Caribbean Financial Centres: a look into the future

| 31/10/2013

The last two decades have proved challenging for the offshore financial industry. It has been an era of heightened initiatives both internationally and onshore, which have had a dramatic impact on the offshore financial services industry. The 2008 financial crisis added to this movement, certainlyin terms of the rhetoric and renewed threats of drastic action against small offshore financial centres (OFCs), which have difficulty in pushing back in a meaningful way.

Post 2008, many OFCs, and those in the Caribbean in particular, experienced declines in their two key industries, tourism and financial services, which inevitably impacted on general local business activity and government revenues. This in turn highlighted both short and long term fiscal problems for their governments.

However, reports of the impending demise of the offshore industry have been somewhat exaggerated.  There will continue to be a place for high quality, innovative and adaptive OFCs, unless the world goes back to a wartime style era of exchange controls, fixed exchange rates and restricted global trade and investment, and despite there being some short term signs to the contrary, eg, currency controls/manipulations and ad hoc black listings, this is unlikely in the long term.

International Initiatives and Implications for OFCs

Driving much of the international activity is the battle to retain control of the world’s capital and thus the ability to tax it. The old guard is fighting hard to maintain the status quo under the cloak of securing financial stability, tax fairness and transparency.

Most major jurisdictions publicly support open and competitive global markets between which capital can freely move. Indeed, there is a growing body of academic studies that argues that OFCs enhance competition in onshore markets and facilitate foreign investment into onshore jurisdictions that might not otherwise be made due to domestic constraints in those jurisdictions.

But many jurisdictions that claim to support free markets principles and the unrestricted flow of capital do so only as long as this system works in their favour. Behind the façade of championing open markets, they actually pursue self-interested financial imperialism and protectionism.

For example, with their financial services and products and in facilitating the global allocation of capital, OFCs pose a major competitive and potentially uncontrolled challenge. Thus, the UK and the US in particular are not keen to see OFCs thrive too much, but they do recognise that for their own financial service industries and multinationals to be competitive they need to use OFCs. Further, they recognise that OFC structures are also often the conduit for valuable inward investment from foreign investors. This traditional position is now under serious pressure as many politicians see more electoral downsides than upsides in the continued symbiotic relationship between onshore and offshore.

Other major European nations with growing and unfunded entitlement programmes and ageing populations fear loss of capital to OFCs and as a result reduced tax revenues. And they wrongly see OFCs (as opposed to their own domestic policies) as the cause. So, while voicing their commitment to open markets for (their own) financial services and products, they continue to impose burdensome and anti-competitive regulation on OFCs and to raise barriers to their residents investing in or using OFC financial products or services.

Ironically, many of the very same major economies continue to give special ‘tax breaks’ to entice companies and individuals to relocate to or remain in their countries.

The international standard setters mandated to execute the various initiatives are generally the creatures of and are funded by the very same major countries that have no real interest in a level playing field open to OFCs or to anyone else threatening to deprive them of control of the world’s capital. The staff of these standard setters also has every reason to preserve and expand their activities and their tax free benefits packages.

Current Position

Various important initiatives are underway or threatened. These initiatives have been significantly energised by broad political support at the highest level in the major economies of the world as a result of the financial crisis. At the very top are the G8 and the G20 policymasters leapfrogging each other every few months in producing macro statements, followed up by often overlapping reports. The G20 now seems to be the preferred leader.

The G8 and G20 have been laying out the ‘big picture’ framework for global standards on issues such as corruption, banking, corporate governance, taxation, financial markets and executive pay. The G20 has endorsed the work of the Global Forum (an OECD subset) on tax transparency and exchange of information and urged completion of the peer review of effective implementation and adherence to international standards and preparation of countermeasures against non-compliant countries. 

The OECD has since 1998 been pursuing its global tax initiative, that has been chameleon like in its changes during the period. The programme is now focused on automatic tax information exchange and transparency (beneficial ownership disclosure) and their effective implementation. In tandem with this, the OECD is now fast tracking its ‘BEPS’ (base erosion profit shifting) project at the behest of the G20. This potential recasting of the international tax regime should keep bureaucrats happy for decades to come.

The FATF (another OECD subset) is reenergised with its planned onsite inspections and assessments to ensure effective implementation of its anti-money laundering regime. The IMF continues its programme of regular visits and assessments. Also active are the Financial Stability Board (regulation and oversight of all things financial), Basel III (bank regulation), IOSCO (securities), IAIS (insurance) and the UN running its own initiatives on taxation and corruption.

In parallel with these global initiatives, there are various unilateral actions by the EU and individual nations, most notably the EU Savings Directive (mark II) and moves against offshore hedge funds (AIFMD), the US driven FATCA regime and its duplicates now being eagerly adopted by other countries, and the UK corralling of the Crown Dependencies and the Overseas Territories to sign up to automatic tax information exchange and beneficial ownership transparency.

The compliance burdens and costs of all these are significant and anti-competitive; and fall on both the private sector and governments in OFCs, and ultimately the clients. 

Price of OFCs Not Engaging

OFCs cannot safely ignore these issues and carry on as before. Switzerland has highlighted the dangers of playing the ostrich. This is simply not a sensible or viable long term option for those OFCs that participate in global financial markets, and for whom exclusion would sound an immediate death knell. Perception and reputation are very important, both for OFCs and their major clients. And uncertainty and delay are not good for either. So active engagement by OFCs is essential.

Actions to be taken by OFCs

The top OFCs are making significant progress in successful engagement on regulation and tax information exchange.  But there are things OFCs should do better:

  • Ensure their legislation, regulation and supervision meet accepted and implemented international standards.
  • More effectively implement and enforce existing financial services laws and regulations, anti-corruption and anti-money laundering laws and cross border assistance in civil, criminal and tax matters.
  • Increase transparency by enactment of holistic data protection laws (balancing legitimate privacy rights and legitimate law enforcement), by increasing the publicly available information regarding both regulated and unregulated entities and by increasing the statistical information obtained and published by their regulators and agencies.
  • Improve the delivery of innovative legislation and regulation, not just in financial services but also in areas such as intellectual property, technology, and medicine. 
  • Improve (legitimate) intelligence gathering, lobbying and media relations, particularly in key centres such as Washington, London, Brussels and Paris to influence political and media perceptions, opinions and outcomes.
  • Embrace joint lobbying and actions by OFC governments to highlight the hypocrisy of many of the initiatives and to strive for a genuinely level playing field.
  • Sponsor and support think tanks, symposia/fora/conferences and publication of quality academic studies analysing the (beneficial) role of OFCs.
  • Ensure their infrastructure (eg, courts, telecommunications, ports and airports) is world class.
  • Improve their domestic ‘environment’ to encourage, facilitate and expedite the establishment of physical businesses and institutions staffed by top decision makers.
  • Ensure their public and private sector cost and fee regimes are competitive.

The Future

The number and wealth of global businesses, families and investors will increase over time and the greatest growth will be in the new worlds not the old world.

Global competition inevitably includes tax and regulatory competition. No-one has yet created the perfect tax or regulatory regime, so competing regimes (within broad agreed norms) are perfectly proper. Individuals and corporations are still entitled legally to maximise their wealth. Indeed, it is one of the principal purposes and obligations of a corporation to do so.

Increased wealth will continue to make proper tax, estate and succession planning for global businesses, families and investors essential and lead to greater demand for tax advantaged/neutral and agreeable places to live and work with easy access to quality professional services and markets.

OFCs with high standards of sensible regulation, appropriate transparency, cross border assistance arrangements and good infrastructure while providing quality value-added services have a valuable and vital role to play in this scenario.

The barriers to entry as an OFC are ever increasing. The cost of developing the infrastructure and meeting international standards is significant and success cannot be achieved overnight or guaranteed. And there are probably now too many OFCs. Competition is increasingly fierce, and jurisdictions and structures are increasingly seen as fungible.

The survivors will be those who engage successfully, meet international standards, have an established infrastructure and track record (in all its aspects), tax efficiency, professional expertise and support services, a solid and diverse base of business, and the ability quickly to adapt and innovate in the ever changing global environment and to add real value to international transactions and capital flows in an efficient and cost effective way.

A number of Caribbean OFCs meet the tests for being survivors. But to thrive, they must learn better from history and from their (and others’) mistakes and work more effectively to be accepted as legitimate participants in the global financial world.

This article first appeared in IFC Caribbean Financial Centres 2014 Review.

Category: Viewpoint

Comments (17)

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  1. Anonymous says:

    I'm not a financial expert like the other poster said so I'll just ask a direst question Tim.  Will Caymanians that get UK passports be taxed by the UK?

    • Anonymous says:

      Nothing is certain in life (except death and taxes), but I think it is unlikely that the UK will change its tax system to one based on citizenship like the US.

       

      Tim Ridley

    • Anonymous says:

      Tim, can you please give us your views on payroll taxes versus property taxes. Would they hurt the financial services industry?   

      • Anonymous says:

        This is of course an entirely different topic. Taxation always has unintended consequences, even if needed. Given Cayman’s particular circumstances, I think that a sensible community service charge (property tax) is the fairest and most sustainable may for Government raising revenue. Preferable of course, is that our Government should effectively reduce waste and unnecessary expenditure and become far more efficient, before any new taxes are contemplated. At the same time, our Government should encourage an environment where our economy can grow and thrive. That means Government should do less rather than more, however counterintuitive that may appear. Tim Ridley

        • Anonymous says:

          Thanks, but you've ducked the question though. Why is property tax fairer than payroll tax? Won't property tax make Cayman less attractive to investors? Won't it add to the cost of living as the tax gets passed on in the form of higher prices for everything?  

          • Anonymous says:

            As I said, this is a huge topic for another article. For more on this, see the article "At home with with a property tax" in the Compass 21 March 2013.

             

            Tim

            • Anonymous says:

              Property taxes will impact Caymanians versus expats since most landowners are Caymanians and the property market being what it is landlords would never get to pass this on to their tenants. Maybe that is the point.

      • Anonymous says:

        I wonder if Anguilla, Bermuda, BVI and TCI are considered tax havens "tax free" jurisdictions because they all have payroll taxes, last time I checked.  Please someone enlighten me as I would really like to know.

  2. Anonymous says:
    Intelligent article, Tim, as always.  Very few understand/can articulate those issues with such a commanding knowledge.
     
    A few points.
     
    1.  Not PC perhaps, but reality- OFC's, including Cayman, ARE tax havens, not really OFC's, that's too pretentious, but we all love saying it, and I know the drill. The reality is, the authorities, and probably everyone else in the onshore world will never view OFC's otherwise.
     
    2.  Other than no-tax, minimal regulation and business confidentiality, and a record of facilitating international business, what else does Cayman offer that's not available most everywhere?
     
    3.  As to Cayman facilitating the global "allocation" of capital; that has a lovely ring to it, and Cayman may feel that the opposition (OECD et al) are impressed/convinced, but they are NOT,and that's NOT what Cayman is, or does, rather it's a place to which banks/businesses can shift deposits/holdings because of that confidentiality, low regulation and no-tax trinity.  So, "allocation of capital", NO, it's mainly tax driven.  And,THAT is why the OECD and all countries with real tax regimes apply pressure to Cayman and other OFC's, and will forever continue to do so until OFC's are "tax harmonised" or at least far less attractive to mobile capital than at present.
     
    The World's capital, is invested by the wealthy individuals/corporations/other organisations (and Governments/authorities, etc) that own it, so it's not really "control" of that Capital that anyone is fighting over, it's the "tax base" pure and simple, and wiping out the use of OFC's by criminal enterprises.  THAT, we may have largely done, but the tax thorn remains.
     
    4.  As to that "mythical" level playing field.  We want it, but we will never get it because we are NOT important enough.
     
    • Anonymous says:

      Correct. Cayman is not an actual capital market so its influence is limited. Your only protection is the desire of New York and London to play tax arbitrage as long as possible.

      • Ya Mon says:

        So why we chasing off the people who bring the business from New York and London?

  3. Anonymous says:

    I wonder what the effect of drug legalization would have.

     

    Much of the money flowing through our banking system is carefully laundered drug money.

     

    We have no idea how much money is involved; we can only guess.

     

    The drug corruption goes really high given the amount of money that is involved.

  4. Alan Roffey says:

    I sincerely hope that CIG will engage you Tim, to assist them in identifying where their efforts should be directed towards ensuring Cayman's future as an OFC.

    • Despairado says:

      Not going to happen I'm afraid. Remember that Tim was uncerimoniously shunted off the CIMA Board during the first PPM regime.

      Politicians want "supporters" not advisers.

  5. Anonymous says:

     Tim

    Could you please expand further on what you think the consequences for Cayman of the EU Savings Directive (mark II) might be?

    • Anonymous says:

      It looks as if the EU now wants to line up the EUSD with FATCA. However, the idea that the EU and the USA will actually have systems that will minimise the duplication of differing styles of reporting and IT is probably wishful thinking!

       

      Tim Ridley

  6. Knot S Smart says:

    I hope that our leaders are reading this as Mr Ridley has proven to be a very credible person who has the interests of Cayman at heart. Thank you Sir.

    Unfortunately this is the most positive comment that I can post because like our first Premier / Minister of Finance always said: 'I am no financial expert'…