The world of offshore has long been under attack and with each new wave of regulatory changes the end of small international financial centers is being decried. But so far IFCs have proven extraordinarily resilient. They have adopted extensive anti-money laundering and terrorist financing rules, signed tax information exchange agreements, survived the financial crisis and emerged from regulatory black or grey listings relatively unscathed.
Still some market observers, like Appleby’s Simon Harding in this issue of the Cayman Financial Review , say “this time it feels different.”
What has changed is the political attitude towards small financial centers and the desire of onshore governments to shore up tax revenues. The low tax IFC model represents, rightly or wrongly, an easy target amid the momentum gathering various tax transparency initiatives.
Tony Travers, senior partner with Travers Thorp Alberga, observes that “in the same way that we have seen tax evasion conflated with tax avoidance, we now see tax evasion conflated with a legitimate right to privacy in commercial affairs.”2
Transparency vs privacy
Calls for public registries of beneficial ownership for instance, if not applied by all jurisdictions across the world, which is unlikely, will tilt the playing field to such an extent that it is rendered unplayable, he says.
Financial centers must therefore achieve the right balance between legitimate privacy rights and the proper needs of law and regulatory enforcement, both domestic and cross border, says former CIMA Chairman Timothy Ridley.3
There is a lot of confusion over the different transparency initiatives from U.S. FATCA, UK FATCA, and the European Savings Tax Directive II to tax information exchange agreements and the OECD Multilateral Convention on Mutual Administrative Assistance in Tax Matters.
However, the writing is clearly on the wall. At the Group of 20 Nations summit in St. Petersburgh, Russia, in September 2013, the G20 leaders mandated the OECD to develop a new international multilateral standard for the automatic exchange of tax information.
Pascal Saint Amans, director of the Center for Tax Policy and Administration at the OECD, has given a strong indication what this standard is going to look like, when he told Swissinfo that the U.S. Foreign Account Tax Compliance Act has been an inspiration for the OECD. The future standard for tax information exchange, expected in 2014, “will be a sort of multilateral form of the American FATCA agreement,”4 he says.
Although legitimate business has the expectation of a legitimate right to privacy, many commentators regard the regulatory drive towards all encompassing transparency in the name of the fight against tax evasion as virtually unstoppable.
Cayman Finance CEO Gonzalo Jalles does not see an alternative to engaging with the global trends and international initiatives. In fact many financial centers regard their reputation and public perception as the key factor of competitiveness and started a race to be recognized as the first movers and early adopters of new standards, he says. “IFCs will continue to see demand for their offering as long as they remain active participants of global standards in the areas of regulation, transparency and international cooperation.”5
The effect the initiatives will have on offshore transactions is not clear. Even extensive, if not excessive and privacy-eroding, transparency does not necessarily have to weaken IFCs as wealth held offshore continues to rise. In the Cayman Islands total international banking assets and liabilities have increased to $1.503 trillion from $1.46 trillion between June 2012 and June 2013.
Perhaps counter-intuitively as transparency is increasing, bank deposits and interbank bookings in Cayman are going up and not down, notes Travers. And the size of the cross-border assets and liabilities meanwhile highlights the Cayman Islands’ role as an important conduit in the international financial architecture.
Paul Byles of First Regents Bank in the Cayman Islands predicts that the combination of the role of IFCs in global finance, the activities of multinationals around the word and the fiscal challenges faced by larger economies will mean that for the foreseeable future competition, regulation and tax related initiatives will all just be a part of the business.
“Those that accept that and deal with the challenges as they surface will hopefully succeed for another few decades, those that do not most certainly won’t.”6
IFCs can no longer wait for their customers to knock on the door but they have to go out and actively attract them. As offshore centers are becoming more competitive, they are venturing into services which they were not traditionally known for, notes Byles.
“What will likely matter most for the future sustainability of IFCs is the extent to which they can balance meeting the continuingly changing global regulatory standards while being able to compete effectively with other jurisdictions in what is starting to look like a crowded space.”
IFCs that can provide a broader range of services are better placed to handle global economic shocks and regulatory initiatives than those that remain niche centers, he says.
At the same time growing competition and an increasing regulatory burden have raised the barriers to entry. Increased compliance costs require proper infrastructure and a scale that allows competitive pricing for IFCs to survive, argues Jalles. Established IFCs which are already largely compliant with most onshore demands might benefit from that.
“As a result we will see fewer and stronger offshore financial centers in the future of which the Cayman Islands will be one,” predicts Travers. Although regulation has resulted in higher operating costs, he believes, the overall quality of regulation, governance and compliance with international transparency and regulatory standards justifies the premium.
The tax model
The demand for offshore services in general is unlikely to decline. IFCs that facilitate trade and financial globalization will remain attractive as long as there is no unexpected radical turnaround affecting the way in which international business is conducted. This is as unlikely as governments relinquishing their power to collect taxes.
Businesses and individuals will continue to accumulate wealth around the world and, says Jalles, they will have an increasing appetite to use that wealth as capital across borders.
“Individuals and corporations will continue to attempt to maximize after tax returns; in fact, it is the duty of the management of a company towards its shareholders legally to do so. Tax and regulatory competition is likely to continue with an enhanced number of tools utilized to curtail evasion and prevent abuse.”
More targeted, multi-IFC solutions
Thus the better regulated IFCs will resume their role but the product offering and/or the target markets will change. The regional shift in wealth generation away from traditional sources in western industrialized economies will give IFCs a new role to play in Asia and Latin America, where to some extent the demand for inheritance, estate, succession and tax planning will involve offshore solutions, says Ridley.
In the past, offshore centers offered fairly undifferentiated products: captives, hedge funds, trusts or shell companies. While the most successful financial centers – Bermuda for reinsurance, Cayman for hedge funds or the BVI for holding companies – will probably continue to flourish, other IFCs will struggle when entering the same market space, writes Harding.
He sees more fragmented markets which will require more targeted products for different industries and products.
“The signs are that the IFCs will need to look at the region on a country-by-country basis in order to shape their products.”
Fragmented markets may also call for bespoke collaborative solutions that encompass several jurisdictions. Yet such multi-IFC solutions for global businesses will raise the threshold for those who want to take advantage of offshore products.
The ability to engage, change and adapt is critical, says Ridley, and established financial centers that can do so proactively, should survive and thrive, absent some unforeseen domestic or international event.
Jalles makes the same point stating that “only those IFCS that remain agile, avoid the pitfalls of others, maintain a welcoming domestic environment for new businesses, ensure existing business have the ability to attract and retain the necessary talent to compete internationally, and do not over rely in this industry imposing uncompetitive fees/taxes and restrictions, will succeed.”
The substance model
Others argue that IFCs will have to change their approach entirely. Carlyle Rogers foresees in this issue the end of “form over substance.”7
“Gimmicks” used to take advantage of the low tax regimes and financial intermediation that IFCs offer, such as nominee directors of shell companies who exercise no independent judgment or decision-making or mobile bearer shares to hide beneficial ownership, will be a thing of the past as they damage the credibility of offshore financial structures.
With the diminishing potential for regulatory arbitrage mid-shore jurisdictions like Singapore and Hong Kong are likely to fare better than small IFCs in the Caribbean, Europe or the Indian Ocean, he says.
The only way for these unaffiliated, smaller centers to continue to serve clients’ needs is to ensure more substance in the IFCs, by moving management, staff and business activity there, and strengthening the link between a company and the jurisdiction.
Rogers cites special economic zone Cayman Enterprise City as an example for substance over form “which epitomizes what IFCs need to do.” Anguilla’s economic residency program or certificates of intellectual property and certificates of economic purpose, attempts to prove substance through documented activities in a jurisdictions, are other examples.
Reputation and image
Most market observers concur that IFCs need to do more to explain and defend their role in the international financial system. Ridley says it is essential that IFCs have good intelligence, good lobbying and proactive and coordinated early engagement with key governments, key international agencies and the media. Reputational problems persist and some household names may continue to pull back from offshore centers due to political pressure or image concerns. But there are also others, Canadian banks for example, that attempt to fill this void and expand their offshore footprint, says Ridley.
Few expect IFCs to emerge with an unambiguously favorable image. Harding, for instance, likens IFCs to the “good bacteria” of the global financial system, which despite their usefulness in assisting international capital flows cannot hope for more than a grudging acceptance by onshore politicians and NGOs.
But Travers says David Cameron’s comment that the Cayman Islands – and the other British Overseas Territories and Crown Dependencies – should no longer be regarded as a tax haven is “indicative of a brighter future.”
“If that is right we can expect that the unjustified criticism of the Cayman Islands must diminish over time and I predict that our robust financial services industry will become accepted to a greater extent as a part of the global financial architecture,” Travers says.