Monday, March 27, 2017

The disruptive rise of machines in finance

From left, Richard Scott-Hopkins, director, KPMG; Suryanshu Mishra, director, head of Hedge Fund Administration, Deutsche Bank; Tarun Ramadorai, professor of Financial Economics, Imperial College London; Raoul Pal, Cayman-based CEO and founder of the Global Macro Investor and Real Vision; Bettina Warburg, founder and managing partner of Animal Ventures; and Vinay Rao, head of Risk at Stripe Inc. - Photo: David Wolfe Photography

The finance industry is just at the beginning of an unprecedented era of disruption. The accelerating speed of technological change and the potential for automation promises massive changes for banks, investment firms and other parts of the financial industry.

Much of the discussion about artificial intelligence and machine learning has focused on manufacturing. Technological innovation manifests itself most visibly in automated processes that until now were the domain of manual labor.

But it is only the first step. The next wave of intelligent machines is threatening to disrupt the white-collar worker and the more creative thinkers.

In the staff-intensive banking industry, for instance, humans are the main cost center, and the ability of blockchain technology to replace some of the workforce is one of the top initiatives pursued by senior executives in shaping their business.

Impact on hedge funds

Even the world of alpha creators in the alternative investment space may not be immune from the rise of the machines, speakers at the recent Cayman Alternative Investment Summit noted.

Raoul Pal, Cayman-based CEO and founder of the Global Macro Investor and Real Vision, says the best hedge funds have a process, and that means that the best hedge funds can be replaced by a machine.

He points to algorithmic trading and high frequency trading as the first highly successful examples.

“I think most trading will be replaced by machines, but you need to understand that what that means is the hedge fund manager of old just gets replaced by a programmer. So the hedge fund manager will need a different skill set to focus on systems-generated returns.”

While Pal believes computers are very good at processing current information, he thinks they are “terrible at looking into the future,” a time horizon much more suited to human intuition.

“As we see the investment management industry shift with the flow of pension money coming in and becoming more short-term in nature, humans are going to do what humans do well: have a strategic vision for the world,” he said in a panel on how technology affects the alternative investment industry.

Where machines fail

A recent example for the current limitations of machine learning are Brexit and the election of U.S. President Donald Trump, which machines were unable to predict.

“The simple reality is machines are not in touch with human emotions and what people feel and think,” said Suryanshu Mishra, the head of Hedge Fund Administration at Deutsche Bank.

Even with the best polling mechanisms, it would be extremely difficult to gather accurate, reliable information from 7.5 billion people. To then combine data collection, information management and statistical analysis to make assumptions about the disruption of economies and political systems or to identify the best trading activities would require a huge amount of human intelligence and research and development.

Simply basing a trading strategy on predictive analysis with limited and partially unreliable data sources is a flawed approach, Mishra said.

“The investment time horizon might be two to five years, but the information time horizons that you can rely on do not extend for more than two or three days. We don’t know what’s going to play on CNN tomorrow, so forget about a year from now.”

Artificial intelligence

In the debate about the disruptive force of artificial intelligence, the term is often used too loosely, said Bettina Warburg, founder and managing partner of Animal Ventures, a tech consulting firm. The strict definition means that machines would develop a consciousness and start to think for themselves.

“What we have today is much more like intelligence augmentation.”

It is not so much that things are new, Warburg said, “but we are advancing in so many different fields that gives people a sense of unease about the future.”

Smart algorithms, machine learning tools and parallel processing are great advancements that in combination will allow augmenting different kinds of human intelligence, she said, adding that rather than conscious intelligence, the aim is “artificial smartness.”

The future will therefore lie in a human-machine symbiosis that will require humans to adapt.

The talk about artificial intelligence, however, is not just speculation about the future.

Most current applications in financial services are based on supervised learning and require the interaction of humans and machines. For example, spam detection systems are trained by giving them a designated outcome: some emails that are marked as spam and some that are not. The systems then analyze a range of features that in combination become indicators of the correct category.

In the payment industry, the prevention of fraudulent transactions using stolen cards relies on a similar approach.

“We have been using this in the fraud space a lot,” said Vinay Rao, head of Risk at Stripe Inc.

Based on the large number of charge-backs in the industry, there are sufficient examples to train a machine to detect the features most indicative of fraud. “Historically these features have been human coded,” said Rao. Humans know the features of a transaction, but as frauds have evolved, humans are no longer good at combining features and determining correlations.

“That’s when you start using feature discovery methods like clustering. And then again you bring humans to determine do these clusters represent fraudulent behavior and use that in your method,” he explained.

Automation

In the alternative investment industry, the majority of back office functions are outsourced, but consultants and technology providers are looking at blockchain and artificial intelligence for automation and to answer the question of how to cut cost and risk out of the business.

Richard Scott-Hopkins, director at KPMG, said all aspects from front to back office have come under scrutiny for potential automation.

On the trading side, he noted, there is already a blockchain solution for derivatives which eliminates the intermediary and saves time by using smart contracts that settle in real time and manage margin collateral.

Even compliance officers need to become technology professionals, he said, and take the rules they have been applying for years and put them into code so that systems can monitor the trading portfolio and allocations.

And at the service provider level, CEOs need to talk to their administrators and custodians about what they are doing about technology.

In this context, asset managers right now are focusing on the challenges around the interoperability from front to back office and the interoperability between this ecosystem and the counterparties, like prime brokers, exchanges and fund administrators, added Mishra. Since systems and tools are often designed with different programming languages, it makes it hard for one system to speak to another and to reconcile data.

“Data becomes a monster unless you figure out how to manage,” he warned. “You may have the best data stored in your database but if you are not able to speak in the same language with the building blocks around you and within you, that is a problem.”

Blockchain

Many new solutions rely on blockchain for automation. Blockchain, the technology that is underlying cryptocurrencies like bitcoin, is essentially a distributed database that maintains a growing list of records or blocks. Although it is much talked about, the real meaning and impact often remains elusive.

Warburg said there are three ways in which blockchain is going to cause dramatic change.

First, we are moving away from an internet of information to an internet of value, she said. “We are actually able now to uniquely create assets out of digital and physical goods and transfer that value without the need for an intermediary.”

The technology itself is used to lower the uncertainty involved in these value transfers.

Second, there are many kinds of blockchain in development, with some focusing on privacy while others are more scalable or have different governance structures. “So we’ll actually see a world of thousands of blockchains that will interact and connect in interesting ways.”

And finally, blockchain will bring about new kinds of assets not limited by making what we already know better, she said, but rather “inventing a new logic to how we do business.”

Blockchain will not only lead to the creation of new products, but also new markets, whether it is around cryptocurrencies or new concepts of ownership and business organization. This could include the idea of a song as a company that doles out profit to the composer, performer, producer and other copyright holders every time it is played. Or new forms of owning an asset, like partial ownership of artwork.

Warburg also predicts a general move toward digital currencies with many kinds of currencies for different purposes. Existing virtual currencies like bitcoin and ethereum are already very different, she noted.

Deutsche Bank’s Mishra agreed, but he cautioned that there is still a long way to go.

Any buildup of a digital currency will need a lot of computing power which translates into hardware requirements and electricity consumption. Security is the other factor.

“Digital currencies will undergo a few security challenges,” he said, in terms of who controls the generation of new currency and ensuring that the mining of new tokens is not corrupted.

Insurance group turns to intelligent technology

Artificial intelligence technology, described as mimicking the human immune system, is planned as the next line of cyber defense for Cayman Islands health insurance provider BritCay.

Technology Security Officer Ben Mobley said Cayman is one of many locations parent company Colonial Group has in mind for Darktrace’s “Enterprise Immune System,” which has already been implemented at the company’s Bermuda office.

The group is also evaluating options for its branches in the British Virgin Islands, the Bahamas and Turks as Caicos.

Darktrace is a cybersecurity company with dual headquarters in Cambridge, England, and San Francisco, California. Its smart technology learns by monitoring network activity and identifies deviations from typical user activity.

Early indicator

Alarms might go off, for example, following a late evening log-in attempt from a user who typically works during standard business hours. The anomaly tips off the system to a possible insider threat, not easily prevented by firewall software.

As a healthy human immune system adapts to disease evolution, EIS technology seeks to create automatic lines of defense against evolving cyberattacks, explained Darktrace Director Emily Orton.

For a company that protects large amounts of personal client data, the technology provides a higher-level safeguard against sophisticated threats.

While firewall and anti-virus technology can prevent outside actors from infiltrating a network, Orton said insider threats, often provoked by unknowing employees, can pose the most difficult challenges.

“Insider threats are one of the biggest areas that the immune system can help you with. It’s one of the hardest types of threats to find,” Orton said.

“We figure a small number is a malicious insider … who has a specific objective. They are difficult because it’s easy for them to get around and they know the system and they specifically try to avoid detection. But a lot of what we see are non-malicious insiders.”

Well-meaning employees can invite attacks by falling for clever phishing scams, following bad links or downloading questionable content on company devices.

As cyberattacks become more advanced, Orton said, more companies and their clients are looking to fortify defense tactics. She has received inquiries from medium-sized enterprises to multinational banks seeking to protect priceless data.

“There is no silver bullet for security. You can’t secure everything but you can deploy very clever systems,” she said.

“(One) fix is taking a different approach and knowing you aren’t going to catch every threat at the door.”

Cayman Islands-based IT adviser Micho Schumann of KPMG added that AI technology is an advanced line of defense, rather than a first step. Companies must also ensure they have covered their basic needs, such as training employees on best practices.

“For a company that’s starting, especially the company sizes that we have in Cayman, you probably want to start with something along the lines of say a gap assessment or a risk analysis,” he said.

“You may have all the anti-viruses and the firewalls and all that good stuff, but if your employee clicks on that link, they might have all been defeated. So that’s why employees are very critical in this whole thing. It’s not all technical. It comes down to human (error).”

He suggested companies take a step back before investing in potentially expensive technologies and first determine their core needs, as well as the data they need to protect.

Schumann also pointed to offline steps that companies should take to ensure their systems are protected. He encourages employees to take care with how they store passwords and to practice caution with who can enter company facilities, where sensitive paper documents may be accessible.

“Nothing is hack proof,” he said. “The perfect golf game doesn’t exist, not does perfect cybersecurity.”

Online standard

In the online world, Orton anticipates AI systems becoming the standard. She describes a possible digital “arms race” in which hackers may one day adopt intelligent methods as well, prompting companies to pursue increasingly advanced technologies.

She encourages businesses to prepare for the rapid evolution of such threats and what she expected will soon be the new norm.

“For us it’s a no brainer. AI is going to be the future of cybersecurity,” she said.

Sustainable prices, scarce waterfront land, global interest

This could be one of those rare moments: The salespeople and the surveyors, the people who value real estate on a business-to-business basis, agree the market is strong and likely to remain so.

Land supply, particularly in premium coastal areas, is healthy and the construction pipeline is strong. The U.S. economy is chugging along, and the political climate surrounding President Donald Trump seems to cut both ways: He will either spark domestic growth, putting more disposable income into American pockets, or spook investors, driving them out of the country and – with a little luck – into Cayman real estate.

“I’m no political expert,” said Sotheby’s International Realty Cayman Islands owner Sheena Conolly, “but, either way, people are encouraged to look at Cayman.

“They may be unhappy with our due diligence requirements, which are stringent,” but, she said, the islands boast a stable environment and an improving economy.

Matt King, senior valuer for Bould Consulting, consultant for sister commercial and residential property expert Avata, and an eight-year member of the Royal Institution of Chartered Surveyors, agrees, but not without caution.

“The Cayman real estate market is overall performing well,” he acknowledges. “Prices have been increasing in some areas through 2016 and into this year in areas around Seven Mile Beach, and South Sound condos in particular have seen large value increases, and there are other pockets of increases, mainly for beach or sea-front properties, plus canal-front land and homes.”

President Trump and new deregulation policies could drive the market either way, he suggests. “Given Trump’s real estate background, it is unlikely the property industry will be one of those that suffers.

“Deregulation measures will likely assist lenders to be more liberal,” even inspiring “non-traditional lenders to enter the market,” King said. “However, should he decide policies at whim and go after the offshore hedge fund market, then he could have a devastating impact on the Cayman Islands economy.”

President Trump has said little about offshore finance, while Treasury Secretary Steve Mnuchin described during Senate confirmation hearings at least one Cayman company he created to shelter his Goldman Sachs clients.

James Andrews, senior managing director at property valuer Integra Realty Resources, offers a measured response, agreeing with Conolly that he is no “geopolitical expert … but there are several potential outcomes.

“For example, he may lower U.S. corporate tax rates, which may encourage corporations to relocate operations and capital back to the U.S., which could be a negative for Cayman’s offshore industry.

“On the flip side, he is anti-regulation, so coupling this with Brexit may mean that there could be less regulatory restraint on the offshore financial industry.”

Neither would necessarily affect the hedge fund industry, the chief driver behind Cayman’s financial services, Andrews said. The key to the local real estate market is the old question of population growth, and that “will be more affected by local politics and the election outcome in terms of what they decide to do with immigration policies.

“In addition, companies need to have financial incentive to stay or move here and to grow; and the cost of doing business in Cayman is quite high.”

Economic growth in Cayman

In a Feb. 15 speech to the Alternative Investment Conference at the Kimpton Seafire, Premier Alden McLaughlin said little about immigration and permanent residence policies, but much about economic growth.

Observing an “age of uncertainty,” McLaughlin said Trump had been elected “on the promise of radical change, and four weeks into his term, his approach to politics and governance would tend to suggest that indeed we are living in … exceptional times.

“The impact of his administration and its yet-to-be-articulated policies with respect to jurisdictions such as Cayman is still very much in question. But there can be little doubt that an unpredictable future is ahead.”

Brexit, he said, was a “glass half full,” and called the Cayman economy “by far the best in the region.”

The islands, he said, had “avoided the ravages of spiraling debt, unsustainable deficits, high unemployment and economic stagnation.”

His government had “grown our economy, reduced unemployment, accumulated fiscal surpluses [and] paid down debt,” improving stagnant 2013 growth of 1.5 percent to a forecast 3 percent in 2016 – accompanied by the lowest level of poverty in the Caribbean and unemployment of less than 4 percent among the entire workforce – and 5.6 percent, down from 10.5 percent, among Caymanians in 2016.

Conolly described the outlook for Cayman real estate as “extremely buoyant,” saying only a few beachfront condos remain available under $1 million, while “the higher end is selling quickly.”

Only one unit remains at Seven Mile Beach’s WaterColours, while South Sound condo development is “extremely busy.” A single-family unit, she said, runs between $3 million and $4 million, and her Sotheby’s Global Network is seeing an uptick in residential enquiries.

South Sound development continues unabated: 56-unit Vela Phase II is 90 percent sold – with another 56 units in Phase III in prospect; Cayman Crossing Phase III is scheduled for completion in late 2017. Naul Bodden will soon complete 24 units at Tides; additional projects by Stephan Baraud and mainland China’s Dating Group will bolster supply; and another 36, $1.3 million homes comprise Fin, which launches an 18-month construction schedule this quarter.

Andrews said “a significant number of pre-sales in projects under construction” had “also lower[ed] the market share for existing units.

“The average price of non-waterfront homes in the SMB area actually rose moderately, but based on a small number of transactions.

“In South Sound, the number of transactions actually declined in all categories except vacant land, with average prices increasing for homes and condos, both waterfront and inland,” he said, although noting his figures were based on Land Registry data, and excluded pre-sales of unfinished projects.

“New projects such as Shore Club, Vela Phase II, South Bay Estates appear to be selling well. We note that there are currently only 12 condos listed for sale in South Sound above CI$500,000, excluding developer pre-sales in projects planned or under construction,” he said.

Paul Pearson, director at Vela’s Davenport Development, repeated his 2016 assessment that South Sound is “on fire,” saying “it’s still on fire. We have seen new developments, the Kimpton [Seafire] and [Howard Hotel Group’s] Margaritaville hotels on Seven Mile Beach, some condo projects and then on South Sound there has been a number of projects started and some completed.

“As we enter 2017,” Pearson said, “Davenport is excited to continue with the next phase of Vela. We also have land on Crewe Road and Old Prospect Road that we are designing plans for.”

He indicated few worries about potentially volatile U.S. politics, suggesting they may work to Cayman’s benefit. Like Conolly at Sotheby’s, Pearson has seen an uptick in interest.

“If anything, we have seen an increase in enquiries from overseas (USA) since the election of the U.S. president,” he said.

“The market was quite soft for a long time, so we are seeing it corrected now.”

He is tight-lipped about new Davenport projects, saying that Crewe Road “is inland and smaller units, about 40 of them.”

He describes them as “starter homes,” priced upwards from $229,000. “We will start towards the end of summer and take about 12 months.”

He declined to name their location, and offered “no comment on Prospect yet.”

IRR’s Andrews said condo sales on Seven Mile Beach slowed in 2016 “due to the virtual sellout of WaterColours,” and a lack of new inventory.

“Because WaterColours was at the highest price point, the average price per square foot has dropped slightly,” he said. “since there were only three sales of those units in 2016.”

The newest alternative, 62 residences at the Kimpton Seafire “competes at the top of the price range,” Andrews said, “and is expected to complete in late spring or early summer and has reportedly sold about 25 percent of its units.”

Non-waterfront inventory down

Sales volume for houses and non-waterfront condos in the Seven Mile Beach area, he said, had slowed; “most likely due to a lack of new inventory and fewer listings than previously.”

Bould Consulting’s King agreed that supply had briefly declined “in the majority of areas,” bringing a kind of market stability, meaning “the outlook should be positive.”

Valuations would follow suit, he said.

“Most people who deal with residential properties focus only on interest rates because they have a direct influence on real estate prices. It’s hard to ignore that record low rates are likely bolstering values to some extent at the current time, and if investors foresee increased variability in future rates, this will likely put a downward pressure on property prices,” King said.

“However, the current low supply levels will certainly ensure stability in the short term and I see Cayman as continuing to be a safe haven in the Caribbean due the huge plans of the Dart Group and the ensuing high-quality development, infrastructure improvements and job creation through hotel development.”

Supply is not likely to remain long in abeyance, however.

Prospects for 2017

In February, Cayman’s largest contractors, McAlpine and Phoenix, proclaimed themselves “guardedly optimistic” about 2017 prospects, mostly in the residential market, particularly around SMB and South Sound, particularly on beachfront property.

“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,” McAlpine General Manager Ian Pairaudeau told the Journal, while observing that an improving economy was never guaranteed.

“The pipeline looks very strong, long-talked-about projects such as Ironwood appear to be coming to reality and should the government agree to rock removal, the Four Seasons could even be under way before the year is out,” King said. “Add this to the infrastructure works Dart is carrying out, the new building at Cricket Square and the ever-increasing pipeline of South Sound condominiums. We are certainly bullish in this field.”

Tourism projects

Tourism projects appear set to boom, he said, ticking off a handful of imminent investments in the wake of a record 385,451 air arrivals in 2016.

“New tourism developments include the planned Four Seasons Hotel in Seven Mile Beach; the Margaritaville Hotel; a 42-room business hotel in Seven Mile Beach (under renovation); a planned hotel by HHG Group on Pageant Beach in George Town; a proposed 49-room eco-lodge in Barkers Beach, West Bay; a 200-room hotel with 75 residential suites in the Beach Bay area [St. James Point]; and Ironwood, a $365 million 600-acre resort with a 27-hole golf course, 100 rooms, a clubhouse lodge, retail, restaurants and homes for 2,000 in Frank Sound.”

Conolly also points to the eastern end of Grand Cayman, naming “a lot of activity” in Queen’s Highway, Colliers and Cayman Kai, including Sotheby’s Camden House, listing for $5.5 million.

“There are a few other large-scale developments such as [East End’s] Health City,” King said. “The plans include ancillary hotel, residential and commercial uses, and should this be successful, additional development of support services in the Eastern Districts is inevitable, especially with Ironwood seemingly going ahead.”

Inland development bore a more-modest promise; long-term development was likely to be slow, Andrews said.

“The East-West Arterial is badly needed and necessary to spur more development in the eastern districts,” he said.

Questions continue to linger regarding Ironwood and government demands the developer fund a multimillion-dollar arterial extension to Frank Sound. Andrews pointed out, “[They] are publicly saying it is moving ahead despite not having an agreement to move the road.”

Eastern districts

“There is a great deal of buildable land including coastal locations in the eastern part of the island, but development will likely be slower in that area without better road access,” Andrews said.

King said the eastern districts are, in effect, a separate market: “You have only to look to areas to the east where prices are static and marketing periods are well over 12 months to see that Cayman comprises a number of different markets, each performing almost independently.”

While inland may face problems, Andrews observes it may provide affordable middle-class residential options.

“Unless we are talking about … land with canal or water views, inland will continue to struggle,” King said. “Only the sought-after commercial parcels are likely to perform well, and we don’t expect any major value increases east of Hurley’s roundabout in the foreseeable future – unless there are exceptional circumstances such as another invitation to provide a solar or wind farm for [the Caribbean Utilities Company],” a reference to the 21-acre solar array scheduled for Bodden Town’s Pease Bay Pond.

“Inland development has been strong on the west side of the island, as residents want to be close to all the commercial services of George Town and Seven Mile Beach,” Andrews said. “The inland lands in the areas further east will require better access (roads) in order for there to be significant development there.”

“Because of the flat topography and the resulting lack of ocean views from inland properties,” he added, “inland development will likely be mostly limited to domestic housing and related small commercial properties.”

What Andrews calls “non-waterfront residential homes,” typically sold to local residents, performed well in 2016. Sales grew more than 21 percent and average prices nearly 12 percent from 2015.

“Non-waterfront condo sales,” he said, were flat, “but there is a fair amount of new product under construction which may have hampered sales of existing units.

He pointed to strong sales in West Bay and both Spotts and Savannah as “conventional buyers” sought detached homes: “Given the lack of reasonably priced homes in SMB and SS, these three districts showed healthy price increases.”

Ironwood

Frank Sound’s Ironwood could also prove attractive – depending on the appeal of the Arnold Palmer golf course – and drive demand for surrounding lots, creating “an as-yet untapped market,” Andrews said.

Another inland development – boasting government support – is Cayman Enterprise City near Fairbanks Road, extending toward South Sound. Overseas companies, taking advantage of a range of concessionary fees and duties, can take space in 200,000 square feet of offices on the landscaped 70-acre site.

Conolly points to “loads of people” interested in inland developments “in the Grand Harbour area, on the canals, at The Shores – where there must be between 100 homes and 150 homes in the last three years – and at the Yacht Club and Salt Creek.”

The hothouse pace and glamour – and profits – of high-end residential development, especially in coastal areas, has left a quiet and strong commercial real estate market, although King indicates it is underserved.

Commercial market

“The commercial market is performing particularly well,” King said, citing his company’s interest in Caledonian House. “Buildings with a large tenant mix, smaller demises [leases] and flexible terms appear to be benefiting from relatively low vacancy rates at present, and rents within these building are more resilient.”

Compared to the larger Caribbean property market, Cayman has a significant commercial sector. It’s a complex segment, he said; values relate only to the returns produced and a frequent relationship with alternative investments, “hence the need for professionally qualified individuals for this specialized market.”

King decried the idea that the practices of residential real estate are efficiently applicable to commercial sales, calling it a “huge disservice to landlords and tenants alike.”

“Only a handful of valuers are able to conduct these to the necessary standard on island,” he said, calling on banks to improve vetting procedures and create “separate panels” for commercial and residential.

“Otherwise the commercial market will not only suffer from a lack of specialized personnel in sales, but will see a rise in credit risk issues,” he said.

New leases on top-quality stock in new buildings are forcing commercial accommodation to accord with international standards, he said, enabling Cayman to compete “not only with other Caribbean countries, but established markets also, whilst continuing to offer the many benefits of being a country with no direct taxation.”

Rentals, capital values and investment yields, he said, have been declining for years on secondary and tertiary commercial property, “heightened to some extent” by an unwillingness of landlords to refurbish older buildings and underlined by a planning system reluctant to allow creation of mixed-use schemes for existing properties.

Camana Bay

Camana Bay – celebrating its 10th anniversary this year – is beginning to rectify that, however, building a plethora of fresh grade-A space as part of its expansion toward Seven Mile Beach.

Declining returns on older property, King said, is because “simply, that Camana Bay was built – and tenants moved there. But the reality is the lack of grade-A space outside of Camana Bay, parking provision and overall master planning for these areas are just as much to blame.”

“We need an overall master plan for the areas that need regeneration” he said, “which usually includes elements of mixed-use.”

Government appears to have awoken to the issue, however, offering Planned Area Development for “potential regeneration sites,” said King, citing, for example, the long-discussed George Town revitalization, and similar urban renewal schemes for Eastern Avenue and Shedden Road. Already, such contemporary developments as Camana Bay’s Salt Creek, Cayman Enterprise City and East End’s Health City are PAD schemes, often generalized under a “mixed-use” rubric.

Other developers have previously tried – and failed – to integrate residential, office, retail and recreational communities. Now-bankrupt Atlanta-based developer Stan Thomas sought to create a mixed-use scheme in Salt Creek. A similar fate befell Ritz-Carlton developer Mike Ryan’s proposed Dragon Bay project.

“Commercial property lease rates will likely remain steady,” said Andrews, “and although a significant amount of office inventory will enter the market, lease rates are unlikely to decline.”

He speculated that new leases and increased rates could occur in George Town and SMB offices and retail, but acknowledged “concern that new buildings planned in Camana Bay and Cricket Square might flood the market with new inventory.

“The good news is that the developer of Camana Bay doesn’t need to discount the rates to lease the space, and can presumably afford to sit on it for as long as it takes,” Andrews said.

He said lease rates for class-A space office were holding steady at US$50-$60 per square foot and class-B between $38 per square foot and $45 per square foot. Retail rates, he said, are similar, and lower for the class-B and class-C “tertiary locations.”

Industrial rental rates were holding steady at an average of CI$23 for longer leases and better properties, while sale prices for commercial properties “are difficult to compare due to the low number of sales and the varying type of buildings that transact,” he said.

King expects more commercial development to support a growing residential sector. “Retail is the strongest commercial sector in terms of occupancy levels and also one that has been a little neglected in recent years – with the exception of Camana Bay – so we would expect to see further development in this sector.”

He also pointed to “a number of light-industrial projects in the pipeline, many including storage, which is an off-shoot of a growing residential market.”

Population growth

Andrews said population growth is essential to a strong real estate market and hoped Cayman’s May elections might inaugurate long-stalled movement on immigration policies.

“The biggest factor is an uncertain future due to an immigration policy in flux, with respect to permanent residency,” he said.

“As long as developers are able to sell residential units such as condos in South Sound they will keep building, and there is optimism that the permanent residency dilemma will be rectified in the coming year; which would give more confidence to expat residents of the island in terms of buying property.”

While prices are likely to continue unabated, they are, for the moment, justified, although King warned that while “the Seven Mile condo market appears to be flying and value increases appear justified, you have only to look to areas to the east where prices are static.”

And while valuations needed to keep pace with rising prices, it is “critical for valuers not to be carried away with the speculators and realtors who will more often than not remain overzealous about the market,” King said.

Pearson acknowledged escalating prices, but said “the units are selling and the prices are more realistic. They are sustainable.”

He cautioned, however, there “will come a tipping point and developers need to be acutely aware of the area in the market. If standards slip and prices increase at an unsustainable level, that would tip the balance, I believe.”

One element that could drive prices to that “tipping point” could be land supply on Seven Mile Beach or South Sound. “We are seeing that land in the most sought-after areas such as Seven Mile Beach is becoming extremely scarce,” King said. “Land is finite and we envisage sustainable growth for the next couple of years unless a major land owner floods the market or the global market, in particular the U.S., suffers a significant setback.”

Andrews agrees: “Land is becoming more scarce, so land will likely continue to increase unless we see population begin to decline or level off,” he said.

“I would predict we may see some redevelopment of some of the older condominium developments on Seven Mile Beach in light of the lack of additional development land on the beach,” he added.

Conolly said prices were “quite affordable compared to elsewhere in the Caribbean, with condos starting at $250,000 or $300,000.”

More than enough land was available island-wide, providing “loads of opportunities for people to develop good product,” she said. As time passed, Cayman was likely to see “more affordable levels of housing” for a broader range of buyers.

“I’m seeing movement across the board of real estate properties,” Conolly said. While visitors are likely to seek waterfront homes, “there are always more affordable opportunities.

“Inland homes in good areas are selling. They just need to be placed at a more- affordable price point.

“There is a real need for that,” she said. “Hey … we can’t all live in million-dollar homes.”

Inflation: It’s not all in the data

Monique Frederick Butterfield

Inflation, an ongoing rise in the general level of prices, is a metric of paramount importance in economic policy, and even more crucial in the daily lives of every single household. Who do you know who would be in favor of higher prices for essentials like food, shelter and transportation?

The U.S. Federal Reserve, analogous to other central banks, is striving for higher inflation. The medium range target for the U.S. central bank is 2 percent annual inflation, but why not aim for zero inflation, you may wonder.

Apart from a history lesson into the genesis of a 2 percent inflation target, one reason for an inflation target above zero relates to the flexibility of the central bank to stabilize the economy when needed.  A low inflation target, and by extension a low benchmark interest rate, leaves central banks almost helpless in the face of a recession, not leaving much room to decrease interest rates and stimulate the economy. Some may argue this premise has already been disproven as some central banks have been forced to implement negative interest rates and other unconventional policies to stimulate the economy or prevent further economic weakness.

Up to December 2016, previous data indicated a lack of inflation as measured by CPI (Consumer Price Index) figures. Some economists have rightly argued, however, that inflation has been building for a while but has not been evident in the data. The decline in oil prices, for example, has contributed to a low CPI number, masking the gradual rise in inflation.

A more subtle form of inflation has crept into markets during the past few years, appropriate dubbed “shrinkflation.” It is a term associated with food items shrinking in size or quality while maintaining the same retail price. Chocolate treats are the most visible example of this phenomenon, with companies like Mondelez reducing the weight of its Toblerone chocolate bars in the U.K. as a cost saving measure to combat a rise in input costs.

We have witnessed the same development with cereal and chips over the years as the weight of each box or bag has diminished. Although the price of a box of cereal has not increased, the average price per cereal puff or corn flake has undeniably risen.

To make matters worse, wage reflation has been absent from the economy. Consumers are not earning more, yet they are finding it more difficult to make ends meet. Juxtaposing rising inflation with the absence of wage growth will result in negative real earnings. It’s at this juncture where the data (the Consumer Price Index and the Personal Consumption Expenditure) and reality part ways. With central banks proclaiming a lack of inflation and seemingly more concerned about deflation, widespread criticism of the Fed’s strategy and its economic models is growing.

With the release of January’s data, the CPI is finally at a level that should give the Fed the impetus it has been waiting for. According to the report, headline inflation reached a five-year high of 2.5 percent, buoyed by a surge in energy prices. This higher level, however, was not limited to energy prices as housing, rent and medical care costs have intensified in several locations. Despite these numbers, the Fed may allow inflation to run higher a bit longer. While Fed Chair Janet Yellen is seeking to stoke inflation from its current low levels, she is also of the view that the inflation target is an average number, suggesting that a period of inflation beyond 2 percent may be warranted.

There is still yet another factor to take into consideration: the Fed’s balance sheet has ballooned to well over $4 trillion and continues to expand every month. A common way of servicing this debt is to inflate your way out of it. In this case, inflation is effectively seen as a haircut on the repayment on the debt. For that reason, coupled with President Donald Trump’s inflationary fiscal plans, higher U.S. inflation should be expected.

Consequently, it’s highly conceivable that the Fed will not only wait a bit longer before raising rates, but will do so at a snail’s pace. Navigating this upward trajectory slowly and in small increments, could allow inflation to rise above the target, while sending a hawkish tone to markets. Admittedly, such rate hikes could be considered meaningless in the grand scheme of things and seen as just a path to normalization vis-a-vis monetary tightening.

Source: Bloomberg LP
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.

 

Cayman and BVI poised to benefit from Islamic finance growth

Anthony Oakes

Offshore centers are poised to benefit from the enormous growth forecast in Islamic finance over the next few years, says Ogier’s Head of Banking and Finance in Asia.

The combination of increasing appetite for Islamic finance products, new variations on existing products and an increased interest in the role of offshore centers in Islamic finance point to a developing area with huge potential, according to Anthony Oakes, who leads the banking and finance team in Ogier’s BVI and Cayman-focused Hong Kong office.

Islamic finance is based on the prohibition of interest (Riba), excessive uncertainty (Gharar) and gambling (Maysir or Qimar), which makes certain financial products, including interest-bearing instruments and derivatives, and practices like short-selling and leveraging, noncompliant with Islamic law.

As such, Islamic finance relies on real economic transactions such as trade and investment based on profit sharing rather than interest-based and speculative financing practices. It integrates Islamic principles such as social justice and kindness to create products and financial markets that are ethical and sustainable.

Research by the International Shariah Research Academy for Islamic Finance estimated the total value of global Islamic finance at around $900 billion in 2009 – that figure had reached $2.4 trillion by 2015, with forecasts reaching $3.4 trillion in 2018 and $5 trillion by 2020.

“The traditional market in the Middle East remains strong, but we are also seeing growth in Asia, Malaysia and Indonesia. At the same time, the industry is developing new products – we are seeing more Shariah compliant retail and corporate banking and trade finance products coming online,” said Oakes.

“A further interesting development is happening in non-Islamic countries, where access to Islamic capital markets is being sought – a good example is the sukuks issued by the Hong Kong government in 2014 and 2015.”

A sukuk is a form of bond that is structured to be “shariah compliant” by not paying interest. This is generally achieved by giving the investor partial ownership in a tangible asset, for example in a sale and leaseback transaction. Instead of interest and coupon payments, the investor will receive rent payments, which end when the sukuk expires.

In May 2015, Hong Kong sold a $1 billion five-year sukuk at a spread of 35bp over U.S. Treasuries. The government of Hong Kong is currently holding investor meetings in Asia, the Middle East and Europe ahead of another potential U.S. dollar sukuk offering.

Oakes, who recently published a chapter on Islamic finance in the Cayman Islands in The Islamic Finance and Markets Review, said “offshore centers, and particularly Cayman, are well-positioned to take advantage of this growing area because of their flexibility and efficiency, and because their underlying legal systems are based on the trusted, well-established and familiar English legal framework.”

Cayman exempted companies are typically used as the issuer, often described as the trustee, in many Islamic financing transactions, including sukuk, wakalah, an agency or service contract, and ijarah, a lease to purchase or lease to own transaction.

In these arrangements, the Cayman company is often set up as an “orphan” special purpose vehicle because it is formed solely for the financing transaction. The SPV is referred to as an orphan because the beneficial interest in the shares of the SPV, rather than being held by a parent company, are held by a trustee such as a charitable trust or Cayman STAR trust, Oakes noted in the Islamic Finance and Markets Review article.

In this way, the SPV is unlikely to be considered an asset of the borrower in case of an insolvency, and “bankruptcy remote” because it is prohibited from undertaking any activities other than the financing transaction, making the SPV unlikely to be liquidated.

The typical sukuk structure involves the issuance of certificates to investors by a Cayman SPV. The invested funds are used to buy an asset that is then leased back to the borrower. For the duration of the sukuk, the borrower pays rent to the SPV, which distributes the coupon and principal payments on the certificates to the investors.

“If specific events of default occur, the borrower is obliged to repurchase the asset at a certain exercise price so that the SPV may redeem the certificates,” Oakes explained.

Islamic funds are another area in which the Cayman Islands is used for investment purposes.

The majority of Islamic funds tend to be close-ended private equity or property funds, which are structured either as exempted limited partnerships or exempted companies.

Since Islamic funds are established in compliance with shariah principles, they can invest only in industries or properties that comply with Islamic law, but they will use structures similar to a conventional fund.

The Cayman ELP is one of the most commonly used investment vehicles both for Islamic and non-Islamic funds, Oakes noted.

Forbes analyst gives Trump a pass on taxation, not immigration

John Tamny, Forbes political economy editor

Forbes political economy editor John Tamny gave the new U.S. president a mixed report card at the Cayman Economic Outlook conference on Feb. 2. Taking a pro-immigration, anti-tax stance, he ranked President Donald Trump’s ideology from good to “quite simply terrifying.”

He pointed to the diverse, international community in the Cayman Islands as an economic driver for the nation and encouraged the United States to continue embracing immigrants who bring with them “essential knowledge, drive and ambition.”

“There is talk today that somehow immigrants and immigration are the source of economic stagnation. Nothing could be further from the truth,” he said at the Kimpton Seafire Resort and Spa in Grand Cayman.

“If America is to remain the greatest country in the world, it must welcome immigrants. If we somehow close our borders to them, we will no longer be great because we will no longer be what made the country great in the first place.”

Tamny warned against rhetoric that pins job losses on immigrants, and said rather, ambitious immigrants are magnets for job-creating investment.

To be most effective for the nation, he encouraged President Trump to spend more time working on his golf technique than tinkering with the economy.

“If (U.S. presidents) would just play golf for most of their time in office, things would be more prosperous,” he said, transitioning to his anti-regulatory philosophy.

He praised President Trump for his plans to reduce corporate taxes and eliminate the estate tax.

“Taxes are nothing more than a price or penalty placed on work. So in an ideal world, the tax rate would be as low as possible. You do not want to penalize people for getting up and going to work every day,” he said.

He said economic growth would be “blindingly easy” if governments were to implement minimum taxation, resort to bare-bones spending and cut regulations.

“Regulation does not work. Let’s be even more clear: regulation cannot work. If you doubt me, all you need to do is go back to 2008 and observe the global banking sector,” he said.

Tamny said it is the rich alone who are able to fund progress through their investments. He described taxes on them as a penalty placed on their success.

Regarding President Trump’s interest in devaluing the U.S. dollar, he warned of provoking another global crisis.

“Investment is the biggest driver of falling prices and devaluation is the biggest enemy of investment,” he said.

“What (President Trump) doesn’t know about currency could fill books.”

Rather than encouraging American exports, he said the U.S. would risk a negative ripple effect across the globe, starting with its own workers.

“Do you think workers will sit back while their check is eviscerated?” he asked.

He pointed to how U.S. banks have handled President Trump since the 1990s, viewing him as “toxic” and a major credit risk that few are willing to touch.

In general, however, he described credit through U.S. banks as experiencing a free fall, representing 15 percent of credit in the nation. He attributed the decline to the banking bailout as well as to regulation.

For offshore financial centers like the Cayman Islands, he sees an opportunity to move in and capitalize on opportunities that U.S. banks cannot or will not touch.

Bull market resumes its climb alongside a wall of worry

The bulls are back.

Leading world stock markets are impressing observers with new record highs. The Cayman Journal explains why this is happening and what speaks in favor of following the bulls on their way up.

For almost three years the world stock exchanges took a time-out. After being placed on hold for so long, many market participants already feared the end of the bull market, which began in March 2009. But with an impressive comeback, the bulls recently eliminated all of these doubts.

During the fourth quarter of 2016, the leading U.S. stock market indices initially began to set new record highs. Around the turn of the new year, other markets started to follow, and in the meantime, even the broad global equity benchmark MSCI World Index, which contains stocks from 23 developed markets countries, started chasing records again. Also very encouraging: Apple, the stock of the world’s most expensive company, recently ended its own two-year-long breather with new records.

The charts scream ‘buy’

From a chart-related point of view, these are all pro-cyclical buying signals of the highest quality – all the more, as the list with promising chart-images can be supplemented almost arbitrarily with further examples. Every investor who believes only a little in the signal-power of charts cannot leave such a chance unexploited.

However, it is not just the charts that suggest such an action. There have also been major positive developments in the economy as a whole, and compared to the recent past, companies lately are delivering on average more positive earnings surprises.

The recent more favorable environment can also be deduced from the BofAML Fund Manager Survey (FMS) Macro Indicator. Its calculation is based on five parameters: Investor inflation expectations, capex demand, risk appetite, cyclicals (industrials, materials and tech) versus defensive sector (staples, telcoms and utilities) positioning, and equity versus bond positioning. The rule says to sell global equities when Global FMS Macro is deteriorating and cash level has fallen by at least 50bp relative to the past two months, or to buy global equities when Global FMS Macro is improving and cash level is rising relative to the past two months.

Currently the indicator is in “buy” territory as FMS Macro has been trending higher for the past seven months and cash level is higher than it was two months ago. According to BofAML Chief Investment Strategist Michael Hartnett, this is a bullish combo for risk assets because investors have been reluctant to deploy cash even though FMS Macro is positive and clearly on the upswing.

Watch the euphoria level

The aim of this article, however, is not to lead the readers to believe that we are living in a perfect new world. Rather, the resumed record hunt is accompanied by a number of risks. These include protectionist tendencies, increasing political populism, ongoing terrorism, renewed crises risk in the EU, unresolved debt problems or relatively high U.S. stock market valuations. In addition, there are certainly other dangers which can cause uncertainty among investors.

The latter point, however, is actually one of the major strengths of the current bull market. As everyone remembers, since the bull market started in 2009 there has never been a lack of trouble spots. Ultimately, despite the strong price gains that were locked in over the past eight years, this has helped to prevent excessive optimism. This, in turn, is reminiscent of Warren Buffett’s saying that the secret to getting rich on Wall Street is to be greedy when others are fearful and to be fearful when others are greedy.

This may be simplistic, but it contains a kernel of truth. From that point of view, the current mood among members of the American Association of Individual Investors is encouraging. According to the latest survey, only 33.1 percent of respondents are bullish for the next six months. Despite the eight-year bull run on Wall Street, the share of optimists is currently lower than the average rate of 38.5 percent since 1987. On the other hand, the number of bears is 32.4 percent above the historical average of 30.5 percent.

There can be no talk of real euphoria. This assessment is particularly true for Europe, including Germany. Hardly anybody there indulges in optimism. As a reminder, in early 2000, shortly before the TMT bubble burst, it was quite different. At that time there were whole compartments in commuter trains to Frankfurt, in which the only talk was of how much profit the next new initial public offering would bring. Whoever observes something like this ever again should pull the emergency brake and sell all his investment positions immediately. However, as written before, this experience from the past cannot be compared with today’s mood among most investors.

Current situation favors bets on rising indices

Of course, things can always change. In the U.S., President Donald Trump is doing everything he can to revive the “animal spirit.” His primary aim in that respect is to increase the willingness of companies to take more risks again. Should he succeed, this spirit will probably also skip to the stock market. As soon as desirable optimism becomes harmful euphoria it will be important to leave the party in time. Before that, however, it is important to use the next wave of euphoria in one’s own favor, since in the past the last leg of bull markets was typically connected with euphoria, which drove the stock prices up in a significant way.

From the point of view of the bulls, however, it would be best if Stephen Suttmeier is right. The BofAML technical research analyst thinks the recent upward move of the S&P 500 Index could be a sign for a secular bull. At least he sees the S&P 500 breakout from the 2000-2013 trading range as a secular bull market breakout similar to those in 1980 and 1950. These prior secular bulls lasted until 1966 and 2000, respectively. This means, in his view, that the secular bull market triggered in the April 2013 breakout remains at an early stage with at least a decade more to run.

“Should history repeat itself, the secular bull market road map says that the best days are ahead with S&P 500 Index at 3.000 points by 2019 and at 5.000 points by 2024,” Suttmeier says. As a reminder: At the editorial deadline, the S&P 500 Index was trading at 2.351 points.

Looking so far ahead, like Suttmeier does, is probably not everyone’s cup of tea in our fast-paced world. Finally, such long-term forecasts are always subject to potential new external disruption, including, not least, a new EU crisis or the outbreak of a war. To protect the portfolio against such negative events, it is advisable to use stop loss orders.

Irrespective of such protective measures, however, the following applies: Should severe new crises fail to materialize, the current situation on the world stock markets can be considered as very promising. Under such conditions, the chances are good that the prices can move up further on a wall of worry before euphoria could set in later on. Anyone who can follow this way of thinking should put some money to work in ETFs whose underlying indices just generated fresh pro-cyclical buying signals.

Investment summit: ‘Hedge funds are not dead’

Mark Yusko - Photo: David Wolfe Photography

Hedge fund investments have been described as failing many times before, so the suggestion that the industry is dead or in decline is an “alternative fact,” according to Mark Yusko, CEO and chief investment officer of Morgan Creek Capital Management.

Speaking at the Cayman Alternative Investment Summit in February, the investment adviser said it is at least the fourth time in his career, after the mid-’90s, the Dotcom bubble in 2000 and the financial crisis of 2008, that active management and hedge funds have been declared dead.

“It’s because they underperformed again and there is this stupid thing called smart beta,” he said about the financial products that are marketed as an alternative to the traditional “active” and “passive” investment strategies. During the recent stock market upturn, smart beta and other passive, rule-based investment strategies that track general stock market movements gained in popularity because they delivered similar returns at a much lower cost than actively managed investments.

This, however, is not likely to continue when the stock market turns. “Smart beta is an oxymoron. There is no such thing. Alpha is smart,” Yusko said, referring to the returns that active managers generate in excess of the investment gains caused by general market upswings.

Figures from data provider Hedge Fund Research show that hedge funds returned 5.6 percent on average in 2016, well below the 11 percent gain of the S&P 500 during the period.

For Yaskey, U.S. stocks are significantly overvalued, and thus his forecast for the U.S. stock market is negative. “Everyone believes that stocks always have to go up. It is a physical impossibility to generate double-digit returns from U.S. equities over the next decade. It cannot happen. No way.”

While it is true that hedge funds have been underperforming for eight years, and common belief is that investors want to reduce their hedge fund allocations, now is the best time to be invested in hedge funds, he said, because the correlation between asset classes is falling. In other words, different types of investments are no longer rising and falling at the same time, making it more important to select the right investments and strategies rather than to follow general market developments.

“Hedge funds outperform during periods of crisis and during periods of rising interest rates, both of which everyone is afraid of,” he argued, “so you want to be in those strategies during those times.”

Another “alternative fact,” Yusko said, is that pension funds are leaving hedge funds. “Yet the fact is that pension fund assets are rising from 2015 to 2016. If we believe what we hear or read without checking the facts, we actually believe the business is dying. It is not.”

Despite $100 billion in redemptions last year, the biggest outflow since the financial crisis, hedge fund assets under management have grown to $3.2 trillion, he said.

The hedge fund manager’s reasoning is confirmed by the latest JP Morgan survey of institutional investors, such as pension funds and endowments, in the asset class.

Three-quarters of large investors said they were disappointed by the performance of their hedge fund investments last year. But nearly 90 percent of the 234 surveyed investors plan to increase or maintain their current allocations to hedge funds in 2017.

Some large investors are looking to diversify their portfolio by adding new managers and different strategies, the bank said.

A third of investors ascribed the large outflow of capital last year to overcrowding – too many investment managers pursuing a limited number of investment opportunities – and 20 percent said the difficult macroeconomic environment was responsible for the high number of redemptions.

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.

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