Caribbean IFCs: Challenges And Future Prospects In 2021

Three key initiatives continued to present both risk and opportunities to Caribbean IFCs; namely; Financial Action Task Force/Caribbean Financial Action Task Force (FATF/CFATF) mutual evaluations, economic substance, and beneficial ownership. Developments in the digital economy onshore also presents some additional opportunities.

FATF/CFATF – It’s Now About ‘Effectiveness’

The emphasis on all jurisdictions, over the past four to five years in particular, is on how well they have implemented the FATF’s global standards. That means looking at the extent to which each country has an ‘effective’ anti-money laundering (AML) and countering of financing and terrorism regime (CTF). The process includes examining both the jurisdictions’ technical compliance (e.g., examining the laws and formal framework in place) as well as its overall effectiveness (e.g., looking at areas such as enforcement actions taken).

Like many of the mainstream Caribbean IFCs, Bermuda’s most recent Mutual Evaluation report, which was carried out by the CFATF, demonstrated that the jurisdiction was compliant with 39 of the FATF’s 40 recommendations. Key recommendations focused on the need for its industry to improve understanding of suspicious reporting obligations, enhance risk rating methodologies, and adding resources towards beneficial ownership regime in part for monitoring purposes. 

A similar evaluation of The Bahamas in 2017 demonstrated that the jurisdiction was compliant or partially compliant with 39 of the FATF’s 40 Recommendations. Key recommendations were to address gaps in legal provisions in several areas as well as to complete its national risk assessment; address gaps in its targeted financial sanctions; enhance risk-based supervision for certain sectors such as gaming and securities; and improve its administrative arrangements to oversee and monitor the country’s AML/CFT regime. A follow up report in 2018 by the CFATF demonstrated that the Bahamas has significantly improved in many of the areas of recommendations.

The latest follow up for the Cayman Islands demonstrated that the jurisdiction had satisfied 60 of the 63 FATF previously recommended actions and was being compliant or largely compliant with the 39 of the 40 FATF recommendations. Two outstanding areas related to the jurisdiction’s need to improve in the area of sanctions on financial institutions for AML breaches and to demonstrate penalties for those who do not provide accurate, up-to-date beneficial ownership information. The country was placed under increased monitoring until it addresses these two recommendations and is already well on the way to addressing them.

The threat to these Caribbean IFCs and others in the region is that over the past decade and increasingly so, international correspondent banking has become less accessible to jurisdictions which have been publicly identified by global standard setting bodies as having deficiencies in their AML/CFT frameworks. In some cases, the potential negative economic impact of the sheer reputational exposure is greater than the actual risks to their financial sectors due to the deficiencies raised. Reports of poor assessments simply makes it more challenging for institutions based in the respective jurisdiction to do business.

Because of the reputational dynamics, there is a genuine opportunity for jurisdictions which meet the global standards to distinguish themselves as being more credible jurisdictions in which to do business. Irrespective of the legitimate debate surrounding whether these standards are being applied equally across onshore and offshore jurisdictions, this reputational benefit remains.

Economic Substance

Economic substance legislation was forced on IFCs by the European Union over the past three years. The initiative originated in the late 1990s with a focus on EU member states but was eventually extended to so-called 3^rd countries such as Caribbean IFCs. The initiative is tax related and its basic purpose is to prevent clients from using structures in the jurisdiction which accrue profits which do not reflect real economic activity carried out in the country.

The EU published a list of non-cooperating countries and several countries were ‘grey listed’, meaning they had made commitments to address the deficiencies in their legislative frameworks within a certain period to avoid being ‘blacklisted’ later.

By early 2019, several Caribbean IFCs including BVI, Bermuda, Bahamas and the Cayman Islands had established economic substance laws in their jurisdictions which impacted their financial services industries.

On the one hand, economic substance presents an opportunity for jurisdictions to benefit from additional ‘bricks and mortar’ presence by international companies, leading to additional government revenues, jobs, and broader economic impact.

But there is also the threat of losing some company incorporations if the requirements are too burdensome which would result in a negative economic impact. Ultimately, the cost benefit analysis and associated economic impact depends on the nature of the entity and circumstances. What can be said thus far is that since the initiative has been rolled out in the various jurisdictions, there has been no obvious or material negative fallout reported. In fact, company registrations continue to grow in most jurisdictions.

There is a real opportunity for jurisdictions to target both existing and new international companies (including, for example, investment managers) to set up a physical presence in IFCs to benefit their domestic economies.

Beneficial Ownership Registries

Under pressure partly from the UK, some  IFCs in the region which are British Overseas Territories have already established a central registry of beneficial ownership of companies. The registers enable law enforcement to access information on the ultimate owners of each company and this information is also accessible by UK law enforcement.

The primary concern before implementation was that public access to the information might signal to legitimate clients that there is no longer financial privacy. While this may still remain a concern, there has been no evidence that jurisdictions have lost business as a result of introducing the registries.

IFCs, FinTech And Digital Currencies

Traditional challenges aside, perhaps the greatest mix of opportunities and threats facing OFCs relates to the digital revolution that has been taking place over the past decade. FinTech, RegTech, and the use of new technologies are taking place at varying pace across both developed and less developed countries. There is a certain sense of inevitability about many of these initiatives; while countries like China and the US are the current leaders, many other countries are being pushed to quickly adapt to the new environment.

The use of FinTech is already on display in many Caribbean IFCs as companies have adopted it as a standard part of their operations. Core banking systems, for example, are now seamlessly incorporating FinTech and RegTech systems where more efficient due diligence, transactions monitoring, and automated reporting are just a few of the value added outputs in the new operating environment.

The opportunities for IFCs in this area are numerous. Not only can they benefit from the efficiency gains by the financial institutions operating within their markets, which fuels growth and more jobs, but the jurisdiction can attract new types of clients in this new era.

Companies in the digital sector value data protection and protection of their ideas and both of these are ideally suited to the IFC environment. Many IFC frameworks have strong data protection plus trademark and patent laws within a generally strict regulatory environment influenced, in large part, by the presence of their financial services sectors.

The wide range of technology companies operating in the Cayman Islands Special Economic Zone is just one example of the models that can be deployed to benefit from the growth in these areas. Bermuda is another example of an IFC that is very receptive to tech companies, being among the first to introduce legislation to facilitate the new sectors.

IFCs’ Future In The Medium Term

As we have seen from the constant global regulatory and tax pressures, despite COVID-19 IFCs will continue to face scrutiny. Whether that scrutiny is ‘fair’ or not, the key focus for IFCs must be to be agile enough to make the adjustments in a way that minimises harm to their economies. The evidence of the past decade offers some robust proof that despite all the changes to the regulatory regimes, much of which was expected to discourage growth of their financial services sectors, IFCs have continued to thrive.

While financial centres both on and offshore will continue to be abused by bad actors, the continued growth, in particular of the main IFCs, demonstrates that they continue to add legitimate value to clients under a strict regulatory framework.