advances, but image lags behind
At the turn of the new millennium, the words due diligence and compliance had little meaning in the realm of financial services. It was no different here in the Cayman Islands.
Long-time banker and former president of the Cayman Islands Bankers Association Eduardo D’Angelo Silva said that historically throughout the world, bankers didn’t feel a need to know their customers before the 90s.
“Bankers felt they weren’t policemen,” he said. “They felt it wasn’t a banker’s role to ask questions.”
A decade and a notorious terrorism attack later, words like due diligence, know-your-customer and compliance are an accepted part of doing business in respected financial services centres, and bankers – as well as many other financial services professionals – have an obligation to ask questions.
D’Angelo Silva said due diligence and KYC actually started in the Cayman Islands years before it became a financial industry buzzword.
“The bankers here put in place a voluntary code from the early ‘90s,” he said, explaining that they would require documentation to prove who a client was and what kind of business he or she was in. “It was done to avoid taking money that had been obtained illegally.”
The voluntary bankers’ code was expanded to other professionals in the financial industry in 1996, with the passage of the Proceeds of Criminal Conduct Law.
“The PCCL had a component of [know-your-customer requirements] in it. It established a certain level of guidance for the industry,” said D’Angelo Silva. “It was the first time the idea of KYC was put into a legal framework.”
Although the thought in the Cayman Islands was that the jurisdiction was doing a good job at preventing money laundering through its financial institutions, organisations like The Organisation for Economic Cooperation and Development had other ideas. In 1998, the OECD issued a report on harmful tax practices.
Thinking it already had a strong anti-money laundering regime in place – and with a clean bill of health from the Caribbean Financial Action Task Force to prove it – D’Angelo Silva said no one really took the OECD report seriously.
In June 2000, despite some glowing reviews of its anti-money laundering regime, Cayman landed on Financial Action Task Force’s list of 15 uncooperative countries, the so-called black list.
“We really were taken by surprise because what we had at the time in terms of an anti-money laundering regime was still more efficient than what they had in the US,” D’Angelo Silva said.
The FATF’s main contention with the Cayman Islands was that the PCCL alone didn’t do enough to mandate compliance.
“They said it was good practice, but not entirely required by law,” D’Angelo Silva said.
Cayman bowed to the pressure, agreeing to legislate KYC requirements. In addition, the Financial Investigation Unit, which had been established in 1989, became the Financial Reporting Unit in 2000 and then the Financial Reporting Authority in 2004. This independent body receives financial intelligence in the form of suspicious activity reports, and then analyses and disseminates the intelligence to law enforcement agencies and overseas financial intelligence units.
But FATF then wanted more; they wanted KYC provisions to apply retroactively.
“They said, ‘yes, you have KYC on your new accounts, but you have all these old accounts on your books. You have to go back and do KYC on these accounts.”
Not wanting to end up on the FATF’s black list again, the Cayman Islands Monetary Authority put in place requirements for conducting due diligence exercises retroactively on all financial industry clients in Cayman.
“The industry was not happy,” D’Angelo Silva said.
“Banks had to spend a lot of time and money to do it.”
When Cayman was half-way through the exercise, the FATF itself bowed to backlash from the United States and United Kingdom and abandoned the retroactive aspect of the requirement.
In the end, the Cayman Islands was one of the few jurisdictions in the world to actually complete the process.
“Cayman was probably the largest in terms of banking business and offshore business,” D’Angelo Silva said.
Karen O’Brien, a former detective with the Financial Crimes Unit of the Royal Cayman Islands Police and managing partner of Global Compliance Solutions, said Cayman did a good job in the retrospective due-diligence exercise, even if it did upset some banking customers.
“A lot of people would say, ‘I’ve been banking here for 20 years, why do you need my passport and utility bill’?”
Besides upsetting clients, the strict KYC requirements are very costly to financial services businesses, which are required to either have dedicated and qualified compliance officers in their firms or to outsource the task to qualified others, like O’Brien’s company.
“A lot of smaller companies simply cannot afford to hire someone full time to do compliance,” she said.
There does seem to be a bit of easing on the KYC requirements, toward a risk-based approach to the application of due diligence, O’Brien noted.
“The regulators are realising that not all rules apply to all people, depending on the risk,” she said, explaining that high-risk clients might require a more thorough process of due diligence, while low-risk clients might only require a minimum of due diligence.
“This allows businesses to apply resources where they are most warranted,” she said.
Although the subjectivity inherent in a risk-based system could be open to abuse, O’Brien believes businesses – at least in the Cayman Islands – are probably being conservative in their approach.“The risk of being too subjective is too costly for businesses here,” she said.
“They can’t afford to take that risk.”
Because of Cayman’s tarnished, if unwarranted, reputation, O’Brien believes businesses are particularly cautious not to have a due diligence failure that would put the jurisdiction under scrutiny.
“We get a bad enough rap as it is,” she said. “We have to make sure we do everything right and don’t get caught doing something wrong.”
O’Brien, like many others, believes the Cayman Islands has been unfairly cited as being noncompliant in due diligence matters.
“Nothing could be further from the truth,” she said. “Other jurisdictions should be looking to at us as a model.”
Certainly, the international regulatory report cards on Cayman’s anti-money laundering efforts bear out O’Brien’s contention. In 2008, in a FATF + 9 report, the Cayman Islands rated higher the UK, Canada, Ireland and every offshore financial centre except Cyprus and Panama in terms of compliance with FATF recommendations. In fact, only three onshore FATF members rated higher than Cayman: the US, Singapore and Belgium. Since July 2008, the US General Accountability Office and the IMF also issued favourable reports on Cayman’s financial supervision and regulatory regimes.
Despite all its accomplishments in implementing effective due-diligence and anti-money laundering regimes, the Cayman Islands often receives criticism from G20 politicians and foreign journalists. As for the media perception, O’Brien believes it is still somewhat linked to “The Firm effect”, referring to the star-studded 1993 Hollywood film and book of the same title that portrayed the Cayman Islands as a money laundering haven.
However, Cayman Finance Chairman Anthony Travers believes the negative publicity goes beyond a fictional image created by Hollywood. In a speech delivered at the Cayman Finance summit in May, 2010, Travers said he thought the negativity could be broken down into three distinct groups.
He said one group consisted of “one or two individuals who operated an Internet blog and who appeared “pathologically wedded to the notion that high taxation is a solution to global poverty”.
Although Travers mentioned no names, the Tax Research UK is one blog that would likely fall into that category. Its author, Richard Murphy, often bashes the Cayman Islands, usually calling it a tax haven or secrecy jurisdiction.
Travers thinks a second source of public relations negativity comes from well-organised public relations campaigns driven by “onshore treasury, supranational and domestic regulatory bodies” that are themselves driven by politicians who “are anxious to suggest that the solution to mismanaged domestic fiscal and monetary policy lies in some mystical offshore pot of gold”.
A US Senate Permanent Subcommittee on Investigations report in September 2008 estimated the United States lost $100 billion in tax revenues annually due to offshore tax abuses, a figure that has been echoed by several US politicians since.
A third source of negative public perception comes from what Travers calls “blame-deflecting politicians or regulators” who are desirous of hiding the failures of their own regulatory systems, particularly in the fallout of the financial crisis that started in 2008.
“This is really all about who controls global financial services and capital flows, and the right to tax those capital flows,” Travers said. “The issue is as it has always been – the fear of the OECD that capital being inherently mobile will flow to the jurisdiction with the most competitive tax rate.”
Although the private sector has tried to counter the myths concerning Cayman’s image on a case-by-case basis, Travers believes it is still partially to blame for the persistence of the negative publicity.
“Before the Cayman Finance initiative of last year, neither the private sector nor successive governments had in the past properly funded compelling public relations campaigns to redress the mischaracterisations,” he said. “If you leave a vacuum, no doubt detractors will fill in.”
The government, however, has continued to advance legislation aimed at better regulation, greater cooperation with onshore jurisdictions and increased transparency in its operations. In September 2008, the Proceeds of Criminal Conduct Law was replaced with the Proceeds of Crime Law, a much broader law that addressed some if the deficiencies in its predecessor. Revisions to Cayman’s Money Laundering Regulations followed in October 2008 and July 2009, and the Cayman Islands Monetary Authority issued new guidance notes on money laundering in December 2008.
In January 2009, the Freedom of Information Law came into effect, opening many government records to the public for the first time.
In spite of these advances, the Cayman Islands found itself on the OECD ‘grey list’ of jurisdictions that had committed to but had not yet substantially implemented information exchange standards. Over the next four months, the Cayman Islands negotiated a number of Tax Information Exchange Agreements to bring the total it had with other countries to 12. The OECD then elevated Cayman to the ‘white list’ of countries that had substantially implemented information exchange agreements in August 2010.
As a result of the various information sharing treaties, tax evasion – particularly on the individual level – is a thing of the distant past in the Cayman Islands, as Travers noted in his speech.
“[T]he effect of the tax information exchange treaties in place is that you would need to be criminally insane to seek to evade tax in the Cayman Islands as the IRS has full access to all accounts, as now do 15 other tax authorities…”
O’Brien agrees. “The days of people coming down here with suitcases full of money are many years behind us,” she said.