The Cayman Islands: A decade of challenges

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Part 5 The Cayman Islands: From obscurity to offshore giant 

Part 4: The booming 1990’s 

Part 3: The Transitionary 1980’s: 

Part 2: The freewheeling 1970’s 

Part 1: The Early Years – 1960’s 

Like a long roller coaster ride, the decade of the 2000s brought Cayman’s financial industry ups and downs, thrills and screams, white knuckles and exaltation. Many financial service industry firms in the Cayman Islands experienced unprecedented success during the decade, but the 2000s also brought some of the biggest challenges the territory ever faced.
 
Terrorism comes to the US
The September 11, 2001 terrorist attacks in the United States proved to be the first challenge of the decade for Cayman financial services industry. But Appleby law firm Managing Partner Huw Moses said the effect on business was minimal. “Immediately following the attack we experienced some disruption to the international transfer of funds via New York, but this was short lived,” he said.
 
Eduardo d’Angelo Silva, former long-time president of the Cayman Islands Bankers Association, also said the effects in Cayman were not too severe.
 
“Tourism took a big hit here, but for the financial industry, it was really the hit on New York and the resulting slow down in the economy,” he said. Although anti-money laundering regimes were already in place in the Cayman Islands at the time of the attacks, d’Angelo Silva said those regimes became more stringent afterwards.
 
“The [know-your-customer] consequences were very strong, especially after the Patriot Act,” he said, referring to the legislation signed by former US President George W. Bush the month after the attacks. The stronger KYC rules required compliance by Cayman’s banks in order to transact business with the New York clearing banks, d’Angelo Silva said. “The Patriot Act also had strong provisions about identifying shell banks that don’t have a physical presence anywhere in the world.”
 
Appleby’s Moses noted that the 9/11 attacks also had an effect on Cayman Islands legislation. “In 2003, the government brought into force The Terrorism Law, which since then has been continuously reviewed and updated,” he said. That legislation criminalising terrorism and terrorist financing, the latter in accordance with the UN Convention on the Suppression of Financing of Terrorism.
 
There were other consequences from the 9/11 terrorist attacks. The US government acted to bolster an already soft economy by trying to spur business and the housing market through lower interest rates. At the same time, lending guidelines were relaxed. The result was a large amount of money available at very low rates, d’Angelo Silva said, pointing out the strategy led to the subprime lending meltdown, which ultimately led to the global financial crisis. “The US government put the interest rates so low, it formed the genesis of the environment that caused what happened in 2008,” he said.
 
Enron fails
When Enron, a high-flying blue-chip US energy company filed for bankruptcy in October 2001, it put a face, or at least a logo, on corporate greed and dishonesty for many Americans. With assets of some US$63.4 billion, it was the largest US bankruptcy ever at the time. When it was revealed later that Enron had used more the 440 subsidiary companies in the Cayman Islands to keep some $3 billion of losses off its balance sheet, America put a face on offshore tax havens.
 
The following year, MCI/WorldCom, which was once the second largest long-distance telephone service provider in the US, also filed for bankruptcy. With a $103.9 billion of assets, it overtook Enron as the largest bankruptcy ever in the US at the time. Again, it was revealed that Cayman Islands offshore companies were used to hide losses to drive up the value of WorldCom’s stock.
 
In 2003 it was Parmalat, the multi-national Italian dairy and food producer that revealed a multi-billion dollar fraud –dubbed by some as ‘Europe’s Enron’– that once again had a Cayman Islands connection. People went to prison in other jurisdictions for these and other high-profile frauds, and Cayman’s international reputation suffered, at least in terms of public perception and Hollywood perception.
 
But Tim Ridley, former chairman of the Cayman Islands Monetary Authority, doesn’t believe it had a major effect on business. “The three high-profile failures were unfortunate for Cayman, but not hugely damaging in the long run,” he said. “After all, the decade after 2000 was, until the global financial crisis in 2008, the most successful ever for the financial services industry in Cayman.” Ridley noted that the criminal activity did not take place in the Cayman Islands. “The offshore structures used were – and still are – perfectly legal, albeit unregulated for the most part,” he said. “But they were abused by the senior executives of these companies. What is important is that the fraud was uncovered and the key criminals were brought to justice in the onshore jurisdictions, where the illegal activity occurred.”
 
Appleby’s Moses agreed that the negative publicity from the high-profile failures caused “little measurable adverse effects”. “For years there has been a great deal of misinformation circulated about the Cayman Islands and our role in international high-profile company failures,” he said. “International politicians quickly point the finger at others, especially offshore jurisdictions, before admitting an oversight or loophole in their own country’s legal and tax system.” Moses said the users of Cayman’s financial services understand the limited legal role played offshore. “In many cases the failures were the result of corporate decisions made in the United States by US – often Delaware – based holding companies,” he said.
 
When concerns were raised, Moses said his firm simply explained the situation. “One of the benefits of working within a small jurisdiction is that government and the local service providers collectively provide a solid and unified response to criticism from overseas,” he said. “We are all in this together and seek to resolve any misunderstandings and educate in order to protect the jurisdiction as a whole.”
 
Hurricanes: the new threat
As the Cayman Islands headed into the 2004 hurricane season, it had been more than 70 years since the Islands had taken the full brunt of a powerful hurricane. Hurricane Gilbert in 1988 confirmed many residents in their complacency because, despite being the strongest Atlantic hurricane on record at the time, it caused minimal damage on Grand Cayman.
 
As Hurricane Ivan approached in September 2004, many thought it, too, would somehow spare the Cayman Islands. It turned out Ivan had Grand Cayman’s name on it. The slow-moving and strong hurricane, which had maximum wind speeds of 155 mph when it passed Grand Cayman, destroyed or damaged more than 90 per cent of the structures on Grand Cayman and destroyed approximately 10,000 vehicles.
 
Despite the devastation, Cayman’s financial sector – thanks largely to private sector-organised recovery initiative – was operational four days after the storm had passed. As a result, the storm’s impact on business volume was short lived, said Moses. “Appleby did see a drop off in business in September and October 2004 but business quickly recovered to pre-storm levels.” Moses said Cayman worked hard as a jurisdiction to ease the fears of clients to ensure them that the Cayman Islands coped well with the devastation caused by Ivan. “Our ability to be up and running in the financial services industry within a few days was outstanding and I am sure to them, relieving,” he said.
 
The financial industry’s quick bounce back actually made Cayman a more attractive jurisdiction with which to do business, said d’Angelo Silva. “After Ivan, a lot of companies that had left before decided to come back,” he said.  D’Angelo Silva said it was important that Cayman’s financial industry kept a calm approach after the storm. “Some of the customers didn’t really know what had happened; they just wanted their business concluded,” he said.
 
“In some ways, we didn’t want to tell customers we’d had a major hurricane. So we put on a good face and told them everything is fine.” By early 2005, the recovery was in full swing. Most of the people who left to work out of offices in other jurisdictions returned. The money was flowing everywhere, said d’Angelo Silva. “We had money going through local banks for hurricane recovery and, more importantly, we were riding the hedge fund wave in the US and Europe.”
 
Although the financial industry business ultimately suffered little as a result of Ivan, there still were a lot of costs associated with the storm, Moses said. “Ivan obviously cost many businesses on island a lot of money… whether it was in repairing and upgrading buildings, replacing equipment, assisting employees financially or in the loss of revenue due to being closed immediately after the storm.”
 
But Cayman’s financial industry also learned a lot of lessons from Ivan. Back-up generators, hurricane-resistant buildings, dedicated hurricane supplies, off-island data back-up, satellite telephones and staff evacuation plans all became part of revamped disaster plans.
 
This led to other problems for firms, said Ridley. “The longer term issue has been the cost of such plans and doing business in Cayman,” he said.
 
“Hurricane-proof buildings, disaster recovery plans and evacuations are expensive. I think Ivan accelerated the outsourcing to less expensive locations such as Canada.” In addition, Ivan took a human toll, even if the storm itself only killed two people directly and two people indirectly. The hardship of the recovery period and the hurricane scares that happened in subsequent years made Cayman less attractive to some foreign workers. “Ivan made employees and potential employees re-evaluate their career plans,” Ridley said, noting that some simply decided that living in the hurricane zone was not for them.
 
The human resource challenge
In 2003, then Leader of Government Business McKeeva Bush announced sweeping changes to Cayman’s immigration law. He said the UK had dictated that foreigners who remained in the Cayman Islands for at least ten years needed to get security of tenure, which ultimately meant citizenship. Not wanting all foreign nationals to be able to attain security of tenure, the government instituted a seven-year term limited for most work permit holders.
 
The law provided for employers to apply for select employees to be exempted from the seven year term limit and instead to be allowed to remain here nine years, long enough to apply for permanent residency after eight years. The rollover policy, as it came to be called, would prove to be one of the biggest sustained controversies ever in the Cayman Islands. 
 
Ridley doesn’t see the rollover policy delivering the desired effects. “I think the rollover was a well-intentioned bipartisan attempt to get to grips with a number of short and long-term problems and to find solutions,” he said. “The outcomes so far have been most unsatisfactory and very few people seem happy with them. The current regime seems to be ‘lose-lose’ not ‘win-win’.”
 
The global financial crisis, and the resulting unemployment of Caymanians, brought renewed opposition to granting key employee designation and increased tension between expatriates and Caymanians. Ridley believes Cayman has to “find a middle ground that encourages the right people to come, work and settle here”. “We have to find an inclusive solution that permits the financial and tourism industries to flourish and also provides meaningful opportunities and careers for Caymanians,” he said. “But the world we operate in is global and highly competitive.
 
Local parochial and protectionist attitudes of the vociferous minority will not work in this environment. “If these attitudes prevail, Caymanians as a whole will suffer rather than benefit in the long term.”
 
Appleby’s Moses admits the immigration policy has caused his firm difficulties in attracting and retaining the specialist skilled staff the firm needs. “This has – and continues – to result in us being forced to develop certain parts of our business overseas in both onshore and offshore locations, other than Cayman,” he said.
 
“This is very frustrating when we are keen to see our business in Cayman grow.”
 
Despite extensive training programmes for Caymanians and offering a scholarship programme, Appleby still needs specialised foreign staff.
 
“We remain in a situation where key employee status is often difficult to obtain for staff we regard as key to our continued business success,” he said.
 
“We have been able to mitigate the effects of rollover to some extent by placing staff subject to rollover in other offices for a year or more, but there are some professional staff that simply will no longer consider Cayman as a place to work due to the uncertainty of being able to stay for the longer term.”
 
Moses pointed out that most professional work permit holders leave Cayman before they reach their seven year term limit. “Rollover has not changed this fact, but it has made the initial recruitment harder and does result in higher staff turnover, which increases the cost of doing business,” he said.
 
The global financial crisis
Cayman has felt the sting of the global financial crisis that began in 2008 just like everyone else, but later than many places, Moses said. “The full effect of the global economic crisis was not felt in the Cayman Islands until mid-2009, over six months after the majority of the world was already deep in the midst of it,” Moses said. “Fortunately this lag tends not to continue when things recover and we expect to rebound quicker.”
 
Business as a whole was affected in Cayman, resulting in substantially less revenue being generated for the government, creating a budget crisis and the possibility of direct taxation. In addition, many of the G-20 nations, working in tandem with the OECD, pointed a finger for the economic crisis at offshore financial centres. In April 2009, the OECD put the Cayman Islands on its ‘grey list’, a list of countries that had committed to anti-money laundering and financial reporting regimes but had not yet implemented all of the required international agreements. The Cayman Islands Government was able to get the country off the grey list and onto the white list of cooperative jurisdictions by August 2009 through the signing of 12 Tax Information Exchange Agreements.
 
The resulting negative publicity has hurt some. Moses said the public relations issues of recent years have been harder to deal with than those created by the high-profile company failures earlier in the decade. “The attack on the traditional offshore centres has been sustained over a much longer period and has been fuelled by the misconceptions of our role in the financial markets in a recessionary period,” he said.
 
Ridley sees a silver lining in the cloud of the financial crisis for Cayman. “The public and private sector finally realised that much more needed to be done to ensure Cayman’s survival as an offshore centre,” he said. “We have as a result seen a much more proactive approach by government to ensure Cayman meets and implements international standards and actively engages in the process of developing those standards.
 
“Both the government and the private sector have also devoted considerably more resources to public relations campaigns to combat the continued flow of adverse and usually unfair political and media comment. But Ridley said clients and potential clients are concerned about reputational issues with the Cayman Islands, particularly given the political and media scrutiny of financial operations after the crisis. “The clients want to continue to take advantage of the benefits of offshore centres and structures, but without the media hysteria and spotlight on it all.”
 
The law firm Walkers Global Managing Partner Grant Stein said his firm has seen an increase of cooperation among jurisdiction and law firms as a result of the financial crisis. “The best example of this is the formation of the International Financial Centres Forum in December 2009,” he said.
 
“Formed by a number of the leading offshore law firms, the IFC Forum aims to present a more coordinated response to the political rhetoric aimed at offshore financial centres, so that policy makers fully understand the positive contributions that IFCs make to the global economy and the potential consequences of restricting their activities.”
 
Stein admitted his firm had felt negative effects from the global economic downturn, but said there have also been some positives as a result. “The global financial crisis resulted in a downturn in certain areas of our work, notably investment fund formation and structured finance work,” he said.
 
“Walkers weathered the economic storm reasonably well with positive growth in our management services group and considerable restructuring work for our funds group.” Stein said Walkers also saw strong growth in insolvency and corporate recovery work as a result of the economic downturn and in response to that formed a global financial restructuring group.
 
Ridley believes the Cayman Islands will rebound from the economic crisis. “The hedge fund market has stabilised and should start to grow again in a meaningful way,” he said.
 
“Debt financing of various types is required to make global markets work and I anticipate it will come back, although when is uncertain right now. The captive industry was relatively unscathed by the crisis and is a stable and relatively unsung success story that continues for Cayman.”
 
But Ridley believes much more needs to be done to move the Cayman Islands away from its tax haven image. “Most importantly, Cayman does need to become more transparent in deed as well as word,” he said, adding that more information needs to be made public by the Cayman Islands Monetary Authority and General Registry.
 
“For example, the identity of the directors, officers, managers and shareholders of record of all limited liability companies should be a matter of public record,” he said.
 
“And so should the limited partners of all limited partnerships. This information should be filed with and made available on request to anyone either by the General Registry or the registered office.”
 
Ridley also said the Monetary Authority should disclose much more statistical information on the entities that it regulates, and in a more timely and useful manner. “If we do not take these steps, we will continue to be criticised,” he said.
 
“The government has shown itself willing to be more transparent through the Freedom of Information Law. The private sector should follow suit.”

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New York skyline post September 11, 2001