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Cayman waits on new political wind blowing from Washington

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It’s probably true to say that members of the financial services industry in the Cayman Islands are awaiting the inauguration of US president-elect Barack Obama on January 20 with a degree of trepi

It’s probably true to say that members of the financial services industry in the Cayman Islands are awaiting the inauguration of US president-elect Barack Obama on January 20 with a degree of trepidation, above and beyond the general concern within the global hedge fund industry dominated by Cayman about the likelihood of increased regulatory pressure amid an unfavourable financial and economic environment.

As he prepared for his successful election campaign a year ago, the then senator from Illinois and co-sponsor of the Stop Tax Haven Abuse Act singled out the jurisdiction for particular scrutiny. ‘There’s a building in the Cayman Islands that houses, supposedly, 12,000 US-based corporations,’ Obama said. ‘That’s either the biggest building in the world or the biggest tax scam in the world. And I think we know which one it is.’

As is well known in the offshore world, Obama was referring to Ugland House, the head office of international law firm Maples & Calder. Leaving aside the questionable accuracy of the number of companies domiciled by Maples – the much-quoted figure of 12,748, which dates back to 2004, had apparently risen to 18,857 by March this year, and more than half of them are entities with no connections to the US – the building has come to symbolise what are widely seen in the US as the pernicious evils of offshore financial centres.

Many people in the industry expect, at the least, that many US-based managers of Cayman funds will come under the supervision of the Securities and Exchange Commission or possibly a US super-regulator that might emerge from a merger between the SEC and the Commodity Futures Trading Commission. But whether that will make an enormous difference to the industry depends on the nature and scope of any regulatory regime for the industry.

Two years ago an initiative to require managers of funds with 15 or more US investors to register and undergo inspection by the SEC was derailed by the courts on the grounds that the regulator had exceeded its powers. But although investment advisers to hedge funds were no longer required to submit to SEC registration, in practice many managers that had already complied with the regime continued to do so.

Despite Obama’s threatening rhetoric, there is a belief in Cayman that once in office the president-elect may adopt a more considered stance toward the offshore financial industry. Following last year’s Congressional debate, the US General Accounting Office was delegated to examine the role of Maples & Calder in the domiciling of companies involving US individuals and corporate groups, and, perhaps to the surprise of critics of the offshore industry, came back with a more balanced and nuanced report than might have been expected.

The GAO suggested that rather than being simply motivated by tax avoidance or even evasion, US business was attracted to Cayman by factors that included geography and culture, the skills of its financial, accounting and legal professionals, and a stable, flexible, cost-effective and business-friendly regulatory environment, as well as the predictability and familiarity offered by a legal system based on English common law.

The report also quoted the description by the Caribbean Financial Action Task Force, an offshoot of the FATF initiative launched a decade ago by the G7 countries to curb money laundering, of Cayman as having a ‘strong compliance culture’ with regard to combating financial crimes and terrorist financing, and the judgement of the International Monetary Fund that its regulatory regime is generally in compliance with a broad range of international standards.

The report also cast doubt on the jurisdiction’s popular image in the US as unco-operative on tax enforcement issues. The GAO investigators were told by the Internal Revenue Service, the US tax authority, that the Cayman government had provided the requested information in a timely manner for all requests made by the US under the tax information exchange agreement between the two countries.

Since the US-Cayman mutual legal assistance treaty, the GAO found, Washington had made more than 200 requests for information regarding criminal cases to the Cayman Islands. Cayman had also been proactive in furnishing details of suspicious financial activity with a US link, had co-operated on the sharing of proceeds from criminal asset forfeitures, and was described as one of the ‘best partners’ among offshore jurisdictions by a senior US Department of Justice official.

The GAO enquiry is important for Cayman, according to government officials and industry practitioners, because it indicates that at closer examination many of the popular assumptions about the jurisdiction encouraging tax delinquency melt away. Even the arrival of Obama in the White House, they believe, will be mitigated by the direct experience of US tax and legal officials who deal with Cayman on a regular basis.

‘The General Accounting Office report that followed their team’s visit produced some glowing references for Cayman as a stable and well-regulated jurisdiction,’ says Jonathan Tonge, head of the hedge funds practice at law firm Walkers. ‘A lot of it is a perception issue. We’ve had exchange of information treaties for a long time, and where they need to be used, we co-operate fully with the US authorities. There may be more questions being asked [under Obama], but we think we’re well positioned to deal with them.’

While the Stop Tax Haven Abuse legislation, which was first put forward by Obama with fellow senator Carl Levin and Norm Coleman in 2007, remains on the Congressional agenda, it has twice lapsed at the end of the legislative year. Although the Cayman government expects to see it re-presented to Congress in 2009, it is not convinced that it will gain sufficient traction to complete the enactment process, and that any hostility toward offshore centres in the new administration will be tempered by the experience of career civil servants who have made clear their satisfaction with the co-operation they receive in Cayman.

However, at the same time Cayman must deal with a fresh outbreak of skittishness about offshore financial jurisdictions in the UK, which is itself home to a significant number of managers of Cayman funds – firms that are already supervised, by no means superficially, by the Financial Services Authority in London.

The jurisdiction is about to face a new examination of the offshore financial centres among the UK’s dependent territories, a list that also includes the crown dependencies of Jersey, Guernsey and the Isle of Man, Gibraltar, Anguilla, Bermuda, the British Virgin Islands and the Turks & Caicos Islands. The inquiry, to be led by former FSA managing director Michael Foot, will focus on financial supervision and transparency, taxation in relation to financial stability, sustainability and future competitiveness, financial crisis management and resolution arrangements and international co-operation, according to the UK Treasury.

The Cayman government has responded calmly to the UK’s announcement, which was in fact largely prompted by the plight of British residents who had placed deposits with the subsidiaries in the Channel Islands and the Isle of Man of failed Icelandic banks. The Cayman Portfolio (ministry) of Finance has promised not just co-operation with the review but an ‘active role’ in examining ‘the long-term opportunities and challenges’ facing each international financial centre.

Leader of government business Kurt Tibbetts says that following discussions with the UK Treasury, the Cayman authorities are satisfied that the review will be ‘serious and constructive,’ adding: ‘It is Cayman’s experience that objective, independent reviews are valuable to all parties involved, and we look forward to working with Mr Foot.’

Members of the industry share the government’s sanguine response. ‘The UK Treasury enquiry is very much to do with the collapse of the Icelandic banks in the Isle of Man, although it includes Cayman and other dependent territories,’ says Mark Lewis, chairman of the executive committee of the Cayman chapter of the Alternative Investment Management Association.

Lewis says that the jurisdiction has made strenuous efforts to demonstrate its willingness to co-operate with other countries’ efforts to curb tax evasion. ‘Cayman’s efforts with regard to tax information exchange agreements and mutual legal assistance treaties are well advanced,’ he says. ‘Cayman is expecting to sign at least six tax agreements with various European countries in the first quarter of next year.

‘The government has already been in touch with Michael Foot, whose been appointed to chair the UK enquiry, and they are not expecting any particular concerns or surprises. On the regulatory side, our legislation is more advanced than any country in western Europe or the US. Cayman fully believes it has done more than any other offshore jurisdiction to satisfy international regulators, and remains very proactive.’

That proactiveness includes an initiative just launched by the industry regulator, the Cayman Islands Monetary Authority, to work together with practitioners to examine areas that could be improved. ‘Aima has been requested to work with Cima to develop standards and practices and come up with improved regulatory guidelines for service providers such as offshore fund directors and administrators,’ Lewis says.

For example, he notes, a professional association has been established for independent directors and has drawn up a code of conduct for the regulation of its members, drawing on work already carried out by Aima internationally. The regulator is notably examining how to ensure that individuals do not take on more directorships than they can effectively fulfil.

The Cayman regulatory philosophy is based on effective disclosure to investors rather than rigid prescription and quantitative restrictions, and Cima’s initial instinct is to reinforce codes of professional practice with the provision of greater access to its database of information about the industry, facilitating research by investors on fund’s investment managers, directors and administrators,

For example, they might be allowed to see how many directorships a particular individual holds and judge the degree of time and effort that they are capable of bringing to each appointment. But Lewis argues that far from this approach demonstrating weakness or laxity, the regulator is always ready to use its teeth where necessary. ‘Cima is looking for the new standards to be voluntary, but they would bring forward regulation if the voluntary code were not adopted,’ he says.

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