Enhancing The Regulatory Framework

How measures such as giving watchdogs real teeth will inspire confidence within the sector

The managing director of the Cayman Islands Monetary Authority recently announced that “anyone that thinks for one minute that increased regulation is not going to happen hasn’t been paying attention. Not only will it happen but I am confident that, if we are to stay in this game, we will have to adopt ALL of the regulations”. These words reverberated around the world leaving stakeholders in Cayman financial services to contemplate a new era of regulation.

The success of the Cayman Islands has always been predicated on continuous improvement, so now is as opportune a time, as any, to consider ways in which our regulatory framework can be further enhanced. It is also clear that none of the problems of the global financial crisis can be attributed to any failure of the regulatory policies of the Cayman Islands despite the fierce rhetoric of the lame Cayman pundits, including those in our midst, to scapegoat our regime.

The recent CNBC House of Cards programme should be mandatory watching for these pundits. CNBC expertly researched and traced the beginning of the crisis back to 11 September, 2001, and identified several causes, none involving the Cayman Islands. The fact that some entities were incorporated in the Cayman Islands is inconsequential. Cayman companies were minor irrelevances in this show with its international cast of unscrupulous lenders, buyers and sellers as the main actors. All were unregulated but operating in regulated jurisdictions. This was not lightly regulated nor internationally applied regulation, similar to that in the Cayman Islands, but entities that were not subject to any regulation whatsoever. It sounds like a recipe for disaster and it certainly was.

Nonetheless, I also agree that the lame Cayman pundits will never allow the facts to get in the way of their own biases, so the Cayman Islands need to stay at the forefront of regulatory change for its economic survival. This article explores the challenges and opportunities presented by the global financial crisis to the Cayman Islands regulatory framework.

 

The role of regulation

Historically, the Cayman Islands has always viewed effective regulation as promoting market confidence in its financial products and services. Acting in the best economic interests of the islands was paramount. It was considered nonsensical to implement regulatory policies that were counterproductive to maintaining the competitive position of the islands, otherwise soon regulators would have nothing to regulate. These principles are enshrined in the Monetary Authority Law and to date CIMA has excelled in achieving these objectives as have other local regulators with similar objectives. There is no reason to believe this excellence will not continue throughout these challenging times.

Historically, the Cayman Islands has always viewed effective regulation as promoting market confidence in its financial products and services. Acting in the best economic interests of the islands was paramount. It was considered nonsensical to implement regulatory policies that were counterproductive to maintaining the competitive position of the islands, otherwise soon regulators would have nothing to regulate. These principles are enshrined in the Monetary Authority Law and to date CIMA has excelled in achieving these objectives as have other local regulators with similar objectives. There is no reason to believe this excellence will not continue throughout these challenging times.

However, it is critical that the pendulum does not swing too far in the opposite direction as when some suggest implementing regulatory solutions to problems that don’t exist in Cayman Islands, or that are inappropriate to Cayman, simply because they are being applied elsewhere. Some argue that such policies are necessary to be internationally compliant when no such standard really exists. Every regulator adopts standards that are appropriate to the challenges in their jurisdictions. The Cayman Islands is no different. There is no one-size-fits-all regulatory solution. Notwithstanding, it can be instructive to consider best practices internationally and adapt these ideas locally insofar as they are relevant and appropriate to the circumstances of the Islands. Indeed, CIMA is bound by the MAL to achieve this goal. Since only the Legislature of the Cayman Islands can change the MAL, stakeholders should rest assured that the parameters for implementing regulatory initiatives are clear and well established.

Act in the best economic interests of the islands

This has never been more important considering the poor global economic climate. Our local financial industry is at its tipping point and what regulators do next will determine the fate of the jurisdiction for many years to come. While it is common for regulators to ratchet up the pressure during a crisis, especially when spectacular frauds are being revealed in other jurisdictions, Cayman regulators should remain focused on promoting sound industry compliance and competition. I strongly believe in vigorous enforcement of regulatory violators, but witch hunts, fishing expeditions and trivial gotcha pursuits will do little to inspire compliance.

This has never been more important considering the poor global economic climate. Our local financial industry is at its tipping point and what regulators do next will determine the fate of the jurisdiction for many years to come. While it is common for regulators to ratchet up the pressure during a crisis, especially when spectacular frauds are being revealed in other jurisdictions, Cayman regulators should remain focused on promoting sound industry compliance and competition. I strongly believe in vigorous enforcement of regulatory violators, but witch hunts, fishing expeditions and trivial gotcha pursuits will do little to inspire compliance.

At a recent conference, it was terrifying to hear a Cayman regulator announce that the new approach would be first to freeze your assets, arrest you, then talk to you. This is a great example of the crisis causing regulators to behave irrationally, panicking to the extent where they abandon core principles like the presumption of innocence. Calm, rational thinking is critical in times of great stress. We all acknowledge that, if our building is engulfed by fire, our chances of survival are exponentially greater if we react calmly rather than rushing for the fire exits all at once. Criminalising our financial industry based on a few bad actors in overseas jurisdictions is an improper and disproportionate response. Internationally, the success of the Cayman Islands is still coveted by many challengers and such capricious actions would be devastating to the best economic interests of the islands.

Uphold transparency and fairness

Regulatory leadership and innovation are needed now more than ever. The best way for regulators to promote transparency is to practise it. Regulatory solutions should not be developed in a black box by a few in the know. Regulators should get out and engage stakeholders in frequent and intense dialogue. Do a listening tour and get into learning mode as the best ideas may lie outside government. Uncertainty is anathema to growing markets so this is a time for regulators to be more candid and transparent about regulatory initiatives. Regulators should seek to eliminate excitement and drama from the regulatory process. Be staid and predictable. This is not the time for grandstanding, informal rule-making and inconsistent interpretation. Regulatory rhetoric needs to be tight and thoughtful because of its enormous potential to disrupt business flow.

Regulatory leadership and innovation are needed now more than ever. The best way for regulators to promote transparency is to practise it. Regulatory solutions should not be developed in a black box by a few in the know. Regulators should get out and engage stakeholders in frequent and intense dialogue. Do a listening tour and get into learning mode as the best ideas may lie outside government. Uncertainty is anathema to growing markets so this is a time for regulators to be more candid and transparent about regulatory initiatives. Regulators should seek to eliminate excitement and drama from the regulatory process. Be staid and predictable. This is not the time for grandstanding, informal rule-making and inconsistent interpretation. Regulatory rhetoric needs to be tight and thoughtful because of its enormous potential to disrupt business flow.

Increase resources

Industry expertise is essential for regulatory success. Regulation works best when regulators are experienced in the various industries they regulate. During the boom times, it was difficult for regulators to attract staff with deep industry experience, but the economic downturn now offers regulators good opportunities to reload their depleted staff ranks with top talent that would not otherwise be available. Like all regulators globally, Cayman regulators will be significantly challenged to do more with less resources. This will necessitate employing more sophisticated enhancements to their risk-based supervision approaches to deploy their limited resources more effectively.

Industry expertise is essential for regulatory success. Regulation works best when regulators are experienced in the various industries they regulate. During the boom times, it was difficult for regulators to attract staff with deep industry experience, but the economic downturn now offers regulators good opportunities to reload their depleted staff ranks with top talent that would not otherwise be available. Like all regulators globally, Cayman regulators will be significantly challenged to do more with less resources. This will necessitate employing more sophisticated enhancements to their risk-based supervision approaches to deploy their limited resources more effectively.

 

Facilitate innovation

Change is inevitable and continuous improvement is always desirable, but regulators should have the courage to stay committed to the core principles that have proven successful, not dismantle and rebuild what is otherwise effective. Regulation can expand, yet stay true to its core principles, not merely imitate our less successful competitors.

Change is inevitable and continuous improvement is always desirable, but regulators should have the courage to stay committed to the core principles that have proven successful, not dismantle and rebuild what is otherwise effective. Regulation can expand, yet stay true to its core principles, not merely imitate our less successful competitors.

Regulatory enhancements should maintain the principles-based framework that has served the jurisdiction well. Prescriptive ideas such as arbitrarily limiting service-provider capacity are a radical departure down the slippery slope of decline that will create unintended consequences for regulators. Such policies reward weak service providers that are unable to compete under free-market conditions at the expense of strong service providers; creating disincentive for the strong service providers to continue to invest in our jurisdiction, derailing innovation and wrecking competitiveness. Also, regulators should seek to regulate, not allocate, the market – this would be a step too far.

Obviously, regulators must remain concerned with whether service providers are fit and proper and capacity is important to this assessment. However, prescriptive regulatory measures would likely violate the precepts of the MAL, drawing the ire of disaffected service providers and unleashing a firestorm of litigation that would only serve to squander the precious resources of stakeholders during a critical time when they are needed most.

Rather than prescriptive measures, strict and meaningful enforcement of the existing financial regulatory laws to disqualify recalcitrant service providers, will do far more to enhance regulatory compliance than fluff prescriptive policies that simply create a false sense of effective regulatory change.

In the end, there is a fine line between stimulating and stifling regulation. The burden can be heavy or light. Regulators have the unenviable task of deciding where to draw this line and how brightly to illuminate it. These choices are not free. Regulators determine the cost of these choices and our economy pays the price.

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Illustration: Robert Coyle
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Don Seymour

Don Seymour was the first Head of Investment Services Division and a former director of the Cayman Islands Monetary Authority. He is credited with establishing its market friendly and responsive framework for regulating hedge funds that propelled the Cayman Islands to the most successful hedge fund jurisdiction in the world. He is the founder of dms Management Ltd., the largest company management firm in the Cayman Islands focused on serving the hedge fund industry.

Don Seymour
Managing Director
DMS Offshore Investment Services Ltd.
dms House 20 Genesis Close
PO Box 31910
Grand Cayman, KY1-1208
Cayman Islands

T:  +1.345.749.2551
M: +1.345.526.7093
E: dseymour@dmsoffshore.com
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