THE CARIBBEAN HAS traditionally been economically dependent on agriculture and tourism. However, in recent years the financial services sector has become increasingly important.
Through a combination of economic stability and a favourable tax structure, the Caribbean’s sophisticated financial centres now attract large capital inflows. However, with tax avoidance and money laundering on the increase, many countries have become a target for international legislation. In July 2005, the implementation of the EU Tax Savings Directive and, later, the Third EC Money Laundering Directive might change the dynamics of offshore banking in the Caribbean.
The Caribbean’s largest economies are Trinidad and Tobago, Barbados, and Jamaica, each with its own currency. Since 1983 the Eastern Caribbean States (Anguilla, Antigua and Barbuda, Dominica, Grenada, Montserrat, St Kitts and Nevis, St Lucia, and St Vincent and the Grenadines) have shared the Eastern Caribbean dollar.
Much of the Caribbean’s economic success has been achieved through regional integration. Formally Carifta, the Caribbean Community and Common Market (Caricom) was established in 1973 as a Free Trade Association and now plays a central role for its 14 member states. Members include the Eastern Caribbean States, Jamaica, Barbados, and Trinidad and Tobago. Recently, the association restored ties with Haiti, after temporary suspension by the interim government.
Caricom has established the Caricom Single Market and Economy (CSME), which will enable members to trade as one market, freeing up barriers to entry and local rules, and providing an extra boost to economic growth. The Caribbean countries boast the highest gross national income per capita of all developing countries.
Barbados is one of the most stable economies. However, declining tourism revenues and increased public spending have led to a fiscal deficit of 5.6%. This year, the island expects to halve the deficit to 2.5% of GDP, which stands at US$2.6 billion, aiming to increase growth to 3% in 2004. Despite this, Standard & Poor’s has lowered the long-term foreign currency ratings, although it has maintained a stable outlook. Warrick Ward, banking analyst at the Central Bank of Barbados, explains that the rise in spending is a result of “the government embarking on a substantial investment programme in the country’s infrastructure”.
In August this year, the IMF gave a positive review of the Jamaican economy when it released its Article IV Consultation. For the first time in 10 years, GDP reached a healthy US$7.8 billion in 2003 and this year the economy has grown by 3.3%. Inflation and interest rates, although still high at 9% and 8% respectively, have dropped. The currency also stabilized in 2003. More challenging for the Jamaican government is the public debt to GDP ratio, which, at 145%, needs urgent reduction.
This year, Jamaica has issued two bonds: a government registered bond at a fixed rate of 16.85%, maturing in 2006 and a government variable rate investment bond at 1.5% above base rate, maturing in 2009/10.
In Trinidad and Tobago, Fitch reported a strengthening economy, with GDP in 2003 reaching US$10 billion.
The smaller anglophone countries in the Caribbean, the Organization of the Eastern Caribbean (OECS) with a total population of less than a million, have unified to create a common central bank and currency (ECCU). It operates under the Uniform Banking Act, and the Offshore Banking Acts. It allows for varying degrees of participation, particularly in the cases of Dominica, Nevis, and St Vincent and the Grenadines. The ECCU has enabled the Caribbean countries to develop highly successful financial centres.
Much of this success springs from the efforts of the Eastern Caribbean Central Bank (ECCB). Established in the 1990s, the ECCB has stabilized the region’s economy, held inflation low and established a sound banking system.
ECCB governor Sir K Dwight Venner states that the region needs to “maintain a common currency, to establish a common central bank with powers to issue and manage that currency, to safeguard its international value, promote monetary stability and a sound financial structure and to further economic development of territories of participating governments”.
In 2001 and 2002, respectively, the ECCB set up the Eastern Caribbean Securities Market (ECSM) and the Regional Government Securities Market (RGSM). So far this year, 11 bonds have been issued, the most recent being in August 2004. St Vincent issued a 91-day EC$16 million (US$7 million) treasury bill, which was heavily oversubscribed.
Capital inflows Stable economies and an attractive financial climate with a sophisticated capital market structure have resulted in a continuous flow of capital into the region. Most of this is legitimate, but some of the increase might be related to international money laundering and tax avoidance.
One organization charged with countering the money-laundering problem is the Financial Action Task Force set up by the G-7 Summit in 1989. Its 29 member states have set out a blueprint for action against money laundering that covers the criminal justice system and law enforcement; the financial system and its regulation; and international co-operation.
The FATF has set up a regional Caribbean task force and meets regularly with the IMF and other international organizations to keep abreast of the situation.
The EU is making a concerted effort to crack down on tax evasion. Having been delayed by six months because of intense negotiations with Switzerland, in July 2005, the Savings Tax Directive will be implemented. Although it covers the tax affairs of individuals and not companies, banks cannot rest easy. They will be obliged to establish the identity and residence of the beneficial owner and there will be specific guidelines, including the submission of tax residence certificates.
There has been sustained concern for many years about the issue of information exchange. In 1992 the Basle Committee on Banking Supervision established in its main principles the need for information access. The aim of the directive is to increase the automatic exchange of information about interest and other income from savings between EU member states.
To soften the blow, there is the option of applying a withholding tax. From 2005, withholding tax rates will begin at 5%, rising to 20% in 2008 and 35% in 2010. Bermuda is not included as it is not in the list of third party jurisdictions. Although technically not in the Caribbean, it might well be incorporated, but the directive does extend to all EU dependent territories.
There is no doubt that regulatory pressure is mounting. In the aftermath of September 11, financial institutions introduced new barriers against money laundering. And if the EU Savings Tax Directive is not enough, then the proposed Third EC Money Laundering Directive should go a step further. While consolidating the previous two EC directives on money laundering, this measure (along with the Eight Special Recommendations of FATF) sets the international standards for combating money laundering and terrorist financing.
The third directive comes in quick succession from the last, recently implemented in the UK via the Money Laundering Regulations 2003 and the Proceeds of Crime Act 2002.
In the past, legislation of the financial services sector did not cover trusts. However, the latest proposal now requires professional advisers to obtain identification from beneficiaries who receive more than 10% of a trust’s assets. Any EU-regulated financial institution with an offshore business in the EU dependent states will be governed by these new rules.
The aim is to ensure that all countries commit themselves to internationally accepted standards of financial regulation and anti-money laundering measures.
Regional doubts There is a consensus in the Caribbean financial community that the repeated introduction of new legislation is effectively moving the goalposts. In this view, the major economies are lessening the Caribbean’s competitive advantage.
Until now there has been a constant flow of capital and investments into the region and next year’s changes might lead to a loss of business. Tightening controls on information exchange might encourage capital to flow to jurisdictions less inclined to follow the EU directive guidelines.
On a more positive note, the Caribbean financial services sector has already experienced greater regulatory pressure and has still seen unprecedented growth.
The region has resigned itself to the regulatory challenges thrown at it by international legislation and the FATF. The EU dependent countries have agreed to adopt the terms, either withholding or reporting taxes, but not all as wholeheartedly.
In the Cayman Islands, the world’s fifth-largest banking centre, feelings are running high. In June 2000, it was listed as a non-cooperative territory in fighting money laundering. As a result it stepped up laws limiting banking secrecy. To show their depth of feeling about the changes in the legislation, in the same year, voters ousted the government. News of the proposed EU Savings Tax Directive has also led the government to protest to the European Court and appeal to the UK government for compensation against the terms.
In the hedge fund business, opinions differ as to the effects of the directive. In his report on the impact of the EU Savings Tax on the EU dependent territories, commissioned by the UK government, professor William Byrnes concluded that hedge funds would not be affected at all. Mike Mannisto, partner at Ernst & Young, writes that “with the trend towards international transparency and an increasing institutional investor base in offshore hedge funds, the legislation might benefit the Cayman Islands, as it shows continued commitment to high standards of transparency”. However, some hedge fund managers believe that 20% of hedge funds might move to east Asia as a result.
Barbados, Jamaica, and Trinidad and Tobago already have a sound regulatory framework, with banking supervision being brought closer to Basle core principles. However, a stricter regulatory framework is still needed, with tighter credit rules, such as loan classification and provisioning and formal cooperation with neighbouring supervisory bodies.
For these non-EU-dependent countries, Ward at the Central Bank of Barbados believes that: “in the case of Barbados, we may well benefit from the EU legislation,
through the shifting of business away from EU dependent countries” and notes that “the Caribbean countries are accustomed to strict regulations from the US and FATF, we should be able to work with them”.
The OECS has initiated the International Banking Act. This brings all financial services under a regulatory entity and will ensure that offshore banks meet the more stringent requirements.
Turks and Caicos has committed itself to the EU directive. St Vincent, with a previous negative listing, now has a high standard of regulatory regime and is becoming a respected offshore financial centre.
A good indication of investor confidence is in the business renewal rate. In St Vincent, this has increased steadily. In July 2004, the International Financial Services Authority (IFSA) reported an 84% growth in registration of international business companies.
However, a different story emerges from the Bahamas, one of the most developed financial centres in the world. Having been classed as “non-cooperative” by the FATF in 2002, it cleaned up its act and legislation is now in line with international standards.
Maintaining international standards has come at a price. When the government imposed new regulations on the financial sector, many international companies took their business elsewhere.
Byrnes believes that “account holders may either switch from naked ownership of an account to holding an account through an IBC or simply redomicile their accounts into another non-impacted EU Territory”. He also reports that “the Caribbean jurisdictions did not contain a majority of European business within their client mix. It is well known that the British Virgin Islands have a significant Asian client base for IBC sales. They are motivated more by political risk than tax”.
Chinese crackdown China also has cracked down on illegal money headed for the Caribbean, in particular, the British Virgin Islands and Cayman Islands. Chinese companies have discovered a loophole whereby to gain an overseas listing or seek the same tax advantages that foreign funded companies enjoy, they can register in offshore financial centres.
In the first quarter of 2004, the British Virgin Islands were the second largest source of foreign direct investment in China with US$1.75 billion.
One of the main advantages of conducting business with offshore banks is that few or no questions are asked. New legislation will force financial institutions to collect the tax on savings account interest paid to EU residents or agree to disclose details of the account holder to the authorities.
The concern in the Caribbean is that countries that comply with the regulations will lose business to those that do not. There is also the danger that many countries, with a view to gaining FATF approval, will sign up with the organization and then drag their feet over implementation. Ensuring that effective mechanisms are put in place could be costly and time-consuming.
The next round of money-laundering legislation will affect the Caribbean. The aim is not to damage economic stability or weaken the financial centres but to establish international standards. In the long term, this might lead to a more sustainable financial services sector in the region.
