The future of offshore financial centres:

Survival traits in a new era

Read our article in the Cayman Financial Review Magazine, eversion 

The only issue more prominent than the mounting challenges faced by offshore financial centres (increasingly referred to as ‘International Financial Centres/IFCs’), is the question of whether their demise is now imminent. This has led in some quarters to the conclusion that the end of the offshore financial world is here.   

A group of only slightly less pessimistic observers argue that IFCs may survive in the short term, but it is simply a matter of time before lawmakers in the major source markets such as North America and Europe either make significant changes to their onshore regimes or become effective in political strategies to end the attraction of IFCs once and for all. There is a third group of optimists, though the reasons for their positive outlook are not entirely clear.

But the past decade of international regulatory and tax developments, and others expected in the future, is unlikely to impact all IFCs in the same manner. The same goes for any criticism levelled at IFCs; not all jurisdictions deserve the inadequate regulation charge, and some are more transparent than others, to mention just a few of the criticisms.

It is therefore unsurprising that the factors which will determine survival of the fittest in this new era, are the same ones that warrant the use of a ‘thinner brush’ when being critical of these centres.

There are several core features that, in my opinion, will make the difference between whether the financial services industry in jurisdictions such as the Cayman Islands, will continue to be a successful and sustainable contributor to employment and government revenues for another two decades (and hopefully beyond that).

These factors include regulatory balance, access to human capital resources, onshore legislative developments, the state of the domestic public sector’s finances, the extent of relations and positioning with multilateral organisations and key G20 governments, the jurisdictions’ international (and domestic) reputation, the extent of confidence and political will to negotiate with the G20 and related bodies and the jurisdiction’s approach towards policy development for the financial services industry. IFCs have an opportunity to influence virtually every one of these areas though they have limited ability to influence onshore legislative developments.

Regulatory balance matters
The first of these factors to be dealt with in this CFR four-part series on the future of the offshore financial services industry, is the nature of the regulatory framework in the jurisdiction. In theory, IFCs that are more in line with so styled global standards would receive far less pressure and informal (but very effective) economic sanctions from the governments of their major source markets than those that choose to operate in a wild west format.

Further, countries that have either recently entered the IFC world or are considering it as a path to development, will find that the upfront cost of regulation alone can be a significant deterrent. And yet, while the regulatory factor is an obvious one, to conclude the analysis with this view of its role in determining the future would be overly simplistic.

What will likely matter far more is not just whether global regulatory standards are met but how individual jurisdictions balance enhancing their regulatory frameworks against the need to maintain a viable economic sector.

As an example, some jurisdictions may decide to ignore or delay implementation of Solvency II, a recent capital standard for the insurance sector. Others have taken a strategic decision to sign as many tax information exchange agreements as possible, while some countries have clearly taken a more conservative approach. There are numerous other examples of jurisdictions taking diverse approaches to regulatory and other policy changes.

The balancing act is complex, involving the interaction between industry stakeholders, regulators, domestic legislators and discussions with international bodies and onshore governments. The objective itself is straight forward: to maintain a vibrant sustainable industry which maximises employment and government revenues, while meeting (and be seen to meet) reasonable international standards.

Confident interaction with the G20
How countries approach the task of meeting such standards and how they interact with the various global stakeholders is a key facet of balancing the regulatory framework. Some countries for example, choose to use a combination of political strategy and lobbying with onshore bodies to help in explaining their position.

Others capitulate at every suggestion by such bodies, without taking any effort to explain or rationalise the position they wish to hold. This last aspect can be key to whether a country imposes a new rule or policy which can have a disastrous effect on the industry.

If an IFC can effectively explain the nature and its treatment of a regulatory risk instead of simply accepting the assessment of the global stakeholders, the jurisdiction may be able to achieve ‘compliance’ in a manner less harmful to industry.

Whiners or informed advocates?
Stakeholders in some IFCs complain regularly about the lack of recognition of the standard of regulation in their individual jurisdictions by the multilateral bodies and more directly the G20 governments. But that makes it all the more surprising that these same centres spend almost no time and resources explaining why their regulatory framework is credible.

There is of course the now overworked observation that it is harder to open a bank account offshore than onshore, and the explanation of the difference between “tax evasion” and “tax avoidance” (a distinction which no longer matters to G20 treasury officials).

But aside from these responses, IFCs have not made any material attempts to explain in a credible manner where regulatory risks lie within offshore structures and how their approach to regulation addresses these risks. The IFC Forum which was established in 2009 by a number of firms with a presence across a wide group of jurisdictions is a good start but more is definitely needed.

Just about every serious multilateral body has access to dedicated teams that produce research/policy papers on a regular basis on IFCs, their role in the global economy and the risks that they pose to global financial stability.

These policy papers which are treated as a luxury in most IFCs, have an influence on the decision making by such multilateral bodies. But to date there has been no similar coordinated equivalent effort by IFCs to respond to some of the arguments in these papers (many which include erroneous and outdated observations on the role of IFCs).

Objective research and analysis has a direct influence ultimately on the extent and nature of regulatory changes proposed and those centres that dedicate serious effort in this area will be in a better position to defend and legitimise their individual frameworks.

Taking a confident approach to regulatory matters
In the end treatment of regulatory matters can play a key role in an IFC’s sustainability. Those centres that meet international standards while maintaining a vibrant industry have a higher chance of survival.

In achieving this balance which can be complex the political directorate of IFCs must be sufficiently confident in their dealings with external bodies to justify their approach. And this can only be done effectively with some form of technical support to give credibility to their positions, while enlightening, at a minimum, their counterparty technocrats.

It is certainly true that international politics and the economic interests of OECD countries plays a key role in the continuing pressures that IFCs face (sometimes more so than legitimate concerns about regulatory risks or the prevention of criminal activity).

But that is not a good enough reason to give up on fighting more effectively for survival. Other things being equal those centres that understand this will have a good chance of survival; those that don’t should start planning now to replace their financial services industry as a major source of employment and government revenues.

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Paul Byles
Paul Byles is owner and Director of FTS, which provided regulatory, economic and management consulting services. He is an experienced economist and finance professional having worked in the financial services industry for 25 years. He is a former director of a big four consulting firm and a former Head of Policy at the Cayman Islands Monetary Authority. He is author of the book ‘Inside Offshore’ which focuses on the reputation of the Cayman Islands as a financial services jurisdiction and author of ‘Offshore Financial Services: a BVI text’, published in 2014. He serves as an independent director on a number of financial services and local operating firms. He is currently President Elect of the Cayman Islands Chamber of Commerce, having served on its council since 2014.

Paul Byles
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Cayman Islands

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