September 2009

CAYMAN ISLANDS: a lighter shade of grey

International co-operation is helping the Cayman Islands to mend its image as a tax haven. Will Cayman maintain its dominant position as a hedge fund domicile, asks Fiona Rintoul...
beach.jpgThe Cayman Islands signed an all-important twelfth Tax Information Exchange Agreement in August.

This is how many tax agreements are needed by so-called tax havens to make the OECD’s ‘white list’. Cayman had been on the grey list but ascended – along with fellow Caribbean tax-free paradise the British Virgin Islands – to the white list on 19 August following the latest agreement, which was with New Zealand.

The agreement followed pressure from world leaders on the Cayman Islands and other jurisdictions to become more tax transparent.

Anthony Travers, chairman of the Cayman Islands Financial Services Association (Cifsa), warmly welcomed the OECD’s decision to move Cayman to the white list – but there was a note of sarcasm in his comments too.

“We are pleased to see that Cayman’s position on tax transparency has now been recognised by the OECD. It is clear that the results achieved by Cayman Islands government in completing the [agreements] and the ongoing initiative remove any basis on which legitimate criticism can now be levelled at the Cayman Islands on the subject of tax transparency. That should also exclude any further inappropriate reference to and mischaracterisation of the Cayman Islands as a tax haven.”

However, the Cayman Islands’ new status begs two questions. First, has it now done everything it must do to avoid the dreaded ‘tax haven’ moniker? And, secondly, is it still an interesting place to domicile hedge funds? The latter consideration is, of course, made the more piquant by the fact that under Ucits III rules in Europe it is now possible to domicile funds with many of the characteristics of hedge funds in Luxembourg and Ireland, and to then receive a European passport enabling them to be sold all round Europe.

Hedge-fund friendly
Attempts to investigate the second question immediately bring us back to the first. The Cayman Islands is commonly held to be the largest hedge fund jurisdiction in the world, and commentators say the tax-free location (I’m choosing my words carefully here) is doing just fine despite the global financial crisis and the new competition from Ucits III.

“We have 85% of the global hedge fund industry here,” says Matthew Feargrieve, partner at Mourant du Feu & Jeune. “There are around 9,200 open-ended funds registered with the Cayman Islands Monetary Authority (Cima), and around 85% of those are hedge funds.”

However, should you wish to dig deeper into the statistics, things get tricky because there aren’t really that many figures available – certainly not the kind of information about, for example, historical assets under management that would be readily available from Luxembourg or Ireland.

Peter Heaps, managing director of Carne, Cayman Islands, acknowledges that this is a problem.
“The point I make in favour of transparency is that the information should be available,” he says. “It would help the industry to remove any remaining stain of secrecy.”

Cima hears him, it would seem. The authority recently announced that it was going to look at transparency and would make more information available, though the details of this initiative are not yet known.

“There’s going to be an industry consultation,” says Heaps. “But whatever information becomes available the authority has stated its intention to make the industry more transparent.”

That aside, can Cayman Islands still cut the mustard as a hedge fund domicile with the likes of Luxembourg and Ireland barking at its heels? Feargrieve says it can.

“The problems of 2008 have left a lot of people burned,” he says. “Fund managers tell me that clients are saying they want to move to a more regulated jurisdiction. This is an ill-informed decision. Over the past five years, the more regulated jurisdictions like Luxembourg and Ireland have started to move towards a Cayman regulatory model.”

Luxembourg and Ireland are not really any more regulated that Cayman, says Feargrieve, just different. Establishing that in people’s minds is “a battle of perceptions which the Cayman Islands has to win”.

But there’s a problem with that. Whichever way one looks at it, a key selling point of the Cayman Islands has always been its hedge-fund friendly regulation. If Luxembourg and Ireland have moved towards a Cayman regulatory model, wouldn’t they be just as good as the Cayman Islands – and with the added advantage of offering a European passport?

Carne’s Heaps acknowledges that Luxembourg and Ireland do represent a threat. “The fact that many alternative strategies can be deployed within Ucits is a competitive challenge,” he says. “It provides the investment management community with an alternative.”

Perhaps both jurisdictions have a place in the market. Larger managers may want to have a fund range in Cayman that is targeted at wealthy people and another range in Luxembourg with a more retail focus.

But even though Cayman may have the disadvantage of being thousands of miles away from the European client, and be dogged by the dubious tax-haven status, these days it is arguably at much less of a disadvantage to Luxembourg in the sense of regulator robustness than in the past. Thanks for this go to Bernard Madoff.

Feargrieve says: “People think that because we are offshore we must have had exposure to Madoff, but none of his funds were registered here. If Luxembourg is so well regulated how did Bernie Madoff come to register funds there?”

How indeed? It’s perhaps worth remembering that Luxembourg itself was only removed from the OECD ‘grey list’ on 8 July 2009. Belgium was removed on 24 July, and Austria and Switzerland are still there. Feargrieve suggests Madoff couldn’t have pulled the tricks he did in Luxembourg in the supposedly light-touch Cayman Islands.

“A Cayman fund has to submit audited accounts as well as appoint a custodian and administrator,” he says. “Madoff did not have an independent auditor. It would have been almost inconceivably difficult for him to set up a fund or a feeder fund here without the alarm bells ringing.”

In any case, Feargrieve believes the risk inherent in a hedge fund lies not in where it’s domiciled, but in what the manager does with it.

“The main risk sits with the manager,” he says. “The manager puts on the trades, decides on leverage and the investment style to be used. The manager may be in London or Greenwich, USA, yet it is the regulation of the manager that fell down, not of the off-shore fund.”

At the same time, he also believes that Cayman Islands-domiciled funds are not for the faint of heart. “The Cima principle is caveat emptor. If an investor is big enough to invest in a Cayman Islands fund, it is big enough to look after itself,” he says.

Otherwise Cayman’s advantages lie in other values, such as speed to market, cost-effectiveness and availability of quality service providers. The available master-feeder structure is also a draw, suggests Heaps, since it can provide investment opportunities for US taxable investors as well as non-taxable
US investors.

“Cayman doesn’t have a unique selling point,” says Heaps. “It’s wrong to suggest that managers should always come to Cayman. What we advise is that a manager looks at what it intends to do and then makes an informed decision as to where to domicile a fund.”

When it comes to a comparison with Luxembourg and Ireland, Cayman can offer the full gamut of alternative strategies whereas the European domiciles under Ucits III can’t. Ucits III funds can’t, for example, short sell, though they can replicate shorts synthetically.

Time will tell whether Cayman can win the battle of perceptions identified by Feargrieve. The Cima appears to be addressing proactively the remaining issues, such as information transparency, but in a nervous post-financial crisis world, institutional investors in particular may prefer the comfort of a jurisdiction such as Luxembourg or Ireland unless they can be convinced that, as Feargrieve suggest, they have made an ill-informed decision.

The myth about Cayman certainly persists. “A lot of dirty money is laundered via tax havens like Mauritius and the Cayman Islands and their source is not easily verifiable,” wrote a Times of India columnist as recently as 20 August this year. 

At the same time, the bell has tolled for tax havens, as evidenced by the Swiss government’s recent settlement with the US Internal Revenue Service (IRS), whereby UBS AG will turn over to the IRS the identities behind 4,450 secret accounts held by wealthy Americans. Accordingly, Cayman is reinventing itself and there’s no reason why it shouldn’t succeed.

“Shutting down offshore tax jurisdictions is misguided,” says Heaps. “What is appropriate is to stop them allowing money laundering or tax evasion, which is exactly what Cayman Islands has done.”

Feargrieve, at Mourant du Feu & Jeune is keen like many other Cayman Island businesses to “destroy the myth that offshore jurisdictions help people avoid tax”.

“The offshore fund is simply a tax-transparent pooling vehicle,” he says. “The Cayman Islands has no tax regime, so funds do not pay tax, but tax is still paid in the investor’s home country. We just ensure that investors do not pay tax twice.”

©2009 funds europe

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