Cayman & the post-crisis world

We are in some of the most turbulent times the Cayman Islands’ financial services industry has ever seen. Over the years, challenges from various quarters have come and gone, but today we are facing them on many fronts and at many levels.   

The financial services industry is vital to the economic well-being of the Cayman Islands. The UK has in the past been an active supporter of the development of the industry in Cayman to ensure financial self-sufficiency. In 40 years, Cayman has been lifted from relative poverty to one of the highest per capita GDP’s in the world. And the recent report on the Economic Benefits of the Financial Services Industry to the Cayman Islands only underscores what we well know intuitively. But the model is facing major challenges so continued success is not a given.

Offshore financial services centres (OFC’s) have for some time been wrestling with numerous international initiatives aimed at making us better world citizens in the eyes of the leading developed nations (G7, G8, G20 et al) and international standard setters, such as the Financial Stability Group (FSG), the Financial Action Task Force (FATF), IMF, IOSCO and OECD. Politicians have also voiced strong criticisms, particularly French, German and UK leaders, President Obama and a number of US Senators, for encouragingand assisting tax evaders, fraudsters and other crooks. Pope Benedict and various charities have added their voices, accusing OFC’s of causing poverty by actively assisting in the looting of third world countries by corrupt officials.

The recent global financial crisis (even if its origins were indisputably onshore not offshore, as most recently acknowledged by the head of the UK FSA) has resulted in a decline in new hedge funds and complex structured finance vehicles and produced a plethora of demands for more action, including global regulation, a single global regulator and tax collector, colleges of regulators, enhanced national or regional regulation (evidenced by the recent US and EU proposals to increase the regulation of hedge fund managers and an expressed desire to regulate significant hedge funds directly if they can figure a way to do it), transparency and cross border cooperation and assistance, principally exchange of information in banking, securities and tax matters (such as an expansion of automatic reporting under the EU Savings Directive-EUSD II).

You will all have seen the product of the recent G20 and OECD machinations in the white, grey and black list (that now has no black listees) for those considered to be good, ugly or bad. And with potentially broad ranging sanctions for those who continue to offend the “not substantially implemented” test. This is complemented by demands for domestic onshore legislation making the legal use of offshore centres increasingly difficult. In the US, the draft proposals from Senators Levin and Baucus will doubtless get melded with the proposals announced by the US Administration on Monday. In the UK and Europe, tighter anti avoidance/anti tax haven legislation continues to be high on the agenda.

While the G20/OECD listing is worrisome and the outcome uncertain (I discuss this in more detail below), there are signs that some of the proposals may not be as draconian as first feared. But the fat lady is a long way from singing and we should not go back to sleep, simply because we think we can live with the likely US and UK tax changes, the mooted fund manager rules in the US and the EU, Basel II (revisited) and the possible changes to the US, EU and IAIS (re)insurance regimes. We have no choice. So while giving hope, these should be considered only as allowing us some breathing space to position ourselves for longer term issues, such as the implications of G20/OECD/FSG programmes, the final Foote Review of British Offshore Centres due at the end of 2009 (there are some troubling matters raised in his progress report of April 2009) and the EUSD II.      

Cayman (like other leading OFC’s) has a long history of stable democratic government, respect for the rule of law, an open market economy and relative fiscal discipline. And it chooses to pay its way through non discriminatory indirect rather than direct taxation. It works hard to maintain a sound, sensible and balanced regulatory regime. We can look to the excellent (but relatively unsung) reputation and success of the regulator (CIMA), the growing reputation and success of the local stock exchange (CSX), the shipping registry (MACI) and the aircraft registry (CAA) and the good work of the Financial Reporting Authority (FRA).

To-date no local banks have failed due to the global meltdown. Cayman also works hard to deter and punish abuse of its financial services and to cooperate cross border with other jurisdictions in appropriate circumstances. In particular, it has: Committed to the OECD to meet international standards on exchange of information on tax matters; Implemented the EU Savings Directive; Executed a mutual legal assistance treaty with the USA and tax information exchange agreements (TIEA’s) with the USA and the seven Nordic countries; Demonstrated a good faith willingness to negotiate further TIEA’s and like agreements; Amended its domestic legislation recently to broaden the gateways for exchange of information on regulatory and tax matters andscheduled a number of jurisdictions as qualified to receive tax matter information on request (the so-called ‘unilateral measures”); Implemented various Laws providing for cross border assistance and enforcement in criminal and civil matters (the Misuse of Drugs Law, the Proceeds of Crime Law, the Criminal Justice (International Cooperation) Law, the Terrorism Law, the Evidence (Proceedings in other Jurisdictions) (Cayman Islands) Order and the Extradition Law); Received favourable assessments of its regulatory and anti money laundering regimes from the IMF and CFATF (and is likely to receive a further favourable assessment from the IMF following the recent visit); Actively pursued membership and participation in international standard setting bodies (to the extent permitted by those bodies; hopefully, CIMA will finally gain membership of IOSCO this year); Routinely assisted foreign regulators and law enforcement pursuant to Laws, Regulations, MOU’s and other arrangements; Successfully prosecuted money launderers and fraudsters and confiscated their assets and recently implemented its Freedom of Information Law and determined that the Anti Corruption Law (and Anti Corruption Commission) will go live on 1st January 2010.

The stated goal of most major jurisdictions is open and competitive global markets between which capital can freely move. There are academic studies from respected economists that show 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. After all, the funds do not remain in the OFC’s. Their domestic markets are far too small and undeveloped to absorb the capital flows.

So why the continued outcry against legitimate OFC’s such as Cayman?

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, they actually pursue self interested financial imperialism and protectionism. In financial services and products and in facilitating the global allocation of capital, OFCs pose a major competitive and potentially uncontrolled threat. So, for instance, the UK and the US are not keen to see OFCs thrive too much, but they have traditionally recognised that, for their own financial service industries and multinationals to be competitive, they must allow them to use OFC domiciled structures. Further, they recognise that such structures are also often the conduit for valuable inward investment from foreign investors. This approach is now under serious pressure as politicians (egged on by the media and the shouting classes) appear to see more 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 and reduced tax revenues. And they wrongly see OFC’s (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 OFC’s and to raise barriers to their residents investing in or using OFC financial products or services. Again, protectionism in all but name, despite protestations to the contrary.

The international standard setters mandated to execute the various initiatives are the creatures of and funded by the very same major countries that have no real interest in a level playing field opento OFC’s or to anyone else threatening to deprive them of control of the world’s capital.

It is always easier to find the mote in someone else’s eye than the plank in one’s own. OFC’s have little political leverage onshore or in international organisations so they are easy targets to blame (unfairly) for the woes caused by poor policies (e.g., easy mortgages and cheap credit in the UK and the US), poor regulation (e.g., the SEC in Madoff and the FSA in Northern Rock) and poor enforcement (e.g., anti corruption in the UK) in the major onshore jurisdictions.  The latest manoeuvring is all part of the struggle to ensure control of the world’s capital remains in the same old hands.

I do not wish to dwell on water under the bridge, but it is important to learn from history and the mistakes of the past (otherwise we are bound to repeat them). If there is one continuing failure it lies in the reactive rather than proactive approach. All too often Cayman has been late out of the starting gate, only to discover that the damage has been done by our inaction (resulting traditionally in a thoroughly frustrated and irritated group of major nations or international organizations, blacklists, bad press etc), and we face a mountain to climb. As we learnt with the FATF and the FSF in the 1990’s getting off a list is much harder than not being on the list to start with. And we applied that lesson in avoiding being on the OECD “harmful practices” tax haven list 10 years or so ago. Unfortunately, we forgot that lesson recently and are now on the latest G20/OECD grey (really the black) list.  

I fear we may be about to experience stalling and moving goal posts from the G20/OECD and more will be required of those, like Cayman, on the greylist than those who like Jersey, Guernsey and the Isle of Man (perhaps magically) made it on to the whitelist at the outset. Recent comments by OECD officials are sending mixed and thus worrisome messages. While welcoming Cayman’s progress in signing TIEA’s and introducing the “unilateral” measures”, they also suggest that higher marks will be given for TIEA’s with some countries than with others (i.e. Greenland and the Faroes do not really count), that ‘effective implementation” (rather than mere quantitative assessment, i.e. how many TIEA’s have you signed) will be brought to the fore and that Cayman’s unique “unilateral” measures may not, for certain technical reasons, be the hoped for silver bullet. I hope I am wrong. We shall have to wait and see, possibly until the next G20 meeting in November or later.

This uncertainty and delay is not good for our reputation or business retention and development. There is anecdotal evidence that international institutions are increasingly concerned about the heightened reputational issues raised by conducting business through or with offshore jurisdictions and certainly with those not on the whitelist. Some of our key competitors have been ‘whitelisted” and are ramping up their marketingon this basis.   

Cayman has become complacent as it has grown. Government, the private sector and the community have become used to the success of the industry and think it runs on autopilot. 

Cayman has not developed focused single political ownership and leadership of financial services in the Cabinet

Cayman has not developed a supporting ministry or department focused solely on financial services and with sufficient resources

Cayman has not devoted sufficient resources to ensure its financial services infrastructure (e.g. Registrar of Companies) or legislation are up to date and meet modern demands and needs

Cayman has not devoted sufficient resources to secure the critical advance international intelligence to enable it to be proactive and position itself correctly

Cayman has not devoted sufficient resources to ensure that its voice is properly heard by international standard setters, key onshore agencies and politicians or the influential media

Let me start by making two points. First, I do not believe that Cayman’s financial services industry need go the way of the dodo (as some in the media would suggest). There will always be a legitimate role for jurisdictions providing quality financial services in a well regulated and tax efficient manner. Secondly, I  recognize that there are limits on Cayman’s ability to have a place at the top table as we are an Overseas Territory (and the UK is responsible for our international relations, except to the extent she delegates matters to Cayman) and also a very small country.

There must be clearly identified and committed political leadership and support for the financial services industry and all it takes for it to flourish. This requires a holistic approach spearheaded by an elected Cabinet Minister backed by a specific, focused, well-resourced and correctly branded Government department to ensure that the right platform (in all its many facets) is in place, is nurtured and enhanced constantly and promoted both locally and internationally.

The devil is always in the details, so what are the specifics that this Minister, his department and the private sector should do? 

Government and the private sector must interact much more closely, respect and listen to each other and be proactive in moving forward together

Both the public and private sectors need to constantly demonstrate to the community as a whole how critical the financial services industry is to the economic well being of the Islands

Domestic legal, judicial, regulatory and enforcement regimes must be kept current, meet internationally accepted and applied standards (including improved transparency and disclosure of information locally and cross border) and be effectively executed while remaining innovative, competitive and not unnecessarily burdensome. 

The financial services infrastructure must be enhanced and made more efficient. The General Registry is a prime example.

There must much better and earlier engagement with the key major jurisdictions and standard setters (including participation in global colleges of regulators) to secure recognition of our regulatory regime and to shape the development and implementation of fair international standards that create a non-discriminatory playing field open to all legitimate OFC’s

Agreements must be developed or improved with keycounterparty jurisdictions for cross border cooperation and assistance (information exchange, including both criminal and civil tax matters, and law enforcement), with appropriate benefits, gateways and safeguards for legitimate privacy and other legal rights (recognising that compromises will be necessary).

Advance intelligence must be improved and ensure early and proactive engagement on, rather than late and reactive responses to, onshore and international developments and initiatives.

Far better targeted and effective lobbying and media relations are essential, particularly in key centres such as Washington, London, Brussels and Paris to influence political and media perceptions, opinions and outcomes.

Think tanks and the research, publication and dissemination of quality academic analyses of the beneficial impact of OFC’s on the world economy should be sponsored and supported. 

We should join together with other quality OFC’s (recognising they are also competitors) in building a cohesive group to conduct the necessary international efforts to protect our common interests. 

The private sector should strive to secure high quality business and to provide an efficient, cost effective and added value service. 

We should take advantage of increasing tax pressures onshore and actively encourage wealthy people to take up physical residence, buy houses and invest locally. 

Similarly, we should encourage new businesses to establish here with  meaningful physical presences and also encourage much greater decision making and economic activity within the jurisdiction by the entities domiciled here.  

We must provide the appropriate physical infrastructure, sensible and welcoming immigration policies to attract and keep the brightest and the best and well educated, motivated and participating local professionals and staff to work in partnership with them

We should actively develop governmental contacts and new business sources in Africa, Asia, Latin America and the Middle East (many of whose countries are usefully G20 members). These countries are less likely to submit to the imperial writs of the US, UK and the EU and have little or no enthusiasm for control of international capital remaining in those protectionist hands or for the impoverishment of small democratic nations

There are welcome green shoots in some of the areas I have highlighted above, evidenced by the much needed local legislation now hitting the statute book, the establishment of the commercial court, Government’s newly found vigour in pursuing international engagement, cross border assistance arrangements and media relations, the CIFSA lobbying Task Force and other private sector initiatives and the opening of overseas offices in new markets by local law firms.

Discussion has started about confidentiality and transparency. In the public sector we have good examples in the Freedom of Information Law, the Complaints Commissioner, the work of the Auditor General and now the Anti Corruption Law. But we must also expand domestic transparency in the private sector. Consideration needs to be given to making more information public about Cayman companies (trusts and partnerships are more difficult), such as the identity of directors and shareholders of record of all entities and the publishing of audited accounts of regulated entities that deal with the public (such as all Class A banks and insurance companies, recognizing that some already do voluntarily). CIMA needs to have its mandate broadened so it can publish much more statistical data about the regulated industries. And the Economics and Statistics Office (ESO) needs to be restructured so that the public can have greater confidence that the financial information supplied will indeed not be disclosed other than in statistical form.

The much-loved (or reviled) Confidential Relationships (Preservation) Law requires a revamp to position it as a Privacy Law (c.f. the US Right to Financial Privacy Act). I do not advocate rushing this as we need to look at the whole area of legitimate and needed data protection and privacy at the same time. The Freedom of Information Law shows that we should not expand publicly available information without ensuring that the right to privacy is properly protected at the same time.

Finally, we can take immediate action to improve our international standing and credibility by quicker enforcement of our existing financial services Laws and Regulations. The international code words for this are “effective implementation”. This requires resources, both financial and human, at CIMA and the financial crimes unit (FCU) of the RCIPS if we are to deflect the next wave of likely international criticism.

I do not believe Cayman need suffer death by a thousand cuts (whatever Aljazeera TV may suggest) and can be in the select group of survivors and thrivers. We are belatedly starting to do some of the right things. But a lot more must be done so our efforts must be greatly enhanced and must be continuing. This is not a short term battle to which there is a short term fix.

This is paper was delivered by Tim Ridley to members of the Cayman Islands Bankers Association on 6 May 2009 at the Ritz- Carlton, Grand Cayman.