A safe harbour

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The world is full of cities and smaller nations staking a claim to be the next big thing in finance. They know they haven't got a hope of toppling London, New York, Singapore, Hong Kong and other locations from the top of the first division of international financial centres - or of even getting into the first division. But many of them make a good case for being taken seriously as emerging regional financial centres and upsetting the order of things further down the table.

Malta is among those challengers as the smallest EU member. But in financial centre terms, it punches well above its weight - and seems to deserve the use of that well-worn cliché, as various surveys attest.

The World Economic Forum's Global Competitiveness Report 2009/10 ranks Malta 52nd among 133 economies. For financial market sophistication it ranks it 13th, up from 34th in the previous year. Malta is in 15th place for strength of regulation of securities exchanges, 13th for soundness of the banking system, and 12th for strength of auditing and reporting standards.

The European Commission's Internal Market Scoreboard, published last year, ranked Malta and Denmark in joint first position for implementing internal market directives, demonstrating not only Malta's efficiency in transposing European rules into domestic law, but also that its economy has rapidly integrated into the EU in the six years since it joined.

The country is also one of the top five EU performers in terms of foreign direct investment inflows as a proportion of gross domestic product (GDP). In addition, it is among 40 countries that were praised by the Organisation for Economic Co-operation and Development (OECD) for "substantially implementing" internationally agreed tax standards - a major achievement for Malta which has long fought for this recognition and which immediately placed it on the OECD's 'white list' of countries complying with tax co-operation and exchange of information.

Malta made huge efforts to raise its game in the 1990s as it introduced reforms in preparation to join the EU. By the time it joined the EU in 2004 it had created a sound legislative and regulatory framework compliant with EU economic and financial practices, and it adopted the euro in 2008.

But how big, exactly, is Malta's financial sector? No matter how good a financial centre looks on paper, unless it has enough critical mass it is never going to make much of an impression on the international scene. The truth is, it is small. But it is making a fair amount of noise in the Mediterranean, marketing itself as 'a stepping stone between Europe and north Africa'.

Growth target

Finance and related administrative services account for about 12% of Malta's GDP, and employs between 6000 and 7000 people. The government's ambition is for the financial sector to account for 25% of GDP by 2015.

A former British colony, the country has 24 banks, 15 other financial institutions providing banking services but not licensed to take deposits, about 40 insurance companies, 401 funds, 81 fund managers and 13 fund administrators. The quality of the country's system of financial regulation, and the accessibility and flexibility of the Malta Financial Services Authority (MFSA), are often cited as reasons for locating there.

When presenting to potential foreign investors, finance minister Tonio Fenech quotes Ernst & Young's 2009 European Attractiveness Survey, which measures outsiders' most significant perceptions of Malta. Top of the perceptions list comes the quality of the workforce, especially its productivity and the fact that English is the joint official language with Maltese. Other positive attributes mentioned in the survey are Malta's membership of the eurozone, quality of life, telecommunications network, political system, corporate tax rate, geographical position, legislative environment and labour law flexibility.

FinanceMalta, a public-private partnership that promotes the country to foreign firms, has been working flat out since it was created in 2007. "Our target market includes financial and credit institutions, funds, insurance companies and family offices," explains Kenneth Farrugia, its chairman. He is also chief officer for Valletta Fund Services, the fund administration division of Bank of Valletta, one of Malta's two biggest banks.

FinanceMalta's modus operandi includes influencing 'gatekeepers' - accountants, law firms, consultancies - to offer Malta as an option to clients looking for an international jurisdiction to place their business. But how can Malta compete against all the other financial centres, many of which may be physically small but already have sizeable financial sectors and giant reputations?

"Well, as they say, small is beautiful and it makes you nimble as well," says Mr Farrugia. "That's one of the unique success factors for the financial services industry in Malta because being small enables us to react very quickly. To cite one example, in the EU Internal Market Scoreboard, Malta ranked first with Denmark for transposing EU directives into national legislation. I think that is reflective of what happens in the local financial services industry, whereby we react very quickly to developments taking place, both within and outside Europe.

"The banking industry has continued to grow at a satisfactory pace. We have a good number of banks here, both those that have decided to promote their services to the Maltese market, as well as international banks that are using Malta as a platform from which to conduct specialised banking services.

"The funds industry is in a state of evolution. We first started attracting domestic funds to the market, predominantly led by the banking institutions in Malta. After that, in the early 2000s, we saw international fund-management organisations setting up funds here. And in the past 24 months, we've witnessed international fund administrators and fund management organisations setting up their operations in Malta. This is giving shape and form to the industry, which is driven by a number of factors; the fact that Malta is highly cost-competitive, the presence of multi-skilled and multilingual personnel, and the can-do mindset."

Mr Farrugia says that the recession affected tourism and manufacturing, two pillars of the economy, but the financial sector proved resilient. "The MFSA's annual report revealed that banking assets, at the end of 2008, grew by 10% that year to €42bn. If you look at the funds industry, we've had a record year insofar as the number of new funds registered in Malta. Likewise, insurance companies continued setting up here."

In some quarters Malta still struggles to shake off its former status as a purely tax-driven offshore financial centre, which it ceased to be as a condition of joining the EU. This is something that rankles Mr Farrugia. "Going back through our history, the finance industry commenced in the mid-1980s with an offshore framework which was predominately tax-driven," says Mr Farrugia.

"Then a change in government brought with it a change in strategy which predominately revolved around EU membership, which took place in 2004. In the intervening period, we updated our legal and regulatory framework to ensure that we shed our offshore framework, our offshore regime, our offshore label, in favour of an onshore one. The legacy of Malta's positioning as an offshore jurisdiction does not go away very quickly but, the recent reviews conducted by international organisations of Malta's fiscal framework, our legal and regulatory framework are clear attestations of the onshore regime that Malta has in place."

Expatriate views

HSBC Bank Malta has been on the island since 1999, serving both local and international markets. Chris Bond, its head of global banking and markets, has only been located in Malta since last October, having previously worked for the bank in New York, and before that Bermuda. As a recent arrival, what does he think of his new home and place of business?

"I would describe the banking sector in Malta as strong, stable, well-capitalised, extremely liquid and extremely well-regulated by a firm but flexible and very accessible regulator," he says. "The domestic market is driven by HSBC and Bank of Valletta. Between us we share 90% of the domestic market but there are some 20 other banks here on the island, subsidiary banks of Portuguese, of Dutch, of Austrian, of German banks, all playing to their respective niches."

HSBC has a strong retail deposit base in the country and does not rely on wholesale funding. Its loans-to-deposit ratio is at the 70% to 80% level. "Speaking on behalf of the whole banking sector, another thing that characterises it is the fact that we all have effective risk management policies," adds Mr Bond. "We have prudent lending policies. We have conservative investment policies. And those things have combined to ensure that we've sailed through these financial storms relatively well. HSBC has certainly contributed towards Malta's financial stability."

Perhaps the last word should go to the International Monetary Fund (IMF). Following an Article IV consultation with Malta last year, which analysed the country's economy and financial system, the IMF delivered a largely complimentary verdict. It outlined the various difficulties that Malta faced as a result of the global economic downturn, and noted that inflation had remained the highest in the euro area since October 2008. It added that "past efforts at fiscal consolidation and export diversification toward high-value-added services activities in the run-up to euro adoption had increased the resilience of the Maltese economy".

The IMF also said that the fiscal stance was "appropriately accommodative" and that "the full play of automatic stabilisers, combined with a limited stimulus package focusing on infrastructure investment, should provide an adequate counter-cyclical response to the slowdown". It stated that being in the eurozone "provides a clear opportunity for Malta in terms of trade and financial integration", but at the same time "it highlights the urgency of improving internal flexibility to remain competitive, especially given persistent inflation".

FinanceMalta chairman Kenneth Farrugia says that Malta may be small, but it is nimble

Caution pays

The IMF also spoke well of Malta's banking system. "Banks have so far withstood the global financial turmoil relatively well, as they were protected by their limited exposure to structured products, a traditional retail funding model, and conservative lending policies," noted the IMF executive directors. "Credit has proved resilient, and no government intervention to shore up capital or liquidity has been necessary. Nonetheless, some institutions suffered large valuation losses on their security portfolio, and credit concentration in the construction and real estate sectors remains a concern, especially as property prices have fallen noticeably."

Although there are many reasons why foreign banks locate in Malta, there is no denying that the favourable tax regime is one of the key reasons, as the IMF report notes: "Out of 23 banks [now 24], 13 are locally incorporated subsidiaries of foreign institutions and three are foreign branches.

"Only seven banks, dubbed domestically oriented banks - accounting for 30% of total assets - play a role in domestic intermediation. Most of the remaining 16 internationally oriented banks, settled in Malta for tax optimisation purposes, use funding from their overseas banking groups to finance assets outside Malta... Malta's favourable tax regime and extensive double-taxation treaties explain in part the presence of IBIs [internationally oriented banking institutions]. Under the full imputation system, foreign shareholders receive full credit for tax paid in Malta on distributed profits."

So there it is, direct from the IMF. Tax is an important pull for foreign firms in Malta. But the IMF is not critical of the country's tax regime, which is fully compliant with its EU membership and OECD standards. Malta's international financial centre model therefore combines a favourable tax regime with many other local attributes - such as a motivated workforce and business-friendly laws and rules - all wrapped up in the EU's trademark blue and yellow colours, to present a winning package.

FT Business Events and The Banker, in partnership with FinanceMalta, is running a series of Financial Services in Malta conferences in Europe and further afield. The next is in Bahrain on April 12; for details go to www.ftbusinessevents.com/investinmalta

Facts & Figures

Country's full name

Republic of Malta (Repubblika ta' Malta)

Capital city

Valletta

Population

413,609 (As at December 2008)

Official languages

Maltese and English

Currency

Euro. Malta jointed the eurozone on January 1, 2008

Religion

Roman Catholic (98% of the population). Other denominations have places of worship

Location

93km south of Sicily and 288km east of Tunisia

International dialling code

+356

Internet domain

.mt

Area

Malta is composed of three major islands:

- Malta island (246 sq km)

- Gozo (67 sq km)

- Comino (3 sq km)

There are also some minor uninhabited islands

Terrain

Mostly low, rocky, with dissected plains and may coastal cliffs

Climate

Mediterranean, with hot dry summers and mild winters. Annual rainfall is 23 inches and falls mostly between October and March

Average temperature

- December to February: 13.2°C

- June to August: 25.8°C

Administrative divisions

The country is administered directly from the capital but has 68 local councils

Source: FinanceMalta

Main economic indicators

Registered unemployed (as at December 2009)

7,680

Labour supply (as at Q3 2009)

174,553

Financial intermediation (2008)

5637

Persons employed in financial intermediation (as at Q3 2009)

5524

Average gross annual salary for employees in financial intermediation (as at Q3 2009)

19,740

GDP (2008)

€5.7bn

Inflation rate (2009)

2.09%

Merchandise exports (2009 provisional)

€1628.5m

Goods and services exports (2008)

€4.7m

Merchandise imports (2009 provisional)

€2767.9m

Goods and services imports (2008)

€4.8m

Internet users (2009)

180,985 (persons who indicated regular use during the three months prior to the survey)

Source: FinanceMalta