state of the market is primarily a result of increased demand. From a peak of 26,659 in November 2008, work permit numbers fell to a low of 18,500 in the fall of 2010. This summer the number of foreign workers climbed back to 24,077 and is expected to reach 25,000 early next year.

Samantha Payne, a realtor at IRG, says the rental market is most sensitive to Cayman’s economic growth.

“As such, the lack of supply in the $1,000 to $2,000 range is largely an indication of demand due to an improving economy. Many in this sector will be workers on permits, and the generally improving economic outlook as well as demand from growth in the tourism area – the opening of the Kimpton for example – has led to an absorption of the existing rental supply.”

This has already resulted in rental rates firming and significantly increasing. Currently rents are about 10 percent to 15 percent higher in the $1,000 to $2,000 market than last year, and they are about 5 percent to 8 percent above 2015 rent rates in the $2,500 to $3,500 segment, Payne estimates.

“Of course, there is an upper end to the amount tenants can afford to pay, so rents will not increase indefinitely,” she says. “That said, it’s definitely becoming a landlord’s market once again.”

The tipping in the demand-supply balance has been exacerbated by some popular rental properties coming offline.

“The Rivera has closed its doors, as has Treasure Island – these were two hot spots for affordable one beds and studios,” says Yates. “All these tenants have had to find new accommodation, thus flooding the lower rental market along with new Kimpton employee service industry staff. As a result of this shift in supply and demand, we have seen more people seeking to share to still be able to afford to be in the prime areas and close to work.”

She notes that Cayman always had a lack of one-bedroom apartments. “The island is booming and it only takes a few things to happen for the dynamics to change within this lower affordable rental section.”

Yates agrees that the market shift caused rental prices to rise, so far without affecting demand.

Demand in the mid to upper-mid segment of the market, in the $2,500 to $3,500 range, has not been as strong as in the lower-mid bracket and there is not the same undersupply, says Payne. But the IRG realtor believes that the general economic growth of the island will bring in more professional and managerial work permit holders, so that the demand-supply equation will also favor landlords in the higher priced segments in the near future.

Commercial property recovering

The commercial property has also rebounded, says Payne.

“The commercial market is recovering nicely too with a low supply in the Class A market and space in the Class A- to B market gradually being absorbed.”

There are still high vacancy rates mainly in central George Town, but landlords have responded with more attractive lease terms, including more aggressive rental rates, upgraded buildings including improving common areas, providing remote parking and by adding generators to improve hurricane resiliency. All this “has led to increased tenant take up of the vacant space and bodes well for the health of the market in future,” she says.

Pension plans cite cautious investment strategies with retirement funds

Silver Thatch Pensions manages nearly half-a-billion dollars, and has, during its nearly 20-year lifetime, returned an average 4.43 percent to 4.57 percent – probably insufficient to underwrite a retirement of uninterrupted luxury, but nevertheless a solid foundation.

Still, local pension plans, have long endured complaints of low returns, anemic investment strategies and antiquated regulations governing those strategies.

Pension plans, however, are unlike other discretionary investments. To begin with, they are compulsory. They are not founded on a family’s disposable income, but are aggregated from monthly salary deductions, matched by an employer’s contributions, with the idea of creating a self-sustaining resource that will provide ongoing support throughout retirement.

Pension plan administrators cannot lose their investments, and this mandates caution, and that caution is enshrined in the National Pensions Law.

Factors affecting returns

“Post-credit crisis, one of the challenges has been navigating what has become known as the low-return environment,” says Jack Leeland, a Saxon Pensions agent for Silver Thatch, pointing out that Silver Thatch has nonetheless produced consistently positive results.

Leeland explains the typical returns, pointing to two factors: National Pensions Law restrictions on the kinds of investments managers may pursue and a built-in conservatism among managers who are handling the life savings of its members.

“Under Cayman Islands law,” he says, “your asset allocation to fixed income has set ranges.”

The National Pensions Law, last revised in 1998, devotes most of its 15 pages to a list detailing where managers may and may not invest their plan’s funds and sets ranges for investments in specific asset classes. The pensions law mandates that between 20 percent and 40 percent of pension funds’ assets be allocated to fixed income. Between 40 percent and 70 percent should be invested in large capitalization equities which are traded publicly. And up to a maximum of 10 percent of the market value of pension funds’ assets can be invested in publicly traded small-to-medium capitalization equities, publicly traded investment-grade convertible debentures or “closed end or open end mutual or pooled funds, which themselves invest in “equities or convertible debentures” listed on one of 28 stock exchanges specified in the pensions law.

Elsewhere, the law stipulates 25 percent or less of pension fund assets must be invested in U.S. Treasury Bills or similar bills – approved by the superintendent – from other countries. The same 25 percent dictates funds placed in investment-grade commercial paper, money-market funds, certificates of deposit or fixed-term deposits or cash in a bank rated as “investment grade.”

Managers are warned against “undue risk of loss or impairment,” and must have “a reasonable expectation of fair return,” keeping in mind “the demographic composition of the members of the pension plan.”

They are also enjoined to hold “at least 70 percent of the market value of the assets” in U.S. currency, and no more than 20 percent in Cayman Islands dollars, and no one “selecting an investment for, or making a loan from, a pension fund” can select an investment or make a loan “except in a category or sub-category of investment or loan that is specifically permitted by these regulations.”

Six areas of investment are prohibited entirely, such as real estate, venture capital and derivative securities, and conflict-of-interest regulations are detailed in section 4(2).

Leeland says “limiting the ability to invest in more conservative asset classes can often lead to more volatility during periods of market stress.”

But he underlines the protections it affords pension members.

“The intent of the constraints is to encourage diversification, help[ing] to limit the potential for losses. These constraints also help to ensure that plans are investing in liquid vs. non-liquid assets, quality assets, etc.

“As you can see from our results, we have been able to produce consistently positive results. One of the [things] we have done is to lower our expense ratio – expenses as a percentage of total assets – each year.”

A summary of Silver Thatch results demonstrates consistent – if modest – gains. Leeland reminds investors that these gains were achieved after navigating the collapse of the tech bubble in 2000, the global financial crisis in 2007/2008 and in a subsequent low-return environment as global economies struggled to their feet.

The asset mix

Silver Thatch, similar to other plans, offers a choice among four investment plans, tailored to age, income, marital status and aspirations of any member.

A “conservative” plan invests 65 percent of its funds in bonds, 25 percent in equities, 10 percent in “alternatives,” hedge funds, and 5 percent in cash. The five-year average return on the conservative portfolio is 5.39 percent.

With slight changes to those elements, portfolios progress through “balanced,” which earned an average 4.48 percent in the last five years, “growth,” which has returned 4.89 annually percent since 2011, and “aggressive,” which recorded an average 4.99 percent during five years.

Silver Thatch is designing a new “ultraconservative” portfolio, but has not yet settled the details: “We plan to advertise it in our next handbook,” Leeland says, “which should be coming out before the end of the year – the portfolio will be active as soon as someone elects to use it.”

“Aggressive” investments, he says, “seek to maximize the long-term growth of capital. Current income is not a consideration as the portfolio does not allocate any portion to fixed-income investments.

“To pursue this goal, the portfolio, which is a fund of funds, normally invests approximately 90 percent of its assets in underlying funds that invest primarily in equity securities. The portfolio offers instant and broad diversification with exposure to a wide range of asset classes and investment styles. The fund may also gain exposure to alternative-asset classes including commodities and hedge funds.”

Silver Thatch’s list of investments takes up eight fine-print pages of the company’s June 30 financial statement. As expected the Balanced and Conservative portfolios largest holdings are in bonds, holding $51 and $22million of iShares Core U.S. Treasury bonds respectively (19 percent and 28 percent of their total respective portfolio). The Growth and Aggressive plans on the other hand have their largest holding in Vanguard S&P 500 ETF Equities, $30 and $1.5 million respectively (24 percent and 34 percent of their total respective portfolios).

Since inception Silver Thatch has outperformed its internal benchmark in the Balanced and the Conservative portfolios, which make up over 71 percent of the total plan, and underperformed in the Aggressive and Growth portfolios.

Silver Thatch’s internal “benchmark” goals, set by the investment board as a sort of ultimate target for managers, are derived from several global indexes such as the MSCI All Country World Index and the Barclays Capital U.S. Treasury Bond Index. The reason it makes sense to use a benchmark is that it helps define the appropriate level of risk and return, Leeland says, with the benchmark having a similar risk profile to that of the portfolio. [see chart]

The results are “net of investment management fees,” which range from 1.5 percent to 1.6 percent, and include management fees, audit fees, everything down to printing and posting of the statements.

Silver Thatch manages $493 million, among the largest of the six – with more than 18,000 individual members.

The Chamber of Commerce is the only other pension plan to publish annual figures – with more than 17,000 individual members, 900 businesses and a reported $305 million under management as of June 2016.

Silver Thatch funds are managed by Deutsche Bank, and the board of trustees – not remunerated for their pension-plan efforts – reviews its investments every two months.

“The trustees review both compliance and performance of the plan at each of these scheduled meetings,” Leeland says. “Deutsche Bank provides active management services and their portfolio-management team reviews each of the portfolios on a daily basis.

“Deutsche Bank’s regional investment committee reviews the [Silver Thatch] portfolios on a monthly basis. Meetings of the regional investment committee take place at minimum once per month and during periods of market-related stress (e.g. Brexit) can occur more often and on an ad hoc basis.”

Each trustee has an additional incentive to make sure Silver Thatch investments deliver attractive yields: All of them are members of “the plan.”

No one should be surprised to learn that Silver Thatch regularly changes its investments. Leeland explains: “This is why diversification is so critical. Asset classes perform differently year over year; the leader from last year may be this year’s laggard.

“A multi-asset class approach allows the investor to benefit by participating in broad-based asset classes. Put simply there would always be a winner to offset any losers,” he says.

Finally, Leeland points to “additional voluntary contributions” as a significant source of funding for a member account.

The Silver Thatch website describes AVCs as “contributions over and above the required basic contributions,” which can be invested in any of ST’s portfolios.

Contributions can be deducted automatically from a salary check and can be increased, reduced, stopped, restarted or – under pending changes to the National Pensions Law – withdrawn for a down payment on a home or other critical needs.

Pointing to government data, Leeland says all the portfolios outstrip average annual inflation of 1.64 percent between 2001 and 2016.

“You can see our results outweigh this considerably by 2 to 4 percent each year,” he says. While acknowledging that investment advice provided to individuals might differ from that provided to pension planners, Leeland reminds everyone that life savings and retirement accounts must be treated carefully: “We must remember that this is a pension plan and by nature should be a low-risk investment.

“I would like to highlight that all of our investments are in high quality liquid assets. We would not want to invest in any lower-quality, high-risk high-reward-type assets.”

Cayman leaders watch for de-risking after US election

Minister Wayne Panton

All eyes are on the changing political landscape in the United States as government and the financial services industry in Cayman worry about continued bank de-risking, the process of banks reducing the risk of money laundering and terrorism financing.

In the weeks since the U.S. election, headlines like Politico’s “Bankers celebrate dawn of Trump era” have proliferated in industry publications and popular websites. President-elect Donald Trump’s transition team posted a statement in mid-November promising to dismantle the Dodd-Frank Act, a suite of financial regulatory reforms passed after the last decade’s financial crisis.

It’s unclear so far whether the president-elect’s plans include de-risking, and as of press time Mr. Trump had not announced his nominee for Treasury secretary. But the conservative ideology of the Republican Party could lead to fewer regulations for big banks, a possibility that has gotten the attention of Cayman’s financial services industry and the government.

In a recent statement, Financial Services Minister Wayne Panton said, “Our issues with local money services businesses, which Cayman’s Government and the private sector worked together last year to resolve, were linked to de-risking.

“This issue didn’t just affect persons who send remittances from Cayman to their families and friends in their home countries. It affected banking services across the board, for all of us.”

Acting Under Secretary for the U.S. Treasury Adam Szubin, addressing a conference the week after the U.S. election, said de-risking “remains a key priority for the U.S. Department of the Treasury.”

He told the American Bankers Association and American Bar Association annual Money Laundering Enforcement Conference, “Last year the World Bank undertook a survey that found that small jurisdictions with significant offshore banking activities were disproportionately affected. Given what we have come to understand about some of the reasons why some global banks are reassessing their business relationships, this is not entirely surprising.”

According to a copy of his speech published on the Treasury website, he said, “These reasons include that correspondent banking is a low-margin business in a global banking environment that has seen many multinational banks reassess their global strategic footprint, cut costs, and reallocate capital.”

Cayman, as one of those offshore jurisdictions, has felt the impact, most publicly when Western Union closed without warning in July 2015. A month later, Cayman National Bank closed the bank account for MoneyGram and JN Money Services, almost shutting down all cash-transfer counters in the islands. Many expat workers rely on cash transfer services to send remittances overseas to support their family.

A Nov. 16 press release from the Financial Services Ministry said a delegation from the ministry visited Washington, D.C., in September to meet with representatives from the Treasury, the State Department, the World Bank and several Democrat congressmen.

“We appreciated their strong interest in hearing how Cayman, as a well-regulated international financial centre, was affected,” Minister Panton said in the statement. “We are planning further visits in the coming months to continue these discussions, and we look forward to working with US leaders to strengthen our collaboration.

“As we told our experiences, we were particularly heartened to learn that the lawmakers we met – some of whom have constituents from the Caribbean who use MSBs [Money Services Business] – agree that de-risking is affecting a significant group of persons whom it was never intended to affect.”

Explaining de-risking, Minister Panton said, “Rather than working to reduce the risk, some banks have moved to eliminate the risk completely by terminating certain types of banking business altogether.

“However, by trying to eliminate risk rather than assessing and mitigating it, they are also cutting off lines of business that were not intended to be captured by the regulation, such as the MSBs, whose business by its nature does not appeal to money launderers and terrorist financiers because the monetary value of the transactions are so small.”

The de-risking actions, he said, have created their own risks by moving people outside of the traditional financial system. “The international banks are hindering law-abiding individuals from conducting daily, necessary financial transactions, such as wiring money home to families. Persons then may turn to alternative means of money transfer, which have greater associated risks,” he said.

Fidelity Bank ran Cayman’s Western Union cash transfer franchise until the windows closed overnight in July 2015. At the time, Fidelity Bank (Cayman) CEO Brett Hill told the Cayman Compass that the costs of compliance with new regulations are increasing while income from the cash transfer business is declining. “It’s been an increasingly marginal business for us,” he said.

In the month after Western Union closed, Cayman National Bank closed the bank accounts for JN Money Services, which runs the MoneyGram franchise on the islands. Without a local bank account, JN had to close or find another way to reach the international banking system. The company opted to accept only U.S. cash, so that it would not have to convert Cayman dollars and the cash could be flown to another country and deposited in a bank.

Cayman experienced a shortage of U.S. cash, with banks running out of the notes and some charging fees to convert local currency to U.S. dollars.

Months of closed-door negotiations between the ministry, banks, the Cayman Islands Monetary Authority and the cash-transfer companies dragged on, while people became more upset with the difficulty in sending cash back home to family members.

Western Union reopened in late November 2015 under Jamaica-based GraceKennedy Remittance Services and with banking through Scotiabank, effectively ending the crisis.

Minister Panton, announcing the deal last year, thanks JN for keeping its windows open for remittances, but JN was left out of the deal and still does not have a local bank account.

Cayman captives gain complexity

Comparing the number of captives in the Cayman Islands – 711 as of Sept. 30 2016, up from 709 captives 12 months ago – would suggest a flat market. But the pure statistics and consolidation in the industry masks a strong influx of new captives and the increasing complexity and amount of business carried out by insurance managers in Cayman.

In the first nine months of 2016, the Cayman Islands Monetary Authority issued 33 new licenses, a significant jump from 22 for the entirety of 2015 and 23 for all of 2014.

“Given the continued soft insurance market and increased competition from many newer domiciles, we are doing exceptionally well to keep adding on that number of new licensees,” says Kieran O’Mahony, chair of the Insurance Managers Association of Cayman.

“And there are at least another 10 applications in the hopper with CIMA,” he adds. “So we could get to 40 or 45 new licenses being issued this year, which is a tremendous achievement.”

On the surface, the trend toward consolidation in the captive insurance industry continues. The Affordable Care Act and healthcare reform in the United States have forced mergers and acquisition in the sector. This amalgamation at the hospital system level leads to the merging of underlying captives in Cayman, the global leader in healthcare captives.

O’Mahony says even the repeal of Obamacare, proposed by president-elect Donald Trump, is unlikely to stop the trend. “In the immediate future, there will not be any impact because even if Trump changes everything, trains have left the station for a number of those mergers and I expect them to continue.”

Cayman, as a mature domicile for self-insurers since 1976, will also naturally see statistics plateau as a certain number of captives reach the end of their life cycle each year.

Statistics alone neither tell the whole nor the most important part of the story, says O’Mahony, which is: “New shareholders in various guises – as single parent captives, as group captives, as SPCs and as larger third party underwriters – are coming to the island.”

Other than healthcare, Cayman is a major domicile for group captives, aimed at small and medium-sized businesses that instead of each forming their own captive, share their risk and purchasing power.

Group captives can have anything from a dozen to 100 members, which in aggregate results in a significant premium volume.

Cayman is also a well-known center for “cell” companies or segregated portfolio companies (SPCs). With about 613 cells within 146 SPCs, cell companies range from straight, simple pass-through entities used to access reinsurance capital to very large, complex programs.

Both group captives and SPCs compete with and tend to suppress the number of single captives, the IMAC chair says. “We are somewhat a victim of our own success in that regard.”

Portfolio insurance companies (PICs), introduced in 2015, which allow standalone corporate entities to be wholly owned by individual cells within a segregated portfolio company, are also gaining in popularity. Following what was essentially a “build it and they will come” strategy, there are now six portfolio insurance companies up and running and a number in the pipeline.

They can be used in a number of ways, from being a receptacle vehicle for business that is transferring from other jurisdictions to Cayman and on to reaping the benefits of a segregated portfolio company formalizing greater corporate governance and oversight of an individual “cell.”

Because a portfolio insurance company is a separate legal entity, it can have its own board, allowing stakeholders to appoint directors and have more input in its governance.

“It is better from a governance and oversight perspective. And we see it being used as an incubator for a future captive that will eventually spin off and form its own single parent captive,” says O’Mahony. “It’s gaining traction and I see … great potential for it.”

Meanwhile, there is a change in the nature of the insurance business that Cayman attracts, with increasingly complex and larger entities that write unrelated party business for a broader palette of risks, which require more management time and effort.

This includes private equity and hedge fund-backed vehicles that write third-party business using various structures.

“The ownership of these entities is more complex, the business plan is more complex and the governance around it has to be more complex as well,” O’Mahony says.

Moreover, he says, existing captive programs are used to manage different forms of risks, for example, equipment maintenance and medical stop loss.

Hospitals and other large companies that use expensive equipment, from computers to specialist diagnostic equipment, have dozens of warranty and maintenance programs to manage. Putting these programs into an insurance policy reduces a huge number of vendor relationships to just one, brings benefits of scale and manages the inherent volatility better. Medical stop-loss, in turn, is driven by U.S. healthcare reform.

“Changes in lifetime limits and on the medical benefits stop-loss side mean that companies now have to manage that risk differently, and a captive is a fantastic vehicle for that” the IMAC chairman says.

After Brexit vote, pound resumes its long-term decline

Juergen Buettner

The British Brexit vote has caught many market participants off guard, particularly in the foreign exchange market.

Since the Brexit vote on June 23, the British pound has lost 20 percent against the euro. Against the U.S. dollar it is down nearly 20 percent. Together that leads to a trade-weighted sterling index which trades significantly less than the average seen between 1975 and 2016.

The negative price reaction can easily be explained by the assumption that the decision to leave the European Union may heavily impact the growth perspectives of the U.K.

Since Oct. 11, however, the British currency has stabilized and even rebounded a bit. That newfound resilience in turn can be explained by the firmness of the latest British macroeconomic indicators, notably the sharp increase in retail sales in October (up 1.9 percent month-on-month compared with an anticipated increase of 0.5 percent). Also noteworthy is the now robust labor market. The unemployment rate fell to 4.8 percent from 4.9 percent last month, while pay rises strengthened to 2.7 percent from 2.4 percent for earnings exclusive pf bonuses and to 2.5 percent from 2.1 percent for regular wages.

U.K. Supreme Court hearing ahead

What happens next will also be determined by the U.K. Supreme Court hearing between Dec. 5 and 8, when the judges will decide whether to uphold or overturn the ruling by the London High Court. As has been reported, the court has decided that Prime Minister Theresa May must seek the approval of Parliament to trigger Article 50 of the Lisbon Treaty, launching official Brexit talks.

If the lower court ruling is overturned, according to the currency analysts at the French corporate and investment bank Natixis, this will penalize sterling and support the scenario of a hard Brexit, with Article 50 being triggered before March 31, 2017. On the other hand, if the lower court ruling is upheld, sterling’s rebound could show more lasting power, especially since short positions on the British currency are significant. This could lead to an acceleration of sterling’s technical rebound.

“But over the medium term, there will be a Brexit, in what promises to be difficult conditions given the upcoming elections in France and Germany, which suggests that sterling could go on the back foot in the first quarter of 2017,” says Natixis research analyst Micaella Feldstein.

David A. Meier from Swiss private Bank Julius Baer is also skeptical. He forecasts that “Once uncertainty rises after the Brexit process is finally initiated, outflows of foreign direct investment hold the potential to significantly weaken the currency again.“

New record lows against the euro would be very negative sign

In that context it is important to recall another very important point: Apart from temporary interruptions, the pound in relationship to the euro in the long term is a depreciation currency. According to recalculations, the pound devalued since the end of January 1976 from 2.70 to 1.02 GBP/EUR until the end of 2008. Then the pound showed one of its temporary recovery movements before the Brexit vote caused a new weakness. Purely from the chart-technical point of view, it is important that the pound holds above the mentioned record low against the euro. However, should this level be undercut, it would be synonymous with a pro-cyclical sell signal.

To avoid the latter, good economic data would be helpful.

It is not only analysts at Bank of America Merrill Lynch (BofAML) who assume that the fallout from the pound’s decline will start to hit consumer spending in the near future. News of price increases has started to mount significantly of late, ranging from “Marmitegate” to Apple computer price increases. The BofAML economists expect this to start to squeeze real incomes and consumer spending over the winter. That fits with the forecast of independent research firm Capital Economics, whose economists think that inflation will breach 2 percent by spring 2017 and will peak at around 3.2 percent in the first half of 2018.

Optimists bet on the pessimism of market participants

Staying bearish on the basis of macro fundamentals is also a high-conviction call for Swiss banking giant UBS. In the opinion of the currency experts there, the direction is still heading toward leave despite the recent ruling by the High Court, resilient activity data and a less dovish Bank of England’s Monetary Policy Committee. As a result, the correction of the U.K.’s current account deficit via the moderation of the capital flows currently funding it remains the main longer-term driver of the currency, “We continue to expect EUR/GBP to reach parity by end-2017 and stay around this level for a considerable period thereafter,“ according to a UBS report.

The most important factor that currently speaks in favor of the pound sterling is the already widespread pessimism about its outlook among market participants. That means unexpected, but positive surprises could make investors rethink their positioning, including in case new political problems should arise in the eurozone or in the United Sates. With the constitutional referendum in Italy that is set for Dec. 4, especially in the case of the eurozone, such a development is possible.

Brian Martin, head of Global Economics at ANZ Research, points out that, “According to the purchasing power parity, sterling is severely undervalued. Producer price estimates suggest it is 30 percent undervalued versus USD, while the Big Mac index estimates imply it is 23 percent undervalued.“

This means that there is already a lot of pessimism in the price. Taking into consideration all the facts makes a price forecast for the pound very difficult. Nevertheless, anyone with sterling income and euro or dollar expenses who does not want to take any risk is probably well advised to hedge at least a part of the pound sterling position.

ETFs continue to disrupt asset management industry

Juergen Buettner

Exchange Traded Funds (ETFs), that track indexes like the Dow Jones Industrial Average, S&P 500, Nasdaq-100 Index etc., are nowadays very popular among investors – a trend that is reflected in the capital flows. While traditional equity funds, which rely on an active selection of individual stocks, have been losing market share for years, passively managed investment products are increasingly in high demand. If that development continues, according to Bank of America Merrill Lynch (BofAML) in the not too distant future this could lead to the following tectonic shift: Passively managed equity assets could exceed actively managed equity assets by 2023, at least based on the projection of trailing five-year growth rates.

Why that happens has a lot to do with the performance: Many actively managed funds simply often fail to beat their benchmark in the long term. The extent of the failure can be seen in the attached table, which is taken from a report published by the French investment bank Natixis. According to that 98% of all global equity funds performed worse than their benchmark over a 10-year period. This result raises inevitably the following question: Why should investors put money in these established products, when alternative offers are available, which at least promise a market-conform performance and that at much lower cost (in some cases the expense ratios are only 0.3 percent per year compared to over 1% yearly cost for actively managed mutual funds).

Critics warn of potential risks

How big the ETF-industry has become, can easily be demonstrated with the help of a few numbers. According to Factset data, the U.S. ETF had $2.4 trillion in assets as of the end of October. BofAML estimates that “passive” funds had inflows of $2.1 trillion since 2002 versus $1.8tn outflows from “active” funds. S&P Equity and Fund Research has rankings on 1,173 equity and fixed income ETFs, 356 that launched less than three years ago. At the end of 2015 based on data provided by Factset and ETF.com among the investment advisors 81 percent recommend ETFs as an investment vehicle to client. This percentage was only 40 percent in 2006 and compares with a percentage of 79 percent for funds (85 percent in 2006). Altogether close to 30% of U.S. domiciled funds are now passive, as J.P. Morgan reports. That is not bad for a sector which was mostly unnoticed by the general public only 10 years ago.

However, as nearly always when an asset class is booming, there are certain risks connected with it. Looking at ETFs, critics claim that there is no longer a distinction between good and bad managed companies or between expensive and cheap stocks. For example, Inigo Fraser-Jenkins, chief strategist at the U.S. investment house Bernstein, because of that considers ETFs to be “worse than Marxism.” On top of that the experts at J.P. Morgan fear, that asset concentration could potentially increase systemic risk and therefor make markets more susceptible to the flows of a few large passive products. Others criticize a potential liquidity risk in many ETF products. In a stressful situation, one day in the future all these factors could have dire consequences, they say.

Decisive is the performance

These warnings should not be ignored, but at the same time it must be acknowledged, that ETFs are for sure not the only asset that carries liquidity risks in a difficult market situation. Beside this, the nowadays available wide variety of different ETF-products already allows investors to conduct different investment strategies, including a value approach. Therefore, the shift in favor of the ETFs should continue until the passive-managed competitors become more successful than in the past in their attempt to consistently beat the market.

To achieve the latter, some representatives of the traditional fund industry secretly may wish to soon witness a strong price correction or even a bear market. The underlying hope for such an attitude could be that at least during a difficult market period it could be easier to play out the strength of the pursued investment approach and to outperform the market. But that is probably not more than a straw a segment in decline is clinging on. Currently the experience based on the past is, that when active success occurs, it tends not to persist. According to Craig Lazzara an inhouse persistence scoreboard demonstrates that an investor has a better change of flipping a coin and getting four heads in a row than he does of identifying a fund manager who will be above average four years in a row.

Observations like this make the Global Head of Index Investment Strategy at S&P Dow Jones Indices think that the ranks of the “passivists” are likely to continue growing. A view, that is shared by J.P. Morgan’s Global Asset Allocation-team lead by Nikolaos Panigirtzoglou, since they predict the following in a note: “There is likely more room for passive investing to grow over the coming years at the expense of active managers until more low skilled active managers are removed from the marketplace and market inefficiencies start emerging for the skilled ones.”

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