26 September 2013

Self-regulating Laundries

One of my friends - dream on - hopes to become fabulously wealthy so that he can park his humungously big yacht off the Caymans (or a similar jurisdiction) as the basis for writing a participant observation report on tax havens. (I would more modestly skip the autoethnography - no need for references to Latour and Bourdieu - and simply enjoy the money.) If you can't report on your own experiences with financial engineering in the British Virgin Islands, Channel Islands, Zug and so forth you can rely on official reports and statements by officials or practitioners. '

Creating Cayman as an Offshore Financial Center: Structure & Strategy since 1960' by Tony Freyer & Andrew Morriss in (2013) Arizona State Law Journal notes that
The Cayman Islands are one of the world’s leading offshore financial centers (OFCs). Their development from a barter economy in 1960 to a leading OFC for the location of hedge funds, captive insurance companies, yacht registrations, special purpose vehicles, and international banking today was the result of a collaborative policy making process that involved local leaders, expatriate professionals, and British officials. Over several decades, Cayman created a political system that enabled it to successfully compete in world financial markets for transactions, participate in major international efforts to control financial crimes, and avoid the political, economic, racial, and social problems that plague many of its Caribbean neighbors. Using archival sources, participant interviews, and a wide range of other materials, this Article describes how the collaborative policy making process developed over time and discusses the implications of Cayman’s success for financial reform efforts today. 
The authors comment that Offshore financial centers (“OFCs”) generally and the Cayman Islands in particular have inconsistent reputations. While critics of offshore jurisdictions frequently assert that OFCs are under-regulated — as with Ronen Palen’s complaint that OFC transactions “are not only free from the regulation of the country in which the bank resides, but are subject to no mandatory regulations whatsoever” — others have seen them as an important part of the world financial system. For example, Prof. William Vlcek termed them “nodal points in the web of banks and financial institutions that interlace the world via electronic connections.” And the Economist Intelligence Unit (“EIU”) published a series of reports on offshore jurisdictions between 1972 and 2002 that showed how Cayman exemplified efforts by OFCs to compete regionally and globally for economic growth through promotion of high value financial products. Although the EIU reports conceded that these growth strategies — as with some strategies used by onshore jurisdictions — sometimes involved illegal practices or political corruption, they noted that Cayman and other OFCs pursued development and competitive advantage through effective regulation that was often consistent with global best practices. If there are OFCs playing constructive roles within the international financial framework, different legal and policy responses to the regulatory competition they provide will be appropriate than if they are merely shady locales ‘subject to no mandatory regulation whatsoever. ’Putting the development of OFCs like Cayman into the proper context is thus essential at a time when there are efforts underway to alter the international financial system and when OFCs are regularly at the center of U.S. and EU political controversies.
This Article employs sources including participant interviews and archival evidence to argue that the Caymanian financial center emerged from, and evolved with, a constitutional structure that legitimated collaborative policymaking among the key stakeholders. Resting on Cayman’s social stability, this constitutional legitimacy promoted a regulatory and tax competitive advantage that avoided capture and resisted both corruption and abuse better than many other jurisdictions.It shows how Cayman developed an effective and cost-effective regulatory framework that enabled it to grow from essentially a barter economy in 1960 with no banks to a sophisticated, developed economy with hundreds of banks playing a major role in the world economy by the 1980s.
Cayman’s development must be examined within the context of broader constitutional trends within Britain’s dissolving post-war Empire. In the Caribbean, Cayman, and other jurisdictions that maintained ties to the colonial powers — as well as those colonies that opted for independence, like Jamaica and the Bahamas — diversified from commodity economies into financial and tourist centers. Cayman was unusual, however, because its government constructed a financial regulatory system that enabled the territory to achieve more economic development and diversification than its peers, bringing it the highest per capita wealth in the Caribbean and put Cayman on par with the prosperity of Britain. This success is all the more remarkable because the Islands began from a base of a barter economy built on subsistence agriculture and the export of labor. Thus, between 1960 and 1980, the Cayman Islands went from being one of the least developed — both legally and economically — jurisdictions in a poorly developed region to surpassing its former colonial power in GDP per capita terms, and developing a sophisticated body of financial law.
The evolution of the British constitutional structure for the dependent territories — including checks and balances and the rule of law—steadily expanded Cayman’s autonomy after 1959. Indeed, although prior to World War II, “at the root of the relationship between the colonial powers and their possessions . . . was the apparent power of the former to control directly the economic development of the latter,”the new constitutional orders that arose after the war created policy space within which even those jurisdictions that did not choose to become independent gained greater control over their development. This constitutional autonomy enabled collaboration among Caymanian and UK officials; and Caymanian and resident expatriate lawyers and financial professionals to implement a series of financial-diversification strategies that incorporated, and eventually helped develop, global best practices in the finance sector. This became a quasi-institutionalized effort in which the government and business sectors worked together to develop an effective regulatory structure that both safeguarded the jurisdiction’s reputation and facilitated profitable financial activity that provided law firms, accountants, insurance companies, company agents, and others with profits and the government with resources from fees. We argue that this produced regulatory efforts focused on developing and preserving the jurisdiction’s reputational capital, enabling it to compete for international business by offering a low cost regulatory environment that credibly committed to controlling criminal activity and fraud. 
In Alfred Chandler’s classic thesis, strategy leads business structure. In Cayman, the constitutional structure enabled the competitive strategy that yielded the OFC, and enabled further evolution of the constitutional structure in pursuit of the strategy. Cayman’s success is due both to the entrepreneurial activity of its business sector and the cost-effective regulatory structures which enabled Cayman to avoid killing the goose that laid the golden eggs: either by stifling it through over-regulation or letting it be destroyed by corruption, crime, or fraud through under-regulation. In addition, Cayman successfully fostered an entrepreneurial climate that brought it new businesses and was so effective as to provoke onshore jurisdictions into closing off access to their economies to Caymanian entities. Cayman’s success in navigating twice between Scylla and Charybdis provides valuable lessons for financial regulators elsewhere.
British overseas jurisdictions were generally well positioned to meet the growing post- war demand for jurisdictions providing opportunities to structure businesses and personal affairs to reduce tax.Not only was there a long history of such activity in the Bahamas, Bermuda, the Channel Islands and Isle of Man, but the City of London had the cluster of accounting, legal, and banking services necessary to design and implement strategies that went beyond simple relocation of assets. Further, British economic and tax policy developments during the 1950s and 1960s gave overseas territories an incentive to meet that demand, both through the capital controls that restricted asset flows out of the post-war “Sterling Area” and through a combination of increasing tax and surtax rates, discussion of wealth taxes, and other measures that motivated wealthy individuals to seek alternatives. At the same time, the post-war push for decolonization created the political space needed by the overseas territories to exploit this demand by reducing British control and empowering interests within the British government which focused on the territories’ economic sustainability rather than on the impact “tax havenry” might have on the British Treasury. Thus, just as Britain was increasing overseas territories’ autonomy with the goal of reducing their demands on British taxpayers, it was also creating conditions that provided a market for OFC services which City firms were happy to help drive.Combined with the development of the telex and long distance telephone systems — which by the 1950s made it “almost as easy to transact business with a bank in a foreign centre as with one just across the road” — there was now an opening for new jurisdictions to enter the market. By contrast, France’s constitutional relationship to the overseas territories it retained after decolonization made those areas integral parts of the French state, leaving no policy space for those jurisdictions to follow such a strategy.
Part I explains how an economy based on seamen remittances and subsistence agriculture produced the 1960 Companies Law, the start of all subsequent tax, banking, and commercial- instruments legislation constituting the Cayman financial center using participants’ accounts. We also explain the law’s origin within the growth of a more open Cayman government and the creation of the 1959 Constitution that formally ended Jamaica’s administrative control. Part II examines the constitutional structure and strategies promoting the first phase of financial diversification up to 1968. At that point, the racial unrest and turmoil surrounding the Bahamas’ independence brought new financial business to Cayman; it also consolidated collaboration among Caymanian elected officials, UK and Cayman civil servants; and expatriate lawyers and financial professionals in shaping financial policymaking. 
The Bahamas’ problems also demonstrated how the more stable Caymanian interracial politics combined with British constitutionalism and colonial status to provide a competitive advantage within the Caribbean and relative to other British OFCs. Part III turns to the role of the 1972 Cayman Constitution that increased self-government, linking elected officials in the Legislative Assembly and the Executive Council. The link strengthened the collaborative policymaking model. This allowed collaboration among resident expatriate and Caymanian legal professionals as well as Caymanian (both elected and unelected) and UK officials.
By 1980 the constitutional structure enabled not only proliferating new, globally-competitive, diversified financial products, it also successfully contributed to social stability— including the encouragement of Caymanian employment—through interracial “Team” coalitions rather than ideologically-polarized or rent-seeking party politics. Part IV examines how during the mid-1980s the constitutional structure enabled Cayman to join the United States and UK in signing international agreements that policed money laundering and drug trafficking. In 1993 constitutional amendments conferred further internal self-government and in 1996 the new Caymanian government created an innovative financial regulatory body, the Cayman Island Monetary Authority (CIMA), which further enhanced Cayman’s competitive position. Part V evaluates claims made from 1997 to the 2009 UK grant of full constitutional self-government that Cayman poorly policed abuse of its financial products. The discourse also suggested that the appearance of party politics, charges of corruption, and budget deficits prompting UK intervention challenged the social order underpinning the Cayman financial center.