Grant Stein reveals how International Finance Centres have helped the global economy begin to recover from the credit crunch – and the knock-on benefits they will provide to international trade and finance as we continue to emerge.
International Financial Centres (IFCs) play an important role in creating jobs in OECD countries and enhancing liquidity in global financial markets. As such, they have been essential in helping the global economy make its slow recovery from the economic difficulties of the last 12 months. It is therefore critical as part of the ongoing international regulatory overhaul that IFCs are able to continue to facilitate international capital flows.
IFCs are integral to the free and efficient movement of capital and trade around the world. The reputation of the leading IFCs for stability, effective regulation, probity and professional competence attracts funds from investors all over the world. This capital is then invested both into the G20 countries (by foreign investors supporting domestic opportunities) and into developing economies (by domestic investors investing in foreign opportunities). When flowing inwards, these financial currents allow new wealth from the developing world to seek out stability and predictable returns in the developed economies. When flowing outwards, they give investors in the developed world exposure to the emerging markets. Both forms of investment will be critical for a sustained global recovery, and both are facilitated by IFCs.
One of the principal benefits of IFCs that seems not to be widely understood is the neutrality that IFCs offer to international investors. IFCs allow the pooling of investor funds in a manner that does not benefit one investor over another; they remove certain legal and political risks associated with investing in certain foreign countries; and they relieve the administrative and logistical burden of doing business internationally.
By supporting international investment and financing arrangements, IFCs support the creation and preservation of jobs in OECD countries across a range of industries. Employment in the manufacturing sector benefits as offshore structures help facilitate international aircraft sales for the likes of Boeing and Airbus, making these companies more competitive.
IFCs have already played an essential role in addressing the liquidity freeze arising from the credit crunch, and have contributed towards reopening capital markets that were otherwise shut down. With financial markets on the edge of the abyss last winter, the formation of new investment funds specifically targeting distressed assets demonstrated how IFCs can drive new and badly needed investment capital into the US and Europe, at a time when traditional investors remained firmly on the sidelines. Special Purpose Vehicles (SPVs) structured offshore have also helped stricken financial institutions remove toxic assets from their balance sheets, while numerous offshore SPVs have been employed as part of the US government's Term Asset-Backed Securities Loan Facility (TALF) programme, designed to revive the securitisation market and the US economy. In addition, according to the US Treasury Department, the main Caribbean IFCs as a group are the fifth largest foreign holders of US Treasury Securities.
It should also be made clear that this method of collecting and pooling capital in an IFC for investment purposes is not motivated by domestic tax avoidance. All investors in the fund are still required to make a full declaration to their own domestic tax authorities. In addition, the fund's investments may themselves be subject to taxation in the jurisdictions in which they are made. The only tax advantage of investing in a fund domiciled in an IFC is, therefore, that the fund vehicle itself is not taxed by that IFC: there is no third level of taxation.
The practices of tax evasion and money laundering are universally condemned by all leading IFCs, which are well regulated in line with international standards. The Cayman Islands and the British Virgin Islands recently joined Jersey and the other leading IFCs on the OECD's White List, while their high regulatory standards have been endorsed by numerous supranational surveys from bodies such as the IMF and the Caribbean Financial Action Task Force. Furthermore, from a commercial standpoint, any IFC which does not enforce the highest standards of governance would be certain to fail, particularly in the current climate. Institutions engaging with IFCs want to be associated with robust and well regulated financial centres as there can be significant problems involved in putting money in a jurisdiction where there are concerns over the political and/or regulatory climate.
Contrary to popular belief, the financial regulations in many IFCs are far more stringent than in their G7 and OECD neighbours. For instance, it is much harder to open a bank account in the Cayman Islands than it is in the US or most of Europe, due to the greater levels of 'Know Your Customer' due diligence that the banks are required to complete. Additionally, the Cayman Islands was one of the few nations to require retroactive Anti-Money Laundering due diligence, resulting in a far stricter and more effective regime than the US.
The issue of tax competition also merits further discussion due to the widely held perception that the actions of IFCs have contributed towards a "race to the bottom" in corporate tax collections. In fact, according to the OECD's own statistics, tax revenue as a percentage of GDP has increased as corporate tax rates have fallen, so tax competition has clearly been beneficial to the global economy.
Also benefiting the onshore tax take is the support IFCs provide for efficient external investment by multinational companies in capital exporting nations through tax neutral investment portals. Such efficiencies allow multinationals to increase investment, thereby boosting shareholder returns and tax income when funds are ultimately repatriated to the country of source.
Against the backdrop of numerous academic studies which have outlined how IFCs help attract economic activity to higher tax nations onshore, the implications of ill-judged actions against IFCs cannot be ignored. It is the ordinary blue collar consumers and voters that will have to pay for these mistakes in the form of higher costs for international investment products and a reduction in diversity, choice and efficiency in the mutual funds, insurance and pension products on which their future will depend. Similarly, as politicians scramble to engineer some form of global economic recovery, to starve the financial system of the liquidity and employment prospects provided by IFCs would appear to be the last thing that anyone, onshore or offshore, needs.
Grant Stein is the Global Managing Partner for Walkers, the global offshore law firm of choice for investment banks, international law firms, collateral managers, and other financial institutions. Based in the Cayman Islands with offices in the British Virgin Islands, Dubai, Hong Kong, Jersey, London, and Singapore, Walkers provides clear, concise and practical advice based on an in-depth knowledge of the legal, regulatory and commercial environment in the Cayman Islands, the BVI, and Jersey.
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