With FATCA and other tax transparency efforts, offshore leaks, and U.S. authorities coming down hard on Swiss banks, the offshore industry has been under increasing regulatory and reputational pressure in recent years.
In a 2013 survey conducted by corporate service provider Offshore Incorporations Ltd. (OIL), professionals in the offshore finance industry painted a gloomy picture. One year later attitudes have brightened.
“When we did this survey 12 months ago, there was a feeling of crisis. Now the impression is that things have improved,” said Simon Filmer, OIL managing director, ex-Asia.
He noted that his firm, the largest incorporator of BVI companies, has seen a significant switching between jurisdictions away from BVI companies to Seychelles and Samoa entities. However, 60 percent of companies incorporated by OIL are still in the BVI.
Any perception that the offshore industry may be in decline is not backed up by the numbers, Filmer told delegates at the Cayman Fund Focus hosted by law firm Campbells in November.
“Regardless of what people are saying, the number of incorporations has not fallen off a cliff. The figures are very slightly increasing and they are stable.” For 2014, OIL estimates there are 99,000 new incorporations in five major offshore jurisdictions, including Cayman.
However, the latest Offshore 2020 report based on a survey of 300 offshore industry professionals predicts that all pure offshore centers are going to be less important five years from now. Instead, midshore centers – onshore countries with significant offshore industries – such as Hong Kong, Singapore, Luxembourg or Ireland – will become more important.
The British Virgin Islands and the Cayman Islands have until now maintained a stranglehold on the top two offshore spots, but respondents expect that the significance of these jurisdictions will wane somewhat. Yet, previous surveys had made the same prediction and still the BVI and Cayman have retained their significance, Filmer said.
Some reasons for their staying power are that their competitive advantages are well known and practitioners are familiar with them. Habit, practice and relationships are often underestimated, he said.
The rise of midshore jurisdictions like Hong Kong and Singapore may be inevitable, but it is not necessarily a zero sum game. Filmer said, “There will be more midshore structuring, but there will be a BVI or Cayman company in these structures.”
Especially in Asia, the big four offshore jurisdictions – BVI, Cayman, Hong Kong and Singapore – are still as relevant as they were in 2010 and they will retain their significance for the region. “There are still good reasons to have BVI holding companies,” Filmer noted.
OIL’s report specifically mentions tax efficiency, due to the elimination of double taxation, legal certainty and general ease of doing business as the motivation for using BVI holding companies as an investment vehicle for ventures in China. For similar reasons, comparable structures exist between other markets and offshore centers.
Wealth management and fund structures
In the BRIC countries – Brazil, Russia, India and China – private equity and hedge fund structures are almost always driven by local tax and securities law issues, Ethan Johnson, partner at U.S. law firm Morgan Lewis, said in another Cayman Fund Focus panel on the use of fund structures in emerging markets. For hedge funds investments in Brazil, for instance, it is best to use a vehicle that holds the investment in a place – like Delaware, certain jurisdictions in Europe or any other place not deemed a “tax haven” by Brazilian authorities. This often leads to a Cayman master-feeder fund structure, with Delaware companies holding the investments, he explained.
For Indian investments, the structure is often again a Cayman master-feeder but with a holding company in Mauritius or Singapore to take advantage of the double tax treaties between these countries and India.
Outbound investment structures differ significantly, and in emerging markets like Brazil, they are on the rise. The country, which has a high concentration of ultra-high net worth individuals, sees a growing portion of that wealth deployed outside of Brazil, according to Jerome Dwight, market head, Americas, at RBC Wealth Management. The trend toward outbound investment solutions is driven by very limited local investment opportunities, political uncertainty, rising interest rates and currency devaluations.
Generally, the fund product is gaining a lot of momentum in the wealth management context, he said.
Brazilian investors typically use Cayman funds or Bahamian SMART funds for these types of investments. The appetite for SMART funds is the result of the different tax treatment in Brazil for investments in companies and funds.
Another advantage of the SMART fund is that it has a much lower level of regulation than in Cayman. Since it does not require an annual audit, it tends to be cheaper and more flexible, “yet it can bear the name fund,” Johnson explained. “It functions almost like a company, but it is treated as a fund and the income generated is taxed at 15 percent rather than 27.5 percent.”
However, Brazilian regulators are looking at the structure, and there is the potential that it may no longer qualify as a fund in the future, added John McCann, managing director at Trinity Fund Administration.
This makes SMART funds a hot topic, and the wariness among family offices and financial advisers about the future treatment of Bahamians SMART funds may be an opportunity for Cayman, McCann said.
Clients believe it is just a matter of time, agreed Dwight, adding that cheaper and lighter regulated products are not always better. About 70 percent of RBC clients confirmed they would be willing to pay more to work with a firm in a jurisdiction of reputation. “We are seeing that in the types of clients that are going to Cayman rather than the Bahamas,” he said.
“The world is changing. Substance is at the top of the list now, not only from a regulator’s point of view, but also from the clients’. They want a structure that won’t be challenged.”
However, Dwight argued that the Bahamas does a much better job than Cayman in marketing its products in Brazil.
The increasing sophistication of high net worth individual investors in emerging markets as an important factor for offshore service providers is confirmed by OIL’s research.
The Offshore 2020 report found that growth in the offshore industry is not driven by multinationals, but rather by entrepreneurs and high net worth individuals, as well as small and medium enterprises. The main use of offshore entities remains asset protection and wealth management (28 percent) followed by fund management (19 percent) and corporate investment holdings (13 percent).
Wealth planning and management, particularly in the emerging markets, combined with growing client sophistication are considered by industry professionals to be the main factors for the continued success of the industry. Privacy and client anonymity are, in this context, of average but rising importance.
Traditional tax planning and higher taxes in developed countries are regarded as less relevant. Respondents said only 10.5 percent of their business was done for individual tax purposes, about the same as last year, but considerably less than the 15.9 percent in 2012.
Geographically, growth of the offshore industry is clearly driven by China (40 percent) followed by the U.S. (13 percent), the U.K. (10 percent) and Hong Kong (9 percent), according to the survey.
Regulation has so far not put a dent into the industry. Despite their cost implications, tax transparency measures are starting to “take the toxicity out of the business,” said Filmer, who predicts that “by 2020, because the business is more regulated and transparent, a more robust and self-assured industry will emerge.”
Some of the smaller jurisdictions will not be able to keep up with the regulatory demands, and there will be consolidation. But offshore financial centers will continue to be needed as facilitators of global trade, said Filmer.
“Chinese investors doing business in the U.S. are not going to use U.S. or Chinese vehicles. They are going to use trusted intermediary jurisdictions such as Cayman or the BVI to effect their global business.”