There are many reasons why the Cayman Islands remains one of the world’s most vibrant offshore financial centres. CEO of Cayman Finance Gonzalo Jalles lists 10 reasons he believes it has retained this position against intense competition.
The demise of offshore centres, particularly the Cayman Islands, has been predicted countless times over the years, especially with each new global transparency initiative. And yet Cayman continues to succeed.
The business of the so-called ‘offshore centres’ has evolved over the years. Unless there is an (unlikely) move out of a globalised economy the services provided by international finance centres (IFCs) such as Cayman will continue to be needed.
I believe that Cayman has 10 characteristics that no other jurisdiction in the Americas can claim to have all of, and I’ll outline how they are unique in positioning Cayman ahead of its competitors.
1. The legal and judicial framework: a vital characteristic
Investors looking to co-invest with foreigners or to deploy capital outside their home countries see the exposure to a different legal and judicial system in which to establish and enforce their rights an added risk. This is without doubt the key driver of an IFC such as Cayman—the provision of a legal framework that is acceptable to all parties involved in the transaction.
Without doubt the use of English common law and statute, and English-style courts are the preferred standard in the vast majority of all international transactions, and for that reason most of the successful centres are Crown Dependencies or Overseas Territories of the UK. In the case of the Americas, Cayman, British Virgin Islands and Bermuda are all Overseas Territories, putting them one step ahead of other centres such as Panama, the Bahamas or Barbados.
A sound legal system independent of the UK could be a viable alternative provided that other key drivers are present and strong enough to compensate.
2. Political stability
Changes in the political landscape can affect the viability of an IFC at a higher speed than any other factor, from extreme cases of property confiscation, independence and therefore change in legal framework, to a different approach to rules that affect some of the key factors needed by the financial industry.
Over the years changes in the political approach to accessibility to the international labour pool have driven the relative success of the major centres in the Americas, with the Bahamas being probably the highest profile example of how a political change can promote the movement of a whole industry from one jurisdiction to another.
Countries that demonstrate a long history of commitment to the democratic institutions and little social pressure to change the political landscape (such as discussions about independence) are better positioned in this regard. Cayman is without doubt ahead of its key potential competitors in this area, including the other major UK territories in the region.
"Cayman is currently running a surplus, and this has been recognised by its retention of its credit rating at the same level it was before the 2008 crisis."
3. Access to human capital
The availability of foreign labour to local financial services providers is one of the ways in which local firms can access the required human capital with the necessary skills. It is also essential to the sustainability of these centres that the local population is given a fair opportunity to train themselves and gain access to the industry.
The key issue that these centres continue to deal with on an ongoing basis is the definition of ‘fair’. While the desire of every politician is, and should be, to ensure that citizens have access to the best jobs available, this must be balanced with the reality that the international clientele being serviced will necessarily look for the best service providers in the international marketplace, wherever they may be located.
The challenge is that many of these centres have, by definition, relatively small indigenous populations and no matter how much is invested in education and career development opportunities, the need to access international talent will continue to exist.
The past has shown how excessively restrictive immigration policies can have a significant negative effect on the prosperity of the financial industry. Experiences such as those of the Bahamas and Bermuda are not to be repeated.
In many cases the political reasons for imposing restrictions on the importation of human capital have to do with the indirect consequences of ongoing population growth, such as the rising costs of living and residential property.
4. Availability of land
Many IFCs have geographical restrictions on the way they can manage growth. In some cases these jurisdictions have seen their architecture radically changed (eg, Hong Kong); in others the desire to preserve their physical beauty has limited the growth of the industry by forcing companies to outsource significant parts of their operations, or by creating policies that limit their ability to provide the level of service locally that is expected by the international market.
Without land the social cost of growth is high, and without growth the countries find themselves faced with typical fiscal and economic problems. Cayman is uniquely positioned in this regard vis-à-vis all the other Overseas Territories in the region.
5. Critical mass
The international standards of regulation have seen an unprecedented growth over the last 20 years, and there is nothing indicating that this trend is likely to reverse any time soon. This growing regulatory standard acts as a barrier to entry for new jurisdictions.
Without the critical mass to support the regulatory framework needed to comply with international standards, some centres will find themselves falling short and unable to offer their products, or imposing taxes, fees and duties that effectively price them out of these markets. Both Cayman and Bermuda have achieved critical mass, while other centres in the Americas are likely to face a challenge of increasing government costs to cope with the increasing global regulatory pressures.
Bermuda is currently struggling with its fiscal position despite its critical mass. Careful management of government expenditure and understanding the volatility inherent in fee-based revenue from the financial industry is essential.
6. Credit quality and the fiscal situation
While these jurisdictions usually act as a conduit for funds between the investors and the destination of the investments, the credit situation, summarised by the credit rating of the country itself can add a layer of risk, and as such the fiscal situation is pivotal.
Cayman is currently running a surplus, and this has been recognised by its retention of its credit rating at the same level it was before the 2008 crisis, while other places such as Bermuda and Barbados have seen a deterioration of their credit quality.
Furthermore, in many cases during recent history and in particular since the 2008 crisis, governments in these centres have responded to a reduction in revenue due to a lower volume of business by increasing prices. While this is neither a sustainable strategy, nor one a private business would make in a perfect market, the true global characteristic of the recent crisis has been such that all centres found themselves in a similar situation with similar responses, validating such counterintuitive measures. Going forward, these jurisdictions need to ensure the cost of running the government remains under control in order to remain competitive.
Cayman has maintained its government cost control assisted by the limitations imposed by the UK government; Bermuda did not have these limitations and is currently struggling with the consequences. It is crucial that this cost control environment becomes embedded in the political system in a way that can be continued for the foreseeable future.
7. The government’s revenue collection system
In order to operate as a facilitator of international capital flows, financial centres need a government revenue collection system that facilitates those flows without taxing them on a variable basis.
Such jurisdictions are often wrongly considered ‘tax free’ or ‘tax havens’—I’m not aware of any such place. All governments need revenue to pay for the services they provide, and these jurisdictions have a government cost base per capita that is comparable and many times greater than that found in traditional economies. Taxes, fees and dues that are paid by the financial industry, directly or indirectly, pay for part of these expenses.
It is crucial that the collection system is properly structured to avoid discouraging these important flows. In order to achieve this, most of these countries have concentrated their taxes on consumption, which is one of the less distortive taxes and the less damaging to economic growth, as Cayman did. Others have chosen to tax labour, discouraging the growth of companies with a physical presence on site (Bermuda) or to have differentiated tax rates for local and international businesses, a practice that has been discouraged by some intergovernmental bodies (Barbados).
These countries, as does any business, need to be accessible to their customers. Location is the first obvious measure of accessibility, particularly in terms of time zone, which can easily explain the correlation between centres in the Caribbean and ‘Americas’ business.
The direct short flights from major hubs in the US that Cayman and Bermuda enjoy are clearly a positive factor.
However, accessibility should also include language, the ability to communicate effectively with the end users, and culture. Successful centres must have diverse yet cohesive societies—an essential part of attracting international businesses. In my experience, Cayman is positioned one step ahead from the other centres in the region in this regard.
All successful centres have a high dependency on the financial services industry; they also have limited natural resources, which has meant lack of alternatives promoting a focus on developing this industry. Lack of alternatives is not an ingredient in itself, but the focus it promotes is. Financial services is a highly competitive global market and these jurisdictions need to remain agile and responsive to customer needs in terms of products, legislation and regulation. Financial services represents more than half of Cayman’s GDP and government revenue, ensuring it receives the attention needed for its continued success.
10. Appropriate regulation
Remaining agile in today’s world means that the regulator needs to perform a constant balancing act. It is vital for IFCs to remain compliant with international standards. However, they need to avoid getting too focused on duplicating the regulatory initiatives of other regulators without understanding the effect that these proposed changes would have on their customer base, the local financial industry.
Indeed, a common characteristic during successful growth of these financial centres is a level of communication between the regulator and its industry that may be considered excessive by other regulators. Some regulators may feel uncomfortable with this fact. While it is essential to ensure the independence of the regulator in its oversight capacity, it is crucial that it sees the industry it regulates as its customers and understands that a vital part of its role is advancing the overall wealth of the economy.
Historically the Cayman Islands Monetary Authority (CIMA), the Cayman regulator, has successfully navigated the changing landscape while maintaining this equilibrium.
The increase in transparency and regulatory burden is likely to generate a consolidation and decrease of the number of jurisdictions conducting this type of business.
Cayman is uniquely positioned in the Americas to remain the undisputed leader in the funds industry and become the leader in others, with one or two other jurisdictions remaining as competitors.
Cayman’s financial industry will remain committed to its key role in the global financial industry, playing within the accepted set of common rules.
Cayman’s current business is not built around any lack of transparency and we will continue to support our government in ensuring we promote a level playing field and do not fall short of globally accepted standards.
We believe in sharing information with the appropriate authorities and through the appropriate channels in a way that respects the right of confidentiality without facilitating tax evasion or any other wrongdoing by our customers.
We believe in facilitating the enforcement of laws by other countries and preventing abuse through a simplification of those rules—as opposed to becoming the enforcer of global laws or relying on a moral duty to determine the appropriate level of tax to be paid.
We respect the right of other countries to determine and enforce their tax systems, as we expect other jurisdictions and multilateral bodies to respect ours.
Gonzalo Jalles is the chief executive officer of Cayman Finance. Formerly the CEO of HSBC Cayman, Jalles founded his own financial services consulting company, Javelin Group. He has also served as president of the Cayman Islands Bankers’ Association from 2009 to 2012. He can be contacted at: firstname.lastname@example.org
Gonzalo Jalles, Cayman Finance, Legal Framework, Political Stability, Human Capital