International business between Brazil and Cayman Islands

Read our article in the Cayman Financial Review Magazine, eversion 

Who would have thought that Brazil, with a GDP over US$2 trillion in 2010 would have a stronger economy than countries like Australia, Spain and even Canada.

The fact is that today more and more, Brazil plays an important role in the world’s economy and currently ranks as the seventh largest economy in the world, according to the CIA World Factbook. 

As chess players know well, when there is a significant change on the chessboard, a change in strategy is a must. Over the past decade some countries did change their strategy given the new power forces and adapted their strategy accordingly. As a result they were able to survive the global crises and even show some growth.

On the other hand, countries that continued to play according to the old strategy are currently struggling to adapt. It is evident that the Cayman Islands was among the countries that wisely adapted their strategies and Cayman is currently well placed to grow together with the Brazilian economy.

In 2007, the Central Bank of Brazil has disclosed that out of the 29 Brazilian banks that had an offshore branch, 21 used Cayman Islands for its offshore activities, five used the Bahamas and three used Uruguay. According to CIMA’s last report of regulated banks published March 2011, there are 23 institutions that are currently controlled by Brazilian groups in the Cayman Islands.

Additionally, there are about 150 Brazilian companies that issue Eurobonds in the offshore market and we note that out of those issues the vast majority uses Cayman Islands vehicles. Therefore, Cayman nowadays plays a crucial role in the Brazilian financial markets and it is very well positioned to surf the growth of Brazil predicted for the next years.

Why does Brazil use offshore financial centres?
Brazil needs an offshore financial centre for a simple reason: access to US dollars and other foreign currencies. Different from many Central Banks around the world, the Brazilian Central Bank does not allow monetary transactions in the country in US dollars. In other words, a Brazilian resident cannot have a local account denominated in US dollars and cannot buy a meal in Brazil using the American currency bills.

The central bank strategy is to have complete control over its monetary policy and although it was hard to implement this has been very successful for Brazil’s current success and stability. Meanwhile, the US dollar continues to be the most used investor currency in the world and Brazil needs access to it and therefore Brazil has a fundamental need for an offshore financial centre.

Why does Brazil choose the Cayman Islands?
Observing the dominance of Cayman Islands in the Brazilian offshore financial markets makes us wonder what is the competitive advantage of the Cayman Islands among so many jurisdictions that can provide a similar service.

The answer: a combination of facts. 
The apparent advantage of Cayman Islands of course is banking privacy and tax neutrality but those facts by themselves are not sufficient attractions since nowadays many countries adopted this regime. The strength of the regulatory body in the Cayman Islands is perhaps the single most important reason why Brazil and other countries choose Cayman.

Although privacy is essential for the success of a financial centre, it attracts bad money as money launderers, terrorist organisations and illegal activities look at these jurisdictions in the hope for a financial solution for their needs. So the only way of offering privacy but avoid its downside is by creating an extremely present and sophisticated internal regulatory body in order to supervise and prevent financial institutions to engage in illegal activities.

Additionally, the Cayman Islands is a British overseas territory and not an independent country, so Brazil and other governments see the benefit of a strong global government with political stability.

Also, even with technology and world’s globalisation, Cayman has appealed to Latin American countries for its time zone. Banks in Brazil have working hours which are negotiated with the Union, therefore, a Branch in a jurisdiction with a time zone that has limited or no overlap with Brazil is not as interesting and competitive for local banks.

The clear Caymanian legislation, efficient court system and the fact that English is the main language are also important factors that contribute to Cayman’s success. It is important to note that for all the reasons above, Cayman attracted many banks and financial institutions which by consequence attracted service providers, i.e. administrators, audit, technology and back-office firms, to establish a physical presence on the Island.

In a positive snowball effect, the fact that those service providers have a local presence motivates other banks to come to the island, which of course develops the service provider industry even more.

Is Cayman’s leadership position vulnerable?
Although the Cayman Islands is a leader in the offshore financial market for Brazil, we must remember that the country is also vulnerable to lose its position. Brazilians can certainly remember that in the 70s and 80s, Bahamas had the majority of the offshore business from the country. We can also recall that the Bahamas was the country that experienced the same positive snowball effect in the service provider industry. So how come did the country lost its leadership?

The answer is one more time a combinations of events. The fact that the country became independent in 1973 created a weaker safe haven for international money as the country lost its British protection and became more exposed to international pressure.

Furthermore, the country had not sufficiently invested in internal regulations to prevent anti-money laundering and counter-terrorism tools. It looks like those are not enough factors to lose its leadership, but the fact is, having other jurisdictions offering a better combination of differentials, banks can easily substitute one offshore centre by another. The private banking industry in the US has witnessed how quickly assets move jurisdictions in the financial markets.

Upon a change in legislation affecting the privacy of account holders, the US private banking market has lost competitiveness compared to other financial centres around the world. Capital and executives has quickly moved to the Caribbean region, Asia and Europe to the point that international customers hardly open private bank account in the US nowadays.

How can Cayman remain on top?
Cayman Islands should not take for granted its leadership position but continue to invest and innovate in order to keep increasing its competitive advantage over other international financial centres. The country must continue to invest in the strength and credibility of its regulatory body, by investing both in skilled human resources and technology.

The Cayman Islands Monetary Authority has recently released an online version of the Basel II and the Quarterly Prudential Reporting which helps that to gain efficiency and timing in the regulation. Those types of investments allow the country to increase the number of regulated entities without losing the quality of supervision.

Furthermore, the combination of banking secrecy with extremely effective and credible compliance rules in place gives the island a competitive advantage to compete in the international financial markets.

Finally, marketing and promotion are always positive for a business and the case of international business between countries the same principal applies. Cayman Islands can always invest in its image in Brazil to market its strength in anti-money-laundering policies and procedures so that the Brazilian financial market continues to differentiate between Cayman and other jurisdictions.

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Charles Aboulafia is a co-founder of Cainvest International SA and member of the Investment Committee of Cainvest Brazil Debt Fund Ltd and Cainvest Latam Debt Fund Ltd. Charles previously worked for Lehman Brothers Alternative Investment Management LLC in New York City. His primary role was in quantitative and qualitative analytics for Lehman Brothers’ fund of hedge funds.

Charles Aboulafia, CFA
Board of Directors
Head of Investment Products & Services
Cainvest International Bank
Harbour Place, 5th Floor
103 South Church Street
Grand Cayman, Cayman Islands

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