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AmericasJuly 2 2006

Offshore, on target

Boasting top institutional and physical infrastructures the Cayman Islands has grown to become the world’s fifth largest financial centre. James Eedes reports.
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The Cayman Islands has a special place in the popular mythology of offshore jurisdictions, not least because of author John Grisham’s best-selling novel The Firm, a tale of crooked lawyers, deception and murder. In the book, the Cayman Islands are where the villains do their dirty work, playing up to the caricature of offshore financial centres as hives of tax dodgers and criminals on the run.

In reality, the Cayman Islands’ lawmakers and regulators have positioned the jurisdiction as something altogether different, going further than most other financial centres to meet international standards on governance, regulation and supervision, while still maintaining regulatory proportionality and flexibility. Benefiting from its close proximity to the US (less than 800 km almost due south of Miami); links to the UK as an overseas territory; supportive, business-friendly legal framework; and a stable political and economic environment, the Cayman Islands have grown into the world’s fifth largest financial centre.

It is a formula that is clearly working. Last year was another record year for the hedge fund industry, with more than 1700 new funds registered in the Cayman Islands, reinforcing the islands’ undisputed status as the jurisdiction of choice for such funds. The captive insurance sector also continued its growth, with the number of offshore insurance licenses rising to 733 at year-end, compared with 693 the year before, ranking the Cayman Islands a clear second to Bermuda in this sector.

Banking prowess

In the same vein, the islands’ banking sector showed resilience in the face of worldwide consolidation – though the number of registered banks fell from 322 at the end of 2004 to 305 at the end of 2005, total assets were modestly up to $1,200bn.

In addition, the Cayman Islands is a preferred jurisdiction for structured finance vehicles; it boasts a vibrant trust and corporate services sector supported by English common law and an impressive array of professional service providers; plus its stock exchange goes from strength to strength, designed to facilitate the listing of mutual funds and specialist debt securities, as well as Eurobonds, derivative warrants and depositary receipts.

Paul Byles, author of Inside Offshore: A Reality Check on the Offshore Financial World and former head of policy at the Cayman Islands Monetary Authority, believes the jurisdiction’s competitive advantage centres on its market leadership across different sectors.

“[Cayman Islands] is number one for structured finance; number one for hedge fund registrations; number two for captive insurance; and the leading offshore centre for banking. There is no other jurisdiction that ranks so highly across so many different sectors, and I have done the research to back this up.

“This becomes self-reinforcing because it attracts the best deals and the best people.”

Mr Byles also notes increasing cross-leveraging of expertise in different business segments to offer creative solutions to clients.

It is all about synergy, says Eduardo D’Angelo P Silva, president of the Cayman Islands Bankers’ Association. “In the beginning we talked about a one-stop shop – you could come and do all your business in the Cayman Islands. Now every offshore financial centre wants to tell you they are a one-stop shop. We are taking this concept further. We are combining expertise in different areas to meet the client’s unique needs. This might mean matching our legal skills for special purpose vehicles to hedge fund managers’ increasingly innovative investment strategies.”

Different factors propelled the Cayman Islands into market leadership in the various sectors. The islands boast excellent institutional and physical infrastructure. Financial sector legislation has been designed to establish a flexible regulatory environment that is suited to the complex needs of global capital and provides more efficient vehicles to manage the multi-jurisdictional structure of complex international financial transactions.

Fair play

At the same time, the government has subscribed to international standards of regulatory enforcement and supervision and participated in various international regulatory agreements with the aim of maintaining appropriate fit and proper standards for all entities doing business in the Cayman Islands.

More specifically, the Cayman Islands offers financial service providers and their clients a number of distinct benefits:

  • There is no direct taxation, meaning no income tax, no capital gains tax, no estate and inheritance tax, and no taxes on financial transactions. As a consequence, there is no need to file any type of tax returns.
  • There are no foreign exchange controls.
  • A strong bank secrecy law passed in 1976.
  • Ease of setting up an offshore operation in terms of expediency in processing of required licences, efficiency in setting up a corporation, and other streamlined procedures.
  • Excellent infrastructure in terms of telecommunications and other utilities, and a reliable air service.
  • Crucially, the country’s financial sector has been allowed to develop in an environment of economic and political stability. With a population of just over 52,000, including expatriate staff, the economy is small but well managed.

 

UK connections

The constitution of 1959 established the Cayman Islands as an overseas territory of the UK. The governor, who is appointed by the Crown, presides over an eight-member cabinet. A formal two-party system has evolved, comprised of the United Democratic Party (UDP) and the People’s Progressive Movement (PPM). The legal system is based on British common law as amended by local statute.

Together with tourism, the other mainstay of the economy, the development of the financial sector began in the 1960s. The government first set out to establish a world-class banking industry; it then put in place legislation to develop the insurance sector in 1979; and most recently it passed the Mutual Funds law in 1993.

The Cayman Islands is not without challenges. Local financial sector firms complain of a shortage of local professionally trained employees and mounting difficulties to attract qualified staff from abroad. New immigration rules have added uncertainty to the process of hiring foreigners. Compounding the problem, the islands’ ongoing development is pushing up the cost of living, especially as a result of spiralling real estate prices.

“We are growing fast and we have to make sure our infrastructure can keep pace. These are not insoluble problems; they are the sorts of problems other countries would love to have,” says Mr Silva.

“We are fortunate to have a very positive relationship with the government. It is very aware of the risks to the jurisdiction, and is responsive and flexible to dealing with them,” he says.

Such challenges are not unique to the Cayman Islands. However, Mr Byles believes Cayman has a critical mass of business in addition to a critical mass of professional services to not just survive but prosper. “Not all offshore centres will survive; the Cayman Islands’ prospects are good because it has scale and proven competency in a number of areas.”

HURRICANE IVAN: COSTLY LESSONS

Before Hurricane Ivan hit with devastating effect in 2004, the Cayman Islands had enjoyed steady growth and modest inflation. The economy even expanded by 0.6% in 2001, despite the sharp global slow down.

Ivan struck on September 12, causing crippling damage to infrastructure and the productive sectors of the economy. Power, water, telecommunications and transport were all severely compromised; 83% of homes were estimated to have suffered extensive damage or were destroyed.

Once tallied, the total bill for the storm came to $3.4bn, or 183% of gross domestic product, though fortunately many of the fixed assets damaged by the storm were insured, thus providing critical financial relief.

Despite the terrible impact, the financial sector was up and running within days, and within hours for some essential services. Careful planning, and in some case the personal bravery of individuals, paid off. “In terms of disaster preparedness, Hurricane Ivan proved the Cayman Islands was up to the task,” says Eric Crutchley, a former director of the Cayman Islands Financial Services Association and long-time island resident. “The financial sector barely skipped a beat, which is a comfort to clients.”

Since then, says Tim Ridley, chairman of the Cayman Islands Monetary Authority, the islands’ disaster planning has been improved further. It is not something Caymanians would wish upon themselves again, but in the event the islands’ financial sector is more than a match for any hurricane.

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