What I am going to talk about this morning is the way in which the macroeconomic changes and the onshore political focus post the financial crisis of 2008/09 have affected and will continue to affect the offshore financial centres and specifically the Cayman Islands. In analysing these issues, I will identify the detractors, separate the truth from the myths perpetrated by the detractors and in doing so analyse which of the criticism of the Cayman Islands is justified and of concern to us and what is not. That in turn will lead me to an analysis of what we therefore need to do to realign our financial services industry to ensure the economic success of the Cayman Islands for the future. There is no doubt that as a result of the global financial meltdown we are facing a fundamentally changed set of financial and regulatory circumstances and a more hostile political environment. Although I agree with the Premier that the Keynesian economic solution (that is high government public sector and infrastructure spending) is not the way forward for Cayman, Keynes did rightly say “When circumstances change I change my mind: what do you do?”
We can right away identify three fundamental external changes that directly affect the Cayman Islands financial services industry. The first is that the high volume, low profit per transaction model may be impaired for the foreseeable future. This occurs because of the deleveraging in the global financial markets, at least in so far as the US and Europe is concerned. The consequence of deleveraging is this: if the pre-crisis financial world was driven by leverage of 40:1 and if that ratio now drops to 2:1, we have to conclude that post-crisis there will be fewer transactions, particularly in the area of structured finance, because now everyone has to structure transactions with money that actually exists. This means in turn that the offshore financial centre and Cayman in particular will need to enhance revenue from each transaction for both the private sector and Government. I will come on in a moment to show you the statistics which indicate a surprising resilience in transactional flow in the Cayman Islands. But even if these statistics are indicative of a short term stabilisation in our financial services industry and I believe they are, there is another dynamic that must be taken into account. That is simply the rate of population growth in Cayman. With 700 school leavers a year, the high volume/low profit-per-transaction model will no longer provide sufficient job opportunity in Cayman for Caymanians and we must therefore, as I will come to later, improve financial infrastructure and job opportunities in the financial services sector within the Islands.
The second fundamental change we must recognise and deal with is that the high tax jurisdictions of the G20 (specifically the United States and Europe) have so badly mismanaged their benefit programmes that they face unmanageable deficits. One estimate of current rates of expenditure by the US concludes that by 2015, 40 cents of every dollar of revenue generated or borrowed by the United States will be needed to service a $15 trillion national debt.
This second fundamental change in my view drives the onshore political imperative that in turn drives the negative publicity that continues to surround the Cayman Islands. So we must ask: What is the real basis for that negativity? It may well be that this onshore negativity is based on genuine misunderstandings of the Cayman Islands business model. My view however, is that these mischaracterisations are deliberate and I will come to the real reason, or what I describe as ‘The Hidden Agenda’, later.
The third fundamental change is the demand from onshore politicians and regulators for more extensive regulation to prevent a reoccurrence of the financial crisis. But as you will see I am sceptical of the current regulatory response and doubt its effect. Financial crises have been occurring since the South Sea Bubble in the 1850′s on a 7 to 10 year cycle despite increasing levels of regulation.
So the question that I will address is, how in the light of these three fundamental changes, do we manage the development of our offshore financial industry so it becomes an Apple and not an Edsel? The conclusion that I will come to is that all three fundamental changes bring us to the same point by way of a solution.
We cannot deal effectively with the increasing wave of mischaracterisation and misperception that is directed at the Cayman Islands unless we understand the sources and justifications that drive the negativity. Who is responsible and why?
In my view, the sources of public relations negativity can be broken down into two distinct groups.
The first group comprises small but disproportionately vocal bodies often of only one or two invariably disturbed individuals who have mastered the art of operating a blog site and who appear pathologically wedded to the notion that one high global rate of taxation is a solution to global poverty. These disaffected souls have always existed. What has changed is that the internet now gives them a platform for their doctrinaire beliefs. No doubt these are beliefs to which they are entitled. What they are not entitled to do is what they actually do which is present fictitious and, needless to say, unverified and unverifiable statistics about the extent of tax evasion in the Cayman Islands which are designed to support their position. These individuals are very often funded by charities like Oxfam and by Trade Unions, all of which share the common belief in large Government, a large public sector, high levels of social welfare spending and therefore very high taxation.
The fallacy in the positions of these groups is not simply the fanciful and unverifiable tax dollars that they suggest may be raised from dealing with tax evasion in the Cayman Islands but is also the delusional notion that whatever monies are raised from increased levels of taxation globally will, in some unspecified way, not fund the deficits of G-20 countries but will necessarily be applied to reduce poverty in Africa (and not find its way to the Swiss bank accounts of various African Dictators).
The effectiveness of these extreme left wing social activists, whom we can describe as the ‘Tax Taliban’, is diminishing because their claims are a heresy and are unlikely to withstand the tax transparency that the Cayman Islands is now demonstrating.
The simple truth is that the Cayman Islands has full tax transparency with 20 jurisdictions under the OECD approved Treaties and full proactive reporting with all 27 European Treasury departments under the 2005 European Union Savings Directive. This means tax evasion is off the table in the Cayman Islands. With this tax transparency also come the verifiable and positive statistics that show tax evasion in Cayman to be statistically irrelevant.
The second source of public relations negativity is more troubling as it is indicative of well-organised and powerful public relations campaigns driven by onshore Treasury, supranational and domestic regulatory bodies which in turn are driven by populist politicians some of whom are anxious to suggest that the solution to mismanaged domestic fiscal and monetary policy lies in some mystical offshore pot of gold. The monies, for example, that Senator Bernie Sanders of Vermont claims are “stashed” in Bermuda.
These blame-deflecting politicians and regulators are anxious to obfuscate the failures of their domestic regulatory systems in the G20 jurisdictions by suggesting that in some way it is the tax or regulatory system of the offshore financial centre that is at fault. This is the reason why we see hedge funds rather than Freddie Mac and Fanny Mae now described as the root cause of the recent financial crisis in the same way that the Enron collapse was supposed to have its cause in the Cayman Islands and not Delaware, and the missing Bonlat monies were supposed to have disappeared in the Cayman Islands rather than in Parmalat’s head office in Italy.
There was surely no better spokesman for this group than the unlamented former Prime Minister of the United Kingdom, Mr Gordon Brown, who in an effort to sound Presidential when addressing the US Congress in 2009, and somewhat ironically for someone who was not even an elected Prime Minister, asked the rhetorical question “Would the world not be a safer place if jurisdictions such as the Cayman Islands were outlawed?”
This is typical of the empty political rhetoric to which we are subjected. But on analysis, we note that no financial institution in the Cayman Islands failed during the financial crisis, that we had no Northern Rock, no HBOS, no Lehmans and no Bear Stearns. Rather than the ovation this question received, the correct answer therefore should have been: “Actually, Mr Brown, no, rather the contrary”. The simple truth is that the regulatory problems Mr. Brown wished to obfuscate were in fact onshore regulatory problems. The banking industry in the US and the UK was regulated under Basle II. Similarly, the provisions that Senator Bernie Sanders complains of in relation to the monies “stashed” in Bermuda are in fact legitimate and lawful tax deferral positions of US law. Even if we conclude that the 3% effective tax rate paid by Google seems wrong in principle, the solution to that problem is in simplification of the US Tax Code, enforcement of the transfer pricing provisions of US law and ending the abuse of double tax treaties all of which were negotiated by the US and operated by the IRS under US law.
It helps I think to identify the fallacies in the negativity adopted by both the ‘Tax Taliban’ and these politicians, (who we shall together call ‘The Truth Deniers’) by analysing the vocabulary they use which is deliberately designed to confuse and mislead.
By ‘tax evasion’, we should mean an abusive process that relies on offshore bank secrecy that facilitates a resident of a taxable jurisdiction in failing to accurately report taxable income or gains. This is criminal and involvement with it may involve the offshore service provider in conspiracy to defraud. The fact however is that the tax transparency in place in Cayman for over a decade which I mentioned has resulted in Cayman moving well away from that practice. Yet because of this deliberate and continual mischaracterisation of Cayman as a tax evasion jurisdiction, the public relations perception as to the legitimacy of what actually occurs in Cayman has lagged.
The expression ‘tax evasion’ is then deliberately misused by ‘The Truth Deniers’ synonymously with the expression ‘bank secrecy’ in a pejorative manner so that bank secrecy and tax evasion become confused with wrong-doing. This confusion prevents an understanding of the fact that bank secrecy, or confidentiality to use the proper term, can perfectly well co-exist with tax transparency provided, as is the case in Cayman, that the bank confidentiality statutes yield to tax enquiry from onshore Revenue authorities under the relevant Tax Information Treaties.
As a result of this confusion, what is also lost completely is the public policy argument in favour of legitimate bank confidentiality. That is to say ‘The Truth Deniers’ confuse the right to confidentiality about personal wealth and personal affairs with criminal conduct. There are legitimate reasons why bank confidentiality is an essential feature in the civilised world if the rights of the individual are to be protected, but I am not going to deal at length with that today, save to say that bank confidentiality when coupled with the tax transparency that exists in Cayman is desirable and perfectly proper, lawful and unobjectionable.
These constant mischaracterisations not only wrongly imply that no value-added financial purpose is conducted in the Cayman Islands but also deliberately conflate the Cayman Islands with those jurisdictions, which until the most recent OECD initiative, maintained strict confidentiality laws that not only enabled tax evasion but actively encouraged it. Briefly put here, we could include in that group, Switzerland, Monaco, Andorra, Hong Kong, Singapore and Liechtenstein. It is no coincidence when the IRS made 45,000 requests for tax information, that their requests were made of Swiss banks not Cayman Islands banks.
More seriously, we see the expression “tax evasion” also deliberately conflated by ‘The Truth Deniers’ with the expression ‘tax avoidance’. But by ‘tax avoidance’, we should mean legitimate and proper structuring that relies entirely upon a lawful provision of the domestic tax law or regulation of a G20 or onshore jurisdiction conducted fully in compliance with such domestic law.
But lawful tax avoidance too has now assumed a pejorative connotation. No one outside the Cayman Islands would have concluded when President Obama made reference to the 12,000 companies in Ugland House that the President was engaged in an initiative to amend a provision of US domestic tax law providing legitimate tax deferral for US corporations operating overseas.
In some way, it was suggested by the US President that this lawful ‘tax avoidance’ which he mischaracterised as a “tax scam” was facilitated by wrong-doing in the Cayman Islands. The simple truth is that it is not appropriate to criticise the Cayman Islands, because tax deferral in the US is no longer considered politically correct. If it is no longer felt appropriate in the US to allow US multinationals to defer taxation then the answer is to amend US tax legislation. Notably, the White House Legislative initiative to amend this deferral provision of US tax law in September of this year failed to pass in the Senate.
The inescapable truth is that the IRS has full access to all accounts in the Cayman Islands and no complaint about tax transparency in Cayman is sustainable. Very possibly, the IRS should be reminded of this power since it has exercised its unrestricted right to make enquiry in relation to the US$1.795 trillion dollars of bank deposits and interbank bookings in the Cayman Islands and the US$2.6 trillion of hedge fund assets under management on less than 20 occasions in nearly a decade and with no discernible benefit to the United States Treasury as a result.
It is also the fact that in 2005, under the European Union Savings Directive (and unlike many European jurisdictions which introduced a withholding tax mechanism and maintained confidentiality with regard to the identity of account holders) the Cayman Islands introduced a full proactive reporting disclosure system which operates now with all 27 European Union jurisdictions. Interestingly, the publically available statistics on deposits from European Union residents show a statistically and fiscally irrelevant US$25 million.
The allegations typified by the comments of the recently retired Attorney General of Manhattan, Mr. Morgenthau that Cayman is a money laundering jurisdiction are as easily refuted. The position with regard to all-crimes anti-money laundering is perfectly satisfactory, although surprisingly an FATF evaluation last year that ranked the Cayman Islands system under the Proceeds of Crime Law and the Money Laundering Regulations as superior to those of 40 other jurisdictions including the UK and the US never saw the light of day. In the event, the Department of Justice in 20 years has managed less than 250 applications pursuant to its all encompassing and unrestricted authority under the 1990 Mutual Legal Assistance Treaty with respect to All Crimes Money Laundering. This notwithstanding no less venerable a personage than Senator Levin feels able to ignore Delaware, Nevada and Wyoming and continues to repeat the comments of Mr. Morgenthau in describing the Cayman Islands as a “money laundering jurisdiction”.
But if these truths as I have just described them are correct, and they are, then all of these negative public relations comments about Cayman as a ‘tax haven” and “money laundering jurisdiction” must in time be unsustainable.
This is not just my opinion. Not only is the operational validity and effect of our procedures continually reviewed by on site investigations by the FATF and the IMF, but recently fully corroborated by the report of the US General Accountability Office. The well-informed criminal would be better employed establishing his company in Delaware where, unlike the position in the Cayman Islands, no information whatsoever is required on ultimate beneficial ownership prior to establishing a corporate structure. There is very little empirical evidence however to support the suggestion that that is the reason why there are 217,000 registered offices situate under one roof in one building in the Vice President’s home State of Delaware.
I have dwelt at some length on the factual position to emphasise how perverse it is that these negative public relations campaigns of the last decade can have persisted in the light of the fundamental advances made by the Cayman Islands in relation to all-crimes anti-money laundering and tax transparency. But persist they do. Let’s look at a recent instance. Two weeks ago in the House of Commons, a Labour MP, Ms. Emma Reynolds, asked the following question, managing to confuse the three distinct issues in a manner that is typical: “Tax evasion and tax avoidance”, she said “were unacceptable”. So why had “the new Government in the UK given up demands to introduce direct taxation in the Cayman Islands”.
Firstly, tax evasion we agree is unacceptable but we are clear that is not permitted or enabled by Cayman legislation. So why does she raise it other than to demonise?
Secondly, tax avoidance is lawful and if Ms. Reynolds finds it unacceptable, she must amend United Kingdom law, which of course she can’t because her party is in the minority, although they had 12 years in power and apparently forgot to get around to it.
But thirdly, it baffles credulity to suppose that tax evasion or tax avoidance are a basis or justification for Cayman to change its time honoured basis of raising revenue by indirect not direct taxation. Every country has the right to fix its own tax rates and method of collection.
All of this type of comment in my view is no more than thinly disguised political doublespeak for ‘The Hidden Agenda’.
To identify the reasons for the continual public relations, negativity and to get the point of the mischaracterisations of Senators Levin, Sanders and Ms. Reynolds, we have to look back to the 1998 OECD report on “Harmful Tax Competition” which sought to create an Alice in Wonderland world in which all countries should be taxed at an agreed super rate of tax established by a globally omnipotent Mad Hatter. In this world, any jurisdiction establishing a lower or no rate of tax is branded as a “tax poaching” tax haven that in the eyes of the authors, harbours weapons of tax destruction. With imperiously retro-engineered Euro-logic, the tax haven was defined in entirely subjective terms to be any jurisdiction with low or nominal taxes, no transparency, bank secrecy and last, but by no means least no substantial business activity.
Now whilst Cayman has dealt perfectly satisfactorily with two of the four so called indicia that described a tax haven in that report, that is transparency and bank secrecy and has a right to set its own tax rate, the issue of substantial presence remains. It is clearly the case that the recent financial crisis has enhanced the threat of tax competition to certain G20 jurisdictions in the light of their budget deficits. This then brings us to the core of the matter. In my view, these negative public relations campaigns are really all about who controls global financial services and capital flows and the right to tax those capital flows. Jurisdictions which provide tax competition are seen as a threat by the high tax jurisdictions.
That is not in truth because of tax evasion or tax avoidance as ‘The Truth Deniers’ would have us believe, but because of their concern that jurisdictions with lower rates of tax will attract capital flows and therefore economic activity from the high tax jurisdictions. We are simply in a trade war for financial services.
Let me make three clear points here. The first is that the attraction of economic activity to lower or no tax jurisdictions occurs because business understands that tax makes less of everything that creates economic activity and results in more government spending. It is this undeniable economic fact that ‘The Truth Deniers’ seek to obfuscate by attempting to label the Cayman Islands as a tax evasion or money laundering jurisdiction. ‘The Truth Deniers’ must know that tax competition is lawful, tax evasion and money laundering are criminal.
The second point is that the Cayman financial services industry operates on the basis that any Cayman entity doing business in a taxable jurisdiction will pay tax in that jurisdiction in accordance with the laws of that jurisdiction. Simply put, taxes are paid where profits are made.
The third point is made irrefutably by Professor Sharman in his report International Finance Centres and Developing Countries: “Jurisdictions like the Cayman Islands pool capital which is invested in G20 and developing jurisdictions”. Capital is not ‘stashed’ offshore. Here then is the heresy in the argument of Senators Levin and Sanders: of the $ 2.6 trillion of assets under management in Cayman hedge funds as at 31st December 2008, nearly 80% was invested into the US placed in the hands of US fund managers. This investment undeniably created jobs and tax revenues in the United States.
The real issue here is therefore as it has always been. The fear of the OECD is that capital being inherently mobile will flow to the jurisdiction with the most competitive tax rate which explains in large part the current success of Hong Kong and Singapore. So too, in the Cayman Islands we regard the absence of direct taxation as fundamental to the continued success of the financial services industry and we should therefore be extremely circumspect about who is suggesting that we introduce any form of direct taxation and analyse better the truth of their intentions.
It is the fourth indicia of that 1998 report, the lack of substantial presence, with which we have not yet dealt adequately here in Cayman, and with which we must now deal, if our financial services industry is to be accepted and viable. Without substantial presence, we will clearly remain the subject of continuing attack. I will return to the subject of substantial presence and how we get there.
But first let’s take a look at the third fundamental change. That is the current regulatory onslaught post the financial crisis and the attendant comment which seeks to attribute blame for the financial crisis on the offshore financial centre.
But do these criticisms on the subject of regulation, once again amplified by the formidable public relations machines of the EU and US governments, withstand scrutiny or are they also simply a transparent exercise in blame deflection. Even the briefest analysis does not suggest a level playing field.
Surely if regulatory protection and a desire to prevent a repetition were the real objectives, the US regulatory response to the financial crisis would have introduced some passing reference to two of its fundamental causes. Yet the framers of the Dodd/Frank Act did not see fit to restrict Fannie Mae and Freddie Mac’s ability to guarantee mortgages to un-creditworthy borrowers, nor to restrict the rating agencies in granting AAA ratings to the repackaged toxic waste that resulted. In the political world therefore, it follows that the cause of the crisis could not have been failed domestic policy but must have been elsewhere and hence this fickle finger of regulatory fate points in our direction.
The position in Europe is no better. Mr. Michel Barnier, Europe’s Single Market Commissioner, in describing plans for regulating Europe’s financial markets proposes Brussels is given new powers to end “abusive speculation” and “impose order” on Europe, including the City of London. “We want to know”, he states with imperious disregard for how regulation works in practice, “who is doing what”. The only way I suppose to he could accomplish this would be to place an EU regulator at the screen of every trader. But Barnier told the Daily Telegraph in early September that the EU authorities are going to “look at every product. [They] can restrict leverage, or in exceptional circumstances even ban a product temporarily”. But, if I pause to turn on the Euro-regulatory double-speak translation device, it seems to me that what Mr. Barnier no doubt meant to say was: “We European bureaucrats cannot possibly prop up a totally bankrupt European fiscal Union if hedge funds are allowed to trade in and price European sovereign debt at its true market value rather than the value we want to attribute for regulatory purposes when applying the Bank regulation to our bankrupt European Banks. So we in Europe must control the market pricing.” This is hardly a ringing endorsement of the free market principles on which the European Union was supposed to be founded.
Thus we see hedge funds, and indirectly offshore jurisdictions like Cayman (which is the domicile of the majority of them) now targeted in Europe and subject apparently in the UK to a regulatory response that will not only restrict leverage and trading activity but will require UK-based fund managers to receive 50% of their remuneration after a deferred three year period, as if hedge funds or their bonuses had been instrumental in the European financial meltdown. Even the FSA has concluded that hedge funds were not responsible for the financial crisis. So is this criticism of hedge funds and the offshore financial centre justified or is the real threat here which hedge funds pose the threat to the political aspirations of those driving a totalitarian federalist agenda in Europe?
Regrettably, due to the questionable strategy of the recent UK government in pandering to EU regulatory aspiration over and above its obligations to the City of London, the UK will have no veto power over EU regulatory determinations for whatever reason they are arrived at, despite the fact that the City of London is the only globally recognised financial services centre in the EU. The UK will as a result, carry the same weighted vote in these matters as Latvia.
In the face of this onshore regulatory tsunami, many self-styled industry commentators have been forecasting the demise of any offshore jurisdiction which does not fall immediately into line with the new world regulatory order. But in determining the course for the Cayman Islands, we need to be somewhat more analytical. Let us start with two more undeniable truths. First, the regulation proposed in the EU is not global, it is limited to the EU and second, no financial institution failed in Cayman during the financial crisis.
An appropriate regulatory regime in Cayman worked exactly as it was supposed to. It is hard see in these circumstances why there should be a rush to apply the regulatory notions of jurisdictions with less than enviable records and whose regulatory responses avoid recognition of the real causes of the financial crisis.
But, the whole truth is a good deal more troubling than that. In his book Engineering the Perfect Storm, Jeffrey Friedman points out that it was in fact ill-considered onshore regulation that fuelled the financial crisis. The risk weightings applied under the Basel Convention under which its banks are regulated globally, including here in the Cayman Islands, encouraged heavy investment in the mortgage backed securities market because in 2001 US banking regulators (the very same bastions of public protection to whom we now look under Basel III) assigned $2000 of regulatory capital for every $1m of MBS on the balance sheet of the bank as against $10,000 for every $1m of commercial loans. The result was that banks owned 45% of all subprime backed mortgages by 2005, “secure” in the knowledge that 95% of these MBS were AAA rated and accepted as such by the banking regulators. Thus does ill-considered regulation distort the marketplace and in the current example assumed a direct causal relationship with the catastrophe that followed.
But we are assured that Basel III, the new global banking regulation, makes no such similar mistake. Or are we? Commentators have already pointed out that none of Bear Stearns, Washington Mutual, Lehman Brothers, Wachovia and Merrill Lynch would have failed the new increased Basel III capital adequacy ratios of 10%, having regulatory capital ranging from 12.3% to 16.1% thus, the much-lauded Basel III would not have saved any of them. It occurs to me that it may have assisted the regulators in their deliberations, if before failing to define adequately what constitutes “too big fail” they had accurately analysed what is meant by “small enough to succeed”.
In all of this we do not take the words of the regulators as gospel. It is becoming increasingly evident that financial professionals have a very distinct voice and in so far as EU regulation is concerned are voting with their feet. The excellent and objective KPMG report “The Future of Alternative Investments” investigates the opinions of over 200 investment managers, administrators, institutional investors and service providers on the effect of the suggested increased regulation. It states in categoric terms:
“Anticipated regulation, driven by external forces that continue to blame alternative investments for the meltdown of the global financial system, is not wanted by the majority of investors, managers or service providers. The widely held view is that the industry did not cause or contribute to the credit crisis. Furthermore, investors believe more regulation will not produce any tangible benefits”.
In the Cayman Islands, we conclude that territorial regulation will ultimately stifle ingenuity and entrepreneurial opportunities in those jurisdictions. The survival of only larger operators will impede potential growth at the peril of UK and the US economies, which are regulating themselves out of a productive industry and the capital flows that are essential the recovery of their failing economies. Further, the effect of localised or regional regulation introduced in the US and the EU, rather than global regulation, is equally perverse given the financial marketplace is not static. The exodus of fund managers and banks from London is now occurring as alternative offices are established in Switzerland, (the most unlikely of unintended beneficiaries), Hong Kong and Singapore, which are booming. Cayman too, would be an excellent choice to relocate an investment management company.
Further we must not lose sight of the fact that a Cayman hedge fund trading with a Swiss, Hong Kong, Singaporean or Cayman situs fund manager does so free of the restrictions of the new Euro-regulatory regime. This means in turn that the Cayman hedge fund with a non EU fund manager, as Blue Crest recently concluded, may continue to trade traditional hedge fund strategies and with traditional rates of return – with which the Euro-based fund manager will struggle to compete, starved as it will be of the oxygen of leverage, a more liberal risk profile and the best-remunerated talent.
Let me say clearly that no one doubts that an EU-situate fund manager of a Cayman Fund trading in the EU will be regulated in accordance with EU law and regulation. So too a fund manager of a Cayman fund trading in the US will be subject to US law and regulation. It was ever thus. Nor do we have a problem with transparency. Cayman has full regulator-to-regulator disclosure under the IOSCO accord. But we should note the macro shift for hedge fund managers in the face of the European regulatory clamp down is away from Europe and Cayman needs therefore to maintain its non-intrusive regulatory approach on securities regulation. If a fund manager wishes to trade a Cayman hedge fund in the EU, he does so knowing he will be subject to and must cope with EU regulation. I would be surprised if one or more of the proprietary trading desks that the Volcker rule requires to be spun off from the major Wall Street investment banks do not find themselves attracted to and located in Hong Kong or Singapore.
So how do these understandings translate into current policy and direction for financial services in the Cayman Islands?
The solution in my view to both the reduced transactional volume and to the allegations of ‘The Truth Deniers’ which can only be based on lack of substantial presence in Cayman must be to increase the financial activity undertaken in the Cayman Islands so that we develop in Cayman a greater financial infrastructure with more of the transaction undertaken here.
We at Cayman Finance have therefore been encouraged that the Premier sees the establishment of an expanded and viable financial services community as critical to the development of the local economy. He is right to do so. In 2007, there were approximately 5,800 persons directly employed in the financial industry which indirectly provided nearly 13,000 total jobs approaching 40% of the local employment, nearly 50% of Government revenue and 1.2 billion dollars or 54% of gross domestic product. More crucially, employment in the fund administration industry was running at about 50/50 Caymanians to expatriates. Eight hundred fund administration jobs exported to Canada as a result of the roll over policy and immigration issues generally means therefore 400 fewer jobs for young Caymanian professionals in the Cayman Islands. This policy must be corrected.
So the Premier is right to focus on and introduce new policies to support immigration for the financial services industry. Specifically, there are two new proposals in an advanced stage of preparation which will provide a minimum 25 year security of tenure for those who wish to purchase a residence in the Cayman Islands and a similar period for those who own and control new financial services businesses.
Further, expansion of our financial industry is not only relevant to government revenues, employment and local trickledown economics. It is critical now to take the range of financial services quantitatively and qualitatively to a much higher standard from within the Cayman Islands to establish here an improved substantial presence to deflect the future attacks that are already formulating based on that 1998 OECD Report. This substantial presence should ideally encompass not only fund management but investment and merchant banking, reinsurance business and indeed an expansion of fund administration and it is therefore essential to attract to Cayman for the long term financial professionals who provide these services. We will not be accepted as a financial centre until we provide the range of services typically provided in a financial centre.
As matters stand, it is too easy for Senator Levin to suggest that because of the conduct of financial operations in the Cayman Islands does not resemble a car manufacturing plant in Detroit with 10,000 people under one roof that in some way Cayman financial operations are a sham and should be ignored. That is the point that really underlies the President’s reference to the 12,000 companies in one building. Simply put, we need then more buildings and more financial professionals in them.
The substantial presence argument is not just a US and EU issue. It has clearly gained more traction recently. Both the Indian Tax Authorities with respect to Cayman private equity funds accessing the double tax treaty between Mauritius and India and the Chinese Authorities with respect to the tax treatment by Hong Kong subsidiaries of Cayman Funds making direct investment in China are now focused on substantial presence as a prerequisite for tax relief that benefits the Cayman Holding Vehicles.
The development of an improved financial infrastructure in the Cayman Islands needs to be supported for a further reason. As I mentioned at the very beginning, a fundamental change for Cayman Islands financial services industry is that our traditional financial markets, the US and the UK, are now operating in a deleveraged financial environment. Indeed we see company incorporation numbers although recovering down by some 30%. This means that in terms of both Government revenues and revenues payable to the private sector, higher fee levels will have to be extracted from each transaction. Current transactional flows resemble that of 2005/2006, and so if nothing more is done, one simple solution is for Government to return to its expenditure levels in the 2005/2006 budget that is some CI$400,000 annually. But that would require extensive and permanent cuts in Government expenditure and should be regarded only as a short term expedient. The recommended approach for the long term must be to boost Government revenue.
In consequence with greater revenue derived from more substantial activity, it should then be possible to recommend that government fees for licensing may be reduced to ensure Cayman remains competitive.
There is no doubt that the current administration’s approach to immigration has done a good deal to redress the negative effects of recent immigration policy and roll over policy but more will have to be done in terms of implementation if Government is to provide the environment in which the financial services industry can develop an enhanced state of revenue generation per transaction.
What has not yet been addressed and what must be solved to ensure implementation of immigration reform, is the concern in the minds of the voting public in the Cayman Islands. That is, the understandable concern that surrounds the issue of work permits and immigration generally. Much is made of the Singapore model and the Hong Kong model but notably this issue does not hamper the development of the financial services industry in either of those jurisdictions. By that I mean that we really have to confront and deal with what I have termed ‘the 800 pound gorilla in the room’. This is the heresy that the highest quality financial professionals can be attracted the Cayman Islands to develop the financial services industry with the requisite substantial presence on the basis that these professionals are here for a finite term and with the view to being replaced. This is an unrealistic delusion. We understand the long term concerns of the Caymanian public but these must be addressed by decoupling the issue of work permits and security of tenure for financial professionals from the issue of status and voting and this conundrum has not yet been effectively solved in the minds of the voting public. Of course, we must ensure proper integration for Caymanian professionals but at no time was the roll over policy ever the correct response to certain specific and limited failures to provide that integration.
As a corollary however, no one in the financial industry should, in the absence of income tax and payroll taxes or indeed any other direct tax, mind paying $20,000 dollars or more for a professional’s work permit, provided these work permits can be obtained by the Cayman financial organisation when they want them and kept for as long as they want them. The stakes here are high. If we cannot elevate our financial services industry by providing substantial presence and verifiable value-added, the recent fee increases borne by the financial services industry will not be sustainable and we face a further exodus of organisations and employment opportunities, and then the inevitable race to the bottom on fees with lower cost jurisdictions which will ultimately see Government revenues from financial services decline not increase. That, in my view, is the stark choice.
Further, we need to be circumspect about those who are suggesting that we cross the Rubicon and introduce any form of direct taxation. Those who seek to do so to a highly mobile financial industry are at best guessing at the outcome or to the more cynical amongst us, have a very good idea of the outcome and it is not a positive one. There are always high sounding reasons for high levels of government welfare and public service spending, free medical health and pensions and the proponents of direct taxation always sound reasonable in suggesting them. But direct taxation simply transfers the cost of the public sector benefits, salaries, pension and health care to the private sector. The question must first be asked what are the appropriate levels of these benefits for an Island population of 60,000? If we first do not answer that question correctly and make appropriate legislative modifications to ensure the public sector benefit levels are appropriate and sustainable, there is no certain limit to the revenue that must be generated to pay for these public sector programmes and therefore no upper limit to the rate of taxation that may be applied.
Some say, superficially, that other offshore jurisdictions have direct taxes and therefore conclude that direct taxes are therefore not now problematic in the offshore context. But the comparison is irrelevant in 2010. The only question is not what may have worked 20 years ago, the question is what is the effect of introducing direct taxation to the Cayman Islands today. No doubt to do so with a highly mobile financial services industry some of which is already relocating because of high cost and difficulties with immigration will simply accelerate the exodus.
Those in Government who have recently travelled to Hong Kong and Singapore have marvelled at the economic boom that is occurring there. However, there is no possibility of replicating that in Cayman without first overcoming the hurdle of immigration policy and recreating here the same conditions that attract to the financial industry the finest professional talent. When we have substantial presence fully established, possibly there can be some debate about alternative revenue collection. For the time being the absence of direct taxation must remain a fundamental that we do not change.
In summary, I believe that to respond to the changed global environment the essential changes that must be made to realign our financial services industry are fourfold:-
Firstly, to ensure substantial presence and a viable local economy that provides sufficient job opportunities for Caymanians we must implement immediately the suggested changes to immigration policy to provide long term security of tenure for financial professionals.
Secondly, we must continue to refute through our public relations campaign the nonsensical suggestions of ‘The Truth Deniers’ concerning tax evasion and tax haven status or indeed money laundering. What we do in Cayman is lawful and proper and we must continue to say so.
Thirdly, we must resist the suggestion from the G20 jurisdictions that we introduce direct taxation. It can hardly be said that their economies are a ringing endorsement of the concept.
Fourthly and lastly, we maintain appropriate regulation recognising that Cayman vehicles trading in onshore jurisdictions are subject to the laws and regulation of those jurisdictions in any event.
With these policies in place I have no doubt Cayman will remain at the forefront of the offshore financial centres and indeed its position as such will be enhanced.