Bermuda

Bermuda – Efficient Capital Movement


By Randall Krebs, Meritus Trust Company Limited, Bermuda (01/12/2012)

There have been many studies done to show that International Financial Centers facilitate an efficient flow of capital. IFCs provide this service better than other jurisdictions, which is why IFCs continue to flourish today. Due to the increasing demand for capital by BRIC and other emerging countries, statistics are showing that IFCs are filling a key role in the development of the economies of the emerging markets.

Developing economies typically suffer from inefficient institutions. Local entrepreneurs are unable to locally access the capital they require quickly or at a competitive price. 

Table 1: Quality of Institutions – Developed vs. Developing Countries

Country

Quality of Institutions

DEVELOPED COUNTRIES:

 

United States

0.980

United Kingdom

0.934

West Germany

0.959

Japan

0.937

Canada

0.967

DEVELOPING COUNTRIES:

 

Brazil

0.636

India

0.576

China

0.569

INTERNATIONAL FINANCIAL CENTRES

 

Hong Kong

0.802

Singapore

0.856

Switzerland

0.998

Institutional Quality This is an index based on data  from  Political  Risk  Services.  The  index consists of an unweighted average of five part-indices:

 

(i) the degree to which the population of a country  accept  its  law-enforcement  institutions,

(ii)  bureaucratic  quality, 

(iii)  corruption  in  government,

(iv) risk of expropriation and

(v) probability that government will honour contractual obligations.

 

The index goes from zero to one, with zero as the worst institutional quality and one as the best.

 

 

Source: Norway. 2009. Tax Havens and Development: Status, Analyses and Measures. Report from the Government Commission on Capital Flight from Poor Countries, Oslo.[1]

Table 1 compares the quality of institutions in developed, developing and international financial jurisdictions.  It is to be noted that the quality of the institutions in developing countries is significantly lower than in the developed countries and international financial centers.

Entrepreneurs and investors demand: (i) ways to diversify risk; (ii) reduction of transaction friction (red tape/fees/taxes)[2]; and (iii) elegant and responsive tools to facilitate the flow of capital. Economics 101 teaches us that where there is demand, the market will seek to supply.  The IFCs respond to the demand by introducing responsive tools that supply capital, reduce transaction friction and diversify risk.

Bermuda’s Response

Bermuda has responded to the demand with the introduction and supply of a number of ‘products’. Some are unique to a specific industry or address a specific need (e.g. financing of Russian aircraft purchases). Others are more universal in their application (e.g. insurance and funds). The following are only a few of the ‘products’ that have been developed to meet international demand for capital, risk minimization and reduced friction.

Insurance:

The Bermuda insurance market began in 1947 when C.V. Starr chose Bermuda as the headquarters for his American International Company. Insurance development accelerated during the 1960s with the introduction of captive insurance, an innovative risk financing solution for corporations. By 1980, Bermuda was by far the world’s leading captive domicile. Beginning in the mid-1980s, Bermuda began to play a broader role in the world’s insurance and reinsurance markets in response to the mid-1980s commercial liability insurance crisis in the United States. Bermuda  has  become  one  of  the  world’s  top  three  jurisdictions  in  the  global  reinsurance  market.

Bermuda has achieved this success by developing a regulatory system which involves lower regulatory burden in comparison with traditional jurisdictions such as the US and the UK  New companies can be formed in a matter of a few weeks in Bermuda, encountering much less regulatory bureaucracy and red-tape than in other jurisdictions.

Insurance companies require significant capitalization, which typically comes from developed economies.  Bermuda has been an innovator in raising new capital with new vehicles such as sidecars and collateralized reinsurance structures.

The overall result is the creation of better and cheaper insurance – insurance which is affordable and in some cases designed for the emerging jurisdictions.  A loss or regional catastrophe in a developing country effectively results in a capital flow from developed to developing country to rebuild their infrastructure and business resources.

Offshore Companies:

Why are there more Bermuda companies on the Hong Kong stock exchange than any other country?

The answer is simple, risk minimization. In 1832 Scotsmen William Jardine and James Matheson formed Jardine Matheson a trading company based in China. Jardine Matheson was instrumental in creating trade with China and the development of Hong Kong. Today the company is known for the Mandarin Hotel chain, financial services and more. Jardines has experienced the financial impact of war and government expropriation, enduring a significant loss of business assets in WWII and as a result of nationalization by Communist China following the war.

In 1984 in anticipation of the handover of Hong Kong to China in 1997, Jardine Matheson incorporated a Bermuda company to hold its business empire as a mechanism to reduce the risks of the uncertain business environment in Hong Kong.  It expressed the view that the Bermuda holding company reduced its exposure in Hong Kong/China from 72 per cent of total assets to a planned 50 percent[3]. Other Hong Kong companies followed suit.

IFCs as conduits for investment:

Emerging economies have significant capital requirements.  It can be shown that a country’s economic growth is directly related to the amount of foreign direct investment (“FDI”). 

Professor Jason Sharman argues that IFCs have supplied the demand for capital by providing efficient institutions and minimizing the transactional friction on capital transactions.[4]  IFCs have developed efficient, timely, risk sensitive, flexible and lower cost ‘products’ designed to meet the demand for capital for these emerging economies. 

Table 2: Foreign Direct Investment BRIC & BVI for 1980 & 2011

Country:

1980

2011

Inbound

Outbound

Inbound

Outbound

Brazil

17,480

38,545

669,670

164,523

Russia

n/a

n/a

457,474

362,101

India

452

78

204,692

111,257

China

1,074

Not avail

711,802

365,981

BVI

1

0

288,987

280,244

Foreign Direct Investment expressed in millions of US dollars at current prices and current exchange

Source: United Nations Conference on Trade and Development[5]

The Table 2 demonstrates:

a)      the significant increase in inbound FDI from 1980 to 2011, this FDI has been used to fuel the growth of the BRIC economies;

b)      during the same period BVI experienced a similar substantial growth in inbound FDI – for 2011 FDI represents over US$12 million per person. 

c)       Unlike the BRIC countries, BVI’s inbound and outbound FDI in 2011 are almost identical, indicating that BVI is a conduit for investment capital

Table 3 illustrates that the preferred source of FDI for China is via IFCs, with Hong Kong, BVI, Singapore, Cayman, Samoa and Mauritius ranking in the Top Ten sources of FDI, most ahead of the US which ranked 7th. 

Table 3: Top Ten Sources of Foreign Direct Investment to China in 2008

table3

 

While China is the most dramatic success story, similar results can be shown in other BRIC and emerging economies.  UNCTAD estimates that IFCs contribution to inward FDI can be as high as 30 per cent for certain Latin American countries (Brazil and Chile), Asian economies (Hong Kong, China) and the Russian Federation[6]. It has been estimated that no less than 38 per cent of direct investment to India in 2006-08 came from Mauritius.[7]  

While Cayman is the clear leader in offshore funds, Table 4 shows that Bermuda is also a significant source of FDI from the Latin America and Caribbean region being the only IFC in the top 5 countries.

Table 4: Top 10 Source Countries from LatAm and Caribbean in 2011

Country

No. of Projects

Brazil

81

Mexico

42

Chile

37

Bermuda

35

Argentina

22

Source: The FDI Report 2012[8]

Trusts: Succession, Management, Risk minimization:

The emerging economies are developing new millionaires and billionaires at a staggering rate. The newly wealthy are aware of the potential impact of corruption and arbitrary rule change on their ability to protect their wealth. Many are first generation wealth and need to also give consideration to succession of their businesses/wealth and management of their investible assets.

Experience shows that, regardless of origin, successful entrepreneurs and wealthy individuals have common concerns, including:

·    family harmony;

·    planning for succession of business control and wealth;

·    preservation of the family’s assets as the family grows and separates (physically and philosophically);

·    instilling the family’s core values/philosophy in future generations;

·    providing for the needs of descendants (without damaging their drive and personal development);

·    protecting the privacy of the family; and

·    how to ‘give back’ to society – charity/philanthropy.

Bermuda has been working with families for decades to develop structures and mechanisms to address these concerns.

One of the most flexible and useful tools is the trust. Bermuda (like other IFCs) have supplemented traditional trust law to make it more ideally suited for addressing the concerns of its clients.

What are trusts used for?

Succession Planning – Successful entrepreneurs are concerned with succession of business control and succession of the wealth. Unfortunately entrepreneurs often have a hard time actually putting succession plans in place. Experience shows that failure to implement a succession plan often leads to disputes/litigation and often the destruction of a business empire and family harmony.

There are many structures that are used in Bermuda that can preserve control during the entrepreneur’s life and provide for a smooth succession upon his death or retirement.  For example, a simple structure would involve the creation of the family’s very own trustee company, which would administer a trust formed for the benefit of the entrepreneur during his life, and then a predefined division of the wealth after his death.  The creation of a private trustee company is actually very common and usually inexpensive. Since this would be the entrepreneur’s own trustee company, the entrepreneur and his trusted advisors could control the trustee, thereby controlling any underlying operating companies and investable assets[9].  More elegant structures, such as family offices, are designed to promote family harmony/unity, instil the family philosophy in future generations, and to train/educate descendants on how to successfully manage the family business and wealth.

In addition, the trust documentation can include provisions designed to stop descendants from challenging the structure.  A common clause is called a ‘no contest clause’ which would provide that any descendant challenging the structure or commencing legal proceedings would automatically lose all right to receive an ‘inheritance’.

Divorce & Forced Heirship –Laws of many countries dictate that how assets are to be divided upon the divorce or the death of the wealthy entrepreneur. One of the advantages of placing assets in a Bermuda trust is that the trustee has legal title to the assets, the assets are no longer owned by the entrepreneur, and might not be included in the calculation of assets to be divided. Even if the foreign court treats the assets as belonging to the entrepreneur, Bermuda has enacted laws that prevent Bermuda courts from using trust assets to satisfy judgements of foreign courts in divorce, forced heirship or bankruptcy proceedings.

Privacy – Public battles are all too common among wealthy families.  The publicity is not only embarrassing, but bad for business. 

Many high net worth individuals are concerned about the disclosure of information regarding their families, their assets and their activities. Journalists search company and court records to get information for their articles. Bermuda has a tradition of protecting the privacy of individuals involved in legal proceedings. Cases involving trust disputes are almost never reported, and it is standard practice to seek a ban on publication.

In addition, trust structures also protect against public disclosure of ownership information for assets. Bermudian trusts are not registered. There is no publicly available information regarding trusts, settlors or the beneficiaries. Also, when trust asset need to be registered (e.g. shares of a company), the trustee is shown as the legal owner. Many entrepreneurs find this additional layer of privacy helpful in business dealings or when they are concerned about threats, such expropriation or kidnapping.

 

Studies have shown that IFCs fill a valuable role in the transfer of capital and the development of emerging economies.  Bermuda has pioneered the development of a number of ‘tools’ or ‘products’ that meet international demand for capital, risk minimization and reduced friction.  Bermuda remains well positioned to provide financial services to businesses, entrepreneurs and  investors in emerging economies.



[1] http://www.cmi.no/publications/file/3470-tax-havens-and-development.pdf

[2] Transactional Economics – North, Douglass C. 1990. Institutions, Institutional Change and Economic Performance. - Cambridge: Cambridge University Press.- North argues that high transaction costs resulting from a lack of institutions, or bad institutions, retard development of economies, whereas the low transaction costs provided by well-adapted institutions facilitate development and poverty reduction.

[3] http://www.fundinguniverse.com/company-histories/jardine-matheson-holdings-limited-history/

[4] Professor Jason Sharman of Griffith University ('International Financial Centres and Developing Countries: Providing Institutions for Growth and Poverty Alleviation'), http://www.ifcforum.org/files/Sharman___International_Financial_Centres_and_Developing_Countries.pdf

[5] http://unctadstat.unctad.org/ReportFolders/reportFolders.aspx

[6] http://unctadstat.unctad.org/ReportFolders/reportFolders.aspx

[7] Norway 2009, page 57.

[8] http://www.fdiintelligence.com/Landing-Pages/fDi-Report-2012

[9] It is important to seek tax advice in structuring, in some jurisdictions control can impact taxation