Around this time of year, it is useful to reflect on the critical issues the financial services industry will face in the coming 12 months and beyond. The financial services industry is presently undergoing elemental change. As the industry and its operating scene have to change, so will financial centres including the Cayman Islands. Therefore industry stakeholders should pro-actively embrace this change and closely collaborate to adopt processes that will increase the international competitiveness of the Cayman Islands as a financial centre.
The macroeconomic environment, competitive landscape, regulatory situation and outlook remain challenging. Growth is scarce, revenue is under severe stress, and the cost of doing business continues to rise. The forces that are influencing this reality are: the dismal economic climate, with record levels of unemployment, low interest rates, the Eurozone crisis, regulators, who are intensifying their scrutiny of business practices and increasing the cost of compliance; and technology, which is enabling competing jurisdictions to enter the market. The global economic rebalancing towards emerging markets is also having a profound effect on global banking and Cayman, particularly its financial industry. In addition, Cayman currently faces a number of specific challenges related to regulatory and reputational image particularly with the US Government. Everyone needs to adapt, and we are no exception.
Since the financial crisis, many industry players have presumed or just wished that these revenue challenges would be a recurring thing. However, there is a sneaking awareness that this presumption is far-fetched. It is my belief that a fundamental, earthly shift is afoot; the industry is evolving from a high-margin industry to a lower-margin one.
As meaningful as these material shifts are for success, there are other forces remodeling the financial services industry. During the next five years, I envisage that three “gamechanging’ drivers will force financial institutions to reconsider their operations: Regulation and taxation, Technology and distribution, and the regional shift and changing competitive positions.
Regulation and taxation
The regulatory environment is progressing rapidly, with many initiatives happening, eg AIFMD, Basel III, Dodd-Frank, FACTA, MiFID, etc. Regulators are changing their previous “hands-off” approach to one of “hands-on”, and fines are increasing exponentially. While the declared aim is to attain a uniform “rule book” globally, it is unclear whether we have embarked on that journey. With national regulators often concentrating more on domestic risk, some of the industry’s globalisation gains of this century may, in fact, be withdrawn. The amplified focus on taxation in some regions may also indicate this. From the industry’s standpoint, one of the positive responses to pre-crisis inequities and regulatory forces is a greater focus on corporate governance.
Technology and distribution
The techniques for distributing financial products and services are changing, and distribution costs are expected to become more evident. The way that people communicate and the availability of data are rapidly changing as evidenced by the ascendancy of social media and the accession of digital banking. As capacity increases, the latter will continue to grow. Incumbents will be confronted by new entrants, eg the Seychelles, using such cutting-edge technologies seeking to gain market share. Therefore, financial institutions will need to invest in these technology enhancements—specifically, cloud computing, business analytics, broadband and social media tools to meet client expectancies, which are growing as new jurisdictions enter the market and offer competing and/or innovative financial products and services.
Regional shift and changing competitive positions
There has been, and remains, a profound change in the contribution to world GDP, world trade and wealth from developed markets to emerging markets, which is spurring a step change in financial market attention. Emerging markets are experiencing domestic capital markets growth and they have gradually opened up to foreign investors, and foreign exchange liberalization (e.g. Renminbi convertibility) has been one of the outcomes. The result will be ongoing changes in global investment flows. Another is likely to be a shift in the competitive landscape with respect to financial institutions and financial centres.
In addition to these changes, the macro environment remains instable and the Eurozone will likely remain a major concern for quite some time. Emerging markets are predicted to remain on a higher growth trajectory versus the developed economies. The Asian Development Bank states that GDP growth in the region will return to 7.3 per cent in 2013, afterwards continuing its ascending path. And according to a PricewaterhouseCoopers (PwC) survey of 273 private banks, Singapore is positioned to dethrone Switzerland as the premier centre for wealth management this year.
To traverse this intriguing situation and position themselves for future growth, stakeholders of Cayman’s financial industry need to shift their mindset from business as usual and become much more agile and aggressive in attracting this portion of the business.
Key success factors
Successful global financial centres have strengths across a wide spectrum of key areas, including factors such as the quality of life needed to attract key talents, legal infrastructure, stable government and the quality of transaction technology.
Several studies have attempted to classify the key success factors (KSFs) for financial centres and use them to rate these centres. Eg the Global Financial Centres Index (GFCI), created by Long Finance and sponsored by the Qatar Financial Centre Authority, assesses centres across five areas: people, business environment, market access, infrastructure and general competitiveness. So how does Cayman fare on these KSFs? According to the GFCI 2012 edition, Jersey and Guernsey remain the leading offshore centres ranked 20th and 28th respectively. The Cayman Islands ranks 44th overall, having fallen by 3 points since 2011, with the BVI nipping at its heels in the 45th spot. Have we been asleep, or are we comfortable with the status quo? We’re certainly not headed in the right direction. And the goalposts are shifting – according to a poll conducted by recruitment firm Astbury Marsden, 450 UK-based bankers felt that Hong Kong, Shanghai or Singapore will replace London as the world’s most dominant financial centres by 2022. Furthermore, nearly 31 per cent of the respondents chose Singapore as their most favoured location to work.
Policymakers are also being proactive in developing their financial centres as the place to live and work. Cities like Singapore and Hong Kong have quickly capitalised on setbacks in London and New York, wooing investment banks and responding to demand from expats and tourists for facilities that can host sporting, music and other international events. This has made them popular destinations for expat investment bankers and hedge fund staff. Moreover, The Global Financial Centres Index published by the City of London ranked Malta fourth out of sixty-six jurisdictions as a financial services centre that is most likely to increase in importance over the next few years.
Jersey has placed itself to service clients in new markets such as Brazil, Russia, India and China (BRIC), where phenomenal growth is occurring. Jersey already has a strong presence in Abu Dhabi and Hong Kong, and is now boosting its international presence in the BRIC markets, aiming to duplicate the success it is having in the Gulf region and in the Far East. It appears that the country has stolen a march on Cayman in financial services for BRIC markets. And with Singapore and Hong Kong set to dominate the Asian market, Cayman will find it very challenging to gain share of wallet in this region.
Cayman as a financial centre – current strengths, weaknesses and priority areas
Due to its stability and tradition of excellence and high quality service, the Cayman Islands are globally known as the leading financial centre focusing on hedge funds.
According to the ESO, the financial industry accounts for 41.9 per cent of the islands’ GDP in 2011 and showed a modest growth of 0.9 per cent during the year.
The Cayman Islands Monetary Authority, the regulator covers both banks and insurers, continues to strengthen its financial market supervision and protects creditors, investors and policyholders.
The established strengths of Cayman – high quality of advice together with the country’s political, economic and social stability continue in situ. In addition, a flexible labour market and a high standard of living that has attracted foreign talent have helped Cayman maintain a leading position as a hedge fund domicile. With Cayman’s modern and efficient infrastructure, combined with its tax neutral status for both companies and individuals, it is somewhat satisfactory that Cayman has held its own – relatively speaking. But is this enough for future survivability as a leading offshore financial centre? Probably not.
Despite these strengths, Cayman is facing growing international competition – especially in wealth management and in certain areas of asset management.
Going forward, these priority areas need to be addressed by Cayman’s policymakers and other financial industry stakeholders:
Upholding and enhancing the status of the Cayman Islands and the financial institutions operating within it is of critical importance for the long-term success of industry.
The anti-money laundering regime should be reviewed and strengthened if necessary to cover any gaps that exist due to evolving criminal activities. Quite frankly there is no substitute to placement of Cayman as a centre that concentrates on providing the best advice, tax-compliant safeguard of privacy and meeting highest ethical canons. Tax information exchange agreements (TIEAs) provide for practical solutions that address these concerns, while also resolving legacy issues. The UK’s Financial Services Authority has clearly specified for customers of investment management firms, including Funds, what it now expects in terms of established conflicts of interest procedures. Cayman should review these specifications and see how that model can be adapted to suit our industry.
Access to global markets
The rise of emerging markets and the transfer of economic power to the Asian and Latin American regions make access to these markets a key priority for Cayman’s financial service providers (FSPs). New EU regulations specifically in the area of investor protection could stymie access to the European market, which is still of vital importance to Cayman’s FSPs. Greater market reach to the EU could be attained via an extensive financial services agreement or via arrangements like the Jersey regimes or variants thereof. Varied, intricate and internationally unpredictable national legislation poses a growing test for Cayman as the top offshore hedge fund domicile. The legal intricacy across and within jurisdictions makes it difficult for Cayman’s FSPs to institute regular internal measures, causing added compliance costs and, eventually, diminished competitiveness.
To be able to compete, Cayman’s financial institutions will have to pare their organisational structures and become leaner. The low interest rate environment reduces net interest and investors’ risk averseness further limits earnings. FACTA in particular, is expected to force banks to further trim the size of their US business. Other key areas of regulatory focus include AIFMD, Dodd-Frank, MiFID II and UCITS IV. Industry professionals in the jurisdiction should consult closely with the regulator CIMA to ensure that Cayman is ready for the forthcoming introduction of these regulations.
An agenda for Cayman
With competition among international financial centres increasing, action to enhance the global competitiveness of Cayman as a financial centre is now more important and urgent. Obviously, any such action should address specific weaknesses whilst preserving traditional strengths. This will require all stakeholders including policymakers and regulators to participate. With limited avenues for growth, the financial services sector will be hypercompetitive for the next three to five years. In this environment, it’s critical for each financial services provider (FSP) to be very aware about how it will compete and win in the marketplace. The best strategy is for FSPs to embrace the new environment and to change proactively.
One such change would be to make the workplace more inclusive. By recruiting managers with experience of different markets, addressing the diversity imbalance, reducing reliance on expatriate workers, and putting in place global talent management programmes that enable the flow of key talent around the world, firms can propagate best practice and create a more global workforce. The financial services industry understands the world is multicultural and FSPs know they serve their clients most efficiently by delivering solutions based on diverse perceptions that mirror the population at large.
Another change can take the form of adeptly pursuing certain customer sectors, crafting innovative products and services, and delivering these via highly competitive (physical and virtual) channels, as these will be competitive requirements.
Yet another is to orient Cayman for the “East-South” economic shift by leveraging Cayman’s status and invest in new infrastructure. As the balance of the global economy swings towards emerging economies, I believe that Cayman should seek to grow its influence in these areas, as moving ahead, more than 50 per cent of the growth in the global banking industry will be in emerging markets. According to Credit Suisse, currently, 19 of the world’s 50 largest banks by market capitalisation are from BRIC countries.
E-government: Cayman has started the process of providing a few services such as company filing, work permit application status checks online, etc. However the delivery of e-government services must be accelerated – competing jurisdictions enable a variety of financial industry requirements to be done online thereby easing the cost of doing business for clients. The financial crisis and the current competitive environment are rapidly making these capabilities minimum requirements. Furthermore, the private sector should consider making additional investments in payment services and market infrastructure for example in these areas:
Payment infrastructure – instead of lengthy cheque clearance times and slow money wires, fund a real-time global platform for cash management and payments.
Fund administration – booking and managing investment vehicles, such as hedge and mutual funds, and private equity partnerships, etc.
Obviously, considering strong systemic interlinkages, any investment to construct a leading-edge infrastructure would have to be appropriately organised.
This is a challenging time for the financial industry, however it is also plentiful in opportunity and potential. Cayman can capitalize on investment trends and harness new technologies to challenge its competitors, take advantage of their problems, and gain new competitive slots. This will require the collaborative action of all of the financial industry stakeholders to maintain and improve Cayman’s standing as a top favoured offshore finance jurisdiction. Investing in new technologies and initiatives even in this depressed environment will yield substantial results when the markets recover.