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AmericasJuly 2 2006

Safe haven for world’s wealth

The number of banks in the Cayman Islands may have dropped after recent rationalisation but their combined assets are flourishing, writes James Eedes.
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The sharp fall in the number of banks operating in the Cayman Islands belies the overall well-being of the sector. Since 2001, the number of registered banks had shrunk from 427 to 305 at the end of last year. Yet in the same period, total assets of the banking system grew more than a quarter to $1230bn.

Several factors account for the reduction in the number of banks, according to a recent study, The economic impact of the banking industry in the Cayman Islands, prepared by US-based researcher StratInfo. These include: ongoing consolidation in the global financial industry through mergers and acquisitions; economic considerations such as licensing fees and other costs of doing business; increasing costs of the regulatory environment and compliance, which in some cases has led to the withdrawal of banks from the offshore business; and competition from other offshore centres.

In 2002, the government more than doubled the fees for banking licences, resulting in rapid rationalisation. However, the Cayman Islands is still host to 45 of the world’s 50 largest banks by assets.

“Growth in other sectors gives the impression that banking is being left behind,” says Eduardo D’Angelo P. Silva, president of the Cayman Islands Bankers’ Association. “But it is still the backbone of the entire industry. Banks are necessary for the other industries to function; hedge funds, special purpose vehicle and captive insurers all need flexible banking services. It is banks that best see cross-selling opportunities. Assets are growing and the total volume of transactions is also rising.”

He believes that there is little threat that the Cayman Islands will lose its status as the world’s largest offshore banking location.

Interrelated markets

The banking industry in the Cayman Islands services two distinct but interrelated markets: the domestic market formed by residents and companies located in the Cayman Islands and the offshore market, which encompasses individuals and entities located anywhere in the rest of the world. Although the offshore segment, with assets of $1220bn, dwarfs the domestic market segment, which has just $10bn in assets, the latter is still attractive. Cayman National Corporation, the only truly indigenous financial group, reported net income of CI$16.1m ($19.3m) in its last financial year to end-September 2005 on assets of CI$784m. This marks an impressive turnaround on the previous year’s CI$39m loss, which reflects the impact of Hurricane Ivan on the group’s insurance division in particular. Compared with fiscal 2003, last year’s performance was up 106%.

Cayman National president and chief executive Stuart Dack says that, aside from Hurricane Ivan’s immediate financial impact to the group, the recovery and reconstruction created a mini economic boom. “CI$1.5bn flowed into the economy,” he says. “At the bottom end, everyone suddenly became a contractor or building specialist. It was a dynamic we did not anticipate but the end result was a lower-than-expected rise in bad debts.”

Total loans and advances by the six primarily local retail banks represented 160% of gross domestic product (GDP) in 2004, almost three times the typical percentage for domestic banking in industrial and emerging market countries. Based on year-end 2005 postings, 33% of totals loans were personal real-estate related, 26.5% were for private sector commercial services providers, 19.1% for non-residents and 5.1% to the public sector.

Offshore banks

Offshore banks provide a wide variety of services to their overseas clients, other financial institutions and their own financial groups. They service private banking and institutional clients, carry out investments for their group’s holdings, manage structured products and administer investment funds. The principal areas for offshore banking are private banking and trust services; corporate services and capital markets transactions; and investment funds services.

Banks in the Cayman Islands provide the full range of private banking products and services to the worldwide clients of their home country banking groups who prefer the advantages of an offshore location. Banks provide mostly the back-office support of their clients’ transactions, although some relationship banking is also available for clients who also want to deal directly with the bank in the Cayman Islands. In the case of a money management account, the management of those assets is usually performed by the parent company.

Private banking clients are also attracted to the Cayman Islands because of its flexible and progressive trust jurisdiction, which is based on British law. The trust is incorporated in the Cayman Islands, and the asset managers are spread around the world.

According to Sheree Ebanks, head of wealth management at Butterfield Bank, a good deal of the wealth managed in Cayman traditionally came from individuals structuring their financial affairs via Cayman Islands trusts. More recently, tighter regulations (particularly with respect to know-your-customer rules), has softened the demand for private client wealth management services. The slack has been taken up by significant demand from institutions such as captive insurance companies – a fast-growing business sector that requires asset management.

The attraction of hedge funds to Cayman has also been a huge success. Consequently, investment funds services have experienced strong growth in the past several years. For those funds registered in the Cayman Islands, the offshore banks maintain the registry and subscription of shares, process and post all orders and trades, compute the net asset value of the funds and co-ordinate the audits.

Offshore corporate services are provided to clients of the financial institutions that also maintain an offshore corporation in the Cayman Islands. International corporations represent a wide range of business interests, including those represented by trust accounts managed by offshore banks. Any offshore entity that is registered under the Office of Corporate Registry (such as insurance companies, ship and aircraft registries and other international businesses) will need banking services. Services for special purpose vehicles that are created in relation to capital markets transactions, such as securitisation, have been expanding rapidly. Offshore banks also perform banking operations for their parent financial group, such as management of their parent holdings’ funding requirements, particularly in the euro-currency markets.

A LEADING CENTRE FOR STRUCTURED FINANCE

Cayman has become one of the world’s leading jurisdictions for the incorporation of special purpose vehicles (SPVs) for structured finance transactions. The jurisdiction is widely known as the domicile of choice for aircraft finance and securitisation.

“It is difficult to come by accurate data but there are literally thousands of SPVs incorporated in the Cayman Islands to service or facilitate structured finance transactions globally,” says Sarah Cowell, KPMG’s head of structured finance in the Cayman Islands.

Zero-tax and the absence of foreign exchange controls are the basic prerequisites offered in Cayman.

“You can get that in other jurisdictions,” says Ms Cowell. “The difference in the Cayman Islands is the availability and quality of the professional service providers, including experienced directors for SPVs. You can set up an SPV within 24 hours, which is a critical factor when a deal has to be closed quickly. The jurisdiction really is a centre of excellence.”

The industry in Cayman benefits from the jurisdiction’s deep well of legal, audit and administrative know-how and international experience.

Other factors include a credit-friendly companies law. One such feature, according to James Bagnall, a partner at law firm Ogier, is the manner in which the law permits an equity element to financing structures with fewer restrictions on the distribution of funds.

In addition, structured finance in the Cayman Islands is supported by a regulatory environment that offers flexibility in the design of the vehicle, allowing the borrower and lender to customise a mutually beneficial financing arrangement.

With jurisdictions such as Dublin, the Channel Islands and recently Dubai courting structured finance deals, the Cayman Islands are clinging onto their preferred status.

“The Cayman Islands is more established. What holds the jurisdiction in good stead is that we have a proven track record with the rating agencies and investment banks that are arranging these deals,” says Ms Cowell.

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