The commercial success of offshore financial centers has received a lot of attention particularly over the past 10 to 15 years, much of this relating to debates on a range of tax and regulatory issues. But far less attention has been given to the contribution of jurisdictions like the Cayman Islands to some of the world’s largest economies such as that of the United States.
The best way to understand the overall economic benefits of an offshore financial service is to take a closer look at the direct commercial benefits. If it is good for the individual institution (which is typically based primarily in an onshore/OECD economy such as the United States) and the transactions are law abiding then it is also likely to be driving a wider economic benefit onshore. Here are a few examples:
The offshore bank is one of the more traditional products offered in the Cayman Islands. Benefits of operating offshore banks include the absence of capital gains tax or taxes on bank transfers and no exchange controls. Practical uses of an offshore bank include; use by a major international corporation to carry out various treasury functions and dealing with foreign currency transactions. Multinational banking groups also use their offshore branches or subsidiaries to issue international debt as it is easier and cheaper for banks to issue bonds, CD’s, TD’s, etc which are then sold to investors.
These efficiencies have a direct benefit to consumers because the funds raised can then be utilised to finance other activities within the banking group, making their cost of funding lower and enabling the banks to lower the interest charged to customers. In some cases an offshore bank has also been used to execute the joint financing for a large international business venture.
There are other benefits to offshore banking. In fact the IMF acknowledged the importance of offshore banking in a report in 2000 in saying that “Wealthy individuals and enterprises in countries with weak economies and fragile banking systems may want to keep assets overseas to protect them against the collapse of their domestic currencies and domestic banks. In some cases, fear of wholesale seizures of legitimately acquired assets is also a motive for going offshore. (Report on Offshore Centers, IMF background paper, 2000).
Captive insurance companies are insurance companies that carry risk originating usually from its owners or affiliates. The owners of captive insurance companies typically did not originate in the insurance business. Captives are normally setup because owners are unable to obtain a certain type of insurance coverage onshore via commercial insurance companies or are unable to obtain it reasonably.
Consider the case of a large hospital network in the United States that has a favourable loss history and superior risk management procedures as compared to other hospital groups within the industry. It may not be able to secure the insurance coverage with the corresponding cheaper premiums (which it should qualify for) because the traditional commercial insurance company has a “one size fits all” approach.
This hospital group can secure the option of setting up its own captive insurance company in the Cayman Islands. This type of self insurance enables it to have a range of direct commercial benefits such as flexibility in the structuring of the policy and the timing of premium payments among others. More importantly it enables a major medical group which operates in the United States to secure the type of insurance it needs at more efficient rates. This can bring significant benefits not only to the group, but to clients of the hospital as savings can be passed on or certain types of services can now be offered by the hospital because they can now access the appropriate type of insurance.
The captive insurance solution can also play a key role in insurance markets within the US that may have hardened due to a major catastrophic event, such as Hurricane Katrina. A hardened market is often characterised by higher premiums and in some cases, the outright refusal of certain US based insurance companies to offer various forms of insurance coverage. The offshore captives therefore can greatly help in the economic recovery after such a disaster.
Healthcare captives have in fact been an important reason for the successful development of the Cayman Islands as a captive insurance jurisdiction. Captive insurance services are available not only in other offshore centers such as Bermuda but have also gained increasing prominence onshore in places such as in Vermont and North Carolina in the US.
Captives therefore have a positive impact on the commercial viability of major institutions not only in the United States but in other economies around the world. In addition to ensuring access to critical insurance, the operational efficiencies gained positively impacts employment levels in the states and countries that they operate and directly influences the amount of expenditures within these communities as a result of the wages of their employees.
The Cayman Islands is known to have a significant market share in the area of special purpose vehicles (SPV) for structured finance transactions. The jurisdiction is widely known as a domicile of choice for aircraft finance and securitisation. One of the key attractions of the Cayman Islands for SPVs is that its legal system is well known as a creditor friendly jurisdiction from a recognition of security and insolvency perspective. This enables investors and rating agencies to be comfortable that the transaction will be treated as contemplated in the documents and upon a default, the deal will be "ring fenced" and the assets protected for the benefit of the investors.
In this case, the onshore corporation may assign by true sale a set of assets such as a portfolio of mortgages to the offshore SPV which in turn offers a variety of securities to investors based on these underlying assets (in effect securitizing the mortgage portfolio).
As an example of value added in this area, in 2007 two German banks utilized a Cayman SPV which assisted Indian Airlines with the financing for 10 Airbus A-320 aircraft as part of a larger arrangement for the Airline to purchase 43 aircraft for a value of two billion.
In a commercial transaction that benefited both the airline and the Indian economy, the SPV enabled collateral for the loan of US$500 million that the banks loaned to Indian airlines and which is paid back over a period of 12 years.
The range of financial activities encompassed by structured finance transactions is broad but many of them have the distinguishing feature of using the offshore SPV to access the international capital markets for the benefit of onshore corporations in the United States and elsewhere. This access provides a significant benefit to these economies. These structures also provide access to cheaper funding that is available by way of banking and quasi bank funding thereby substantially reducing costs of car loans, mortgages, airline tickets, and credit card receivables, to name but a few categories for domestic consumers.
There are other areas whereby offshore centers facilitate the global economy. The hedge funds industry, which has come under attack with the fallout in global markets, has nonetheless played an important role in the world economy for many years. The Cayman Islands as the leading domicile for hedge funds, has facilitated hundreds of billions of dollars of investment into OECD based economies such as the United States using offshore hedge funds. These funds enable investors from countries around the world to participate in a tax neutral venture for the purpose of investing into major projects in economies such as the United States. Hence, contrary to popular opinion there is effectively no true “capital flight” from OECD economies as a result of offshore centers. In fact when one follows the path of funds in a typical hedge funds transaction it shows that offshore centers actually facilitate major inward capital flows into OECD based economies from various global investors.
The economic impact on investment into economies such as the US resulting from these various services can be significant. Data from 2008 shows that Cayman controlled domestic corporations facilitated over 75 billion in investment into the US according to a PWC study based on IRS published data. While there is no formal study on the implications of this investment for employment in the US one can assume that the impact has been to create many jobs for Americans.
The economic benefits of offshore centers to the global economy are significant and long lasting. The ability of a country to secure the necessary investment into major infrastructure such as roads via securitisations or the availability of insurance coverage to major hospital groups are distinct economic advantages.
The ability of offshore centers to preserve and protect wealth is also an important value added service to many countries. Jurisdictions like the Cayman Islands have done their part in meeting the various global international regulatory standards. Even if recognition is still lacking in this area, their direct positive contribution to the global economy is hard to dispute.
Mr Coles is an experienced lawyer both in England and in the Cayman Islands, being a Solicitor admitted in England, a Cayman Islands Attorney-at-law and Notary Public. For six years he was the Attorney General for the Cayman Islands, a Member of the Cabinet and Legislative Assembly and a Government Minister, having been appointed to that position on the recommendation of the British Government. He was also acting Governor of the Cayman Islands.