Offshore Financial Centers: Myth And Reality

Bryan Hunter

For too long, offshore financial centers like the Cayman Islands have been stereotyped as refuges for the wealthy to stash their fortunes. Like most stereotypes that grow more out of myth than reality, the role of today's offshore financial centers is quite different from what many perceive.

Successful offshore financial centers uphold global transparency and cooperation standards and enable market efficiency and competition. It's time to dispel the stereotypes that have long driven global efforts to stem the vital role of financial services centers. The realities of what offshore financial centers are and their contributions to global financial markets are explained below, alongside four of the most commonly held myths.

Myth: Offshore financial centers only benefit the rich and powerful.

Reality: The Cayman Islands and other offshore financial centers compete aggressively with each other every day to offer the most cost-efficient environment for international capital flow. This competitive market allows companies to raise financing and package financial risk more economically. These efficiencies benefit businesses, consumers of goods and services sold by these companies around the world and shareholders, which include such venerable clientèle as non-profit endowments and public-sector pension funds.

Myth: Companies and investors doing business in offshore financial centers are driven by a need for secrecy.

Reality: Today's successful offshore financial centers have a long history of promoting commercial certainty for global clientèle. For the Cayman Islands, this has meant adherence to recognized and relevant international standards--not absence of regulation--which has helped fuel sustainable growth of the sector. Since the early- to mid-1980s, the Cayman Islands has progressively reinforced its international cooperation channels in law enforcement, regulation and exchange of information on tax matters. These channels include a tax information exchange agreement that was signed with the U.S. in 2001 and is in force, as well as a mutual legal assistance treaty with the U.S. on criminal matters in effect since 1990 and under which the Cayman Islands and the U.S. have cooperated in some 230 requests for assistance.

Myth: Offshore financial centers prey upon other countries' tax codes, fostering illegal tax shelters.

Reality: Investors and/or their advisers choose the Cayman Islands for tax neutrality. This simply means that investors and their specific corporate activities--which can often involve two or more countries--are not subject to additional layers of taxation over and above those of their home country, which is where capital flows ultimately end up and are then taxed. In a similar context, numerous U.S. companies have left states where they were founded or have substantial business operations and established registered offices in Delaware, Nevada, Colorado and Texas so they can take advantage of the tax savings and efficiencies of having a registered office there. This is not seen as being shady or unduly evasive in the least.

Myth: Offshore financial centers foster illicit activity and are unregulated.

Reality: The Cayman Islands has a strong track record of effectively regulating a full spectrum of financial services that measures up with standards found anywhere in the world. Effective oversight of complex financial activity--where literally billions of dollars trade hands every day--can only be accomplished by regulating services typically unregulated in other global regimes, such as company formation services, trust-services providers and fund administration. In addition, the Cayman Islands government invests significantly back into regulation and into combating cross-border financial crime.

Over the past 15 years, the Cayman Islands financial regulation and prevention of financial crime regimes have been evaluated, "road-tested" and recognized by many third-party organizations such as the IMF, FATF and OECD. The Cayman Islands continues to participate in these valuable "health checks" to help ensure the integrity of its regimes.

Due to necessity and market expectations, offshore financial centers must be mature, sophisticated and specialized providers of financial services with sound legal frameworks and modern infrastructure in order to succeed. The "Big Four" accounting and auditing firms, most of the world's fund-service providers and substantially all of the world's top global banks have a presence in the Cayman Islands.

It's time to focus on the reality. Offshore financial centers are increasingly critical economic catalysts in today's fast-paced, cross-border, open-market system. Their continued and singular focus on transparency and appropriate levels of regulation is vital to a dynamic and resilient global economy.

Caymanian Leaders Excel at Pimping out Their Country

WILLIAM E. GRAYSON, the president of EGM Capital, a hedge fund firm in San Francisco, has never set foot on the Cayman Islands, but he knows that sun-baked Caribbean haven quite well. That’s because he set up one of his funds in the Caymans, where lucrative tax breaks and fabled financial secrecy have made this British territory a magnet for hedge fund managers.

“All of the offshore jurisdictions are competing against each other to provide the most hospitable regulatory landscape, and the Caymans are really coming on strong,” Mr. Grayson says. “As a hedge fund manager, you just might be deciding whether you want to golf or scuba-dive more.”

In as little as two weeks, and for about $35,000 in fees, hedge funds can set up shop in the Caymans — just a fraction of the time and up to one-tenth the price of incorporating a fund in drearier climes like Delaware.

While speed and bargain prices are big attractions, the real draw, say analysts and Congressional investigators, are perfectly legal Caymans-based corporations and partnerships that allow major investors to avoid taxes of up to 35 percent that the Internal Revenue Service levies on unearned business income. Cayman tax laws also help American fund managers legally defer domestic taxes on their personal profits by channeling them offshore through their funds.

The biggest of the three islands that make up the Caymans, Grand Cayman, is only 22 miles long and, at its widest, 8 miles across. But the territory’s tax advantages have turned it into one of the linchpins of the estimated $1.5 trillion global hedge fund business.

“So many of the best money managers have set up in the Cayman Islands,” says Kurt N. Schacht, managing director of the CFA Centre for Financial Market Integrity, a nonprofit research organization in Charlottesville, Va. “It has become the place to go.”

As recently as a decade ago, regulators and law enforcement officials regarded the Caymans, an outpost 480 miles south of Miami that once served as a shelter for pirates like Blackbeard, as a hotbed for money laundering and other dubious financial schemes. Today, it is the corporate home for what the Cayman Islands Monetary Authority estimates to be three out of every four of the world’s hedge funds — more than anywhere else — thanks to its friendly tax and regulatory regimes, as well as an army of foreign bankers, tax lawyers, accountants and fund administrators who make it all work.

“With some of the other jurisdictions, there’s an island mentality,” says Michelle Kline, a principal at Genesee Investments, a hedge fund based in Bellevue, Wash. “The thing that’s different about Cayman is that the regulators realize that hedge funds are a business, rather than just something to regulate.”

For their part, Cayman officials, regulators and private-sector lawyers, bankers and accountants say that there is nothing illegitimate about how the territory supports offshore finance, and that it is a system that is unfairly tarred and much misunderstood by its critics.

True, “we’re not a widows-and-orphans jurisdiction,” says Ted Bravakis, the director of public relations in the Portfolio of Finance and Economics, a Cayman government agency that helps to oversee financial services there. But, he adds, “the Cayman Islands sees the use of our jurisdiction and service providers by U.S. entities and individuals to avoid their tax responsibilities as abusive — we feel equally abused because our regime is not intended to be used in that way.”

The Caymans’ ascent as a hedge fund haven coincides with recent calls by American legislators for greater oversight and taxation of hedge funds — lightly regulated, secretive investment pools for wealthy individuals and institutions — as well as greater scrutiny of the tax status of private equity firms.

As legislators like Senators Carl M. Levin, Democrat of Michigan, Charles E. Grassley, Republican of Iowa, and Max S. Baucus, Democrat of Montana, also make renewed calls for a broader crackdown on financial abuses in offshore tax havens, the Cayman government has continued spending heavily on high-profile lobbyists, public relations firms and well-connected lawyers to persuade the world’s senior financial officials and regulators that the Caymans has outgrown its past as a center of financial high jinks.

During the spring, Cayman representatives lobbied the Securities and Exchange Commission, aides and members of the Senate Banking Committee, tax policy officials of the Treasury Department, and the office of Vice President Dick Cheney in an effort to foster the impression that the island territory has remade itself into a law-abiding, smoothly run financial supermarket.