When one hears a reference to the Cayman Islands, it is normally in connection with criminal activity: drugs, money laundering, and tax evasion. This tiny territory in the western Caribbean has earned quite a reputation – one that is undesirable and usually undeserved. While this particular article is not intended as a defense of the Caymanian finance industry, I hope that by providing some background and solid facts the name of the Cayman Islands will be thrown around less as a synonym for the bad guys and more so as a tangible topic of conversation when discussing the role of Offshore Financial Centres.
Until the 1960s (and even through most of that decade), the Cayman Islands suffered from relative poverty, isolation, and perpetual decline. Advances such as air travel, telephone communications, and paved roads only began to become realities in the late 50s as Caymanian men left the country for jobs aboard the world’s merchant ships. Remaining were less than 8,000 residents forced to endure the harsh realities of a tiny nation with few fresh water sources, little arable land, and the intolerable dominance of mosquitoes.
The Caymanian transformation began in legislation with the advent of the Banks and Trust Companies Regulation Law, the Trusts Law, and the Companies Law. The Government of the day (newly freed from the colonial disregard of Jamaica) thought perhaps a few companies might choose the country as a place to do business. Few did until Bahamian independence in 1972 when ‘flight capital’ began to flee that country in favour of Cayman. By the mid 1980s nearly 500 banks conducted their business in the country.
This rapid growth in international business in a tiny unknown colony raised concerns in the United States about money laundering and criminal activity – and rightfully so, as Cayman regulation was new, weak, and susceptible to corruption. Recognising the need to establish a long term regulatory relationship with the United States, the Cayman Islands facilitated the passage of the 1984 Narcotics Agreement and the 1986 Mutual Legal Assistance Treaty which worked to eliminate financial activity in the Cayman Islands that supported the illegal drug trade or other illegal activity. Advances in legislation and the strength of local regulators have led to the world’s most strict “know your customer” regime. It is harder to open a savings account in Cayman than in any major western city.
Under the auspices of an increasingly sophisticated regulatory system Caymanian firms became very selective. The economic growth through the 70s and 80s gave Caymanians a decent standard of living for the first time in history and attracted expatriates to the territory to work. Up until 1993 Cayman’s banks conducted a largely conservative and traditional business. Increased regulation (and its associated costs) discouraged private clients seeking the secrecy of banks in Switzerland. The Mutual Funds Law in 1993 was a game-changer. Today Cayman is the world’s location of choice for hedge funds and institutional clients are the primary beneficiaries of Cayman’s tax neutrality.
Despite popular belief, Cayman is among the world’s most transparent and highly regulated financial centres. This rings true for most other offshore financial centres as well. The days of the secrecy regime are long gone and continued success is based on respected levels of regulation, strong legal protection, and access to international investment opportunities. Tax information is automatically shared with nearly 30 states including the United Kingdom, France, Canada and the United States. In today’s world a financial centre’s reputation is a key factor in success.
The Cayman Islands has graduated to a standard of living comparable to the United States or Western Europe. The finance industry has brought success, but the outside world often forgets that Cayman’s reality includes the ebbs and flows of any modern country. The Caymanian state has spent the last four years on the brink of bankruptcy: suffering from decreasing tax revenues, a shrinking economy, and rising debt.
That the Cayman Islands is a hub for criminal activity is a myth, and hopefully this article helps to enforce that. Offshore Financial Centres play a big role in the global economy in real terms, conducting actual business that facilitates international investment and simplifies tax structures. Perhaps with this understanding, we can approach the question of offshore jurisdictions with clarity. If they need to be reformed, how so, and what effect will it have onshore? How are they different from large tax-neutral centres (London being a key example)? Finally, does the global financial system suffer from the perceived misdeeds of OFCs or from gross mismanagement at home?
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I would just add, that the only reason that the Islands, or indeed all ‘tax havens’, received this bad name was as a result of the pressure that ensued following the OECD’s 1998 report into what they conveniently labeled ‘Harmful Tax Practices’.
They disliked the fact that the free actions of sovereign states were having a competitive effect on tax bases and structures around the world, lowering their revenues. They therefore colluded to force these states into adopting practices which would better affect OECD nations’ economies. They labeled them with negative connotations and urged media outlets to do the same. So what can we deduce? Well, in short, the only reason we associate bad guys with these places is because an organisation committed to stimulating competition and thereby economic growth became hypocritical, anti-competitive and protectionist.
Agreed, Max.
Hopefully in future I’ll be able to hand over some more detailed pieces on specific aspects of finance in Cayman (and by extension, other OFCs), but hopefully feedback from this very general article will help to inform the next one!