How offshore centers benefit the world economy

The commercial success of offshore financial centers has received a lot of attention, particularly over the past 10 to 15 years, much of it relating to debates on a range of tax and regulatory issues. But far less (in fact almost none) attention has been given to the contribution of jurisdictions like the Cayman Islands to the global economy. The best way to understand the overall economic benefits of an offshore financial service is to take a closer look at the direct commercial benefits. If it is good for the individual institution (which is typically based primarily in an onshore/Organisation for Economic Co-operation and Development (OECD) economy) and the transactions are law-abiding, then it is also likely to be driving a wider economic benefit onshore. Here are a few examples:

International banking

The offshore bank is one of the more traditional products offered in the Cayman Islands. Benefits of operating offshore banks include the absence of capital gains tax or taxes on bank transfers, and no exchange controls. Practical uses of an offshore bank include use by a major international corporation to carry out various treasury functions and dealing with foreign currency transactions. Multinational banking groups also use their offshore branches or subsidiaries to issue international debt, as it is easier and cheaper for banks to issue bonds, CD’s, TD’s, etc., which are then sold to investors. These efficiencies have a direct benefit to consumers because the funds raised can then be utilized to finance other activities within the banking group, making their cost of funding lower and enabling the banks to lower the interest charged to customers. In some cases an offshore bank has also been used to execute the joint financing for a large international business venture.

There are other benefits to offshore banking. In fact the International Money Fund (IMF) acknowledged the importance of offshore banking in a report in 2000 saying “Wealthy individuals and enterprises in countries with weak economies and fragile banking systems may want to keep assets overseas to protect them against the collapse of their domestic currencies and domestic banks....” In some cases, fear of wholesale seizures of legitimately acquired assets is also a motive for going offshore. (Report on Offshore Centers, IMF background paper, 2000).

Captive insurance

Captive insurance companies are insurance companies that carry risk originating usually from its owners or affiliates. The owners of captive insurance companies typically do not originate in the insurance business. Captives are normally set up because owners are unable to obtain a certain type of insurance coverage onshore via commercial insurance companies or are unable to obtain it at a reasonable rate.

Consider the case of a large hospital network in the United States that has a favorable loss history and superior risk management procedures as compared to other hospital groups within the industry. It may not be able to secure the insurance coverage with the corresponding cheaper premiums (which it should qualify for) because the traditional commercial insurance company has a “one size fits all” approach.

This hospital group can secure the option of setting up its own captive insurance company in the Cayman Islands. This type of self-insurance enables it to have a range of direct commercial benefits, such as flexibility in the structuring of the policy and the timing of premium payments among others. More importantly it enables a major medical group, which operates in the United States, to secure the type of insurance it needs at more efficient rates. This can bring significant benefits not only to the group but to clients of the hospital, as savings can be passed on or certain types of services can now be offered by the hospital because they can now access the appropriate type of insurance.

The captive insurance solution can also play a key role in insurance markets within the U.S. that may have hardened due to a major catastrophic event, such as Hurricane Katrina. A hardened market is often characterized by higher premiums and, in some cases, the outright refusal of certain U.S.-based insurance companies to offer various forms of insurance coverage. The offshore captives therefore can greatly help in the economic recovery after such a disaster.

Healthcare captives have in fact been an important reason for the successful development of the Cayman Islands as a captive insurance jurisdiction. And captive insurance services are available not only in other offshore centers, such as Bermuda, but have also gained increasing prominence onshore in places in the U.S., such as in Vermont and North Carolina.

Captives therefore have a positive impact on the commercial viability of major institutions not only in the United States but in other economies around the world. In addition to ensuring access to critical insurance, the operational efficiencies that are gained positively impact employment levels in the states and countries where they operate and directly influence the amount of expenditures within these communities as a result of the wages of their employees.

Securitization

The Cayman Islands is known to have a significant market share in the area of special purpose vehicles (SPV) for structured finance transactions. The jurisdiction is widely known as a domicile of choice for aircraft finance and securitization. One of the key attractions of the Cayman Islands for SPVs is that its legal system is well known as a creditor-friendly jurisdiction from a recognition of security and insolvency perspective. This enables investors and rating agencies to be comfortable that the transaction will be treated as contemplated in the documents and, upon a default, the deal will be “ring fenced” and the assets protected for the benefit of the investors.

In this case, the onshore corporation may assign by true sale a set of assets such as a portfolio of mortgages to the offshore SPVl, which in turn offers a variety of securities to investors, based on these underlying assets (in effect securitizing the mortgage portfolio).

As an example of value added in this area, in 2007 two German banks utilized a Cayman SPV, which assisted Indian Airlines with the financing for 10 Airbus A-320 aircraft as part of a larger arrangement for the airline to purchase 43 aircraft for a value of 2 billion.

In a commercial transaction that benefited both the airline and the Indian economy, the SPV enabled collateral for the loan of $500 million that the banks loaned to Indian airlines to be paid back over a period of 12 years.

The range of financial activities encompassed by structured finance transactions is broad, but many of them have the distinguishing feature of using the offshore SPV to access the international capital markets for the benefit of onshore corporations in the United States and elsewhere. This access provides a significant benefit to these economies. These structures also provide access to cheaper funding that is available by way of banking and quasi-bank funding, thereby substantially reducing costs of car loans, mortgages, airline tickets, and credit card receivables, to name but a few categories for domestic consumers.

Hedge funds

There are other areas whereby offshore centers facilitate the global economy. The hedge funds industry, which has come under attack with the fallout in global markets, has nonetheless played an important role in the world economy for many years. The Cayman Islands, as the leading domicile for hedge funds, has facilitated hundreds of billions of dollars of investment into OECD-based economies, such as the United States, using offshore hedge funds. These funds enable investors from countries around the world to participate in a tax-neutral venture for the purpose of investing in major projects in economies, such as the United States. Hence, contrary to popular opinion, there is effectively no true “capital flight” from OECD economies as a result of offshore centers. In fact when one follows the path of funds in a typical hedge funds transaction, it shows that offshore centers actually facilitate major inward capital flows into OECD-based economies from various global investors.

The economic benefits of offshore centers to the global economy are significant and long-lasting. The ability of a country to secure the necessary investment into major infrastructure, such as roads via securitizations or the availability of insurance coverage to major hospital groups, is a distinct economic advantage.

The ability of offshore centers to preserve and protect wealth is also an important value-added service to many countries. Jurisdictions like the Cayman Islands have done their part in meeting the various global international regulatory standards. Even if recognition is still lacking in this area, their direct positive contribution to the global economy is hard to dispute.

Paul Byles is Managing Director of Focus Corporate Services & Consulting. He is a former regulator who has worked in the offshore sector for over 18 years and as an economist and international consultant on offshore services and its regulation. He is author of the book Inside Offshore.