ARTICLE
15 November 2000

A New Off Shore World

Bermuda Wealth Management

Coordinated initiatives against the offshore world will continue to reshape the private client investment industry in all tax-neutral centres. On shore agencies making such initiatives include: The Group of Seven, the Organization for Economic Co-operation & Development, the Financial Action Task Force and the US Internal Revenue Service’s "Qualified Intermediary". Despite bravado by some smaller jurisdictions indicating they plan to ignore the wishes of these agencies, it has become apparent that in today’s global, interdependent economic world "no island is an island". Sooner or later, all offshore jurisdictions will accept G7 dominance over global financial affairs and come to terms with these initiatives. In the interim, further stratification is expected between legitimate "white list" countries and illegitimate "black list" jurisdictions.

It seems manifestly unfair that offshore financial centres are being requested to adopt rules and regulations that are in many cases not matched by the onshore financial world within the G7. These standards and double standards will result in substantial changes in the legal environment of all reputable offshore jurisdictions. Thus, we expect the regulatory and supervisory environment in offshore centers to change radically, moving from the existing predominately "gatekeeper" regulations (that governed who was involved in offshore services), to "defined" regulation (that emphasizes what companies are allowed to do, with whom and with what minimum capital, systems, personnel and experience). Jurisdictions that choose to ignore these G7 impositions will find that their financial institutions have increasing difficulty in keeping counterparty relationships with onshore financial institutions intact.

A New and Improved Industry

These changes will affect both the nature of business done offshore and the minimum effective size of companies. Over the past ten years, with the falling cost of telecommunications, computer systems and software, there have been many new start-ups in the offshore investment industry. On numerous occasions market professionals physically relocated to offshore jurisdictions and opened investment firms. Many of these firms made extensive use of onshore service providers to perform everything from security execution, to custody, to valuations, to the production of account statements. Of course, this meant that these service providers could not be thought of as "truly offshore" as most of their client records and files existed on onshore databases.

The traditional advantage to the principals of these "front office only" companies was that they could operate offshore with few support staff and little capital. This advantage has turned into a disadvantage, as many of these small businesses have found it increasingly difficult to meet all the legislative and regulatory requirements of the new offshore environment. "Front office only" companies do not have the scale or scope of operations to support the professional staff required in the compliance, legal, information technology and accounting departments.

The result will be a concentration of the investment business into fewer larger companies with robust operational and professional depth and strong capital. This phenomenon will be beneficial to the emergence of a more sustainable offshore investment industry with the capital and expertise to offer a greater range of products and services -- while at the same time accepting the challenge to maintain the flexibility and innovation demanded by mobile capital flows.

The Future

During the coordinated onshore attacks on the offshore world, with their charges of "unfair tax competition", there have been many comments that this is the end of the offshore financial sector. This is not the first time that the death of this sector has been propounded. Over the past 50 years, currency controls, changes in trust legislation, grantor and gift taxes, CFC and PFIC rules, restrictions on cash movements and increased reporting requirements on individual tax returns all, when implemented, caused concern that it would mean the end of the offshore industry. Despite these threats, the sector is larger, more diverse and the amount of assets offshore is greater than ever. We are convinced that these forced changes to our offshore environment will certainly alter the manner of the private client financial industry but it will not stop the growth of it, and will engender the emergence of an even stronger larger industry. The G7 initiatives referred to above will mean that offshore investment firms and jurisdictions that service the international private client will have to become far more sophisticated and knowledgeable about onshore taxation regimes, insurance linked tax shelters and asset protection structures.

The New Opportunities

For high net worth individuals and their onshore professional advisers the stakes have been raised when doing business offshore—in particular, there will be higher rites associated with doing business in jurisdictions and with institutions that are not "truly offshore". There is now a significant premium on ensuring that the jurisdiction one chooses has not only a sustainable legal environment, but is governed and regulated in such a way as to enable it to be on effective participant in the global financial system. Additionally when choosing a truly offshore provider of investment services one must ensure it is small enough to provide service and flexibility and yet large enough to have the capital, independent systems, personnel and operational depth to meet and stay ahead of the challenges presented by the new offshore environment. Due diligence is the key to ensuring this outcome and thus it is most important that onshore professional advisors and their high net worth clients take the time and trouble to not only visit offshore jurisdictions but ask the right questions of the companies they envision working with.

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