Offshore financial centres in the Caribbean (increasingly referred to as “International Financial Centres or IFCs) have experienced significant economic success over the past three decades.
While many often larger and more modern countries have had mixed success with the global transition towards serviced based economies, IFCs have had a relatively superior record in terms of economic success as a direct result of their chosen model to provide international financial services.
This reign of economic success has been threatened over the past decade and for some countries the IFC route is starting to look like an unstable path to continued development.
There are three primary challenges which have surfaced over the past decade which pose this threat, namely regulatory & tax initiatives, the global economic recession and increased competition.
Global regulatory initiatives such as the IMF periodic reviews of financial centres which included IFCs focus specifically on the extent to which financial centres comply with formal international regulatory standards set by bodies such as Basel, the IAIS, IOSCO etc. Over time these reviews have incorporated anti-money laundering measures resulting in significant overlap with the FATF style reviews (see below)
The international standard setting body in the area of fighting money laundering and the financing of terrorism has several regional arms such as the Caribbean Action Task Force (CFATF). Regular reviews are carried out on the extent and effectiveness of a country’s anti-money laundering regime.
OECD Tax Initiatives
By far the most well-known of the OECD initiatives currently affecting IFCs, is the recent push for countries to participate in signing of tax information exchange agreements modeled after a template created by the OECD technocrats. Reviews are also carried out with a focus on the framework in place for the sharing of information and the enforcement and implementation aspects.
Other initiatives include the Foreign Account Tax Compliance Act (FATCA), a recent development in US efforts to improve tax compliance involving foreign financial assets and offshore accounts, and the AIFM directive, a European based regulatory initiative aimed at the funds sector.
Enhanced regulation, more growth
Despite initial concerns by IFCs about lack of fairness and a level playing field, all of the above initiatives have now been more or less fully accepted by most IFCs and are in advanced stages in terms of their participation.
The original speculation that IFCs future may be in jeopardy due to the above initiatives is based on the mistaken assumption that regulatory arbitrage and tax evasion were active ingredients in IFCs economic success.
But the adherence to global regulatory standards, (and in some cases IFC compliance levels have been shown to be superior to the compliance levels of some OECD countries based on objective reviews) has completely dispelled the notion of regulatory arbitrage. Indeed, many IFCs have continued to experience phenomenal growth rates after spending an extraordinary amount of resources on enhancing their regulatory regimes to meet the objective standards set by the international bodies.
Similarly, the notion that the sharing of information based on tax agreements will lead to discovery of hidden tax evasion has been disappointing for OECD and treasury officials, simply because the now more open and cooperative IFCs continue to thrive without much incident in that regard. There has been an increase in requests for information, but little has been reported on successful cases of tax evasion based on the new information sharing regime.
The global economic recession has played its role for most IFCs. Jurisdictions have witnessed a drop in new registrations and demand for their services, though in some cases overall numbers are still strong. This has been most obvious in the case of new hedge funds.
These challenges have also presented certain fiscal challenges to IFCs. In the same way that many countries around the world have faced the impact of rising debt levels plus a reduction in government revenues many IFCs are also grappling with these issues.
As a result there is the threat that IFC governments will implement either revenue generating or employment protection related polices which could potentially have a negative impact on the success of their respective financial services sectors.
The third factor which imposes on the future sustainability of IFCs is competition. Over the past two decades many countries have noticed the relative success and naturally have explored the possibility of venturing into this area. Jamaica has launched a new initiative to introduce an IFC and there have also been talks about the Dominican Republic doing something similar as examples.
In addition existing IFCs are becoming more competitive, venturing into services which they were not known for traditionally. The presence of marketing teams and booths at international conferences over the years shows the increasingly aggressive and sophisticated approach taken by IFC Governments as they vie for the additional revenues and employment that a successful financial services sector brings to their economies.
This aspect of increased completion is important because historically some IFCs in the region have been known for providing certain niche services. As an example Bahamas were known primarily for their banking & trust services, Bermuda for its reinsurance services, BVI for its simple and effective corporate vehicles regime and the Cayman Islands for its dominance in the hedge funds space in addition to banking and captive insurance.
Venturing into new areas and competing against existing IFC ‘brands’ is not as straight forward as it seems. It will take many years for another IFC to overtake Bermuda’s brand as a centre of excellence for reinsurance business. Likewise it may not be possible for another jurisdiction to successfully market its fund product in the way that the Cayman Islands do. IFCs that wish to venture into the Asian market to sell their corporate vehicles will similarly find it difficult to compete with the BVI (where in some Asian countries an offshore company structure is referred to simply as a ‘BVI’ in the same way that Kleenex is used for a tissue or band aid is used for well..band aid).
Additionally those countries seeking to establish a new IFC will face significant entry costs as the regulatory framework, tax agreements, and other policy related aspects are all necessary for a successful IFC. Being able to attract top class professionals to work in the industry and investing into training and educating local professionals is also a huge investment of time and resources for IFC governments and private sector firms.
But over the past 15 years or so IFCs have been trying hard and are slowly gaining ground in their respective target areas. These continued efforts will be especially fruitful when new clients, particularly from emerging markets (such as Brazil and China) which are sometimes cost sensitive, seek to secure offshore financial services particularly when this is coupled with the relatively minimal presence of IFC firms in some of these countries.
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. Those IFCs that offer a broader range of services are better placed to handle global economic shocks (or indeed regulatory initiatives targeted at specific sectors) better than those that choose to remain as niche centres.
What has become clear is there is no ‘easy’ way to start or operate as an IFC in the current climate; IFCs’ role in global finance and the activities of many multinationals around the world coupled with the fiscal challenges faced by the larger economies, means that for the foreseeable future competition, regulation and tax related initiatives are all just 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.
Paul Byles is Director of FTS, a Cayman Islands compliance and management consulting firm. He also serves as an independent director and consultant to financial services firms. He is an economist and former regulator who has worked in the offshore sector for over 25 years. He is author of the books ‘Inside Offshore’ and 'Introduction to Offshore Financial Services: A BVI text'.