Like other offshore jurisdictions, the Cayman Islands have been under siege from overseas authorities for almost a decade. The jurisdiction has been labelled either a tax cheat, unfairly robbing other countries of their rightful fiscal revenues, or a sanctuary to criminals, who would use the islands’ financial system to conceal their nefarious deeds.
In that time, Cayman has answered its critics with beefed-up regulations to deter criminal activity; tightened up overall supervision of the jurisdiction; and relented to demands for increased information-sharing with onshore authorities. It has done this without abandoning its ‘light touch’ regulatory philosophy or compromising clients’ legitimate rights to privacy. And it has held firm against fierce accusations of unfair tax competition, protecting its right to administer taxes as it chooses.
Stronger voice
New threats loom from different quarters, not least competition from large onshore jurisdictions that historically have had considerable influence in defining the rules of the game. Only now, Cayman regulators say the jurisdiction is better placed to ward off the threat, having done a good job of getting its voice heard on the inside of the various international bodies that ultimately set the rules. The challenge for the Cayman Islands is to meet international standards without eroding its jurisdictional attractiveness, a tightrope it appears to be walking successfully if new business development is an indicator.
The first real sign of trouble emerged in 1998, when the Organisation for Economic Co-operation and Development (OECD) published a report arguing for the harmful impact of low-tax jurisdictions. The landmark report, Harmful tax competition: an emerging global issue, set the stage for a grinding battle to force low-tax jurisdictions to share more information with authorities in OECD countries – industrialised economies that feared substantial tax leakage to low-tax jurisdictions.
Information sharing
In reply, the Cayman Islands has signed a number of bilateral agreements with onshore authorities to share bank account information in instances where foreign governments could prove there was a legitimate suspicion of tax evasion. The country has been careful that such agreements do not equate to a ‘fishing expedition’, the practice of foreign tax authorities speculatively scrutinising bank accounts for suspicious activity.
Separate to the tax issue, onshore bodies have long since highlighted the potential for criminal activity in offshore jurisdictions, especially money laundering. The clearest threat materialised in June 2000, when the Financial Action Task Force (FATF) listed the Cayman Islands on a so-called blacklist of non-co-operative jurisdictions. The FATF was established at the 1989 G7 summit in Paris, tasked with tackling money laundering. In 2001, after the terror attacks on the US, its remit was expanded to cover the financing of terrorism.
The Cayman government and regulators moved swiftly to legislate FATF standards, resulting in the jurisdiction being delisted exactly a year later. The main areas of intervention were to strengthen know-your-customer requirements, record-keeping, regulatory co-operation and the reporting of suspicious activity.
Lately, the country has begun to win praise from various bodies for the lengths it has gone to meet international standards. According to the International Monetary Fund, the Cayman Islands financial industry and regulators have “developed an intense awareness of the measures required to combat money laundering and the financing of terrorism” through legal reforms and new supervisory practices.
During US Congressional hearings, testimony was given by the CEO of an asset recovery agency that in the past 15 years has been enlisted by US state and federal agencies to recover and return stolen money pursuant to cases of fraud. He commended the Cayman Islands, saying: “Legitimate offshore internationals centres such as the Cayman Islands now have robust anti-money laundering programmes and co-operate fully to recover illegal funds that find their way into their jurisdictions. Fringe financial centres have a more spotty record.”
Regulation levels
Having acquired some breathing space, the hotly contested point now is whether the Cayman Islands is over-regulated. “It is uppermost in our minds,” says Tim Ridley, chairman of the Cayman Islands Monetary Authority (CIMA), the islands’ principle regulatory body. “The risk is that regulation is seen as intrusive and burdensome rather than necessary and helpful.
“The private sector wants as little regulation as possible. But if there was some sort of crisis, that same private sector would ask what we had been doing with ourselves. There is no question that regulation is needed but we need to strike the balance to remain competitive,” says Mr Ridley.
Cayman regulators have been criticised for going too far too quickly. For instance, they made it compulsory for service providers to perform know-your-customer checks on existing clients, causing much nuisance and annoyance and leading to some business leaving the jurisdiction. In contrast, major onshore centres such as New York and London abandoned similar measures, citing complexity and cost.
Mr Ridley dismisses such criticism. “You have to understand the historical perspective. In the 1990s, the Cayman Islands was under intense pressure from various international bodies, including being added to the FATF blacklist of non-co-operative jurisdictions. It was gunboat diplomacy. Locally, the government and financial sector committed to whatever measures were needed to be removed from the blacklist and avoid other threats. At the time, we did not have any other option,” he says.
In the process, the islands ended up with ‘gold-plated’ anti-money-laundering regulations, similar to the UK’s rules but going further. “There is a feeling of overkill; people feel we were ahead of the curve,” says Mr Ridley.
Changing perceptions
Others see an upside to this. “There was a negative perception in some quarters to the Cayman Islands,” says Eduardo D’Angelo P Silva, president of the Cayman Islands Bankers’ Association, alluding to a common perception of the islands as a haven for shady characters with sacks full of cash. “We have gone a long way to change that.”
Today, there is a more cautious approach to new legislation and regulation. CIMA is obliged to put new rules up for discussion with the private sector and it undertakes a cost-benefit analysis before imposing regulations. “We have to meet international demands and standards or face exclusion. But we are now more diligent in checking that international demands are broadly accepted and universally applied. We are also more careful to assess the applicability of any principle to the Cayman Islands and look to see if we can make it better.”
Mr Ridley does not expect the squeeze on offshore jurisdictions by international bodies to let up, citing various initiatives that could affect the Cayman Islands. The IMF and FATF are looking at the misuse of corporate vehicles, seeking to develop methods to deter criminals from using corporate and trust vehicles and services to help them disguise the proceeds of crime for entry into the financial system. Italy has recently approved legislation that could lead to the blacklisting of jurisdictions that Italian authorities regard as “not guaranteeing adequate transparency”.
The UK Financial Services Authority (FSA) has been studying hedge funds and the retail investment sector, proposing to consult next year on allowing new authorised funds of hedge funds to be marketed to retail investors. The danger is that the FSA may take the same restrictive regulation that is necessary for the protection of retail customers and apply it to the regulation of non-retail funds, and insist that other regulators follow suit. That is a possibility given calls for increased standardisation of hedge fund regulation.
“Unless the distinction between retail and non-retail markets is made and maintained, attempts to harmonise hedge fund regulation could have adverse effects on the dynamism and innovation that allows hedge funds to play that vital role in the efficient reallocation of capital and risk that the FSA recognises,” says Mr Ridley, who fears a knock-on effect on the islands’ booming hedge fund sector.
Unlevel paying field
For Mr Ridley, changing regulatory demands is one thing; but he says that the lack of a level playing field frustrates him. Despite the onslaught on offshore jurisdictions, OECD member countries still fall short of the various international standards. The 2005 FATF report concluded that Australia was compliant with only 12 of the 40 anti-money laundering recommendations. “Yet Australia has never been on a list of non-co-operative territories. On the contrary, it is a leading member of the Financial Stability Forum, FATF and other organisations that continue to criticise offshore financial centres for non-compliance with international standards,” says Mr Ridley.
He does not expect the Cayman Islands to be treated on equal terms but what is changing now is that whereas before it had a small voice and little international clout, it is becoming more effective at making its case in the right places. “The Cayman Islands must be at the table that determines these playing fields. We are not there yet but we are being invited more often,” says Mr Ridley. “The principal challenge for the Cayman Islands and CIMA internationally continues to be engagement with standard setters and regulators to ensure the legal and regulatory regime in Cayman is properly understood, recognised and accepted.”
A follow-up assessment by the IMF is slated for a year’s time. According to Mr Ridley, CIMA is well ahead in implementing the accepted substantive recommendations in the last IMF assessment.
