Quarterly Review

Banking

Offshore banking continues to decline

The number of banks in the Cayman Islands dropped by 7 percent in 2015, compared to 2014.

The 12-month decline from 198 to 184 registered banks mostly concerned Class B banks, which are licensed by the Cayman Islands Monetary Authority but only allowed to offer services to customers outside of Cayman.

The number of locally operating Class A banks fell from 13 to 12 and includes six retail and six non-retail banks, the latest CIMA statistics show.
The banking industry has been diminishing constantly since the 1990s, when there were more than 500 banks registered in Cayman. The reasons for the decline range from consolidation in the industry to new regulations that have made operating offshore banks less cost effective. Most recently, the so-called “de-risking” by U.S. correspondent banks provided a new threat to the business model of offshore banks.

Paul Byles
Paul Byles

“The decline generally over the years is due to global consolidation of banks, which has resulted in their branches and subsidiaries merging across various jurisdictions,” said Paul Byles, managing director of First Regents Bank & Trust. “But more recently it has also become more challenging to operate in the offshore banking arena.

“Class B banks in particular are finding it very difficult to maintain correspondent bank accounts in the U.S. and elsewhere. As a result, I believe we will see a further decline in the number of licenses as shareholders question the point of having a Class B license.”

Cayman Class B banks often offer depository services to international clients and maintain access to the U.S. dollar clearing system by establishing correspondent banking services with local Class A banks in Cayman, which in turn have correspondent relationships with U.S. banks.

Local banks are under pressure by their U.S. correspondent banks which, under international regulations governing anti-money laundering, take a risk-based approach on a client-by-client basis.

While the guidelines defined by the Financial Action Task Force would require financial institutions to terminate client relationships only when money laundering or terrorism financing cannot be mitigated, banks have taken an increasingly risk-adverse view when evaluating their client relationships, including their business relations with Cayman banks.

During the past 18 months, many retail banks in Cayman started to inform their Class B bank clients that they can no longer offer correspondent banking services if they relate to funds of the bank’s clients.

This development is threatening the business model of those offshore banks that are not branches or subsidiaries of U.S. banks.

“The new policy of not allowing Class B banks to have correspondent banking accounts has the potential to wipe out an entire industry offering,” Byles said.

The issue echoes the recent problems of money service providers in Cayman to access correspondent banking services that are needed to process remittance payments. Most services were terminated by the banks, which cited “de-risking” and costs as the primary reasons. While the demand for private banking, once a staple service of offshore banks, is still growing globally, there is a danger that Cayman’s reputation for banking services is eroding in line with the fall in the number of banks, Byles said.

“Cayman’s reputation as a leading international banking sector continues to be one of the main features of the jurisdiction. But it’s hard to see how it can remain so if there is a dramatic reduction in the number of banks operating from the jurisdiction,” he said. “A jurisdiction that no longer accommodates smaller private banks runs the risk of losing this service offering entirely.”

Not all banks are affected equally. Cayman continues to be the sixth-largest financial banking center on the basis of its cross-border assets of US$1.37 trillion. International assets and liabilities of Cayman banks of US$1.39 trillion and US$1.44 trillion, respectively, were unchanged between June 2014 and June 2015, the latest available statistics show. According to CIMA, more than 80 percent of more than the US$1.3 trillion on deposit and booked through the Cayman Islands, represents inter-bank bookings between onshore banks and their Cayman Islands branches or subsidiaries.

“These institutions present a very low risk profile for money laundering,” CIMA says on its website.

Cayman companies plead guilty to tax evasion conspiracy

Cayman National Corporation’s affiliated trust and securities management businesses conspired with American taxpayers to hide US$137 million in assets managed by those companies from the U.S. Internal Revenue Service, according to a guilty plea to tax evasion conspiracy allegations recorded in March in Manhattan.

Cayman National Trust Co. Ltd. and Cayman National Securities Ltd. have agreed to forfeit US$6 million as part of the deal. In addition, the companies agreed to turn over account information on the alleged tax evaders whose accounts they managed.

The pleas made in March represented the U.S. Department of Justice’s first criminal conviction of non-Swiss financial entities for tax evasion conspiracy.

Federal prosecutors said Cayman National Trust and Cayman National Securities helped U.S. taxpayers evade income tax bills during a period of “at least” 10 years between 2001 and 2011.

In their guilty plea, Cayman National Trust and Cayman National Securities admitted to encouraging U.S. taxpayer clients to open accounts in the name of sham trusts and sham companies in the Cayman Islands to conceal their beneficial ownership of these accounts.

The sham trusts were nominally directed by Cayman National trust officers, but were controlled by the U.S. clients. The managed companies, for which the trust company provided management services, were shell companies with the sole purpose of holding the assets of U.S. clients, the Department of Justice said.

At its peak in 2009, Cayman National Securities and Cayman National Trust had approximately $137 million in assets under management relating to undeclared accounts held by U.S. clients.

“At least half of those assets … were undeclared,” according to the plea agreement.

The total amount of assets held by Cayman National Corp. companies during the period totaled between US$700 million and US$900 million, according to the U.S. plea agreement.

Between 2001 and 2011, prosecutors said, the two Cayman companies earned US$3.4 million in “gross revenues” from the undeclared U.S. accounts they managed.

Financial services

Company terminations outweigh new registrations

The Cayman Islands Company Registry saw an 8-percent increase in new companies in 2015, but the number of active companies on the registry failed to breach the 100,000-company mark as terminations exceeded new registrations.

New registrations have grown for three consecutive years, and last year’s increase followed 17 percent growth in 2014.

But despite 11,864 new companies registered in the Cayman Islands last year, the number of active companies declined by 1 percent, from 99,459 to 98,838.

Company terminations jumped 66 percent, from 7,321 in 2014 to 12,206 in 2015. Both active resident and non-resident companies on the register experienced a 12 percent decline, whereas exempt companies, the most common company type, continued to increase by 1 percent.

Meanwhile, partnership registrations set a new record with 3,370 new partnerships registered in 2015, compared with the previous high of 2,893 new partnerships in 2014.

Active partnerships registered in Cayman climbed 16 percent to an all-time high of 18,041 last year.

New trust registrations fell to 104 during the period from 140 new trust registrations a year earlier. However, terminations of trusts also dropped from 142 in 2014 to 108 in 2015.

As a result, the number of active trusts registered in Cayman remained virtually unchanged at 1,789, compared to 1,804 in 2014.

Cayman mergers and acquisitions activity highest in five years

The Cayman Islands reached a five-year high in the number of local mergers and acquisitions in 2015.

Deals involving entities registered in Cayman accounted for about a third of the overall deal volume and more than a quarter of the transaction value in major offshore financial centers analyzed by offshore law firm Appleby.

“For four years now, we have seen the Cayman Islands ranked as the most popular destination for investors seeking to acquire offshore assets,” said Simon Raftopoulos, a Cayman-based partner and member of the firm’s Corporate Finance and Private Equity teams. “With nearly 1,000 deals recorded in 2015, Cayman had another standout year and was a significant contributor to a robust year for transactional activity in the offshore markets by all key metrics – deal value, deal volume and average deal size.”

Cayman attracted 974 deals in 2015 worth a cumulative US$125 billion, a 14 percent increase in deal value over 2014. Both the number of deals and the average deal size of US$129 million were 7 percent higher than in the previous year, the Appleby’s Offshore-i report found.

Two of the 10 largest transactions of 2015 involved Cayman-incorporated companies as targets. In one notable institutional buyout, Qihoo 360 Technology, a software publishing business incorporated in Cayman, was sold to True Thrive, a consortium of investors also incorporated in Cayman, for $9.3 billion.

The total cumulative value of offshore M&A deals across all offshore jurisdictions measured in the report in 2015 increased 56 percent over the previous year, with average deal value topping highs not seen since 2007.

Three of the largest quarterly periods of the last decade occurred in 2015 and contributed to a cumulative deal value of US$442 billion across offshore jurisdictions. The year also saw nine megadeals worth in excess of US$5 billion each and more than US$150 billion when combined.

Moreover, there were 75 deals each worth more than $1 billion last year, compared with 52 recorded in 2014.

“The offshore markets are thriving and enjoying some of the best deal activity ever witnessed,” said Frances Woo, managing partner of Appleby’s Hong Kong office. “Offshore saw more value than the Middle East, Africa, Eastern Europe, South and Central America combined. Although 2016 remains fraught with uncertainty and challenges at the macroeconomic level could slow global deal activity, we are quietly optimistic that such good news will continue in 2016.”

The majority of M&A deals, about 30 percent, involved insurance and financial service companies (883 deals), followed by manufacturing with 610 deals; IT and telecoms (287); construction (233); and mining and quarrying (192).

The Cayman Islands also led offshore financial centers in the number of initial public offerings involving offshore-incorporated companies, despite an overall drop in the number of offshore IPOs in 2015.

Cayman-incorporated entities accounted for 45 out of a total 82 IPOs of offshore companies last year.

Economy

Cayman’s economic growth slows

The Cayman economy grew an estimated 1.6 percent in the first three quarters of 2015, down from 2.4 percent for the same period in 2014, according to the Economics and Statistics Office.

The ESO projected a gross domestic product growth of 1.7 percent for the year.

Finance and insurance services led economic growth with a 3.6 percent increase. Real estate and renting, electricity and water supply, and agriculture and fishing also grew in the first nine months of last year.

Some sectors did see declines, including a 2.3 percent drop in wholesale and retail trade and about a 1 percent drop in producers of government services. Mining and quarrying, construction, and hotels and restaurants all recorded small drops of less than a third of one percent.

Marco Archer
Marco Archer

“Since the beginning of 2013, the local economy averaged 1.5 percent real GDP growth, that is, 10 of the last 11 quarters recorded positive economic growth,” Finance and Economic Development Minister Marco Archer said in a statement.

While the economy continued to grow, the Cayman Islands recorded a 2.3 percent rate of deflation for the first three quarters of last year. The ESO noted the drop in inflation “resulted mainly from lower price indices for housing and utilities (6.4 percent), transport (4.3 percent), restaurants and hotels (3.0 percent), and miscellaneous goods and services (1.6 percent).”

Government surplus grows to nearly $105 million

Government revenue dropped by 2.4 percent in the first three quarters of 2015, to about $520 million, but the government surplus continued to increase, to almost $105 million.

The Framework for Fiscal Responsibility, signed in 2011 by then-Premier McKeeva Bush, requires the Cayman government to get approval for its budget from the Foreign and Commonwealth Office.

The framework prevents Cayman from taking out additional long-term loans and restrains government spending.

Government’s outstanding debt declined in the first three quarters of 2015, down by almost 5 percent to $518 million as government continues to pay off long-term loans. Government has paid off more than $50 million in outstanding debt since September 2013.

Government spending dropped in almost every category, led by a $5 million drop in personnel costs and a $10 million cut to supplies and consumables, according to the ESO report. The drop in personnel costs, the ESO notes, was “mainly due to lower payment towards the employer portion of pension liability and other personnel cost.”

Subsidies to statutory authorities, including Cayman Airways and the Health Services Authority, dropped by almost $1.5 million in the first three quarters of the year to less than $95 million.

Moody’s maintains Cayman’s credit rating and outlook

International credit rating agency Moody’s has maintained an Aa3 rating for bonds issued by the Cayman Islands government in a foreign currency, and an Aa2 rating for long-term foreign currency ceiling bonds and notes.

In its credit opinion, Moody’s noted government’s “fiscal and debt positions are comparatively robust given fiscal surpluses, low levels of debt, and high debt affordability.”

The rating agency expects budget surpluses of 2 percent to 3 percent of gross domestic product both this year and next, which will result a falling government debt burden.

“The debt-to-GDP ratio is slated to decline to approximately 18.5 percent of GDP in 2015 compared to a peak of 24.4 percent in 2011. We forecast that debt-to-GDP will continue to trend down, declining to around 17.5 percent of GDP in 2016,” Moody’s said.

Despite comparatively lower economic growth rates than equally rated peers, Cayman’s per capita GDP is higher than the median for Aa-rated sovereigns and a key support factor of its high credit rating.

Of the 16 sovereigns rated Aa by Moody’s, only four have a higher per-capita GDP than Cayman and two of them are Middle Eastern oil-producing countries.

“Cayman’s high GDP per capita supports its resiliency in the face of economic and natural disaster shocks, of particular importance given the country’s vulnerability to hurricanes,” the rating agency said.

The rating outlook is stable. Moody’s noted a positive outlook could be considered in the event of a significant reduction of government debt levels coupled with a policy framework that makes it unlikely debt will increase significantly again.

One potential economic risk noted by Moody’s is the shrinking of the financial services sector as a result of tighter regulations from G-20/OECD initiatives involving offshore financial centers.

This would lead to lower economic growth and negatively impact fiscal revenues, but it is a risk that would play out over a longer term of five to seven years.

Meanwhile, the likelihood of a major shock remains low, Moody’s stated.

Beneficial ownership

Beneficial ownership agreement with UK finalized

In April, the Cayman Islands government and the United Kingdom announced a new agreement to provide foreign law enforcement and tax authorities with faster access to beneficial ownership information maintained by local service providers.

The deal does not include a public registry, nor does it create a central government-maintained registry, as previously demanded by the U.K.
Instead the new system will give Cayman officials centralized access to databases held by the financial services companies.

Premier McLaughlin
Premier McLaughlin

Under the new regime, foreign law enforcement and tax agencies will be able to ask Cayman authorities to gather the information from the system. Companies will not know when law enforcement agencies request a search of the databases or what they are searching for.

“The U.K. has recognized that our system of enhancements meets their criteria for the sharing of information; meets global standards; and is best for this jurisdiction,” Premier McLaughlin said.

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Michael Klein
Michael Klein Editor Pinnacle Media Group Ltd. PO Box 1365, Grand Cayman, KY1-1108, Cayman Islands T: 345-326-1720C: 345-815-0064 E: mklein@pinnaclemedialtd.com Michael is a financial journalist and copywriter.  In the past he has been responsible for the Risk Management and Corporate Finance sections of a British monthly Corporate Treasury publication.  He has written various financial handbooks, notably on European Banking and Cash Management and the Debt Capital Markets.   In addition he has worked as a copywriter for banks and investment funds and served as corporate communications consultant to US and European blue chip companies.   Michael holds an MA in Political Science and International Law from the University of Bonn in Germany. 

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