Caribbean At The Crossroads: Climate Change And Geopolitics Give IFCs Tough Choices

 

Caribbean international finance centres find themselves at a pivotal moment. Many of the factors that will most impact them lie outside their control. To take one example, the islands are especially exposed to the impacts of the climate crisis, although they are neither large polluters themselves nor significant enough geopolitical players to have a sizeable impact on the pollution levels of other countries. To take another, the finance centres are dependent on volatile international financial flows, which contract and expand based on global economic factors. Nevertheless, some important decisions are within their control. If the islands cannot control global finance’s development, they can choose how to respond to it; if they cannot wholly control the climate, they can vigorously promote environmental finance and tourism practices.

Rising Tides Or Rising Sea Levels?

Amidst the azure water and vibrant culture, the Caribbean is exposed to the escalating challenges brought by climate change. The sixth anniversary of Hurricane Irma is stark reminder of the importance of striking a harmony between the region’s economic and environmental sustainability. Although the whole world is grappling with the profound impacts of rising temperatures, rising sea levels and extreme weather events, these island hubs are ground zero for such catastrophic threats – low-lying and coastal communities are some of those most at threat from climate change. Rising sea-level predictions are projected by NASA using varying levels of future greenhouse gas emissions. At very low levels of greenhouse gas emissions, sea-levels are projected to rise by half a metre by 2130. However, at intermediate and very high levels of emissions, sea-levels are projected to rise by half a metre before the end of this century.

According to a 2018 report, roughly a million people in the Caribbean basin live within a metre of the high-tide line[1]. The Bahamas is especially vulnerable, with a quarter of the population living below half a metre above sea level. With NASA predicting sea level rises above this (at intermediate, high, and very high levels of future greenhouse gas emissions) before the end of this century, people in the region cannot see climate change as a problem only for future generations. Furthermore, Atlantic extreme weather events are becoming more common. Warming oceans make tropical storms and cyclones both more likely and more damaging when they do happen, and small islands are the most at risk.

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The economic sustainability of the islands is inherently tied to the impact of climate change. The Caribbean benefits from abundant sunshine throughout the year, and possesses historical connections to both North America and Europe, which contribute to their appeal as an enticing holiday destination. Including indirect and induced impacts, Pragmatix Advisory estimated that tourism’s contribution to the economic output of some Caribbean islands ranges from less than ten per cent to more than 80 per cent of gross domestic product. However, the tourism industry in the islands, and the jobs that rely on the visitor economy, are threatened by the risks of climate change.

While climate change poses significant risks to the region, the international finance centres have opportunities in the realm of international sustainable finance. In our Beyond Globalisation report which focusses on the British Virgin Islands, we highlight that changing attitudes and demand for conscious investment and reporting have the potential to cause a major shift in transnational investment[3]. Sustainability is increasingly factored into corporate decision-making, with companies and organisations using environmental, social and governance scores to assess the ethical and sustainable impact of investments. Long term investment in sustainable projects has increased as a result. The global market for sustainable investments is set to grow exponentially, driven by socially and environmentally conscious investors.

Sustainable exchange-traded funds (ETFs) have experienced remarkable growth, with over 250 funds added to global stock exchanges since 2010. The assets under management in sustainable ETFs have grown significantly, now exceeding twelve times their value in 2010. In 2019, sustainable investments reached between US$3.8 trillion and US$12.5 trillion, with up to US$10 trillion subject to sustainability-focused strategies led by activist shareholders. Sustainable investments outperformed global funds during the pandemic, delivering an average return of 22 per cent in 2020 compared to 13 per cent for all global funds. While currently dominated by European investors, there is a potential shift expected in the coming decade, with investors in the United States and other regions surpassing those in Europe.

The region’s finance centres have a unique opportunity to be at the frontline of the rapidly expanding market. As centres for evolution and innovation in the past, international finance centres are ideally placed to meet growing demand for environmental, social and governance investment and reporting. They can use their status as neutral locations with well-established asset holding vehicles which are already attractive to traditional investors and combine it with a bona fide passion for green policy. The Caribbean’s genuine anxiety at the prospects of climate change will fit well with the upcoming wave of ESG investors who are demanding greater alignment of their values and ethics across the entire value chain. This attitude comprises of both a hostility to greenwashing and an interest in not only the destination of their investments but also how, by whom, and where the investments are managed, administered and located.

Competing Caribbean Interests

However, the development of environmental, social and governance finance markets will itself depend on the development of international finance. Commercially as well as environmentally, the finance centres are at an intersection of international interests, with pressures from different directions. Their historic links with Europe incline them one way, toward policies of increasing regulation, but for many, the makeup of their current client bases pushes them in another direction. Considerations of future opportunities may add further complications. So far, the Caribbean has been able to prosper from straddling the continents and their different interest groups despite the differences in the outlooks. Continuing this would likely be their preference. However, if the paths of these groups of interest diverge sharply, the international finance centres may have to make some tough decisions.

Historic ties are not mere tradition for the islands’ finance centres. The United Kingdom Overseas Territories (including Anguilla, British Virgin Islands, Cayman Islands, Montserrat and Turks and Caicos) all retain constitutional links with the United Kingdom – for each, King Charles is the head of state, and the highest court is the Judicial Committee of the Privy Council, largely comprised of British Supreme Court justices and other senior judges from the Commonwealth. Curacao and Aruba are constituent countries of the Kingdom of the Netherlands, and as well as sharing a head of defence and foreign affairs representation with the Netherlands, the final court of appeal is the Hague. The United States Virgin Islands is a federal territory with the Supreme Court in Washington its highest court of appeal.

Arguably, these jurisdictions’ constitutional connections with Western powers increase perceptions of stability. Large, developed states backing the finance centres could assuage concerns about the investment security. Furthermore, clients of the finance centres may be comforted by the thought that the highest courts of appeal (should business go bad) would be in places like Parliament Square in Westminster. Traditionally, these institutional links have been reinforced by financial ones, with Eurodollar markets providing the main source of finance for the Caribbean international finance centres. Nassau, one of the first international finance centres in the region, had as their first clients wealthy Europeans in the inter-war periods trying to avoid recently increased taxation[4]. The predominance of historic Western funding is indicated by the preponderance of European and American financial institutions branched in the area – in 1991 there were 400 US bank branches in the Bahamas alone, and while Cayman Islands domicile two thirds of global hedge funds by number and assets, 70 per cent are managed by US managers and a third administrated by US administrators.

However, the history of the clients of the finance centres shows that Western business is no longer the only concern of Caribbean finance. For example, most British Virgin Islands Business Companies have ultimate beneficial owners in Asia, with 44 per cent located in China (including Hong Kong and Macau). British Virgin Island structures are increasing in popularity in the Middle East, which has seen five per cent growth in finance markets between 2018 and 2021, largely due to the compatibility offered for different legal structures. Meanwhile, the Cayman Islands represent the single largest market for Foreign Direct Investment from Brazil, with $26 billion invested relative to a $3 billion domestic economy in 2017. In the same year, Chile had $7.5 billion invested[5]. Cayman has also increasingly developed close ties with China – in 2020, researchers estimated that over 50 per cent of all equity in low-tax jurisdictions was represented by Chinese companies in the Caymans[6].

The Future Of Finance

Recently, the Caribbean international finance centres have been successful in providing services to both Western nations and rising players like China, the Middle East, and South America. This success means that the British Virgin Islands, for example, has a more geographically diverse source of assets than a European finance centre like Luxembourg.

However, given recent geopolitical developments, it appears this business model might not be sustainable in the long run. In our report on the British Virgin Islands, we sketched out three scenarios for how the geopolitical order might develop: Weak internationalism, new economic nationalism, and the bloc economy.[7] These three scenarios would affect how finance within the Caribbean islands develops in very different ways.

In the weak internationalism scenario, trends would continue as they did pre-Covid, albeit more slowly. The global economy will continue to grow gradually but steadily, and though regulation would develop, the Caribbean finance centres would be able to continue selling their products to clients across the world.

In the new economic nationalism scenario, countries would put in place strong protectionist policies and international trade would be sharply reduced. Paradoxically, this would likely benefit the islands’ international finance centres in the short term. There would still need to be some international business, and tax neutral jurisdictions would become even more attractive as places to do such business were there to be a breakdown in free trade agreements and double taxation agreements, because they have expertise in complex cross-border transactions and they would minimise the transaction fees for companies wishing to engage heavily in international trade. However, in the long run, the reduction in growth caused by the lack of global trade would reduce their income.

In these two scenarios, the role of the international finance centres is prescribed. They do not have the economic clout to divert the course of globalisation, and in both cases, there is a clear course of action that would be best for them to take. Given both weak internationalism and new economic nationalism, continuing to try to straddle a varied international client base seems like the obvious choice. However, in the third scenario, there would be a substantial decision to be made.

The final, ‘bloc economy’ situation sees the world separating into semi-autonomous international regions, with a high degree of economic regulation and political integration within blocs, and low coordination between them. International finance centres may find it hard to maintain simultaneous access to increasingly opposed regimes – indeed, the divergence of standards and regulations between the United States, China and the European Union is already posing the industry tough questions about how to serve these markets. Though America and Europe have often presented themselves as having aligned interests, a widening divide on tax and transparency between Washington DC and Brussels is driving a wedge between long-established markets. The danger in such a regionalised world is that the offshore centres (and potentially individual businesses) must, in effect, align to one bloc – at the expense of access to others.

Choosing A Path

In such a bloc scenario, the international finance centres would presumably prefer to act as inter-bloc traders, somewhat similar to their role in the new internationalism scenario. However, if trading between blocs was scarce, the Caribbean finance centres would be forced into deciding which bloc to side with. In the scenario we lay out, the economic blocs the Caribbean international finance centres could join are: Europe and the United Kingdom; the United States; China; India; Other emerging Asia; and Rest of the World.

The benefits of siding with the United States would be clear – geographic proximity, developed nation status, and a looser regulatory environment than could perhaps be had with Europe. Equally clearly, China offers yet looser regulatory demands, and a higher growth rate, although a less similar culture. Aligning with the Other emerging Asia or Rest of the World blocs could anticipate the rapid rates of economic growth expected from Middle East or Africa.

How might Europe appeal to the finance centres? Firstly, the historic ties of the islands with Europe have often served them well. Appealing to shared history, the cultural and constitutional links may create a presumption in favour of sticking with what the finance centres know.

Secondly, though the regulatory environments Europe proposes are more stringent in the short term, they would argue that compliant jurisdictions will be better future-proofed. Paying attention to environmental, social and governance factors when investing is not only an ethical preference – it can also be prudent business. Poorly governed companies will become corrupt and badly run; not considering social impact will create advocates to militate against you; ignoring environmental impacts is a sign of short-term thinking. As discussed above, the vulnerability of the Caribbean to climate change is likely to make the islands particularly receptive to countries which take environmental concerns seriously, as is consensus politics for much of Europe.

The Caribbean international finance centres are at a crossroads, with different paths offering different things, and conflicting reasons for which one to choose. Parties with interests in how the Caribbean islands choose should recognise the position they are in, and the alternatives they have. Pressure without engagement will not ensure positive change.

 

1 Inter-American Development Bank, Sea-Level Rise Threats in the Caribbean Data, tools, and analysis for a more resilient future., (Inter-American Development Bank, Princeton, New Jersey), 2018 Available at: https://sealevel.climatecentral.org/uploads/ssrf/Sea-level-rise-threats-in-the-Caribbean.pdf (Accessed: 01 August 2023).

2 NASA, NASA Sea Level Change Portal, NASA. Available at: https://sealevel.nasa.gov/ipcc-ar6-sea-level-projection-tool?type=global, (National American Space Agency, Washington, D.C.), 2023  (Accessed: 01 August 2023).

3 Pragmatix Advisory, Beyond Globalisation (BVI Finance, Road Town), March 2023

4 Tooze, A., The hidden history of the world’s top offshore cryptocurrency tax haven, Foreign Policy., 15 January 2023, Available at: https://foreignpolicy.com/2023/01/15/the-hidden-history-of-the-worlds-top-offshore-cryptocurrency-tourist-trap/ (Accessed: 01 August 2023).

5 Fichtner , J. , LSE, The Cayman Conundrum: Why is one tiny archipelago the largest financial centre in Latin America and the Caribbean?, LSE Blog., (London School of Economics, London), 13 November 2017 Available at: https://blogs.lse.ac.uk/usappblog/2017/11/11/the-cayman-conundrum-why-is-one-tiny-archipelago-the-largest-financial-centre-in-latin-america-and-the-caribbean/#:~:text=It’s%20the%20Cayman%20Islands%2C%20a,Caribbean%20just%20south%20of%20Cuba. (Accessed: 01 August 2023).

6 The New York Times, Chinese companies are doing risky business in the Caribbean, The New York Times., (The New York Times, New York), 9 March 2023 Available at: https://www.nytimes.com/2023/03/08/opinion/china-tax-haven-shell-companies.html (Accessed: 01 August 2023).  

7  Pragmatix Advisory, Beyond Globalisation (BVI Finance, Road Town), March 2023