A strong legal and regulatory system is the necessary foundation for jurisdictions that want to succeed in the global financial services economy due to the intense sophistication of institutional investors, expanding global standards and vigilant regulatory scrutiny. The Cayman Islands exemplifies this kind of system thanks to a continuing focus on stability, transparency and innovation.
Stability is not only a key consideration for potential investors, it is also a hallmark of the Cayman Islands political, legal and regulatory system. As a British Overseas Territory, the Cayman Islands is a steady democracy whose financial services' legal framework extends back decades.
Cayman maintains the use of UK common law and its judicial system's ultimate appellate court is the UK Privy Council, which is true for a number of International Financial Centres (IFCs). However, after decades as a leading IFC, Cayman's legal and judicial practitioners also have significant expertise in dealing with complex financial services transactions, laws and regulations. The consistent function of Cayman's political and judicial system gives investors the confidence they want to invest through Cayman-domiciled structures.
That confidence is further enhanced by Cayman's globally accepted adherence to international standards for transparency. A key component of Cayman's embrace of transparency is its pure tax neutral regime.
When institutional investors evaluate using an intermediate jurisdiction like an IFC, they want certainty that their investments will not be undermined by double taxation. Some IFCs have chosen to try to provide that certainty through the use of Double Tax Treaties. However, the Double Tax Treaty system is complex and frequently opaque, which can increase investors' concerns about risks and certainty, as well as the administrative costs for compliance.
The Cayman Islands utilises a policy of pure tax neutrality to eliminate the threat of double taxation in the most transparent way possible. This policy automatically alleviates double taxation by allocating all of the taxing rights to an investor's or parent entity's home jurisdiction. That jurisdiction is then free to impose its domestic tax policy on the cross-border transactions or subsidiary's retained profits with Cayman as it sees fit without the need for a Double Tax Treaty. Unlike the complexity of a Double Tax Treaty, Cayman's pure tax neutral regime transparently provides certainty by having the same stated and effective tax rates.
Cayman's longstanding commitment to transparency is further reflected in its leadership on global transparency standards. As a progressive jurisdiction, Cayman was among the first to agree to share tax information about investors with tax authorities under the OECD's Common Reporting Standards and the EU Savings Tax Directive, as well as the US' Foreign Account Tax Compliance Act. The Cayman Islands also has in place tax information exchange agreements with 36 other countries. This information sharing enables more effective tax collection by other countries.
For nearly 20 years, Cayman also has maintained a beneficial ownership regime that requires investors to have personal information collected and verified by licensed corporate service providers under laws with strict civil and criminal penalties – a model the UK is considering to maintain its overseas entities register. Information can be provided quickly to tax and law enforcement authorities and Cayman has committed to a public register by 2023 in line with evolving global standards.
The Cayman Islands' adherence to current and emerging legal and regulatory standards was tested recently at the same time the jurisdiction was managing the outbreak of COVID-19. The Cayman Islands was among the nearly 100 jurisdictions assessed by the Economic and Financial Affairs Council (ECOFIN's) Code of Conduct Group and initially was considered cooperative on transparency and fair taxation. Throughout the EU's process, the Cayman Islands Government – with complete support from the Cayman Islands financial services industry – fully and transparently engaged with the COCG and ECOFIN. Thanks to that engagement, and some initial legislative actions, ECOFIN chose not to add Cayman to the blacklist in 2018 but did flag a concern about economic substance rules for Cayman's funds industry.
Cayman's engagement with the EU to address concerns about economic substance expanded throughout 2019 and 2020 and included some significant changes:
- The implementation of an enhanced AML/CFT supervisory regime for Registered Persons, formerly Excluded Persons, under the Securities Investments Business Act;
- The enactment of the Private Funds Act, which resulted in 12,695 new private funds registrations as of 31 December 2020;
- The Mutual Funds (Amendment) Act which now requires funds with 15 investors or less to be regulated by the Cayman Islands Monetary Authority (CIMA). Prior to the commencement of this Act in February 2020, these funds were exempt from licensing and registration;
- The Mutual Funds (Annual Returns) (Amendment) Regulations 2020, which outline additional information required by regulated mutual funds which will assist CIMA in attaining the requisite information for macro-prudential supervision;
- A total of 19 legislative changes to position the Cayman Islands to meet the emerging global standards for economic substance for collective investment funds.
The Cayman Islands' legal and regulatory regime passed this test under the most difficult circumstances. The EU recognised Cayman's willingness to update its legal and regulatory framework to stay current with emerging global standards and ensure its tax neutral regime does not pose tax harm to other countries. This decision is consistent with the assessment of other respected entities like the OECD.
The Cayman Islands legal and regulatory system demonstrates a vibrant innovation on two fronts. The first is the kind of modernisation reflected above in steps taken to meet evolving standards while still enabling a vibrant investment climate. The other is steps Cayman takes to create a strong legal framework to anticipate and match industry creativity.
Among the most notable examples of this kind of legislative and regulatory innovation was the creation of the Cayman Islands LLC. While the LLC had been a common vehicle for US fund managers to use, very few IFCs offered this kind of structure – and none of those played as pivotal a role in global funds. Cayman saw the opportunity in the market and developed and passed legislation to create a new Cayman Islands LLC for use by managers and investors when structuring funds in Cayman. It has subsequently been widely utilised in the funds market.
More recently, the Cayman Islands established new legislation and regulation to enable the use of digital assets. Effective October 2020, the Virtual Asset Service Providers Act requires entities wishing to provide related services to be registered with CIMA. According to CIMA, this regulatory framework will be implemented in two phases: a registration and notification process, which ended on 31 January 2021, and a licensing and approval process that will begin once the appropriate aspects of the Act come into effect.
The success of the Cayman Islands' legal and regulatory regime, and the appropriate balance it creates between efficient business and effective oversight, is reflected in Cayman's leadership among IFCs. Increasingly, financial services firms and family offices relocate to the Cayman Islands to benefit from its optimal infrastructure ecosystem that supports world class financial services.
Despite the severe challenges resulting from COVID-19, the Cayman Islands Financial Services Industry was resilient and prospered. According to the latest CIMA statistics, there were 24,591 regulated funds as of December 2020, compared to 10,857 the previous year. This significant increase is largely due to the required filing for private funds and limited investor funds but the overall numbers reflect a strong industry.
The Cayman Islands Financial Services Industry is also diverse. The Cayman Islands' insurance industry also maintained an upward trend and remains the world's leading domicile for healthcare captives and the second largest for captives. CIMA statistics show that the Cayman Islands is home to 771 insurance licensees and in 2020, 36 new international insurance companies were added to the market, compared to 33 a year before. New insurer formations included 30 captives, four insurance-linked securities and two Class 'D' reinsurers.
Investors choose Cayman because they know that such a well-regulated environment is the best location to pool their capital and seek global investment opportunities to generate good returns for their investors, including pension funds and the pensioners they serve. According to the 2019 Investments Statistical Digest, Total Gross Assets in Cayman increased by 10 per cent and Reported Net Income was US$451 billion compared to the loss of US$30 billion the previous year. According to CIMA, "These activities represent a steady growth in overall assets managed by Cayman-based funds, confirming Cayman's position as the leading jurisdiction for establishing offshore investment funds".
Where To Next?
Maintaining a global leadership position is a constant effort to keep pace with legal and regulatory changes and the Cayman Islands is meeting the challenge head on. This year, Cayman will hold elections for its parliament, once again demonstrating the stability of its democratic system. Although Cayman's political landscape is competitive, there is widespread support for maintaining the strength of our financial services industry.
Cayman has made excellent progress in keeping pace with assessments of its Anti-Money Laundering/Combatting Financing of Terrorism legal and regulatory regime, having addressed 60 out of 63 recommended actions by the Financial Action Task Force (FATF). However, three recommended actions remain and Cayman will be cooperating further with the FATF under enhanced monitoring to ensure they are dealt with successfully.
The Cayman Islands will also expand its commitment to innovation in the global financial services market by developing a virtual asset framework that captures coin issuances, trading platforms, exchanges and sandboxes. CIMA will lead this effort in collaboration with industry and will include new definitions for how this new framework fits into the existing regulatory regime and implementation of the necessary support infrastructure.
The Cayman Islands' continued commitment to a legislative and regulatory framework focused on stability, transparency and innovation is positioning our jurisdiction and our industry for continued leadership well into the future. Although challenges to leading IFCs continue to develop, we are confident that the Cayman Islands' strong foundation will enable it to successfully meet them.
Originally Published by IFC Review.
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