The global financial services industry – and, in particular, International Financial Centres (IFCs) – are evolving at a rapid and accelerating pace. Changes in global standards and regulatory requirements are changing alongside needs and expectations of market participants to create a very different playing field. That new environment will pose significant challenges for many of today’s IFCs that lack the strong foundation necessary to keep up with the pace of change.
IFCs of the future are likely to look very different than those of today and there are likely to be fewer of them. Given the vagaries the market is undergoing, to be one of those future IFCs, jurisdictions will need to exhibit five key characteristics:
• a tax neutral regime;
• trusted, expert legal framework and regulations;
• demonstrated commitment to global standards;
• leadership in FinTech, among a range of diverse sectors; and
• world class professionals and credibility.
Some IFCs such as the Cayman Islands have already made significant progress toward developing these characteristics. Leading institutional investors are responding to that leadership with a flight to quality that will increasingly draw in investment capital.
Tax Neutral Regime
The era of Double Tax Treaty (DTT) investment hubs is coming to a close. The Double Tax Treaty system is complex and frequently opaque which can increase investors’ concerns about risks and certainty, as well as the administrative costs for compliance. The threat from double taxation remains, but IFCs’ use of DTTs to alleviate it will increasingly fail to meet new requirements for transparency and economic substance.
In contrast to Double Tax Treaty investment hubs, a tax neutral regime eliminates the threat of double taxation in the most transparent way possible. This policy automatically alleviates double taxation by allocating all of the taxing rights to an investor’s or parent entity’s home jurisdiction. That home jurisdiction is then free to impose its domestic tax policy on the cross-border transactions or subsidiary’s retained profits as it sees fit, without the need for a DTT. Unlike a Double Tax Treaty, a tax neutral regime – including a zero corporate income tax rate – also transparently provides the same stated and effective tax rates.
The transparency and efficiency of such a regime will increasingly be seen as a superior model that more closely aligns with global standards and market demands. The Cayman Islands has always had this kind of regime and others may work to emulate it as it becomes a more defining feature of IFCs of the future.
Trusted Legal Framework & Regulations
Adopting a more transparent and efficient tax neutral regime isn’t as simple as passing a few new tax laws. Although the policy itself is based on simplicity, it requires a legal and regulatory framework that investors trust to hold up to regulatory scrutiny and the demands of a complex and fast-paced global market.
Investors and global standard-setters in the future will be evaluating whether a jurisdiction has specialised laws that adequately address the complexity of global financial services and judicial officials with the necessary knowledge and proficiency. Those leading global investors must have absolute confidence that a jurisdiction’s legal system is fair, honest, transparent, and experienced if they are going to entrust millions, billions or ultimately trillions in investment capital to its safekeeping.
The Cayman Islands has set an illustrative example, maintaining the use of UK common law and the ultimate appellate court of the UK Privy Council. While this is true for a number of IFCs, decades as a leading IFC have provided Cayman’s legal and judicial practitioners with a leading level of expertise on complex financial services transactions, laws and regulations.
Even for existing jurisdictions that benefit from solid legal systems, expanding the necessary skill capacity among judicial, legislative and regulatory officials to keep current with changing demands requires long-term focus and investment. Many will be unable to keep up and investors can be expected to quickly adjust their focus accordingly.
Demonstrated Commitment To Global Standards
Among the most rapidly changing developments that will impact IFCs of the future are global standards and expectations. Leading global standard setters like the OECD and jurisdictions like the United States and the EU are pushing for changes in requirements on tax and economic substance that will significantly alter the global financial services marketplace.
Jurisdictions without an existing foundation of a demonstrated commitment to global standards will struggle with both the pace of change among those standards as well as a level of trust in their ability to adhere to them.
The Cayman Islands has spent decades developing a widely-recognised commitment to global standards. Most recently, Cayman went through a thorough review with the European Union which resulted in updated legislation that meets OECD and EU economic substance requirements. Cayman was assessed by the EU as a cooperative jurisdiction on tax good government principles and the recognition that the jurisdiction poses no risk of unfair tax competition. This kind of outcome would not have been possible without the firmly established commitment to global standards that already existed with government and industry which was reflected in Cayman’s legal and regulatory foundation.
Leadership In FinTech Among A Range Of Diverse Sectors
Perhaps no sector illustrates the pace of change in the market – and the challenge for IFCs to keep up with that change – more than FinTech. FinTech is revolutionising financial services through the rise of digital assets, cryptocurrencies, blockchain and similar technologies. At the same time, the new technologies present potential problems for both investors and authorities: how to permit an appropriate degree of transparency to allow people to know who they’re doing business with and also allow law enforcement and tax authorities to prevent crime and collect revenue.
The pseudo-anonymous nature of FinTech broadly, and cryptocurrencies more specifically, do give rise to an increased risk of money laundering and even terrorist financing. Many tokens used in FinTech processes today are like bearer shares of past decades – anonymous and portable. These developments represent a potentially systematic threat to global financial services. Providing the benefits of innovation and the protection of an appropriate regulatory structure requires smart FinTech regulation that can strike the right balance.
Achieving this kind of balance between privacy and transparency will be a game changer for the use of FinTech around the world and especially within the funds industry and among larger institutional investors. For example, high quality digital tokens could then be issued by funds and could be listed on digital exchanges and traded by investors with globally certified digital IDs, thereby creating liquidity and stickier capital for fund managers.
Attracting FinTech companies and keeping current with FinTech changes in existing sectors will be an enormous challenge that neither government nor industry can achieve alone. The Cayman Islands has embraced a collaborative approach. Government and industry are working together to create a legal and regulatory regime that supports innovation to fuel successful FinTech development, while it incorporates the commitment to anti-money laundering transparency and cross-border sharing of information with tax and law enforcement authorities into the legal and regulatory regime.
That approach has established the Cayman Islands as one of the leading jurisdictions not only for FinTech but also a diverse set of financial services sectors. This will also become a defining requirement of IFCs of the future if they are to remain competitive. Large institutional investors will increasingly demand the efficiency that comes with accessing a range of financial services sectors in a single, neutral location. Strong, long-term success for IFCs comes through going beyond simple diversification within industry sectors to leading in multiple sectors, as the Cayman Islands does.
World Class Professionals And Credibility
None of these other characteristics will be possible without attracting and retaining top professional talent. This is not only one of the most important factors in the success of IFCs of the future, it is also among the most difficult factors to replicate.
To attract and retain world-class professionals, IFCs must demonstrate a commitment to creating an environment in which smart, hard-working professionals want to work, live, and raise families. The Cayman Islands, for example, makes strategic investments to provide an outstanding quality of life for them and their families through world-class infrastructure, health care, education and culture. These investments pay off with a knowledgeable and committed workforce that has the expertise to provide leadership in a rapidly changing environment.
IFCs have always had to evolve to keep pace with the competitive demands of the market. However, the intensity of those demands and the speed at which the market and standards environment are changing is greater than ever before. Some IFCs, like the Cayman Islands, are better positioned to adapt to those changes due to investments made in previous decades to lay the groundwork for growth. Success in focusing on the core characteristics outlined here will define which IFCs emerge from this period of uncertainty to serve the global financial services industry of the future.
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