IFCs Need to Become Apple

By Andrew P. Morriss, Dean, School of Innovation & Vice President for Entrepreneurship and Economic Development, Texas A&M University (03/09/2019)

In his ground-breaking work on competitive advantage, Harvard Business School Professor, Michael Porter, set out two strategies for businesses: either, they can seek to be the low-cost competitor, or they can try to differentiate themselves in order to charge prices above what people would pay for a generic commodity.[1] Wal-Mart exemplifies a low-cost leader. Its innovative supply chain enables the offering of the ‘everyday low prices’ its competitors struggle to match. Apple is a model differentiator – its products are a package of design, function, innovation and integration that distinguishes its products from commodities and allows premium prices.


In today’s regulatory environment, International Financial Centres (IFCs) have just one choice left – differentiation. IFCs need to be the Apple of their market segments. Here’s why.


The Law Market


IFCs compete in a global market. They compete by having high quality firms that offer the necessary legal, accounting, compliance and other services necessary for specific transactions. And critical ingredients in IFCs’ competitive positions come from their legal and regulatory frameworks. IFCs must offer up-to-date laws, dispute resolution services, regulatory systems and participation in global financial networks. All these enable their clients to use entities and structures to accomplish their goals. Jurisdictions that lack any of these are unable to compete effectively.


The playing field is the global ‘law market’. Professor Erin O’Hara and Larry Ribstein’s path-breaking The Law Market provided a conceptual framework for thinking about competition among jurisdictions as a form of market competition we can analyse with economic theories.[2] In the law market, jurisdictions seek transactions and business entities that generate economic activities within their borders that would not otherwise be there. This yields everything, from legal and government fees to the hotel bills of people coming to the jurisdiction to transact business.


Why Just One Choice Today?


Through the 1970s, jurisdictions could choose to be IFCs that sought to be low-cost competitors. A number of early IFC jurisdictions focused on lowering the transaction costs of doing business in them. For example, the Cayman Islands modelled its first company law in the 1960s on English company law and its first banking law on Bahamian banking law, making it easy for those familiar with those sources to bring business to Cayman.[3] Indeed, when Cayman entered the law market, it lacked a sophisticated legal and business community, a financial services regulator, and a serious body of financial law. Its main asset was a British-derived legal system and some entrepreneurial government officials seeking a way to fund improvements. Through investments in infrastructure to cut the cost of doing business (an undersea cable, a modern airport) and in its legal system, the islands attracted business.


This strategy is no longer viable. The extraordinary growth of international regulatory efforts aimed at the financial industry requires substantial investment to compete. Today, effective participation in the global law market requires serious regulatory bodies, activity in international regulatory forums, creating treaty networks, and regular updating of laws and regulations. Being a low-cost competitor is no longer a viable strategy because participating in the global financial network is a requirement for success, and that participation is costly.


A Differentiation Strategy


If differentiation is the only viable path, what does this mean for IFCs? Once again, we can find guidance in Porter’s work. He applied his framework to jurisdictions in The Competitive Advantage of Nations and identified four broad attributes that shape the environment in which a jurisdiction’s firms compete globally (figure 1)[4]. He arrayed them in a diamond format to illustrate their mutually reinforcing nature. What do these attributes mean for IFC jurisdictions?


Factor conditions: Each jurisdiction has a factor endowment – the people, natural resources, capital (financial and human) and infrastructure that enable businesses and individuals to transact with one another. While IFCs are distinguished by their lack of natural resources, nonetheless they have important factors. The Channel Islands benefit from their proximity to the City of London and its financial networks and European markets; Caribbean IFCs use their location to build businesses for North American clients; Hong Kong and Singapore benefit by being close to Asian markets.


The most important factor condition for IFCs is their governments. These are the parties that invest in developing the legal and regulatory frameworks necessary to make capital feel ‘at home’ in their jurisdictions. They do this through the high-quality judiciaries, collaborative processes for drafting laws and regulations that provide industry input early and often, and accessible regulators willing to meet with clients to demonstrate the soundness of the jurisdiction. Crucially, as Porter noted, “The standard for what constitutes an advanced factor rises continually, as the state of knowledge, the state of science, and the state of practice improve.”[5] As a result, IFCs must continually reinvest in advancing their legal and regulatory infrastructures.


Demand conditions: Porter described demand conditions as the impact of demand within a jurisdiction. For example, Sweden’s population is located far from its hydroelectric resources and so it developed expertise in high voltage transmission. Similarly, IFCs grew out of demand for services not being met in larger jurisdictions. For example, offshore banking developed because of demand for banking for Eurodollars and staggering marginal tax rates in developed countries through the 1970s. IFCs were able to step forward and offer tax neutral platforms that enabled Eurodollar transactions, reducing interest costs for borrowers and putting money to work for lenders.


Today, demand is not for simple business structures but for complex ones that enable multijurisdictional businesses and families with global assets to find platforms that enable them to manage their affairs efficiently. For example, the growth of offshore captive insurance and offshore investment funds requires sophisticated dispute resolution services and regulatory infrastructure as well as the avoiding of the retail-level regulations larger jurisdictions impose.


Related industries: This captures the synergies that result when industries reinforce one another. Porter used the example of Italian strength in shoe design and manufacturing leading to a ski boot industry built on those strengths. With IFCs we can see this dynamic playing itself out in the expansion of product lines, such as the development of catastrophe bonds and alternative risk management tools out of the captive industry.


Strategy, structure, and rivalry: This rests on how business culture affects firm behaviour, recognising that Swiss culture differs from Japanese culture. Here we see the impact of the small size of IFCs and the predominance of island jurisdictions. The Channel Islands and Caribbean IFCs grew out of seafaring cultures, while Singapore and Hong Kong have long histories as entrepôts in major trade corridors. The resulting business climates emphasise outward orientation and adaptability, key features in being successful.


Innovation Needed


IFCs can do little to change the hand they were dealt; their challenge is to play it as well as they can. Fortunately, they hold some high value cards. First, IFCs have high quality business and legal resources and governments who (mostly) understand the need to maintain their competitive positions. Second, the rapid decline in transportation and communication costs have dramatically reduced the cost of relocating transactions, enabling IFCs to compete for business. Third, big jurisdictions aren’t nimble or credible. IFCs’ small size and dependence on financial industry revenues make their commitments to maintain tax neutrality, quality courts and sensible regulations credible in ways that larger jurisdictions’ efforts are not. For example, no-one would believe a commitment from the UK to maintain current tax rates as the prospect of a Corbyn-led Labour government replacing a minority Tory administration riven by internal strife is just a few by-elections from reality.


A key part of IFCs’ strategy has to be to embrace innovation in their products. As Porter noted, “The nature of economic competition is not ‘equilibrium’ but a perpetual state of change. Improvement and innovation in an industry are never-ending processes.”[6] Supporting a ‘never-ending process’ of innovation requires close cooperation between IFC governments and their financial industries, both to develop new products and to refine current ones. Jersey’s collaboration with Jersey Finance is an excellent example of such a process.


What does innovation look like for an IFC? It is not a ‘race to the bottom’. Think instead of the evolution of the protected cell company structure, from its 1997 beginnings in Guernsey through its rapid global spread, with jurisdictions experimenting with levels of regulatory support and modifications to the basic concept. Most recently, a number have permitted incorporated cells, allowing cells to contract with one another. Not only is this a remarkably speedy spread of a significant legal innovation, but it illustrates how the competitive pressure among jurisdictions brings change to meet market needs.




In a world in which the fixed costs of participating in the global financial system are continuously rising, the cost of being an IFC is also rising. To compete requires IFCs to innovate to develop specialised products for which customers will be willing to pay a premium. We can see this emerging in markets such as captive insurance, where the focus is shifting from cost control to risk management. Businesses put their captives in jurisdictions like Bermuda, Cayman, Dublin and Guernsey, not because those are the cheapest places to operate, but because those jurisdictions have built robust, flexible regulatory regimes that can adapt to changing conditions. Without the competitive advantages those jurisdictions gain from their investments in their infrastructure, they would be able only to compete on price. That competition would starve them of the revenue they need to invest in the next generation of compliance infrastructure. The only viable choice is to differentiate and IFC governments need to be asking themselves, “What’s our equivalent to the iPhone?”

[1] Michael E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (Free Press: 1985).

[2] Erin A. O’Hara & Larry E. Ribstein, The Law Market (Oxford: 2009).

[3] Tony A. Freyer & Andrew P. Morriss, Creating Cayman as an Offshore Financial Center: Structure and Strategy Since 1960, Arizona State Law Journal 45: 1297 (2013).

[4] Michael E. Porter, The Competitive Advantage of Nations (Free Press: 1990) at 71.

[5] Porter, The Competitive Advantage of Nations, at 79.

[6] Porter, The Competitive Advantage of Nations, at 70.

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