As the leading Caribbean IFCs grapple with the seemingly existential threat of regulatory sanctions that appear to represent a constantly moving target, the challenging conditions for financial centres in 2023 are only compounded by an uncertain economic outlook and an ultra-competitive market.
Competition between financial centres at a jurisdictional level has never before been so intense, with the rise of mid-shore centres such as those in Asia and established rivals from within the European Union like Dublin and Luxembourg. At the same time, after COVID lockdowns gave way to re-openings, the ‘new normal’ for firms operating in the key Caribbean IFCs, such as the Cayman Islands, Bermuda, British Virgin Islands and the Bahamas, has been one of price pressure, squeezed margins and tough competition for every deal.
New investment and further industry consolidation in sectors such as Trusts, Fund Administration and Governance services have helped this difficult environment flourish as the cost of compliance increases as fast as the complexity for the end users of these services, such as hedge fund managers, especially those still trying to get established in the business. To flourish in these conditions and support their clients who require a greater number of high-quality services, IFCs seemingly need to be all things to everyone.
Global Initiatives: More Of The Same
Of all the challenges ahead, the ongoing regulatory dance with such bodies as the FATF, OECD and European Union has the greatest potential for missteps. Having engaged with these standard setters for so many years, it is perhaps telling that – with the exception of Bermuda, which has just been removed from the European Union’s Annex (ii) Grey List having suitably demonstrated commitment to monitoring economic substance compliance requirements of resident companies – all of the other main Caribbean IFCs have been on the wrong end of these blacklists in the space of just the past few months.
Most recently, the British Virgin Islands was added to the EU blacklist as non-cooperative on tax matters for the first time, in February 2023, after the EU Council found it to not be in sufficient compliance with the OECD standard of information on request. That move took place just a few short months after The Bahamas was included on the blacklist in October 2022, when the EU raised concerns over the enforcement of economic substance requirements.
The last evaluation in October 2022 by the FATF of its Jurisdictions under Increased Monitoring, meanwhile, failed to remove the Cayman Islands from its Grey List, despite raised hopes in the industry that it would happen this time, amid the continued dialogue and engagement with the government. While it had initially come off the EU AML List in 2020, a new EU regulation in 2022 meant that due to Cayman’s position on the FATF list, it would again return to the EU AML List. As the industry lifts its hopes every six months for a reprieve from the FATF, it has now become a regular source of collective disappointment. The message from the FATF remains that more needs to be done, notably in demonstrating Cayman is capable of prosecuting all types of money laundering cases, consistent with its risk profile, with such prosecutions resulting in dissuasive, effective and proportionate sanctions. CIMA’s recent AML/CFT Activity Report (2021) showed the authority tabled fines of over CI$4.5 million during that year, including its largest fine against a trust and corporate services provider of CI$4.2 million. While CIMA’s now annual AML report does a good job in highlighting the many ways it is fighting potential money laundering activity, the FATF are clearly focused on prosecutions and fines in order to show the sector is being effectively policed.
ESG For IFCs
Without doubt, one of the most significant themes in global investment markets during 2022 was the rise to prominence of Environmental, Social and Governance (ESG) issues and it has been interesting to see the more progressive financial centres in our region attempt to integrate these factors into their offering. Greater awareness of social justice and the climate emergency has only accelerated these trends; and movements towards the implementation and financing of clean and green energy projects have become a greater priority, highlighted by the annual United Nations Climate Change Conferences.
More typically legislated for and implemented at the front-end of investment decisions, in terms of negative screening for companies involved in activities such as weapons or tobacco, or investments in carbon heavy companies, ESG funds and investments provide investors with comfort that their returns do not come at the expense of the planet. In this context, 2022 can be seen as the year when broader ESG issues such as diversity, inclusion and advancing society’s wider goals came to the fore for IFCs. Investors are not only concerned about the harmful activities coming from their capital, but also want to understand that the organisations they are partnering with share similar values on key issues such as biodiversity, adapting to climate change and human capital management, as well as more usual governance factors such as executive compensation and business ethics.
As the ESG theme has become more dominant, Caribbean IFCs are in a unique position. Not only are they at the vanguard of international finance as highly successful and innovative financial centres with the capability to address ESG in a meaningful way, these jurisdictions are also themselves dramatically exposed to the effects of climate change, being low-lying territories in a hurricane zone. The infamous comments by an HSBC ‘responsible investing’ banker that no-one would care if Miami was under six feet of water in 100-years were clearly coming from an extreme viewpoint, but Cayman, Bahamas and Bermuda are all similarly located and similarly facing a greater frequency of more intense weather events.
Bermuda’s moves to position itself as a global hub of climate finance and resilience collaboration will be interesting, particularly given its expertise in global risk transfer. Bringing together the collective minds of the reinsurance industry, an initial study coordinated by the Business Development Agency – Bermuda, has looked at how participants can improve their own ESG credentials, including office impact reductions and specific carbon offset policies, as well how climate change can be addressed by supporting technological innovation or funding academic research. The wider insurance industry is encouraged to adopt and embed the Principles of Sustainable Insurance. Reinsurers should establish their ESG risk appetite and embed negative externalities into their risk management approach.
Further west, the Cayman Islands is leveraging on its specialism in debt securities to advance shared global goals and capitalise on a trend, as the Cayman Islands Stock Exchange recently established a separate market segment for listing ESG investments. As a preferred exchange for the listing of CLO securities, the CSX aims to play a greater role in sustainable debt financings to help participants manage climate risk and create impact. CIMA also issued a supervisory information circular on ESG investing, highlighting the urgent need for investor education related to risks in this market segment, particularly with regard to data and establishing transparency and disclosure requirements. In terms of its expectations for governance in the industry, CIMA said at a minimum, there must be clear roles and responsibilities assigned in relation to climate change and other ESG risks in line with the fund’s set investment objectives. Funds are also required to ensure clear and ongoing disclosures in the context of their reporting requirements.
A private sector initiative on sustainability has also garnered some attention in the Cayman Islands, led by one of the jurisdiction’s law firms. The Chancery Lane Project is a collaborative community of international lawyers working to produce ‘green clauses’ that can be incorporated into commonly-used documents for investment structures. Led by Collas Crill, with more than 10 other firms joining the lawyers’ ESG working group, it is hoped that because of the sheer size of the Cayman investment fund industry, the initiative can make a meaningful contribution towards decarbonisation of the global economy. Proponents of sustainable finance in the BVI have also touted the jurisdiction’s advantages in structuring green bonds, particularly the flexibility of the BVI company and its relatively low administrative costs which allow more capital to flow through to sustainable projects.
Although the cryptocurrency sector has already gone through a number of bear markets in its relatively short history, the collapse in 2022 was unlike anything seen before. While bitcoin fell around 65 per cent during that calendar year, that was merely collateral damage compared to the collapse in a matter of days of crypto exchange FTX which had previously been valued at US$32 billion. With its headquarters and international operations located in the Bahamas, regulated under the Digital Assets and Regulated Exchanges (DARE) Act, the response from the Securities Commission of The Bahamas was going to be closely watched from around the world to assess any fallout to the fledgling digital assets industry and the sector’s role in the future of the region’s financial centres. Seen as an enthusiastic early adopter in legislating for digital asset companies, much like Bermuda, the Bahamas also viewed the sector as an opportunity to reclaim lost ground in the financial services industry, in addition to providing some form of mechanism for Bahamians to share in the benefits of its growth, through employment and investment opportunities. Clearly the events of last year were not foreseen, particularly the scale of the questionable internal management practices, however the Securities Commission’s action to seize US$3.5 billion of FTX crypto assets can certainly be seen as a decisive step.
The British Virgin Islands meanwhile recently enacted its Virtual Asset Service Providers (VASP) legislation, which brought a number of previously unregulated activities involving virtual assets to now require licensing. The registration and supervisory framework is generally seen as balanced without additional requirements that may stifle growth, providing confidence and certainty on ownership and identifying digital assets. The Cayman Islands continued with a more cautious approach in this space although its efforts are still moving forward, with 18 Digital Asset Service Providers registered by the Cayman Islands Monetary Authority as of 31 December 2022 and several more understood to be in the pipeline.
The crypto industry’s ability to bounce back from severe retracements in the past is fairly well tested now, so these highly developed digital ecosystems that have emerged within our IFCs are well placed to support continued innovation and institutional adoption. On the flip side, technological advances have of course brought the associated risk of cybercrime and the need to be ever vigilant. It is well understood that smaller financial centres face an increased threat to these attacks, due to the size of the companies involved having less resources for protection. Demonstrated resilience to the threat of cybercrime can be another key differentiator between Caribbean IFCs going forward.
Paul Byles is Director of FTS, a Cayman Islands compliance and management consulting firm and founder of the Cayman Islands Financial Services Institute. 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'.