However, to look at the future requires a look back at some of the things that happened during the roller coaster decade of the 2000s, which saw Cayman’s financial services industry hit some of its highest highs and lowest lows within a period of just a few years.
Starting in June 2000, when the Financial Action Task Force listed 15 non-cooperative jurisdictions in the fight against money laundering, international pressures increased against offshore financial centres, including Cayman, which was one of the ‘blacklisted’ countries. Over the remainder of the decade, there were a number of initiatives undertaken designed ostensibly to stop money laundering, the financing of terrorism or tax evasion in offshore jurisdictions.Tim Ridley, a former Maples and Calder partner and the former chairman of the Cayman Islands Monetary
Authority, says one major effect of the measures is added cost.
“Internationally, there has been a continued push by major economies and their client international organisations and agencies, such as the International Monetary Fund, EU Commission, the OECD, FATF, BIS, etcetera to reduce the competitive threat posed by OFCs like Cayman under the guise of imposing global standards of regulation and supervision, taxation and cross-border transparency, assistance and enforcement. This push imposes ever-increasing cost-of-doing-business burdens on OFCs, both the private and public sectors.”
Sean Flynn, a director of HF Fund Services Ltd, agrees that increased regulation has impacted the ability of fund managers to raise money.
“They have to be more cautious and do more due diligence. It takes more time from marketing to launching a fund.”
Although there was a good bit of negative publicity in the international media about offshore financial centres in general and the Cayman Islands in particular, Flynn says clients remain very happy with Cayman as a financial services jurisdiction. “
Despite the pressures of overseas governments and politicians, including President Barack Obama, and some less-than-kind press, Cayman is still seen as a very well regulated jurisdiction by institutional investors.”
Regardless of the external pressures, Cayman’s financial services industry thrived for most of the 2000s. The hedge fund industry in particular did very well right up until the global financial crisis in 2008, says Flynn.
“But there were some things on the horizon even before the financial crisis in 2008 that led to a reversal of growth in fund administration and in fact to jobs leaving Cayman”.
The first real bump in the road occurred in September 2004, when Hurricane Ivan caused widespread damage to Grand Cayman. Although the hurricane only disrupted the financial services industry here for a short period of time, Flynn says it had larger effect.
“People looked at this and realised they needed to improve their business continuity plans and this led companies to establish operations in other jurisdictions over the next few years.”
About the same time as Hurricane Ivan, Flynn – who headed up UBS Fund Services until 2006 – says there was also a trend to globalise fund administration as companies looked for ways of “improving cost efficiencies through use of global platforms and operating in low-cost centres. With fund administration, you don’t necessarily have to sit in Cayman to do it,” he says.
Also in the immediate aftermath of Hurricane Ivan, changes to the Immigration Law brought term limits for expatriate workers in Cayman with what became known as the rollover policy.
“It was implemented at a time when globalisation of business was happening and impact of Hurricane Ivan was still been felt by businesses.
“It was a time when as a jurisdiction we should have been making it easier for companies to plan to grow their Cayman operations and sending the right signals to companies’ head offices that we were open for business. It was a bad policy.
“Cayman has paid the price for that and will continue to pay the price in terms of lost jobs both for expatriates and Caymanians, which will never return,” Flynn says.
“I think it will be a very long road back for Cayman to rebuild the fund administration business. There are too many competing jurisdictions now.”
Ridley notes that this trend is exactly opposite of what Cayman needs to reduce some of the external regulatory pressures.
“It is critical that Cayman attracts more real businesses, with real people making real decisions in real offices. That is the best defence against continued attacks that Cayman is just a shell jurisdiction with no economic substance in what goes on here. Unfortunately, the current atmosphere in Cayman is in direct conflict with that. If Cayman is to succeed in the future, this has to change.”
Ridley also notes that “unnecessary and unproductive red tape, evidenced by immigration, planning and regulation generally” has also made the attractiveness of Cayman’s business environment decline.
“There has been much well-intentioned talk about improving the situation, but few on-the-ground results as yet”.
Mergers and expansion
Mergers of offshore law firms were another significant occurrence during the 2000s, brought about largely by the globalisation of world markets.
Huw Moses, managing partner of Appleby, saw his firm join forces with several other offshore firms during the decade.
“There was a realisation in the market place that sophisticated clients were looking for legal solutions that involved the use of multiple offshore centres for a single transaction and the law firms moved to meet that demand”.
Appleby was one of the first offshore law firms to merge in April 2004 when Hunter & Hunter, a Cayman Islands-originated firm, merged with Appleby Spurling and Kemp, a Bermuda-originated firm. Other offshore law firms followed the merger trend, forming several large offshore multi-jurisdictional firms. “It has created a ‘magic circle’ of firms offshore, separating those firms that remain national in their scope of services from the larger multi-jurisdictional super league,” says Moses.
After also merging with Bailhache Labesse and joining with Dickinson Cruickshank, plus expanding to other jurisdictions, Appleby has grown to having more than 800 employees globally.
One major benefit of the mergers is that it has become easier for Appleby to attract and retain talented lawyers, Moses says.
“As we have grown, our reputation has improved and we have seen an increase in magic circle lawyers approaching us for jobs, rather than the other way around,” he says, adding that mergers have also resulted in client base growth, giving the firm the ability to spread operational risks across multiple jurisdictions.
The clients themselves also benefit, Moses says.
“Clients continue to benefit from the extensive expertise of the lawyers with whom they are familiar, but that expertise is be supported by a greater strength and depth of resources, experience and skills across this wider range of offshore centres. There have been a number of cases where a client came to us in one of our jurisdictions with a potential matter, but it became apparent that they might be better served in accomplishing their goals if they used a different jurisdiction. We are easily able to introduce them to our partners in another office and quickly move forward. In other cases, the matters require the use of multiple jurisdictions and we are able to assemble the team to efficiently and expertly handle the matter.”
Despite the benefits to all, Appleby’s mergers have not come without challenges; integration creates more complexity to administration and IT requirements. It has also had a price.
“Opening offices and merging with firms obviously costs money and has a short term negative effect on profitability,” Moses says.
“However, long term, we expect the combination to reap improved profitability via globalisation of support functions and consistent practices and systems. As the firm grows, cash-hungry capital projects become more and more manageable than they would be for a single-jurisdiction firm. In short, we can achieve economies of scale we could not achieve before.”
In addition to mergers, offshore law firms had have also expanded their presence to other jurisdictions. Moses points out that specific jurisdictions have emerged as leaders in particular areas of service or products. “While each jurisdiction offers a wide array of opportunities, some have greater experience and infrastructure for one area of service over another. For instance, Cayman is the domicile of choice for funds. Jersey is known for funds and general financial services and many turn to the BVI for quick and easy company formations.”
The fact that several of the major offshore law firms have a presence in Cayman enhances it as a jurisdiction. Grant Stein, global managing partner of Walkers, says expansion overseas has led to increased business in Cayman. “As offshore law firms strengthen their presence in other jurisdictions, the demand for Cayman Islands based financial structures continues to increase.
Additionally, while international financial centres have long played an important role in carrying out complex financial transactions, instructions traditionally came from the onshore firms. In the past decade, however, we have seen onshore and offshore lawyers work more closely than ever before, building stronger relationships that help both firms grow in each jurisdiction. This change reflects the increasingly important role of offshore jurisdictions in international business. It is also a reflection of how the onshore and offshore worlds work together against the background of an interconnected global financial system.”
The financial crisis
The reality of the global financial crisis hit Cayman in the fall of 2008. Ridley notes that not only did the crisis slow down business significantly, but it also re-energised the pressure on offshore financial centres, which were seen as easy scapegoats for the crisis.
“The 2008 financial meltdown came as a nasty shock to those who thought the party could never end,” Ridley says. “Local financial service providers had become complacent and expanded on the basis that only good things could happen. In this, they were no different from their colleagues in London and New York.”
The financial crisis caused jobs to leave Cayman, significantly reduced the number of hedge fund registrations in Cayman and virtually destroyed the structured finance market, an important product of Cayman’s financial services industry.
However, not every aspect of Cayman’s financial industry took a nose dive as a result of the financial crisis, as Stein points out. “[Our] new Financial and Corporate Restructuring Group has seen a high demand for their services, helping organisations recover from the economic crisis or developing strategies based on lessons learned to better plan for any changes to the financial climate in the future,” he says.
After being down significantly in 2009, hedge fund registrations in Cayman rebounded in 2010.
Stein says clients continue to have the utmost confidence in the Cayman Islands as the hedge fund domicile of choice. “In fact, monthly hedge fund registration statistics from the Cayman Islands Monetary Authority show a strong recovery and solid gains for the industry as new fund registrations continue to outpace fund terminations by a significant margin. We have also seen a robust upward trend in company incorporations in 2010.”
Although the financial crisis was in no means a good thing, it did have some upsides for offshore financial centres, notes Stein. “While it sounds counter-intuitive, the economic downturn was also an opportunity to highlight the important role of jurisdictions such as Cayman. The Troubled Assets Relief Program used private equity structures and offshore vehicles to help stimulate growth and recovery in the US economy, which had a ripple effect globally.”
In addition, despite many high-profile failures of banks in the world, Cayman banks held their own quite well.
Long-time Cayman banker Eric Crutchley notes that Cayman’s banks, mainly because of their traditional conservative lending and investment criteria, did not suffer major credit defaults. “The banks are therefore solid, but with the financial crisis and almost zero interest rates, profits and targets are more difficult to meet. Reduction in personnel [and] outsourcing back-room operations can assist in reducing expenses, but increasing revenue streams is more difficult,” he says, noting that investing surplus funds generated little return. “So, consolidation occurs and it is up to financial institution to gain more business by being better than the completion by way of excellent service and coming up with innovative ways of increasing their customer base though improved customer service channels and state-of-the-art IT friendly systems.”
Some banks did leave Cayman, Crutchley says. “The numbers have dropped through mergers and consolidation where parts of the business are transferred elsewhere, with the consequent reduction in personnel and, in some instances, closure of offices. Smaller banks and branches have closed where they may have served their original purpose and are now redundant, where others may have home office pressures to not have representation in Cayman for a number of reasons.”
The 2000s offered the opportunity to learn several lessons.
Stein says one of the key lessons learned was the importance of due diligence. “The credit crises created demand for heightened levels of due diligence on fund managers and all service providers. Risk assessments became more penetrating and many answers now need to be independently confirmed.”
Another lesson that has been recognised is the importance of the role international financial centres play in the path to global financial recovery, Stein says. “International financial centres such as the Cayman Islands play a key role in enhancing liquidity in international markets and providing neutral jurisdictions for investors which simplify the challenges of doing business where participants are based in multiple countries.”
Stein adds there was also a lesson learned about the importance of illiquidity as a major contributor to hedge fund difficulties. “Illiquidity affected the strong performers as well as the weak – even funds which had performed well in the market were affected by a surge in redemption requests from nervous investors anxious to re-balance investment portfolios. Our collective experience from this period of difficulty suggests that funds that were properly structured and which had planned for liquidity issues from the outset, and incorporated mechanisms to deal with illiquidity in their constitutive documents, fared relatively well. In our experience, many funds acted on this lesson when possible, seeking to restructure in response to liquidity issues in order to preserve value and retain investors either within the same fund or in a new structure.”
Stein sees a strong outlook for the Cayman Islands in terms of fund formation as well as insolvency and corporate recovery work. “We also predict a steady demand for restructuring work as we help organisations recover their losses. Future work will also focus on developing strategies based on lessons learned to better plan for any changes to the financial climate in the future.”
Ridley thinks the structured finance market is far from recovering. “The 2008 collapse killed the complex debt market in the USA and the Cayman deals stopped, too. The market may come back for simple deals, but it will take a while for investors’ memories of the disastrous complex deals to fade. The European market has shown some signs of rebirth, but these deals typically do not come to Cayman. So, the bottom line is that I doubt we shall see the heyday of complex debt deals return any time soon.
However, there is hope for a rebirth of the structured debt market. “The silver lining is that current yields are so low that investors are starting to clamour again for new products,” Ridley says. “So the merry-go-round may restart, but with what it is not immediately obvious.”
Ridley also notes that although the G7/G20 countries continue to call for more regulation of offshore financial centres, there is some resistance. “[T]he old guard economies are having to cede their traditional control to the rising economic powerhouses of China, Brazil, India and Russia. These countries have been less enthusiastic to go after OFCs as they see real value in the role they play as key facilitators of capital flows that produce significant inward investment into their economies.”
With the world’s economic power shifting, Ridley believes Cayman must become more global in its outlook and search for new business areas, and less dependent on traditional sources. “We need to get back to developing new legislation [and] enhancing existing legislation in an expeditious way to attract and support new products. There are too many committees, councils, etcetera talking about it, but achieving little in a meaningful way.”
Crutchley says the strong will survive in the banking business. “Looking forward there may be more mergers and more pressures internationally to close OFCs who do not toe the line in practice. We have to work at it and notwithstanding the downturn in the global economy, we still have to advertise and market ourselves.”
Ridley sees the future of Cayman’s hedge fund industry being “murky”, partially because of poor performance in 2010. “Investors increasingly question why they should pay high fees to hedge fund managers who deliver average or worse performance.”
There are also many concerns about the outcome of The European Commission’s Alternative Investment Managers Directive, which would put strict regulations on investment fund managers. “The industry is sheep-like,” Ridley says. “There is much talk about becoming EU compliant and forming/re-domiciling funds as UCITS. This may be unwise and not in the best long-term interests of investors or managers, but it is a possible threat to Cayman that needs to be watched.”
Stein believes Cayman can survive the AIFM Directive.
“While some have suggested that these changes could drive some business to Ireland or Luxembourg, it’s hard to speculate on the outcome until the Directive is passed. At this point in time, the Cayman Islands remain the jurisdiction of choice for funds and we fully expect to maintain a high level of this activity to be facilitated in the Cayman Islands. That said, we have seen a small number of our larger institutional clients establish parallel structures in Europe that serve to complement their financial vehicles based in the Cayman Islands.”
Subject to the final outcome of the AIFM Directive, Flynn also believes Cayman will remain the major player in the hedge fund industry. “
I still think that while Cayman may lose some market share to the onshore regulated jurisdictions, it will continue to be domicile of choice for many hedge fund managers, especially start-up managers,” he said, adding that he doesn’t believe that existing Cayman hedge fund domicile business will migrate to regulated products in places like Dublin.
“It’s not going to happen.”