Looking forward: An industry on the move

Transcription

1 Looking forward: An industry on the move A Vistra Group Company

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3 Contents 2 Foreword 3 Introduction Key Trends 4 1. Big picture: Bruised but not beaten 8 2. Jurisdictions: Defensible market position? Regulation: A heavier burden Customers: From China to the world Market drivers: Less about tax planning Service providers: Coming consolidation 34 The future state of the industry 37 Summary 38 Methodology 40 Acknowledgements Looking forward : An industry on the move 1

4 Foreword Are we beginning to see the end of the storm clouds? Has the industry weathered the convergence of external pressures to find itself more robust and confident to withstand the changes being forced upon it? Rewind 12 months and the industry was facing perhaps its greatest threat in decades an existential threat you could say. The International Consortium of Investigative Journalists (ICIJ) had published the so called offshore data leaks; a handful of international banks were making it increasingly difficult to open bank accounts using key jurisdictions; the moral debate raged about multinationals not paying their fair share of tax regardless of the legal soundness of their approach; and the issue of tax transparency and public registries of beneficial ownership were debated at the G8 summit. A year on and a sense of optimism is beginning to return. The pervading mood is that, despite the negative publicity, the offshore industry is integral to the concept of globalisation and continues to play a crucial role in the financial supply chain. Now in its 5th year, the Offshore 2020 project continues to look into the key trends and issues facing the industry. We are delighted by the growth in participation with approximately 300 senior level stakeholders taking the time to share their views. It is particularly pleasing to see that respondents are now split roughly between Asia and the rest of the world, giving the survey a true global perspective. We are confident that the Offshore 2020 research remains the key annual temperature check for the industry at large. An encouraging development in the past 12 months is the more confident, assertive approach the industry is taking against much of the misleading and at times downright biased case made against it. Rather than remaining below the parapet, industry participants are becoming more forthright in articulating their value to the global economy. Given the initiative has now been running for five years, we thought it appropriate to examine some of the trends that have taken shape and extrapolate them into a series of predictions that offer a picture of the offshore industry in Some of these predictions may be obvious and others you may disagree with, but hopefully they will provoke dialogue about the opportunities for those willing to embrace change. We also wonder at what stage certain G8 nations will realise that the so called trillions of dollars stashed in a range of Caribbean islands is a misguided fallacy, designed to take away attention from the real issue of economic mismanagement within their home countries. A final thought: one day, the industry might even get some credit for the role it plays in facilitating foreign direct investment. These are the capital inflows that drive economic growth, fuel job creation, and ultimately lift people out of poverty in emerging markets. Wishful thinking? Most likely, and we re not holding our breath in anticipation of the recognition! We trust you enjoy the read and welcome any feedback on how the report can be improved. Martin Crawford Chief Executive Officer Jonathon Clifton Group Managing Director Simon Filmer Deputy Group Managing Director 2 OFFSHORE 2020

5 Introduction The offshore industry continues to weather a political storm, but is perhaps emerging all the stronger for it. Pressures that seemed almost irresistible 12 months ago have been withstood, and then there is succour from the fact that demand for offshore structures remains robust. No jurisdiction or service provider can sway a non-governmental organisation (NGO) with entrenched views of the industry, but they can convince customers of their ability to build best-in-class financial services infrastructure. The regulatory development uppermost in most people s minds is the US Foreign Account Tax Compliance Act (FATCA), which is designed to encourage foreign financial institutions, including offshore investment vehicles, to disclose the identities of US investors to the Internal Revenue Service (IRS). But it sits at the top of a list of initiatives that may yet converge into a single set of standards for the industry. The Organisation for Economic Cooperation and Development s (OECD) ongoing push for greater transparency; the Multilateral Convention on Tax Matters; the Common Reporting Standards programme; the prospect of wider adoption of FATCA as well as FATCA itself. Taken together, they will increase the cost of business as jurisdictions and service providers are obliged to invest in the people and systems required to meet compliance standards. This is not necessarily a bad thing. Overregulation remains a key concern the call for publicly accessible registers of beneficial owners is the latest example of how political zeal can be counterproductive but obliging the industry to conform to a higher standard is essential to its long-term health. Although higher costs can be passed on to clients, they will eat into service providers profit margins and encourage consolidation. Those able to offer a genuine value proposition will prevail and prosper; and use the proceeds to invest in better infrastructure which will reinforce their competitive advantage. Jurisdictions face a similar battle to prove they are relevant in an increasingly complex commercial environment. A number of offshore financial centres have already carved out niches for themselves of varying sizes and across various disciplines in some cases this is the result of years of effort and it is difficult to see them being supplanted. Others must identify a unique selling point and invest in it, or face extinction. Part of staying relevant means engaging with China, still the fastest-growing source of new business yet a constituency that is now looking to put capital to work overseas as much as find ways to bring it in. This amounts to a more global opportunity, which can be tapped by industry participants almost irrespective of their location. However, it also emphasises the importance of providing a multi-jurisdictional service, which brings us back to the innate advantage of being a global player with standardised and reliable systems and processes. Price remains a factor for customers, but it is not the only one. Service providers must be able to cope with the evolving needs of clients, whether this means hiring people capable of finding tax efficient paths through a regulatory jungle, investing in IT hardware that can cope with the workload brought by automatic exchange of information, or having the bandwidth to help an investor establish substance in Luxembourg as well as Hong Kong. And it is worth reminding the wider world that in spite of what politicians might say the majority of these needs have more to do with facilitating international trade and asset management than traditional tax planning. Looking forward : An industry on the move 3

6 BIG PICTURE Bruised but not beaten 1The offshore industry remains a target for politicians, investigative journalists and non-governmental organisation (NGOs), but it appears to be getting used to the attention. Indeed, steps are being taken from ensuring business practices are whiter than white to engaging and educating stakeholders to address the public relations problem. It remains to be seen whether this will have a meaningful impact. Twelve months ago, this survey offered a snapshot of industry sentiment amid the fallout not only from the leak of records identifying the owners of assets held offshore but also pressure from the G20 group of nations on multinationals perceived to be shuttling money around the globe to avoid tax. And all this was on top of the continued attentions of the Organisation for Economic Cooperation and Development (OECD) and its transparency drive. These issues are still pertinent. It was only in July that details of a cache of files this time from a Jersey-based wealth management firm entered the public domain after being leaked to journalists. The gleanings identified celebrities, sportspeople, aristocrats and in some dark irony political donors with interests offshore. Opening a bank account for a company has become harder as lenders tighten up on oversight while automatic exchange of information between jurisdictions has gone from being a possibility to near nailed-on certainty. 4 OFFSHORE 2020

7 And yet, demand for offshore structures remains robust, suggesting that a majority of investors are not letting political attacks and bad press get in the way of their practical wealth management and other needs. New incorporations in the British Virgin Islands (BVI), Cayman Islands, Seychelles, Samoa and Jersey are projected to reach 99,000 in 2014, up from 97,000 in 2013 [Figure 1]. This would continue a run that has seen incorporations exceed 95,000 in each of the past three years. FIGURE P Global offshore jurisdictional new incorporation volumes (Thousand) (Projected) 73 Remark: 2014 (Projected) is estimated by using latest jurisdictional actual volume. Jurisdictions consist of: The BVI, Seychelles, Cayman Islands, Samoa and Jersey (Delaware & Guernsey are excluded in this case). OIL s in-house calculations point to steady incremental growth in new incorporations, with a corresponding trend to higher value work. The attractiveness of mid-shore jurisdictions which are well-equipped to handle more complex demands and offer reputational comfort supports this trend. New incorporations in Hong Kong are expected to surpass 202,500 this year compared to 173,561 in 2013 [Figure. 2]. While activity in Singapore is likely to be flatter, with incorporations dropping to around 57,000, this may be a result of the regulator s efforts to position the jurisdiction as a premium location, with tighter restrictions in the private banking sector. FIGURE P Hong Kong/Singapore new incorporation volumes (Thousand) (Projected) HK SG (Projected) Looking forward : An industry on the move 5

8 The battle for public opinion has not been lost.. but the industry needs to get on the front foot Partner at a law firm, UK Industry participants appear to have reclaimed some of their bullishness following a challenging Last year, 42% of respondents in the Offshore 2020 survey agreed that the battle for public opinion had been lost. Today, the yes camp has fallen to 26% with 13% uncertain. It is worth noting that in both 2013 and 2014, a similar proportion of respondents 58% and 61% denied that the industry s reputation was beyond repair. More than half of the sample said there would be no change in demand for offshore services but the pressures weighing on the industry are likely to result in customers switching between jurisdictions [Figure 3]. Last year, 46% were of this view. A smaller minority 41% believe overall demand will be adversely affected and only 7% expect no change in the underlying market. Change is coming but the consequences don t have to be fatal, appears to be the message. FIGURE 3 Has the dynamic offshore industry environment (data leaks, G20 and OECD regulatory pressure, changing banking policies, etc.) undermined client confidence and adversely affected the demand for offshore companies? Yes, it will have an adverse impact on overall demand for offshore companies No change in demand, but it will likely result in switching between jurisdictions No, there will be no change in the underlying market 7% 16% 38% 41% 46% 52% As to how the industry can best address its image problem, the most heavily endorsed solution was professionalism and training, effectively seeking to put the industry beyond reproach [Figure 4]. Interestingly, lobbying of governments and regulators and media outreach were ranked as more important steps than the certification and licensing of offshore service providers and coordination with other industry participants. FIGURE 4 Less Important Most Important Industry responses in addressing its image problem Industry professionalism and training 4.2 Lobbying of governments and regulators 4.1 Public relations in the media 4.0 Certification & licensing of offshore service providers in markets where they serve clients 3.9 Coordination with other industry participants (e.g. banks) 3.7 Independent industry and market research 3.6 Engagement with the NGO sector OFFSHORE 2020

9 Given the mixed appetite for collaboration the offshore industry remains highly fragmented, although the very challenges now being addressed are likely to help drive consolidation it is unsurprising that many efforts have been individual groups acting in their own strategic interests. Nearly one quarter of survey respondents have held conferences, seminars and forums in the last 12 months to address the public relations issue, and 11% followed up with client education. Meanwhile, Jersey, which has suffered heavily in the media storm, has published papers detailing the benefits the jurisdiction brings to the UK economy and promoted at least one academic study that questions the arguments put forward by its critics. The Society of Trust and Estate Practitioners (STEP) has sought to represent the industry s interests on a macro level. Responding to moves by the United Kingdom (UK) to require Crown Dependencies and British Overseas Territories to commit to public registers of beneficial ownership, STEP has made the case for the opposition to policymakers in London and Brussels, sought to coordinate lobbying activities in different jurisdictions, and examined what training and resources might be required if the changes go through. The International Financial Centres (IFCs) Forum likewise liaises regularly with senior UK politicians and civil servants, the EU Commission and United States (US) policy advisers, with particular focus in 2014 on UK and European Union (EU) proposals for government registers of beneficial ownership, Foreign Account Tax Compliance Act (FATCA) and the OECD Common Reporting Standard. It also engages with NGOs including Christian Aid and Action Aid, and leading media outlets, with some success. These acts of outreach amount to a series of incremental positive developments. More can be done in terms of engagement and it is OIL s view that the largest industry participants should take the lead. While we support and encourage lobbying efforts, these should be targeted and focused. Mass media is not the answer, and efforts should be directed to clients as well as to policymakers. This can be achieved through active participation as a member of industry bodies worldwide and direct engagement with governments and regulatory bodies. (These groups already reach out to OIL for consultation on draft legislation and regulatory standards.) One of the starkest conclusions to be drawn from the survey is that engagement with NGOs on these issues is futile. Of the possible responses to the public relations problem put before respondents, reaching out to NGOs was by some distance the most poorly received. On a scale of 1 to 5, with 5 being the most important, it was scored 3 or below by nearly 70% of respondents. This cynicism is understandable and some NGOs will never come to appreciate the benefits of offshore financial services. Often these arguments are made from a position of ignorance: NGOs see the offshore component as a malign influence even believing there are vast amounts of untaxed money hidden in the BVI, a ludicrous notion to anyone who has visited the jurisdiction rather than an essential part of the infrastructure that facilitates international trade and capital efficiency. However, by employing the correct approach and the IFC Forum have engaged with a few prominent NGOs it is possible to inform the debate. Looking forward : An industry on the move 7

10 JURISDICTIONS Defensible market position? 2In each edition of the Offshore 2020 survey, participants have been asked to rank jurisdictions based on their importance today and their expected importance in five years time. The British Virgin Islands (BVI) and the Cayman Islands have maintained a stranglehold on the top two spots but respondents were also in agreement that the significance of these jurisdictions would wane. The 2014 survey is no exception. As in previous years, offshore financial centres were rated on a scale of 1 to 5, with 5 being most important. The BVI scored 4.0, with Cayman Islands and Hong Kong joint second on 3.8, followed by Singapore on 3.5 [Figure 5]. These are almost exactly in line with the 2013 assessments. Over the next five to ten years, industry participants expect the established order to be turned on its head. Hong Kong and Singapore will occupy the top spots come 2019 with ratings of 4.1 and 3.8, respectively. The BVI and Cayman Islands will slip to 3.4 and 3.6, not that far ahead of the likes of Luxembourg and the Netherlands. 8 OFFSHORE 2020

11 FIGURE 5 Less Important Most Important Jurisdictions by importance Anguilla Bahamas In the next 5 to 10 years Now Barbados Bermuda The BVI Cayman Islands Guernsey Crown Dependencies or British Overseas Territories Europe Others Mid-shore Asia Isle of Man Jersey Cyprus Ireland Luxembourg Malta Netherlands Hong Kong Labuan Singapore Belize Cook Islands Mauritius New Zealand Panama Samoa Seychelles United Arab Emirates USA (Delaware) There is a real perception that the sun is setting on the traditional Caribbean offshore centres as poor press and regulation erode their advantages.. US based lawyer The theory is clear: As the industry comes under increasing regulatory pressure, business will gravitate to jurisdictions that are seen as more transparent, offering traditional offshore benefits combined with onshore credibility. However, this has been the prevailing view ever since the first Offshore 2020 survey, and yet five years on, the BVI and Cayman Islands remain as significant to the offshore community as they ever were. Twelve months ago, the crisis of confidence that impacted all jurisdictions was felt particularly keenly in these two locations, largely as a result of their high profiles. While many of the pressures remain, the industry has not imploded and participants are articulating a response to the changing operational environment. The BVI and Cayman Islands are central to this process. Looking forward : An industry on the move 9

12 Setting up a bank account for a BVI company has become much harder survey respondents ranked it fourth out of 10 jurisdictions by this measure in 2013, but it has dropped to ninth in 2014 [Figure 6]. There has also been a decline in professional infrastructure from fifth to seventh while both Cayman Islands and the BVI have slipped in terms of the strength of regulatory environment. But the BVI remains the most attractive jurisdiction based on set up and maintenance costs and Cayman Islands retains third place for professional infrastructure. The two jurisdictions also continue to rank highly for commercial mindset. Above all, the question for investors in need of offshore financial services is: If not Cayman Islands or the BVI, then where? FIGURE 6 Performance of major jurisdictions against key service criteria Cost (set up and ongoing maintenance) Ease of use (e.g. opening a bank account) Robust regulatory environment Professional infrastructure Commercial mindset (willingness to work with stakeholders) The BVI Cayman Islands Cyprus Guernsey Hong Kong Jersey Luxembourg Netherlands Samoa Seychelles Singapore The rise of mid-shore jurisdictions such as Hong Kong and Singapore is inevitable, but predictions that it would come at the expense of the traditional market leaders have so far not played out. In a more complex commercial universe, there is a place for pure offshore and quasi-offshore financial centres in multi-layered corporate structures. The BVI and Cayman Islands are high profile because they are popular. The two jurisdictions cannot stand still as the industry evolves, but they are so well used and their competitive advantages so well known it is difficult to envisage a significant number of investors breaking established habits and going elsewhere. 10 OFFSHORE 2020

13 Ask the same question of other locations and the answer is different. It is estimated approximately 66 jurisdictions describe themselves as offshore financial centres. Smaller players will inevitably suffer as regulatory forces converge and scrutiny of the industry intensifies. Smaller jurisdictions and service providers will no longer be able to compete on a global stage CEO of a consulting firm, BVI The compliance burden means the cost of doing business will increase. For jurisdictions, this means investing in the systems, infrastructure and people they need in order to meet higher standards. Some simply don t have the resources to take appropriate action. If, for example, jurisdictions have to engage in frequent automatic exchanges of information with multiple counterparties, would a subscale financial centre be able to handle the workflow and ensure security? Clients will flee to established locations with the infrastructure to meet their needs. Of the 10 jurisdictions survey, respondents were asked to rank by certain service criteria, Samoa came in last for ease of use, robust regulatory environment, professional infrastructure and commercial mindset. It ranked fourth for set up cost, behind the BVI, Seychelles and Hong Kong. Samoa can lay claim to a unique value proposition a reasonably convenient time zone for China and a familiarity with Chinese characters but it remains to be seen whether this will be enough to compete with more established players in the long-term. The onus, therefore, is on carving out a defensible market niche. Both the BVI and Cayman Islands effectively did this, it s just their respective areas of specialisation international holding company structures and fund formation are core to the offshore industry. Smaller but arguably equally successful in building strong defensive capital market positions are the Marshall Islands for ship registration, Gibraltar for online gambling companies, and Bermuda for reinsurance. They got in early and were proactive in engaging customers. In this context, it is worth re-examining respondents perceptions of different jurisdictions importance now and in five years time. Samoa, Seychelles, Mauritius and Labuan are expected to hold steady on 1.9, 2.4, 2.2 and 1.8, respectively, perhaps because of potential business growth in China and ultimately Africa. Other pure offshore locations are all tipped to lose business. Of the European jurisdictions, Ireland and Luxembourg well known for multinational incorporations and investment funds are likely to see increased demand. The same can be said of Malta and the Netherlands. The Channel Islands Crown Dependencies are in an interesting position: Will there be weaker demand as regulators eat into their competitive advantages or will compliance serve as a great leveller and clients return simply because these are places for efficient transaction of business? Anecdotal evidence suggests the latter. It is worth bearing in mind that the Offshore 2020 survey was limited to 26 jurisdictions, each of which is recognised by the international investment community. The prospects for many of the smaller players that fill out the 66 strong markets are not captured here, but based on the prevailing trends, their future will be about finding an appropriate, differentiated niche. Looking forward : An industry on the move 11

14 REGULATION A heavier burden 3On July 1, 2014 arguably the single most significant piece of legislation in a generation impacting offshore financial centres came into force, with the industry at varying degrees of readiness. The United States (US) Foreign Account Tax Compliance Act (FATCA) encourages foreign financial institutions, including offshore investment vehicles, to disclose the identities of US investors to the Internal Revenue Service (IRS). Failure to comply will result in the imposition of a 30% withholding tax on any US source payments. Nearly 88,000 entities featured on the first iteration of the IRS list of foreign financial institutions that have registered for tax disclosure. To reach the point of registration, groups are supposed to have screened client bases and established the extent of their liability. The next phase of the process involves putting in place the infrastructure that will enable ongoing monitoring, with the transition to full reporting to the IRS scheduled to happen in Anecdotal evidence suggests some foreign financial institutions have been working on FATCA compliance for two years while others have yet to take substantive action, which will inevitably result in plenty of last minute calls to administrators and accountants as enforcement begins. 12 OFFSHORE 2020

15 FATCA, FATCA, FATCA.. the most important regulation effecting the industry HK private banker The more proactive groups are likely those with large and complex US customer bases, but even an offshore structure without any US exposure is not immune to FATCA. Either its jurisdiction of incorporation will have signed an intergovernmental agreement (IGA) with the US, which may make FATCA compliance a local issue; or it will have counterparties for example, banks where they hold accounts that want to be compliant and therefore start asking questions of clients. On a broader level, FATCA should be seen as a stalking horse for a raft of other legislation leading to a convergence of regulatory standards for offshore financial services. The Organisation for Economic Cooperation and Development s (OECD) ongoing push for greater transparency is philosophically identical to FATCA and bears a number of similar characteristics in terms of practical implementation. Bringing them together will give greater impetus to other initiatives, such as United Kingdom (UK) FATCA which directly impacts the British Overseas Territories and Crown Dependencies the Multilateral Convention (MLC) on Tax Matters [Figure 7], and the OECD-endorsed Common Reporting Standards programme. FIGURE 7 Belize Cyprus Malta Ghana Countries which have signed the Multilateral Convention on Tax Mtters Source: OECD North America South America Europe Africa Asia Oceania Canada Costa Rica Guatemala Mexico Saudi Arabia US Argentina Brazil Chile Colombia Albania Andorra Austria Azerbaijan Belgium Croatia Czech Republic Denmark Estonia Finland France Georgia Germany Greece Hungary Iceland Ireland Italy Latvia Liechtenstein Lithuania Luxembourg Moldova Netherlands Norway Poland Portugal Romania San Marino Slovak Republic Slovenia Spain Sweden Switzerland Ukraine UK Cameroon Gabon Morocco Nigeria South Africa Tunisia China India Indonesia Japan Kazakhstan Korea Russia Singapore Turkey Australia New Zealand * Israel has not signed the MLC Agreement. Remarks Extension by UK: Anguilla, Bermuda, the BVI, Cayman Islands, Gibraltar, Guernsey, Isle of Man, Jersey, Montserrat, Turks & Caicos Islands Extension by the Netherlands: Aruba, Curacao, Faroe Islands, Sint Maarten Extension by Denmark: Faroe Islands, Greenland Looking forward : An industry on the move 13

16 FATCA means more business for law firms due to higher awareness and compliance pressure Partner of a law firm in Hong Kong There are still many unknowns. FATCA compliance means additional costs, from more intensive client due diligence to continuous reporting, and it is unclear how steep they will be. The IRS has also indicated that requirements will not be rigorously enforced in the first couple of years for those who make good faith efforts to comply. But ultimately there is no escape and the Offshore 2020 survey indicates that most in the industry recognise this. Asked to name two regulations that are having a significant impact on business now, respondents overwhelmingly opted for FATCA at 41% [Figure 8]. Anti-money laundering being second with 14%, while the European Union (EU) Alternative Investment Fund Manager Directive (AIFMD), exchange of information and beneficial ownership disclosure each below 10%. The results are not so dissimilar from last year s survey. FIGURE 8 Regulations having the most impact on the industry In next 5 years Today FATCA Anti money laundering AIFMD 5% 8% 9% 14% 25% 41% Exchange of Information 7% 13% Beneficial ownership disclosure 3% 15% * Others includes: Savings Directives, UCITS, EU Directives, BEPS, International Trust Act, KYC, bank account opening requirement and compliance, tax transparency initiatives, increased DTAs and accounting standardisation. Five years from now, FATCA is still expected to be the key issue, but the gap narrows: FATCA received 25% of the votes, while beneficial ownership disclosure at 15% and exchange of information 13%. This is in effect regulatory convergence writ large. Nearly two thirds of respondents expect FATCA to be adopted universally across the OECD by 2017 last year 60% said this would happen by 2020 and 88% anticipate automatic exchange of information between OECD nations within the same time frame [Figure 9]. Asked which of these developments will be introduced first, 59% of respondents opted for automatic exchange of information with 24% going for universal adoption of FATCA [Figure 10]. 14 OFFSHORE 2020

17 FIGURE 9 Yes No Average Rating Regarding the potential OECD regulatory end game, are the following likely by 2017? Publicly available beneficial ownership information The end of the use of offshore structures 17% 7% 83% 93% What is the likely impact on clients business (Scale of 5, 5 being most significant) A central (non-public) registry of beneficial ownership Automatic exchange of information between OECD nations 57% 88% 43% 12% FATCA will be adopted universally across the OECD 65% 35% 3.4 Tax accounting standardisation 29% 71% 2.9 Uniform global (non-tax) regulation such as licensing 17% 83% 2.9 FIGURE 10 Which of these regulatory initiatives will be implemented first? Automatic exchange of information between OECD nations FATCA will be adopted universally across the OECD 24% 59% A central (non-public) registry of beneficial ownership 12% Others* 4% * Others include tax accounting standardisation, publicly available beneficial ownership information, end of the use of offshore structures and uniform global (non-tax) regulation such as licensing. The peer reviews that underpin the OECD s efforts on tax transparency are now into their second phase, where the focus moves from whether or not a jurisdiction has the requisite legal and regulatory framework for exchange of information for tax purposes to the level of compliance with a global transparency standard. An automatic exchange mechanism is seen as the next step. FATCA, to the extent that it requires foreign financial institutions to provide reports on US-based clients on an ongoing basis, is an automatic mechanism that is already being rolled out. Indeed, as of July 1, the US had signed 39 IGAs and reached an agreement in substance with another 62 jurisdictions [Figure 11]. The majority are Model 1 agreements, which means compliance with FATCA is a local tax requirement, with local authorities collecting the relevant information and passing it on to the IRS. Looking forward : An industry on the move 15

18 FIGURE 11.1 Canada Denmark Italy UK Countries/Jurisdictions who have signed US FATCA-IGA Source: OECD Costa Rica Honduras Jamaica Mexico Bermuda Estonia Finland France Germany Gibraltar Jersey Latvia Liechtenstein Luxembourg Malta Austria Switzerland Mauritius South Africa North America South America Europe Africa Asia Oceania Chile Belgium The British Virgin Islands Cayman Islands Guernsey Hungary Ireland Isle of Man Netherlands Norway Spain Slovenia Israel Japan Australia New Zealand FIGURE 11.2 Countries/Jurisdictions who have reached an agreement in substance with US FATCA Antigua and Barbuda Bahamas Barbados Armenia Azerbaijan Belarus Portugal Romania San Marino Iraq Kuwait Malaysia Grenada Bulgaria Serbia Qatar Source: OECD Haiti Croatia Slovak Republic Saudi Arabia Nicaragua Curaçao Sweden Singapore North America South America Europe Africa Asia Panama St. Kitts and Nevis St. Lucia St. Vincent and the Grenadines Turks and Caicos Islands Argentina Brazil Colombia Guyana Paraguay Cyprus Czech Republic Dominica Dominican Republic Georgia Greenland Kosovo Lithuania Moldova Montenegro Ukraine Algeria Anguilla Cabo Verde Seychelles Bahrain Hong Kong India South Korea Taiwan Thailand Turkey Turkmenistan United Arab Emirates Uzbekistan Peru Poland Indonesia 16 OFFSHORE 2020

19 While the industry is broadly supportive of moves to improve regulation, there are concerns about the debate becoming politicised. Tracking beneficial ownership has emerged as a contentious issue in this context. The Financial Action Task Force, in its recommendations to the G20, stressed the importance of regulators being able to establish who owns, controls and benefits from companies as part of efforts to combat tax evasion. It led to calls for the introduction of central registries naming beneficial owners, but opinion is divided as to whether this information should be placed in the public domain. The UK pre-empted the release of results of a public consultation on the matter to announce plans for a publicly accessible register maintained by Companies House. France has said it will follow suit, while the remaining members of the G8 Italy, the US, Canada, Germany, Japan and Russia continue to consult on the matter. More than half of respondents in the Offshore 2020 survey expect a central, but privately held registry of beneficial ownership to be introduced by However, only 17% envisage this information becoming publicly available within the same time frame. In jurisdictions such as the British Virgin Islands and the Cayman Islands, beneficial owners details are held by privately owned and licensed service providers that are legally obliged to cooperate with regulators. Documentation is kept in confidence, but not complete secrecy: service providers must report any suspicions to the authorities and then there are mechanisms through which regulators can make information exchange requests. The system offers privacy and security a public registry would not permit the former and a central registry may not allow the latter and it is the result of a well established and functioning regulatory regime that has yet to be matched by the G8 nations. The current stand-off is a stark reminder that regulation involves striking a balance between a variety of interests meeting oversight requirements without undermining the benefits offshore structures bring. Excessive political pressure throws this balance out of kilter. Looking forward : An industry on the move 17

20 4 The CUSTOMERS From China to the world swing from China inbound to outbound was widely anticipated and in last year s Offshore 2020 survey there were signs of it being realised. Approximately half the respondents conduct China related business and, in 2013, 56% of those said this business was outbound, the first time the 50% threshold has been crossed [Figure 12]. The breakdown is similar this year, in keeping with anecdotal evidence that an increasing amount of the wealth being generated in China is heading overseas. 18 OFFSHORE 2020

21 FIGURE Inbound Outbound 12 Percentage of China inbound versus outbound % 56% % 56% % 45% And this is a global view. Over the past five years, the survey has become broader both in terms of sample size and location indeed, the 2014 respondents represent a near split between Asia and the rest of the world. It is not a case of Asia-based service providers focusing on China as the nearest market of scale; industry participants from the Middle East to the Caribbean are looking to the country for business. Asked to name the top 10 locations for client origination over the next five years, 40% respondents opted for China, well ahead of the United States (US) and the United Kingdom (UK) in second and third, with 13% and 10%, respectively [Figure 13]. FIGURE 13 Client origination by country: Top 10 locations in the next five years US UK United Arab Emirates India China 40% Russian Federation Hong Kong Taiwan Singapore Australia 13% 10% 7% 4% 6% 9% 4% 4% 3% Looking forward : An industry on the move 19

22 In this respect, the offshore industry is following in the footsteps of countless others. In 2013, BMW sales in China rose 20% year-on-year as the country overtook the US as the group s largest market. The likes of Audi and Mercedes- Benz are also profiting on the back of demand that will see China s premium car market grow at 12% per annum through 2020, according to McKinsey & Company. At this rate, the country will surpass the US as the world s leading luxury car consumer as early as Chinese consumers of luxury goods are not immune to the impact of a slowing economy and a crackdown on corruption that has reigned in lavish gift-giving, but they remain the most prolific. Bain & Company estimates that China accounts for 29% of luxury purchases worldwide, more than any other country. Interestingly, a sizeable proportion of these transactions occur overseas. A more prosperous and internationally oriented population is likely to seek ways to preserve this wealth overseas. Unsurprisingly, Asia remains by some distance the most important region for business origination, with a score of 4.1 out of a possible five, the same as last year. The UK and Europe ex-uk retain joint second spot on 3.2 in another repeat of 2013 [Figure 14]. Five to 10 years from now, Asia is expected to consolidate its dominant position, with 4.4. Developed markets are likely to stay more or less the same, while there will be significant jumps in both the Middle East and Africa. The former scored 2.4 this year and is tipped to reach 3.1 by 2019; the latter is expected to jump from 2.0 to 2.7 over the same period. FIGURE 14 Less Important Most Important Client origination by region Asia In next 5 to 10 years 2014 UK Europe (ex-uk) Middle East North America Latin America Africa Australia/ New Zealand OFFSHORE 2020

23 It is also worth noting that the perception of regulatory pressures differs markedly between clients in developed and developing countries. Close to two thirds of survey respondents agreed that authorities in developing markets are less aggressive towards the offshore industry, either because their regulatory regimes are not sophisticated enough or they feel problems can be addressed by other means [Figure 15]. FIGURE 15 Is there a perception difference of regulatory pressure between clients in developed versus developing markets? Yes No Don t know 62% 12% 26% There is certainly a correlation between economic growth and demand for offshore financial services. A country in rapid expansion mode tends to prioritise attracting foreign direct investment which, for practical reasons, usually arrives via an offshore jurisdiction over concerns about tax leakage. This is its sovereign prerogative. As it leaves this phase of the development cycle, though, the focus shifts from speed of growth to preservation of wealth, and so government attitudes towards the perceived benefits of the offshore industry change. The three regions identified by survey respondents as those becoming more important most quickly Asia, the Middle East and Africa are all still in this rapid expansion mode. GDP growth in Asia is projected to be 5.4% in 2014, rising to 6.7% for emerging and developing nations, while the Middle East and North Africa will expand by 3.1% and Sub-Saharan Africa by 5.4%. By comparison, the UK economy will grow by 2.9% and Europe ex-uk by 1.2%. At the same time, it can be difficult to reconcile the business expectations of the offshore community with the economic reality. For several years, Africa has been tipped for greatness five years down the road. In the 2014 survey, respondents see the region s importance rising from 2.0 to 2.7 by 2019, surpassing Australia and New Zealand, matching Latin America and coming within touching distance of North America. This is broadly comparable to 2011 when Africa was awarded a rating of 1.7 with the expectation it would reach 2.5 by While there is certainly economic momentum this hasn t necessarily led to a commensurate increase in demand for offshore structures or at least not beyond jurisdictions that are comparatively close to Africa, such as Dubai and Mauritius. In China, progress is more advanced and more tangible, yet demand should be viewed in its wider context. For a generation, companies and individuals have channelled capital into the country through offshore vehicles, driven not only by tax efficiency but also by the comfort drawn from robust legal systems and professional infrastructure. Looking forward : An industry on the move 21

24 Outbound investment can also take advantage of double tax treaties (DTTs) but there is the additional consideration of capital account restrictions. Without a fully convertible renminbi, investors tend to use a conduit when going offshore; a high net worth individual might go through Hong Kong for a trust product while ownership of a private enterprise could be structured through the British Virgin Islands (BVI)-incorporated special purpose vehicles. Indeed, Hong Kong and the BVI were cited by survey respondents as by some distance the preferred conduit for China outbound business, with 40% and 33% of the vote, respectively. The Cayman Islands ranks third on 7% with Seychelles in fourth on 5% [Figure 16]. FIGURE 16 Preferred jurisdictions for outbound China investments Cayman Islands The BVI Jersey Seychelles Hong Kong Samoa Others* 40% 33% 7% 2% 5% 4% 9% * Others include Labuan, Luxembourg, United Arab Emirates, Ireland and the UK. 22 OFFSHORE 2020

25 Hong Kong has the right mix of proximity to the China opportunities, professional ecosystem and legal system to take advantage of new business HK Big 4 accounting partner Chinese outbound direct investment continues to grow, reaching US$90 billion in 2013, up from US$60 billion just two years ago. More than three quarters of outbound direct investment is said to be corporate merger and acquisition (M&A). Strategic acquisitions of energy and materials assets by state-owned enterprises still feature strongly but there has been an upsurge in private sector involvement across multiple sectors in recent years. In WH Group, the pork producer that bought US-based Smithfield Foods in 2013 and added then a majority stake in Europe s Campofrio Food Group, China has a major global player in the consumer space. And in Fosun International, it has a domestic state-owned conglomerate that is building up a portfolio covering everything from insurance to baked goods. Chinese companies use offshore structures, if not for the transactions themselves then for various ancillary functions. Where these companies are under private ownership, the founders rely on offshore services for wealth management purposes as well. The question remains as to what impact renminbi liberalisation will have on demand. On one hand, it could lead to a fall in demand for offshore structures because using conduits for outbound capital flow is no longer a structural necessity. On the other, easing Chinese companies passage into international markets may boost activity, creating a larger overall pie of which offshore service providers have a share. In this context, the legal and financial infrastructure offered by the likes of Hong Kong and the BVI continues to be a value-add. There is no formal time frame for fully opening up China s capital account but the steps the government has taken to internationalise the currency naturally prompts industry participants to think about the future. Roughly four in five survey respondents said the continued liberalisation of the renminbi will have a medium-term impact on the offshore market and the vast majority expect this impact to be positive [Figure 17]. FIGURE 17 Yes No Don t know Will the continued liberalisation of the RMB have an impact on the Chinese offshore market? If yes, indicate whether this will be a positive or negative impact Negative 82% 12% 7% 56% Positive 25% Negative Positive 0% 1% 5% 13% Looking forward : An industry on the move 23

26 5MARKET DRIVERS Less about tax planning An ongoing theme of the Offshore 2020 survey in the past few years is the decline in traditional tax planning as an industry driver. Asked to rank a series of factors on a scale of 1 to 5, with five being the most important, in terms impact on business, tax planning scored 3.8 in This fell to 3.6 in 2013 and to 3.4 this year [Figure 18]. No other factor has experienced such a rapid demise. 24 OFFSHORE 2020

27 Asset protection and emerging market wealth remain the key issues, with 4.1 and 3.9, respectively, representing a slight increase on They are joined in the top five by increased client sophistication, cross-border trade and the improving global economy all three of which haven t previously featured as questions in the survey. GDP growth and privacy and client anonymity are both now seen as more important than tax planning. FIGURE 18 Less Important Most Important Key drivers of business Asset protection/wealth planning Increased client sophistication Emerging market wealth Cross border trade 3.8 Improving global economy 3.7 Privacy and client anonymity GDP growth Traditional tax planning Double tax treaties 3.4 M&A activity New IPOs and capital market activity Higher taxes in developed markets Asset protection is the key driver for individual clients Lawyer in HK Respondents said 10.5% of their business is done for individual tax purposes, roughly the same as last year, but well down on the 15.9% of Asset protection tops the rankings on 28.2% followed by funds management on 18.8% [Figure 19]. Looking forward : An industry on the move 25

28 FIGURE 19 Key usage of offshore entity Asset protection & wealth management 28% 29% 2014 Fund management 19% 20% 2013 Investment holdings for corporate 13% 15% Individual tax planning 11% 10% Special purpose vehicles 9% 9% Trading for corporate 8% 12% Tax planning for companies 8% Listing vehicles for IPO 4% 5% Asked specifically whether tax planning has become less important for individual clients, 59% answered in the affirmative, while just 25% disagreed outright. And these entrepreneurs and high net worth individuals remain the fastest growing segment of end-users, according to 41% of respondents, up from 37% last year. The gap between first and second place has increased substantially in 2013, with hedge funds and private equity cited by only 21% of respondents compared to 30% in 2013 [Figure 20]. FIGURE End-user segments driving growth in the past two years Entrepreneurs/ High Net Worth Individuals Hedge Funds/ Private Equity 21% 30% 41% 37% 2013 Multinational Corporations 11% 11% Small and Medium Enterprises Small Medium 19% 13% Family Offices 8% 9% 26 OFFSHORE 2020

29 A group of international investors identifies a Chinese infrastructure developer that needs capital for a series of desalinisation projects [Figure 21]. They set up an international business company in the British Virgin Islands (BVI) as a holding structure and deposit the money, supplementing it with bank loans. The funds are then routed to the Chinese developer and the projects get up and running. Profit travels back to the BVI structure in the form of dividend payments that are distributed among the investors. FIGURE 21 International investors Shareholdings Invest in Chinese company A sample of a non-tax driven structure The BVI Company Source: Harrneys & Stikeman Elliott Loan Bank Infrastructure Projects in China Entrepreneurs/ HNWIs is the end-user segment of the offshore market where business has seen the biggest growth in the last two years Chairperson of an investment management firm, Hong Kong Clients Individual are inclined to pay their taxes as required, however, they are more concerned about maintaining and preserving their assets after filling their tax obligations BVI registered agent Investors benefit from British-based: law courts professionals This scenario is not unique to China, although the BVI has become a tried and tested conduit for overseas capital entering the country. Contrary to widespread public perception of offshore financial services, the motivation is not tax avoidance; each investor is subject to taxation in the jurisdiction in which it is incorporated. Rather, the BVI is used for purposes of tax efficiency, legal certainty and general ease of doing business. The structure is tax neutral, so there are no double taxation issues to untangle and the dividends generated by the Chinese company as well as any capital gains that accrue on exiting the investment are not touched by local revenue authorities. Should problems arise, there is the comfort from the British-based law under which issues are assessed, with the option of recourse to the Privy Council. In the BVI as elsewhere, there is a deep pool of service provider talent familiar with these structures. And international banks are happy to extend loans to companies incorporated in the jurisdiction, citing local creditor friendly legislation and an effective system of registering charges. Looking forward : An industry on the move 27

30 It is worth noting that multinational corporations are the fastest growing market for just 11% of the survey sample. The percentage of business most closely linked to corporations has also fallen over the past couple of years. In 2012, trading for corporates accounted for 13.4% of activity but it has since dropped to 8.3%; investment holdings for corporates has declined from 16.7% to 12.9% over the same period. Meanwhile, tax planning for companies a new category this year only has an 8.2% share. MNCs have to satisfy their shareholders and also have huge operational costs that make tax planning much more significant BVI registered agent These numbers, to a certain extent, allow us to disentangle myth from reality in terms of who is using offshore structures for what purposes. Last year, the likes of Apple and Google appeared before committees comprising members of the United States (US) Senate and United Kingdom (UK) Parliament to answer accusations that they deliberately avoid tax. Google, it was claimed, generated US$18 billion in revenue from the UK between 2006 and 2011 yet paid the equivalent of US$16 million in UK corporation taxes during that period, essentially by basing its sales force in Ireland and leveraging the UK- Ireland double tax treaty (DTTs). If the system has been abused then it should be cleaned up and multinationals that have transgressed for example by falsely claiming substance in a lower tax jurisdiction for the purpose of minimising payments should be punished. But by explicitly targeting large multinationals, politicians have made them the public face of offshore financial services; where in the minds of politicians, these are the groups that are short changing governments and eating into budgets for schools, roads, elderly care and social services. Tellingly, there is scant acknowledgement of multinationals contribution in areas such as job creation and driving innovation. Nearly half of survey respondents said that tax planning may indeed be the primary reason why multinationals use offshore structures; the remainder were divided equally between No and Don t know. Yet the survey also confirms that these multinationals are not the primary source of business. If anything, the offshore industry is investing in the skills and infrastructure required to ensure the system is as watertight as possible. Asked to rank a series of constraints in terms of their impact on business, competition and pricing scored highly [Figure 22]. There is unlikely to be much short-term change in this area. However, the obstacles created by anti-money laundering and know-yourcustomer processes, DTTs and information exchange, and the lack of qualified staff have all dropped by comparatively large margins from two years ago. This suggests best practices are increasingly understood and ingrained. 28 OFFSHORE 2020

31 FIGURE 22 Less Important Most Important Key constraints on the industry Competition and pricing AML/KYC processes Opening a bank account using an offshore companies The industry s public relations image FATCA and similar regulations Lack of qualified staff DTTs and information exchange Information leaks eroding client confidence Higher taxes 3.1 The Ukraine/Russia incident 2.2 Looking forward : An industry on the move 29

32 6 The SERVICE PROVIDERS Coming consolidation arrival of double tax treaties (DTTs) and tax information exchange agreements (TIEAs) created enormous uncertainty among offshore practitioners. However, within a couple of years these codicils were seen more as an opportunity than a threat. Shouldering the administrative burden that comes with greater regulation is a point of differentiation for service providers it creates a barrier to entry and enables them to prove their value-add to clients. In this context, there is no reason why the industry cannot adapt to the next phase of change and the challenges presented by the Foreign Account Tax Compliance Act (FATCA) and automatic information exchange. 30 OFFSHORE 2020