In early 2016 popular opinion on the utility and function of
offshore centres (OFCs) or, to use the more inflammatory term, tax
havens, must be close to an all-time low. The general view, stirred
up by cash-strapped governments and the media, is that the vast
majority of the world's wealth is hidden away in secret island
jurisdictions, controlled by shady businessmen and inaccessible to
the common man.
OFCs face a constant battle to justify their existence to the
general population, as few non finance professionals understand
their value and contribution to the world's economic systems.
In contrast, knowledgeable and sophisticated clients continue to
use jurisdictions such as the British Virgin Islands and the Cayman
Islands for incorporating their financing entities, as the use of
such jurisdictions facilitates and lowers the transaction and
regulatory costs of cross-border lending, enabling a wider access
to funding.
Islamic banks in particular have recognised the benefit of
arranging their financing activities through such jurisdictions.
Tax-mitigation and privacy are significant factors, but are not the
main drivers behind selection of jurisdiction for Islamic investors
and institutions. If they were, we would not see so much business
coming out of the Gulf, as the local tax regimes tend to be
favourable for local business. So why do we see so many BVI and
Cayman-incorporated SPVs in Shariah financings?
Benefits of using OFCs
There are many reasons to use an OFC in a Shariah-based
structure, the most important being reliability, efficiency and
flexibility. Business friendly OFCs benefit from having a stable
political foundation, a strong regulatory framework and a legal
system based on English law; ultimate recourse is to the Privy
Council, which provides comfort that any disputes will be
determined fairly. These jurisdictions are also committed to
adhering to international standards of transparency, investor
protection and anti-money laundering (AML); for example, the BVI
proactively participates in international measures relating to AML
regulations, information exchange, mutual co-operation and
transparency. It has entered into bilateral tax information
exchange agreements with 27 countries as well as an
inter-governmental agreement with the USA to comply with the
requirements of FATCA. Finance and legal professionals are
knowledgeable and responsive, companies can be set up very quickly
and economically and there are few restrictions on company
structures and activities. Crucially, foreign ownership and
directorship are permitted.
The use of a neutral (not just tax-neutral) OFC in cross-border
financing structures is also very much in keeping with the Shariah
principles of fairness, equity and risk-sharing. If the relevant
entities are incorporated offshore, then disputes as to governing
law and differences in interpretation are less likely and lender
and client are on a more equal-footing. An offshore vehicle is also
less at risk from issues arising from political unrest and
fluctuating commodity prices; the use of an OFC can provide comfort
and certainty to lenders, thus enabling a developing country or a
country experiencing other difficulties to attract investment where
otherwise it might not be possible. Security interests can be taken
over shares in an offshore SPV or monies in an offshore account in
cases where the laws in the sponsor's jurisdiction do not
permit this or are otherwise not lender-friendly.
OFCs have the ability to pass legislation to benefit the business
community relatively quickly. Onshore financial centres are
unwieldy in comparison, requiring a much longer and more
complicated process to amend existing laws and respond to market
forces. The BVI is constantly reviewing and updating its companies
law and recent changes to legislation have been implemented which
will, among other things, streamline and provide certainty in
lending transactions:
- the enforcement of share security has been simplified so that registered agents must effect a transfer of ownership of shares in a BVI company when validly instructed to do so by the board, irrespective of the wishes of their "client of record";
- a BVI company may go into voluntary liquidation even if there is a security interest registered against it, but the liquidator will have a duty to apply the BVI company's assets towards payment of the secured creditor;
- consent of secured creditors will be required when a BVI company wishes to continue out of the BVI;
- transaction completions have been simplified by the express authorisation to add pre-signed pages to the final form of deeds; and
- changes to a BVI company's privately-maintained register of charges must be made within 14 days of the change.
The future
The "traditional" OFCs are former British dependencies
but such has been their success in attracting nonresident business
that many other countries have passed legislation to enable them to
compete and keep investment closer to home. Key onshore Islamic
jurisdictions such as Malaysia and the GCC have replicated the OFC
model by establishing "offshore" free-zones where doing
business is simpler, less expensive and with fewer restrictions.
This trend began with the establishment of the Dubai International
Financial Centre, with Qatar and Abu Dhabi following suit with the
Qatar Financial Centre and the Global Marketplace Abu Dhabi.
Malaysia has responded with the formation of the Labuan
International Business and Financial Centre.
The UAE (Dubai in particular) and Qatar have benefited enormously
from foreign investment and immigration, thanks to the foresight of
their governments in opening up these special economic zones. But
despite the emergence of such free-zones, traditional OFCs should
continue to flourish, as some of their advantages cannot be
duplicated. They will ensure that they maintain their
market-leading position by developing and innovating, as they have
done many times in the past.
This article was originally published in Islamic Finance News.
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