• Strategy
  • The Economist

What It Takes to Succeed

For offshore financial centres, not only low taxes but a great deal besides.

These days new OFCs must invest in regulation, legislation and enforcement up front. That explains why some of the newer ones are wealthy countries that can afford to do this. Dubai, for example, has spent billions of dollars setting up the legal and supervisory systems to underpin its new financial centre. A big chunk of this money was spent on hiring regulators, mostly from Britain.

Some countries have decided that all this is more trouble than it is worth. Tonga, Niue and Nauru, three miniscule islands in the Pacific Ocean, have quit offshore banking to avoid the cost of meeting international standards, as, in effect, have the Cook Islands.

Getting Down to Business

So what does it take to run a successful OFC? First and foremost, you need a tax system that foreign capital finds attractive but still pays the bills. The model that most OFCs choose keeps corporate taxes low or does away with them entirely but makes up for this through a combination of indirect taxes and fees, which are in any event easier to collect.

Regulation, too, is critical. It must be “necessary, appropriate and proportional…and benefits [must] outweigh costs,” asserts Timothy Ridley, chairman of the Cayman Islands Monetary Authority. That applies not only to OFCs but also to big financial centres such as New York and London. The job is never easy, but a risk-based supervision regime, which most OFCs use, is more manageable in small jurisdictions because supervisors tend to know most of the movers and shakers. Moreover, in such places regulators tend to be easy to reach and take the gripes of the business community seriously. Regulators in Singapore, for instance, habitually consult local businesspeople to see how they can improve co-operation. Their clients say this is not just public relations. “They are willing to listen and change. They are not rigid like regulators in Japan and Korea,” says one banker at a British firm.

In the nature of things regulation in small OFCs can also be simpler than in big countries. In America, for instance, a national insurer may find itself being regulated by each of the 50 states. In Bermuda, by contrast, “you can focus simply on running a sound business and making money — not on red tape,” says Karole Dill Barkley, an insurance consultant.

More importantly, many OFCs are involved mainly in wholesale rather than retail business. Of the Cayman Islands’ $1.3 trillion in bank deposits, 93% are interbank bookings, not personal or corporate accounts. The 8,000-plus hedge funds domiciled in Cayman cater only to rich, sophisticated investors able to look out for themselves, so regulators do not have to worry about protecting widows and orphans and can streamline procedures. In the BVI hedge funds can be set up and registered within a couple of days.

The two pillars of Bermuda’s insurance industry — captive insurance and reinsurance — also cater to sophisticated businesses only. Captives are set up by companies (or groups of them) to lower their insurance bills by covering predictable risks themselves. British Airways, for instance, until recently had a captive in Bermuda that insured its aviation and other risks. Because no third parties are involved, regulators in Bermuda apply a lighter touch. Reinsurers underwrite part of the risks of other insurance companies. They are subject to stricter disclosure rules in Bermuda because, under many contracts, unrelated third parties are at risk.

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