Smaller International Financial Centres (IFCs) have made significant strides in the past year in terms of exerting a greater influence over the global process of transparency, regulation and information exchange. The leading IFCs, including the Cayman Islands and the British Virgin Islands, have been placed on the Organisation for Economic Cooperation and Development's (OECD’s) ‘white list’, which recognises jurisdictions that have substantially implemented internationally agreed upon tax standards.
One factor that helped put these leading IFCs on the ‘white list’ was that they all signed a series of tax information exchange agreements with numerous OECD members and other countries. After years of political rhetoric, these jurisdictions have been recognised by the OECD as high-quality jurisdictions for international cross-border financial transactions and investment funds. From Walkers’ own experience operating in the Cayman Islands and BVI, the ‘White Listing’ had very little impact on our clients' attitudes and requirements for doing business in these jurisdictions. Our clients – which include FORTUNE 100 and FTSE 100 global corporations and financial institutions, capital markets participants, investment fund managers, and growth-and middle-market companies – have worked with jurisdictions such as Cayman for many years and are familiar with how stringent and transparent the laws, regulations and service providers are. The governments of the leading IFCs also acted swiftly to demonstrate their respective commitment to openness and the highest regulatory standards.
The impact of the economic downturn on financial institutions and companies around the world had a far greater impact on business in IFCs than did the move to the ‘White List’. To keep these jurisdictions, and indeed the global economy, on the path to recovery, the positive contribution that IFCs make to the global economy must be fully appreciated. The potential consequences of restricting the activities of IFCs, as the OECD's Peer Review Process begins, must also be evaluated against the backdrop of a fresh wave of global financial regulation.
In addition to the recognition from the OECD, IFCs around the world have been united by the establishment of the International Financial Centres Forum (www.ifcforum.org). This new organisation is working to stimulate the global debate and recognise the positive and vital contribution IFCs make to international markets. Launched in December 2009 by founding members Appleby, Conyers Dill & Pearman, Mourant, Ogier and Walkers, and advised by Stikeman Elliot, the International Financial Centres Forum was designed to promote greater cooperation between offshore jurisdictions and provide for a more coordinated response to many of the misconceptions about IFCs.
Through the launch of the website and formal discussions between key organisations recognised as thought leaders in international finance, the International Financial Centres Forum will showcase the vast body of authoritative academic work on this subject and make key resources publicly available. Modern economic theory confirms the essential and constructive role that tax neutral jurisdictions play in the world economy. The International Financial Centres Forum will highlight this dynamic through existing empirical evidence, by commissioning new research, and by addressing the common misconceptions about IFCs.
These misconceptions can be more effectively countered with the IFCs working together, rather than each jurisdiction responding to these false accusations separately, or even organisations within the same jurisdiction offering different information. Traditionally the individual offshore financial centres may have regarded each other as competitors, with the principal centres moving towards their own areas of specialistion. Today, however, it is clear that our interests are aligned at a higher level, while the trend towards more complex multi-jurisdictional transactions has also reinforced the need for greater collaboration.
The advantages of this collaborative approach are significant. When IFCs can speak together with one voice through the International Financial Centres Forum, the benefits can accrue to all our jurisdictions. Furthermore, by working together we can ensure that all market participants can see and appreciate how IFCs have a symbiotic relationship with both developed and developing countries.
IFCs provide a vital lubricant in the process of globalisation, which has resulted in a significant contribution to the major growth in world prosperity over the past three decades. Economists cite IFCs as stimulants to trade and the efficient flow of capital, as well as aids to investment, employment and improvements in tax and regulatory policies in neighbouring countries. Research published in 2009 by leading US economist Professor James R. Hines, Jr. of the University of Michigan Law School demonstrated that credit is more freely available in countries proximate to IFCs, a statistic which reflects the degree of banking competition and the stability of financial architecture within IFCs.
Despite some of the inaccurate media commentary and political posturing, the financial and commercial functions performed by IFCs are quite straightforward. By acting as portals for the efficient collective investment into and out of the major developed countries, the tax-neutral platforms of IFCs provide for the smooth passage of key financial flows where otherwise unnecessary or uncertain onshore tax rules, legal systems, and/or banking infrastructures would make the transaction unattractive, thus inhibiting investment in a particular jurisdiction. All investors in, for example, offshore hedge funds are still required to make a full-tax declaration to their home tax authorities. Tax-neutral platforms simply reduce the risk of multiple taxation which can occur where investments cross borders, as onshore tax systems are rarely integrated with foreign regimes.
The reduction of costs and subsequent enhancement of returns in investment funds domiciled in IFCs promotes consumer choice and competition in the management of pension fund assets, as well as providing greater diversity of investment. The proposed European Union's Alternative Investment Fund Managers Directive is a case in point as there is concern that alternative investment fund managers will find it difficult to market alternative investment funds domiciled in IFCs to investors in Europe. While this will clearly restrict their access to capital, the primary issue for investors in Europe is that access to the full range of investment products will be restricted, leaving behind a smaller pool of European funds with higher costs and lower returns. By restricting the activities of IFCs, governments would be inadvertently reducing the retirement savings of their population, whose institutionally managed funds rely on IFC structures, exacerbating the problems many governments already have in terms of making adequate pension provisions for their citizens.
The economic benefit that IFCs provide to developing nations is clear in that tax-neutral platforms directly create jobs as flows of foreign direct investment are unimpeded, boosting both shareholder returns and revenues available for taxation in the investor country. Offshore structures also contribute significantly towards job creation in the developed world. For example, the special purpose vehicles established in IFCs for aircraft financing facilitate sales of aircraft which in turn creates manufacturing jobs in the Northwest of the United States and several countries in Europe.
There is formal empirical evidence resulting from academic research that has proven the benefits of direct foreign investment and job creation that IFCs can enable. In 2007, a publication by the University of Toronto School of Management demonstrated that Canadian Direct Investment Abroad (CDIA) that flows through offshore IFCs results in significantly higher Canadian exports globally. It verified that such increases in Canada’s trade results in higher levels of Canadian capital formation and employment. This study demonstrated therefore that CDIA that moves through conduit offshore IFCs results in higher levels of Canadian exports, employment and capital formation.
More evidence was offered by a study in September 2009 by Professor Hines, who concluded:
IFCs contribute to economic activity by improving the potential profitability of business operations elsewhere. As a result, for a typical American firm, a one per cent greater likelihood of establishing an IFC affiliate is associated with a 0.5-0.7 per cent greater sales and investment growth in the same region in countries other than IFCs. Furthermore, foreign investment stimulated by IFCs also appears to encourage greater domestic investment: the American evidence is that 10 per cent greater foreign capital investment triggers 2.6 per cent additional domestic capital investment, and that 10 per cent greater foreign employment is associated with 3.7 per cent greater domestic employment. Evidence of the behaviour of European, Canadian, Australian and other firms offers similar conclusions: expanded foreign economic opportunities are associated with greater domestic investment and employment.
Significantly, IFC structures have also been central to transactions and initiatives designed to support the global economic recovery. The Troubled Asset Relief Program (TARP) in the United States, which has been used to revive the securitisation market, utilised numerous offshore vehicles.
With so many misunderstandings about the role of IFCs, the importance of this global debate cannot be overstated, particularly against the backdrop of this fragile economic recovery. Regulatory changes that inhibit the activities of IFCs must be carefully considered given the adverse impact changes may have on economies, jobs, investment opportunities and retirement savings in both the developed and developing world.
The newly created International Financial Centres Forum will play an important role in educating regulators, financial experts, and others on many complex global financial issues including economic liquidity, efficiency and jobs; the global financial crisis; tax competition; transparency, regulation and information exchange; and developing countries and IFCs.
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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