Don’t Dither: Climate Change Is An Opportunity For IFCs

Caribbean islands with international finance centres have fallen prey to the myth of the ‘tax haven’. Because jurisdictions such as Bermuda, the British Virgin Islands, Anguilla, and the Cayman Islands are low tax or tax-neutral, they have been criticised. However, considering the inherent challenges of small island economies and the destructive reality of climate change, these critics not only misunderstand the nature of cross-border trade and investment but also fail to appreciate that globally accessible financial services centres are essential for Caribbean economic and environmental sustainability.

Challenges Of A Small Island Economy

The Caribbean is dominated by nations and territories that are both small and islands. These geographical characteristics have economic consequences.

Small economies struggle with scalability. Without ‘economies of scale’, the unit costs of doing business are higher. Where larger economies have markets and resources with the scale required to maximise efficiency and productivity across multiple sectors, the likes of Cayman and the BVI cannot access these competitive advantages quite so easily, if at all. It’s tough for them to diversify; small economies typically have greater reliance on a few or even a single industry than their larger counterparts.

CLICK TO VIEW: Small island economies: Balancing challenges

With an average of 28 times more sea than land within their borders, island jurisdictions face restricted connectivity and, consequently, higher transport costs. Physical isolation compounds the problems of size by making it harder to increase market scale by trading with neighbours.

But this remoteness also demands a level of self-sufficiency that better connected locations do not require. The graph below compares the economic structure of islands with those of nations generally, and shows the minimum percentage of the workforce employed in each sector across both samples. Mainland jurisdictions with land borders and connected neighbours have lower minimum percentages than islands in every sector. Proportionately more jobs on islands are needed to cover essential services, such as education and health.

CLICK TO VIEW: Self-sufficiency demands diverse sector mix

Economic Specialisation: A Logical But Risky Solution

The natal response to the limits of small island economies has been to specialise – albeit within the constraints imposed by the need for higher degrees of self-sufficiency.

In the Caribbean, given its climate, natural capital, culture and links to the large and prosperous markets of North America and Europe, tourism has become the most common specialisation. Indeed, the Caribbean is among the most tourism-dependent regions in the world. According to the World Travel and Tourism Council, the sector accounts for over a quarter of gross domestic product in more than half of countries there; the global average is 10 per cent.

CLICK TO VIEW: Tourism dominates Caribbean economies

Such specialisation potentially brings systemic risk.

Islands’ prosperity wax, wane and can be wiped out based on trends beyond their control in one often-volatile global sector. This has been demonstrated all too clearly in the past five years by two once-in-a-lifetime events: the coronavirus pandemic and Hurricane Irma.

The rapid worldwide spread of COVID-19 closed borders and massively curtailed international travel. Like other holiday destinations, the public health emergency dealt a significant blow to the Caribbean. In 2020, tourism’s contribution to the region’s gross domestic product fell by 53.2 per cent – three percentage points worse than the global average. For The Bahamas, this figure was 70.1 per cent. In the same year, the Caribbean saw a loss of 708,000 jobs and the fastest decline of overall gross domestic product of all regions worldwide.[i]

Nonetheless, as evidenced by the devastation of the 2017 hurricane season, climate change remains the most pernicious risk and presents a potentially existential threat to the Caribbean. Five years ago, two ‘category five’ hurricanes – the strongest recorded in the history of the Atlantic – swept across the region. For the first time ever, the entire population of Barbuda had to be evacuated. Over 800,000 tourists were dissuaded from visiting – a loss of US$741 million to the islands’ economies and more than 11,000 local jobs.[ii] In the British Virgin Islands, where Irma landed on its most populous island Tortola, more than 600 homes were destroyed and 85 per cent of buildings sustained damage. Tourism was disproportionately impacted. For example, three-in-five of the islands’ 3,800 charter yacht berths were lost, while businesses had to wait to 2018 to receive insurance pay-outs for damaged vessels.

Although record breaking in 2017, Irma-like storms are unlikely to be ‘black swan’ events in the future. The tourism sector and the economies and livelihoods in the region are already being affected by sea level rise and erosion and by extreme impacts such as coral bleaching, flooding, and drought. As far back as 2011, the Inter-American Development Bank was warning that the effects of climate change in the Caribbean are not events in some distant future.[iii]

The science is clear: manmade climate change means natural disasters will continue to affect the Caribbean – with increasing frequency and greater intensity. Analysis of satellite imagery by James P. Kossin, a researcher with the National Oceanic and Atmospheric Administration, shows that climate change intensifies the power of a hurricane.[iv] Not only does physics suggest hurricanes will strengthen as the world warms, but, according to Kossin, ‘historical observations are also in agreement’. Further studies predict six to 10 hurricanes will hit the Caribbean in 2022 alone, with more than half being ‘major’. The outlook thereafter is bleaker.

International Finance Centres As Diversification

In order to better prepare for climate-related threats to their leading industry, Caribbean islands need to diversify their economies. For some, especially those that have an effective and well-established rule of law, international financial and business services provide opportunities for sustainable and high-value diversification.

With around 370,000 companies registered in the BVI for the purposes of facilitating cross-border trade and investment alone, the Caribbean is already home to one of the highest concentrations of offshore finance activity – placing it in the crosshairs of numerous misinformed and so-called ‘tax justice’ campaigners.[v] But the IFCs have brought economic stability, funding for local public services and high paid jobs to the islands.

CLICK TO VIEW: Finance sector over third of Cayman economy

The authors of this article worked together back in 2016-17 on a study that demonstrated that the BVI’s international business and finance centre employed 2,200 people directly and supported a further 3,000 jobs on the islands – generating US$330 million of gross value added and contributing three-fifths of government revenues.[vi] More recently, local clergyman Bishop John Cline is quoted in the Financial Times as saying: ‘We have seen the quality of life and the standard of living of BVIslanders greatly improved through financial services.’[vii]

IFCs enrich the incumbent population. Over two-thirds of all jobs in the BVI’s centre are held by BVIslanders and Belongers, with rates of pay well-above the average. In the Bahamas, only 6.6 per cent of employees in banking were non-Bahamian in 2019.[viii] Meanwhile, the taxes paid by businesses and employees in the IFCs fund public services for all.

And, an active international finance sector can help underpin the tourism sector, especially supporting higher-end accommodation and hospitality. Albeit somewhat dated now, research for the Cayman Islands Bankers Association calculated that around 31,000 financial services clients, vendors and conference attendees visited the Cayman Islands in 2008 – spending around £20 million on local businesses.

The finance sector has proven durable to the perils of climate and pandemic. Financial services in the BVI were able to recover within days of Irma. New business incorporations increased in both 2017 and 2018, with performance in the final three months of 2017 outstripping the same period in 2016.[ix] In the Cayman Islands, the financial and insurance industry’s gross domestic product grew by 0.3 per cent in 2020, compared to the hotels and restaurants industry, which shrunk by 76.6 per cent.[x]

Sustainability: The New Business As Normal

While climate change is a threat to tourism, it provides new opportunities for international finance.

With 193 signatories to the Paris agreement and representatives from nearly 200 countries in Glasgow to attend the United Nations Climate Change Conference last November, there is finally a nascent global consciousness of the negative impact of climate change and the need for governments, companies and organisations around the world to take urgent action. Society can only function and prosper if it is sustainable.

Sustainability is emerging as a corporate standard.

Companies and organisations are using environmental, social and governance (ESG) scores to measure the ethical and sustainable impact of an investment in a company or business, while a growing number of investors are using them to evaluate companies. To be deemed a good ESG stock, a company must credibly align its operations to support programmes that benefit the environment, employees, local communities, and shareholders. Ultimately, the purpose of ESG investing is to increase profits by backing well-managed, socially responsible companies. More and more companies, including major corporations like Microsoft and Accenture, are using ESG standards and guidelines when making investment decisions. This is leading to more long-term investments in sustainable economic activities and projects. Meanwhile, because of new laws – such as the 2021 United Kingdom Environment Act – and mandatory requirements by the Taskforce on Climate-Related Financial Disclosures, companies are being held to an ever-increasing level of regulatory scrutiny. Corporate service providers in IFCs across the globe are rapidly gearing up to support their clients deliver robust cross-border corporate governance, monitoring and reporting as these new norms evolve.

CLICK TO VIEW: Green funds to grow almost fifty-fold by 2035

The market for sustainable investments and funds is set to take-off.

While it is near impossible to put a precise number on the size of the sustainable investment market at any one point in time, estimates suggest that more than US$3.8 trillion (and up to US$12.5 trillion) of assets were invested sustainably in 2019. Currently dominated by European investors and historically associated with philanthropists, development finance and similar quasi-government institutions, the 2020s will see root and branch change. Where Europe has led, the United States and elsewhere will quickly follow and overtake. A new generation of socially and environmentally aware investors are in the process of taking sustainability to the mass market, aided by the large and ongoing intergenerational wealth transfer from older generations to millennials. Although many others were hit hard by the pandemic, sustainable investments thrived. The pandemic demonstrated their strong financial returns, delivering an average return of 22 per cent compared with 13 for all global funds in 2020. We expect the global sustainable fund market to grow almost fiftyfold by 2030.

There is tough competition between IFCs globally (big and small) to win the rights to domicile newly established ESG-based funds and similar vehicles – and, with that, potentially lucrative associated administration, professional services and even asset management revenues.

Unique Role And Opportunity For Island IFCs

Island finance hubs, especially those in the Caribbean, are uniquely placed – as they have (to coin a crude but nonetheless apposite phrase) skin in the game.

Ecologically fragile small islands and coastal areas are at ground zero of climate change. The Caribbean, with its string of islands exposed to the risks of sea level rise, more intense hurricanes and more torrential rainfalls, is at greatest risk of catastrophic disaster. Their IFCs not only want the new revenues from ESG business, but the very existence of the islands demands the success of measures worldwide to tackle climate change.

The new generation of ESG investors are increasingly expecting to see their values and ethics align throughout the value chain – not just in where their money is invested, but also how, by whom and where it is managed, administered and domiciled. They are wise to and will increasingly punish greenwashing, and demand authenticity and shared purpose from financial service providers.

The likes of BVI and Cayman have a distinctive advantage to both position themselves as centres for green finance or ESG activity and at the same time get financing for their adaptation/mitigation plans and projects to address the impacts of climate change. Some are already doing so. The BVI for instance has established one of the first Climate Change Trust Funds in the region, which allows the territory to receive funding for climate change related projects. Moreover, the Caribbean can be treated as a microcosm and experimental incubator for climate consequences. Incubator investments in prototype pro-environment public-sector policies or innovative technologies, if successful, will help prove concepts for corporates wishing to support larger projects around the world.

Seize The Moment, Before It’s Too Late

It’s time for businesses, investors and governments in the Caribbean to join the climate change dots.

The fundamental realities of small islands mean there will always need to be economic specialisation and risk-taking. Both tourism and the IFCs remain the best bets to secure jobs and prosperity – although more work is needed to recognise and leverage the synergies between them. But, a new balance needs to be found between economic growth and the environment. The Caribbean is at the sharpest end of climate change, but this gives its IFCs the opportunity and authenticity to be leaders in the rapidly growing global sustainable investment market.

Don’t dither: neither the markets nor the climate will wait.

Footnotes:

[i] https://wttc.org/Portals/0/Documents/Reports/2022/Travel-and-tourism-in-the-caribbean.pdf?ver=2022-06-14-163047-037

[ii]https://wttc.org/Portals/0/Documents/Reports/2018/Caribbean%20Recovery%20Report%20-%20Full%20Report%20-%20Apr%202018.pdf?ver=2021-02-25-182520-540

[iii] Inter-American Development Bank, Climate Change’s Impact on the Caribbean’s Ability to Sustain Tourism, Natural Assets, and Livelihoods, 2011

[iv] https://www.nytimes.com/2020/05/18/climate/climate-changes-hurricane-intensity.html

[v] ‘Financial Services and Small Island Jurisdictions’, Carmen Saliba, Bank of Valletta Review, No. 35, Spring 2007

[vi] BVI Global Impact

[vii] https://www.ft.com/content/f7f7a07b-656d-42c8-9919-5ae954357d98

[viii] https://www.centralbankbahamas.com/viewPDF/documents/2020-07-09-03-06-55-Gross-Economic-Contribution-of-the-Financial-Sector-2019.pdf

[ix] https://bvifinance.vg/

[x] https://www.eso.ky/UserFiles/page_docums/files/uploads/the_cayman_islands_annual_economic_repor-6.pdf

Kedrick Malone
Kedrick Malone is president and founder of NorthStar Consulting, a Caribbean consulting company offering marketing, strategic planning, business development and management consulting services in the travel and tourism, SME, international business, and government sectors. Kedrick has been driving innovation and change in the tourism and international business sectors for much of his career having served as BVI Director of Tourism, Director of the London Office/UK-EU Representative for Government of the BVI, Executive Director of BVI International Finance Centre (now BVI Finance) and Head of the Financial Servicesd Implementation Unit (FSIU) charged with implementing the recommendations of the BVI Financial Services Report, “Building on a thriving & sustainable Financial Services sector in the British Virgin Islands” by McKinsey and Co. As a Director of Tourism, Kedrick implemented innovative programmes in service standard traning , data driven tourism management and tourism strategic marketing. As Director of BVI IFC, he led the rebranding of BVI IFC to BVI Finance and initiated the Capital Economics report on “BVI’s Global Value, Creating Value: The BVI’s Global Contribution”. As UK/EU Representative, he played a lead role in strengthening diplomatic and international business relationships between BVI and the UK, EU and international organisations. As Director of the FSIU, he successfullly implemented recommmendations of McKinsey Report to strengthen financial services, including the establishment of BVI Finance as a limited company. Kedrick holds an MBA from the Zicklin School of Business, Baruch College, City Unversity of New York.

Mark Pragnell
Mark Pragnell, director of Pragmatix Advisory, has over 25 years’ experience as a macroeconomics consultant and forecaster. He has worked with a number of IFC governments, promotional bodies and businesses, and has led seminal research to explain and quantify the value of IFCs.