Caribbean IFCs Come of Age, What's Next?

Monday, 9 September 2013 marked a significant milestone for the United Kingdom’s Overseas Territories (OTs) and Crown Dependencies (CDs).  It was the day that UK Prime Minister David Cameron stated in the UK Parliament that, given the significant steps the jurisdictions had taken with regards to regulation and compliance with international best-practice, it was no longer fair to label these international finance centres as ‘tax havens’.

In his declaration, Mr Cameron officially recognised the steps that the OTs and CDs have taken to ensure that they operate ‘fair and open tax systems’ and went on to emphasise the importance of these centres to the UK and, more widely, the global economy. 

This was an especially poignant moment for the Caribbean territories that, led by the British Virgin Islands (BVI), have for several decades been fighting to gain acceptance of their role as conduits in a dynamic, competitive global economy.

The growth of offshore and international financial centres is a corollary of a globalising world economy that has increased trade and boosted foreign direct investment in many countries, particularly in emerging and developing markets.  The positive impact on major, emergent ‘super’ economies such as China has also been profound.

Helen Hatton, managing director of Sator Regulatory Consulting Limited, who has been regulating financial services for close to 25 years in the Channel Islands and most recently the Caribbean, says that Caribbean centres such as the BVI and the Cayman Islands have carved out the biggest slice of this financial services demand.

Ms Hatton says: “The Caribbean jurisdictions have developed incredibly in terms of size, sophistication and capability, in terms of the economic contribution, and in terms of the integration and importance the economics of home state countries.”

She adds that it would be hard to imagine inward investments without the intermediation of offshore jurisdictions.  Well known, well-regulated Caribbean structures such as the British Virgin Islands Business Company (BVI BC) are used to raise financing in multiple jurisdictions to fund expansion and investments back into home state markets.

"[Offshore financial centres] are collection points for international assets.  People tend to focus on high net worth individuals and focus on the notion that money is removed and lodged offshore, but it is only the vehicle that owns it that is moved.  The real value is the way [OFCs] collect assets and funnel them into home state countries," says Hatton.

Supporting the Development of China

The authors of The Role of Caribbean Tax Havens and Offshore Financial Centres in Chinese Outward Foreign Direct Investment[1], support this premise and claim that an important yet unrecognised aspect is how international finance centres provide institutional support for the restructuring of business back into major economies such as China.

“Our results demonstrate that some of China's most dynamic companies extensively use offshore vehicles, typically involving dual structures in the CBVI [Cayman Islands and the British Virgin Islands] to tap international capital markets.”  Their sample showed that “capital raised outside of China is primarily to fund expansion back inside China,” thereby enabling Chinese companies "to circumvent imperfections in the domestic Chinese capital markets.”

Similarly, The World Investment Report 2012 notes that offshore financial centres have surged as significant destinations for foreign direct investment since the beginning of the global financial crisis in 2007; indeed, they have remained more significant than their pre-crisis levels.

For example, the BVI has become the second largest source of foreign direct investment into China after Hong Kong.  Between 1979 and 2011, US$1.2 trillion entered China in the form of foreign direct investment overall, and US$112 billion of this was channelled through the BVI.

It is this level of involvement in the global economy that underscores just how significant jurisdictions in the Caribbean have become.  Regional international finance centres have been among the world's leaders in providing offshore financial services.  Three jurisdictions, particularly, have dominated the financial services landscape and are considered giants in their respective sectors: Bermuda in insurance; the Cayman Islands in hedge funds; and the British Virgin Islands in business company formation and mutual funds.

Critics have accused most ‘offshore’ jurisdictions, particularly those in the Caribbean, of aiding and abetting individuals seeking refuge for nefarious activities.  Hatton's response is this: “The old arguments of offshore being based on secrecy and tax evasion are dead and have been dead for 15 years.  We have implemented international cooperation mechanism and properly compliant frameworks.  The International Monetary Fund (IMF) and Organisation for Economic Cooperation and Development (OECD) have assessed us and given us a clean bill of health, but the rhetoric continues.”

Tax, Transparency and Trade

In the global debates about tax, transparency and trade, the spotlight has been focused on the offshore finance centres with particular scrutiny of their business practices.

Kevin Higgins, author of Offshore Financial Services: An Introduction says the Caribbean centres are victims of their own success.  “We are getting so much attention because of how successful we have been - look at the wealth that has been accumulated.  The constant challenge is the countries from which we draw our clients will keep raising their standards to bring the investments back home.”

At the heart of the debate about international finance are the key themes of tax, regulation and transparency.  Much of the narrative has been co-ordinated and fuelled by the likes of the OECD, the IMF, the Financial Action Task Force, the European Union and other supranational standard setting bodies.  In response to international political demands, these bodies have been shifting the goalposts and raising the demands for offshore jurisdictions to comply.  These have been accompanied by scathing reports from other entities – including the media and NGOs - accusing IFCs of facilitating harmful tax practices, including allowing multinational corporations and the wealthy to shift their profits across borders to avoid or reduce tax burdens.

For the most part, offshore jurisdictions, particularly those in the Caribbean, have been able to keep pace with the rapidly moving goalposts to remain on the ‘white lists’ of jurisdictions that cooperate in international tax matters.  They have remained at the forefront of efforts around corporate transparency and continue to meet the requisite standards for anti-money laundering and counter terrorist and proliferation financing.

Over the past 20 years, for instance, the BVI has implemented the highest standards of transparency, accountability and information exchange, as set out by the OECD, the IMF and other supranational and regulatory bodies.  The extent and scope of this regulation, including on beneficial ownership, exceeds that found in most other jurisdictions – including countries in the G8.

Additional steps taken more recently by the BVI include being a committed participant to the EU G-5 automatic multilateral information exchange pilot; a commitment to enter into the Inter-Governmental Agreement with the UK to support automatic information sharing in tax matters; and a commitment to a US FATCA Model I Inter-Governmental Agreement.  The BVI has already stated it will in principle commit to joining the Multilateral Convention on Mutual Assistance on Tax Matters. 

Compliance by Caribbean centres, however, still does not appease their harshest critics, especially those from the tax justice camps and the big economic powers, including Britain, who find it convenient to cast blame on the IFCs for dwindling tax dollars in their national treasuries.  And although the global financial crisis was precipitated by actions and systemic regulatory failures in London and New York, they also find OFCs culpable there too.

As Robert Mathavious, MD and CEO of the British Virgin Islands Financial Services Commission, states: “What this all means for Caribbean financial centres is that they must redouble their efforts, never to be weighed in the balance and found wanting.”

As a measure to correct for the market inefficiencies, the United States, which taxes its citizens on their worldwide income, has passed perhaps the most sweeping tax legislation the world has ever seen with its Foreign Accounts Tax Compliance Act (FATCA) designed to find American tax cheats anywhere.

Other G8 countries are following suit and have called for international financial centres to sign on to a convention on the multilateral automatic exchange of information for tax purposes.  They have also been required to publish action plans on beneficial ownership.  Here too the British IFCs, like the BVI, have been quick to react.

Survival of the Fittest

Critics of the ‘big stick’ standard setters say international financial centres are capitulating too readily.  Professor Gilbert Morris, for instance, a regular commentator and expert on financial services, argues that their survival depends on them organising themselves and standing up to their aggressors.  Others predict that growing market efficiencies will naturally determine which jurisdictions will survive.  The strong will continue to grow and thrive, while the weak, less efficient will atrophy.

Instead of attrition, Higgins predicts that the next phase for international financial centres will be consolidation -- "companies are merging, becoming stronger and becoming more diversified in the services they offer, so too will the international financial centres that they use."

A recent report, Oil Offshore 2020 - Opportunities and Challenges Facing the Offshore Industry (2012), posits that financial centres that are consolidating existing advantages or repacking themselves in order to stay relevant will likely remain the most important in the market.  While this report outlines that the leading Caribbean centres can expect to see displacement from Hong Kong and Singapore, BVI and Cayman Islands will still remain among the top tier most important financial centres globally.  It stated: "Cayman Islands and BVI are so well entrenched, their structures and services so well-known and well used, that it would take a massive shift in client sentiment to displace them."

The same report ranked the BVI as the most important jurisdiction out of 26 jurisdictions, including power houses like Hong Kong, Singapore and Jersey.  Among the preferred jurisdictions for business purposes, BVI ranked first for asset protection and estate planning, special purpose vehicles, individual tax planning and investment holdings for corporations.

Indeed, competition is increasing – both on- and offshore – as countries try to replicate the successful business models of international centres.  Baron Laudermilk's analysis and predictions mirror those in the Offshore 2020 report, arguing: "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.”

He adds, however, that: "Those international financial centres that offer a broader range of services are better placed to handle global economic shocks than those that choose to remain in niche markets."

On this, most of the experts concur.

[1] Dr Dylan Sutherland, School of Contemporary Chinese Studies, University of Nottingham , Dr Ahmad El-Gohari, Cardiff School of Management, University of Wales Institute, Professor Peter J. Buckley Centre for International Business, University of Leeds and Dr Hinrich Voss, Centre for International Business, University of Leeds.

Elise Donovan
CEO