The most recent estimates from the United States Treasury Department calculate that approximately US$8 trillion resides in the 45-plus recognized "offshore" jurisdictions that circle the globe. With most financial experts agreeing that this amount will grow rapidly over the next 10 to 20 years, it is no surprise that the competition among offshore centres to attract and retain this mass of capital is growing, with new entrants to the market emerging almost every year. The array of offshore financial products and services that are available is also on the rise, with the traditional offshore trust and banking concerns now being joined by insurance, stock exchange, mutual fund, and debt restructuring businesses. Another area set to explode is the provision of e-commerce services as offshore centres scramble to be the first to develop the appropriate regulations and infrastructure.
However, for those doing business in paradise, a dark storm is brewing on the horizon. While the traditional benefits of a pro-business government and the associated minimal bureaucracy look likely to continue uninterrupted, the other attractions of low taxation and strict privacy that characterize the offshore world are now under threat. Recent Organization For Economic Co-operation and Development(OECD) reports targeting so-called "harmful tax competition", and other international (OECD) Reports targeting so-called "harmful tax competition", and other international investigations into money laundering and privacy laws in the offshore world, have created great concern. Under threat of sanctions, established centres are moving to implement legislation that will put the international financial community on-side. On the other hand, a number of the newer jurisdictions are dragging their feet knowing that dodging the demands for reform may give them the advantage needed to gain a competitive edge.
The Offshore Environment
While the offshore world includes jurisdictions as diverse as Hong Kong, Luxembourg and the Channel Islands, for the majority of North American investors and businesses, interest is concentrated on the Caribbean and West Atlantic islands. With their proximity to the US mainland, their historical links to Europe, and the strong reputation and quality of the resident banks, legal and accountancy firms, this picturesque string of islands include some of the most successful offshore jurisdictions in the world. While most investors are familiar with the traditional offshore centres of Bermuda, the Bahamas and the Cayman Islands, less familiar jurisdictions such as St. Kitts & Nevis, the British Virgin Islands and Turks & Caicos Islands have now entered the offshore market. Suffering from declines in traditional agricultural industries and battling increased competition for tourism dollars, these islands have been attracted by the success of their neighbours, which have all achieved steady-in some cases phenomenal-business growth in the past decade.
As the price of entry, most jurisdictions now share a similar complement of legislation providing for the setting up of offshore banks, trusts, and a variety of corporate structures (such as International Business Companies, Foreign Sales Corporations, and "Exempted" Companies). Clients are attracted by a range of factors-little or no tax, strict bank secrecy rules, flexibility of trust and corporate arrangements, minimal reporting requirements, fast-paced incorporation and a general pro-business attitude on behalf of the local governments.
However, while the laws of successful jurisdictions are quickly copied throughout the region, as the market matures each jurisdiction is finding that their particular combination of legislation and infrastructure attracts a different type of clientele. Indeed, some centres are actively refining their laws to suit the particular needs of specific clients. The established centres of Bermuda, the Bahamas and the Cayman Islands, for example, have begun to focus recent efforts on attracting larger corporate clients. They are shrewdly taking advantage of their stronger financial infrastructure, more stable government and greater capital base they enjoy in comparison to newer jurisdictions. Within this group, each is already beginning to develop particular strengths.
Bermuda, for instance, the oldest and most established jurisdiction in the area, has emerged as the leading centre for the offshore insurance and reinsurance industry in the world. A major innovator in the "captive" insurance market, Bermuda is a world leader in this field, and is now third only to New York and London in the broader insurance market. The most recent statistics show that there are almost 1,500 insurance and reinsurance companies operating in the region, employing over 2,000 people. In 1997, these companies reported a total of more than US$48 billion in capital and surplus and nearly US$112 billion in assets-accounting for more than half the output of the island's diverse financial industry. Another significant undertaking revolves around the Bermuda Stock Exchange, which is capitalized at over US$47 billion and is able to trade for the 12 hours that the Hong Kong Exchange is shut.
The Cayman Islands has achieved success in institutional fund management administration (it is now second only to Luxembourg in the area) and debt structuring businesses, which have both been growing at between 10 and 20 per cent a year during the past decade and now account for as much as 70 per cent of financial business in the jurisdiction. The 2,238 mutual funds on the island have estimated assets of over US$215 billion. The Bahamas has cultivated a reputation as having the leading private banking industry in the region, with almost every major bank in North America and Europe now having a presence. The 400 private banks that are registered in the island have an asset base of more than US$200 billion, and are now being joined by an increasing number of foreign-owned financial institutions opening offices in Nassau.
New Kids on the Block
For the newcomers, the situation for the most part has been trying to replicate the successes of the established centres and all are fast-tracking efforts to update and develop trust and company laws and to build the local intellectual capital base. Most have started with trust and banking businesses and are keen to expand laterally as capital and infrastructure develop. Already, the British Virgin Islands, Anguilla, Turks & Caicos and St. Vincent & The Grenadines are building impressive businesses in mutual funds and insurance. The eight eastern Caribbean States who are members of the Eastern Caribbean Central Bank (Anguilla, Antigua and Barbuda, Dominica, Grenada, Montserrat, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines) are set to launch the Eastern Caribbean Securities Exchange this year, which will be the first organized regional securities market in the Western Hemisphere and will provide a platform for the trading of stocks, bonds and government securities.
Of particular interest to both the established centres and newcomers is a recent development widely regarded as potentially the biggest area of future growth: that is, the commercial opportunities presented by the Internet. The traditional attractions of low tax and pro-business regulations are made even more alluring to the e-business world by the relative ease of establishing a presence in the region and the unique ability of Internet companies to migrate out of high tax regimes. Jurisdictions throughout the offshore world are furiously setting up committees, establishing working groups, drafting legislation and introducing codes of conduct to ensure that they obtain a share of this lucrative emerging market.
Of all the jurisdictions, Bermuda appears to have made the most tangible progress. In 1999 it introduced the Electronic Transaction Act to provide a legal framework for an e-commerce processing business that has now been up and running for more than a year. This was soon followed by the Computer Misuse Act that covers computer crime. The Bank of Bermuda now offers a facility to process and settle e-commerce transactions for Internet merchants incorporated on the island. Last year, it offered a facility to settle e-commerce transactions in a number of currencies, allowing easier settlement of cross-border trades.
Growth of the business has been rapid, with the number of clients rising from 16 in 1998 to 45 in July, 1999, and 119 in January this year. Other initiatives include the introduction by a number of local companies of a new structure known as "e-suites", which are essentially an electronic substitute for having a bricks and mortar presence in the jurisdiction. Indicative of the pro-business attitude of government, e-suites have now been clothed with legal form by specific legislation.
Peter Bubenzer, who heads the corporate department at the well-known Bermuda law firm Appleby Spurling & Kempe, believes that "Bermuda is now the leading offshore electronic commerce jurisdiction in the world." According to Bubenzer, the Electronic Transactions Act "is the most progressive piece of legislation in the world and has now clearly set the standard for all other offshore jurisdictions in the area of e-commerce." That this is the case is evidenced by the fact that both the Bahamas and the Cayman Islands, in classic "me too" fashion, are set to introduce similar legislation later this year. Bubenzer's firm has also taken a leap into the e-commerce world itself with the launch in March of this year of Just AS&K [Inc]-which is Bermuda's first Internet site for the incorporation of Bermuda companies. Clients of the firm are able to begin the incorporation process by completing an on-line questionnaire, after which the electronic product automatically prepares the necessary documents for filing with governmental authorities.
A key to Bermuda's advantage in the e-commerce area is the sophistication and competition present in its telecommunications infrastructure, which is something threatening to hamstring other offshore jurisdictions in their entry into this particular market. The monopoly, which a small number of telecoms on some of the islands exercise, has led to costs that have, in some cases, effectively neutered the low tax and other benefits that these jurisdictions have to offer. In the Caymans, for example, Cable & Wireless enjoys a monopoly, and in the Bahamas, the state-owned Batelco has, until this year, had complete control of the market.
Offshore Professional Services
With the diversification and growth of offshore industries in the Caribbean and West Atlantic, demand in the professional services market has also significantly increased. While accountants dominate the market, and most of the Big Five accounting practices have a presence in the larger centres, the importance of the legal community is increasing. Bermuda, for instance, has approximately 190 lawyers already practising on the island and the Bahamas has over 500 attorneys registered. Law firms on the islands are generally local affairs, with no major onshore firms having yet established a significant presence. Bubenzer, who studied law in the UK and was called to the Bar there, says that the background of lawyers operating in the region varies depending on the jurisdiction, but that generally lawyers have either a local background or a background in UK or US law, as most of the legal systems in the region are based on the commercial codes of these two countries.
Bubenzer goes on to note that the increasingly international nature of the work performed in the islands has led to the entry of lawyers from other common law jurisdictions, particularly Canada. Appleby Spurling & Kemp, Bubenzer's firm, which numbers around 70 lawyers and another 60 fee earners, is currently on a recruiting drive in Canada to take on up to a further 8 lawyers. In some jurisdictions that have a strong connection with this country, Canadian trained lawyers almost dominate the local scene. The two name partners and almost half of the associates at leading Turks & Caicos firm McLean McNally, for example, are Canadian qualified lawyers who had practised in this country before moving to the region.
The professionalism and skill sets of the major offshore legal firms is surprising. It is a rapidly developing market. As Bubenzer explains: "Work that is performed nowadays is generally of a similar nature to that performed in onshore jurisdictions, for both international and home-grown businesses. While there is still a large amount of work in setting up companies and trusts in the islands, over time we have seen an increasing move towards high-value transactional matters. Insurance is obviously a big area, and we are constantly involved in a wide variety of matters for these clients-anything from incorporations, to securitizations, to increasingly exotic insurance products. Other areas include capital markets work, asset financing for the shipping and transport industry, mutual funds work and an increasing amount of work in the telecoms sector as Bermuda has been able to attract a number of high profile telecoms to base their operations here." Bubenzer points out that there is also a significant litigation practice in the islands, with local courts handling almost all the legal matters that arise as well as arbitrations. While a significant percentage of the work is referred from onshore firms, Bubenzer is quick to note that as more and more companies locate key personnel in the region, considerably more work now comes in through the front door. "As a result," he says, "the pressure on the local firms to be competitive and to ratchet up the service is also increasing."
The speed of growth, proliferation of offshore centres, and potential for further expansion, particularly in the area of e-commerce has, however, attracted-depending on who you speak to-welcome and unwelcome attention from the international financial community. In recent months, a plethora of international reports have landed on the desks of offshore government officials, bankers, lawyers and accountants. The OECD, the UN (through the Offshore Forum), the G-7 countries (through the Financial Stability Forum), and the European Community (with its tax harmonization agenda), have all made significant moves in the two key areas that are troubling onshore governments-tax evasion and money laundering. These two major irritants directly result from the low tax regimes and strict privacy provisions that are at the heart of the offshore success story. The nature of the complaints have practically guaranteed an impasse.
Taxation
The OECD has been leading the way on tax with the publication, in April, 1998, of the first significant report in the area-a damning critique entitled Harmful Tax Competition, An Emerging Global Issue. Not only did the Report make strong allegations against the low tax practices of offshore centres, but it also took the hitherto unprecedented further step of naming countries which it thought were operating "harmful tax practices". A number of Carribean and West Atlantic jurisdictions were included. The Report called on members of the OECD "to develop measures to counter the distorting effect of harmful tax competition on investment and financing decisions and the consequences for financial tax bases." Clearly alarmed over the damaging impact that offshore centres are perceived to have on (member country?) treasury coffers, the OECD has already contacted 47 "tax havens "-defined in the Report as centres that combine a "no or low effective tax rate" with other features, such as the absence of legal and administrative transparency or international arrangements which permit an effective exchange of information-pressing them to introduce greater transparency and to co-operate with legal investigations into tax evasion.
The Harmful Tax Competition broadside was recently followed up on April 12, 2000 by another OECD Report on bank secrecy in tax cases entitled Improving Access to Bank Information for Tax Purposes. While the Report stresses that it "recognizes the legitimate role that bank secrecy can play in protecting the confidentiality of financial affairs and in maintaining the soundness of financial systems", it does make a number of harsh observations and far-reaching recommendations. Among the recommendations are the elimination of anonymous accounts, a re-examination of exchange of information procedures, and the undertaking of appropriate initiatives to achieve access to bank information for civil tax cases.
While the OECD has decided, for the moment, that the best approach is to negotiate a solution with the offshore jurisdictions, it has made threats to take what it considers appropriate sanctions against jurisdictions that fail to reform their regimes. One such threat has been to "blacklist" non-conforming centres, which could result in the termination of tax treaties and penalties for companies that carry on business in the offending jurisdiction. Publication of the "blacklist" was scheduled to take place in June, 2000, but has since been postponed another year until July 2001, to give the offshore centres more time to comply in view of more co-operative attitudes being suddenly demonstrated.
Money Laundering
A similar approach appears to be taking shape in relation to claims of poor financial regulation in the offshore centres and the resultant problem of money laundering. While concerns regarding money laundering have been long-standing, efforts to flush out the problem have intensified in recent years, partially in response to the number of new jurisdictions wanting to enter the offshore market. The crux of the complaint is that when the number of offshore regulatory systems with numbered bank account facilities is coupled with the number of trusts and international business companies which do not identify settlers or beneficiaries, the end result is that it is far too easy to screen or otherwise mask the flow of dirty money.
The most recent move was a critical Report on money laundering released in February, 2000 by the Financial Action Task Force (FATF), an inter-governmental body linked to the OECD. The Report repeats many of the allegations that have been made by the international financial community in recent years. The task force identified a number of detrimental practices in offshore jurisdictions, ranging from weak licensing requirements, to excessive secrecy, and obstacles to international co-operation, particularly in offshore legal systems. Like the OECD in relation to tax, the FATF has announced that it is prepared to negotiate with those jurisdictions that do not make the grade, but that, if unsuccessful, then sanctions against non-compliant centres will be considered. Already, the FATF has published a list of 15 countries which it views as being "non-cooperative" in its anti-money laundering efforts.
A number of onshore jurisdictions have recently demonstrated that they are prepared to act unilaterally on perceived illegal offshore activities. In April, 1999, the US Treasury Department issued a financial advisory suggesting that financial institutions give "enhanced scrutiny to all financial transactions routed into or out of Antigua." The UK government followed with a similar advisory soon after. While the suspect legislation has since been repealed, the advisories still stand. The US also demonstrated its ability to take matters into its own hands in a recent dispute between the Internal Revenue Service (IRS) and the Bank of Nova Scotia. In that case, the IRS was investigating the affairs of a US citizen who had assets in the Bahamas and held by the bank. When presented with a request to assist their investigation, the bank cited the Bahama's strict secrecy laws and declined to co-operate. Subsequent to this rebuttal, the IRS was successful in securing a US$50,000 per day fine against the bank's operations in Miami. Only when the fines accumulated past the US$1,000,000 mark did the Bank of Nova Scotia finally agree to provide the information sought.
The UK, largely under pressure from the European Community, has also been taking direct action respecting its dependent territories-Bermuda, the Cayman Islands, the British Virgin Islands, Anguilla, Montserrat and the Turks and Caicos Islands-in relation to tax evasion and privacy. A February Report by the UK Treasury and the March UK Budget both targeted the regimes of the islands, with the clear intent to legislate for broader exchange of information mechanisms being signaled. The announcements follow earlier efforts initiated by the British Government to insert strict anti-money laundering and fraud provisions into the statute books of the region with the negotiation of mutual legal assistance treaties (MLATs) with the islands, and the issuance of a check list of measures that need to be undertaken. This was followed up by the appointment of international consultants from KPMG to conduct a review of offshore banking and financial services regulation in the islands.
Canada has also played a hand recently in the Turks & Caicos Islands. Earlier this year, the Royal Canadian Mounted Police (RCMP), in a joint initiative with the local police authorities, raided the offices of the British West Indies Trust Company (BWIT). The investigation related to money laundering charges against the CEO of BWIT. The RCMP force closed the BWIT office and seized over 100 boxes of documents. However, at the last minute, lawyers for the trust company were able to prevent the RCMP from taking the documents out of the country and obtained a court order requiring return of the documents.
To a large extent, the more established financial centres in the region have already had legislation in place that generally complies with the demands from the US, the UK and important international organizations. Other initiatives include the laying down of a rigorous framework of "know-your-customer" practices, including the requirement to provide domestic references prior to the establishment of offshore accounts and corporate structures. For the established centres, it is acknowledged that they would not have been able to attract the global financial industry institutions that form the basis of their economies without being able to demonstrate internationally accepted due diligence standards and effective international co-operation mechanisms. The Cayman Islands and Bermuda, for example, both have legislation that allows local courts to compel the disclosure of confidential information if someone is accused of being involved in a dishonest activity, including information held by a bank. Ray Medeiros, Chairman of the Bermuda International Business Association (BIBA) typifies the approach of the established jurisdictions to the problem. "From our perspective, an appropriate level of transparency validates the integrity of our jurisdiction. Ultimately, as we look to the future of the global economy, it will be those jurisdictions that adopt and maintain international standards that will be most highly regarded and that will succeed in the market."
However, while the larger, more established jurisidictions are working hard to be seen as "good citizens" in the eyes of the OECD, other jurisdictions have taken the position that the expectations of the OECD and other organizations are an interference with their domestic affairs. While these countries profess willingness to tighten their financial regulations and do not wish to harbour fraudsters and money launderers, they are anxious to maintain their privacy and taxation systems. Barbados, for instance, has been named on the OECD list of harmful tax jurisdictions, yet, as Mary Mahabir at Ernst & Young in Bridgetown, Barbados explains, the government there is not keen to enter into negotiations with the OECD. "The government here is very aware of the issues and the problems, and is not averse to addressing them, however it has taken the view that they are not going to negotiate directly with the international bodies as they have seen it as an undue interference with their affairs. Rather, the government is set on building on its current legislation and developing its own measures to combat any perceived problems." Mahabir goes on to point out that Barbados already has an established network of double taxation agreements with countries such as Canada, the UK, the US, Finland and Sweden and has a strong reputation as an anti-money laundering jurisdiction with legislation in place that clearly sets forth its no-nonsense position in this matter.
Other jurisdictions express an esurient resentment over the international pressure. Many are in difficult financial straits and the development of a successful offshore finance industry is seen as the only realistic opportunity to significantly improve their standard of living. Local politicians complain that the bellowing and fingerpointing taking place is by rich nations that are equally suspect with respect to money laundering, and that a number of these, such as (recently humiliated) Switzerland, Luxembourg and the US (i.e. Delaware, Nevada and Wyoming) have similarly geared taxation policies in place aimed at attracting international finance. Indeed, for some of these offshore centres, the current antagonistic climate provides a welcome opportunity to gain a competitive edge over their neighbours by not changing strict secrecy rules and zero tax regimes. The governments of St. Vincent and the Grenadines, for example, have made public their intention to maintain their confidentiality laws intact, which are now among the tightest in the offshore world.
Ultimately, however, the offshore world is more focused on future growth opportunities. This is the principal driver. The stakes are simply too high to permit serious discord with organizations such as the OECD to disrupt taking advantage of lucrative developments such as the growth of offshore e-commerce. As Bubenzer at Appleby Spurling & Kemp says, "It really is a competitive and high value business climate here now, which is requiring everyone to keep an eye out both internationally and locally. While the challenges are continuing to mount, so are the opportunities. It is a matter for governments and local businesses deciding what it is that they want to achieve, and setting about that in the most productive manner. Those offshore centres that get the right combination will obviously be the ones that succeed in the long run." In other words, for most jurisdictions, it is pretty clear that they are better off inside the tent than
outside the tent.
*article courtesy of Alasdair McLean, a Lexpert staff writer.