Cayman Islands: Anti-Money Laundering Review

The Cayman Islands maintains a robust anti-money laundering regime, which it began implementing as early as 1984. The creation of the Cayman Islands Monetary Authority ("CIMA") in 1996 put in place a central regulator ensuring that financial services continued to meet international standards.

Following the Organisation for Economic Cooperation and Development ("OECD"), Financial Action Task Force ("FATF") and Financial Stability Forum ("FSF") initiatives and the KPMG Report, there was an unprecedented flurry of legislative activity, which updated the statutory framework to meet the highest international standards. This effort was recognised by confirmation on 21 June 2002 that the Cayman Islands had addressed all previous deficiencies and no longer required non-cooperative-jurisdiction monitoring by FATF.

Regulation in the Cayman Islands continues to evolve and whilst the jurisdiction is keen not to diminish the flexibility of its regulatory system, it recognises that a proactive approach is required in order to maintain its standing as a leading financial centre.

The recent accounting scandals in the US, terrorism and challenging economic conditions onshore guarantee that offshore centres will continue to be scrutinised, starting with a financial sector assessment programme launched by the International Monetary Fund ("IMF"). The IMF is scheduled to visit the Cayman Islands in May 2003.

The Cayman Islands has two principal industries – tourism and financial services. The forecast recurrent revenue for the territory for the first six months of 2003 is US $225 million, of which approximately US $60 million is directly attributable to the financial industry. A further US $65 million is raised by duties (primarily import duty) and further significant amounts are raised by work permit fees. A substantial proportion of both duties and work permit fees is referable to the financial services industry.

The Cayman Islands is a very small territory with a population of just over 40,000. Accordingly, potential money laundering risks are primarily limited to the misuse of the financial system.

Suspicions are sometimes aroused when it is disclosed that banks in the Cayman Islands have in excess of $900 billion in assets. However, only seven per cent. of the assets in Cayman's banking sector are derived from transactions between a bank and its individual customers. Ninety-three per cent of banking assets in the Cayman Islands are generated by transactions occurring between institutions, the majority being between major international banks. The world’s top international banks use Cayman Islands branches or subsidiaries for a number of reasons, including:

1. better access to the eurodollar market;
2. more tax efficient funding structures;
3. low reserve requirements;
4. cost-effective administration provided by licensed and well-regulated "Class A" banks.

HSBC, UBS and Barclays are examples of international financial service providers with long-established Cayman Islands subsidiaries or branches. The Cayman Islands branches are well regulated as the main branch is subject to regulation in its onshore jurisdiction and the sub-branch is regulated in the Cayman Islands. Moreover, these branches cannot be established in the Cayman Islands without the consent of the regulator in the onshore jurisdiction, such as the Federal Reserve in the US and the FSA in the UK.

The perceived risk of the misuse of offshore corporate vehicles in facilitating money laundering is evidenced by the OECD report issued on 27 November 2001, "Behind the Corporate Veil: Using Corporate Entities for Illicit Purposes". In response to this report, the International Tax and Investment Organisation and the Society of Trust and Estate Practitioners issued a rebuttal report entitled "Towards a Level Playing Field", which outlined the weaknesses of the OECD report. The fact is that the formation and maintenance of companies in the Cayman Islands is a licensable activity with each service provider being subject to regulatory supervision, including onsite inspections by the regulator.

In May 2000 the Cayman Islands gave a letter of commitment to the OECD relating to alleged harmful tax competition. Under the letter of commitment, the Cayman Islands Government will implement a plan to share bank account information with foreign Governments that are conducting criminal tax evasion investigations for the first tax year after 31 December 2003, and on civil and administrative tax matters for the first tax year after 31 December 2005.

On 27 November 2001 the Cayman Islands entered into a tax information exchange agreement with the US. The agreement is structured to conform with the Cayman Islands’ OECD commitment of May 2000. The implementation procedure will require that information be provided only in response to a specific request which is relevant to a tax examination or investigation conducted in accordance with the laws of the requesting state. Requests will be submitted by foreign tax authorities to a competent authority in the Cayman Islands who will act in a capacity similar to that in which the Cayman Islands Chief Justice has acted pursuant to other international information exchange agreements. Confidentiality provisions will ensure that information that has been exchanged is adequately protected from unauthorised disclosure.

It is likely that there will be further bilateral tax information exchange agreements. However, the Cayman Islands Government has made it clear that it will not enter into any agreements with countries that have legislation discriminating against the Cayman Islands.

What has become known as the Savings Directive is part of a package of measures by the European Commission to tackle "harmful tax competition" in the European Union. It is designed to address the ability of "residents of Member States …. to avoid any form of taxation in their Member State of residence on interest they receive in another Member State".

The current form of the Savings Directive is a compromise solution following the failure of Member States to agree on the original proposal for the imposition of withholding tax on interest payments (which would have had a serious effect on the Eurobond market in London). In implementation of the requirement that Member States "promote the adoption of the same measures" in their dependent or associated territories, the UK Government has committed its Caribbean dependent territories, including the Cayman Islands, to their adoption and has threatened to "legislate" for them.

The Savings Directive requires the reporting of certain information relating to interest payments (including dividend payments by certain investment vehicles whose investments in debt instruments exceeds a certain percentage) to individuals resident in Member States. That information is to be provided by the paying agent (essentially, the last intermediary in a chain of intermediaries), who is also responsible for determining the residence of the payee.

The Cayman Islands Government is concerned that any application of the Savings Directive to the Islands, without equivalent application to their competitors, will result in little benefit to the European Union at a disproportionate cost to the Islands. The UK Government is aware from its own regulatory impact assessment that implementation of the Savings Directive will result in significant additional costs to both the public and private sectors in the UK, and the same will undoubtedly be true in the Cayman Islands.

The Cayman Islands has declined to commit to the implementation of the measures in the Savings Directive, and is now bringing legal proceedings to challenge the legality of certain aspects of the Savings Directive.

The Confidential Relationships (Preservation) Law (1995 Revision) makes it a criminal offence, subject to a number of exceptions, for any person who obtains confidential information during the course of business to divulge such information to a third party. However, the Mutual Legal Assistance (United States of America) Law (1999 Revision) implemented in the Cayman Islands is a bilateral treaty between the UK and the US and provides the legal machinery whereby the US can request, through the MLAT Authority (currently the Chief Justice of the Cayman Islands), the disclosure in connection with the investigation or prosecution of criminal activity, of information which would otherwise be confidential.

The Monetary Authority (Amendment) (International Cooperation) Law 2000 enabled the Cayman Islands Monetary Authority ("CIMA") to access and share information with overseas regulators (subject to a number of safeguards), including in appropriate regulatory circumstances, information regarding the identity of customers.

1. Misuse of Drugs Law (2000 Revision).
2. Misuse of Drugs (International Cooperation) Law (2000 Revision).
3. The Proceeds of Criminal Conduct Law (2001 Revision):

1. Proceeds of Criminal Conduct (Designated Countries) Order 1997;
2. Money Laundering Regulations, 2000;
3. Proceeds of Criminal Conduct (Amendment) (Financial Intelligence Units) Law, 2001 (Law 7 of 2001);
4. Proceeds of Criminal Conduct (Designated Countries) (Further Designation of Countries) Order, 2001;
5. Money Laundering (Amendment) (Client Identification) Regulations, 2001;
6. Money Laundering (Amendment) (Electronic Payments) Regulations, 2001;
7. Money Laundering (Amendment) Regulations, 2001;
8. Money Laundering (Amendment) Regulations, 2002;
9. Money Laundering (Client Identification) (Extension of Period) Order, 2002.

The Misuse of Drugs Law, the Misuse of Drugs (International Cooperation) Law, the Proceeds of Criminal Conduct Law (the "PCCL") and the Money Laundering Regulations (the "Regulations") comprise the base of the anti-money laundering legislation. The Regulations apply to all financial service providers conducting "relevant financial business".

It is important to note that "relevant financial business" is not limited to those activities requiring licences but extends to other financial activities including real-estate business, money transmission services and relevant legal services.

The Regulations require anyone engaged in relevant financial business to have in place systems and training to prevent money laundering. In particular, procedures must be in place for:

1. identification of clients;
2. keeping records of evidence of client identification;
3. reporting of suspicious transactions;
4. internal controls and communication;
5. employee anti-money laundering training.

The PCCL and the Regulations provide that a person is guilty of a criminal offence if in the course of his trade, profession, business or employment he knows or suspects that another person is engaged in money laundering and he does not disclose to the Financial Reporting Unit the information on which his knowledge or suspicion is based as soon as reasonably practical.

Protection is provided for the breach of rules of legal privilege, and for breach of any other law arising directly from the reporting of such a suspicion.

To supplement the legislation, CIMA and the professional associations engaged in financial services have issued the Guidance Notes on the Prevention and Detection of Money Laundering in the Cayman Islands (the "Guidance Notes"). These aim to provide consistency in the interpretation and implementation of the Regulations in relation to the key areas of:

1. client identification and verification;
2. record-keeping procedures;
3. internal reporting procedures;
4. reporting of suspicious transactions and staff training;

and they represent the financial services industry best practice.

The Guidance Notes will be taken into account by the courts in determining whether a person conducting relevant financial business has complied with the Regulations; however, they should not be relied upon in respect of points of law. Reference for that purpose should be made to the appropriate legislation. The Guidance Notes are available on CIMA’s website at www.cimoney.com.ky.

In February 2000 FATF issued criteria for identifying non-cooperative countries and territories. This was followed by a report during June 2000 in which FATF cited the Cayman Islands for the absence of certain legislative elements required by anti-money laundering criteria.

All of these areas have since been addressed. Legislative action has been taken to ensure that many of the guidelines, which existed previously within a "Code of Practice", have become legal requirements.

Following two rounds of mutual evaluation, FATF concluded on 21 June 2002 that the Cayman Islands has addressed all Recommendations requiring "specific action" and restored it to "cooperative" status.

FATF decided in October 2000 to begin a review of the Forty Recommendations. At the end of March 2002 a consultation paper was issued and this document was open for comment until 31 August 2002. These comments are available for review on the FATF website. Invited representatives of non-FATF countries and jurisdictions, the financial and other affected sectors and other interested parties met during October 2002 to discuss the proposals. All views received are still being considered. The FATF has also adopted Eight Special Recommendations against terrorist financing. These recommendations have been developed in addition to the existing Forty Recommendations.

In January 2002 FATF member jurisdictions completed the first phase of a self assessment exercise and all countries have been invited to participate on the same terms as the FATF members.

There are two bodies responsible for financial services regulation in the Cayman Islands. These are the Cayman Islands Monetary Authority and the Stock Exchange Authority. CIMA is responsible for the day-to-day supervision of banks, trust companies, mutual funds, mutual fund administrators, insurance and company managers.

The Stock Exchange Authority is responsible for the regulation of the Cayman Islands Stock Exchange ("CSX") including the approval of any rules that the CSX wishes to introduce.

CIMA is a statutory agency created by the Cayman Islands Government and is a top-quality regulator that aligns itself with "best practice" standards at an international level. CIMA adopted a strategic initiative to upgrade supervisory standards by implementing onsite inspections in 1998. The inspections are intended to improve regulatory efficiency and effectiveness.

Onsite work includes a review and assessment of an institution’s:

1. risk-management policies, procedures and control environment; and
2. compliance with laws, regulations and supervisory directives.

During the inspection individual transactions are tested to evaluate the effectiveness of the controls, and they are risk profiled using international benchmark standards such as the Basel Core Principles and the International Association of Insurance Supervisors’ Principles.

Following through on its prior commitment, the Cayman Islands Government passed the necessary legislation which became effective on 22 January 2003 for CIMA to become an independent regulatory authority. This action has satisfied one of the key recommendations made by KPMG in its 2000 Review of Financial Regulation in Caribbean Overseas Territories and Bermuda.

The Financial Reporting Unit ("FRU") is comprised of experienced and senior officers of the Royal Cayman Islands Police ("RCIP"), who form an integral part of the anti-money laundering system.

The FRU is a stand-alone unit that reports directly to a committee consisting of [senior members of the Cayman Islands Government and] the Attorney General.

The FRU is responsible for receiving suspicious activity reports ("SARs") and investigating and prosecuting money laundering offences. It also undertakes all international enquiries, deals with international requests for assistance (from the Chief Justice and the Attorney-General’s office) and routinely carries out vetting for CIMA.

Under existing laws, the Cayman Islands has cooperated, through the FRU, on an "all crimes" basis, exchanging information with other jurisdictions in the fight against international crime.

On 13 June 2001 the FRU was admitted to the Egmont Group of Financial Intelligence Units, an international organisation that includes approximately 69 similar agencies.

The FRU has recently come under scrutiny as a result of the collapsed Euro Bank case, and it is likely that some restructuring will take place in the near future. However, the role of the FRU as an important part of the anti-money laundering system remains unquestioned.

On 25 September 2002 the Government of the Cayman Islands pledged its support to the US authorities. This pledge was rapidly followed by a proposal from the Attorney-General for the introduction of comprehensive legislation to deal with terrorism and its financing.

The legislation has been drafted and is currently under review by the Attorney-General. It is expected to:

1. provide a definition of what constitutes "terrorism"; and
2. address the issues surrounding the sources of financing of terrorist acts.

Current anti-money laundering legislation is directed at criminal activity involving illegal proceeds of crime and allows for the freezing of such assets. To stop terrorism it is necessary to stem the flow of funds, some of which may well be from legitimate sources.

www.cimoney.com.ky

www.caymanfinance.gov.ky

www.camlg.org.ky

www.oecd.org

www.ustreas.gov

Guidance Notes on the Prevention and Detection of Money Laundering in the Cayman Islands.

The Cayman Islands Anti-Money Laundering Group ("CAMLG").

The Cayman Islands Compliance Association ("CICA").

The International Tax and Investment Organisation.

The Society of Trust and Estate Practitioners.

The Cayman Islands Government Statistics Office.