The Cayman Islands Chamber of Commerce has a new face at its helm as of last month, with Paul Byles replacing Kyle Broadhurst as the organization’s president.
However, not much will change under the new president’s leadership, Byles told the Journal last month. Instead of instituting his own vision and plan for what the Chamber should do over the next year, Byles is taking the proverbial baton from Broadhurst, with the plan of continuing a three-year advocacy and action plan that was developed in late 2017.
That action plan focuses on four broad issues to improve the business and wider community: education, employment, and workforce development, economic growth and diversification; regulatory efficiency; and community development. Within those issues are a number of specific goals – some of which were accomplished under Broadhurst’s tenure, and others that Byles hopes to carry out this year.
Last year, Broadhurst made much headway in the education category, spearheading the Chamber’s “Growth Matters” campaign – a series of videos that explained the importance of economic growth to the territory, and how that growth is generated.
“The campaign was a resounding success, with the educational videos having been viewed hundreds of thousands of times by a worldwide audience,” Broadhurst said at the Chamber’s annual general meeting last month. “We were presented with two international industry awards for this outstanding campaign, and other Chambers from the Caribbean region have reached out to us for guidance in creating their own, similar initiatives.”
Broadhurst also talked with a number of education officials throughout the territory, getting their feedback on what are the major issues facing educators and students today. Byles said he plans to take that feedback and formulate a plan for how the business community and the schools can partner to prepare students for the workforce.
One of Byles’s major goals that he hopes to accomplish during his tenure is the creation of a vocational program for teenagers to learn technical skills. He said he plans to meet with businesses and other “stakeholders” to get this done.
In addition, the Chamber will continue to help carry out annual events such as the career fair, the Mentoring Cayman program, and the Junior Achievement program.
As for the category of economic growth, the Chamber is aiming to help establish a “small business center” that offers members with business support services, training, and other assistance.
Commerce, Planning and Infrastructure Minister Joey Hew said at the Chamber’s annual general meeting that establishing such a center is also a goal of the government.
Another category the Chamber has been working with government on is achieving regulatory efficiency. At last month’s annual general meeting, Hew promised a number of policy changes aimed at growing Cayman’s small-business sector.
First, government will eliminate the requirement for business and trade license applicants to provide a cover letter, a business plan, strata approval and character reference, he said. Government was wrapping up this phase at the end of January.
The second phase will entail the elimination of bank reference and utility bill requirement for Caymanians, as well as the Department of Environmental Health and Planning Department approval requirements, according to Hew.
The minister also said government will remove the requirement to provide evidence of compliance with pensions and health, and the requirement to submit corporate documents. These will instead be accessed from the General Registry system.
Hew said this phase should be completed by the end of March.
The Ministry of Commerce is also making efforts to allow people to file their applications for license grants and renewals online, according to the minister.
“These changes are being developed as a part of an ongoing e-government initiative,” he said.
Additionally, government is renewing its micro- and small-businesses incentive program for two more years, which Hew said will allow those entities to benefit from reduced license fees.
Byles touted the impending changes as a positive change for the business community.
“These changes will make it easier for Caymanians to start their own business, and in turn will help to boost our economy,” he said. “On behalf of the [Chamber] Council, I would like to thank the honorable minister for this outstanding initiative. We will collaborate with the ministry in any way possible to ensure this initiative succeeds, as we are a Chamber for all businesses.”
However, Byles said that the business community should not just rely on government to improve the territory’s economic environment.
“We don’t need a new policy or a new piece of legislation to get everything done,” he said. “We can work together to get things done.”
Byles said the Chamber can help do this by continuing to put on training, educational seminars, networking sessions, and other events.
He also said the Chamber will continue to work towards educating businesses about regulatory requirements, and how to navigate government’s red tape.
“We can educate the private sector so they know what to do,” he said. “It’s not all about government being inefficient.”
In terms of the last category, community development, Byles said the Chamber will continue to undertake annual events, such as the Earth Day roadside and beach cleanup. Additionally, the Chamber plans to initiate a public awareness anti-littering campaign to make residents aware of the impact litter has on the environment and the perception of visitors, potential investors, and other residents.
Byles said he hopes to engage with the community to change their impression of what the Chamber does. Some people think that the economy is a zero-sum game where one person’s profit is another’s loss, and some think that the Chamber only represents Cayman’s big-business interests, according to Byles.
But that’s not the case, he said.
“That’s a pet peeve, if I have any. I hope I can try to get the message across that commercial success does not equate to abuse of anyone or anything,” he said. “And the Chamber is for all businesses. In fact, most of our members are small businesses.
While the Chamber’s members employ about 18,000 people in total, most of the members only have between three and 15 workers, he said.
“If the Chamber was a person, he would not be a wealthy guy making lots of money in the corner. If the Chamber was a person, you would get a hardworking entrepreneur of 3-15 staff workers making a small profit or just breaking even,” he said. “That’s the true profile of the vast majority of members – a plumber on Eastern Avenue trying to hire a Filipino or a Jamaican to lay bricks. That’s the vast majority of businesses.”
As the sharing of false or misleading “news reports” on social media has become a global issue, after accusations that Russia tried to influence votes in the United States, Britain and France, technology companies like Facebook and Twitter have been hit with considerable criticism about their impact on society and on the journalism industry, according to the latest Journalism, Media and Technology Trends report by the Reuters Institute for the Study of Journalism.
Online platforms like Facebook are growing increasingly wary of potential reputational damage in the fake news debate, with fact checking, news literacy, and transparency initiatives unable to stem the tide of misinformation and low trust.
U.S. lawmakers meanwhile have held hearings on the role of social media in elections, and Facebook in January widened its investigation into the campaign leading up to Britain’s 2016 referendum on EU membership.
While these investigations into misinformation and the role of platforms have intensified, they have so far led to little concrete action other than new rules for election-based advertising in some countries.
Germany is an exception, with tough new rules requiring social media platforms to remove hate speech on their platform within seven days or face fines of up to 50 million euros. As a result, Facebook doubled the staff monitoring its content.
The Reuters Institute report predicts that this year Facebook and Google will be regularly accused of censorship after removing content that they feel might leave them open to fines.
Facebook was already forced into a major turnaround. In January, the social media giant announced changes to the News Feed, the main source of its revenue, and acknowledged that social media can sometimes be bad for its users and for democracy.
Mark Zuckerberg declared Facebook would change its algorithm to promote more personal content rather than news. Other changes to the News Feed include a plan to ask users which media outlets they recognize and trust, and to use the feedback to show trusted outlets more often.
Facebook warned it cannot guarantee that social media are, on balance, good for democracy, but the company vowed to prevent in the future the alleged meddling in elections by Russia or any other actors.
In a blog post discussing the issue, Samidh Chakrabarti, a Facebook product manager, wrote, “I wish I could guarantee that the positives are destined to outweigh the negatives, but I can’t.”
Facebook has a “moral duty,” he said, “to understand how these technologies are being used and what can be done to make communities like Facebook as representative, civil and trustworthy as possible.”
On the whole, the company should have done better, Chakrabarti conceded, but noted that Facebook has moved to disabling suspect accounts, requiring those running election ads to confirm their identities and making election ads visible outside of the targeted audience.
Twitter, Google and YouTube have followed suit with similar self-regulatory measures.
Yet traditional news organizations are severing ties with these platforms, because they are struggling to make money from their partnerships with tech giants like Facebook and Snapchat.
Facebook’s Instant Articles, which were initially marketed as a publishing game-changer, still lack the monetization opportunities sought by news outlets.
Publishers found they were making less money from Instant Articles than from content on their own website, given the inability to insert display advertisements to these stories. Until last year, Facebook also did not allow the embedding of paid subscription sign-ups or other ways to enforce a paywall to the articles to convert readers into paying subscribers, an element that is a growing source of revenue for media organizations.
As a result, major publishers like the New York Times started to cut back the amount of content they push to the Instant Articles platform.
Almost half of publishers (44 percent) surveyed for the Reuters Institute report say they are increasingly concerned with the power and influence that the tech platforms wield. Only 7 percent are less worried than last year.
But not all electronic platforms are viewed equally as more publishers feel negatively towards Facebook and Snapchat than about Twitter and Google.
Ben de Pear, editor at the U.K.’s Channel 4 News, says 2018 is a crucial year in the battle for the future of journalism. “After years of ‘disruption,’ will the digital platforms really act on the emergency they have created, which has brought about a devaluation in the profession of journalism and a collapse of trust in media organizations and what they report?” he asks in the Reuters Institute report.
At the same time, media organizations are aware that they are also responsible for their own ongoing struggles. Rather than blame platforms, publishers identify internal factors (36 percent) such as resistance to change and failure to innovate as important causes.
Changing business models
The further breaking down of advertising revenue streams and insufficient monetization from online platforms have resulted in a mixed year for media organizations.
Stronger titles like the Washington Post and the New York Times led the way in growing their subscriber base. The New York Times now has 2.3 million digital subscribers and the Washington Post doubled its subscribers last year to 1 million. And the Guardian in the U.K. reported 800,000 paying customer, including half a million subscribers and 300,000 one-off donations. This meant, for the first time, the Guardian attracted more revenue directly from readers than from advertisers.
However, many smaller news organizations faltered as the shift in reader revenue did not work for every type of media business.
“In that regard, perhaps the least surprising development of the year was the poor business results of some online pure-play news, opinion, and entertainment websites,” the report said. “Heavily dependent on both online advertising and Facebook distribution, BuzzFeed and Vice were reported as missing revenue targets while tech and pop culture site Mashable was sold for a disappointing $50 million.”
A survey of digital leaders showed a clear view that advertising will become less important over time (62 percent), with one in 10 saying they are actively planning for a future with little or no display advertising.
This turnaround can be illustrated by adjacent display advertising, which worked well in print, but much less so on the desktop, and has become irrelevant on a mobile screen at a time when the news consumption on the cellphone is exceeding that in print and on computers.
Meanwhile, the supply and demand economics have driven down prices and ad-blocking has become much more effective on most devices. Most importantly, the big tech platforms are taking most of the new digital advertising revenue because they can target audiences more efficiently and at scale, the report noted.
As a result, the continued rapid decline in both print and digital advertising revenues will lead to growing “economic distress” this year, forcing publishers to look for new revenue streams.
Online, most publishers (44 percent) see subscriptions now as a very important source of digital revenue. This is a larger share than digital display advertising (38 percent) and branded and sponsored content (39 percent).
Membership, which is a regular fee paid by loyal users to keep the site free for all, was considered very important by 16 percent and one-off donations by 7 percent of the respondents.
Not surprisingly, the vast majority of publishers pursues multiple revenue streams.
The drive towards paywall content, in particular, is not a one-size-fits-all model as it is mainly effective in richer jurisdictions like the U.S., Germany or Scandinavia, whereas publishers from Southern and Central Europe and from Asia and Latin America are recognizing the need but find it much harder to break their dependence on advertising.
“We need to build new streams of revenue, but we still do not have them. [There are] no serious examples of successful digital subscriptions in Spain, a country that does not have a strong model of paper subscriptions,” says an unnamed director general of a leading Spanish media group in the report.
Even those media companies that find it difficult to grow a paying subscriber list will attempt to turn anonymous users into registered users so that they can develop more personalized services and more loyal relationships.
U.K. publisher the Daily Telegraph for instance wants to reach 10 million registered readers. “A registered reader – as opposed to an anonymous one – is far more valuable to the business than the vast majority of our audience,” the Telegraph’s CEO, Nick Hugh, told the Reuters Institute.
The increasing economic pressure will inevitably lead to more consolidation, and fewer journalists, in the industry. Consultant Kevin Anderson notes “there are simply too many players chasing a limited audience and advertising pool to survive.”
The report concludes that although there is pressure on both technology platforms and media outlets, there is no sense that the technology revolution is slowing down. “If anything, it seems as if we are the beginning of a new phase of disruption.”
The use of artificial intelligence, as one example, could bring new opportunities for creativity and efficiency but also lead to greater misinformation and manipulation.
But almost three-quarters (72 percent) of publishers say they are planning to actively experiment with artificial intelligence to support content recommendations and drive production efficiency with the advent of “robo-journalism.”
Despite Cayman’s reputation for fast-and-easy banking, residents of the islands know the headache that can come with opening a personal bank account. One appointment can turn into several, as would-be clients track down the necessary paperwork and await the weeks-long approval process.
If a newly launched blockchain initiative takes root, the once unavoidable slog of such bureaucratic tasks could become as easy as swiping a credit card.
Cayman-based attorneys for Appleby, Sam Banks and Peter Colegate, served as lead legal advisers for the launch of SelfKey, an international project seeking to establish token-based digital identity wallets.
For offshore jurisdictions, Banks described the initiative as a gamechanger for the necessary but often slow process of KYC and AML compliance.
“SelfKey is intended to be a global solution to allow individuals and companies to transact business with each other with a higher degree of confidence with whom they’re doing business, whilst allowing the KYC-onboarding process to be completed in seconds – not weeks,” he said.
For personal purposes, the network would, in theory, provide a once inaccessible level of sovereignty over personal documents. Rather than submitting paper files that are then stored in a company’s potentially hackable databases, users would maintain control of such sensitive information by maintaining certified copies on a protected blockchain network.
“Everyone knows that opening a bank account in an offshore jurisdiction can be painful. But, what if instead of having to provide paper copies of all of your documents, you could keep encrypted versions of each of those documents in a digital wallet that only you possess? These documents would be certified in the usual way: visit a notary, justice of the peace, etc., who’s a ‘certified’ on the SelfKey Network,” Banks said.
The concept of self-controlled, verified digital documents met an enthusiastic investor response when SelfKey released its tokens, issued by a Cayman company, for public sale on Jan. 14. Following a four-day, US$15.8 million pre-sale in December, the public launch in January reached its sales cap in 11 minutes. The offering sold a total of US$22 million. Ninety percent of the proceeds are slated for growth grants, 5 percent for governance and legal expenses, and the remaining 5 percent for operations.
Products available at launch included bitcoin and digital asset exchange signup, citizenship services, company incorporation, and international insurance applications, among others.
SelfKey founder Edmund Lowell described the launch as an important step toward self-sovereign identity and individual rights.
“After the successful sale, we are pleased to be able to carry out our mission to put identity owners in control of their data and change the current centralized approach of identity management systems to one which is decentralized and self-sovereign,” Lowell said in a press statement.
While the initiative boasts a litany of benefits – digitally signed and verified identity claims, data minimization, proof of individuality, proper governance and a user-centric system – the concept must still contend with data protection laws, including Cayman’s recently established legislation aimed at minimizing vulnerable data stores.
Centralized databases are notoriously difficult to secure – as highlighted by major breaches like Equifax, among others – and replicating identity data across blockchain nodes can increase the risk of cybercrime.
“Even if the personal data is encrypted, this still does not solve the problem of legal compliance, as encrypted data can still run afoul of personal data regulations. Anyone sufficiently motivated to seek to re-identify individuals from transaction records held on a decentralized ledger would likely have the wherewithal to re-identify individuals from other available databases,” explains SelfKey’s white paper, posted on the organization’s website.
The SelfKey wallet seeks to overcome such risks by providing users a digital “pen” to apply a unique digital signature to documents. A public key and a private key, only known by the identity owner, are used to authorize transactions.
“Whenever this digital signature is applied, it serves to authenticate and validate the owner’s identity to requesting parties confidentially and securely (without having to appear in person),” the white paper adds.
“Where a username/password combination is stored in a third party’s database, a SelfKey user would never share their private key – this would always remain a secret to the user. At this stage, no one – not even the SelfKey foundation – would know that this was the user’s container, or that the SelfKey number even existed. No other entity issued it, and it was created solely by the user. This is exactly what it means to be self-sovereign.”
The process of sharing KYC documents with a bank, for example, would be secured through public key signatures, Banks said.
“You can then exchange this (document) with your bank by signing it with your public key – and addressing it to your bank’s public key. In this way, only your bank (the intended recipient) is able to open and verify its contents. This process can be done in seconds, automatically by your bank’s back-office systems (with full cross-referencing of terrorist watchlist, politically-exposed persons and other public record sources),” he said in an email.
In coming months, SelfKey will unveil desktop and mobile apps, followed by an anticipated beta corporate identity wallet launch in 2019.
Broadly, Banks hopes to see regulators become more comfortable with blockchain technology and the potential applications from initiatives like SelfKey.
“This is a dialogue that is already happening with regulators in progressive jurisdictions like Estonia, Singapore and Hong Kong. The hope is that once regulators in these first-mover jurisdictions have confirmed that the system satisfactorily meets their compliance requirements, that regulators in other jurisdictions will follow suit,” he said.
The British government announced a new public register that from 2021 will require overseas companies that own or buy property in the U.K. to identify their beneficial owners to tackle money laundering through property transactions.
More than 75 percent of properties currently under investigation use offshore vehicles, a tactic to hide the true owners that is regularly seen by investigators pursuing high-level money laundering, the U.K. government said.
More than US$252 million worth of property in Britain has been brought under criminal investigation as the suspected proceeds of corruption since 2004.
The Department for Business, Energy and Industrial Strategy’s register will require overseas companies that own or buy property in the U.K. to provide details of their ultimate owners.
“This will help to reduce opportunities for criminals to use shell companies to buy properties in London and elsewhere to launder their illicit proceeds by making it easier for law enforcement agencies to track criminal funds and take action,” the prime minister’s office said in a statement.
Business Secretary Greg Clark said, “We are committed to protecting the integrity and reputation of our property market to ensure the U.K. is seen as an attractive business environment – a key part of our Industrial Strategy.”
He added, “this world-first register” will build on the U.K.’s reputation for corporate transparency, as well as helping to create a hostile environment for economic crimes, like money laundering.
The register will also provide the government with greater transparency on overseas companies seeking public contracts, he noted.
Government committed to publishing a draft bill this summer and introducing it in parliament by next year. Following legislation, the register would go live by early 2021.
The British government made the announcement during a debate of the Sanctions and Anti-Money Laundering Bill in the House of Lords in January, amid attempts to insert a clause into the legislation requiring a “public register of beneficial ownership of U.K. property by companies and other legal entities registered outside the U.K.”
Conservative Lord Faulks introduced the amendment stating that he felt dismay that large parts of central London and other parts of the country “are dark at night,” with property either wholly unoccupied or occupied for brief periods only.
“Who owns these properties? We simply do not know, there being no obligation to identify beneficial ownership of foreign companies which own property yet no restriction on foreign ownership,” he said.
“We may not know, but we have strong suspicions,” he added, citing anti-corruption organization Transparency International, which says that £4 billion-worth of property in London is bought with suspicious wealth.
“It is a supreme irony that this country’s adherence to the rule of law encourages criminals and fraudsters to invest here, when in their own countries there may be little or no respect for the rule of law,” Lord Faulks said. “Are we to stand idly by and to act in effect like a handler of stolen goods?”
Lord Hodgson of Astley Abbotts noted in support that the facts surrounding the use of companies by overseas investors to invest in U.K. property, enabling them to conceal their identity, are generally agreed.
The U.K. government had committed to creating a register to disclose the beneficial owners as early as 2016 at the Anti-Corruption Summit in London.
Lord Ahmad, the Foreign and Commonwealth Office Minister, explained that the Department for Business, Energy and Industrial Strategy has sent more than 100 pages of drafting instructions to the Office of the Parliamentary Counsel, and work preparing the clauses for the bill is under way.
Specific provision will have to be made for Scotland and Northern Ireland, which have different land registration systems and their own land registries.
Lord Ahmad noted that the department commissioned research on the potential impact of the policy on investment decision but work on the impact assessment was ongoing.
He added that the register would warrant a separate bill. “The register will be first of its kind in the world and will affect people’s property rights. A robust enforcement mechanism will be essential.”
The U.K. government believes that criminal sanctions may not be sufficient in isolation, but that additional enforcement through land registration law will also be needed if the register is to have teeth.
“A key proposal is that those who own property who do not comply with the register’s requirements will lose the ability to sell the property or create a long lease or legal charge over it. This will be reflected in a restriction on the register of title,” Lord Ahmad said.
Meanwhile, the U.K.’s National Association of Estate Agents reported that estate agents are being heavily fined for failing to comply with new anti-money laundering and anti-tax evasion legislation.
Her Majesty’s Revenue and Customs confirmed the fines handed to estate agents but could not provide any details.
Tighter rules were introduced in 2017 under the Money Laundering Regulations. They require agents to conduct anti-money laundering checks on the buyers and sellers of properties.
Under the Criminal Finances Act, industry professionals can also face sanctions for failing to prevent tax evasion.
Since the legislation was introduced, there has been a “ramping up of compliance activity,” Mark Hayward, CEO of the National Association of Estate Agents, told Business Insider.
“Fines are not publicly being made known but, anecdotally, we know they are significant,” he said.
Non-compliant firms have faced “business busting” six- and seven-figure fines, said Hayward.
HMRC confirmed issuing a total of 880 anti-money laundering-related penalties but said it could not provide a breakdown by industry.
In matters of government policy, it is often difficult to take a dispassionate view. Some would say the modern discourse is so polarized, the strictly rational, factual view is drowned out. In this brief overview, we are going to attempt to lay out a few of the potential implications of the recently passed U.S. tax legislation. The aim is not to judge the merits of the legislation, or to say that the adjustment of policy is “good” or “bad.” Our role is think through the macroeconomic and market consequences of its enactment and lay out what we believe are the most important and relevant effects on the U.S. economy, the fixed income markets and the equities markets.
The U.S. economy is strong. Most academic and commercial economists agree that the growth rate of the U.S. economy that is considered its long-term “full potential” lies somewhere in the range of 2 percent. Since the middle of 2016, the U.S. economy has been growing at a faster pace than 2 percent. At the beginning of 2017, we forecast that GDP would grow at a 2.3 percent pace and it is highly likely that the year will end with growth at 2.5 percent or better. Similarly, the labor market in the U.S. is strong and has been stronger than we, and most others, had anticipated. Household balance sheets are in much better condition than a decade ago, consumer confidence is high and retail sales reports suggest the Christmas season capped 2017 with very strong consumption. Notably absent amidst the strong growth pattern was inflation, with all measures of inflation undershooting expectations for now.
The tax legislation somewhat reduces statutory tax rates for individuals, and changes some deductions and exemptions for some cohorts of income distribution. It also decreases the statutory tax rate for most mid-sized to large corporations and some “pass-though” corporations. Our estimate of the effect that this will have is a 0.2 percent to 0.4 percent boost to real GDP in 2018 and 2019 through moderate increases in both consumption and capital spending. The implication of this estimate is that we now forecast 2018 GDP will be 2.8 percent. A 2.8 percent growth rate is 40 percent higher than the U.S. trend growth rate at a time when the unemployment rate is at 4 percent. The potential for unemployment to fall further, into the range of 3.8 percent to 3.6 percent, is high. Unemployment rates that low are traditionally associated with periods of strong wage gains, as qualified labor becomes scarce. In the last several months of 2017, inflation trended higher and we believe the core inflation rate has bottomed and will end 2018 above the U.S. Federal Reserve’s “target” of 2 percent.
Fixed income – interest rates
Our view that inflation has bottomed and that the tax legislation can push growth, at the margin, to somewhat lofty heights, has implications for interest rates and therefore fixed income positioning. The Federal Reserve has a median forecast of three additional rate hikes for 2018, but yields in the bond market indicate a lack of belief in the resolve of the Fed to carry through with this. We believe that this position is untenable and given our growth and inflation forecast, continue to advise caution in bond markets as both short and long-term interest rates are set to rise.
Fixed income – credit markets
With growth already strong in 2017, and the tax legislation favoring a pro-growth agenda, credit markets are receiving a boost by virtue of a continuing positive outlook for corporate profits. In an environment where corporate profitability is strong, we see little reason to doubt that the market for corporate bonds can remain stable. This is not to say that we expect corporate credit spreads versus government bonds to continue to narrow, but a stable environment is reason enough to continue to own credit versus government bonds. There are mixed views on M&A activity, but for companies that benefit from a lower marginal tax rate under the new law (not universally the case), the extra cash flow after tax should be positive for both capital expenditure and M&A. Research has shown that somewhere between 60 percent and 70 percent of investment grade-rated companies have effective tax rates above the new statutory rate 21 percent and therefore benefit from the reduction.
For high yield credit markets, the reduction in the corporate tax rate has a smaller effect. Only approximately 40 percent of high yield issuers in the U.S. have an effective tax rate above 21 percent, but of that cohort a large percentage of the BB and B-rated universe will have some benefit through lower rates and the full depreciation provision for capital expenditures that was included in the legislation. In the legislation, there is also a cap on the deductability of interest expense, but this should negatively affect only the most highly levered companies that sit in the “C” ratings tiers.
As we alluded to above, it would appear that equities markets are a clear beneficiary of the reduction in corporate tax through increases in profitability and a better growth outlook. On average, analysts predict an 11 to 13 percent rise in earnings per share for the S&P 500; estimates have risen from a consensus of 9 to 11 percent since November. The average S&P 500 company had an effective corporate tax rate of 26 percent, but this could have ranged from 0 to 35 percent in the previous system. The benefit is, therefore, unequally distributed amongst sectors and individual companies within sectors so it is difficult to generalize that the legislation benefits “everyone.”
One of the sectors that appears to be a big beneficiary of the lower corporate tax is retailers, most of whom would be classed as “consumer discretionary” companies. Wall Street estimates are that U.S.-focused retailers may benefit from as much as a 20 percent lift in earnings per share in 2018, whilst those with more international reach will have a much lower benefit. However, U.S.-based retailers face myriad structural headwinds and we believe equities valuations have fully priced the boost in EPS. This example clearly shows that some industries that may be beneficiaries of policy change still may not be good investment opportunities. Another area that is a clear beneficiary is small and mid-cap companies that derive a majority of their earnings from the U.S. and therefore pay structurally higher effective tax rates than S&P 500 multi-nationals. Buying U.S. mid-cap equities, versus small-cap growth stocks, is one way to own a lower risk position for tax reform within an equities allocation. In short, tax reform is certainly helpful to equities at the margin, but we would fight the temptation to move to an overweight position in the asset class as current valuations based purely on tax policy.
The views expressed are the opinions of the writer and while believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information.
Twenty years after a computer, IBM’s Deep Blue, beat a reigning chess world champion, Garry Kasparov, for the first time, machines have made another extraordinary breakthrough.
DeepMind, a London-based alternative intelligence project and Google subsidiary, published a paper in December 2017 that outlined how its latest artificial intelligence (AI) program called AlphaZero has beaten Stockfish, the strongest chess software, which is able to calculate 70 million moves per second and outplays the best human players.
This in itself would not be remarkable, given that in 2016 one of DeepMind’s AI engines had already beaten 18-time World Champion Lee Se-dol at Go, a game that combines intuition and logic and is considered to be more complex than chess.
In October, DeepMind then presented AlphaGo Zero, a self-learning Go-playing predecessor of AlphaZero, which thrashed by 100 games to nil the program that had beaten the best human Go player.
What makes the latest achievement so significant is that AlphaZero was never programmed to play chess. The neural net was taught the rules of the game but, unlike DeepMind’s first Go program, had not been given any opening, endgame or match databases. AlphaZero learned its chess strategy simply from playing the game against itself.
After only eight hours of so-called reinforcement learning, the AI program outclassed the the best chess programStockfish program in 100 matches by winning 28 matches, drawing the remainder and not losing a single one.
In other words, after only a few hours of studying the game, AlphaZero was able to exceed or completely demolish, depending on the viewpoint, 1,500 years of accumulated chess knowledge.
“By not using human data – by not using human expertise in any fashion – we’ve actually removed the constraints of human knowledge,” said AlphaGo Zero’s lead programmer, David Silver, at a press conference. “It’s therefore able to create knowledge itself from first principles; from a blank slate …. This enables it to be much more powerful than previous versions.”
For chess players, the AI’s learning progress showed how AlphaZero initially favored certain opening and defense techniques, like the Ruy Lopez or the Caro-Kann defense, only to discard them later as unsuccessful. In turn, it started to prefer some of the best known human strategies, the English and Queen’s Gambit opening and the Berlin defense, as more promising.
The results are likely to change the strategies of the world’s best chess players, just like they did for the game of Go, but there are also real implications for the wider uses of AI.
Although critics have pointed to the differences in hardware during the matches – AlphaZero was powered by a supercomputer, while Stockfish was not – the results may have wider implications, nonetheless.
It was never the goal of DeepMind to create AI programs that would beat humans or computer programs at board games. The company’s objective is to create an intelligent machine that can tackle a broad range of challenges.
According to DeepMind, the results could bring the company closer to creating general-purpose algorithms that can help solve some of the most complex problems in science.
“If similar techniques can be applied to other structured problems, such as protein folding, reducing energy consumption or searching for revolutionary new materials, the resulting breakthroughs have the potential to positively impact society,” co-founder Demis Hassabis says on the company website.
He concedes that it is still early days. “We’re trying to build general purpose algorithms and this is just one step towards that but it’s an exciting step.”
Scientific problems are, of course, very different from the controlled environment of complete information-based and easily simulated board games with few basic rules such as chess, go or backgammon.
But AlphaZero refutes one of the criticisms of AI, that the recent highlights were simply the result of increasing computer power and the ability of analyzing ever larger datasets more quickly. Because AlphaZero is self-taught, it does not depend on large stacks of data.
It shows that the fine-tuning of the algorithms can produce significant gains in machine learning and it indicates that the field of reinforcement learning, a subset of artificial intelligence, can potentially reap greater rewards than supervised learning where software programs learn from datasets and human intervention.
Satinder Singh, a computer science professor who wrote an accompanying article on DeepMind’s research in Nature, told The Verge that in the past years, reinforcement learning has started to have a broader impact in the wider world.
“The fact that [DeepMind] were able to build a better Go player here with an order of magnitude less data, computation, and time, using just straight reinforcement learning – it’s a pretty big achievement. And because reinforcement learning is such a big slice of AI, it’s a big step forward in general,” Singh said.
Deep learning and reinforcement learning
Researchers hope that deep learning and reinforcement learning using neural nets are a way for machines to master skills that would be too complex to put into the code of a software program. The method has already improved machine-based language translation and is now applied to making financial investment, medical diagnosis and other decisions.
The general concept of deep learning is three decades old. It was known for even longer that nets of several layers of interconnected artificial neurons were in theory able to solve certain problems, but neither the hardware nor the techniques for training neural nets existed.
In 1986, David Rumelhart and Ronald Williams published a paper on backpropagation, a process that enables the individual neurons in a neural net to produce a desired output. It, thus, developed a method to train a deep neural net, but it took again much longer before the computer power needed was sufficiently advanced to produce first results.
Neural nets mimic the neurons of the brain. In a simplified way, they can be imagined as the layers of a sandwich, in which each of the layers represents thousands of artificial neurons. In an array that simulates the synapses of the brain, these artificial neurons are simple computational nodes, which each include a number value for their level of “agitation” and a number value for the strength at which this “excitement” should be passed on to a connected neuron.
To train the neural net to recognize an image, for example, the input layer would be made up of one neuron for each of the image’s pixels and the value of each neuron would represent the brightness of the corresponding pixel.
The input layer is then connected to another layer of several thousand or more neurons, which itself is connected to the next layer and so on. Depending on what type of images the machine is looking for, for example, images of horses, the final output layer in this example would only two neurons to express that the image either is or is not a horse.
Supervised learning trains a neural net by feeding it huge amounts of data, in this case images, that have the correct output value (a horse, not a horse) and teach the machine to learn backward from the correct image to recognize other similar images. It will do so without any information about the characteristics of what a horse looks like (such as four legs, long neck, mane etc.).
Initially, the neural net will have random connection values, also called weights, between each neuron. The objective of the learning process is to change the stage of excitement between the neurons of each layer to arrive at the correct level of excitement at the output layer.
Backpropagation determines where the weights of the neurons have contributed to a positive or negative output and changes the weights from the output back through the network.
When this is done millions of times, the neural net can effectively learn and its error rate diminishes over time by reorganizing itself to most effectively express the desired output.
Crucially, such a machine becomes not only a representation of images but of ideas and complex concepts that as in the case of AlphaZero’s board game strategy, may have been imperceptible to humans.
While the machine is therefore capable of excellent fuzzy pattern recognition, it is typically dependent on large amounts of data and not by itself a complex intelligence. Introducing noise, or irrelevant data, that is simply disregarded by a human, for instance, can easily fool the AI.
Now, AlphaZero has produced remarkable machine learning results without relying on human input.
Rather than relying on human generated data with the correct answer key, the reinforcement learning algorithm of AlphaZero is based on experience and the data it collects from the trial and error of self-training. This might widen its potential applications but what these applications are is not clear yet.
Despite massive expectations for the use artificial intelligence, few businesses have so far implemented any form of machine learning. A survey of 3,000 business executives by MIT Sloan Business Review last year showed that the gap between ambition and execution at most companies is very large.
While three-quarters of executives believe AI will break new ground for their business and 85 percent think it will enable their companies to obtain or sustain a competitive advantage, only one five companies have attempted to incorporate this type of technology in their services or processes.
And only 5 percent of the surveyed companies have used AI extensively.
Many companies also misunderstand the data-dependency of most machine learning projects to produce viable results that can be leveraged by a business.
Jacob Spoelstra, director of data science at Microsoft, observes in the report: “I think there’s still a pretty low maturity level in terms of people’s understanding of what can be done through machine learning. A mistake we often see is that organizations don’t have the historical data required for the algorithms to extract patterns for robust predictions. For example, they’ll bring us in to build a predictive maintenance solution for them, and then we’ll find out that there are very few, if any, recorded failures. They expect AI to predict when there will be a failure, even though there are no examples to learn from.”
Another problem for adoption of AI will be whether business managers, patients, investors or consumers have sufficient confidence in the automated decisions that machines are going to make, especially when the reasons for taking a specific course of action over another are often unfathomable.
In contrast to developers of mathematical models, the creators of deep learning machines cannot fully explain how they work. The artificial intelligence is largely a black box that resembles intuition more than reasoning.
The delegation of important decision-making tasks concerning health, defense, education, finance and other fields to machines may be an uncomfortable idea for most people. Not knowing how a machine arrived at its conclusion or decision will do little to alleviate the unease.
As a result, AI engineers have recognized that “explainability” or “interpretability” is a key feature needed to create trust in human-machine interactions.
Ultimately, the results produced by machine learning promise to improve human thinking and insight into complex system. After the world number one Go player Ke Jie played, and lost to, Alpha Go at the Future of Go Summit in Wuzhen, China, he recorded a winning streak of 20 matches.
“After my match against AlphaGo, I fundamentally reconsidered the game, and now I can see that this reflection has helped me greatly,” he said last July. “I hope all Go players can contemplate AlphaGo’s understanding of the game and style of thinking, all of which is deeply meaningful. Although I lost, I discovered that the possibilities of Go are immense and that the game has continued to progress.”
Government officials in the Bahamas are attempting to stay abreast in the competition for attracting international investors and businesses. The island nation recently passed the Commercial Enterprises Bill, which makes it easier for foreign companies to land there and obtain permits for non-Bahamian workers.
The bill, which was passed by both the Assembly and Senate in recent weeks, has drawn criticism from the opposition Progressive Liberal Party, which says some of the provisions in the bill put Bahamians and Bahamian-owned businesses at a disadvantage.
One of the more controversial elements in the bill is a default mechanism on immigration. Current wording gives the government 14 days to process foreign worker applications. If it fails to do so, the permits are automatically approved. The move is meant to speed up the process to be more in line with competing countries, such as the Cayman Islands. Companies that have a specified business license can bring in workers for a year with nothing more than an application that needs to be submitted 30 days before they arrive.
Labour Minister Dion Foulkes was quoted in local media, Tribune 242, as saying the bill would not hurt Bahamian-owned businesses and would give the economy a boost.
“We are losing a lot of business to other jurisdictions, such as the Cayman Islands, for example, because of their ease of doing business and the rate at which they turn around applications,” Foulkes was quoted as saying, “whether it’s business licences [or] work permits. We are determined to … be the major player, as we have been, in the financial services industry.”
The bill also requires new businesses to invest a minimum of $250,000 into their companies. Edison Sumner, CEO of the Bahamas Chamber of Commerce and Employees Confederation, said he does not think that figure is high enough for international corporations and was too high for Bahamian-owned businesses, especially small businesses.
“We felt the playing field should have been more leveled,” Sumner said. “That has been addressed to some degree in the amended bill.”
The amendment removed the requirement for Bahamian-owned businesses, but kept the US$250,000 threshold for foreign-owned companies. Sumner said the government seems more interested in quantity rather than quality in appealing to outside businesses.
“It’s an attractive bill for foreign investment,” he said, calling it a “step in the right direction.”
That is, as long as it does not hurt locally owned business.
“The door’s open to the foreign investment, but the Bahamians who have been working in the economy ought to be given the same level of consideration,” he said.
He is expecting further modifications to the law. “We’ve seen some amendments being made,” Sumner said. “As it goes further, I think we’re looking to see further amendments.”
On Dec. 5, the EU Council agreed, after long debate, haggling and horse trading, on a blacklist of 17 countries that the European finance ministers consider uncooperative in tax matters. They also voted on a commitment list of 47 countries that would be deemed uncooperative, according to the EU’s own criteria, had they not agreed in writing to remedy their shortcomings by the end of 2018.
The reaction could not have been more diverse.
Blacklisted countries expressed their “sadness” and “dismay.”
NGOs like Oxfam and the Tax Justice Network, who in the week before their announcement had released their own, much longer tax blacklists, lamented the omission of European countries and the absence of “the most notorious tax havens” on the EU list.
The EU Commission, in the person of Tax Commissioner Pierre Moscovici, called the list an important but insufficient first step.
Toomas Tõniste, minister for finance of Estonia, meanwhile noted on behalf of the EU Council that the initiative was already proving its value because numerous countries had made commitments to change their tax regime based on EU criteria to avoid the blacklist.
And the countries on the commitment list described their “graylisting” as a seal of approval, certifying that unlike the non-cooperative countries on the blacklist, they were in fact “cooperative.”
The Isle of Man, for instance, “welcomed” its graylisting as a decision not to place the island on the blacklist. Bermuda said it reaffirmed its status as a cooperative tax jurisdiction. Jersey considered itself “cleared” from inclusion on the blacklist. And Cayman said the EU recognized it as a cooperative jurisdiction.
However, while it is clear, based on the criteria employed by the EU, that a blacklisting of any offshore jurisdiction had become increasingly likely – Bermuda’s former Premier Michael Dunkley went as far as calling it a “foregone conclusion” – desscribing the graylisting, which may require as yet undefined changes in local tax practice and legislation with unclear economic consequences, as an outright success might be a step too far.
In November 2016, the EU Council established three criteria that meant the examined jurisdictions had to be considered compliant on tax transparency, fair taxation and the implementation of measures to prevent tax base erosion and profit shifting (BEPS), a term for the loss of tax revenue due to tax evasion and aggressive tax avoidance by multinational companies.
Cayman’s government emphasized that the EU lists confirmed Cayman’s compliance with the required tax information exchange regime, the implementation of BEPS and its lack of preferential tax mechanisms that treat foreign companies differently than local ones. But much like Bermuda, Guernsey, the Isle of Man, Jersey and Vanuatu, Cayman had not met the EU’s fair tax criterion, which stipulates that jurisdictions should not facilitate offshore structures that attract profits without real economic activity.
Lack of substance
How the six jurisdictions are supposed to change their tax regime or legislation to meet the fair tax objectives of the EU is uncertain. Yet, in an apparent effort to buy time, they have all committed to doing so.
While the EU appears to expect changes in tax law, with a European Commission document stating Cayman had committed to “introduce substance requirements,” Cayman’s government aim appears to be to keep the conversation going and educate EU officials about Cayman structures.
Exempted companies in Cayman do rarely have staff on island and under the law they are not allowed to trade with any person or business locally, except to further the business of the exempted company carried on outside the Cayman Islands.
This means that exempted companies can, and some do, have substance but often they are mere legal structures, a fact that may be at odds with the EU’s desire to ensure that jurisdictions do not facilitate letterbox companies.
Premier Alden McLaughlin acknowledged that the majority of Cayman’s companies “are not bricks and mortar,” but he insisted, “they also are not letterbox companies” in the sense that they are solely used to avoid certain tax obligations rather than pursue economic objectives.
Instead he stated, “they are financial instruments that pool investment capital and facilitate international transactions.”
Taking into account the transparency regime that shares information with foreign tax authorities, including all EU member states and G20, the premier noted, “there is no interest in setting up these companies to circumvent tax obligations.”
Tim Ridley, former chairman of the Cayman Islands Monetary Authority, said the substance requirement could be an opportunity to bring more economic activity to the island.
In a speech at the annual STEP Caribbean conference last May, he highlighted the economic activity criteria inherent in the EU blacklist and BEPS initiatives to recommend that offshore jurisdictions encourage economic activity in their jurisdictions to thrive.
“Having warm bodies in cool offices making real decisions,” is part of what Tim Ridley called the long game that offshore centers must play to survive.
The economic benefits would undoubtedly be greater than for the mere corporate services of registering and administering legal structures. But to encourage companies to relocate staff, offshore centers must also put in place attractive packages, encompassing little red tape in terms of immigration and business services and cost-effectiveness, he noted.
Others are more skeptic. Tony Travers, senior partner at Travers Thorpe Alberga, warned in a speech in November that “substantial activity doctrine” in the BEPS initiative, which advocates that profits can only be taxed in the jurisdiction where substantial activities are undertaken, was in fact a Trojan horse.
In Cayman and other overseas territories, he said, it is highly unlikely that a sufficient substantial presence can be developed, “given the current immigration rules and particularly, with regard to the rollover policy and the manner of its application which make it highly improbable that skilled financial professionals would consider a long-term career in an offshore financial center.”
The Crown dependencies in the British Channel, in contrast, indicated they are prepared to change their laws to introduce legal substance requirements and made bullish statements how this would be an opportunity to grow their local economies.
Howard Quayle, the chief minister of the Isle of Man, said his government had a constructive dialogue with the EU’s Code of Conduct Group, which developed the tax criteria, about their concern “relating to a potential lack of substance, which it highlighted may be due to the absence of legal substance requirements for entities doing business in, or through, the Isle of Man.”
Mr. Quayle said his government will create an island of enterprise and opportunity: “We have a strong and diverse economy which we will grow, alongside encouraging a skilled workforce to relocate to the island. We can do that while ensuring we meet our EU and international commitments.”
Jersey’s Chief Minister, Sen. Ian Gorst, said his government’s discussions with the Code of Conduct Group may include changes to Jersey’s legislation on economic substance.
“We have already begun the necessary preparations, having regard to the Code Group requirements and Jersey’s best interests. I am committed to ensuring that, working with the finance industry, this process will be completed by the end of 2018,” he said.
Process not over
That the process is far from over is evident in the statements of Commissioner Moscovici who said, “the countries that have taken commitments must change their tax laws as soon as possible.”
To keep them on the straight and narrow, EU finance ministers should quickly agree on sanctions.
“We must not accept unfair tax competition and opacity,” he said. “Tax havens must not slip off Europe’s radar screen. As a European citizen, I share the expectations of those who hoped for more. I say to them, let us take this list for what it is: a first step. And let us keep up the pressure together, on the member states and on third countries.” Countries that are not on the blacklist, he added, “will only be fully off the hook once they have fulfilled their commitments.”
To assess jurisdictions under the fair tax criteria, the EU Code of Conduct Group will apply any guidance it has developed over the years.
The most pertinent assessment criterion from a Cayman point of view is whether any tax advantages are granted without any real economic activity and substantial economic presence.
This analysis will take into account the “adequate” level of employees, “adequate” expenditures, physical offices and any activities such as investments that are undertaken in the jurisdiction.
EU documents show that a jurisdiction can only fail the assessment if its offshore structures that attract profits without real economic activity “are due to rules or practices, including outside the taxation area, which a jurisdiction can be reasonably asked to amend.”
The introduction of a corporate income tax system or a specific income tax rate “is not amongst the actions that a third country jurisdiction can be asked to take in order to be in line with the requirements under this test, since the absence of a corporate tax base or a zero or almost zero level tax rate cannot by itself be deemed as a criterion for evaluating a jurisdiction as non-compliant,” the EU Council Outcome of Proceedings document stated.
When Dr. Stephen Klasko was a medical student in 1977, he said healthcare in the United States was still not a right. Prices were rising and customer service was poor.
Some 40 years later, not much has changed, said Dr. Klasko, the president and CEO of Philadelphia-based Thomas Jefferson University and Jefferson Health.
“Why can I do all my shopping on Amazon in my pajamas while watching ‘Game of Thrones,’ but still have to use a phone and go through 11 options when I want to call my doctor?” he asked an audience at the 2017 Cayman Captive Forum.
Nevertheless, Dr. Klasko said he is optimistic that within the next 10 years, the healthcare industry will be radically transformed.
Technology will be the primary driving force behind that transformation, according to Dr. Klasko and others who spoke at the 25th annual Cayman Captive Forum.
Dr. Klasko’s Jefferson Health is one of the many hospitals throughout the world that is expanding its “telemedicine” services – the remote diagnosis and treatment of patients by means of telecommunications technology.
The potential benefits of telemedicine are many.
Larry Smith, president of the Cayman-based captive insurer Greenspring Financial Insurance Ltd., said that telemedicine drastically reduces the time it takes surgeons to conduct post-surgical visits to monitor patients’ progress. That means those surgeons can take on extra patients, he said.
“Every two post-surgical visits we can avoid means one new patient visit we can have by that same surgeon,” Smith said.
Telemedicine can also allow family members of patients to remotely be involved in patient visits, he said.
Additionally, telemedicine channels have been established between emergency hospitals and urgent care centers. That way, there can be three-way communication between a patient, an urgent care doctor, and an emergency room physician to determine how the patient should be treated, Smith said.
Benefiting both the patient and the provider is the reduction in transportation costs – and not just driving costs – Smith added.
Whereas a patient at a hospital might have to be transported to another facility via helicopter to visit a vascular neurologist to assess whether the patient had a stroke, now that determination can be made remotely. Then, the patient can be treated on the spot, Smith said.
When Jefferson Health first started its telemedical service, JeffHealth, not many people used it, Dr. Klasko said. But then, a fortuitous event happened: The Pope visited Philadelphia in 2015.
Pope Francis’s four-day visit made travel around the city nearly impossible. This caused some 300,000 patients to book appointments with JeffHealth rather than deal with gridlocked traffic, Dr. Klasko said. Since then, JeffHealth has been a staple of Jefferson Health.
Telemedicine also has a presence in Cayman. In 2013, for example, the Cayman Islands Seafarers Association donated a telemedical remote presence robot to the Health Services Authority.
The robot allows doctors on-island and overseas to monitor patients remotely. The device also enables remote access to specialists in the United States at the touch of a button.
By 2027, the majority of patient-doctor interactions will be remote and will use artificial intelligence, Dr. Klasko predicted. This is projected to make telemedicine a $36-billion-plus industry. Right now, JeffHealth is partnering with Amazon to have “Alexa” – the company’s artificially intelligent personal assistant device – help evaluate patients. Dr. Klasko showed the audience at the Captive Forum a video clip of how this would work, with Alexa asking a patient basic questions about his condition.
JeffHealth is also working on “eco fiber,” which is clothes that essentially monitor people’s health. “While you’re sleeping, your pajamas will monitor things like your heart rate, your breathing rate, and we’re working with things to monitor glucose,” Dr. Klasko said. “If anything goes wrong, you’ll have a security system like you have in your house.”
Another JeffHealth feature is a text-messaging service that sends reminders and links to easily book appointments straight to a patient’s phone. Dr. Klasko said that Jefferson Health analytics show that patients are about 40 percent more likely to book their scheduled appointments when they are sent this reminder.
All of this has ramifications not only for the patients, but the physicians too, he said. Even now, iPhones can provide the information that used to require intensive year-long courses in organic chemistry. This has rendered large portions of medical school obsolete, Dr. Klasko said.
“Technology will replace 80 percent of what doctors do,” said the Jefferson Health CEO. “Anything that can be replaced by a computer, should be.”
With technology capable of serving basic healthcare needs, doctors will have to place more emphasis on the human touch, he said.
Dr. Klasko, an obstetrician, gave the example of a doctor delivering a baby with Down syndrome. Any computer can factually explain to a mother how Down syndrome can affect a baby, but it will take human interaction to provide the mother the support system that she needs.
But while telemedicine and other technology has the potential to radically transform healthcare, legal systems and laws are still behind in many jurisdictions.
Many places in the U.S. are still establishing reciprocity rules and exemptions so that physicians from other states and countries can provide telemedical care without having to be licensed in the state where the patient is, said Angela Russell, a managing partner at Wilson Elser Moskowitz Edelman & Dicker.
“One of the big issues is licensing. Are they licensed in the state where they’re providing care? Most states want you to be licensed, but some have a common consultation exception that even if one doesn’t have a license, if he or she meets criteria, they can provide telemedical services,” she said, adding that physicians cannot use telemedicine to prescribe drugs or perform certain other services.
Additionally, there is a lack of case precedent involving the telemedicine industry. Out of some 300,000 cases analyzed by a recent study, telemedicine was only mentioned in about 50-60, Russell said. Of those cases, some involved the use of a telephone rather than modern telemedicine technology.
However, Smith viewed the lack of telemedicine malpractice cases as a positive. Because most malpractice cases still involve human error, he said, people should not be hesitant to adopt the new technology and help the industry move into the future.
New anti-money laundering regulations have been adopted in the Cayman Islands which, from May 31, 2018, will apply to unregulated investment entities as well as regulated funds and more traditional financial services providers. The obligations and penalties imposed by the new Regulations have been expanded. The Cayman Islands is committed to meeting global anti-money laundering and counter-terrorist financing standards.
The Anti-Money Laundering Regulations, 2017, came into force in the Cayman Islands on Oct. 2, 2017, replacing the Money Laundering Regulations (2015 Revision). The adoption of the Regulations is the latest step in a program of enhancement of Cayman’s anti-money laundering (AML) and countering the financing of terrorism (CFT) legislative framework, aimed at aligning the AML/CFT regime with the revised Financial Action Task Force (FATF) Recommendations.
Main changes introduced by the regulations
The revisions introduced by the Regulations represent an extension and enhancement of the previous AML regime, as set out in the money laundering regulations, rather than an overhaul. The main changes are summarized below:
The Regulations apply to persons carrying out “relevant financial business” (RFB). RFB was previously defined by the MLRs but is now defined by the Proceeds of Crime Law (2017 Revision) (the PCL) and the definition has been extended with the result that the Cayman AML regime now applies to a broader range of Cayman Islands entities. The definition of RFB continues to encompass traditional financial services providers (FSPs) which were covered by the MLRs; including banking business, trusts business and the business of a regulated mutual fund. However, RFB now includes the business activities of:
otherwise investing, administering or managing funds or money on behalf of other persons; and
underwriting and placement of life insurance and other investment related insurance.
As a result, unregulated investment entities, specifically private equity funds whose investment activities did not fall within the previous definition of RFB under the MLRs, will now clearly be in-scope of the Regulations and Cayman’s AML regime.
It should be noted, however, that as a consequence of an amendment to the Regulations, entities which fall within scope of the Regulations under one of the two new categories of RFB activities listed above are not required to comply with the AML obligations imposed by the Regulations until May 31, 2018.
The mandatory AML procedures relating to client identification and verification (KYC), record keeping, internal and external reporting, internal control and communication procedures and employee training and awareness remain, but are supplemented by the following additional procedures:
application of a risk-based approach (see below) to monitor financial activities, together with adequate systems to identify risk (including checks against all applicable sanctions lists) and the adoption of risk management procedures;
observance with the list of countries which are non-compliant, or which do not sufficiently comply with the recommendations of the FATF;
procedures to screen employees to ensure high standards when hiring; and
designating a Deputy Money Laundering Reporting Officer, in addition to the Money Laundering Reporting Officer and Compliance Officer (now titled the Anti-Money Laundering Compliance Officer).
The Regulations require persons conducting RFB to adopt a risk-based approach to AML. This means that FSPs must identify, assess and understand the money laundering and terrorist financing risks applicable to them in relation to their customers, the countries or geographic areas from which the customers operate or reside in and the products, services, transactions and delivery channels involved. Risk assessments must be documented, monitored and kept current and must also incorporate policies and procedures approved by senior management which enable that person to manage and mitigate any risks identified.
The risk-based approach then leads to simplified or enhanced customer due diligence procedures being applicable depending on whether lower or higher risks, respectively, are identified. However, a finding that there is a low level of risk cannot be made unilaterally by the relevant FSP. Instead, a determination as to the level of risk is only valid if it is consistent with the most recently issued findings of the Cayman Islands Monetary Authority (CIMA), or any national risk assessment report of the Anti-Money Laundering Steering Group.
Customer due diligence
The requirements relating to customer identification procedures, or CDD, have been generally extended and clarified as compared to the assistance previously provided by the Guidance Notes on the Prevention and Detection of Money Laundering and Terrorist Financing in the Cayman Islands, issued in August 2015 (the Guidance Notes). In particular:
a new definition of “beneficial owner” has been adopted, aligning more closely with that used in the FATF Recommendations and corresponding Guidance;
a new Part VI of the Regulations provides details as to the circumstances in which enhanced due diligence must be carried out;
a new Part VII sets out additional requirements relating to politically exposed persons and their family members;
a new Part V provides for simplified customer due diligence (SDD) measures where lower risks have been identified.
Simplified due diligence
The CDD procedures relating to verification of identity are not applicable to certain types of customer, including:
Cayman Islands entities that are FSPs and, accordingly, subject to the Regulations themselves;
government agencies, government organizations and statutory bodies of recognized foreign countries;
entities which are regulated in a recognized foreign country; and – companies listed on a recognized stock exchange.
The exemption to CDD which was applicable to electronic payments under Regulation 8 of the MLRs, where a transaction is to be funded by payment from an account in the name of the customer at a bank regulated in the Cayman Islands or in a recognized foreign country, is still available with some changes. Under the Regulations:
the customer must still be identified; and
whilst verification of identity is not required at the time of receipt of the payment, such verification will generally be required before any further onward payment is made.
The ‘eligible introducer’ route to SDD remains available under the Regulations, though a more detailed written assurance must be provided by the introducer whose AML procedures are to be relied upon.
Any contravention of the Regulations constitutes an offence punishable, on summary conviction, to a fine of CI$500,000 (approximately US$600,000) and, on conviction on indictment, to a fine and to imprisonment for two years. This represents a significant increase in the circumstances which constitute an offence and the amount of the fine which may be imposed. In addition, where an offence is committed by an unincorporated entity, body corporate or partnership, the members, directors, partners, managers, secretary or other similar officer of that entity will also commit that offence and be liable accordingly if it is proven that the offence was committed with their consent or connivance, or is attributable to their neglect.
In the future, CIMA will have the power to impose administrative fines in relation to breaches of the Regulations pursuant to the Monetary Authority (Amendment) Law, 2016 and regulations to be made thereunder, neither of which are yet in force. Those administrative fines will be levied according to the categorization of the breach, as minor, serious or very serious, and may be imposed in addition to any fines resulting from a prosecution under the Regulations. We will issue a further update relating to the administrative fines in due course.
Following on from the updated revisions of the PCL and the Regulations recently brought into force, the Guidance Notes are currently in the process of being revised and will be updated in due course. It is anticipated that the replacement Guidance Notes will contain sector specific guidance detailing how the Regulations will apply in practice to those investment entities who find themselves in-scope for the first time.
Year to date, global financial markets are on track to deliver some of the strongest cumulative returns on record. Similarly, broad-based U.S. equity indices are experiencing double digit returns above the 20th percentile as of writing. In the words of John C. Williams, president and chief executive officer of the Federal Reserve Bank of San Francisco, “The economy is in a good place.”
A significant aspect of the good news story is the synchronised growth currently underway in the global economy. Gross domestic product (GDP) projections from the Organization for Economic Cooperation and Development (OECD) are expected to top 3.6 percent this year and 3.7 percent for 2018, with all 45 of the world’s largest economies experiencing positive growth. The momentum in U.S. GDP growth in particular, was accompanied by strong consumer confidence numbers, low borrowing costs and solid gains in personal income as a result of low unemployment and record gains in equity markets. But does the full economic picture support this sanguine mood in markets? And what factors seem to be driving this optimism?
Despite the weak first quarter readings that have plagued the U.S. economy in the last two years, revised Q3 numbers lend strong support that growth will continue into the rest of the year. The long awaited lift in growth was supported by monetary policy stimulus, and now the sweeping tax bill is expected to provide even more boost to the economy in the coming year. But is this tax reform enough to support the 3 percent growth rate the president had hoped for? In dissecting the new bill, it is highly anticipated that most consumers will only see a one-off increase in disposable income. Most of benefits of the reform appears skewed towards higher income earners who forecasters believe will save versus spend the additional income.
Further, according to Capital Economics, there is little empirical evidence linking a cut in the corporate tax rate to significant and sustained boost in business equipment and spending. Although the headline corporate tax rate was 35 percent, most firms pay an effective rate closer to 25 percent. This implies that the actual reduction in the tax bill to a 21 percent corporate rate will be minimal. Making matters worse, previous tax cuts to individual income and small businesses are set to expire after almost a decade, forcing lawmakers to grapple with extending these cuts at a time when the U.S. debt is approaching 100 percent of GDP. To be fair, there are some bright sparks evident in the recent tax reform. Firms now have the ability to expense equipment investment and there are significant tax breaks to repatriating foreign earnings. The corollary of the tax reform, however, is that the benefits are at best likely to be temporary. This partially explains the unison in GDP forecasts by markets and policymakers alike for only a temporary boost in 2018, with growth decelerating into 2019 and beyond. It is also widely expected that the current tax reform could boost inflation more than it spurs growth, lessening its intended impact. It is therefore quite plausible that the optimism in markets as a result of the recent tax reforms is vastly over exaggerated.
Strength of the labor market
Despite the temporary setbacks from a very active hurricane season this year, U.S. unemployment is perhaps the best performance indicator on the Fed’s scorecard. Overshooting the maximum employment target within its dual policy mandate, the Federal Open Market Committee (FOMC) is firmly on track to add close to two million jobs in 2017. With non-farm payrolls averaging close to 178,000 over six months, the unemployment rate is expected to dive even further to less than 4 percent by Q3 next year. But with such stellar performance in employment, wage pressure, one of the greatest contributors to inflation, remains subdued. The lack of wage pressure could be explained by lags inherent in the impact of policy initiatives on the general economy. Another reason could be the presence of even more slack in the labor market than previously anticipated. This argument appears unlikely however given recent reports that the quality of labor available is one of the largest problems firms are facing, approaching pre-crisis levels.
Perhaps the most widely discussed economic factor since the start of the recovery is inflation. Equally as import as maximum employment to the Fed scorecard is maintaining price stability. In the last eight years, the Fed has undershot their medium range inflation target of 2 percent citing transient factors as the primary driver of inflation weakness. As the effects of transitory factors anchoring inflation dissipates, labor markets continue to improve and the temporary boost from the tax reform takes effect, the U.S. economy seems well poised to experience an increase in inflation over the coming quarters. Some strong concerns remain however that the lag from transitory factors may continue to drag on Personal Consumption Expenditures (PCE), wage pressure may fail to manifest in inflation and the global economic slack could widen as a result of a strong U.S. dollar. Admittedly the U.S. economy is signaling a very clear path to strong growth in 2018. A significant and growing number of factors could however disrupt its path. The challenge for the FOMC will be to keep the expansion going whilst balancing growth, productivity levels and preserving improvements in the labor market. The tripartite effect of monetary policy normalization, a sweeping tax reform with the propensity to widen the budget deficit, all while inflation remains stubbornly anchored at 1.6 percent, presents significant headwinds for growth. As markets assess these threats, opportunities and the Fed’s ability to navigate uncharted territory, minus a Black Swan event, the challenges facing the U.S. economy are some very good ones to have.
Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information.
Not least since the Panama Papers, media around the world have tirelessly repeated allegations that offshore financial centers are secrecy havens that enable financial crime. These claims are at odds with recent investigations into money laundering schemes, which show that international criminals have increasingly used companies registered in the U.K.
In November, campaign group Transparency International UK released a report that claimed in the past 14 years, U.K.-based shell companies have been linked to 52 money laundering scandals involving more than $100 billion.
Although the U.K. intended to lead the world in deterring criminals by becoming the first country to open the records and information on beneficial owners of U.K. companies to public scrutiny, it appears the greater transparency has done little to stem financial crime.
In fact, the U.K. may have attracted financial fraud simply because it is not considered offshore.
Fraudsters in Eastern Europe and elsewhere have routed money through U.K.-registered entities because they appear to many people as more legitimate than offshore-registered companies, Transparency International said.
The desire of the U.K. government to facilitate company registrations by allowing online registrations and the self-reporting of unverified identity information has contributed to the growth of an industry of formation agents who establish blocks of companies and partnerships which they then make available to overseas parties, the report noted.
Faced with U.K. demands to establish centralized public registers of beneficial ownership, Britain’s overseas territories and Crown dependencies have long criticized the insufficient quality of information based on self-reporting at U.K.’s Companies House.
Cayman Finance, the organization that represents the finance industry in Cayman, has frequently stated that Cayman’s system of financial services providers verifying the beneficial ownership information for offshore companies is superior to that of the U.K.
At the Offshore Alert conference in London in November, Cayman Finance CEO Jude Scott reiterated this point stating that service providers are much closer to the transactions and have better insight into evaluating whether these are consistent with the information they are receiving.
“The criticism of self-reporting registers is, unless you think that hardened criminals are going to certify to you that they are hardened criminals, it is really a useless tool at preventing real, hardened criminality in a jurisdiction,” he said.
The Transparency International report found 766 companies registered in the U.K. that have been directly involved in laundering stolen money out of at least 13 countries. The companies were used as layers to hide money that would otherwise appear suspicious.
The U.K.’s own defense mechanisms against this activity “have proven to be woefully inadequate,” Transparency International said, as only six staff in Companies House are charged with policing 4 million companies.
U.K. magazine Private Eye warned as early as 2013 that British limited liability partnerships were particularly popular with money launderers. In contrast to private limited companies, LLPs and limited partnerships (LPs) do not need to name a natural person as a director or member of the company.
While many of the LLPs involved in the schemes no longer exist, some remain on the U.K. public register and continue to successfully disguise the control persons behind their holding companies despite a new requirement for British-based companies to disclose any shareholders of 25 percent or more.
The extent of the problem with British companies and partnerships as a key link in fraud schemes becomes even apparent in the U.S. investigation of Paul Manafort’s business activities, which culminated in money laundering and conspiracy charges last month.
Research by The Cayman Islands Journal shows that certain companies that Manafort’s businesses dealt with were controlled by the same companies that were named in connection with large Eastern European money laundering and corruption schemes.
These cases range from government corruption in Ukraine and weapons smuggling to South Sudan to bank fraud in Moldova and Deutsche Bank’s Russian mirror trade money laundering scandal.
The various money laundering schemes all involved British limited liability partnerships and limited partnerships held by the same offshore companies.
Manafort’s Ukraine investment
In 2014, a firm belonging to Russian oligarch Oleg Deripaska filed a petition in the Cayman Islands Grand Court to wind up Pericles Emerging Market Partners L.P., a private equity firm run by Paul Manafort, Richard Davis and Richard Gates, that sought to invest in businesses in Ukraine.
The Russian aluminum magnate Deripaska, who had been Manafort’s business partner before, agreed to invest in the firm. According to court filings in Cayman and the United States, Deripaska’s Cyprus-based investment firm Surf Horizon Limited was the sole limited partner in Pericles.
In total, Deripaska’s investment firms paid $7.35 million in management fees for the partnership and $18.9 million for the only transaction Pericles ever undertook in the acquisition of Chorne More (Ukrainian for Black Sea), a cable TV and internet company in Odessa.
Surf Horizon sought the winding up of Pericles because the firm had reason to believe that the proposed structure for the acquisition of Chorne More had not been used and there were serious doubts whether the acquisition had taken place at all.
While Surf Horizon was unable to obtain the purchase agreement, other documents relating to the Chorne More transaction did not mention Pericles. Instead they indicated that EVO Holdings, owned by Gates, was to pay a purchase price of $17.8 million, less than purported to the investor, to a previously undisclosed seller named Colberg Projects LLP. Colberg was the owner of TechCorp Universal LLP, which supposedly owned the Chorne More entities through their parent Chorne More LLC, the Cayman court-appointed liquidators of Pericles said in a U.S. court filing.
Both U.K. limited liability partnerships Colberg Projects and TechCorp Universal were initially controlled by Ireland & Overseas Acquisitions Limited and Milltown Corporate Services Limited. These companies were first registered in Ireland and over the years replaced by businesses of the same name first in the BVI and then Belize.
Ireland & Overseas Acquisitions and Milltown Corporate Services were incorporated in Ireland at an address belonging to Philip Burwell, a company formation agent, who says he set up “give or take” 2,000 offshore companies during his career.
The first directors listed for the companies were Latvians Stan Gorin and Erik Vanagels. The two men, together with a number of other Latvian company directors, reached near legendary status in crime investigation circles because they nominally headed hundreds of companies, many of which were involved in serious crime ranging from Ponzi schemes to embezzlement, corruption and weapons smuggling to money laundering.
Erik Vanagels, however, is not a wealthy criminal mastermind but a man in his late seventies who allowed his passport details and signature to be used to set up companies around the world. Stan Gorin equally said he allowed others to use his personal details but he never had an active role in the companies he represented as a director.
Eastern European media uncovered a whole roster of company directors whose identities had been used to incorporate businesses they had no part in – either in return for monetary compensation or because their identity had been stolen.
Irish company agent Burwell admitted to the Irish Times in 2013 that he set up companies for other agents in eastern Europe which were subsequently involved in criminal activities or other scandals, but he said he did not provide the directors or operated these companies.
Latvian media established that Burwell worked with a company called International Overseas Services that used Latvian nominee directors.
Many corporate agents in eastern Europe took advantage of liberal company laws in countries in western Europe, particularly in the U.K., with some of them not speaking enough English to understand that their activities may breach company laws, Burwell told the Irish Times.
He claimed that nobody in the business had expected the volume of corrupt or illegal activities involving customers from Russia and Ukraine over the past 10 years.
Ireland & Overseas Acquisitions and Milltown Corporate Services were the original members of hundreds of companies. Dozens of them switched control to the same parties at roughly the same time, suggesting they are still controlled by the same people who remain anonymous.
For Colberg Projects LLP, the owners of Chorne More, for example, Ireland & Overseas Acquisitions and Milltown Corporate Services were in 2011 replaced as partnership members by Intrahold A.G. and Monohold A.G., two Seychelles companies.
Prosecutors in Ukraine named all four companies – Ireland & Overseas Acquisitions, Milltown, Intrahold and Monohold – in relation to various government corruption schemes involving associates of former Ukraine President Viktor Yanukovych and his Party of Regions. The various alleged schemes all involved U.K. companies controlled by some of the four entities.
Another U.K. company controlled by Monohold and Intrahold transferred $850,000 to Black Sea View Limited, the Cyprus company that was supposed to hold Pericles’ Chorne More (Black Sea) cable TV investment under the initial plans presented to Surf Horizon.
The purpose of the payment is not known and although it appears in Black Sea View’s annual return filed in Cyprus, none of the financial records filed by the company with the U.K. company register reflect the payment.
Pericles liquidators represented to a U.S. court that TechCorp – the direct owner of Chorne More LLC – retained ownership of that company through early 2010, “well after the supposed consummation of the transaction in 2008.”
In mid-2010, a BVI entity called CardMan ImpEx Corp. became a joint shareholder of Chorne More LLC, and TechCorp was dissolved. CardMan is owned by Panamanian entity Cascado AG, another business that spawned hundreds of other companies. The director for Cascado, according to filings with the U.K. corporate registry, was once again the infamous Erik Vanagels.
In 2014, the Seychelles regulator announced it would investigate Intrahold A.G. and Monohold A.G. after media reports about the two companies being involved in government corruption and money laundering in Ukraine reached the archipelago in the Indian Ocean. Subsequently, most companies controlled by the two Seychelles holding companies switched ownership to other holding companies around the world.
Some of the U.K. LLPs named Tallberg Ltd and Uniwell Inc. on the island of Nevis in the Eastern Caribbean as new directors.
A cursory search of the U.K. company register reveals more than a dozen companies that changed control to the same two companies at about the same time.
Records at U.K. Companies House show that a certain Ali Moulaye signed documents filed with the company register on behalf of Ireland & Overseas Acquisition, Milltown, Intrahold, Monohold, Tallberg and Uniwell.
Deutsche Bank mirror trading
The same control companies have been named in connection with other laundering schemes in Eastern Europe.
Earlier this year Deutsche Bank settled investigations into a mirror trading scheme used to launder $10 billion out of Russia by paying fines of $425 million New York’s Department of Financial Services, a banking regulator, and $204 million to the U.K. Financial Conduct Authority.
Between 2011 and 2015 related companies in Moscow and London bought and sold quantities of the same stock in transactions that are not inherently illegal. By buying a stock in Russian rubles in Moscow and subsequently selling the same quantity of stock through a related offshore company in London for euro, U.S. dollars or pound sterling through Deutsche’s equity desk, a client effectively sold the stock to himself but was also able to expatriate Russian rubles, which are under exchange controls.
The fact that the clients lost money in each of the trades, in the form Deutsche Bank’s commission and the difference between the purchase and sales price, should have been a red flag for the bank especially because many of the mirror transactions were instructed by the same broker.
In 2011, the Federal Financial Markets Service in Russia barred two mirror-trade companies, Westminster and Financial Bridge, for employing stock market transactions to transfer money overseas, but Deutsche Bank continued to execute the trades.
In a 2016 analysis of the mirror trades scandal, U.S. magazine The New Yorker named a number of companies involved in the scheme, including two U.K. LLPs Chadbourg Trade LLP and Ergoinvest LLP.
The New Yorker article speculated that the companies were middlemen who made it their business to facilitate sending funds offshore. Those interested in expatriating funds from Russia would invest in ruble into a Russian fund which would use the money to execute mirror trades with an offshore fund which in turn would transfer the money to the client’s offshore account in U.S. dollars.
A search of the U.K. Companies House shows that Chadbourg Trade and Ergoinvest were set up by two companies – Kenmark Inc. and Ostberg Ltd – registered on the Caribbean island of Dominica. Corporate filings for Chadbourg Trade and Ergoinvest were signed by Ali Moulaye.
The fees for such a transaction, which evaded anti-money laundering controls, tax officials and currency regulators, were as high as 5 percent when Russian authorities tightened currency controls, the article stated.
The Moldovan Laundromat
Earlier this year, the Organized Crime and Corruption Reporting Project (OCCRP), a network of investigative journalists in Eastern Europe, uncovered a massive money laundering scheme in Moldova, which channeled at least $20 billion (and possibly as much as $80 billion) out of Russia using fake debt agreements.
The scheme typically involved two companies controlled by Russian money launderers. One of the companies would become a creditor of the other by signing a promissory note but no money changes hands. The transaction was guaranteed by a Russian company fronted by a Moldovan citizen.
The lender in the transaction then claims the borrowing company has defaulted on the loan and demands that the Russian company as guarantor pays the money. Because the guarantee involved a Moldovan citizen, the case went to court in Moldova, where a corrupt judge who was part of the scheme ordered the Russian company to pay the fictitious debt under the supervision of the court.
The funds are then sent from Russia and passed through several shell companies, including U.K.-based partnerships and other EU-based companies.
For instance, one of the companies named in the Moldovan Laundromat by the OCCRP, is Tronlux Ventures, LLP, which like Chadbourg Trade in the Russian mirror trading scheme lists Kenmark, Inc., and Ostberg, Ltd. as directors.
From this year, Companies House requires U.K. companies to file persons of significant control for each company on the register. The aim is to identify the natural persons that are the ultimate owners of registered entities.
The information is public and available free of charge but for most of the LLPs used in the various schemes this does not mean that new light is shed on the real owners behind the companies.
While it is still possible in the self-reporting system advocated by the U.K. government to report another Erik Vanagels as a “nominal” control person, i.e., a “fake” beneficial owner, many LLPs have taken a different route.
They simply introduced another company or LLP as a member and nominated this entity as the person of significant control.
This entity then avoids naming a PSC, or beneficial owner, itself by exploiting a loophole that requires only shareholders of 25 percent to be reported.
The company can do so by dividing its shares among five shareholders who each own less than 25 percent. These shareholders are often companies and partnerships in far flung places likes Dominica, the Marshall Islands, Canada or South Africa.
Trying to determine the owners of the shareholders will often end in a circle leading to the same member companies that control the U.K.-registered entity in the first place.
Although the U.K. is the only country that has introduced publicly available register of true beneficial owners of companies, the system remains poorly policed because Companies House has insufficient resources to verify the submitted information, Transparency International said in its report.
“Financially these scandals could amount to 80 billion pounds or more in illicit wealth, with some of them threatening the financial stability of whole economies. The human damage inflicted on the victims of these crimes is still being counted,” the organization said.
With the looming decision by the European Union over which countries to put on a tax blacklist, Cayman should look elsewhere for new business says local attorney Anthony Travers.
Cayman was on an initial shortlist of 53 countries and jurisdictions that the EU might consider uncooperative in tax matters. In November the EU sent letters to each of the jurisdictions threatening they would be blacklisted unless they committed to changing their tax rules.
The final decision on the blacklist is expected for Dec. 5.
In a speech to the Cayman Islands Institute of Professional Accountants, Travers, a former managing partner of Maples and Calder, echoed the sentiment expressed earlier by Premier Alden McLaughlin that there is no point in the Cayman Islands offering further concessions to the EU or to the OECD to avoid a blacklisting.
Travers said it is unlikely that EU politicians will ever accept the existence of low or no tax jurisdictions “which are an embarrassment to their profligate spending.”
It is not clear which actions the EU is going to take against any “uncooperative” countries but some form of tax penalty on transactions between EU members and these jurisdictions is anticipated.
“The Cayman Islands, if it should come to it, in my view, should simply accept the European Union black list if it should materialize and focus on portfolio investment from the rest of the world.”
In the short to medium term, EU-based institutions would move to solely using EU havens like Luxembourg, Ireland and the Netherlands, who were excluded from the listing process.
“Effectively, for jurisdictions like the Cayman Islands, the European Union jurisdictions should be regarded as a dead zone,” the senior partner at Travers Thorp Alberga said.
The level of resentment towards offshore centers like Cayman is so widespread, “that the Cayman Islands should write off any consideration of attracting capital flows out of Europe,” he added.
Quoting IMF statistics, he noted only about 8 percent of the US$2.4 trillion of hedge fund investments through Cayman is attributable to the EU jurisdictions.
Since the financial crisis, Travers argued, Cayman had been subject to three macro-trends the negatively affected offshore activity.
Offshore capital flows have declined, especially in the area of structured finance, and could not be balanced by quantitative easing measures, as the money remained largely on the balance sheets of European and U.S. banks.
Meanwhile, regulation has increased with Dodd Frank, the Alternative Investment Fund Management Directive, MiFiD II, Basel III and, in the insurance space, Solvency II, which all, to varying degrees, apply the principle of increased capital adequacy in support of risk retention by the principal.
The net effect has been to increase the capital cost of establishing new offshore structures, Travers said.
Added to that tax transparency initiatives like FATCA, the OECD’s Common Reporting Standard, or beneficial ownership disclosures and increased levels of anti-money laundering laws and regulations have increased the cost for offshore operators.
This in turn had an effect on hedge fund and company formations.
And finally, offshore financial centers are constantly the subject of negative publicity campaigns and mischaracterizations.
Although it is “laughable” to apply the word “secrecy” to the Cayman Island given that tax information is exchanged worldwide under FATCA, the Common Reporting Standard, tax information exchange agreements and the Proceeds of Crime Law, Travers said, “some of the mud has stuck and the expression ‘tax haven’ carries with it a negative connotation and that in itself has increased transactional flow to onshore centers such as Dublin, Luxembourg and the Netherlands, which for no fundamentally good reason have achieved a higher degree of acceptability.”
He apportioned some of the blame to the offshore centers themselves which had done “an extraordinarily poor job of refuting the mischaracterizations.”
“We professionals know tax evasion in the Cayman Islands to be non-existent and the evidence of aggressive or as the extreme left wing would have it, illegal tax avoidance, which is of course a contradiction in terms is in any event, statistically insignificant,” he said.
Ultimately, the exchange of tax information will “not move the needle on onshore tax collections from the Cayman Islands” to a relevant degree and it will also make the criticism of Cayman unsupportable in the longer term.
In the interim, however, Travers expects a continued shifting of transactions to onshore jurisdictions, especially the U.S. states of Delaware, Wyoming, Nevada and South Dakota for private client transactions, which are characterized by a “complete absence of transparency.”
Transactional flows, from Latin America, Asia and the U.S. that anticipate a tax neutral jurisdiction with strong and tested legal structures, will be fewer in number than in the decade’s before the financial crisis, Travers said. “But those offshore financial centers that adopt an enlightened immigration policy with the result that the technical expertise available is no different from that available in New York, Chicago or London, will remain attractive centers for this type of structuring.”
The overall pressure will lead to a consolidation of offshore financial centers, he believes, with a flight to quality.
But the desire to harmonize tax rates at a high level in Europe, could well mean more demand for offshore structures by European competitors.
Another threat comes from the Base Erosion and Profits Shifting project of the OECD, which seeks to eliminate some of the inconsistencies of cross-border tax rules and in particular the double taxation treaty network that has proven to be ineffective in taxing multinationals in certain industries.
Travers said the OECD Model Double Taxation Treaty Network was “a catastrophic failure in dealing with transfer pricing and cross-border payments of royalties, deductibility of interest and cross-border tax credits and specifically, in the context of European Union sales transactions by U.S. corporations.”
BEPS, however, was nothing more than “a Band-Aid,” he said.
Even according to the OECD’s own calculations, global profit shifting, estimated to be between US$100-250 billion annually, represents only about 0.8 percent of the US$23 trillion of global tax revenues.
Still, Travers said, even though Cayman does not have any double taxation treaties, government should not have rushed to adopt the BEPS initiative, because the provisions are harboring a Trojan horse in that they revive the “substantial activity doctrine” advocating that profits can only be taxed in the jurisdiction where substantial activities are undertaken.
In Cayman and other overseas territories, it is highly unlikely that a sufficient substantial presence can be developed, he said, “given the current immigration rules and particularly, with regard to the rollover policy and the manner of its application which make it highly improbable that skilled financial professionals would consider a long-term career in an offshore financial center.”
While it is by no means certain that all of the BEPS measures are going to be implemented, Travers concluded, “attracting the highest quality professionals from overseas is critical to the future development of this and other offshore financial centers.”
Advisers agree the U.S. and Europe are probably 2018’s best bets, while forecasting modest returns in China and Japan, pondering the risky promise of “emerging” economies and minimizing the headwinds of inflation and unemployment.
And for the cynics who think financial advice is a rigged game or a fool’s errand – or possibly both – Cayman boasts at least 133 qualified, licensed professionals, duly educated, instructed and dedicated to the “fiduciary rule” that investment advisers must act in the best interests of clients rather than generating profits for themselves.
They are tested, approved and “licensed” by the Chartered Financial Analyst Institute, and its local Cayman society.
Putting investors first
“Ethics is at the core of what the CFA Institute and its member societies stand for in the investment management and financial services industry,” says Jessica Jablonowski, president of Cayman’s CFA. “Putting the client first is at the core of the CFA ethical curriculum, before company and practitioner interests.”
As an operating parameter, the fiduciary rule seems obvious, but it is not always, and in February, lawmakers moved to suspend the rule, enacted after the 2008 financial crisis, fearing it could hinder free discussion and advice, generate expensive lawsuits and raise costs to consumers.
Philadelphia-born Jablonowski points to the group’s remarks on the subject, which is more complex than one might imagine.
The CFA, says its Director of Capital Markets Policy Linda Rittenhouse, seeks to ensure “clients’ interests come first and that they receive advice that is impartial and transparent.” She worries, however, the rule could create “high compliance costs, increase concerns about when legal liability could attach, impose excessive point-of-sale disclosures, and potentially result in different standards for advice providers.”
Ultimately “investors win,” she says. “The issue of what duty is owed to investors by all advice providers has finally come to the forefront.” The final review of the rule has been delayed until July 2019.
“The mission of [the] CFA Institute,” Jablonowski says, “is to lead the investment profession globally by promoting the highest standards of ethics, education and professional excellence,” gained through university-level classes, speakers, large-scale events such as the annual Cayman Investment Forum and literacy and advocacy initiatives, including CFA’s “Putting Investors First.”
Specific advice comes from RBC Dominion Securities’ nine-member “Price Team” chief Stephen Price, vice president and portfolio manager, and Butterfield Bank Chief Investment Officer Andrew Baron.
Price is a ninth-generation Caymanian and has been advising individuals, institutions, corporations, captive insurance companies and not-for-profits for RBC since 2001, managing nearly $2 billion.
Baron has been at Butterfield 11 years. For the first nine he was head of fixed income, focusing on bond markets. Two years ago he moved to CIO. Butterfield Asset Management, he says, handles 350 clients and $5 billion in three offices: Cayman, Bermuda and Guernsey.
“We have a wealth-management focus that serves high net worth individuals, but we manage several hundred million dollars of pension assets and we have a large presence in the captive [insurance] space both in banking and asset management,” he says.
Both speak of “bespoke investments,” strategies tailored to each client, meaning, says Price, “we base our investment decisions and advice on the particular clients’ investment objectives, risk tolerance and time horizon.”
Baron says he implements “our skill at active management in a similar manner across all of the accounts of clients … In other words, we operate a group investment philosophy and process.
Among Asset Management clients, Baron counts “several hundred million dollars of pension assets and we have a large presence in the captive space both in banking and asset management.
“Captive insurance has applications across a wide variety of industries and coverage lines and our clients reflect that diversity,” Baron says, although healthcare predominates. “In Bermuda we have had a pretty wide variety of industries represented, from large retailers to mining companies and everything in between.”
Captive invstment trends
By nature, he says, captives are conservative, focused on “its insured lines and underwriting, and there is generally a lower focus on return in a captive than on principal preservation and liquidity. After all, the assets are meant to be claims-paying resources, if required.”
However, in the face of sustained low global interest rates, Baron detects signs of change: “We have seen some clients searching for better-yielding investments and branching out into riskier fixed-income asset classes.
“Additionally, we have seen much more recognition amongst captives that a more-global approach to investment in equities is more appropriate than a traditional ‘home bias’ to the U.S.,” a positive development, he says, for the overwhelming number of U.S. captive parents – combining with Canadians to form nearly 90 percent of Cayman’s 665 international insurance companies.
Butterfield’s “group investment philosophy” means a couple of things, Baron says: “For example, if we as a group are recommending that clients be positioned to be underweight fixed income, our clients will be positioned to be tactically underweight across all client types – whether they are individuals or captives and whether they are managed in Guernsey or the Cayman Islands.”
The Bermuda-based bank’s “bespoke basis” means advice differs slightly among clients, but the sense of collective effort ensures that “thematically, strategically and tactically, we are all ‘rowing in the same direction.
“No client should be left behind or only receive a reduced level of service or scrutiny regardless of asset size or type,” Baron says.
Cayman and Barbados managers at RBC Dominon Securities also focus on captiveclients, overseeing millions of dollars for the mostly U.S. and Canadian parent companies.”
Conservative investment mandates govern management of high-priced, low-yield U.S.-dollar denominated holdings, he says, also detecting signs of change: “In the current low-interest-rate environment and the expectation for below-average returns, we work with captive insurance managers and owners to diversify their portfolio and seek opportunities into other areas, namely dividend-paying equities, alternative-yield structures, capital-protected structured notes or structured cash alternatives.
Like Baron, Price declines publicly to recommend specific investments, but reflects on broad economic trends, seeing a “synchronized, durable upswing in most major economies” in 2018.
“RBC Wealth Management’s view,” he says, “is optimistic, invested, but still vigilant toward global equities,” fulfilling expectations that “the global economy would gradually return to something approaching normal, led by the US.
“This has finally occurred, as major regions are in sync for the first time during the eight-year recovery cycle … We believe the U.S., Europe, China, and Japan have the potential to grow GDP at trend rates or better in 2018. Assuming U.S. recession risks remain low, [and] we think they will, the stage seems set for worthwhile gains in developed equity markets and select opportunities in the credit segment of fixed income.”
Global GDP “trend rates,” according to the World Bank and OECD, have averaged 2.6 percent growth since 2012.
China grew 6.7 percent in 2016; the UK, 1.8 percent; the US, 1.6 percent; and Japan, 1 percent. US economists have, however, made much of 2017 second-quarter GDP growth of 3.1 percent and third-quarter growth of 3 percent, beating forecasts and raising 2017 growth projections to 2.5 percent.
For the balanced investor able to take on risk to capital and handle volatility, Price suggests a “moderate overweight position” in global equities, informed by “low recession risks and relatively tame monetary policies” while “corporate revenues, earnings and estimates should continue to rise.
“Valuations of major markets have pushed higher, but are not high enough to foreclose further gains, and remain attractive compared to bond prices,” he says.
Baron points to GDP growth in China and the U.S., and a 2 percent Eurozone rate, but calls that “relatively simplistic,” looking instead toward “sustainable growth,” or the maximum growth rate that a company can sustain without having to increase financial leverage.
“In essence, finding a company’s sustainable growth rate answers the question: how much can this company grow before it must borrow money?”
In terms of a “sustainable trend,” Baron says, “both the U.S. and Eurozone appear to be in very good health, with the Eurozone in particular growing at roughly double its long-term sustainable pace after many years of moribund results.”
China, however, “has seen growth decline sequentially over a number of years, approximately mirroring the decline in its own ‘sustainable’ growth rate after two decades of industrialization.”
Baron echoes Price’s description of global growth as “relatively well synchronized at the moment,” but sees, “pockets of relative weakness globally,” naming Brazil as “barely positive year-on-year, for example.”
However, he says, “at present, there are no OECD-member countries showing negative GDP.
“We remain believers in the long-term investment thesis that emerging markets will continue to grow,” he says. “This can remain an investment theme both near-term and far into the future. The demographic and income profiles of countries that qualify as ‘emerging’ is changing rapidly in the information age.
“There probably isn’t a tremendous industrialization tailwind looming in the future, as was experienced in China in the earlier part of this century, but hundreds of millions can still be lifted out of subsistence and into the global economy over the next decade,” Baron says.
In a startling set of figures, Manhattan-based monthly Global Finance on Nov. 22 listed International Monetary Fund details of soaring GDP rates in dozens of emerging economies, led by Pacific island nation of Nauru with 16 percent growth through the last two decades, driven by enormous, if now depleted, phosphate deposits.
Ethiopia tops the next four slots, recording 10-year average growth of 9.8 percent. Third on the list is Turkmenistan with 9.5 percent; followed by Qatar with 8.2 percent; and Uzbekistan at 8 percent. Asian and African countries lead the rankings, even including hapless Rwanda in eighth place with 7.4 percent.
Panama, in 13th place and growing at 6.6 percent in the last decade, tops the rest-of-the-world list.
Baron reacts cautiously, however, saying his enthusiasm for emerging markets, marked by equity investments, is tempered “on the fixed-income side. We recently sold all of our clients’ exposure to US dollar-denominated emerging-market debt,” he says.
“We held a positive view of this asset class for [more than] four years, but valuations in the market had risen to a point where continued investment there presented a poor reward for the risk and volatility.
“Our analytical framework is led by a relative risk assessment, as opposed to thinking first of an estimate of the potential return of an asset class. This would be one of those cases where a reduction of risk was more important,” he says, than diminution in yield.
Still, U.S. economic expansion remains the global benchmark, and Price says that while it has been “more muted than usual,” he is impressed by its duration: “We think there’s wind left in the sails – good news for the global economy and for equities – in 2018 and probably beyond.”
By most traditional measures, market reverses and recession remain remote.
“The stock market has typically peaked right before a recession or in the early stages of one. Most other equity markets tend to follow the same pattern,” Price says.
Comparative interest rates are another indicator: “Since World War II, U.S. recessions have always been preceded by the arrival of restrictive credit conditions when loans have become prohibitively expensive for borrowers and difficult to get at any price.”
Long-term rates are usually higher than short-term rates, he says, but “during Fed tightening, the gap between short-term rates and longer-term bond yields usually narrows, indicating that credit (liquidity) is in short supply.
“In the postwar era, whenever the gap between 90-day Treasury Bill rate and the 10-year Treasury Note yield has narrowed to less than 30 basis points, the economy has weakened significantly. All recessions since the war were preceded by such a tightening.
“Today,” Price says, “the gap is about 115 basis points, comfortably above the ‘less-than-30 bps’ danger zone, and is still within the range that historically delivered attractive equity returns.”
Additionally, low U.S. unemployment augurs well globally: “In our opinion, the unemployment rate tells the tale. The unemployment rate tends to move steadily upwards in recessions and downwards through economic expansions.
“The unemployment rate has been trending lower since shortly after this economic expansion began in late 2009. Today, at 4.1 percent, it is about one-tenth of a percentage point away from an 18-year low, and only six-tenths above a 50-year low.”
Baron is similarly sanguine: “We would categorize the probability of a near-term global recession as very low at present. In the U.S., we are much more worried about growth and employment being too fast than too slow at this point in the cycle.
“We are confident that the positive-growth environment can continue in the three main growth engines of the world, the U.S., China and the Eurozone,” extending, he says, beyond “our forecast period, which is 12 months to 18 months. Beyond this time horizon, as most economists will freely admit, it’s much more of a guessing game.”
As an example of an immediate “positive-growth environment,” Baron points to healthcare as a “longer-lasting top-down theme.
“Consequently,” he says, “we currently overweight the global healthcare sector. Global demography supports this long-term theme, with ageing populations in Continental Europe, the UK, Japan and China – remember the one-child policy?” The sector is “geared toward higher healthcare expenditure whether by individuals or governments.”
Finally, says Price, global central banks will be a 2018 focus “as they gradually follow the Fed in normalizing monetary policy.
“Slow growth, low inflation and shifting demographics should ensure this is a gradual process,” he says, further restraining interest rates.
Price expects Jerome Powell – U.S. President Trump’s nomination to replace Janet Yellen as Fed chairman – to be confirmed, indicating “no major monetary policy shifts,” although, Price adds, Powell could promote a lessening of financial regulations.
“Credit will continue to provide selective opportunities, but investors will be challenged by rich valuations,” he said. “The dollar is poised to gain ground in 2018 after broadly underperforming through 2017. The ongoing tightening cycle set against firm economic growth should underpin USD strength with the market underpricing the trajectory of rate hikes.
However, he names the uncertainty of Washington’s tax reform as “the chief source of downside risk.”
Tax reform efforts dominate Washington’s end-of-year legislative landscape – and Republican hopes to reconcile House and Senate versions in time for Christmas passage. Vocal Democratic opposition seeks to derail the move, however.
Both Price and Baron illustrate Jablonowski’s recommendations regarding financial advisers: “Investors should seek out advisers that have investment strategy expertise, integrity and are clear communicators.”
Best-in-class advisers balance technique with emotional intelligence, meaning they understand behavioral biases common in investing and are able to educate their clients when such biases are exhibited, she says.
Jablonowski draws a distinction among financial counsellors, too-often insufficiently understood among investors, who should avoid hiring an adviser based on performance only.
“It’s important an adviser asks questions of your situation and future goals, in order to design a suitable investment strategy,” she says. The investor-adviser relationship “should have open two-way communication,” which is likely to determine “how your portfolio will be managed, how the fee structure is set up and how they will measure progress.
A greater number of women may sit on the boards of Financial Times Stock Exchange 100 companies, but that does not mean women are achieving seniority.
The 2017 Female FTSE Report, conducted by Cranfield School of Management and Exeter University Business School, found more women than ever, 33 percent, fill non-executive positions on the FTSE 100. Executive directorships held by women remain low, however, at less than 10 percent.
Just six women hold chair positions, 14 hold senior independent directorships and 6 are CEOs, the report indicated.
On the FTSE 250, women fair worse with just 7.7 percent filling executive directorship roles and only 10 women serving as CEO.
While the data shows marked improvement over the past decade, it also shows a continued divide between male and female leadership, explained Professor Sue Vinnicombe of the Cranfield School of Management.
“So back in 2007, only 15 percent of non-executive directorships on FTSE 100 boards were held by women. The good news is, in 2017 that percentage has jumped to 33 percent, which I think is really excellent news and shows how well companies have been paying attention to gender diversity on their boards,” she said in a prepared video.
“But I think the rather disappointing news, again hidden in our trend analysis, is that whereas a large percentage of the male non-executive directors hold senior positions, and by that I mean senior independent director or chairman of their board, very few women do.”
While the Female FTSE Report provides insight into global trends, it also echoes concerns in individual jurisdictions.
In the Cayman Islands, little data exists on workforce gender diversity, but an independent group of professionals, sponsored by several Cayman companies, is working to address the topic.
The initiative committee recently released its first “Gender Diversity in the Cayman Islands” report, based on survey results taken in 2017 from approximately 600 people, 20 percent of which were men.
While the initial findings indicated notable frustration by working women, they also pointed to strong female ambition in the Cayman Islands, said committee volunteer Roxanne Lorimer.
“Roughly speaking, more females in senior positions are running companies here (than globally). But again it depends on the sample. Our sample came mainly from government and from the accounting and financial industries, and law firms. We did try to get samples from across sectors but those were the main samples,” Lorimer said.
The data, analyzed by a third party in the United States, show a gap between women and men seeking promotions and those who actually receive them.
“Over the last year, more men have been successful (in obtaining promotions) relative to females. When asked whether males or females had applied for promotions over the past 12 months, they said yes at similar proportions,” Lorimer said, adding that future surveys will allow stronger analysis on this topic.
The gap in the Cayman Islands does not appear to arise due to lack of female interest in senior positions, said fellow project volunteer, Louise Reed.
“Something that is slightly different from global (statistics) is that men and women are applying for promotions at the same rate here. When you look at most global stats, that’s not the case at all,” Reed said.
When asked whether they had applied for a promotion within the last 12 months, 14 percent of women responded yes, compared to 15 percent of men.
In contrast, 39 percent women who applied for promotions in the past year indicated they were successful, compared to 56 percent of men. For promotions over the past five years, success rates vary. The project committee said this will be another area of interest to follow in successive surveys.
“We don’t have the stats to show how we’re performing year-on-year because there haven’t really been these kinds of surveys before. You can see globally though, things aren’t really changing much regardless of initiative,” Reed said.
One issue may be lack of communication between management and female staff regarding employment opportunities. The survey results suggest men and women hear about promotions in different ways.
While 31 percent of men reported hearing about promotions from senior leadership, only 4 percent of women said the same. Additionally, 23 percent of men reported learning of promotions from a line manager, compared to 16 percent of women.
Women were most likely to hear about an opportunity for promotion from an internal posting, at 27 percent. In contrast, 23 percent of men learned of promotions this way.
One possible solution may be providing mentorship and relatable role models in senior management for female workers.
“Often managers don’t know where employees want to go and they make assumptions. Having people processes that are quite clear in this regard, I think, would make a difference and force, in a good way, conversations with ambitious people on where they want to go and how companies can support them,” Lorimer said.
“My interest is the talent pipeline. We want a really healthy talent pipeline so we have good leaders running organizations and running parts of society. I’d like to see more equality in that pipeline.”
The call for greater mentorship reflects the suggestions of the Female FTSE Report. Based on a series of in-depth interviews with board evaluators, the report emphasized the importance of gender diversity on boards and the significant role chairs play in promoting such diversity.
“There’s now a critical mass of chairmen who really get it, who really understand this is a case about leveraging your best talent. This is the most effective way of reaching your marketplace. But that’s still not the case for every chairman and every leader,” Vinnicombe said.
The Cayman Islands survey group will be working in coming months to drive conversation about female leadership and gender policies in the workplace.
“This isn’t just a woman’s issue. It’s a societal issue and equally a business issue. There is a lot of global data to show the impact it has on business. We’re trying to encourage those discussions,” Reed said.
The group is currently planning next steps and working to integrate more project participants.
Even for a jurisdiction used to an ever-changing regulatory landscape, the end of 2017 particularly tumultuous time for the Cayman Islands financial services industry.
From Dec. 4-15, the Financial Action Task Force is set to begin evaluating the Cayman’s safeguards against money laundering and terrorist financing in a review that has implications for the territory’s international reputation.
By Dec. 5, the territory should also know whether it will be on a European Union blacklist of allegedly “non-cooperative tax jurisdictions,” which could lead to yet to be specified economic sanctions imposed by year’s end.
If those two major events weren’t enough, government and industry officials will soon have to deal with another policy that could have a much larger impact on the financial sector and wider economy: U.S. tax reform.
The Caribbean Regional Compliance Association held a panel discussion on Nov. 17 featuring several U.S. tax attorneys, who discussed what the U.S. federal government’s coming policy changes could mean for Cayman.
While there are currently separate bills from the U.S. Senate and House of Representatives that have to be integrated into one plan, BakerHostetler partner John Lehrer said that the plan’s general features will likely include a lower corporate tax rate of around 20 percent and a one-time lower repatriation rate for corporations who bring their foreign earned income back into the country.
A proposal that could affect investment fund managers is the “carried interest provision,” which is a portion of an investment fund’s profits that the fund’s manager receives. This income is generally taxed at the lower capital gains rate rather than as income earned.
While calls have been made for investment managers to pay income-tax rates on these profits, both the Senate and the House plans state that managers with interest in a fund can be taxed at capital gains rates if they hold the interest for three years or longer, said Lehrer, who represents clients facing enforcement actions from the Internal Revenue Service.
Most other provisions that could affect Cayman are those designed to attract funds back to the U.S., including the repatriation tax, rumored to be around 10 percent and 12.5 percent.
Another provision that could encourage repatriation is the proposal to create a “territorial tax system,” which would mean that U.S. corporations would not have to pay U.S. taxes on the profits they earn overseas. Currently, overseas profits are subject to a 35-percent tax when they repatriate their earnings to the U.S., so doing away with this would remove the disincentive for companies to keep their earnings abroad, according to proponents of the territorial system.
Successful repatriation efforts by the U.S. could mean less business for Cayman, a jurisdiction where nearly 200 of the U.S. Fortune 500 companies have subsidiaries domiciled. Repatriation could also mean that Cayman will see less investment from tax planning, leaving it with business that’s here for less than legitimate reasons, according to Alma Angotti, a former senior official at the U.S. Securities and Exchange Commission.
“What I’m worried about is that you guys get left with all the bad money,” Angotti said at the CRCA conference.
However, some tax experts don’t think the repatriation tax or the global minimum tax will be sufficient incentives for multinational corporations to move their funds back onshore.
Kimberly Clausing, an economics professor at Reed College, wrote in Fortune on Nov. 20 that the Republicans’ tax plan could actually encourage more money being moved offshore because the territorial tax system will encourage more companies to book their profits abroad. And even with the lower one-time repatriation tax, many firms also will still find it cheaper to raise funds in the U.S. by borrowing at a low interest rate rather than bringing their offshore cash back to the U.S., according to some experts.
Several conference attendees asked about the future of the U.S. Foreign Account Tax Compliance Act, which requires financial institutions to provide the IRS with information about U.S. citizens who have accounts overseas.
In the Republican Party’s platform released at the GOP convention in July 2016, officials stated that a Republican-led government would attempt to repeal FATCA because it “allows unreasonable search and seizures” and “threatens the ability of overseas Americans to lead normal lives.”
However, Lehrer said it’s unlikely that FATCA will be repealed any time soon.
“While there is discussion about it, the issue is you have this information and this perceived benefit coming out of it, so I don’t think we’ll see rollback any time soon,” he said at the conference.
Another question asked was about whether the U.S. will collect the beneficial ownership information for the companies registered there.
“There is now a customer due diligence rule in the U.S. that goes into effect in May that will require U.S. banks and other financial institutions to get and verify UBO information at 25 percent. It’s a big step,” said Angotti, eliciting laughter from the roomful of attendees, many of which are subject to a 10-percent ownership threshold for collecting such information.
Angotti added that the federal government will likely not collect beneficial ownership information for U.S.-registered companies because company formation is administered at the state level.
“It would be a nuclear option for the federal government to say you can’t do that anymore because corporate formation has always been a state activity, and states generate millions of dollars from this,” she said.
Along with potential impacts coming from legislative and regulatory changes, Cayman’s financial sector could be indirectly affected by human resource decisions coming from the Trump Administration, said Lehrer.
Over the last several years, there has been a hiring freeze at the IRS, which has also seen a reduction of some $3 billion from 2010 to 2016, he said.
Moreover, the IRS has also been operating without a full-time commissioner since October, when John Koskinen left the office. The current acting commissioner, David Kautter, is also serving as the assistant secretary for tax policy at the Treasury Department.
Lehrer said that the IRS could be operating without a clear policy mandate until a new full-time commissioner takes control.
“Whoever that person is will be able to set directional policy for the IRS in terms of enforcement and other efforts, so stay tuned,” he said.
A further strain on the IRS could come if tax reform is passed. This is because many of the IRS’s 77,000 employees could be moved from focusing on enforcement and compliance matters to interpreting, learning, and educating taxpayers about the thousands of new rules coming down the pipeline.
For the financial industry, this all could mean less scrutiny from the IRS in the short-term, said Angotti.
“You may see fewer enforcement actions because people don’t have the time to do them, or lower fines as there is more pressure to settle quickly because they don’t have resources,” she said.
However, Klausing noted that the Department of Justice is still hiring more attorneys to pursue anti-money laundering cases. So while the industry may be pressured less by tax collectors, it will still be under strict scrutiny from other regulators.
“It is not a good soundbite for any administration to say, ‘We’re making things for money laundering and terrorists,’” said Angotti. “So I don’t think you’ll see any overt policy that limits examination and enforcement for AML sanctions.”
Technology is becoming an important factor for hedge fund managers who are actively seeking to innovate to improve operational efficiency and attract capital.
More than half of all managers (57 percent) are implementing new approaches in their operations to avoid falling behind in the industry, the latest EY hedge fund and investor survey found.
Managers also invest in cutting-edge technology that improves the speed and quality of data reporting to attract capital (36 percent), to attract and retain talent (28 percent) and to inform their front office (25 percent).
Whereas, in 2016, only half of all managers used or expected to use non-traditional data or tools in their investment processes, this year, more than three-quarters indicate they currently use this technology (46 percent) or have future plans to do so (32 percent). They are particularly interested in leveraging social media data, private company data and credit card data, the EY survey found.
Investors also see the need for funds to use new technology, with nearly a third emphasizing that managers should focus these efforts on the front office.
Investor sentiment reflects the general excitement around FinTech and advancements in data set analytics. While investors say only 24 percent of the hedge funds to which they currently allocate use non-traditional or next generational data and tools, they expect that number to rise to 38 percent in three years.
Managers recognize that the effective use of data can offer key advantages with nearly half confirming that they are using non-traditional data to support the investment process. This includes for example software to extract data from multiple earnings calls to evaluate information more quickly.
Michael Serota, EY Global Hedge Fund Services Leader, says the pace at which the hedge fund industry is being disrupted continues to accelerate, as advances in technology bring new threats, but also opportunities.
“The evolving landscape forces managers to not only be reactive but also proactive in identifying novel solutions that allow them to deliver alpha and remain competitive. Managers of all sizes are embracing innovation to stand out in a crowded hedge fund universe and to achieve a common strategic objective: growth,” Mr. Serota said.
Fewer allocations to hedge funds
Consistent with last year’s EY survey findings, fewer investors plan to increase their allocations to hedge funds.
Only 11 percent of the investors surveyed indicated they are more likely to increase allocations to hedge funds in the next three years compared with 11 percent stating they plan to lower their allocations. The remainder and majority expect to maintain the same level of hedge fund investments.
Hedge funds face competition from alternative asset classes and non-traditional hedge fund products. Especially, private equity continues to attract capital and leads to a shift away from hedge funds, the survey found.
To attract and retain investors, the results show, more than half of managers now offer separately managed accounts (56 percent) and funds with customized fees and liquidity terms (52 percent), and two-thirds of managers have adopted or are considering non-traditional fee structures for growth (66 percent).
“Investors are turning to customized products for a number of compelling reasons,” said Natalie Deak Jaros, Americas Co-Leader, Hedge Fund Services, Ernst & Young LLP. “Managers of all sizes must engage in dialogue with their investors and align product offerings that are responsive to shifting investor needs.”
The pressure on fees has forced managers to lower their operating expense ratios from 1.95 percent in 1.75 percent. However, EY noted that hedge funds are realizing the need to break the cycle and invest in operational efficiency.
By investing in technology half of the managers surveyed are hoping to counter continued margin pressures from the added complexity, increased product offerings and more extensive reporting requirements.
Forty percent say they plan to invest in automating manual processes and more than a quarter of managers (27 percent) have or will be making investments in artificial intelligence and robotics to strengthen their middle and back office.
“Managers with growing businesses will often need to add to their headcount to support the business, but modern advances in technology provide helpful solutions in supporting operating models that add to the bottom line, rather than reduce it,” said Zeynep Meric-Smith, EMEIA Leader, Hedge Fund Services at EY.
The impact of technology is also visible in the funds’ recruitment strategies, which has shifted the staff profile sought by managers to talent that has experience in using technology to improve an organization.
The ability to compete for the right talent is a strategic imperative for hedge fund managers, particularly in the front office, where more than half of those surveyed say they struggle to attract and retain executive investment professionals and more than a third find it difficult to bring in non-executive investment professionals.
Elliott Shadforth, EY’s Asia-Pacific Leader, Wealth & Asset Management, says: “Competition for talent is fierce, as hedge funds compete with others in the space as well as Silicon Valley and the FinTech community. Hedge fund managers must be attuned to the wants and needs of newer generations of talent to attract the right people and foster an unmatched work environment.”
Nearly half of managers say they have taken steps such as formally surveying or employing consultants to understand what employees are looking for in the workplace and found that collaboration, compensation and work-life balance are key.
Every day, highly experienced investors and thought leaders are sounding the alarm about an impending market crash. Since the 30-year anniversary of Black Monday less than two months ago, the sirens are blaring progressively louder. With an eight-year U.S. equity bull market behind us, coupled with positive GDP growth, the sustained market rally seems too good to be true. On the surface the economy appears to be plodding along, but according to the bears, something is brewing in the depths below.
Many different factors are being cited as the impetus for the making of potentially the worst bear market. The most common concern mentioned is stretched U.S. valuations based on non-fundamental factors. The search for yield in a historically low interest rate environment has pushed both private and institutional investors to take on significantly more risk than they would have been comfortable with a decade ago. Increased flows into equity markets, exacerbated by a push into exchange traded funds, has propelled stock markets even further. Consequently, investors are now asking themselves the proverbial question: Should we not just sell all our equities and get out before it’s too late?
To answer this question, I propose examining the investment landscape from a risk management perspective. What are the risks of selling everything and investing solely in cash?
Unfortunately, keeping all your financial assets in cash does not provide immunity from all risk, as inflation and counterparty credit risk still remain. With the cost of living increasing every year, you would need to earn a rate on deposit greater than inflation just to maintain the purchasing power of your earnings. Being ultra conservative by only investing in cash or cash equivalents, whilst considered safe, would most likely prevent you from reaching your financial goals. Consequently, to prevent purchasing power erosion, taking some risk is necessary. Usually, during times of higher anticipated inflation, investors turn to real estate, gold and inflation-protected securities as a hedge. Regardless of the financial instrument held, the stability and credibility of the financial institution is also a risk factor; one more commonly referred to as counterparty risk.
The most widely discussed risk in recent times has been interest rates risk. Even well before the Fed commenced its monetary policy tightening initiatives, most investors have been positioned anticipating rate hikes. Rising interest rates have the greatest negative impact on longer dated and higher coupon bonds. For this reason, investment managers have maintained a short duration strategy for quite some time now. So why invest in bonds at all, you may ask?
That highlights another well-known investment risk: concentration risk. The potential detrimental consequences of investing one’s wealth in only one asset class, one sector or even one stock is self-evident. Surely you could sell all your bonds and only hold equities. However, this is when diversification becomes an essential element within your portfolio. There is no denying that fixed income returns are highly unattractive these days, but putting all your eggs in one basket rarely turns out well. Likewise, despite the fact that investment professionals rely on their expertise to forecast the best way to be positioned, sometimes events out of their control can impact markets faster than they can react. As such, no one would argue against the importance and power of diversification.
In addition to the few common risks highlighted earlier, the list of possible risks is endless and includes such perils as currency risk, liquidity risk, credit risk, market risk, default risk and many more. Even after accounting for the infinite types of risks, there is one type we cannot even plan for. Black swan events, the metaphor used for an unforeseen event with massive repercussions, will catch us by surprise and cannot be planned for. In the words of former U.S. Secretary of Defense Rumsfeld, “there are things we don’t know we don’t know,” otherwise classified as unknown unknowns.
Admittedly, it is impossible to completely eliminate all the risks we face. All investors – individuals and institutional investors alike – are exposed to various investment-related risks. It is imperative that one assesses these risks in an effort to determine those that are of greatest concern as there is no one-size-fits-all solution.
Tax information exchange initiatives like FATCA and more recently the Common Reporting Standard (CRS) are in full motion in most international financial centers and certainly well under way in the Cayman Islands.
With the new automatic exchange of information protocol, local financial institutions have numerous obligations under the CRS regulations. One of the most important of these is essential to any chance of complying with the new regulations: namely the need to have written policies and procedures in place.
Section 7 of the CRS regulations requires financial institutions in the Cayman Islands to have policies and procedures in place to ensure (in summary) that:
The FI is able to identify each jurisdiction in which an account holder is resident for tax purposes.
The FI is able to apply the due diligence procedures required by CRS (which are extensive).
Ensures that information obtained in accordance with the CRS regulations is kept for a minimum of six years.
The above is simplification of the actual wording in the regulation and at first glance seems fairly straightforward. That is until you read the details of what information is required, the circumstances under which an account becomes reportable, and the nature of documentation required in the due diligence stage etc. In short in all likelihood the firm will need a robust set of polices and procedures in order to ensure compliance with the regulations.
Onboarding forms are not procedures.
Many firms will likely have some form of practice internally whereby they are fulfilling or attempting to fulfill these requirements. And many others will have the necessary forms to be completed with client data in accordance with the various indicia and other data required by CRS.
But it is also very likely that some firms will not have in place a tax information compliance framework (TICF) that fulfills the following criteria to affect successful compliance:
A set of policies relating to the firms’ approach to CRS that has been adopted formally at the board level and has been communicated to all staff.
A corresponding set of procedures, which provides step-by-step guidance to staff, in particular onboarding/client facing staff, in the key areas as set out in the CRS Guidance Notes.
Training sessions aimed at ensuring that the relevant staff members are all fully prepared to implement the new set of procedures.
An internal system to test compliance and an annual external tax information compliance audit to ensure that its internal compliance staff and systems are working as intended.
An assessment of the firm’s tax information compliance vulnerabilities (risk profile of client portfolio specifically in respect of tax matters such as residency, type of business, client group structures etc.)
If that sounds too much, it is actually just one basic requirement outlined in the CRS regulations. But it is a key requirement. Most firms see ‘polices and procedures’ as an add-on requirement which ‘may not be all that necessary’ if you are doing largely what is required on a day to basis anyway.
But experience shows that roughly 60 percent of all recommendations from a typical inspection report from the regulator relates directly to the absence or inadequacy, of a policy or procedure to mitigate the risk be it anti-money laundering fraud, tax or cyber security. That is why it is so important for the entire risk management framework to begin with a set of policies and procedures approved at the board level.
Unwritten practices within the firm can change often even daily. They will also be somewhat subjectively applied depending on the circumstances and the staff members involved at the time.
But written policies remove this ambiguity, substantially decreasing a firm’s risk exposure.
And neither are policies and procedures necessarily long unwieldy documents with complex action steps and decision-making. In fact the easier to read and the more simplicity applied the better chance of successful implementation.
Tax information compliance is firmly here to stay and will only likely become more intensified over the next few years. This is because the next natural stage of CRS is for the authorities both in Cayman and overseas to require independent tax information compliance reviews whereby firms are tested to determine if they have the necessary systems in place to provide accurate CRS reporting.
But firms should not wait for authorities to impose reviews. If a firm is exposed materially to tax compliance risk due to the actions of one of its clients, the reputational damage stemming from a single news story linking that firm to a tax evasion scheme is sufficient to cause irreparable damage to the business.
For a country like Cayman whose currency is tied to the U.S. dollar and therefore to the whims of the U.S. Federal Reserve’s monetary policy actions, the Cayman Investment Summit had a decidedly gloomy message: the U.S. dollar-led global currency system is in urgent need of reform and central banks have essentially no power to affect monetary or economic goals.
The conference, hosted by the Chartered Financial Analyst’s Society of Cayman, is never shy on pessimism and often invites speakers whose theories run contrary to mainstream economics. But given the track record of mainstream economics, that can be of significant value for investors who have to anticipate the big and small swings in the markets and their underlying economic factors.
Most recently, U.S. central bankers seemed at a loss as to why there is no inflation.
While some blame sharp online retail price declines, to an extent that is still misunderstood by economist, for low inflation figures, others argue that central bankers have been unable to interpret money supply and other monetary indicators for quite some time.
In an article about a crisis of confidence for central bankers, The Financial Times wrote in October that “the ability of central banks to resolve these questions does not just affect growth rates, but is fundamental to the health of the democracies of advanced economies, many of which have been assailed by populist uprisings.”
Jeff Snider, head of Global Investment Research at Alhambra Investment Partners, agrees with these political and social implications, but he says that after the financial crisis “central bankers did not suddenly lose all their power, they did not have it to begin with.”
Snider identifies the Eurodollar market, U.S. dollar-denominated deposits, as well financial instruments and transactions in U.S. dollars outside of the United States, as one large element of the shadow banking markets that are outside of any monetary control.
“There is no other, more appropriate place on Earth to talk about money than here” in the Cayman Islands, where U.S. banks are holding more than $1 trillion in U.S. dollar-denominated claims on Cayman banks, he said at the conference on Oct. 11.
Snider’s theory is that economists who viewed each economy as a closed system failed to recognize the effect of Eurodollars. They first misunderstood the growth of the market as capital outflows and then as a global savings glut. Central bankers, on the other hand, recognized these markets but ignored their effect even though monetary supply trends veered increasingly off trend.
Shadow banking means a lot of things to different people. For Snider, it is the balance sheet capacity of private banks globally for Eurodollar instruments, repurchase agreements or repos, interest rate swaps and other financial instruments like FX derivatives.
In September, the Bank for International Settlements, which is sometimes called the central bank of central banks, published a study that estimates $13 trillion to $14 trillion exist in offshore interbank FX derivative dollars that “are functionally equivalent to borrowing and lending in the cash market.”
“It takes the form of whatever liability one bank can dream up that another bank will accept,” Snider says.
Crucially, much of this money is not captured by any monetary statistics which should guide central bankers in their actions and when they set monetary policy targets.
It is not that these developments had gone unnoticed by central bankers. Both Eurodollars and repo were once included in M3, the broadest money supply figure, but discontinued in March 2006 when the Federal Reserve decided it would take too much effort to determine what is going in these markets when for the most part they do not affect the United States.
Former Federal Reserve chairman Alan Greenspan warned for years that finding money and measuring it had become an increasingly dubious proposition.
“The proliferation of products has been so extraordinary that essentially a decision-based policy on measures of money presupposes that we can locate it,” he said in June 2000. Even during his famous “irrational exuberance” speech in 1996, a warning that the markets were overvalued several years ahead of the dot.com crash, he noted that “money supply trends veered off years ago as a useful summary of the overall economy.”
This is evidence, Snider contends, that central bankers have not acted as monetary stewards for a long time. As early as in the 1970s, central bankers suspected the Eurodollar market undermined money supply in some form. Guido Carli, an Italian central banker at the time, warned that there was a monetary blob lurking hidden in the shadows of global finance which multiplied U.S. liquid liabilities outside of any monetary control.
Repo transactions, for instance, were not believed to be monetary transactions. Today, economists understand that in the real economy they are used as a monetary equivalent. The proliferation of products that defy monetary classification and national boundaries has made monetary policy very difficult.
“Because of this, we are forced to reassess everything that happened during the period,” Snider says.
“The idea of a great moderation, a golden age if you will, of classic economic conditions in the ‘90s up until 2007 always seemed a bit off for what actually took place.”
The bank balance sheet capacity of Eurodollars may have been missing from official handbooks, he says, but it has been out there all this time “reshaping the global economy for decades.”
As such, it is a currency system without any currency and it is in urgent need of reform.
“When global money was growing, the global economy was too. No more growth in global money, no more global growth. It’s that simple,” Snider says.
“Now that the Eurodollar system is no longer functioning, the global economy is not fine. It is in fact heading in the wrong direction and the political and social order is slowly being taken down with it.
“The primary risks here are not necessarily economic, they are social and political,” he says. “The economic damage has been done.
“People realize there is something wrong here. They don’t know what it is and their leaders are telling them there is nothing wrong. If you listen to Ben Bernanke and Janet Yellen talk, it is as if the economy is fine and we know it’s not. Not the United States, it is all over the world, Europe, China. The problem is that the longer this continues, the more dissatisfaction will be there.”
Snider has little faith in the central bankers or the politicians, because there is very little consensus what is wrong and much less how to get it right.
A second Bretton Woods that stabilizes the global currency system would be a very positive outcome, Snider believes but he suspects that most reform only comes after a crisis.
Simon Mikhailovich, co-founder Tocqueville Bullion Reserve, agreed that current markets are heading for another crisis.
“Nobody knows when a crisis is going to happen. All we know is that it does not make sense. And when a situation does not make sense, it will eventually resolve itself. But we don’t know how and we don’t know when.”
Mikhailovich’s list of things that do not make sense in today’s market is long.
Real income growth over three decades compared with nominal growth is virtually zero, he notes.
Negative interest rates have never happened before in 5,000 years. “This [makes] no sense, it never did make sense and it makes no sense today.”
European BB-rated junk corporate bonds, he says, are now trading at a yield that lower rate than U.S. Treasuries. “Are they less risky than U.S. Treasuries or does it mean that we have a problem with the way prices are formed?”
Meanwhile, pension funds cannot fund themselves when only 20 percent of all fixed-income securities are yielding over 4.5 percent. The only solution is to increase leverage, but the problem is that asset prices are correlated with the rise of leverage and the rise of debt, which is growing faster than the economy. As a result, there is 40 percent more debt in the world since the financial crisis.
Derivatives are another market conundrum that Mikhailovich points out. Deutsche Bank has $47 trillion of derivatives on their books, three times the size of the European economy, he says. The banks, of course, claim the net exposure is zero as long as they can meet their obligations. Yet it takes only one bank not to be able to meet those obligations to throw the system into crisis.
For the past 35 years, Mikhailovich says, it has been a one-way ride as interest rates kept declining and the values of financial assets kept rising. Very few people working today have experienced a prolonged period of rising interest rates and the effect that has on prices, asset values and markets. “Nobody under 70 has ever seen a real bear market. We have no gut feel for any of this.” Most importantly, “we have lost the culture of preparedness,” Mikhailovich says.
“The key is not to predict the future but to prepare for it.”