The Cayman Islands as a Global Banking and Finance Centre
A key challenge for multinational companies, investment banks and fund managers is often how to create an investment structure which is able to accommodate investors from all over the world, within the parameters of tax and securities laws applicable to the investors, management and the business or investment activities, in multiple jurisdictions. The Cayman Islands offers a tax neutral platform to achieve these objectives without foreign exchange controls and without significant restrictions on interest and dividend payments, while allowing the repayment of capital, or the ability to repurchase or redeem equity or debt.
In relation to banking and finance, the Cayman Islands is one of the leading international financial centres providing legitimate advantages to financial institutions and wealth managers. At the time of writing, the Cayman Islands was the domicile for over 220 banks; almost two thirds of which are branches of international banking organisations largely from Europe, the US, Asia and Latin America.
All banks carrying on banking business in or from the Cayman Islands are licensed and regulated by the Cayman Islands Monetary Authority ("CIMA"). Branches and subsidiaries of international banking groups are regulated by CIMA as host regulator, on a consolidated basis with the home regulator, in accordance with the Basel Principles. Private banks are required to establish a full physical presence (i.e. staff and resources) with CIMA as the primary regulator. The model of consolidated supervision and the risk procedures and ratios adopted by CIMA have been assessed and approved by the International Monetary Fund ("IMF").
For those entities where CIMA is the primary regulator, risk management policies and procedures will be implemented in accordance with Cayman Islands law. Entities which are principally regulated by the home supervisor will be required to primarily adhere to home jurisdiction requirements. Both home and host supervisors will have access to relevant information retained by Cayman Islands branches or subsidiaries.
Reasons to use Cayman Islands Vehicles
There are many practical reasons for the establishment of Cayman Islands entities by financial institutions, major corporations and government agencies, including:
(a) The speed and simplicity of establishment, and relatively low cost, particularly in the context of typical transaction sizes;
(b) An English-based legal system (without certain statutory amendments) and established judiciary (with final appeals to the Privy Council of the House of Lords in London). The legal system is ideally suited to undertaking finance and banking transactions. It is flexible, credible and creditor friendly. An example of this flexibility is the development of investment products for markets that are unable to invest in certain debt instruments; e.g. Islamic finance or sukuk vehicles. This results in increased liquidity and investment outside the relevant region;
(c) Low country risk. The Cayman Islands is a politically and economically stable jurisdiction. The Cayman Islands has a sovereign debt rating of Aaa from Moody's Investors Service and Aa3 by Fitch. The Cayman government must seek approval for additional borrowings from the United Kingdom, under the Framework for Fiscal Responsibility;
(d) Appropriate standards of regulation by CIMA which have been assessed by the IMF, and other international organisations, as being in compliance with international prudential regulatory, transparency, cooperation and anti-money laundering and combatting of terrorist financing (AML/CFT) standards;
(e) Professional infrastructure and reputation. The Cayman Islands is well known for its established and experienced financial services sector and their substantial capacity;
(f) Recognition of corporate personality and integrity. The ability of multinationals to use separate group subsidiaries to maintain separate businesses and assets, often with their own ring fenced financing, can be a major contributor in the successful management of business and jurisdictional risks in cross-border transactions;
(g) Flexible, innovative and practical business statutes, catering to corporates, partnerships and trusts. Some examples for structuring finance deals are noted as follows:
(i) Corporate transactions are essentially limited by solvency, rather than traditional notions of 'capital'. Accessibility of share premium (being the funds received on the subscription for shares in excess of such shares' nominal or par value, again subject to ongoing solvency - i.e. creditor protection) for the payment of dividends and redemption of shares. This can be highly significant for corporate groups who want to ensure that funds are easily distributable between group subsidiaries;
(ii) More flexible company laws on 'financial assistance' which enable a company to provide financial assistance to a shareholder for the purchase by a shareholder of shares in the company;
(iii) The Cayman Islands was one of the first offshore jurisdictions to introduce 'segregated portfolio' companies to manage cross-liability concerns in multi-issue vehicles;
(iv) User-friendly merger and continuation (into other jurisdictions) provisions; and
(v) The introduction of a limited liability company, based conceptually on the Delaware model, is also being considered and may be influential particularly for private equity transactions.
(h) Bankruptcy remote vehicles established in the Cayman Islands are recognised worldwide and Standard & Poor's has published specific criteria for Cayman Islands companies;
(i) Cayman Islands insolvency law is simple and effective, which is of great comfort to lenders and investors (again benefiting costing). In particular, the absence of administration, or Chapter XI type moratorium or stand-still, is attractive to creditors. For the Cayman Islands financial sector, speed and certainty in relation to the enforcement of creditors' and contractual rights are crucial; and
(j) General tax neutrality, which involves minimising extra layers of foreign taxation, not avoiding taxes altogether. Cayman Islands entities provide a tax neutral platform so that investors from multiple jurisdictions are not subject effectively to double taxation by virtue of the investment fund or offshore company adding extra layers of foreign taxation at different levels of the structure in addition to the investors' home country tax. This neutrality is important because it provides a level playing field for all investors and avoids creating a vehicle in a jurisdiction that may provide more benefits to some investors than others.
The Cayman Islands offers the opportunity to do this without foreign exchange controls and without significant restrictions on the payment of interest or dividends, the repayment of capital or the ability to repurchase shares or redeem or repurchase debt. The fact that there are no taxes in the Cayman Islands and that, accordingly, transactions can be structured on a 'tax neutral' basis, unfortunately often leads to a public misconception that investors in offshore companies are free from all forms of taxation. Investors based in onshore jurisdictions are likely to be taxed on dividend and other income received from the offshore company and on any capital gains realised on the sale or redemption of shares in the offshore company. Many onshore jurisdictions have also introduced tax rules that tax income and gains which are rolled up in the offshore vehicle as if they had been distributed.
Additionally, the offshore company may itself be subject to withholding taxes imposed in respect of income or gains on its investments by tax authorities in the onshore jurisdictions in which the offshore company's businesses or investments are located and such withholding taxes are frequently not creditable against taxes paid by the investor in the offshore vehicle in respect of the same income or gains.
The Cayman Islands as a Banking Centre
Some of the key commercial reasons why the Cayman Islands attracts banking business include:
(a) The provision of a depository sweep function. This enables banks to be able to pay interest on deposits, where domestic laws or regulations would not permit such interest to be paid; e.g. on US corporate checking accounts, where such 'overnight' sweeps are recognised by the Federal Reserve. This also provides an alternative to domestic banks using the federal funds loan market, by facilitating overnight loans of excess reserves structured as Eurodollar transactions;
(b) The mitigation of federal deposit insurance premiums. Where certain jurisdictions charge a depositary insurance fee/premium for the total aggregate amount of deposits held on a daily basis, financial institutions utilise the overnight (or longer) sweep, or similar methodology, to hold these funds offshore in a branch or subsidiary until required for domestic purposes;
(c) The provision of an intra-bank treasury function, which allows the bank to be able to better manage its balance sheet and safely retain funds in a jurisdiction which would not attach additional expense or restrictions;
(d) The facilitation of the allocation of asset and capital funding, so as to balance and comply with capital adequacy ratios and liquidity or exposure limits; and
(e) Greater access to international markets (for credit and deposits) that it may not be able to access under domestic laws, by providing a globally recognised finance platform.
The Cayman Islands as a Structured Finance and Capital Markets Centre
The typical structured finance or capital markets clients are primarily institutional and include:
(a) Global investment banks (including the leading Wall Street financial institutions acting through their offices in New York and through their operations in London, Tokyo, Hong Kong and other major financial centres);
(b) Institutional asset managers;
(c) Supranational and quasi-government bodies and organisations, for example the International Finance Corporation (a part of the World Bank Group), the European Bank for Reconstruction and Development and OPIC, an agency of the United States Government;
(d) Global industry bodies such as the International Swaps and Derivatives Association, Inc. (ISDA), The Bond Market Association, The International Capital Markets Association, The British Bankers Association, The Japanese Bankers Association, The Canadian Foreign Exchange Committee and institutions that are members of the Foreign Exchange Committee and/or the Financial Markets Lawyers Group (organisations independent of but sponsored by the Federal Reserve Bank of New York);
(e) Issuers of securities listed on the global stock markets, e.g. NYSE, NASDAQ, Hong Kong Stock Exchange and the London Stock Exchange; and
(f) Family offices and private wealth managers.
What types of structured finance deals use Cayman Islands entities?
Cayman Islands entities are used for a range of structured finance and capital markets products. Investors worldwide purchase instruments issued by Cayman Islands entities. These include sovereigns, quasi-governmental bodies, pension funds and the usual financial markets players such as hedge funds. Instruments issued by Cayman Islands entities are regularly traded on the largest stock exchanges of the world. As part of these transactions Cayman Islands companies acquire assets of many different types, for example, loans, bonds, derivatives, commodities, lease receivables, credit card receivables, project finance receivables, aircraft, ships and other assets, which may be situated all over the world.
The types of transactions undertaken in the Cayman Islands include:
(b) Note repackagings;
(c) Credit linked transactions such as credit derivatives and credit linked notes;
(e) Finance subsidiaries;
(f) Investment fund financing;
(g) Structured and derivative products;
(h) Catastrophe bonds and other alternative risk transfer products;
(i) Bank capital raising transactions; and
(j) Aircraft finance.
What benefits do these transactions provide onshore?
There are a number of reasons why these transactions are undertaken, including to:
(a) generate onshore fees and income for investment banks, trustees, asset managers and other onshore service providers;
(b) disperse credit, currency, interest rate and other financial risks in the capital markets;
(c) enable banks to make more efficient use of capital and service clients more efficiently;
(d) provide liquidity in the market place and provide access to capital from investors in different jurisdictions;
(e) produce greater efficiency and produce higher returns for investors (in many structures the whole is greater than the sum of the parts);
(f) provide efficient inward investment opportunities for foreign investors into the US and other jurisdictions;
(g) avoid sovereign or political risk for US and other international investors investing in jurisdictions with less sophisticated legal systems or governments;
(h) enable major onshore corporate groups to manage risk and cash flow more efficiently (e.g. securitisations); and
(i) reduce the cost of financing for corporations and banks thereby enabling them to run their businesses more efficiently and increase returns for investors.