Timothy Ridley comments on the future for the offshore financial industry, amid exaggerated reports of its demise in the aftermath of the 2008 financial crisis.
The last two decades have proved challenging for the offshore financial industry.
It has been an era of heightened initiatives both internationally and onshore, which have had a dramatic impact on the offshore financial services industry. The 2008 financial crisis added to this movement, certainly in terms of the rhetoric and renewed threats of drastic action against small offshore financial centres (OFCs), which have difficulty in pushing back in a meaningful way.
Post 2008, many OFCs, and those in the Caribbean in particular, experienced declines in their two key industries, tourism and financial services, which inevitably impacted on general local business activity and government revenues. This in turn highlighted both short and long term fiscal problems for their governments.
However, reports of the impending demise of the offshore industry have been somewhat exaggerated. There will continue to be a place for high quality, innovative and adaptive OFCs, unless the world goes back to a wartime style era of exchange controls, fixed exchange rates and restricted global trade and investment, and despite there being some short term signs to the contrary, eg, currency controls/manipulations and ad hoc black listings, this is unlikely in the long term.
International Initiatives and Implications for OFCs
Driving much of the international activity is the battle to retain control of the world’s capital and thus the ability to tax it. The old guard is fighting hard to maintain the status quo under the cloak of securing financial stability, tax fairness and transparency.
Most major jurisdictions publicly support open and competitive global markets between which capital can freely move. Indeed, there is a growing body of academic studies that argues that OFCs enhance competition in onshore markets and facilitate foreign investment into onshore jurisdictions that might not otherwise be made due to domestic constraints in those jurisdictions.
But many jurisdictions that claim to support free markets principles and the unrestricted flow of capital do so only as long as this system works in their favour. Behind the façade of championing open markets, they actually pursue self-interested financial imperialism and protectionism.
For example, with their financial services and products and in facilitating the global allocation of capital, OFCs pose a major competitive and potentially uncontrolled challenge. Thus, the UK and the US in particular are not keen to see OFCs thrive too much, but they do recognise that for their own financial service industries and multinationals to be competitive they need to use OFCs. Further, they recognise that OFC structures are also often the conduit for valuable inward investment from foreign investors. This traditional position is now under serious pressure as many politicians see more electoral downsides than upsides in the continued symbiotic relationship between onshore and offshore.
Other major European nations with growing and unfunded entitlement programmes and ageing populations fear loss of capital to OFCs and as a result reduced tax revenues. And they wrongly see OFCs (as opposed to their own domestic policies) as the cause. So, while voicing their commitment to open markets for (their own) financial services and products, they continue to impose burdensome and anti-competitive regulation on OFCs and to raise barriers to their residents investing in or using OFC financial products or services.
Ironically, many of the very same major economies continue to give special ‘tax breaks’ to entice companies and individuals to relocate to or remain in their countries.
The international standard setters mandated to execute the various initiatives are generally the creatures of and are funded by the very same major countries that have no real interest in a level playing field open to OFCs or to anyone else threatening to deprive them of control of the world’s capital. The staff of these standard setters also has every reason to preserve and expand their activities and their tax free benefits packages.
Various important initiatives are under way or threatened. These initiatives have been significantly energised by broad political support at the highest level in the major economies of the world as a result of the financial crisis. At the very top are the G8 and the G20 policymasters leapfrogging each other every few months in producing macro statements, followed up by often overlapping reports. The G20 now seems to be the preferred leader.
The G8 and G20 have been laying out the ‘big picture’ framework for global standards on issues such as corruption, banking, corporate governance, taxation, financial markets and executive pay. The G20 has endorsed the work of the Global Forum (an OECD subset) on tax transparency and exchange of information and urged completion of the peer review of effective implementation and adherence to international standards and preparation of countermeasures against non-compliant countries.
The OECD has since 1998 been pursuing its global tax initiative, that has been chameleon like in its changes during the period. The programme is now focused on automatic tax information exchange and transparency (beneficial ownership disclosure) and their effective implementation. In tandem with this, the OECD is now fast tracking its ‘BEPS’ (base erosion profit shifting) project at the behest of the G20. This potential recasting of the international tax regime should keep bureaucrats happy for decades to come.
The FATF (another OECD subset) is reenergised with its planned onsite inspections and assessments to ensure effective implementation of its anti-money laundering regime. The IMF continues its programme of regular visits and assessments. Also active are the Financial Stability Board (regulation and oversight of all things financial), Basel III (bank regulation), IOSCO (securities), IAIS (insurance) and the UN running its own initiatives on taxation and corruption.
In parallel with these global initiatives, there are various unilateral actions by the EU and individual nations, most notably the EU Savings Directive (mark II) and moves against offshore hedge funds (AIFMD), the US driven FATCA regime and its duplicates now being eagerly adopted by other countries, and the UK corralling of the Crown Dependencies and the Overseas Territories to sign up to automatic tax information exchange and beneficial ownership transparency.
The compliance burdens and costs of all these are significant and anti-competitive; and fall on both the private sector and governments in OFCs, and ultimately the clients.
Price of OFCs Not Engaging
OFCs cannot safely ignore these issues and carry on as before. Switzerland has highlighted the dangers of playing the ostrich. This is simply not a sensible or viable long term option for those OFCs that participate in global financial markets, and for whom exclusion would sound an immediate death knell. Perception and reputation are very important, both for OFCs and their major clients. And uncertainty and delay are not good for either. So active engagement by OFCs is essential.
Actions to be taken by OFCs
The top OFCs are making significant progress in successful engagement on regulation and tax information exchange. But there are things OFCs should do better:
Ensure their legislation, regulation and supervision meet accepted and implemented international standards.
More effectively implement and enforce existing financial services laws and regulations, anti-corruption and anti-money laundering laws and cross border assistance in civil, criminal and tax matters.
Increase transparency by enactment of holistic data privacy laws, by increasing the publicly available information regarding both regulated and unregulated entities and by increasing the statistical information obtained and published by their regulators and agencies.
Improve the delivery of innovative legislation and regulation, not just in financial services but also in areas such as intellectual property, technology, and medicine.
Improve (legitimate) intelligence gathering, lobbying and media relations, particularly in key centres such as Washington, London, Brussels and Paris to influence political and media perceptions, opinions and outcomes.
Embrace joint lobbying and actions by OFC governments to highlight the hypocrisy of many of the initiatives and to strive for a genuinely level playing field.
Sponsor and support think tanks, symposia/fora/conferences and publication of quality academic studies analysing the (beneficial) role of OFCs.
Ensure their infrastructure (eg, courts, telecommunications, ports, airports) is world class.
Improve their domestic ‘environment’ to encourage, facilitate and expedite the establishment of physical businesses and institutions staffed by top decision makers.
Ensure their public and private sector cost and fee regimes are competitive.
The number and wealth of global businesses, families and investors will increase over time and the greatest growth will be in the new worlds not the old world.
Global competition inevitably includes tax and regulatory competition. No-one has yet created the perfect tax or regulatory regime, so competing regimes (within broad agreed norms) are perfectly proper. Individuals and corporations are still entitled legally to maximise their wealth. Indeed, corporations have an obligation to their shareholders to do so.
Increased wealth will continue to make proper tax, estate and succession planning for global businesses, families and investors essential and lead to greater demand for tax advantaged/neutral and agreeable places to live and work with easy access to quality professional services and markets.
OFCs with high standards of sensible regulation, appropriate transparency, cross border assistance arrangements and good infrastructure while providing quality value-added services have a valuable and vital role to play in this scenario.
The barriers to entry as an OFC are ever increasing. The cost of developing the infrastructure and meeting international standards is significant and success cannot be achieved overnight or guaranteed. And there are probably now too many OFCs. Competition is increasingly fierce, and jurisdictions and structures are increasingly seen as fungible.
The survivors will be those who engage successfully, meet international standards, have an established infrastructure and track record (in all its aspects), tax efficiency, professional expertise and support services, a solid and diverse base of business, and the ability quickly to adapt and innovate in the ever changing global environment and to add real value to international transactions and capital flows in an efficient and cost effective way.
A number of Caribbean OFCs meet the tests for being survivors. But to thrive, they must learn better from history and from their (and others’) mistakes and work more effectively to be accepted as legitimate participants in the global financial world.
Timothy Ridley is a Cayman Islands attorney-at-law. He provides legal consulting and advisory services and acts as an expert witness in Cayman Islands legal and regulatory matters. He was for many years a senior partner of Maples and Calder, a leading offshore law firm based in the Cayman Islands. He is a member of the Disciplinary Tribunal Committee of the Cayman Islands Society of Professional Accountants (CISPA) and a member of the Board of Advisors of the Foundation for Fund Governance. He has taught law at the University of Southampton and at Trinity College, Cambridge and has served on the editorial boards of the Harvard International Law Journal and the Cayman Financial Review. He served as a director of the Cayman Health Service Authority (2002-2005) and as a director and chairman of the Cayman Islands Monetary Authority (2002-2008). He was appointed an Officer of the British Empire (OBE) in 1996 in recognition of his services to the financial services industry and the local community in the Cayman Islands.