Brexit and Trump – a reboot for global tax policy?

What do the electoral shake-ups of 2016 mean for Cayman and other offshore centers?
With Trump now inaugurated and in command of the White House, and the Brexit referendum freeing Britain from the chains of European Union policy, there is a breath of fresh air on both sides of the Atlantic.

But how will this affect Cayman and other offshore finance centers?  Will the old bureaucracy continue to tighten its grip, trying to squeeze more tax money out of global business, or will the new governments adopt pro-investment policies and usher in a new era of global prosperity?


There are encouraging signs that the new governments see lower taxes as potentially a good thing.

Trump seems to have the right gut instincts about tax, having openly said that he had been “smart” to reduce his tax bill.  This is a refreshing change from the virtue-signaling David Cameron, who publicly condemned people engaging in tax planning and lectured us on the importance of our paying more taxes to “fund public services,” while having benefited from offshore family tax-avoidance structures himself.

Sadly, it doesn’t seem that Trump has any direct experience of offshore structures.  Although there were some Trump companies listed in the Panama Papers, they seem to be joint venture partners or franchise holders, not companies Trump actually had a shareholding in.  But at least it shows that several of his business associates do understand the offshore world.

More positively, Rex Tillerson, now Secretary of State and responsible for the USA’s international relations, has been director of a Bahamas-incorporated company.  Again, this was part of a joint venture between Exxon and another oil company, so it is not certain whether he was actually responsible for the decision, but at least he will not assume that all offshore operations are suspect.

Sadly, on my side of the Atlantic, the post-Brexit Chancellor Philip Hammond did not take such a robust line when he was accused of reducing his own tax bill by transferring an investment property to his wife.  Instead of Trump’s positive pro-investment response, Hammond issued a statement saying that the transfer had not been done in order to avoid tax, which I suppose might even be true.

Worse, Hammond’s latest budget included proposals to punish professionals for advising their clients on how to reduce their tax bills, an idea that is completely contrary to the rule of law and the right to fair representation.

So a mixed message, but the new governments certainly seem more pro-business and less culturally attuned to tax-grabbing than their predecessors.

A better American tax system?

Trump’s proposal is for a 15 percent tax on business income, but applied to worldwide income for American companies, with no deductions or postponements for offshore income.

That sounds good for American businesses, but could cause problems for international finance centers.  That’s because the current 35 percent corporate tax is not only ridiculously high, but also gives companies the ability to shelter non-U.S. profits so long as they are kept out of the USA.  That gives a big incentive for American companies to use offshore structures, particularly those in Cayman, but that incentive will be reduced under Trump’s proposed tax system.

Although Trump’s plan wouldn’t change what can be done in Cayman, it does mean that the relative advantage of an offshore structure is greatly reduced, because the U.S. tax saved is lower.  Indeed, Richard Murphy, left-wing campaigner for higher taxes and long-term opponent of offshore finance centers, has said of Trump’s tax policies: “Is there a downside? Not that I can see.”

But I wouldn’t get too worried; Trump has to get it through Congress first, and even if his reforms survive that process without being watered down, there will still be plenty of other advantages to offshore structures, such as more sensible regulation and less risk of tax rates being increased in the future.

So we aren’t expecting the sort of all-out assault on offshore finance that Bernie Sanders might have proposed.  Instead, the risk to offshore finance centers from Trump is that he will make American taxes so low and straightforward that offshore finance becomes, comparatively, less attractive.  There are worse problems to have.

Britain – a European Singapore?

On the other side of the Atlantic, Britain has voted to leave the European Union, but that is merely the start of a long, slow progress toward freedom.  As I write this, the government has just got its Brexit Bill through Parliament and announced that they will serve notice on Brussels at the end of March, formally beginning the two-year negotiation on what will happen when we leave.

At the moment the two sides are just starting the opening salvos in what seems likely to be a war of attrition.  But Hammond has responded robustly, announcing that, if Britain is shut off from access to European markets (particularly the City of London’s financial markets), we will abandon the high-tax, high-regulation European-style social model and become “the tax haven of Europe.”  Nor is he alone; Prime Minister Theresa May apparently “stands ready to do so” too.

The disappointment is that Hammond is not proposing to do this anyway.  The U.K. becoming a “European Singapore,” a global hub for trade and investment, is the very thing to make a success of Brexit.  Disappointingly, our Chancellor seems to stick with the failed “European economic and social thinking” that has led to 20 percent and greater youth unemployment.  But at least he seems ready to change to a better model if necessary.

If Hammond is going to properly turn Britain into a successful global economy, he needs to improve our relationships with its associated international finance centers, not just the local ones in the Channel Islands, but also Cayman and the other Caribbean centers.

These links have been strained in recent years as Britain has put pressure on its associated territories to comply with increasingly draconian European Union tax rules, but post-Brexit that can stop.  If Hammond is serious about making Brexit work and attracting inward investment, one of the best sources of capital will be the funds managed in British-connected offshore finance centers.

Leaving just in time

It is just as well Britain is leaving the European Union because in the last few months the EU has started another tax squeeze on businesses, with a package of measures designed to increase the tax take and make it more difficult to invest or trade in Europe without suffering swinging taxes.

I intend to write more on this in future issues, but the bureaucrats’ plans include exit taxes (a fiscal Iron Curtain around Europe to trap business inside), extending Europe’s tax net to catch non-European subsidiaries, and a return to the infamous, often rejected, “Common Consolidated Corporate Tax Base” (CCCTB), effectively a centralized European corporation tax system under which the European Union, rather than national governments, will centrally set what deductions, allowances and exemptions companies can claim.

This is a power-grab by the EU’s Brussels bureaucracy.  Tax is one of the few areas where their control is limited, with national governments having jealously guarded their tax-raising powers.  But with European governments, as Margaret Thatcher warned, “running out of other people’s money,” and desperate to prop up their unreformed, out of control spending, the bureaucrats are promising that if they are given the power, they will “stop tax avoidance” and get more money flowing into the national coffers.

The EU’s proposal are designed to make it more difficult for multinational groups to take advantage of legitimate offshore structures, such as group financing companies, captive insurers and IP holding companies, many of which are based in Cayman and other Caribbean jurisdictions.  By leaving the EU, Britain can keep its companies out of that tax cartel and enable them to continue to use offshore structures to help their international expansion.

The problem is that a centralized tax system means that there is no room for innovation, reform becomes almost impossible (because it will need all national governments to agree) and it is a near-certainty that in time, once businesses are locked in to the EU tax net, the rates will increase.

And in the long term it won’t bring in more money; as the tax system tightens, business and investment will stay away from the European Union, wealth and employment opportunities will reduce even further, and Europe’s decline will continue.

It looks like Britain is getting out just in time.

The rest of the world

So America is to be made great again through low taxes, encouraging businesses and employment to stay in, or even move back into, the USA.  And Britain is apparently going to rediscover its global role in business and turn its back on European bureaucracy and protectionism.

But what of the bigger picture?  How will Brexit and the Trump presidency affect the rest of the tax world, and what impact will they have on Cayman?

The European press has generally been presenting both Brexit and Trump as part of a wider move to isolationism.  Brexit they see as Britain cutting itself off from Europe, while under President Trump, they claim, the USA will look after itself alone and retreat from the rest of the world, with both abandoning free trade areas.

But how accurate is this?

Brexit could be portrayed as isolationist, Britain turning its back on Europe, but if it is done well it will actually be an internationalist, globalizing move.  Although the European Union has (sometimes rather fitfully) encouraged a “Single Market” of goods, services, people and capital, it is only an open market within its own borders.  As regards the rest of the world, the European Union adopts a “Fortress Europe” mentality, shutting itself off through tariffs and regulations.

Once Britain is out of the European Union it can forge its own trade deals with other countries, which is not allowed within the EU, where all trade policy is controlled centrally by the Brussels bureaucracy.  The hope is that Brexit will see Britain reopen its trading and investment links with the rest of the world, instead of being trapped inside a declining Europe.

As for Trump’s America, the fears of future American policy do seem to be rather exaggerated.  It is true that significant American isolationism would be a retrograde step, but there is little sign that this is happening.

On international trade, it is true that TTIP, the U.S.-EU trade deal (the “Transatlantic Trade and Investment Partnership”), is probably dead.  But it was dead anyway.  Protectionism did indeed kill it off, but protectionism by the EU rather than the USA.  Look at the fuss Europe made over the far less controversial EU-Canadian trade deal, which was almost scuppered when one of the Belgian parliaments voted it down in a fit of protectionism.  There is no way a decent U.S. trade deal would have got past the EU, which is another good reason for Britain to regain control of trade policy from Brussels.

So withdrawing from the flawed TTIP does not make Trump a dangerous isolationist.  Nor does he seem to be opposed to all international trade agreements; he was quick to offer the U.K. one after the Brexit referendum.

So, no, I’m not terrified; I don’t expect international trade to end.

One international system to leave

But just because international trade and global free markets are beneficial, that does not mean that all international organizations are forces for good.

If President Trump is looking for international systems to withdraw from, and Britain wants to advertise its post-Brexit pro-growth policy, I have a good suggestion – abandon the OECD and its tax-grabbing “BEPS” project.

Initially the OECD did good work, helping restore the world economy after the ravages of the Second World War and, through its model tax treaty, reducing the double taxation that discouraged international business.  Sadly, over the decades it has lost its original purpose and is now acting as a tool of the high-tax, high-spending European governments, and rather than growing wealth and opportunity by encouraging international business, it is now propping up bloated governments and helping them squeeze more tax out of their moribund economies.

This started in the 1990s with the OECD’s “harmful tax competition” initiative.  Tax competition is the process by which governments improve their tax systems in order to encourage and attract more business and investment; it is a beneficial action that promotes economic growth and boosts jobs.  Unfortunately, some governments see it as a challenge to their desire to squeeze as much tax out of business as they can, regardless of the negative effects on their population.

Those governments that persisted with their inefficient, uncompetitive old tax systems soon found themselves losing out to those more dynamic countries that had made improvements, not just international centers such as Cayman but also the more dynamic European economies (yes, there are a few) such as Ireland and Estonia.  But rather than improving their tax systems to encourage business and investment, they labeled tax competition as “harmful” and tried to force their failed policies onto other countries.

Sadly, the OECD, to some extent, went along with this and attempted to force low-tax countries to change their tax systems to make them less attractive, and made it more difficult for businesses to use offshore centers. Now this is going further through the OECD’s current initiative, “BEPS.”

Time to leave BEPS

BEPS stands for “Base Erosion and Profit Shifting,” reflecting the OECD’s claim that companies, primarily multinationals, are “shifting” their profits away from high-tax countries and are thereby reducing their taxable profits, known as their “tax base.”

This is aimed primarily at successful multinationals, particularly American-owned ones; Google, Apple, Starbucks, Amazon have all been pilloried in the media, and by governments, for not paying as much tax as governments would like.  Never mind that they are providing services that people want, and much-needed employment in Europe’s stagnating economies; to many governments the only purpose of business is to pay taxes.

The OECD’s BEPS project is aimed squarely at allowing European governments to extract more tax from businesses such as those.  And to add insult to injury, those OECD bureaucrats pushing for businesses to pay more tax enjoy tax-free salaries themselves, thanks to the French government granting diplomatic status to the Parisian palace that is the OECD’s headquarters.

The OECD’s plan, enthusiastically supported by the high-tax European governments, is to change the international tax system so that tax authorities will be able to ignore certain legitimate business costs for tax purposes.

If a company has sales of £100 million and costs of £80 million, it has profits of £20 million and pays tax on that.  But if the tax authority ignores, or “disallows,” £10 million of those costs, suddenly the taxable profit is treated as being £30 million and the company’s tax bill becomes one and a half times what it was.

Worse, the OECD’s primary targets are vital features of the new knowledge economy.  The main costs that they are seeking to disallow are royalties or other payments for intellectual property, and interest or other financing costs.

The European Union is also pushing through its own version of BEPS, which seems likely to be even more restrictive and damaging.

Innovation has been the vital driver of Western economies, and payments for the use of intellectual property, for the right to exploit inventions and new ideas, are what underpin that growth.  But the OECD and European Union do not seem to be worried about the damaging effect their proposals will have on job creation or improving living standards for their citizens; instead their sole worry is that when companies pay royalties for the right to use an invention, there is less profit for them to tax.

Over-taxing intellectual property is like eating the seed potatoes; it may help this year, but it causes far more problems next year.  As we all know, and have known for centuries, if you tax something you get less of it, and the more you tax it the less of it you will get.  But somehow the governments that enthusiastically make that argument about smoking seem surprised when it also has the same effect on innovation.

The problem for offshore finance centers is that the assets being attacked by BEPS – intangibles such as intellectual property and finance – are the ones often held by companies in their jurisdiction.  The BEPS initiative is intended to make it more difficult for companies to take advantage of offshore structures.   If, after Brexit and the Trump victory, Britain and the USA will be less favorable to these harmful tax cartels, the world will benefit.

Britain and the U.S. should set their own tax policy

The OECD’s BEPS project is a retrograde, harmful process that is trying to shore up inefficient European governments and their uncompetitive tax systems, and is doing so by attacking business innovation.

Britain is just escaping from the European Union’s anti-innovation restrictions, and that will hopefully help rebuild its relationship with its related offshore finance centers.  It would be folly for them to escape one draconian tax system merely to plunge straight back into the OECD’s version.  And this is certainly one international system that the USA should withdraw from, for the sake of its own businesses and to save the rest of the world from European governments’ folly.

Blockchain innovation for private investment funds

Blockchain technology offers unprecedented innovation opportunities for the private investment fund industry. Several private investment funds have spearheaded the implementation of blockchain technology and smart contracting in their business model. While some funds simply focus on trading bitcoin and other cryptocurrencies to avoid market fluctuations, others invest in or acquire companies that use blockchain technology to provide synergies to their other portfolio companies. Yet others go much further by fully automating a hedge fund secured by blockchain technology, using blockchain technology to improve administrative procedures of private equity deal making, or using cryptocurrencies as incentives for data scientists’ competitive models that facilitate investment analysis efficiencies. Examples include private investment funds such as Polychain Capital, the Northern Trust in cooperation with IBM, Numerai, LendingRobot, and Intellisys Capital LLC, among many others.

Naturally, this article cannot encapsulate all recently emerging trends in the private fund industry pertaining to the application of blockchain technology but rather is limited to pointing to prominent examples that illustrate the emerging use of blockchain technology in the private investment fund industry.

Despite these limitations, it is possible to forecast that once blockchain-based hedge funds that trade by algorithm are able to expand beyond peer-to-peer lending investments into the stock market, it is possible that they will monopolize and substantively change the hedge fund industry.

Blockchain technology

A blockchain is a shared digital ledger or database that maintains a continuously growing list of transactions among participating parties regarding digital assets – together described as “blocks.” The linear and chronological order of transactions in a chain will be extended with another transaction link that is added to the block once such additional transactions is validated, verified and completed. The chain of transactions is distributed to a limitless number of participants, so called nodes, around the world in a public or private peer-to-peer network. The central elements of blockchain technology include: transaction ledger, electronic, decentralized, networked, immutable, cryptographic verification, among several others.

Vitalik Buterin, the founder of Ethereum, perhaps most prominently defined blockchain as follows: “A public blockchain is a blockchain that anyone in the world can read, anyone in the world can send transactions to and expect to see them included if they are valid, and anyone in the world can participate in the consensus process – the process for determining what blocks get added to the chain and what the current state is. As a substitute for centralized or quasi-centralized trust, public blockchains are secured by crypto economics – the combination of economic incentives and cryptographic verification using mechanisms such as proof of work or proof of stake, following a general principle that the degree to which someone can have an influence in the consensus process is proportional to the quantity of economic resources that they can bring to bear. These blockchains are generally considered to be ‘fully decentralized’”.

Smart contracts and smart property are blockchain enabled computer protocols that verify, facilitate, monitor, and enforce the negotiation and performance of a contract. The term “smart contract” was first introduced by Nick Szabo, a computer scientist and legal theorist, in 1994. An often-cited example for smart contracts is the purchase of music through Apple’s iTunes platform. A computer code ensures that the “purchaser” can only listen to the music file on a limited number of Apple devices.

More complex smart contract arrangements in which several parties are involved require a verifiable and unhackable system provided by blockchain technology. Through blockchain technology, smart contracting often makes contractual legal contracting unnecessary as smart contracts often emulate the logic of legal contract clauses. Ethereum, the leading platform for smart contracting, describes smart contracting in this context as follows: ”Ethereum is a decentralized platform that runs smart contracts: applications that run exactly as programmed without any possibility of downtime, censorship, fraud or third party interference. These apps run on a custom built blockchain, an enormously powerful shared global infrastructure that can move value around and represent the ownership of property. This enables developers to create markets, store registries of debts or promises, move funds in accordance with instructions given long in the past (like a will or a futures contract) and many other things that have not been invented yet, all without a middle man or counterparty risk.”

Private investment funds’ use of blockchain technology

Several private investment funds have spearheaded and continue to expand the implementation of blockchain technology and smart contracting in their business models. In February 2017, Northern Trust and IBM entered into a partnership for the commercial use of blockchain in the private fund industry. The partnership provides an enhanced and efficient approach to private equity administration. The implementation of the Northern Trust and IBM blockchain is intended to increase efficiency, transparency, and the speed of private equity transactions, improve security, and bring innovation to the private equity market by simplifying the complex and labor intensive transactions in the private equity market. While the current legal and administrative processes that support private equity are time consuming, expensive, lack transparency, involving lengthy, duplicative, and fragmented investment and administration processes; the partnership’s solution delivers an enhanced and efficient approach to private equity administration. More specifically, unlike the current deal practice in private equity, which requires parties to reconcile multiples copies of documents that form deals to understand the greater picture, the blockchain program announced by Northern Trust and IBM allows all involved parties in an equity deal to look at one single compiled version of the transaction and all other data relating to the deal.

Another example of the use of blockchain technology for private investment funds is Numerai. Numerai is a private investment fund with a global equity strategy that will go live on the blockchain later this year. Numerai operates on the Ethereum blockchain, utilizing a cryptocurrency called “Numeraire.” Numerai uses artificial intelligence to convert financial data into machine learning problems for data scientists. On February 21, 2017, Numerai, announced: “[Today] 12,000 data scientists were issued 1 million crypto-tokens to incentivize the construction of an artificial intelligence hedge fund.”

Using data scientists for investment analysis creates efficiency through a synthesis of data. Data scientist working in this model work to solve the same problems in their own unique way with different strategies. Numerai synthesizes these models to create a meta-model out of all the predictions from the data scientists. In the Numerai model, the use of artificial intelligence ultimately helps achieve the goal of efficiency and perfect capital allocation by reducing overhead costs because there is no cost of human capital. In addition, Numerai eliminates barriers to entry because users do not need capital or any special finance or data knowledge.


Robot’s Lending Robot Series is a fully automated hedge fund secured by blockchain technology. Unlike other blockchain-based hedge funds that invest specifically in crypto currency, such as Global Advisers and Polychain Capital, Lending Robot Series invests in lending marketplaces such as Lending Club, Prosper, Funding Circle, and Lending Home. Its trading is determined by an algorithm based on the investor’s risk preferences. Once the investor has created a trading profile, Lending Robot selects and executes trades that are recorded in the blockchain public ledger on a weekly basis. Unlike traditional hedge funds that are rather secretive, the Lending Robot ledger shows detained holdings and provides a “hash code” signature as evidence that the data is tamper-proof in the blockchain. Unlike investors in traditional hedge funds, Lending Robots’ investors can cash out on a weekly basis at no additional cost and Lending Robot only charges a 1 percent management fee and a maximum of 0.59 percent fund expense fee per year. Lending Robots’ business model creates superior efficiencies by removing the investment advisers, overhead costs, and legal fees associated with each investor agreement.

Mainstreet Investment, LP incorporates blockchain technology into its operations. Mainstreet Investment LP operates like a private equity firm by allocating investment capital in American companies, blockchain companies, and real estate. By using blockchain technology the fund intends to provide investors with higher returns in the U.S. compared to low-yielding bonds, high risk equity picks, and profit-erasing fees of mutual funds. Mainstreams’ managers incorporated blockchain technology into the funds structure by issuing an asset-backed token security on the public Ethereum blockchain using a smart contract that records all assets in the portfolio. Moreover, blockchain is also used by issuing cash flow distributions to token holders through the smart contract. Mainstreet is powered by Ethereum with an organizational framework focused on transparency of the investment portfolio. Blockchain technology will be used to facilitate and administer the decentralized fund, which includes token purchasing, tracking, dividend payouts and dissemination of investor information.

Explaining Cayman’s success through its role in the Anglo-American triangle

Figure 2

The foreign capital booked in the Cayman Islands is enormous by any standard. Combined data for external banking activity, portfolio investment Iand direct investment show that over US$4,000 billion have been invested from abroad. This huge value is nothing but astonishing, given that the Cayman Islands has a population of only about 60,000 people, a domestic economy of approximately $3 billion, and because Cayman occupies a geographic location, which is quite remote from the centers of the global economy. However, this small Caribbean archipelago has in fact attracted more external assets than advanced industrial countries such as Japan, Canada or Italy, despite them having economies several hundred times Cayman’s GDP. Thus, Cayman is big in global finance in absolute terms.

Research on the Cayman Islands

In some segments of international finance, the Cayman Islands is even among the largest jurisdictions worldwide. For instance, the Bank for International Settlements provides data on external loans and deposits of all reporting banks vis-à-vis individual countries. According to this metric, in 2015 Cayman had the third highest value in the world – over US$1,300 billion in external loans and almost $1,800 billion in external deposits. This puts Cayman on place three globally, after the United Kingdom and the United States. Besides banking, the Cayman Islands is also very large in portfolio investment.

In relative terms, Cayman’s size in finance is even more surprising. Setting the amount of foreign assets in relation to the GDP of a particular jurisdiction results in what I have called the offshore-intensity ratio, a rough yardstick of how intensively a jurisdiction acts as a magnet for foreign capital.  With a value of over 1,500, Cayman has by far the highest ratio in the world – the British Virgin Islands (BVI) and Bermuda follow with values of roughly 1,000 and 200, respectively.

In a recent research paper, I have conducted one of the most complete studies on the position of the Cayman Islands in global finance. I have utilized all sources of publicly available data on the three major financial segments: banking, direct investment, and portfolio investment. In short, my argument is that Cayman is a key node in an Anglo-American triangle together with the United States, its major counterpart jurisdiction, and the United Kingdom, its sovereign power.

The status of the Cayman Islands as a British Overseas Territory should be seen as fundamental for the unparalleled success of this offshore financial center. Being a dependency that is under the sovereignty of the United Kingdom provides Cayman with political and economic stability. In contrast, competing jurisdictions, such as the Bahamas or Panama, have been rocked by political instabilities in the past. Stability is of paramount importance in order to create and to maintain investor trust. In addition, a crucial Cayman property that stems from British rule is the stable and business-friendly legal system based on English common law. What is less known is that it is still legally correct today to refer to the Cayman Islands and other British dependencies, such as BVI or Bermuda, as “colonies” of the United Kingdom.


The United States is among the largest counterparties in banking, direct investment as well as in portfolio investment. American and other foreign banks use Cayman intensively for intra-group transactions in U.S. dollar, such as overnight sweep accounts. However, according to the “Locational Banking Statistics” by the Bank for International Settlements (BIS), intra-group transactions by foreign banks have peaked in 2011 and are declining since then.

The “Consolidated Banking Statistics” by the BIS enable another perspective on the Cayman Islands banking center. They provide information on claims by foreign banks on counterparties (e.g. hedge funds) resident in Cayman. In Q3 2016, foreign banks had consolidated claims on counterparties resident in the Cayman Islands of over $1,200 billion – a new all-time high. American banks are responsible for about 30 percent of that large value.

Surprisingly, Japanese banks account for over 40 percent, which is the highest share of all countries. These two very large counterpart countries in banking are followed by Switzerland (9 percent), the United Kingdom (5 percent), Germany (5 percent) and France (4 percent).

Figure 1: Cross-border claims on non-banks surpassed intra-group activity for the first time in 2016.

Figure 1 shows that in mid-2016 the Consolidated Banking Statistics, claims from foreign banks on Cayman entities, surpassed the Locational Banking Statistics, cross-border claims from banking offices located in Cayman, for the first time since statistics began in the 1980s.

In other words, intra-group activity in Cayman is declining while claims by foreign banks on non-banks, likely hedge funds and other investment vehicles, resident in Cayman keep rising.

Direct investment

Banking is big in Cayman, but foreign investment is even bigger. The huge domain of investment can be separated into direct investment and portfolio investment. Portfolio investment is defined as equity or debt instruments that are held passively to make financial gains. The characteristic feature of foreign direct investment (FDI), by contrast, is the aim of the investor to exert a certain amount of control over a foreign company.

The Cayman Islands is not reporting FDI data to the IMF. However, the outward direct investment statistics reported by counterpart economies make it possible to derive data for Cayman. FDI into Cayman has grown from close to $300 billion in 2009, when IMF statistics began, to over $550 billion in 2015. This should be seen as a lower bound estimate, as the value is derived from outward FDI by participating jurisdictions, a value which some countries, such as China, do not report.

FDI is often associated with “greenfield” investment, i.e. the construction of new plants. This is clearly not the case in Cayman and other offshore financial centers, such as the BVI and Bermuda, because their domestic “real” economy is simply far too small to absorb large flows of foreign capital.

The United States is by far the largest source of FDI into Cayman. In 2015, the United States accounted for almost $260 billion, i.e. about 47 percent of total inward FDI. From information by the U.S. Bureau of Economic Analysis, we can infer that the vast majority of U.S. FDI to Cayman is concentrated in just two segments: 1) holding companies (nonbank) and 2) finance (including depository institutions). Other significant sources of FDI are Hong Kong with $56 billion, the Netherlands with $53 billion and Brazil with $52 billion.

Outward direct investment emanating from Cayman goes to Luxembourg ($98 billion), the United States ($93 billion), Hong Kong ($85 billion), Singapore ($58 billion), the Netherlands ($49 billion), and China ($48 billion). Luxembourg and the Netherlands are the two dominant global FDI conduits for multinational corporations, which explains their prominence here.

Portfolio investment

The largest segment of the Cayman offshore financial center by far, however, is portfolio investment. Again, the Cayman Islands do not participate in the portfolio investment statistics collected by the IMF, but data derived from counterparty economies is available.

According to this data, in mid-2016 Cayman has been the world’s fifth largest financial center concerning foreign portfolio investment with an astonishing value of over $2,640 billion – roughly $2,000 billion in equity and investment fund shares, the rest in debt securities. Thus, Cayman has attracted less external portfolio investment than the United States, the United Kingdom, France and Luxembourg, but more than Germany, the Netherlands and Japan.

There is one simple explanation for this. Cayman is the global jurisdiction of choice for hedge funds. These investment vehicles use Cayman as their legal domicile, the actual hedge fund managers work almost exclusively in the New York–Boston area and in London, which makes hedge funds a quintessentially Anglo-American industry.

Data from the IMF and the U.S. Treasury allow the visualization of Cayman’s role in international portfolio investment. Figure 2, using data for mid-2015, shows that the Cayman Islands primarily acts as a conduit to U.S. financial markets. Actually, Cayman is mainly used for what could be called some kind of “round-tripping” by American investors who invest in hedge funds that are legally domiciled in Cayman but which predominantly buy U.S. securities.

In fact, when excluding U.S. long-term debt, of which the central banks from both Japan and China hold more than $1,000 billion each, Cayman is the largest holder of U.S. securities in the world. See figure 2

Figure 2

The high value of portfolio investment by Japan is remarkable too; it has risen strongly from $547 billion in mid-2015 to almost $713 billion on year later. Thus, Japanese investment is more than two times the portfolio investment from Hong Kong, which amounted to $337 billion. One reason for the high value of Japan is that Cayman has enacted special legislation to attract investment funds specifically targeted at Japanese investors. Nonetheless, this figure is certainly surprising. Similar to the role Luxembourg plays as the dominant investment fund hub for Germany, Italy and other European countries, Cayman arguably acts as the preferred investment fund domicile for Japan.

In recent years, Cayman has increasingly catered to investors from Greater China. A key event in that respect has been the initial public offering (IPO) of the Chinese e-commerce giant Alibaba through a holding company legally domiciled in the Cayman Islands. However, foreign investment in Chinese e-commerce is actually restricted considerably. How did Alibaba do it? The company used a legal structure known as “variable interest entity” (VIE).

The problematic aspect of this structure is how to consolidate the restricted businesses that are part of the VIE without violating Chinese rules on foreign investment. The solution devised by accounting was to mimic ownership through a series of contracts between the Cayman company and the VIE. These legal contracts give the Cayman holding enough de facto control over the Chinese VIE that it is able to consolidate it under international accounting rules, even though Chinese laws actually prohibit foreign investment in this sector. Hence, this legal structure represents a grey area with significant hidden risk for investors in the Cayman company, because the whole structure rests on the willingness of Chinese authorities to tolerate it. In 2014, the Chinese e-commerce giant Alibaba (the Cayman holding, that is) raised a record $25 billion by going public on Wall Street, thus probably perpetuating the VIE structure given the sheer size of this IPO. However, investors in Alibaba have no de jure control over the Chinese corporation, as they only own shares in the Cayman holding.


The data presented above clearly shows that Cayman is not a random exotic small island financial center but a key component of contemporary global finance. My argument is that the Cayman Islands represents a central node in an Anglo-American financial triangle together with the United States and the United Kingdom. The United States is the largest counterpart economy of Cayman and the United Kingdom is its sovereign power. No other financial industry illustrates this Anglo-American triangle better than hedge funds, which are quintessentially Anglo-American. Hedge fund managers are extremely concentrated in New York and London, while most funds are legally domiciled in the Cayman Islands. Actually, in this respect Cayman could be seen as a branch of or a special bookkeeping device for Wall Street and the City of London.

However, the global hedge fund industry seems to have peaked recently or at least growth rates are likely to be low in coming years as investment flows are strongly shifting into index mutual funds and exchange traded funds. So how is the outlook for the Cayman Islands offshore financial center?

Brexit and the Trump Administration represent two factors that arguably are going to reduce international pressure on offshore financial centers to become more transparent. On the other hand, if the United States changes its corporate tax code in a way that creates strong incentives for U.S.-based multinational corporations to repatriate capital this could cause an outflow of funds from jurisdictions such as Bermuda and the Cayman Islands.

The IMF has identified reputational risk as the biggest danger to the Cayman Islands financial center. One strength of Cayman is that the regulatory bodies react swiftly to new international requirements. The Cayman Islands could further enhance its international reputation and its status as a trusted jurisdiction that participates in global regulatory initiatives by, for instance, finally reporting complete data on foreign direct investment and portfolio investment to the IMF. A small jurisdiction with a domestic economy of just $3 billion that has attracted foreign assets of well over $4,000 billion clearly should do everything it can to maintain investor trust and keep its reputation with global regulators.

Bring on the Robot Revolution

The story of human development is a story of disruptive – and liberating — innovation. More particularly it is a story of new tools. Early humans tamed fire, a tool that enabling them to eat cooked meat, which – according to Richard Wrangham – increased the protein density of their diet. As a result, humans grew big brains that, eventually, enabled them to develop other new tools. Over time, these tools have evolved from simple hand axes to robots – but they all share one thing in common: they enable humans to do more with less.

New tools, first and foremost, liberate our most scarce resource: time. This is implicit in many of the words we use to describe them, which relate to human functions they replace. The term “computer,” was originally applied to people who made calculations. The term “robot” was adapted, by Isaac Asimov, from the Russian word for “worker.”

The brilliant sword-swallowing Swedish physician and statistician Hans Rosling, who sadly died in February, was one of the foremost exponents of the benefits of new tools. In a highly entertaining TED talk in 2010, he made a persuasive case – aided by his own Trendlyzer software – that the humble washing machine is the most important technology to have been developed in the past 100 years. Why? Because it liberated women from the drudgery of hand washing clothes, enabling them to spend more time doing other, more productive and interesting things.

Over the course of the past fifty years, new tools have changed the way we pay and the way we invest. Payment cards, which can be traced back to the early 20th century but became a major force in the 1958 with the introduction of the American Express card and BankAmericard (which became Visa), enable consumers to make payments electronically, thereby avoiding the need to carry cash, reducing theft from consumers and merchants. Likewise, electronic trading platforms have replaced trading floors. And ETFs automatically track indices, reducing the need for human traders to buy and sell securities and thereby reducing the cost of holding a diversified portfolio.

Big brained humans have sought to identify and exploit vulnerabilities in these electronic transaction systems. Traders identify intra-day discrepancies between the price of ETFs and the value of the underlying securities, arbitraging the difference through long-short trades. And criminals have found ways to steal and use payment card information en masse.

But new tools that take advantage of advanced computational power, “artificial intelligence” (AI) programs, and vast amounts of data are addressing these vulnerabilities. Payment network operators have invested in AI-based systems to identify and stop instances of fraud and theft. Meanwhile, algorithmic trading has enabled such rapid exploitation of ETF discrepancies that prices rapidly adjust to the market clearing level.

Now, as several authors in this issue demonstrate, distributed ledger-based systems of various kinds are disrupting payments, investments and other kinds of transactions. These systems reduce the cost of authenticating transactions, liberating us from the inefficiency, ineffectiveness and bias of human-mediated transactions.

Smart contracts, which increasingly use blockchain and other distributed ledger-based systems, are beginning to replace a wide range of conventional contracts and even enable computers to contract with one another. Frustrated with your stock broker or fund manager and their high costs? An AI-powered app trading over a distributed ledger-based platform will do the job better, more securely and at lower cost.

Peruvian economist Hernando de Soto has for three decades been searching for ways enabling the poor to own the property they occupy, which represent trillions of dollars in what he calls “dead capital” (without formal rights, occupiers have been stymied in their efforts most effectively to use, develop, sell or mortgage their land). Now he and his team at the Institute for Liberty and Democracy have developed systems of standardized property registration using smart contracts that, in combination with GPS and satellite mapping, offer the ability to create at very low cost alternatives to absent or defective government property registries. Such registries may soon liberate billions of people to participate in formal economic activity from which they have been excluded.

In nearly all cases, new tools replace functions previously performed less efficiently and often with less precision by humans. And from the spinning Jenney to desk-top publishing, the tools make some human skills redundant. The new tools now being developed extend this revolution to knowledge workers, from doctors and lawyers to bankers and bureaucrats.

Some commentators have raised concerns that AI and robots will make humans redundant. In The Age of Em, economist Robin Hanson envisages a world in which multiple emulations of a small number of smart, wealthy humans do all the jobs. But while such a world is imaginable, it is neither inevitable nor is it likely to occur in the next few decades. Current AI-based systems are designed to do jobs for humans, not replace them entirely. That will enhance our prosperity.

New tools do not exist in isolation. The washing machine built upon innovations in mechanical and electrical engineering – and requires access to large amounts of electricity and running water. Likewise, the Internet is built upon innovations in information processing and transmission – and requires networks of data pipes and electricity. This cumulative nature of innovation makes it impossible to predict with precision which new tools will be developed in the future. But one thing can be said with certainty: that new tools will continue to liberate humans from drudgery, enabling us to do more with less and freeing us to do what we want, rather than what we must. And already entrepreneurs are searching for ways to enhance human abilities so that we can continue to learn, adapt and improve ourselves – and thereby take best advantage of all the new tools that emerge.

The greatest threat to human progress does not come from artificially intelligent robots eating our lunch. It comes from those who seek to use the power of the state to regulate new tools and other technologies. Many new technologies offer far superior alternatives to current systems of regulation. The algorithms and evaluation systems built into share economy apps such as Airbnb, Uber and Lyft, do a better job of providing user-relevant information about the price and quality of services being offered than regulators could ever do. Similar systems are being developed in the fintech space. Regulators simply do not have access to the granular information needed to police such transactions, so the best they can do is get out of the way.

Quarterly Review

The Cayman Islands government withdrew the Legal Practitioners Bill after repeated attempts to negotiate a compromise failed.

Cayman’s bond rating ‘stable’

The Cayman Islands government’s debt rating has stayed the same and maintains a “stable” outlook going forward, according to Moody’s Investors Service.

Moody’s reaffirmed Cayman’s Aa3 debt rating on Feb. 17, putting it three places below the highest possible rating of AAA for sovereign debt.

The Moody’s evaluation gave Cayman high marks for gross domestic product, financial strength and institutional (political/government) strength.

“Our rating proves that government’s general fiscal fundamentals are strong,” Finance Minister Marco Archer said.

“The high rating and stable outlook for the Cayman Islands is attributed primarily to a very high gross domestic product per capita, high levels of economic development and the government’s commitment to reducing debt,” he added.

Moody’s said the rating decision was driven by Cayman’s comparatively low and falling debt burden, a high per capita income and a strong institutional framework including a broad consensus on macroeconomic policies and fiscal oversight by the U.K.

Moody’s reported that Cayman’s estimated GDP per capita of US$57,936 for 2017 is among the highest in Moody’s rating universe.

Strong revenues and budget surpluses, since 2013, have reduced Cayman’s debt burden. The debt-to-GDP ratio is expected to fall to 17 percent in 2017 and further still in 2019 when the government plans to pay most of a single large bullet bond payment from its cash reserves.

A further improvement of Cayman’s bond credit rating would require greater and more diversified economic growth and sustained lower debt, the rating agency said.

In March, the Economics and Statistics Office announced that the Cayman Islands’ economy grew by an estimated 2.8 percent in the first nine months of 2016, higher than the 2.6 percent recorded for the corresponding period of 2015.

Government’s fiscal surplus widened to $112.5 million as total revenue growth outpaced government expenditures. The central government’s outstanding debt also continued its downward trend and settled at CI$198.7 million as at September 2016, 3.8 percent lower than at the end of the third quarter 2015.

Beneficial ownership registry on track for June launch

Following the passage of three legislative amendment bills last in the first quarter of this year, Cayman will establish a centralized beneficial ownership platform by the June 2017 deadline agreed to with the U.K.

The amendments to the Companies Law, the Companies Management Law and the Limited Liabilities Companies Law define beneficial ownership and enable the creation of a corporate registry that is accessible by U.K. law enforcement and tax authorities.

Cayman has collected beneficial ownership information for anti-money laundering purposes for the last 15 years. The Financial Action Task Force, the international anti-money laundering body, sets out in its recommendations that countries should collect beneficial ownership data and have the ability to share that information through centralized registries or similarly effective systems.

Although the U.K. has been advocating publicly accessible centralized registries, Cayman agreed with the U.K. government in April 2016 to the creation of a similarly effective system.
The deal requires the Cayman Islands to establish a centralized platform that retains the current system whereby financial service providers collect and maintain beneficial ownership information.

The centralized platform will simply provide faster delivery of the data by connecting decentralized databases at each of the about 180 service providers with one centralized access point.

However, the process of requesting corporate ownership data does not change for U.K. authorities. The U.K.’s National Crime Agency and Serious Fraud Office will typically request beneficial ownership information as part of criminal investigations from Cayman’s Financial Intelligence Unit.

Under the new system, the information can then be retrieved electronically without having to inform the financial services provider.

In the past, U.K. authorities sent about eight requests for beneficial ownership information per year, in addition to an average of four cases per year in which the Cayman government proactively provided unsolicited information.

Wayne Panton, minister for Financial Services, denied that the new platform is only one step away from a public register, which would reveal all beneficial owners of Cayman-registered companies to the public.

“The approach that we are taking is to protect the privacy of our clients,” he said. Only if those clients are under legitimate investigation would the beneficial ownership information be provided to the authorities, Panton added.

Government has offered to provide beneficial ownership data on request through the centralized platform to countries other than the U.K., but none has shown any interest so far, the minister confirmed.

He said the costs for the project are likely to be twice as high as originally thought, “but not that significant.”

Private sector companies typically have sophisticated systems for corporate record keeping, the minister said, and off-the-shelf type solutions would be available for smaller firms.

Government drops Legal Practitioners Bill again

The Cayman Islands government has, once again, dropped plans to rewrite the law governing legal practitioners in the territory after repeated attempts to negotiate a compromise failed.

The withdrawal of the Legal Practitioners Bill marks at least the sixth time lawmakers have tried in the past 15 years to update the 1969 law that regulates the operations of law firms and the rules of conduct for lawyers in Cayman.

The bill’s passage is considered a crucial step toward protecting Cayman’s financial services industry from external competitors with no connection to the islands who profit from the use of local financial services regimes without being licensed to practice law locally.

It is also viewed as required legislation ahead of a territorial evaluation of money laundering and terrorism financing safeguards in September.

The crux of the dispute over the bill centers on law firms that wish to expand their presence in overseas financial services markets to remain competitive in what has become a global industry, and Caymanian-born attorneys who fear they will be left behind in that expansion and believe that globalization will lead to outsourcing.

There is no significant evidence of Cayman-established law firms moving large numbers of staff overseas to the detriment of their local operations, Financial Services Minister Wayne Panton said during a Legislative Assembly debate on the bill.

However, the minister said the government did have evidence of foreign operations starting up that were “practicing Cayman Islands law” and using Cayman-registered financing vehicles without maintaining any local presence, an activity the bill sought to prevent.

Panton said it was simply a function of the modern financial services industry in a globalized world that required local law firms to maintain and grow their presence in overseas “centers of commerce” like Hong Kong, Singapore and London.

During the debate, opposition Legislative Assembly members quoted from a number of documents written by Caymanian attorneys, dating back to a January 2013 presentation to the Grand Court opening by Law Reform Commission Chairman Ian Paget-Brown.

“The evidence shows that Caymanians are deliberately being marginalized in the workplace, denied fair opportunities to advance, have been instructed on occasions about how to vote at Caymanian Bar Association elections, told that to be a ‘team player’ they must allow the status quo to continue uninterrupted, and used as pawns to secure status grants and permanent residence and once the Caymanian has outlived his or her usefulness in securing those grants they are unfairly or constructively dismissed,” Paget-Brown’s 2013 statement read.

It made further allegations that some firms had “misled” the Trade and Business Licensing Board and potentially misled immigration authorities about the experience of their job applicants and in the filing of job advertisements. Legislative Assembly member Winston Connolly noted during his debate on the Legal Practitioners Bill that no one had publicly disputed those claims, and that “nothing happened” after the claims were made.

The law society responded to these by reiterating “that it strongly objects to allegations that actions by local law firms in hiring attorneys overseas could amount to a breach of Cayman Islands laws and notes that Attorney General Samuel Bulgin has previously refuted such claims in the Legislative Assembly.”

Opponents of the legislation, which included a number of local lawyers who wrote letters to the government and assembly members complaining of discrimination in hiring and promotion at local law firms, said the current version of the bill merely cemented the “status quo” that had prevented Caymanian attorneys from advancing in the profession.

However, some recent numbers from the financial services industry indicate the winds of change are blowing, the minister said. The large law firms have reported 65 percent staff retention of Caymanians after three years on the job, which Minister Panton said is better than in many other jurisdictions.

The Caymanian Bar Association has 130 student members and there are now 21 Caymanian articled clerks [trainee lawyers], with a further 114 who have completed that training, he said.

Of the roughly 700 lawyers now licensed in the jurisdiction, about 240 are Caymanian, the minister added.

“We don’t need mechanisms which give Caymanians anything,” Panton noted. “There are many young Caymanians out there and others in the profession … who got there on their own merit. We simply need a framework that provides that platform for them to do that … they don’t need to be handed anything.”

The government would not support any “mandates” that made “a certain number of people” law firm partners regardless of merit, the minister said.

Following the withdrawal of the bill, Premier Alden McLaughlin said the government elected in the May 24 general election would be left to deal with the bill, hopefully before the September review of the Cayman Islands’ protections against money laundering and terrorism financing by the Caribbean Financial Action Task Force.

If Cayman fails to pass the bill, it is “guaranteed to fail” a territorial assessment by the Caribbean Financial Action Task Force due later this year, Minister Panton said.

Premier: UK must ‘moderate’ Brexit impact on territories

The U.K. government must do its best to back financial services industries in its overseas territories, both before and after Brexit talks with the European Union, Premier Alden McLaughlin said in February.

The premier attended discussions in London with British leaders who are overseeing Britain’s exit from the EU, including MP Robin Walker and Overseas Territories Minister, Baroness Joyce Anelay.

Premier McLaughlin noted that EU countries had sought to place Cayman on various “black or grey lists,” even after it had attempted to cooperate on tax enforcement and anti-money laundering efforts. Because of this, McLaughlin said it was important for the U.K. to be a “moderating voice” both before and after the EU exit occurs.

Britain formally announced its intention to separate from the union in March.

The Joint Ministerial Council, made up of British representatives and leaders from its remaining overseas territories, will meet again in June to discuss Brexit progress. “This initial [council] on European negotiations was promising,” the premier said.

During the meeting, he was joined by representatives from nine other British Overseas Territories, to discuss a range of issues related to Brexit.

The main subjects included international trade agreements, including territories’ access to the EU single market, and free movement of overseas territories citizens within the EU countries.

Effort to repeal FATCA gains steam

When the United States passed the Foreign Account Tax Compliance Act (FATCA) in 2010, it precipitated a shift in global tax enforcement. Enforcement efforts moved away from reactive investigations of suspected tax evaders, and toward a system of proactive, invasive information collection premised on the view that anyone who holds assets outside their country of original is a tax cheat.

The U.S. adoption of FATCA was soon followed by similarly aggressive efforts by the OECD and the European Union. Now, however, there is growing reason to believe that the United States is realizing what a disaster FATCA has been for their citizens, the financial sector, and the global economy, and could soon reverse course. Just as when it was created, abandoning FATCA may have significant impact on the direction of international tax policy.

The FATCA fallout

FATCA’s core provisions included new reporting requirements on both individual taxpayers and the foreign financial institutions that service them. Although the United States has no jurisdiction over the latter, it achieved effective control by threatening a 30 percent withholding tax on institutions that do not comply.

The negative consequences of FATCA, many of which were predicted by critics from the beginning, have proven to be extensive. The costs on financial institutions to comply with the law have far exceeded the revenues generated, and because the added burdens that come with them, many institutions have shut out American clients in response. Multinational businesses not wanting to get tangled up in the FATCA web have similarly removed or refused to hire Americans for positions with signing authority.

Onerous FATCA penalties have proven devastating for many Americans guilty of nothing more than simple oversights or minor errors in filling out complicated tax forms. In some cases, they can even exceed the value of the relevant assets. Citizens of other countries are also being penalized, as more so-called “accidental Americans” discover everyday that their place of birth, or their parents’ citizenship, has made them U.S. taxpayers for life in the eyes of the IRS.

The list of problems introduced by FATCA could go on and on, and even the ‘taxpayer advocate’ at the IRS has faulted both the intent of FATCA and the agency’s implementation efforts. These problems have proven significant enough to draw widespread opposition both within the U.S. and internationally, though foreign institutions and government have operated under the erroneous assumption that there was nothing that could be done and so they might as well go along with it all.

Opposition renews under a new administration

Under President Obama, perhaps it is true that there was little that could have been done about FATCA, though we will never know since the effected parties did not make an effort. But even if that is the case, it is certainly no longer true. The 2016 Republican Party Platform decries FATCA’s “warrantless seizure of personal financial information without reasonable suspicion or probable cause,” while calling for its repeal. Under unified Republican government, FATCA is now clearly vulnerable.

Reacting to this opening, Nigel Green, founder and CEO of financial consulting firm deVere Group, teamed up with Jim Jatras, a former U.S. diplomat and leading authority on FATCA, to launch a DC-based lobbying and media campaign for FATCA repeal. Alongside the Center for Freedom and Prosperity, the Repeal FATCA campaign is putting pressure on Republicans to walk the walk and eliminate the Obama-era financial spying regime.

How repeal might happen

Senator Rand Paul and Congressman Mark Meadows both introduced repeal legislation in previous sessions of Congress, and they are expected to do so again during the current session if they have not already. Congress could certainly opt to advance these stand-alone bills and remove FATCA that way. However, it is much more likely that FATCA repeal will find its way into a comprehensive tax reform package currently being drafted.

Tax reform is a top agenda item of both the new administration and congressional Republicans, and is widely expected before the August congressional recess this year. A comprehensive tax reform package aimed at simplifying the tax code, particularly if it moves away from a worldwide tax system, would be the opportune time to unwind FATCA and reset U.S. policy toward the millions of Americans living overseas and the many more who choose to legally invest offshore.

Some are suggesting a compromise solution whereby a “same country exception” would exempt individuals using offshore accounts in the same country where they live or work. Pursuing this would be a mistake. For one, it does little to resolve most of the negatives associated with FATCA. To be sure, some individuals suffering under FATCA would get relief, but the industry costs would still be there, and the law’s complexity would arguably be worse. Institutions would still be incentivized to keep away from potential American clients or employees. And by “fixing” FATCA in only such a narrow fashion, it would effectively give the stamp of approval to the invasive global financial surveillance regime that would remain intact. This compromise, in other words, can only serve as a distraction for those who pursue it.

It is worth noting that, if the Trump administration is so inclined, it can stop FATCA without Congress. The original law was hastily and poorly drafted, and as written would have been completely unenforceable due to its demands that foreign institutions violate the privacy laws of their host nations. To circumvent this problem, the Obama administration pursued so-called intergovernmental agreements, whereby the United States promised to share information ‒ an ultimately meaningless promise without Congressional action ‒ in return for foreign governments agreeing to eviscerate their privacy protections and help facilitate spying on financial accounts of U.S. persons for tax purposes. The foreign governments consider the agreements to be treaties and have acted accordingly, whereas the United States labels them only executive actions, meaning they have not gone to the Senate for confirmation and are not legally binding.

Simply put, the IGAs represent an extralegal expansion of executive power and were not authorized by FATCA. If the new administration were to pronounce them null and void for this reason, it would return FATCA to its original unenforceable status. FATCA would be effectively repealed until such time as Congress cleaned up its mess and removed it for good. It remains to be seen whether the Trump administration would consider this approach, but it is available to them should they so choose.

The industry needs a wake-up call

Foreign financial institutions have spent a lot of money complying with FATCA, in part because self-interested compliance industry consultants told them from the beginning that “FATCA is here to stay,” and are still repeating this nonsense today. Bad laws can be repealed the same as they can be adopted, and if institutions had spent a fraction of the resources fighting FATCA as they have complying then it would probably be gone already.

Nevertheless, that investment has left many of them complacent due to the sunk cost fallacy. They have already put significant funds into complying with FATCA, so why not just continue? Moreover, if FATCA is repealed, it will leave many decision makers left trying to explain why they could not be bothered to invest a tiny percent of the resources they spent on compliance into actually fighting FATCA.

That is an awfully expensive mistake to try and justify, but they should stop deluding themselves about the true cost of allowing FATCA to proceed.

FATCA itself is evidence that politicians are never satisfied. Neither know-your-customer rules, nor the Qualified Intermediary regime, or countless other burdensome regulatory efforts were enough, or else we would not have FATCA. What makes them think FATCA will be any different?

FATCA is certainly not going to move the tax compliance needle very far. So long as high tax rates give people incentive to evade, and tax code complexity provides ambiguity to help them do so, evasion will be a reality. If foreign financial institutions are going to let the U.S. walk all over them and force the expenditure of massive funds to help them collect a tiny fraction of that in revenue, then U.S. politicians are going to continue to treat them as willing participants in their hair-brained tax collection schemes. The only viable option is to say that enough is enough.

Where repeal leaves offshore

But whether all of FATCA’s victims support it or not, effort is finally being directed at repeal. Should it bear fruit, what happens next? For one, foreign institutions and governments are likely to be rather miffed at the United States for imposing such costs on the world for ultimately no reason. However, they should make sure to emphasize that they are upset that the United States unilaterally claimed jurisdiction over the entire globe in the first place, not that it finally came to its senses.

Second, several recent international initiatives, such as BEPS and the Common Reporting Standard, are premised on the FATCA-style idea that financial privacy is irrelevant and that financial institutions can and should be compelled to act as deputy tax collectors. These projects could only advance because nations that would otherwise object assumed the United States was on board. After all, why would the same U.S. that passed FATCA not support other nations pursuing similar policies? Never mind that the U.S. offers many of the same privacy protections to foreign investors that it condemns in other jurisdictions.

But if FATCA is abandoned, the political calculus changes. Smaller jurisdictions tired of having their tax policy dictated by the OECD could come together in opposition, and even gain the support of the current U.S. administration. Whether or not they have the courage to finally stand up and fight remains to be seen, but if FATCA goes, it may well just be the first domino to fall.

New year, new laws and new judgments

The first quarter of 2017 has been a busy one, both for the Cayman Islands Government and for the local judiciary. With the commencement of election year, the Legislative Assembly has a number of bills before it, which, given their importance to the financial services industry, will likely be the subject of lengthy debate in the lead-up to the dissolution of parliament. As the general election is scheduled for May 24, 2017, and the final sitting of the Legislative Assembly was under way at the time of writing, there is limited time to implement change and much progress is expected to be made. Meanwhile, the Grand Court has already released a number of interesting judgments that will provide helpful guidance to the finance industry in respect of disputes arising out of merger and acquisition deals, as well as concerning general matters of civil procedure across the Financial Services Division.

Legislative changes

Through late 2016 and well into the New Year, the jurisdiction has seen the introduction of a raft of new legislation designed to modernize local law and, in certain instances, to ensure consistency and compliance with global transparency efforts.

Intellectual property protection

In late December 2016, a new suite of legislation was passed into law pursuant to which the Cayman Islands seeks to modernize its intellectual property protection regime. This new suite of legislation, all of which will likely come into force in the first half of 2017, will operate as follows:

  • The Patents and Trade Marks (Amendment) Law 2016 continues to allow the extension of patents registered in the U.K. into the Cayman Islands, as has been the case under the Patents and Trade Marks Law 2011 for many years, but will have “stripped out” of it the provisions that relate to trade marks in order to pave the way for the new Trade Marks Law 2016.
  • The Trade Marks Law 2016 makes provision for the direct registration of collective marks and certification marks, and establishes a new standalone trade mark registry in the Cayman Islands. In practice, it will allow a business wishing to protect its trade mark in the Cayman Islands to avoid the expense of first obtaining a U.K. trade mark (as has been the requirement up until now) by providing for a system of local registration.
  • The Design Rights Registration Law 2016 will introduce a new law allowing owners of U.K. or EU registered designs and registered community designs the opportunity to extend their registered design rights to the Cayman Islands. Such applications will need to be made to the Registrar of Design Rights via a registered agent in the Cayman Islands and, once registered, the design right will have the same duration and attract the same rights and remedies otherwise available in respect of the design right in the U.K. or EU.
Companies and LLP legislation

Changes to the companies legislation was also pending in the Cayman Islands. As at March 2, 2017, the Legislative Assembly had passed the Companies Amendment No. 2 Bill 2016, the Companies Management Amendment No. 2 Bill 2016, and the Limited Liability Companies Amendment Bill 2016. While their commencement dates had not been announced at the time of writing, these three new pieces of law are expected to be in force by the end of the second quarter of 2017. Together, they will require Cayman Islands companies (other than certain listed or regulated companies) to establish and maintain beneficial ownership registers and for the information on those registers to be made accessible to certain enforcement and tax authorities through a centralized and electronic beneficial ownership platform.

Importantly, the platform will be searchable only by the competent authorities in the Cayman Islands and the information on it will otherwise remain private. The legislation, which has been requested by the U.K. of all British Overseas Territories, aims to bolster financial crime investigations and target corruption.  The centralized platform will likely be implemented by June 30, 2017, in accordance with the Cayman Islands’ beneficial ownership information exchange agreement with the U.K.

It is also anticipated that two new financial services vehicles, a limited liability partnership and a foundation company, will be introduced into the jurisdiction by the Legislative Assembly during its present sitting. The Limited Liability Partnership Bill 2017 introduces a new business structure in the form of a partnership which has both separate legal personality and provides limited liability for its partners. The creation of an LLP will offer professional firms, such as lawyers and accountants, a flexible alternative to a company or general partnership structure.

The structure is designed to increase the attractiveness of the Cayman Islands to professional service providers, and to develop potential new lines of business for international clients to utilize Cayman Islands structures.

The Foundation Companies Bill 2016 functions as an amendment to the Companies Law (2016 Revision) (the “Companies Law”), and provides for foundation companies to be established as a new form of Cayman Islands company. A Cayman Islands foundation company will share many of its features with regular exempted Cayman Islands companies, save that a foundation company is prohibited from paying dividends or other distributions to its members. A foundation company may cease to have any members if its constitution so provides, and can thereby truly achieve “orphan” status. Consequently, foundation companies will likely have a number of uses, including as a special purpose vehicle in finance transactions, as an alternative to a trust, and as a vehicle for philanthropic objects. Once passed into law, it is anticipated that foundation companies will fit seamlessly into the local legal regime, and offer an attractive and flexible structuring tool for private clients with offshore interests, regardless of whether they are located in civil law countries or common law jurisdictions.

New judgments regarding dissenter shareholder litigation

The jurisdiction has recently seen a flurry of merger activity, in many instances as a result of listed entities engaging in “go private” deals involving companies incorporated in the jurisdiction. The statutory merger and consolidation process set out in Part XVI of the Companies Law can be used to effect such mergers. However, the operation of the law in these circumstances has recently triggered an increase in litigation before the Grand Court of the Cayman Islands.

The Companies Law contains a statutory appraisal regime, found in section 238, which, with some exceptions, permits shareholders involved in certain mergers or consolidations to dissent to the merger or consolidation and be entitled to payment of the “fair value” of their shares. In reliance on this statutory appraisal regime, the Grand Court can be called on to determine disputes regarding the valuation methodology by which ‘fair value’ of the shares is determined. The first decision in the Cayman Islands regarding this issue was that of Justice Andrew Jones, QC, in In The Matter Of Integra Group (Unreported, August 28, 2015, Jones J) (“Integra”), which analyzes the section and its operation in detail and is now considered to contain the primary guidance on section 238 appraisal actions in the Cayman Islands. In Integra, Justice Jones approved of the definition of the concept of “fair value” in that particular case as the value to the shareholder of his proportionate share (without any minority discount or premium for compulsory acquisition of the shares) of the business as a going concern, without taking into account any enhancement in value (or reduction in value) as a result of the merger.

The Grand Court has since added to the guidance of Justice Jones in two further judgments concerning section 238, which indicate how dissenting shareholder fair value petitions, and the related issues of interim payments and discovery, will likely be dealt with by the Grand Court.  The two judgments are:

  • Blackwell Partners LLC – Series A v Qihoo 360 Technology Co Ltd (unreported, January 26, 2017):  In this case, Justice Charles Quin considered an application by three dissenting shareholders (who had exercised their appraisal rights in relation to a merger) for an interim payment pursuant to Order 29 of the Grand Court Rules. The company argued in response that the interim payment provisions did not apply as the proceedings were outside what was a “self-contained statutory code” in section 238, and the dissenting shareholders were not owed a debt or entitled to damages as otherwise required by Grand Court Rules Order 29 to trigger payment. The company argued that the dissenting shareholders were only entitled to be paid fair value for their shares as assessed by the Court in due course pursuant to the petition. Justice Quin disagreed with the company, finding that a fair value determination by the court in section 238 proceedings falls within the category of proceedings in respect of which an “interim payment” could be made under Order 29, rule 9. Justice Quin found that the dissenting shareholders would receive at least the amount of the company’s statutory fair value offer made under section 238, being the “substantial sum” of US$17 million, following the final determination of the fair value assessment by the court, and ordered an interim payment in this amount. The judgment therefore confirms that the Grand Court will be prepared to make orders for interim payments in the context of section 238 applications, particularly if the company has not already voluntarily made an interim payment in the amount of its statutory fair value offer.
  • In Homeinns Hotel Group v Maso Capital Investments Limited & Ors (an unreported ruling delivered on August 12, 2016, but not released for publication until February 7, 2017), the company petitioned for a determination by the court of the fair value of the dissenting shareholders’ shares in another merger case. At an interlocutory stage, the “fundamental source of dispute” between the company and the dissenting shareholders was the process of discovery, pursuant to which the dissenting shareholders sought access to all documents relevant to the fair value assessment. Asked to give directions on this issue pending trial of the section 238 application, Justice Ingrid Mangatel found that, in assessing fair value for the purposes of section 238, the experts and the court are to have regard to all relevant documents and information that the company has readily to hand, not just publicly available information. The court also rejected the traditional “list of documents” approach (where there is a mutual exchange of documents in the parties’ possession custody or power) and accepted the dissenting shareholders’ submissions that it was more appropriate in such a case for specific categories of documents to be ordered at the directions stage, rather than being left to a subsequent specific discovery application.

Case law on access to court documents

The issue of access to information on the files of the Grand Court was recently considered by the Honourable Chief Justice Anthony Smellie, QC, in the context of liquidation proceedings. As the Chief Justice noted in his judgment concerning In the matter of the Sphinx Group of Companies (In Official Liquidation) unreported, January 30, 2017 (“SPhinX”), determining whether documents kept on file by the Grand Court should be kept confidential requires a close assessment of the particular circumstances in which access is sought, and the wider consequences of the publication of the information in question.

In SPhinX, the Scheme Supervisors (“Scheme Supervisors”) had applied for the sanction of the court to complete a confidential settlement agreement and, flowing from that, for orders that affidavit evidence sworn in support of the sanction application be sealed and kept confidential on the court file. It was the view of the Chief Justice that the fact that a settlement was pending in the SPhinX matter was highly relevant, noting that it was essential that the Scheme Supervisors were able, like any other commercial party, to compromise claims on confidential terms – and that this ability would be lost if the court was not prepared to seal papers filed in support of the sanction application that the liquidator was required by law to make. Flowing from this, it was also in the interests of justice for a sealing order to be made so as to protect the economic interests of the stakeholders in SPhinX. The judgment serves as confirmation that the court is required to balance the general rule as to publicity of information on court files against any requirements for confidentiality or privacy in the interests of justice that may arise in a particular case.

US tax reform, border adjustment taxes, and international trade law

With the Republicans now in control of the U.S. Congress and the White House, tax reform is high on the agenda. One of the proposals being discussed is a shift away from a traditional corporate income tax, towards what has been called a Destination Based Cash Flow Tax (DBCFT). In essence, this plan attempts to collect tax in a way that focuses on the location of the business sales. To achieve this, the measure involves a “border adjustment,” through which exports are exempt from the tax, while imports are subject to it. In this way, the tax applies to “cash flow” in the United States.

The border adjustment raises concerns about protectionism and the consistency of U.S. tax reform with international trade agreements. Exempting export income from tax could be deemed an illegal export subsidy; imposing a border tax on imports could violate rules that limit import taxes and require that internal taxes be nondiscriminatory. However, there is a long and complex legal and diplomatic history that needs to be taken into account when evaluating the proposed measures under international trade rules, and in the end politics may be as important to this discussion as the law.

Basics of a border adjustment tax

The idea behind border adjustments is that, in some instances, imports need to be taxed to create equivalence with how domestic products are being taxed. To understand the issue, consider three common types of taxes: sales taxes, income taxes, and value added taxes (VAT). As explained below, no adjustment is used for the first two, but an adjustment is usually applied for the last one.

A sales tax is imposed on a product at the point of final sale to a consumer. The national origin of the product is irrelevant in this regard, as taxes are applied regardless of whether the product was made domestically or abroad. Thus, no adjustment is needed. It would not make sense to exempt imports from this tax, as it would be burdensome to do so and would give imports a price advantage over domestic products.

Income taxes are generally calculated based on the profits (revenues minus costs) of a company. Tax rates vary by country, but so do government services. As a result, the cost and benefits of taxes are roughly the same for companies across countries, so there is no obvious reason to make an adjustment at the border.

The situation of the VAT is more complicated. With a standard “credit invoice” VAT, this tax is collected from companies at each stage of the production and distribution process. It is passed on to consumers in the final sales price, but it is not collected directly from them, as with a sales tax. A problem therefore arises because the VAT cannot be collected on imports at the point of sale. The solution has been to impose a tax on imports at the border, so as to collect an amount equivalent to that collected on domestic products, thereby ensuring that domestic and foreign products are treated the same. In this way, the VAT functions somewhat like a sales tax.

While sales taxes are often fairly low, some VAT rates are as high as 20-25 percent. It is the combination of the high VAT rate and the border adjustment for imports that created a concern about these taxes in the trade arena, and discussion of these issues has a long history in the GATT/WTO.

Border adjustment tax discussions at the GATT/WTO

To fully grasp the trade policy implications of a border adjustment tax, it is important to understand exactly how and why trade obligations apply to tax measures. In order to prevent domestic laws from being used as a means of disguised protectionism, international trade obligations impose constraints on the use of both domestic taxes and regulations. Broadly speaking, such measures may not be used to favor domestic producers over their foreign competitors.

With regard to tax measures, there are three core trade obligations that are relevant for the issue of border adjustments: (1) Border taxes are generally prohibited, unless specifically allowed in the Schedules of Concessions that governments sign (GATT Article II); (2) internal taxes must be nondiscriminatory (GATT Article III); and (3) tax exemptions for exports are prohibited (GATT Article XVI and Subsidies Agreement). As we will see later, the border adjustment tax imposed on imports could be a problem under the first two, while the tax exemption for exports could be a problem on the third one.

Also of relevance to this discussion is that trade rules draw a distinction between direct and indirect taxes. Direct taxes are imposed on income and property,  whereas indirect taxes are defined as “sales, excise, turnover, value added, franchise, stamp, transfer, inventory and equipment taxes, border taxes and all taxes other than direct taxes and import charges.”   Thus, as currently drafted, WTO obligations classify sales taxes and value added taxes together as “indirect taxes.” As we will see, this grouping has implications for which kinds of taxes may be adjusted through a border tax.

Discussions of the legality of border adjustment taxes at the GATT be traced back as far as 1955, when Germany proposed an interpretation that would allow its “turnover” tax (in which a charge is imposed at each stage of production) to be considered a product tax.  As a product tax, the argument went, a corresponding border adjustment tax could be imposed. No conclusion was reached at this time, but in the ensuing years, as additional countries adopted similar measures, in the form of a VAT, the GATT debate heated up. By the late 1960s, it had become one of the most contentious trade issues, and a special working party was established to examine it.

On one side of the Working Party discussion was the United States. In the U.S. view, because border adjustment taxes were only being applied to product taxes, there was a fundamental imbalance between countries that collect most tax revenue from income taxes and those which were relying heavily on product taxes. The use of border adjustments by countries with a VAT meant that U.S. companies paid their own income taxes but were also affected by foreign country border adjustment taxes. By contrast, a company from a VAT country paid its domestic taxes, but was exempt from these taxes on exports and also did not pay foreign income taxes.

On the other side were many countries using a VAT and a corresponding border adjustment. In their view, the value added tax with border adjustment was a simple non-discriminatory application of a product tax, no different than a sales tax.

In a report issued in 1970, the GATT working party noted the views of both sides and offered a brief analysis which seemed to endorse these border adjustment taxes in the context of a VAT.   However, it was not a formal ruling by a neutral third party arbitrator of the kind that today’s trade adjudication would provide. As a result, there remains some legal uncertainty on these issues, and it is not entirely clear how a challenge to border adjustments related to a VAT would be treated if a WTO complaint were brought today.

Over the years, the United States continued to look for political solutions to this issue, but never had any success.


Into this long-standing debate comes the DBCFT, with a border adjustment tax of its own. First developed by some economists in the early 2000s, the DBCFT has gained traction in recent years, and in 2016 leading Congressional Republicans began supporting it. In the context of the general economic nationalism of Donald Trump, along with the specific concerns still being expressed about border adjustment taxes imposed by other countries related to their VATs,  there is a possibility that the United States may begin imposing a border adjustment tax of its own.

The key features of the specific DBCFT currently under consideration are: a lower tax rate; full write-off of capital investments; no tax on profits earned abroad; no deduction of interest; and a border adjustment. Through the border adjustment, the DBCFT is said to be “destination-based,” in the sense that “the tax is levied based on where the good ends up (destination), rather than where it was produced (origin).”  Specifically, as the Tax Foundation has explained, “if a business purchases $100 million in goods from a supplier overseas, the cost of those goods would not be deductible against the corporate income tax,” while “if a business sells a good to a foreign person, the revenues attributed to that sale would not be added to taxable income.”

As currently envisioned, however, the DBCFT will almost certainly violate WTO obligations, due to its deduction for wages. If these deductions are included, the measure would not treat imported and domestic products the same, as the deductions would apply to domestic products but not to imported ones.

The more interesting question is whether a revised version of the measure that removes this deduction would be consistent with WTO obligations. Note that if the measure were to be found in violation in its current form, the United States would have a chance to revise it before any retaliatory measures were authorized.

Normally, a border tax would only be permitted if a government negotiates for it, and specifically identifies it in its WTO Schedule. A border adjustment tax that is not mentioned in the Schedule would violate Article II of the GATT. However, there is an exception for border taxes that are “equivalent” to an internal product tax. For these taxes, the applicable provision is Article III, which requires that the taxes on imports and the taxes on corresponding domestic products be equal. Thus, if the border adjustment tax imposed in conjunction with the DBCFT is equal to the tax imposed on domestic companies, there is an argument that the measure does not violate WTO obligations.

On the export side, the situation is more challenging for the DBCFT. Normally, a tax break for export sales would be considered an export subsidy. However, there is an explicit carveout in GATT/WTO rules for “[t]he exemption of an exported product from … taxes borne by the like product when destined for domestic consumption, or the remission of such duties or taxes in amounts not in excess of those which have accrued.”  Such exemptions “shall not be deemed to be a subsidy.”  This provision clearly applies to typical value added taxes, which are taxes on products “destined for domestic consumption.” But it is less clear whether it applies to the DBCFT, which is not a tax on products in the same way.

On both the import and export sides, a key issue will be whether the DBCFT and related border adjustment are close enough to an “indirect” product tax to be treated like a VAT. The standard VAT used by most countries involves a “credit invoice” approach that is similar in nature to a sales tax on products. At each stage of production and distribution, a tax is collected on the sale of the product, which is reflected in the final sales prices. However, there is also a “subtraction method” approach that is less closely tied to products. With this kind of VAT, the tax base “is computed as the difference between the business’s taxable sales and its purchases of taxable goods and services.”  WTO rules do not specify one or the other, simply referring to “value added taxes” as an example of an indirect tax. Arguably, then, either such method falls within the category of an “indirect” tax on products, and therefore a border adjustment tax is permitted for both. If the DBCFT can be framed as similar to a subtraction method VAT, as it sometimes has been,  then perhaps a border adjustment would be permitted here as well.

However, the nuances of WTO obligations are unlikely to provide much of a check on whether the DBCFT is adopted. The House Republicans have said they believe the DBCFT border adjustment tax is consistent with WTO obligations.  It is not clear if they mean the DBCFT as currently envisioned, or if they anticipate revising the DBCFT after an initial adverse ruling. Regardless, their confidence is probably misplaced, as the consistency of the DBCFT with WTO rules is, at best, very uncertain. At the same time, in the current atmosphere of economic nationalism being expressed by the Trump administration, perhaps the DBCFT border adjustment tax is better than the alternatives, which might include tariffs that are blatantly protectionist and clear violate the rules.

Of course, if the United States turns its income tax into a DBCFT with a border adjustment tax, other countries might, instead of bringing challenges at the WTO, deal with their trade concerns in another way:  They could decide to adopt a DBCFT/border tax of their own. If this were to occur, any supposed advantage to the United States from switching to a DBCFT would disappear. More broadly, if business taxes around the world include an import tax component, trade tensions could escalate, as differences in rates could be deemed “unfair” by one side.


The conventional wisdom has been that border adjustments for a VAT are legal under WTO obligations, perhaps because the VAT seems closer to a sales tax than it is to an income tax. But with this new kind of tax coming onto the scene – one that has features which perhaps bring it closer to a value added tax, at least in the sense of its “destination” focus – perhaps a rethinking of these tax categories is appropriate, as the economics of a border adjustment applied only to product taxes were always suspect.  Perhaps a border adjustment is justified for both the DBCFT and the VAT; maybe it should not be applied to either one.

One way to test these ideas is through WTO litigation, through which both sides challenge each other’s measures. But this is a time consuming and costly endeavor, which may not offer much in the way of a practical solution. It has been suggested that a finding that the DBCFT violates WTO obligations would allow the rest of the world to retaliate in the amount of $385 billion.  That figure is highly speculative, but nevertheless a trade war is not likely to be helpful here. A political effort may be more useful in this regard. Rather than a narrow legal ruling, a broader solution developed by tax and trade experts could be a better approach.

At this stage, it is very hard to predict how the trade issues will play out in relation to the DBCFT and the border adjustment tax. The current discussion sometimes suggests that the border tax could escalate trade tensions. But with the future of the DBCFT clouded by domestic politics, and alternative tax reform suggestions out there which would be much less likely to lead to trade conflict, at this point we can only wait and see how things progress.

The United Kingdom targets offshore tax evasion “enablers”

Offshore tax evasion has received substantial scrutiny in recent years. The United Kingdom’s 2016 Finance Act empowers U.K. regulators to sanction lawyers, accountants, and other advisors who assist with offshore transactions that are utilized to evade income, capital gains, and inheritance taxes. The purpose of this article is to provide an overview of the new law and its implications for financial professionals who may work with UK-affiliated businesses and individuals.

The United Kingdom has considered legislation to impose civil penalties on so-called “enablers” of tax evasion since 2015. The legislation was ultimately passed as part of Section 162(1) and Schedule 20 of the 2016 Finance Act and brought into force by Her Majesty’s Treasury immediately prior to the new year. The primary purpose of the new law is to allow regulators to levy civil penalties against deliberate enablers of offshore tax evasion in connection with income, capital gains, and inheritance taxes.

In announcing its new powers, Treasury expressed a desire to create a “level playing field for the vast majority of people and businesses who play fair and pay what is due.” It also emphasized that the U.K. is one of the first countries in the world to specifically target enablers of offshore tax evasion.

Who is covered

The law is broad in scope and does not apply to any specific class of professionals. Rather, it is directed towards any person “who has encouraged, assisted or otherwise facilitated conduct … that constitutes offshore tax   evasion or non-compliance.” The breadth of the language would tend to suggest that lawyers, financial advisors, and accountants as well as non-professionals who take any part in offshore tax planning could be subject to the law’s penalties.  The alleged enabler needed not be located on U.K. territory.1

There are, however, two conditions that must be satisfied before civil penalties can be assessed.  First, alleged enablers must know that their assistance is being used, or is likely to be used, for purposes of offshore tax evasion. This condition would rule out penalties for professionals and non-professionals whose services are unwittingly used in connection with clients’ offshore tax evasion. Second, the client must first be convicted of a relevant criminal offense, found civilly liable, or enter into an agreement concerning the offshore tax evasion with Her Majesty’s Revenue and Customs.  Hence HRMC is required to conclude its action against the alleged offshore tax evader before pursuing penalties against secondary actors who may have assisted the evader.

Severe penalties and negative publicity

Although lawyers, accountants, and other professionals are subject to codes of conduct that prohibit them from assisting clients to commit illegal acts, HRMC is now able to directly impose substantial financial penalties on enablers of offshore tax evasion. The penalties are the higher of 100 percent of the Treasury’s lost revenue from the tax evasion or £3000 and are dispensed in the same manner as tax assessments.  If the amount of lost revenue exceeds £25,000, the HMRC is able to publicize enablers’ names, addresses, and nature of their businesses, and other information. Financial professionals who are named by HRMC could also then be subject to professional discipline from professional bodies.

The rationale for these severe penalties is that they are needed to increase tax compliance by targeting those who knowingly aid and abet tax evasion. Nevertheless, as set out in the next section, an additional goal appears to be to incentivize lawyers, accountants, and others to provide client information that regulators can use to prosecute difficult-to-detect offshore tax evasion.

Incentivizing reporting

The penalties described in the previous section can be reduced if enablers disclose their role in offshore tax evasion or offer assistance to an investigation that leads to charges.  In the case of unprompted disclosure or assistance, the enabler’s penalty can be reduced to the higher of 10 percent of lost revenue or £1,000 whereas prompted disclosure or assistance can be reduced to the higher of 30 percent of lost revenue or £3,000. In all cases, the enabler must be prepared to provide HRMC access to relevant records.

Equally important is that enablers who choose, prompted or unprompted, to either disclose or cooperate with an investigation are able to avoid having HRMC identify them. Indeed, if HRMC agrees to reduce a penalty to the maximum extent allowed, it cannot then publish the enabler’s information.

Between the possible reduction in penalties and ability to keep involvement in alleged offshore tax evasion from being publicized, financial professionals now have strong incentivizes to cooperate with HRMC when they work with clients whose use of offshore transactions is likely to be scrutinized. An interesting and as-of-yet-unanswered question is how the law’s reporting rules accord with the confidentiality obligations of lawyers and other professionals, especially in situations where the client’s alleged tax evasion could plausibly be viewed as legitimate tax avoidance.

What lays ahead?

The U.K.’s targeting of so-called enablers is part of a larger effort to clamp down on offshore tax evasion. Indeed, the U.K. government has already announced plans to introduce legislation that would levy significant fines against taxpayers who have used certain offshore interests in the past to diminish their liabilities and fail to correct their returns. Another proposed law targets businesses that market complex offshore arrangements. As Treasury has noted, it has recovered £2.5 billion from offshore tax evaders since 2010, and it clearly believes that additional revenue can be recovered in future years.

What differentiates the anti-enabling law is that it appears specifically designed to create a schism between financial professionals and their U.K.-affiliated clients. Lawyers, accountants, and other professionals may refrain from advising offshore tax avoidance techniques that they regard as lawful for fear that they will be subject to penalties for assisting with tax evasion as well as public shaming for their involvement therein. They will also have strong financial and reputational incentivizes to cooperate with regulators in instances where clients may have used offshore strategies of which regulators do not prove. Clients, for their part, may be more reluctant to share information and documents with advisors for fear that any information or documents they share could eventually be provided to HMRC.

There is no doubt that some taxpayers in the U.K. and elsewhere, use offshore arrangements to evade their payment obligations. However, the U.K.’s decision to specifically target enablers is bound to affect both the type and quality of advice that financial professionals are able to provide to U.K.-affiliated clients, even if it achieves its goal of discouraging offshore tax evasion.

  1. The government conceded in a 2015 communication that it would be more difficult to pursue civil penalties against enablers located outside of the U.K. but indicated that it hoped to do so with the assistance of international partners. See HMRC, Tackling Offshore Tax Evasion: Civil Sanctions for Enablers of Offshore Evasion, p. 8 (Dec. 2015), available at

A new era for the real estate industry

The digital age

The digitalization of the real estate industry is happening just as quickly as in any other industry. Improvements in the transfer of property and the closing of real estate transactions is currently taking place, with such transactions soon moving to an online system. Moving to an online method for legal processes within our industry has been the point of focus for a committee of real estate and conveyancing professionals and government representatives. We can see real progress being made, with the goal soon to be achieved of creating an easier, quicker and more cost-effective method for closing transactions for everyone concerned.

I am pleased that such forward-thinking steps are being taking within the real estate industry, yet I cannot help but think that digitalization still does not lead to less paperwork, or even more security. In particular, I am concerned about the possibility of information being disrupted, essentially, of data becoming vaporized. Data, it seems, is becoming reduced to literally an electronic pulse, one which I am concerned could evaporate in an instant. As much as people talk about the security that surrounds digital information, there always seems to be someone who is able to hack into that information. It is therefore a real concern, not that the information is so private but rather the inconvenience of losing it and what that means.
The cost of digitalizing the way we do business is another drawback to this progress. The licensing process for software is one example. Securing the security is another. I have at present 85 different passwords that I need to remember in my daily life. Storing these passwords securely is therefore another worry.

While I am pleased at digital progress speeding up processes and making them more efficient, I am conversely pleased that government is to retain a physical file for the original deeds to parcels of land, which are a vital backbone of real estate in the Cayman Islands, just so long as they are kept safe from hazards and disasters, both man-made and natural.

Immigration a key point, moving forward

In the last edition of the Cayman Financial Review I looked ahead, speculating how the new American president might affect Cayman’s real estate industry. It is interesting to note that, since that article, the world has probably focused the most on President Donald Trump’s immigration policies, more than any other changes he has made in his first 100 days in office.
Likewise, we, too, have had considerable focus drawn upon our own immigration policy, in particular the rules around permanent residency. I noted that the topic of immigration came up at a recent real estate and property conference held in February by the Royal Institute of Chartered Surveyors (RICS) at the Kimpton Seafire in Cayman. In fact, an entire panel discussed the implications of immigration on the industry and it was noted that government policies on this issue were crucial for the health of the real estate industry.

Wealthy retirees, it was heard, looking to purchase property to qualify for their 25-year permanent residency certificate, were having to wade through an incredible and off-putting amount of red tape in order to attain their residency.  Those in limbo waiting for their permanent residency grant, who also reside and work in Cayman, were unsure as to whether they ought to sell up or remain, with the uncertainty surely being an extreme inconvenience and terrible worry for themselves and their families.

Additionally, local construction firms rely on the efficiency of the immigration process, having to hire a considerable number of skilled and semi-skilled workers from overseas to meet the shortfall of available labor in the Caymanian workforce. This is another reason why it is crucial that Cayman’s immigration laws need to meet the appropriate needs of the industry. With the expected growth in our population over the coming years, I believe it is critical that government works to quickly resolve these issues.

Professionalism in this new era

At the RICS conference, John Hughes, RICS president-elect, spoke about professionalism within our industry, another point which I touched on earlier last year in this publication. Last year I detailed how the Cayman Islands Real Estate Brokers Association (CIREBA) worked diligently alongside government to ensure that our members behaved with the utmost professionalism, transparency and respectability. As far as the conveyancing industry was concerned, RICS members could not just keep pace with a changing world, they should strive to set an example, Mr. Hughes advised. Professionalism, he said, was about being accountable to others, about being at the top of your technical ability and about the behavior you display. These are sentiments that I believe are particularly relevant to our real estate industry as we move into a new and exciting era of growth for the Cayman Islands.

Welcome to the VUCA world

In recent months, something new and structurally revolutionary has been brewing in the global financial markets. This new trend, traceable in its beginnings to 2015-2016, is now highly pronounced. The same trend is also linked to the global social, economic and even political fundamentals. In simple terms, most recent signals from the financial markets indicate a structural decline in the prominence of traditional risks and the elevation of a so-called VUCA (volatile, uncertain, complex and ambiguous) environment in driving assets valuations. This structural switch – from a familiar, hedging-friendly world of risk, to an ambiguity-rich, higher uncertainty world holding promise of systemic shocks – is a hard reality to handle for investors, regulators, and the markets in general. With time, the problems of navigating through the VUCA world will also start feeding through to mainstream politics, setting the stage for the next global crisis.

Evidence forward

While there are multiple various metrics for measuring risks in the financial markets, one of the most comprehensive and common gauges of risk perceptions among the investors is the VIX index or, using its full definition, the CBOE Volatility Index. Per CBOE, VIX “is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.” In general, both in academic and practitioner finance, VIX Index is broadly considered to be a relatively accurate barometer of investor sentiment and a decent predictor of the direction of market volatility.

Taking S&P500 and NASDAQ Composite returns, inclusive of dividends payouts, since 1997, and comparing their volatilities to VIX indicates that starting from 2Q 2016, shows that both future expected and recent historical risk measures have declined. In terms of intra-day volatility, by the end of February, the S&P500 has managed to run 50 days of uninterrupted sub-1 percent intraday volatility – the longest stretch for more than 34 years. In other words, investors and traders are no longer operating in the environment where ordinary risks materially influence markets behavior. Complacency and over-confidence are now medium-term behavioral drivers of markets prices, implying that the world of investment finance is in a rapidly developing bubble.

At the same time, also starting with early 2016, indices that measure economic and markets uncertainty have been hitting historical highs. One such measure of uncertainty is the Global Economic Policy Uncertainty Index which can be measured using the extent of media focus on policy uncertainty across the globe. The EPU Index is a de facto proxy for broader VUCA-type environment, where risks cannot be fully priced or insured against, and where markets participants are forced to rely on more intuitive understanding of the complex, ambiguous and volatility-inducing trends.

As chart 1 clearly illustrates, both VIX and the EPUI have been trending in the opposite direction since the end of 2015. More crucially, short-term and medium-term correlations between the two indices, having generally been positive on average over the last 20 years, have now turned negative. This is only the second time in history of both indices that such a reversal took place, and the current period is the longest for which all types of correlations are negative.  See figure 1

Figure 1

In line with the EPUI, CBOE Skew Index – an index capturing the price of buying insurance contracts against larger shifts in S&P500, or an indicator of demand for extreme (tail) risk hedging – has been on an upward trend, with historically high degree of volatility. Funds inflows into gold are also accelerating: Xetra Gold Shares rose from around 60 in 2015 to around 120 by the end of 2016. The price currently stands at over 138. Finally, the Insiders Transactions Ratio (a ratio of insider sales to insider buys) – a good indicator of insiders’ pessimism about the future markets direction – is currently running around its all-time highs.
As investment markets set aside concerns about traditional short-term risks and focus on a more complex and highly ambiguous systemic uncertainty, the “smart money” investors reposition their portfolios toward short-term speculative strategies, away from long-term hold acquisitions. Which sets the stage for potential systemic crises should macroeconomic environment turn sour.

Welcome to the VUCA world

Rising likelihood and severity of the uncertainty-driven markets crises is a core feature of the VUCA environments. And the tail signs of the events ahead may already be visible on the horizon.

At the end of February, the European Financial Stability Fund, Europe’s collective undertaking backed by its sovereigns, ran into what Bloomberg called “a stunning lack of investor appetite for its long-end debt.” EFSF’s debt spreads on German Bunds rose from 21 basis points at the end of October 2016 to 69.2 basis points at the end of February.

In equity markets, complacency is the name of the game. For the S&P 500, the current forward 12-month Price-to-Earnings (P/E) ratio is 17.6. Which beats all recent historical averages: the five-year average (15.2), the 10-year average (14.4), and even the 20-year average (17.2). The latter includes the period of boom. The end of February 2017 marked the highest forward 12-month P/E since June 23, 2004. Notably, current forward 12-month P/E ratio is estimated using highly optimistic earnings per share forecasts for 2Q-4Q 2017. Should earnings fail to deliver in these expectations, the forward P/E ratio will rise even higher. In other words, markets pricing currently implies a truly excessive degree of investors’ optimism.

While much has been written about the political cycle drivers for increasing markets pressures, little is generally said about the macro and micro economic factors underpinning the rise of the VUCA environment. In fact, recent analysis of the uncertainty in economics and financial markets from Peter Praet, member of the Executive Board of the European Central Bank, focused exclusively on the former, de facto ignoring the latter. Likewise, most recent comments from the Fed suggest that the U.S. monetary authorities are seeing key risks to the financial system as being politically driven, with macroeconomic risks rapidly abating.

Yet, things are far from rosy in the world of investment even when it comes to economic fundamentals. With political uncertainty reinforcing the economic ambiguity, we are witnessing a dramatic buildup of structural uncertainty in the markets. In historical comparatives terms, current fundamentals suggest a rising tide of imbalances in the financial assets valuations across the board, while the popular narrative among investors and analysts is reminiscent of the era when the heuristic of the “Great Moderation” dominated mainstream economic policy making and analysis.

Consider the U.S. Fed. At the end of 2015 and through the first couple of months of 2016, the U.S. Federal Reserve struck a relatively hawkish note when it came to forward policy guidance. Then, driven by weakening economic growth and rising political uncertainty, Yellen had to hold Fed rates untouched, barely managing to squeeze in a rate hike at the end of the year. The Fed started 2017 with clear signals that the markets can expect at least three rate hikes over the next 12 months. This time around, it appears that inflationary and growth dynamics may be on its side. But under the surface, the U.S. economic growth remains fragile, with just 1.9 percent annualized rate of real GDP expansion in 4Q 2016.

Unemployment is low, but underemployment is high and labor force participation is anemic. Much of the inflation uptick in 2016 and in the first months of 2017 is down to a shallow upside trend in energy prices and the rising cost of housing, not due to improving demand. In fact, disposable personal income growth, based on the latest data through January 2017, continues to underperform inflation, implying a deteriorating financial position of U.S. households.

On the policy side: the International Corporate Governance Network – a group of investors and fund managers with some USD26 trillion in assets under management – has explicitly warned the markets about the policy priorities of the current White House administration. In particular, the ICGN  highlighted the policy environment rife with “potential short-termism” that can lead to poor policies structuring and longer-term damages from rushed policy and regulatory proposals, and opaque governance structures within the current administration.

The political uncertainty is fueling ambiguity about the overall direction of the economy, leaving the Fed in position as the sole underwriter of stability in the seas of turbulent macroeconomic waters. The first result was the Fed’s refusal to raise rates in February, and markets consensus shifting from expecting three rates hikes to two over 2017, and a drift in the next rates hike expectations from February-March to 2Q 2017. Then came early March, with markets’ sudden and dramatic repricing of the Fed hike expectations. The uncertain, ambiguous nature of the markets and investors’ expectations are now translating into rising volatility in monetary policy forecasts, tying the Fed’s hands into the next two to three months. This is a classic example of how VUCA environment works, transmitting general uncertainty into specific large-scale risks: suddenly, unexpectedly and sharply.

Beyond the rates hikes, even more mild policies toward reversion to monetary normalcy are hard to structure. For example, the Fed can start gradually shrinking its balance sheet by ending the practice of using principal repayments on maturing mortgages bonds to purchase new bonds and / or stopping the practice of rolling over maturing Treasuries. This move can take place before raising the official rates, since the policy was, in the first place, designed to help lower borrowing costs after the official rate already hit the zero bound. But, paralyzed by the political uncertainties and economic environment ambiguity, the Fed is reluctant to test the economy and the banks’ balance sheets through such a move.

Half of the problem is, the longer the Fed stays inactive, the larger the adverse impact of its balance sheet measures will be in the future, and the more likely it will severely impact ordinary households.  Another half of the same story is that rising rates and tightening the Fed balance sheet today will most likely trigger the said crisis. The markets are, therefore, caught between a rock and a hard place: more accommodation from the monetary policy side is required to sustain current valuations, but more accommodation today implies a greater crisis and less predictable markets trends tomorrow. “Smart money” investors can do nothing else but take speculative positions and hedge against deeper uncertainty.

VUCA contagion across the Atlantic

Now, take the European markets view. Here too political uncertainty is driving a switch from traditional risk assessment scenarios toward the VUCA environment. Unlike in the U.S., however, this trend has been present for a number of years. Hence, the predictable spiking in markets’ perception of uncertainty in line with the re-emergence of the Greek crisis early this year. VStoxx options contracts volumes surged to historical highs at the end of February, with traders betting on increasing volatility in the European stocks going forward. But as with VIX, the actual VStoxx index is running close to its 2014 lows. Analysts attribute this to the investors buying hedges against the upcoming French elections.

In reality, there is much more than simple risk-hedging going on in Europe. In fact, VStoxx options moves have to be considered within a broader context of rising uncertainty. To see this, take the Sentix Euro-break up Index, which indirectly measures contagion risk across the euro area economies and directly reflects markets’ expectation of the probability of cross-euro area contagion risks from at least one member state exiting the euro area within the next 12 months. It is currently at the highs last witnessed at the peak of the 2012 sovereign debt crisis, with end-of-February reading at 47.61, up from the lows of 25 in mid-2016. Sentix-measured one-year probability of France exiting the euro area was at 8.25 percent – an eight-fold rise over the last seven months. Sentix Italy Index is currently at around 14 percent marker, down on an all-time high of just over 18 percent in 4Q 2016, but still well above previous historical highs.

All of the above stands are contrasted by a bull markets boom across European burses. Behavioral indices measuring the degree of overconfidence among financial investors in Europe are touching new two-year highs, just as the VUCA environment is coming into greater focus. Just as in the U.S., Euro area markets are currently combining seemingly contradictory environments of declining risk perceptions, rising uncertainty and ambiguity sentiment, booming asset valuations and weak economic fundamentals.

With a lag of about 18-24 months – judging by both the macroeconomic fundamentals and the financial sector performance data – the euro area is tracing out the U.S. trajectory.

The fallout

In both the euro area and the U.S., the ongoing divergence between the risk valuations and the VUCA / uncertainty perceptions among the financial markets’ participants is creating an environment where assets valuations are increasingly becoming disconnected from the underlying macroeconomic, political and corporate balance-sheet realities. The end game of this development is a dramatic, albeit more ambiguous and less visible buildup in market imbalances. This translates into reduced effectiveness of the monetary policy as a tool for macroeconomic and financial markets stabilization. Powerless to normalize monetary policy and powerless to stimulate the real economic activity, monetary authorities on both sides of the Atlantic are forced into inaction, passively watching as asset values rise above the 2007-2008 crisis period relative valuations and heading toward the era ratios. Meanwhile, the current buildup of markets imbalances is starting to resemble a classic speculative bubble, where an increasing share of investors take short-term, liquid long positions in the markets, standing by to unwind these at the first sign of market weakness.  In simple terms, the current VUCA environment is about as safe as an overloaded spring pushed against a slippery wedge.

Book Review: ‘The Money Problem: Rethinking Financial Regulation’ by Morgan Ricks

Morgan Ricks

Morgan Ricks’s Money Problem is unusual in that it presents the creation of money by banks in simple but detailed terms that should be easily understood by the general public while at the same time presenting a novel perspective and recommendations that will challenge professional economists.  While I do not agree with all of his conclusions, Ricks explores all of the main alternatives and critics of his proposal in a straightforward, illuminating and readable fashion.

Ricks’s central proposition is that the primary risk to financial and macroeconomic stability comes from financial panics, by which he means the equivalent of runs on banks.  Bank runs reflected the rush by depositors to withdraw their funds before their bank ran out of cash, thus forcing the bank to sell its assets under fire sale conditions.  Financial panics in the form of bank runs were eliminated by deposit insurance established in 1933 (Federal Deposit Insurance Corporation) but the equivalent potential now exists in the shadow-banking sector financed by “money equivalent,” short-term debt.  This was what the U.S. experienced following the bankruptcy of Lehman Brothers in September 2008 when non-bank financial institutions that relied on rolling over short-term debt for their financial stability faced the inability to retain such financing.

“Ben Bernanke expresses a similar point in a slightly different way.  In his analysis of the recent crisis, Bernanke distinguishes between what he calls “triggers” and “vulnerabilities.”  The triggers of the crisis consisted of developments in the U.S. housing and mortgage markets.  (“Some Reflections on the Crisis and the Policy Response,” remarks at the Russell Sage Foundation and the Century Foundation Conference on Rethinking Finance, New York, April 13, 2012.)  Bernanke argues that these triggers alone can’t explain the magnitude of the accompanying economic downturn….  “Any theory of the crisis that ties its magnitude to the size of the housing bust,” he says, “must also explain why the fall of dot-com stock prices just a few years earlier, which destroyed as much or more paper wealth—more than $8 trillion—resulted in a relatively short and mild recession and no major financial instability….  One of the biggest vulnerabilities, he contends, was the financial sector’s heavy reliance on ‘short-term wholesale funding.”

Ricks’s argument for the importance of panics (runs) as a source of serious recessions is convincing, but his demotion of the importance of debt crisis and asset bubble bursts is less so.  He does not deny, however, that these and other factors might also be important in explaining the particular responses of economies to individual financial shocks and reviews such competing theories as Austrian Business Cycle Theory, Keynesian Aggregate Demand Theory, Neoclassical real shocks Theory, Market Monetarism, and Debt Cycle Theories.

Ricks proposes to extend deposit guarantees to all bank deposits, including time and savings deposits, without limits, as well as to all bank liabilities of less than one-year maturity in order to eliminate the basis for runs.  The government would charge for this guarantee with the equivalent of risk based insurance premiums to minimize the risks of moral hazard (excessive risk taking by banks when their source of funding is guaranteed).  Nonbanks (the existing shadow banking sector) would not be allowed to issue money or cash equivalent liabilities (deposits or short-term debt).  Thus the incentive for depositors and short-term lenders to withdraw funding if their bank’s soundness came into question (bank runs) would be eliminated.

Ricks builds his proposal around an unusual way of viewing the process of creating money.  Fractional reserve banking, by which banks hold loans and other assets against depos its with the bank (plus a modest balance of cash reserves with the central bank), allows most of what we treat as money to be created by banks rather than by the central bank.  This “public private partnership” allows money to be created against a much broader range of assets than would be appropriate or easy for the central bank on its own.

Central banks generally create money by purchasing government debt in the market.  But the stock of such debt may not be sufficient for creating the amount of money demanded by the public.  If the central bank were forced to buy privately issued debt or even to extend loans to private companies or individuals, it would face several daunting challenges.  It would need to develop the capacity to evaluate the credit worthiness of such borrowers and would need to put in place credible safeguards against abuse in the form of favoritism toward one borrower over another.  The practice in some countries of central banks lending to state-owned companies (often through state owned development banks) has not generally ended well.  By allowing banks to create money, the range of counterpart assets can be greatly expanded by subcontracting to commercial banks the development of credit evaluation capacity and competitively provided loans.  Banks lend money by creating deposit balances for the borrower.

Viewed in this way, the design of bank and financial sector regulations should be motivated by the goal of providing the supply of money (deposits and short-term debt) needed by the economy in such a way that banks are run-proof but without creating the moral hazard of excessive risk taking that such guarantees normally create.  Following Milton Friedman and others, Ricks convincingly argues that the “moneyness” of short-term debt (he chooses a cut-off of one year) justifies including it in the definition of the broad money aggregate targeted by the central bank.

Ricks “defines banking as the business model under which portfolios of financial assets (typically credit assets) are funded largely with short-term debt that is rolled over continuously.”  He maintains that while pruential portfolio regulations would still be needed for banks, nonbanks would no longer need regulation of their risk taking other than “requiring all entities that are not member banks to finance their operations in the capital markets and not the money markets.”  He argues, “that once the monetary-financial system has been made panic-proof, other forms of stability-oriented financial regulations could be dramatically scaled back.”  The aggregate amount of “broad” money that could be issued by the banking system would reflect monetary policy decisions and would be enforced by the use of tradeable entitlements to issue deposits and short-term debt in a cap and trade system.

Traditionally the potential but temporary illiquidity of a bank with fractional reserves was address by the central bank’s role as a “lender of last resort.”  This was the primary purpose for establishing the Federal Reserve System in the U.S. in 1913.  And bank soundness was “assured” by imposing capital and asset quality and concentration regulations, in conjunction with the provision of deposit insurance.  Ricks argues that these subsidize and do not fully overcome the distortion to risk pricing and thus risk taking avoided by his risk-based fees levied in exchange for a full government guarantee of all bank monetary liabilities.  This is at least debatable.

Ricks also argues that regulatory structures that rely on investor (depositor) regulation of bank risk taking are misplaced (e.g., limiting deposit insurance coverage to modest amounts).  Bank depositors and short-term lenders, he argues, do not invest much if anything in evaluating the soundness of their counterparts (banks) and thus do not provide effective market discipline of bank risk taking.  They trust their bank until they don’t, at which point they run.  The best indicator that their bank is no longer sound is when others lose confidence in it and start withdrawing their funds.

Ricks’s commercial banks exist to broaden the assets against which money is created.  He defends his proposals against others that would also make banks run-proof while reducing or eliminating many of the regulations currently in place.  For most narrow banking proposals, especially the Chicago Plan of 100 percent reserves, all assets acquired in creating money are held by the central bank.  See for example my:  “Changing direction on bank regulation” Cayman Financial Review, April 2015.  In the Chicago Plan, commercial banks exist to outsource the management of the payment system (the transfers of deposit balances between deposit holders).  Government regulation, beyond the 100 percent reserves, would be almost nonexistent.  Ricks rejects this approach (as well as large increases in required capital) on the grounds that the market might not contain sufficient assets appropriate for purchase by the central bank to provide for its money growth target.  However, this problem is avoided by limited monetary financing of government spending as discussed in my “A modest proposal: Helicopter money and pension reform,”  Cayman Financial Review, May 2016 .  Moreover, the appropriate (optimal) growth in the nominal money supply depends on the desired and targeted rate of inflation.  Milton Friedman argued that the optimal rate of inflation was the modest deflation likely to result from keeping nominal M2 constant (real M2 would grow at the rate of deflation).

This book is well written and thought provoking but not always right, in my view.  That does not keep it from providing a solid basis for a serious discussion of better monetary arrangements and the regulations appropriate to them.

U.S. suspension of premium processing for H1-B visas creates opportunities to attract high-tech business to the Caribbean: Barbados as a model

The temporary suspension of premium processing of H-1B petitions

With the recent uncertainty regarding the Trump administration’s current position on skilled immigrants, including the U.S. Citizenship and Immigration Service’s (USCIS) announcement that starting April 3 it temporarily  suspended the Premium Processing program for H1-B visas,  companies may want to look for new jurisdictions where they can locate highly skilled immigrants. The main industry which utilizes the H1-B program is the high-tech sector, which requires certain types of infrastructure to function effectively.

The H-1B visa allows foreign professionals to work in the U.S. for up to six years.  The fast-track processing option has been utilized to fill positions for new projects on short notice.  These visas are frequently used at large technology companies to bring top engineering talent to their U.S. offices.   The U.S. allows only 85,000 people per year to enter the U.S. on H-1B visas.

Under the premium processing route, applications for the visa are processed within 15 days following the payment of an additional fee of $1,225.  On the other hand, the standard procedure can take three to six months or even eight to fifteen months.  In fact, a reason for the temporary suspension of premium processing is to facilitate the processing of long-pending petitions, since the USCIS has been unable to process due to the volume of income petitions and the significant surge in premium processing requests over the past few years.

According to recruitment experts, the temporary suspension is in line with the U.S. president’s anti-immigration stance and could hint at a tighter H-1B visa policy in the future.
The suspension of premium processing of H-1B petitions may last up to six months and perhaps longer.  The suspension will not only affect new workers coming to the U.S. on the H-1B program, but also persons who already hold an H-1B visa and are changing jobs within the country (e.g., an engineer who had an H-1B visa with Microsoft is taking a new position at Google).

Although premium processing is suspended, petitioners can submit a request to expedite an H-1B petition if they meet the criteria on the Expedite Criteria webpage.   The petitioner must show that they meet at least one of the narrow expedite criteria (e.g., severe financial loss to the company or person, emergency situation, humanitarian reasons) and documentary evidence to support their expedite request.

In addition to the end of the H1-B Premium Processing Program, the State Department announced new procedures for increased vetting of visas.  The new directive, made in an intradepartmental cable by Secretary of State Rex Tillerson, requires consular officials to review the social media accounts of any applicant who has entered territory controlled by the Islamic State. In addition, it requires additional scrutiny of all visa applicants, recommending that consular officials “not hesitate to refuse any case presenting security concerns,” and suggesting officials schedule no more than 120 visa interviews a day. The heightened scrutiny does not apply to visa applicants from visa waiver countries.

ICanada as the main alternative

Canada’s Information Technology (IT) sector is currently growing. In recent years, the Canadian government has taken steps to attract the world’s best IT companies and most promising professionals. Some IT workers, such as computer engineers, may be eligible to apply for Canadian Permanent Residency without a job offer, through the Federal Skilled Worker (FSW) or Quebec Skilled Worker (QSW) programs. Many IT workers can also come to Canada as temporary foreign workers if they obtain a Canadian job offer and work permit. Once in Canada, IT workers can enjoy high-paying jobs and one of the highest qualities of life in the world.

Information Technology is one of the most successful industries in Canada today. With statistically full employment, professionals in the field appear to have a high chance of finding and keeping jobs. IT professionals are also compensated very well. The Information Technology Association of Canada has noted that IT professionals are paid an average wage that is 52 percent higher than the national standard.

Web designers and database analysts were named on a recent list as earning some of the 20 highest starting salaries in Canada. Even recent graduates in these fields with little or no career experience make on average more money than their peers in other industries.

IT professionals have several ways to come to Canada and fill these job vacancies. Workers in this sector have a vast array of potential job opportunities, and the Canadian government has taken measures to help these valuable employees immigrate to Canada relatively quickly and easily.

Several immigration programs are open to IT professionals. Two popular Canadian immigration categories, the FSW and QSW programs, have included certain IT fields on their lists of eligible occupations/areas of training. The FSW program is currently open to computer engineers, while the QSW program awards points for a wide range of computer-related professions. These include computer engineering, computer support, computer science and computer science techniques.

In addition, Canada recently opened a new program designed to attract promising immigrant entrepreneurs. The Entrepreneur Start-Up Visa program, the first such program in the world, grants successful applicants Canadian Permanent Residency and helps them to secure funding and support to set up their business in Canada.

With an economy searching for talented IT professionals, IT workers with an interest in working in Canada do not necessarily need to wait to obtain Canadian permanent residency.
In order to come to Canada as a temporary worker, one must be offered a job in Canada and receive a Temporary Work Permit. Interested individuals can search for jobs in Canada by using the Canadavisa Job Search Tool.

Canada has a number of international agreements that help facilitate the entry of foreign workers. Perhaps the most popular is the North American Free Trade Agreement (NAFTA), which facilitates the work permit process for U.S. and Mexican citizens coming to Canada to work in specified professions. Both Computer Systems Analysts and Graphic Designers are listed amongst these professions.

The Caribbean as a potential for skilled hi-tech persons

The inability of high-tech companies to quickly obtain H-1B applications for high-tech workers, either new persons coming from India or changing positions in the U.S., will mean that many of them will want to place the persons in a nearby jurisdiction where they can work with U.S. high-tech companies.

The high-tech companies will want to continue to quickly bring persons from jurisdictions, such as India, so that they can work with them.  To continue to work with them means that the U.S. high-tech companies will want to place these workers in a jurisdiction in the same time-zone, and one which has a good infrastructure, good living conditions, and is safe.

Although Canada seems to be for the above-mentioned reasons the main alternative for U.S. high-tech firms to place their skilled high-tech workers who can at least temporarily not obtain an H-1B visa, Barbados and the Caribbean may be able to serve as an alternative for some of these jobs.

Barbados, as compared to other jurisdictions in the Caribbean, is relatively well-equipped to meet those needs. It is, for its size, exceptionally well-connected regarding telecommunications. Barbados was ranked by the International Telecommunications Union in 2007 as the 14th most wired country per capita in the world, behind only fully developed Western nations like Canada and the U.S., and the highest ranked in the Caribbean or Latin America.  Barbados has long played a key role in transatlantic communications, and is connected by transatlantic cables originally laid by the British during the colonial period. In 1982, it became the first Caribbean nation with fiber optic telecommunications cables.

Barbados has strong broadband internet access, with widely available ADSL services, Frame Relay services, and additional, more advanced services , including an advanced cloud computing platform available to businesses throughout the nation and provided by Digicel.

While the Cable & Wireless Company, a legacy from British colonization of the island, had a monopoly in cellular services, the government negotiated an end to the monopoly in 2003, and now mobile providers include Flow and Digicel – the 2007 report showed that from 2000 to 2004, Barbados had a telephone usage rate of 124 phones per 100 people, higher than Canada or Japan.

Barbados has invested heavily in terms of both resources and planning to create an infrastructure for ICT, and a population that can enjoy its benefits. Community Technology Programs have succeeded in placing computers in community centers across the country to establish nationwide access, and the government has invested millions in the Education Sector Enhancement Programme (ESEP, and previously known as EDUTECH), which succeeded in integrating information technology into Barbados’ public and private schools.  Additionally, the government’s multimillion dollar investment in ICT infrastructure has allowed them to fully utilize the infrastructure to provide additional services in many sectors, such as banking, insurance, and customs enforcement.  Hence, on the 2006 Digital Opportunity Index, an international metric rating a country’s success in utilizing ICT and making it widely accessible, Barbados ranked 27th of 181 countries, best in the Caribbean, behind only

Canada and the U.S. in the Americas.

In terms of other types of infrastructure, Barbados is connected to the world through Grantley Adams International Airport, which has year-round direct flights to Charlotte, Miami, Toronto, London, Atlanta, Boston, New York, Bogota and numerous locations throughout the Caribbean. It is among the highest-ranked countries in the world with a 99.7 percent literacy rate, offering free public education through university, with numerous post-secondary schools including the Samuel Jackman Prescod Polytechnic (SJP), the Barbados Community College (BCC) and the University of the West Indies (UWI) Cave Hill campus. Barbados has a well-developed medical sector which includes two major public hospitals, medical laboratories, a well-established dental sector, and full medical specialization. The Barbados Postal Service, run by the government, has 18 post offices around the island, and offers full international services; FedEx, DHL and UPS also operate in Barbados. The island maintains a diversified electricity supply, utilizing solar power as well as other sources to keep a consistent and reliable supply of electricity at all times.

Barbados has been ranked first in the world (jointly with other nations) in political liberties and civil rights, was ranked by the UN HDI as 31st of 177 countries in 2006, ranked 38th in 2003 in GDP per capita and 32nd out of 155 countries in economic freedom in 2005 by the Wall Street Journal and Heritage Foundation.  It was ranked by the World Economic Forum in 2015 as 39th of 143 countries in its Networked Readiness Index, which measures the nation’s readiness to become a marketplace for information and communications technology.  This ranking was higher than any other Caribbean nation, below only Chile (which ranked 38th) among Latin American nations, and comparable with fully developed European nations such as Spain.

One success story of the Barbadian investment in ICT infrastructure is that of ACR Business Solutions. Founded by Barbadian husband and wife team Anthony and Celeste Foster, ACR has developed into an internationally recognized and utilized business services and data analysis firm. ACR was one of the first companies in the Caribbean to enter the medical transcription business, and is now transitioning into the IT-intensive field of medical data coding. This work requires a qualified and skilled labor force, one which ACR has been able to find in Barbados and the greater Caribbean. ACR’s success demonstrates the effectiveness with which the Barbadian investment in ICT education has been able to create conditions suitable for the development of a high-tech economy.

In Barbados a short-term attachment is available for 11 months.  The employer or “sponsor” has the responsibility to make the application on behalf of the employee.  Long-term Work Permits are valid for a period of up to three years. In order to become eligible for a long-term Permit, prospective employers must sufficiently prove that no resident or Barbadian national is capable of and willing to fulfill the requirements of the position in question.    Processing of an application for a Long-term Work Permit typically takes six to eight weeks, and applicants can begin work once the application is approved.  Non-immigrants can apply for extensions of the stay.

Barbados can serve as a model for other Caribbean jurisdictions looking to attract high-skill immigrant workers, particularly in high-tech fields that require strong information technology infrastructure. In light of the recent uncertainty in the United States regarding the H1-B visa program, this could prove an increasingly viable way to attract foreign investment and grow the economy.

Grey matters

Which Institutional Investor Types Are the Most Informed?

Zhe Chen, David Forsberg, & David R. Gallagher

(October 24, 2016) available at

The authors examine the informativeness of quarterly disclosed portfolio holdings across four institutional investor types: hedge funds, mutual funds, pension funds, and private banking firms. Overweight positions outperform underweight positions only for hedge funds. By decomposing holdings and stock returns, they find that hedge funds are superior to other institutional investors both at picking industries and stocks, and that they are better at forecasting long-term as well as short-term returns. Furthermore, their results show that hedge funds, mutual funds and pension funds are able to successfully time the market. The outperformance of hedge funds is not explained by a liquidity premium.

CFR comment:
This is a terrific empirical piece, which finds that hedge funds seem to outperform other institutional investors, showing an avenue by which fund managers add value. Interestingly, this advantage comes from liquid investments rather than illiquid ones. Worth a read.

Funding Liquidity Risk and the Dynamics of Hedge Fund Lockups

Adam L. Aiken, Christopher P. Clifford, Jesse A. Ellis & Qiping Huang

(October 5, 2016) available at

We exploit the expiring nature of hedge fund lockups to create a dynamic, fund-level proxy of funding liquidity risk. In contrast to the prior literature, our measure allows us to identify how within-fund changes in funding liquidity risk are associated with performance and risk taking. Lockup funds with lower funding liquidity risk take more tail risk and have better risk-adjusted performance, suggesting reduced funding liquidity risk enables funds to better capitalize on risky mispricing. Surprisingly, lockup funds outperform non-lockup funds even when controlling for restricted capital, suggesting that a portion of the lockup premium is attributable to a “lockup-fixed effect.”

CFR comment:
In an interesting paper, a group of graduate students explore the impact of lockup provisions in hedge funds using a dataset of over 3,800 funds. An excellent read.


With a new administration and Congress on the way in the U.S. and new governments potentially on the horizon in many EU countries (plus Brexit!), a look at some calls for reforms can help identify changes that may be in the works.

Preserving the Corporate Superego in a Time of Activism: An Essay on Ethics and Economics

John C. Coffee Jr.

(September 16, 2016) available at

This essay focuses on the impact of recent changes in corporate governance on ethical behavior within the public corporation. It argues that a style of corporate behavior – one characterized by a risk tolerant, even reckless, pursuit of short-term profits and a disregard for the interests of non-shareholder constituencies – is attributable in significant part to recent changes in corporate governance, including the rise of hedge fund activism, greater use of incentive compensation, and the appearance of blockholder directors. It then surveys feasible responses intended to strengthen the role of the boards as the corporation’s conscience and superego. Given the difficulty of reform, it predicts that the problems identified are likely to get worse before they get better.

CFR comment:
Prof. Coffey is among the preeminent corporate law experts in the U.S. legal academy and this essay gives a good overview of what he sees as a significant problem that needs to be addressed.


A Tale of Regulatory Divergence: Contrasting Transatlantic Policy Responses to the Alleged Role of Alternative Investment Funds in Financial Instability

Hossein Nabilou

CAPITAL MARKETS LAW JOURNAL 12(1), forthcoming, available at

This article analyzes the regulatory measures adopted to address the potential contribution of hedge funds to financial instability in the U.S. and the EU in the wake of the global financial crisis. The relevant provisions of the Dodd-Frank Act include two sets of direct regulatory measures. The first set of these measures addresses information problems, whereas the second set is intended to address potential too-big-to-fail problems by imposing prudential regulation on systemically important nonbank financial companies. The article then studies the Volcker Rule, as an indirect regulatory measure intended to address the potential systemic risk of hedge funds originating from their interconnectedness with Large Complex Financial Institutions (LCFIs). The second part of this article analyzes the European Directive on Alternative Investment Fund Managers and its attempt to address the potential contribution of hedge funds to financial instability.

CFR comment:
Despite the common driving forces of hedge fund regulation across the Atlantic, ultimate policy outcomes were significantly divergent. Primarily concerned with creating a single market for Alternative Investment Funds, EU regulators prioritized the EU passport mechanism, which engendered demand for investor protection and more stringent and direct regulatory measures. In contrast, the main concern in the U.S. remained to be addressing potential systemic risk of hedge funds. Such differential regulatory objectives gave birth to indirect regulation of hedge funds with a focus on their interconnectedness with LCFIs. This is mainly embedded in the provisions of the Volcker Rule; a rule whose absence is significantly palpable in the EU regime for regulating hedge funds.

Are markets predictable enough for a border-adjusted tax to be revenue neutral?

The first shot of the modern “Showdown at Gucci Gulch” was fired on June 24, 2016. That’s the day Republicans in the U.S. House of Representatives released their tax reform “Blueprint.” A keystone of the Blueprint is the DBCFT, or destination-based cash flow tax. This is known publicly as the “border-adjusted tax.” The tax is an inventive VAT-esque plan that would essentially replace the U.S. corporate income tax. It would allow business taxpayers to immediately expense capital assets instead of deducting them after amortization. It would also eliminate the interest deduction. But the completely new aspect of this tax would be to deny corporate tax deductions for imported goods or services while exempting corporate revenues from exports; hence the “border-adjusted” moniker.

Mainly through op-eds, scholars such as Martin Feldstein, Paul Krugman, Alan Auerbach, Douglas Holtz-Eakin and Michael Devereux have touted the tax as a simplification that should appeal to Republicans and Democrats alike. Their starting point is that the U.S. corporate tax system is broken and the border-adjusted tax is the solution. They have been persuasive in addressing criticisms of the tax from various camps, including importers, progressives and free-market advocates.

What they do not address in general are the market predictions necessary to make the tax revenue neutral. Many of these same economists predict the value of the U.S. dollar increasing 25 percent relative to foreign currencies almost immediately after instituting the tax. If the dollar experiences the 25-percent boom, there will be no price increases as a result of the tax’s enactment.

That’s a big “if.”

Assuming the linear analysis is sound from “tax plan” to “dollar increase” in a paper model, what about the system of tax compliance in between these two points? There is evidence that we should regard tax compliance as a “wicked system;” one beyond merely the simple, complicated, or complex. Wicked systems are highly unpredictable in that results from controlled inputs often deviate from expected outputs that would otherwise result from linear systems. This in turn can collapse an entire enterprise. For example, if we place the initial condition X into a wicked system and our reasonable, linear expectations are that we get Y as a result, it is very possible that we will instead get Z (or more importantly, not Y). If we are depending on getting Y as the output that made developing X in the first place rational and cost-effective, getting Z might be disastrous for our project.

This notion of a wicked system springs from the now-ubiquitous concept of a “wicked problem.” First introduced as a label in 1967 by West Churchman’s publication discussing Horst Rittel’s articulation of management problems without generally-applicable solutions, Rittel further developed the characteristics of wicked problems as they apply to social planning and policymaking with co-author Melvin Webber in 1973.  In this paper, the authors note that every solution to a wicked problem is a “one-shot operation” since there is no opportunity to learn from trial and error. Also, wicked problems do not have well-defined solutions that one can list out or accurately calculate. A wicked system, then, is a social structure that generates systemic wicked problems.

To be clear, it is not the tax reform plan to have a border-adjusted tax that is the wicked system. It is tax compliance that is the wicked system in that the actions taken in between the tax reform plan’s launch and its linearly-analyzed results can send these results wildly off course. Consequently, the best that we can predict in instituting the tax as policy is that certain results will take on various measures of probability, but all of the results will be far from certainty.

Another wicked system that has a similar aim of tax reform in that it attempts to solve a large-scale problem is cloud seeding. Cloud seeding is similar to tax reform in that the analysis from initial silver-iodine seeding to final precipitation yield (or hail intensity reduction) can be modeled linearly. Yet, it is the “in between” system of the weather that is the wicked system that can take the seeding as input and generate an output quite different than that expected from the models. In fact, it was our early attempts to control the weather after World War II that led to the discovery of what we now call chaos theory. Simple models that generated highly-predictable results changed wildly if the inputs differed, not significantly, but at the nth decimal place. Recognizing this, the cloud-seeding industry no longer seeks to predict the precipitation yield with anything close to certainty. In fact, the investment is profitable if the yield is only 10 percent of the projections.

Can we conclude the same about the border-adjusted tax as cloud seeders do about their precipitation yields? Most likely not. The economic analyses that predict the immediate 25-percent increase in the dollar fail to include the effects of the wicked system known as tax compliance; that “in between” reality of aggregate human action that is as (un)predictable as the “in between” weather systems for cloud seeders. The difference is that cloud seeding remains a profitable venture if the precipitation yield is only a fraction of the model’s projections. Can the border-adjusted tax venture still produce revenue-neutrality if tax compliance reduces economists’ projections to a fraction of the 25-percent increase in the dollar’s value? Tax policy drafters have the public duty to at least ask and attempt to answer this question before implementing the new tax; especially since significantly different economic results can prove ruinous for the current tax reform project.

Proponents of the tax are correct in stating that our corporate tax system is broken. Still, it would seem wiser for tax policy makers to realize from go that long-term market results will most likely look different from a model’s forecasts. We must be confident not in the economic predictions, but in the high probability of the realization of the tax reform plan’s objectives even if/when these economic predictions prove inaccurate. This is true even under a White House “Plan B” that tweaks the proposed tax. Any Plan B will also face the same wicked tax compliance system if its constituent parts are enacted regardless of its exclusion of the border-adjusted portion.

The solution? By definition, that’s not easily articulated. But finding a solution begins by neither rationalizing nor justifying any part of tax reform as “revenue neutral” based on the prediction that markets will respond to tax stimuli in a linearly-predicted fashion. Can we pay for the border-adjusted tax without a relative value increase of 25 percent in the U.S. dollar? In other words, can we pay for this tax in a way that doesn’t rely on the market’s actions (which include the wicked system of tax compliance) to be linearly predictable, much like the cloud seeding industry has done? If so, then the proponent economists are correct that the border-adjusted tax very well might fix the broken U.S. corporate tax, at least in part, by making U.S. corporations more competitive globally. But if the success of the tax depends on the 25 percent increase, the wicked compliance dynamic might very well deliver a drastically different result to the U.S. dollar’s relative value. We would then have a new broken system to fix.

Given tax compliance as a wicked system, the choice between tax reform Plans A and B with a dependence on a very specific market reaction is most likely to result in Plan 3. The question that policymakers must attempt to answer is whether the Plan 3 result will still make the initial plans revenue neutral. If not, then we need to face the fact that the border-adjusted tax might very well increase the U.S. deficit.

Panama Papers: cui bono?

When you visit the Offshore Leaks Database from The International Consortium of Investigative Journalists (ICIJ), you will find a legal disclaimer that reads as follows: “There are legitimate uses for offshore companies and trusts. We do not intend to suggest or imply that any persons, companies or other entities included in the ICIJ Offshore Leaks Database have broken the law or otherwise acted improperly.”

This begs the question, what is the scandal then? If the ICIJ recognizes that it cannot affirm that any person or company linked to the Panama Papers has committed a crime in any jurisdiction (much less meet the more appropriate standard of dual criminality), what was this about? The ICIJ did not just release the database to the public. This organization made a clear effort directed at achieving the highest media impact worldwide. The ICIJ wanted to create in the public mind the impression that offshore business providers, particularly the particular services provider whose documents were illegally retrieved (Panamanian Law Firm Mossack Fonseca & Co.), knowingly dealt with criminal organizations and actively helped customers commit crimes, launder money, and hide their trails.

We are talking about the biggest release of confidential information ever to take place. Indeed, the members of ICIJ and journalists covering the release of the documents, made a notable effort to emphasize that, in terms of data, the Panama Papers release was several orders of magnitude greater than any other in the past. Many articles were written just to stress the numbers comparing the 2.6 Terabytes of data of the Panama Papers to the now, in comparison, pale 1.7 Gigabytes of the 2010 Wikileaks release, or the 60 Gigabytes of materials leaked by Edward Snowden related to surveillance activities of the National Security Administration.

If the claims of the ICIJ and associated journalists are correct, and what the Panama Papers revealed is a systemic aiding and abetting from the offshore legal and financial services industry of criminals, tax evaders and corrupt politicians worldwide, one would expect that from such a great amount of data illegally extracted from Mossack Fonseca, prosecutors around the world would be busy for many years to come. In fact, a full year since the Panama Papers scandal was broken to the public, there have been no indictments for alleged crimes evidenced in the files. Both Mr. Mossack and Mr. Fonseca have been detained in Panama in February this year, but the prosecutors have been emphatic that their detention had nothing to do with the Panama Papers, and was for a different investigation related to the Lava Jato scandal in Brazil.

And this year must be added to the full year that ICIJ had access to the files before they announced it to the public.

This absence of any criminal indictments in the West and the rest of the world, against any major (or minor) criminal organizations or persons in relation to illicit activities of any substantial impact, is in and by itself fairly conclusive evidence that the whole affair was not much more than a gigantic release of hot air. And this raises a few questions: Why then the scandal? Who was behind the release and what was the real motive?

What is the connection of ICIJ with George Soros?

The International Consortium of Investigative Journalists lists on its website a number of donors, among which is mentioned the Open Society Foundations, founded by Hungarian-American billionaire investor George Soros. Soros is a philanthropist who tends to fund and donate to organizations that view capitalism as the cause, rather than the solution to the world’s problems.

The choice of name for his foundation, Open Society, comes from the term used by twentieth century philosopher Sir Karl Popper. The latter’s book, “The Open Society And Its Enemies” is a political science classic. The central argument of Popper in that book is that fundamentalism in any direction tends to lead to regression of society to either tribalism or tyranny, and that sustained societal improvement is possible only under a political and economic system that allows for diversity instead of aiming to impose one worldview. This requires a political system that ensures that political power is bound within very strict limits, with constitutional mechanisms for peaceful and non-traumatic change of power, very strong guarantees for individual liberty and human rights, and a firm respect for the Rule of Law. For those very same reasons, Popper tended to favor free market economies and political systems with strict constitutionalism and restricted powers, such as the United Kingdom and the United States of America.

The Open Society that Soros favors, however, is not quite the same as the one proposed by Popper. Although not totally hostile to capitalism, Soros is an ardent critic of it, or at least what he perceives as capitalism. In fact, he has argued that since the end of the Cold War and the demonstrated failure of Communism, the system of laissez-faire is the major threat to the open society. In other words, he thinks of capitalism as an extreme ideology, rooted in what he calls “excessive individualism.” As he penned in his opinion piece in The Atlantic in 1997 titled The Capitalist Threat: “Although I have made a fortune in the financial markets, I now fear that the untrammeled intensification of laissez-faire capitalism and the spread of market values into all areas of life is endangering our open and democratic society. The main enemy of the open society, I believe, is no longer the communist but the capitalist threat.”
He does not put capitalism on the same level of evil as communism or nazism.  However, he clearly believes that the economic system currently in place the United States of America is too much individualistic. In other words, he wants a turn left.

Unfortunately, his views are based on several errors. For example, he views free market as antagonistic to cooperation. In this he makes the common mistake of equating competition in the marketplace with competition in sports or in conflict.  Thus, he sees transactions between free individuals in the marketplace as a zero-sum game, a common fallacy that is at the heart of all hostility to the free market.  But competition in the marketplace is not a zero-sum game for one key reason, and that is the existence of property rights. With property rights, competition in the marketplace leads to cooperation.

How? When no individual is forced to work for others or to share his property with others (and his property rights naturally include his own time and energy), any person wishing to engage in a transaction must do so appealing at the other person’s interests. The freedom to choose that is the essence of the free market system is the reason why anybody wishing to sell his product or service to other persons, must offer something that other people are willing to buy paying with something that in turn is more valuable to the former, on the margin, than the product or service he sold to the latter. This leads to division of labor phenomenon that even Marx recognized is conducive for the improvement in the quality of life of all people in society. As Adam Smith famously put it: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their self interest.”

It is no surprise that Soros holds these antagonistic views towards capitalism, given that Nobel Laureate economist Joseph Stiglitz, whose wife sits on the Advisory Board for The Open Society Foundations, advises him in economic matters. This can serve to explain Soros’ focus in wealth redistribution, as this is a major theme as well for Professor Stiglitz (though nothing explains the mysterious decision of the Panamanian government to appoint Stiglitz to serve on the High Level Presidential Commission for the Defense of International and Financial Services – CANDSIF) in the aftermath of the ICIJ leaks.

The statist idea of transparency

Why is this statist ideology relevant to the Panama Papers and the effort of the Organization for Economic Cooperation and Development (OECD)? For two reasons: the first, because by believing that today’s economic system is too individualistic, Soros favors empowering governments to more stringently regulate (i.e. restrict) people’s liberties, particularly in the economic field. In particular, he expresses the need for governments to force wealth redistribution. This requires high taxation. But high taxation, we all know, tends to make people want to invest their capital in other places with less taxation. That is where international tax competition helps deter governments from imposing tax rates that hinder growth and impede the improvement in the standard of living. Thus, whoever wants more wealth redistribution must aim to eliminate international tax competition.

The second reason is that one of the ideas that Soros promotes consistently through his Open Society Foundations is that we need more of a world government and international rules than we have at present. He believes, incorrectly, that laissez faire is conducive to international conflict. Here again, he confounds the word competition when referred to the marketplace, with competition in zero sum games such as the struggle for power between states.  But, typically, wars are waged precisely when at least one of the states refuses to recognize the property rights of the people of the other states. Wars and international conflict are not a feature of capitalism, quite the contrary, they almost always result from the insistence from at least one of the combatant governments in securing by force the valuable resources that pertain to other states or to nationals of those other states. To suggest that the use of force to take something that belongs to other persons is consistent with capitalism reveals that one does not know what capitalism is. The negation of the property rights of others is the negation of capitalism or free market system.

But when you take Soros’ animosity towards international tax competition and mix it with his avowed wish for more centralized world government, and you can only get a desire to expand the international bureaucracy towards an international system where taxes are more or less homogeneous across borders. And for many years, the enemies of international tax competition have understood that in order to achieve their objective of harmonizing world tax rates (something that inevitably would lead to much higher, instead of lower, rates of taxation), it is absolutely necessary to eliminate financial privacy. For the right of maintain one’s financial and legal affairs confidential and beyond the reach of taxing bureaucracies, it will never be possible to impose much higher tax rates in the rich countries without causing an exodus of capital to more attractive jurisdictions.

And so this is the reason why ICIJ, a consortium of investigative journalists, a specialty we traditionally associate with uncovering governments’ and public officials’ actions of abuse of power, based on the correct idea the in a republic whatever concerns the state and the administration of public funds is of interest to all citizens, has now with the Panama Papers reversed the standard and pretends to impose a new one, whereby instead of politicians being accountable to citizens, we citizens should be accountable to politicians, including in our own personal affairs.

That is what they mean with the so-called transparency they now push forward, which is nothing more than the Panopticon that can only serve to reduce freedom of the people and provide politicians with ever more power to abuse.

Ironically, that can only lead to closed societies, instead of the open ones Mr. Soros supposedly favors.

Universal Basic Income – disease or cure?

Figure 1. The current U.S. welfare state.

A big, bold new plan for a radically revised social safety net is sweeping the world. It’s called the Universal Basic Income (UBI). In its pure form, UBI would completely eliminate the current welfare state – a sprawling and bureaucratic morass – and replace it with a single redistributive program that would provide a monthly payment to everyone. Whether rich or poor, all people would get enough money from the government to cover basic needs, like food or shelter. Sound too good to be true? That is what social scientists are trying to figure out and the outcome of that discussion may have a big impact on taxpayers.

Given the profound deficiencies of most state-run welfare programs, the world’s shifting demographics, and movement toward automating large sectors of the economy, UBI has become an increasingly appealing idea. Its appeal seemingly transcends ideological divides, with contemporary thought leaders as different as Charles Murray (self-professed libertarian at the American Enterprise Institute) and Andy Stern (the left-wing president emeritus of the Service Employees International Union) both advocating the adoption of the concept. Each has written books espousing the idea.

The UBI also counts a variety of Silicon Valley entrepreneurs among its list of supporters. This includes big names in technology, like Tesla and SpaceX CEO Elon Musk, Y Combinator’s president Sam Altman, and Facebook co-founder Chris Hughes.


Although the idea feels fresh and new, the history of UBI is an old one. The concept was endorsed by enlightenment figures like the Marquis de Condorcet and Thomas Paine and later, in the mid-twentieth century, it was endorsed by classical liberal economists and philosophers, like Frederick (F.A.) Hayek. The Nixon Republican administration even pushed a version of basic income legislation during its tenure, although it ran into insurmountable opposition when it reached the Senate.

So what led to the idea rearing its head in the modern debate? Modern agitation about the automation of jobs is certainly one of the leading drivers, and recent research on this topic has led to growing anxiety in academic circles. In 2016, a White House Economic report suggested that jobs that pay $20 or less per hour have an 83 percent median probability of automation. Meanwhile, McKinsey research suggests that as many as 45 percent of current paid jobs could be automated by utilizing or adapting current technology. And a 2013 report from Oxford University suggests that 50 percent of jobs could be taken by robots in 10 to 20 years.

Some tech and science voices share these concerns. Moshe Vardi, a computer science professor at Rice University and Guggenheim fellow recently suggested that “We are approaching the time when machines will be able to outperform humans at almost any task.” Elon Musk reiterated the point in a recent CNBC interview where he said that “there’s a pretty good chance we end up with a universal basic income, or something like that, due to automation.”

This is not to say that agreement regarding the threat of automation is universal. For example, MIT economist David Autor suggests that automating repetitive tasks will make complementary skills more lucrative and essential, rather than less. He points to historical examples, like the automated teller machine (ATM) for evidence: in the 45 years since its invention, the number of human bank tellers has roughly doubled. Autor also points out that the fraction of human adults employed in the labor market is higher in 2017 than in 1890, despite the explosion in technological development that’s occurred over the intervening 125 years.

But interest in UBI is not driven just by concerns about rising automation. Many advocates are actually more concerned with social trends. Changes in inequality, upward mobility, flat lining wages for workers, and the weakening ability of higher education to provide job security feature prominently in their writings.

Still other advocates have grown weary of making incremental tweaks to welfare programs that don’t ever seem to yield good results. These supporters are ready for a radical overhaul, and UBI fits the bill.


In response to these concerns, a variety of legislators, academics and philanthropists around the world have become intrigued by the idea and eager to test its viability. In Kenya, a charity called GiveDirectly is testing the idea on 40 villages over a 12-year time horizon beginning in 2017. Meanwhile, in Silicon Valley, California, the largest startup accelerator will provide $1,500 to 100 families from a variety of socioeconomic backgrounds during a pilot experiment later this year. If it’s successful, the study will be scaled. A variety of other nonprofits or research institutes have followed.

Some countries are even sponsoring their own basic income pilot experiments. In Marica, Brazil, the town’s former mayor spent last year piloting a version of UBI for its 14,000 poorest families. Finland is currently in the process of its own UBI experiment, where 2,000 randomly selected citizens will be provided a $630 monthly stipend in lieu of welfare benefits. The city of Utrecht, in the Netherlands, is expected to begin its own study in May 2017.

Governments in such diverse locations as Livorno, Italy, Madhya, Pradesh, India, and Ontario, Canada, have followed suit.

In many cases, these experiments are nascent or incomplete. In a few cases, they have been completed, but practical differences between experimental treatments and geographic contexts make it challenging to draw concrete conclusions. For these and other reasons, UBI is still more of a thought experiment, and the results of the experiment are more often described in the theoretical.

Arguments in favor

So, what are the arguments in favor of UBI? Depending on who you talk to, there are a variety of rationales for the idea. For one thing, an idealized UBI effectively sidesteps many of the traditional welfare state’s conventional problems. See figure 1

Figure 1. The current U.S. welfare state.

For example, many UBI proposals promise large efficiency gains. These occur both because some or much of the existing welfare state would be eliminated in favor of it, and also because printing checks requires minimal oversight and monitoring as compared to managing a complex welfare system (see Figure 1). Part of the promise of UBI is limiting bureaucracy and dollars lost in transfer.

Closely connected to improvements in efficiency are improvements in transparency and fairness. The current welfare state rewards individuals who learn to “game” a complicated benefits system or individuals with the highest tolerance for standing in line. Under UBI, economically unproductive activities like these produce no additional payoff.

Supporters also tout the soft social benefits of UBI. In theory, because individuals are provided for equally by the state, class division and social isolation would fall. The usual dividing lines between “takers” and “makers” would evaporate. For some people, choices to engage in non-paid work like caretaking or creative ventures would become possible.

UBI also reduces or eliminates the paternalism that is typically a prominent feature of welfare programs. It does this by ending government’s role as the arbiter of eligibility to receive benefits. Under UBI, everyone is equally deserving. Then, once individuals receive their income, it allows them freedom to decide what to do with it: no seafood restrictions on your food stamps, or location restrictions on your housing voucher.

For economists, some of these features recommend the policy. They look at UBI as decision- and utility-maximizing for the individual, as well as a program that avoids the steep benefit cliffs that penalize work. They argue that recipients are always better off with a cash transfer than an in-kind benefit. These benefits, in tandem with a reduction in overhead costs and efficiency improvement, make the idea especially tantalizing.

Arguments against

Although UBI is a departure from traditional welfare, the idea isn’t truly devoid of welfare’s pitfalls. On some fronts, UBI seems not only unable to avoid traditional welfare’s problems, but also likely to exacerbate them. Many of the utopian qualities that recommend UBI to its supporters are strained in the real world.

To begin with, the numbers for UBI don’t seem very feasible – at least not without large tax increases. According to Michael Tanner’s calculations, if the government provided just $12,316 for every individual in the United States, or enough to bring them to the non-elderly federal poverty line, the cost of UBI in the U.S. would be nearly $4.4 trillion, more than the entire U.S. federal budget. In his paper on the topic, he notes that “even if the guaranteed national income replaced every existing anti-poverty program, we would still be some $3.4 trillion short.” In order to make ends meet in this scenario, the tax liabilities of high-income individuals would likely be substantially impacted.

The practical realities of budget constraints inevitably lead advocates – at least in the real world – to consider whether to limit the eligible population to strictly low-income individuals. However, this leaves UBI looking a lot less “universal” and a lot more like your average cash transfer welfare program, which fell out of favor in the U.S. in the 1990s.

Outside of the cost of the program, providing every U.S. citizen with a cash grant is likely to have a large and negative behavioral effect. Economists agree that welfare programs create labor supply disincentives, meaning that individuals reduce work because of government benefits.

As the Congressional Research Service has noted, an “increase in [the value of welfare benefits] is expected to cause people to reduce work hours.” While this is true of all welfare programs, only around 1/5th  of the current U.S. population is currently impacted. If UBI were instituted, labor supply disincentives would touch 100 percent of the population, rather than a subgroup of eligible applicants.

Finally, whether UBI’s promised transparency/efficiency would actually materialize is an open question. The ability to deconstruct programs which benefit legions of special interest groups seems dubious at best. In place of that, the ability to amend the U.S. constitution to direct all redistributive spending through a UBI system, as Charles Murray suggests,  seems ever more unattainable.


When we discuss UBI, we accept a high degree of uncertainty about the details. But those details matter, because the strange bedfellows that support the idea often only favor it under incompatible conditions. For example, while some advocates lend support to the concept contingent on a promise to dissolve the existing social safety net, others maintain that UBI is only acceptable in conjunction with existing programs.

Regardless of political feasibility, in an era of rising populism, exercising restraint in advocating for a costlier, more comprehensive welfare program seems essential. For those that support open society policies like immigration, the provision of a larger benefit package with fewer strings attached is likely to reduce political support for friendly immigration policies. Taxpayers intuitively understand that a comprehensive policy like UBI will place extra pressure on government finances and institutions.

As Milton Friedman stated in his lecture What is America,
“… it is one thing to have free immigration to jobs. It is another thing to have free immigration to welfare. And you cannot have both. If you have a welfare state, if you have a state in which every resident is promised a certain minimal level of income, or a minimum level of subsistence, regardless of whether he works or not, produces it or not, then it really is an impossible thing.”

In public policy, timing is everything. Although UBI is an appealing idea, that alone does not imply it is the right idea given the circumstances. Over the upcoming year, additional research will become available that will help the world form an opinion about UBI’s viability. Both now and then, it is prudent to remain cautious about promises of a panacea in a policy area where there are no easy choices.

Fintech and the future of finance

In the years since the financial crisis of 2008, the landscape of banking has changed dramatically. The Occupy Wall Street movement galvanized popular outrage over perceived Wall Street abuses. The Dodd-Frank Act ushered in the greatest changes to financial regulation since the Great Depression. And “too big to fail” became a collective bogeyman, as journalists, scholars, and politicians bemoaned the ever-greater concentration of wealth and power within a few elite Wall Street firms.

But an even greater change is afoot in finance, one that is being driven less by Wall Street than by that other great bastion of prosperity: Silicon Valley. As large financial institutions in Manhattan have hunkered down in the wake of the financial crisis, a set of new players have sprung up in their place, offering new and innovative financial services to fill the gaps left by the retreat of traditional players. These financial technology, or “fintech,” firms promise to disrupt the financial world in fundamental ways.

Fintech is an expansive term, but it generally refers to a new breed of financial institution that provides traditional financial services in new ways, utilizing innovative online platforms and algorithmic decision-making. Fintech’s innovations are shaking up broad swathes of the financial sector. In the asset management industry, new “robo-advisor” firms offer to optimize investment portfolios through risk-assessment algorithms that constantly monitor market developments. In the debt market, peer-to-peer lending platforms connect borrowers, such as students and small businesses, looking for loans to willing lenders around the country. In the equity market, crowdfunding sites create ways for new companies to raise money through online campaigns, often using viral marketing and social media sources to connect with potential backers.

In perhaps its boldest innovation yet, fintech is pioneering the use of virtual currencies that aim to replace traditional forms of money entirely. These currencies, such as bitcoin and ethereum, rely on online digital ledgers maintained by users to keep track of transactions as they occur.  The currencies can be used to buy and sell goods much in the same way that normal currencies can, and they have steadily grown in popularity and acceptance.

Silicon Valley is coming

“Silicon Valley is coming.”  That is the stark warning that Jamie Dimon, the CEO of J.P. Morgan Chase, issued to investors about the threat posed by fintech to his bank. The statement has received near-mythic status in fintech circles, but it also raises an important question: How precisely will fintech change the world of finance?

It will do so in three ways. Fintech will dramatically reduce the cost of financial services. It will broaden access to financial services to a much greater slice of the population. And it will decentralize the locus of power in finance, creating disaggregated financial markets filled with small specialist actors.

These changes will force traditional players to reconsider their business models as they grapple with new expectations and greater competition.

First, fintech will reduce the cost of providing and receiving financial services. One of fintech’s great discoveries is that the world of finance is filled with inefficiencies: financial products are complex, overpriced, and bloated with fees; and consumers have paid the price. Fintech overturns that model.

It is now possible for an investor to receive cutting-edge, data-driven investment advice from a robo-advisor firm at a fourth or a fifth of the price that traditional asset management firms charge. Small businesses that used to struggle to find banks willing to give them loans now have access to loans at much lower interest rates through online peer-to-peer lending platforms. Savers looking for a place to invest their money can similarly receive better yields through peer-to-peer platforms than they could through regular bank accounts.

Second, fintech will broaden access to financial services. This is partially due to the lower cost of fintech. When high quality financial services such as loans and investment advice are available for cheap, we should expect that more people will use them. But low cost is not the only reason why people are migrating to fintech. Fintech also appeals to a new generation of internet-savvy consumers who are comfortable using their smartphones and laptops to interact with each other. Many of these consumers have an abiding distrust of large banks, whom they view with suspicion after the rash of scandals in recent years. Fintech also allows groups that been excluded from financial services (because they do not have sufficient savings or a proven track record, or they do not meet the traditional profiles expected by financial institutions) to gain access to the financial sector.

Finally, fintech is decentralizing and disaggregating financial markets. While finance was once dominated by a few large institutions, that is no longer the case, as a plethora of new fintech firms have entered the market. In doing so, they have injected a dose of competition and disruption into once staid industries. The typical fintech firm is a small start-up with only a few employees. It focuses on a small slice of the market, such as student loans or small business funding. This is the opposite of the “too big to fail” phenomenon that played such a central role in the financial crisis.

In sum, fintech is showing that finance can be done in a different way, one that is more convenient, more open to outsiders and more cooperative.

New concerns

But as with any industry that is founded on innovation and disruption, fintech comes with its own challenges and concerns. While fintech promises to make financial services cheaper, more widely available, and more competitive, it also presents questions about the proper role of finance in a modern economy and in society more generally.

Fintech’s promise to broaden access to financial services, while potentially transformative and immensely important, will place pressure on consumer protection laws. If individuals can invest large amounts of their money in startups and risky loans, all at the press of a button, they may be more likely to enter into transactions that they do not fully understand. If homebuyers can take out mortgages in a matter of minutes and entirely on their smartphones, they may reflect less about the potential risks of such loans. Regulation will need to take into account these situations, which will only become more prevalent as fintech expands into new areas.

Regulators will also need to ensure that fintech is not being used to evade national laws.  Bitcoin, for example, was used as the currency of choice for the Silk Road, the darknet website that trafficked in drug sales. Even more troubling is the potential for terrorists and organized crime to use virtual currencies to fund their illicit activities. Some commentators worry that peer-to-peer lenders and crowdfunding sites will encourage sham companies and Ponzi schemes. These are worrisome developments, and regulators must act to stamp them out. It would be a shame if fintech were tarred as the playground of criminals and fraudsters.
All of this suggests that regulators have a role to play in fintech. Financial regulators will need to keep a watchful eye on fintech innovation as it emerges as a growing force in the financial world. This is easier said than done, of course. Algorithmic decision-making and crowdsourced financial ledgers are not simple concepts, and they may have vulnerabilities that we cannot fully understand. It is therefore paramount that all parties – firms, consumers, and government – have adequate information about how fintech products work and what their risks and rewards are. The only way for this to happen is for fintech and government to work together on a cooperative basis. But if they do, fintech might well prove to be as revolutionary as its backers claim.

The Internet of Payments and the future of banking: Crisis and opportunity

Imagine a world where your washing machine can recognize it needs more detergent and orders it for you. Now imagine a world where your self-driving car needs to fill up, or charge if it is electric, and does that on its own time. Then go a step further and imagine a self-driving truck crossing borders, not only filling itself up on the way but dropping off goods and buying new ones, based on an artificial intelligence (AI) that selects the best profit margin available and paying any customs fees – all without human input. That’s the difference between the current Internet of Things and the future Internet of Payments. It has profound implications for the future of banking, trade, and finance in general. The finance industry may be about to experience the same disruption that the internet inflicted on print media.

The crucial thing about the Internet of Payments is that it involves transactions undertaken by machines – whether they be actual tangible things like a self-driving car or a virtual company that exists only in lines of code. While humans own the machines and see the payments come out of their pockets or the profits that accrue to them, their direct human authorization is not needed for every one of them.

This is a major change. It will mean the possibility of many more payments taking place. As long as the human is happy with the arrangement and can cover them, the ease of the transactions will likely mean more of them happening. This is because of a phenomenon that economists call “transaction costs” – the higher the transaction cost, the less chance of it occurring, and vice versa. If you can “set it and forget it,” you’re more likely to make the transaction.

This should be a happy thing for banks. Moreover, the advent of such mobile technology offers banks the ability to reduce costs and concentrate more on customer service. Banks will be able to communicate more with the customer through their phones or other central device, such as a home “hub” like Amazon’s Alexa device. Indeed, developing the API (application program interface) technology to enable bank systems to talk to other systems to enable all of this should be top of any bank’s to-do list.

However, most current payments require human authorization through at least one third party. Often there are several parties to the transaction – customer, vendor, each party’s bank, and probably payment processors and networks as well. Each of the third parties charges something for the service. Those too are transaction costs. They can reach as high as 3 percent of the total payment. Fixed fee elements also make small payments problematic.

Importantly, the Internet of Payments also holds out the possibility of these costs lowering, and thereby presents a threat to banks’ income streams almost as problematic as the disappearance of print advertising has been for newspapers.

This is because Internet of Payments transactions will probably require a much more scalable payments system than the one currently dominating the payments market. Customers will want to have their machines engage in small-scale payments as much as large ones. If the technology exists they might want to have their self-driving cars pay others small amounts to get out of their way, for instance.

Such a system already exists in the form of cryptocurrencies like bitcoin. The nature of these currencies allows for extremely small payments to be made at little or no cost.

Indeed, lowering transaction costs was at the heart of the original case for bitcoin. The white paper written by the mysterious Satoshi Nakamoto starts with a discussion of transaction costs and how the need for third party involvement raises them. Nakamoto’s solution to this problem was to have financial transactions mediated not by a trusted third party but by a distributed public ledger, also known as distributed ledger technology, called the blockchain.

The ledger would be available to anyone participating in the project and its distributed nature, being held on huge numbers of computers around the world, would ensure that discrepancies would be avoided.

Thus the bitcoin system disintermediates not just payment processors but also banks. It reduces transaction costs substantially and allows for micropayments. Ironically, the possibility of micropayments could provide a lifeline for cash-starved news organizations who would be able to charge acceptably small sums for people reading an article (the writer was involved in discussions in the early years of blogging about how to monetize the content of popular blogs – a discussion that always foundered on the rock of payments transaction costs).

Furthermore, cryptocurrencies by their very nature provide an income stream to those who provide the computing power to run the blockchain on their machines, who are called “miners” by analogy with resource extractors. Already startups like San-Francisco firm 21, Inc., are developing dedicated mining modules for Internet of Things devices. This means that some devices could pay for themselves even without an AI.

However, bitcoin and other cryptocurrencies are not for everyone. Ironically for systems based around trust, they suffer from reputational difficulties given their early adoption by criminal enterprises – a problem that was at the heart of the recent decision by the U.S. Securities and Exchange Commission to reject an application for an exchange traded fund based on bitcoin. There is a persistent problem with exchanging assets held in bitcoin for the equivalent in national currencies and the risk that exchanges might prove vulnerable to hacking. And there are issues of governance of the blockchain, which resembles more an old-fashioned commons than a privately managed corporation.

This means that banks and other finance industry players have a chance to find the best of both worlds – combining the low transaction costs of cryptocurrencies with their own operational advantages. Small wonder that most major banks in the developed world are experimenting with distributed ledgers to see if it can increase trust and reduce their own costs. Some are using public blockchains distributed beyond their own environment, others private blockchains they can control, and yet others are developing hybrid systems or other distributed ledger systems based on similar concepts of consensus.

For instance, Westpac is working with shared ledger company Ripple to experiment in cross-border payments, while BNP Paribas is testing distributed ledger technology to enable faster payments. Among non-banks, NASDAQ is using distributed ledgers to help power its Private Market Platform aimed at enabling pre-IPO trading among private companies.

Meanwhile, startups aplenty are providing other use cases. Projects include providing banking services for the unbanked, micropayments for social networks, and escrow services for the gaming industry. Many of these startups will presumably be bought up by banks as their technology starts to show promise, but the possibility remains that one of them will be as disruptive as TransferWise has been to European banking.

Moreover, distributed ledger technology provides a variety of innovative non-financial uses that banks could easily monetize if they become the undisputed masters of the technology.

Blockchains are already being used to provide land titling services in countries like Honduras and Georgia. They can similarly be used to provide proof of ownership for assets as diverse as a diamond, a song, or medical marijuana. Things that are easy to steal, like a diamond, can be traced back to their original owner, while things that are difficult to transfer legally, like a song, can now be sold. People who require proof that they are entitled to own something that other people are not, like medical marijuana, can obtain that proof. Indeed, the technology could even provide a solution to the vexed question of ownership of items derived in times past from endangered species like ivory chess sets, allowing them to be traded legally, even across borders, while not encouraging any new trade.

It should be apparent that there is a Holy Grail in all this development. As Internet of Payments thought leader Roger Bass of Traxiant, Inc., puts it, the potential “killer app” for the Internet of Payments is interoperability. Just as the original internet only reached critical mass when standard protocols were developed to allow the interoperability of systems like email and the world wide web, standard protocols for API, the anonymization process known as tokenization, and similar technologies could be what  turns payments from a headache for developers into a “plug and play” proposition. The rewards to be reaped by the creator of such standards could be immense, or they could present the technology as a gift to the world.

Indeed, the world stands to benefit greatly from the Internet of Payments. As mentioned above, one potential use of the technology is as a facilitator for trade. In the post-Brexit world where trade deals could come to be defined by mutual recognition agreements for regulation, as I argued in a previous issue (Cayman Financial Review 4Q/2016), automated trade will become much easier. If the presumption is no border inspections between countries with such agreements, then proof of carriage can be provided by automated means, probably using some form of distributed ledger, and cross-border transaction costs can be significantly reduced.

There is a policy lesson here for governments. To reap these benefits and grow economies and household wealth, they should provide as innovation-friendly an environment in this arena as possible. The U.K. government has already decided to follow that route with its “regulatory sandbox” for financial technology innovation. Other Anglosphere governments would be well placed to follow suit, given their similar approaches to such things as dispute resolution using the common law. The U.S. could profitably move away from its hyper-regulation of financial activity by doing so.

The emerging Internet of Payments therefore represents both a threat and an opportunity for financial institutions. If banks and payment networks allow nimble technology startups to steal the water they should be rowing in, they could find themselves sinking fast. On the other hand, if they embrace the technology and, crucially, are allowed to do so by regulators, they could find themselves with vastly expanded markets in which to operate, not to mention an increased volume of profitable transactions. Banks will have only themselves to blame if they wonder why self-driving cars are not pulling up to their drive-thru windows.

Contingent liabilities: Points for the Cayman Islands voluntary liquidator to consider

A liquidator is generally concerned with admissibility to proof of contingent liabilities in an entity’s liquidation and its creditors’ entitlement to attend and vote at meetings of the entity.

Contingent liability is a matter for careful consideration by a voluntary liquidator because where a contingent liability is missed and then crystallizes:

i. any distribution made by the liquidator to the exclusion of the contingent creditor prejudices that creditor; and
ii. where the liability so impacts the solvency of the company that it becomes or is likely to become insolvent, the liquidator has a statutory obligation to file a court application (sec. 131) for continuation of the winding up under the supervision of the Cayman Islands court. This results in significant costs and a change in the liquidation procedure entirely.

There is not only a potential risk that the liquidator who fails to identify a material contingency will be in breach of his statutory duty, but also that any resulting prejudice may result in personal liability if attributed to the liquidator’s negligence.

How do entities report contingent liabilities?

Contingent liability from an accountant’s perspective is dealt with and reported from the standpoint of recognition, measurement and disclosure. The exact accounting treatment varies depending on whether an entity’s financial statements are prepared in accordance with Generally Accepted Accounting Principles in the United States of America (US GAAP) or International Financial Reporting Standards (IFRS).

Accounting Standards Codification (ASC) 450 Contingencies is the accounting principle which provides guidance on contingencies under US GAAP. IAS 37 Provisions, Contingent Liabilities and Contingent Assets is the standard which provides similar guidance under IFRS. Whilst the guidance extends to contingent assets, and in the case of IFRS, to provisions, our focus here is on contingent liabilities. Summarized below are some of the differences between US GAAP and IFRS as regards contingent liabilities1.

As demonstrated in the table, accrual or disclosure of contingent liabilities in an entity’s financial statements is dependent on whether the entity prepares its accounts pursuant to US GAAP or IFRS, and further dependent on management’s estimate of the likelihood of the liability materializing.

Under US GAAP, accrual is dependent on an assessment of likelihood. Whilst it is understood that the intent of the principle (ASC 450-20-25) is to proscribe accrual of losses that relate to future periods and to prevent accrual in the financial statements of amounts so uncertain as to impair the integrity of those statements, the subjective judgement and estimates of management ultimately affect the financial information that is reported.

In the case of IFRS, the contingent liability is disclosed but not accrued. This necessitates a review of the accompanying notes to the financial statements. Further, per IAS 37.86 disclosure is not required if payment is remote.
See figure 1.

Figure 1

The challenge for the Cayman liquidator

The above could pose a challenge for a Cayman Islands liquidator seeking an independent or verified basis to identify contingent liabilities in a voluntary winding up of a company. His first point of reference (for material other than the management accounts) is typically the company’s audited financial statements.

As indicated above, these may not contain a reference to a contingent liability.  He can also make enquiries of management, but you would assume that management who did not consider liabilities sufficiently likely or proximate to make provision for, might not raise them with the liquidator.  And, of course, management may have opted to avoid recording such obligations to enhance performance, or because of an inherent belief that the liability is not real.  This is a typical problem in the case of legal disputes, or tax liabilities (the latter a particular risk in offshore entities where the fact of offshore establishment may make management consider they are immune from onshore tax obligations).

The liquidator cannot rely purely on the financial statements and simple management representations to gain that comfort of an independent, verified, or certified confirmation on liabilities.  Whilst he is not expected to conduct a “needle in the hay stack” search for liabilities that may not even exist, to gain additional comfort he must look elsewhere.

But the liquidator does not have the benefit of requesting a sworn Statement of Affairs (“SofA”) which includes any contingent liabilities.  The provisions of section 101 of the Companies Law (2016 Revision) which provide statutory authority to obtain a sworn SofA from a number of relevant parties, not limited to the directors (and which provide for criminal penalties in failing to comply or the provision of false information) do not apply in a voluntary liquidation2. And yet, for the voluntary liquidator’s purposes, he will want to know of the existence of all contingent creditors who are also entitled to be notified of the liquidation and to prove their claim in the winding up of the company.

A look beyond the financial statements

Apart from the financial statements or inquiries with management, a proper review of company records in the voluntary liquidator’s possession offers a useful means of identifying contingencies.  In a recent Cayman Islands voluntary liquidation in which we were appointed, the company’s financial statements failed to disclose the existence of a contingency which, it was determined, was also unknown to management. The contingency was only discovered following discussions with the company’s service provider and our review of the company’s books and records in our possession.

This brings to bear the necessity for some consideration by directors into any contingent liabilities when making a Declaration of Solvency, as they could be liable if they swear that the company is solvent and it turns out that they were negligent in not foreseeing a liability. A person who knowingly makes a declaration without having reasonable grounds for the opinion that the company will be able to pay its debts in full at the specified time commits an offence under Cayman Law (sec. 124).

Notwithstanding the difficulties, it is the duty of a liquidator to find out from the books and papers of the company in his possession who the creditors of the company are [Pulsford v Devenish [1903] 2 Ch. 625].  A voluntary liquidator is deemed to have knowledge of potential creditors where information to that effect exists within the company documents in his possession.  In re Armstrong Whitworth Securities Company, Limited [1947], Jenkins J held that the liquidator did not fully perform his duty as regards the ascertainment of the company’s liabilities accrued or contingent shown by the company’s records in his possession.  It was his duty as liquidator to take all steps reasonably open to him on the information in his possession to ascertain whether any of the potential creditors concerned did make any such claim.

It follows, therefore, that in addition to reviewing the company’s books and records, a liquidator should directly notify creditors whom it appears to him from the company’s records may have a claim in the liquidation, and invite such claims. Whilst advertisement for claims is typically undertaken, mere advertisement is not sufficient. In re Armstrong Whitworth Securities Co. Ltd. [1947], Jenkins J further declined to regard notice by advertisement as absolving a liquidator from individual communication with persons appearing from the company’s records to be persons who have or may have claims accrued or contingent against the company.

In Pulsford v Devenish [1903] 2 Ch 625, the court held that the liquidator should communicate with any creditor who omits to put in his claim. Farwell J stated that he considered it to be the duty of a liquidator, namely, not to merely advertise for creditors, but to write to the creditors of whose existence he knows, and who do not send in claims, and ask them if they have any claim. As further illustrated in Austin Securities Ltd v Northgate and English Stores Ltd [1969], in such a case there is a duty to ascertain by direct enquiry whether the claim is being pressed.


Whilst the addition of SofAs to Cayman Islands voluntary liquidations should be a point for consideration by the Insolvency Rules Committee, in the meantime, the voluntary liquidator should be careful to:

  • Consider accounting perspectives in his review of financial statements noting that contingencies may or may not be accrued or disclosed;
  • Make enquiries of management not only as to the possible existence of unrecorded contingent liabilities, but sufficient to properly understand the nature of the business and, in so doing, form a view on the possible existence of contingent liabilities that may require further enquiry;
  • Conduct a proper review of the company’s books and records in his possession to ascertain the existence of contingent liabilities which may not have been disclosed in the company’s financial statements or by management; and
  • Once creditors, actual or contingent, have been ascertained, make direct enquiries of them to determine whether they wish to make a claim in the liquidation.
  • Document the process of enquiry and review to demonstrate an active and proper enquiry has been conducted.

The matter of proving is one that would require another article entirely, but suffice it to say that, as with the SofA, there is no formal proving process under Cayman statute for a voluntary liquidation.