The Boom and Gloom decade of the 2000's

Like tThe opening of “A Tale of Two Cities”, the decade of the 2000s represented the best of times and the worst of times for the Cayman Islands financial services industry.

In a time when the hedge fund was king in the financial world, the Cayman Islands served as the investment instrument’s seat of power. More than 80 per cent of the world’s hedge funds were domiciled in the Cayman Islands during parts of the decade.

The money flowed and the good times rolled.

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But the 2000s were also a decade of severe challenges that the Cayman Islands could do little about, except try to cope.

Before the decade ended, Cayman would face two harsh economic downturns, one caused by the September 2001 US terrorism attacks and another caused by a global recession worse than anything since the Great Depression.

In addition to strong international pressures on offshore financial centres at various points during the 2000s, the decade would also see Grand Cayman and Cayman Brac experience their worst hurricanes since 1932.

There was also political turmoil arising from a peaceful, but acrimonious, non-election-year change of government in November 2001. The decade also saw four changes of government and the formation of Cayman’s first political parties.

Despite the many challenges, the Cayman Islands remained a major force in the offshore financial world.

A storm of alphabet soup leading up to 2000, international pressures on offshore financial centres had been increasing.

The Organisation for Economic Cooperation and Development had issued a report on harmful tax practices in 1998. As a result, the Financial Action Task Force, an organisation formed to combat money laundering, started focusing more attention on offshore financial centres.

The Cayman Islands’ Financial Secretary at the time, George McCarthy, said the government proactively engaged the OECD and FATF and made an early commitment to refrain from harmful tax practices, while increasing its already tough practices on money laundering.

Cayman was also a founding member of the Caribbean Financial Action Task Force, an organisation that agreed to implement common counter-measures against money laundering. In 1996, Cayman received the organisations’ only clean bill of health for its practices in controlling money laundering.

But none of it mattered. In June 2000, the FATF listed the Cayman Islands as one of 15 non-cooperative jurisdictions in the international fight against money laundering. The inclusion on the FATF’s so-called black list outraged the Cayman Islands government.

The government pointed out that in the FATF’s own summery report issued the same day it stated the Cayman Islands had “been a leader in developing anti-money laundering programmes throughout the Caribbean region” and that it had “demonstrated exemplary cooperation on law enforcement matters.”

For the Cayman Islands, a decade of contradictory messages was just beginning.

Eduardo d’Angelo Silva, the president of the Cayman Islands Bankers Association at the time of the FATF blacklisting, doesn’t think the action was deserved, but admitted the private sector might have reacted too slowly in responding to the OECD and FATF.

Although Cayman already had anti-money laundering codes of conduct and know-your-customer regimes in place, especially in the banking business, Silva said it was rather disconnected from the international anti-money laundering bodies. He said that even though Cayman had passed a series of laws dating back to the 1980s – including the Narcotics Agreement, the Mutual Legal Assistance Treaty and the Proceeds of Criminal Conduct Law – all aimed at curtailing money laundering and criminality – it was, to a large degree, self-regulating.

“The OECD came back and said self-regulation was not enough,” he said.

Still, the FATF blacklisting came as a shock to the private sector.

“We really were taken by surprise because what we had at the time in terms of an anti-money laundering regime was still more efficient than what they had in the US,” he said.

Over the remainder of the decade, Cayman had to deal with several other kinds of alphabet soup. The EUSD, IOSCO, FSF, GAO would become the known acronyms of the European Union Savings Directive, the International Organisation of Securities Commissions, the Financial Stability Forum and the US Government Accountability Office. All of them seemed to have one goal in mind – to stifle the offshore financial centres.

The tilted playing field some of the jurisdictions calling for more stringent regulations in offshore centres weren’t subjecting their own financial business to the same regulation regimes they expected of others.

This lack of a level playing field, as it was termed, became a major thrust of the Cayman Islands early in the 2000s.

Legislator Alden McLaughlin noticed the hypocrisy early on. “There have always been two standards: one standard for the offshore jurisdictions and one for onshore,” he said.

“If we have to put clients through hoops that other jurisdictions don’t have, it puts us at a competitive disadvantage,” he said. “We don’t want others to ask us to impose systems and structures and regulations that others don’t have to do.”

One example of an unfair regime Cayman and other offshore jurisdiction were pressured into was making know-your-customer regulations apply retroactively to existing clients and not just new clients, according to Silva.

“Only Cayman and a few others actually did it,” he said. “I don’t think the industry was totally against it; it was just a huge cost to be absorbed. They were very time intensive and resource consuming exercises for the banks.”

Speaking at the Cayman Islands Bankers Association conference in 2006, Timothy Ridley, then chairman of the Cayman Islands Monetary Authority, pointed out a case of the FATF telling offshore jurisdictions to do as they said, not as they did.

He noted that the FATF’s 2005 report indicated Australia was only compliant with 12 of 40 of its anti-money laundering recommendations.

“Australia has never been on a list of non-cooperative territories,” he pointed out. “On the contrary, it is a leading member of the FSF, FATF and other organisations that continue to criticise offshore financial centres for non-compliance with international standards.”

Boom Time

The Cayman Islands managed to avoid the OECD’s 2000 black list, but it remained on the FATF’s list of non-cooperative jurisdiction for a year.

In response, the government hastily pushed through a slate of amending legislation less than a month after the FATF’s blacklisting.

Four laws were substantially amended, including the Proceeds of Criminal Conduct Law, the Monetary Authority Law, the Companies Management Law and The Banks and Trust Companies Law. Some in the financial industry claimed the amendments would put an end to banking as it was known in the Cayman Islands.

Ridley said it was mostly a matter of people not liking change and uncertainty.

“Every time a new measure is introduced, the naysayers come out of the woodwork,” he said, noting the dire prognostications about the adverse impact of the 1980s Narcotics Agreement and the Mutual Legal Assistance Treaty.

“The main downside was that the compliance aspects drove up the cost of doing business,” he said. “But the upside was that Cayman kept pace with the rest of the world in terms of international standards, and quality reputable business accepted the extra costs that went along with this.”

Despite the international pressures, the more stringent regulatory regimes and the extra costs, the Cayman Islands thrived.

In October 2000, while still on the FATF’s list, the Cayman government announced a 51 per cent increase in registered companies in the 12-month period ending in September 2000.

Along Came Ivan

Until 2004, the Cayman Islands had not been hit by a serious hurricane since 1932.

People and businesses in the Cayman Islands were understandably complacent in early September 2004, as Hurricane Ivan approached.

A week later, after a strong and slow-moving Category 4 Ivan had passed less than 25 miles south of Grand Cayman on 12 September, residents and businesses were surveying a devastated landscape of smashed cars, damaged buildings and denuded flora. Grand Cayman looked like a war zone.

Miraculously, by the end of that week, power and water was restored to the business district in central George Town and Cayman’s financial industry was operational again, even if not fully.

Ground zero for the recovery process – which started immediately after the storm had passed – was the offices of the law firm Appleby.

Managing Partner Huw Moses met others from the financial industry on the streets of George Town while surveying damage after the storm on Monday. A meeting of the private sector was set up in the Appleby boardroom for the same afternoon and more than 25 people attended.

The government became involved and so did the governor at the time, Bruce Dinwiddy. Out of these early meetings, and ad hoc committee called the Cayman Islands Recovery Steering Group was formed.

“The governor wanted a liaison between the National Hurricane Committee, Cabinet, himself and the private sector to spearhead the initial stages of the recovery,” said Mr Moses, who was appointed to the committee as a representative of the private sector.

“The whole point of the committee was to think strategically to solve problems. We needed a control and command strategy with a clear chain of command leading to the governor.”
With that unified effort, recovery, especially of the financial sector, occurred rapidly.

“Politics went out the window when we started having the [committee] meetings,” Moses said. “The governor sat there with [then Leader of Government Business] McKeeva Bush on one side and [then Leader of the Opposition] Kurt Tibbetts on the other side. No one let any political differences interfere with the problems at hand.”

In many ways, the period immediately following Hurricane Ivan was the Cayman Islands’ finest hour of the 2000s.

In a decade that was marked by adversarial politics and a less than ideal relationship between the government and the private sector, the various stakeholders all worked together toward to a single goal. Grand Cayman’s speed of recovery, compared to many other places that experienced similar devastation, was nothing short of remarkable and it only enhanced the jurisdiction’s appeal to investors.

After Grand Cayman rebuilt, it was stronger and more prepared than ever.

Moses said Appleby, like most businesses, was relatively unprepared for Ivan.

“We had a building that was not Category 5 rated, with regular windows and no shutters,” he said. “We had one 5-kilowatt household generator and a few large fans and lights and no dedicated hurricane supplies.

“Now we have Category 5 ready buildings with hurricane-rated windows, a generator to power both buildings, a back-up water supply, a large store room full of dedicated disaster recovery supplies, a developed and tested business continuity plan and a team of tried and tested professionals that can prepare the business and operate a shelter.

“Now we have radios, back-up communication links and satellite phones. Then we did not know what to expect, now we do. It makes all the difference.”

Challenges to Doing Business

During the 2000s, there were some key developments that made doing business easier, and less costly in Cayman.

The ending of the Cable & Wireless monopoly on telecommunications in July 2003 brought new competition and significantly lower prices in the industry. Although Internet and email became established in the 1990s, it wasn’t until broadband Internet became widely available and more affordable that it became a common tool with which to do business.

Despite the technological advancements, businesses in Cayman also faced a steady stream of challenges from the government.

In response to government budget problems resulting from global economic downturns after the 9/11 terrorism attacks in 1991 and the stock markets crash in 2008, the government significantly raised various licence fees, work permits fees and client-based fees. Those higher costs were passed on to clients, making Cayman a more expensive jurisdiction.

Another challenge for businesses was the institution of immigration controls aimed at preventing the vast majority of foreign workers from being able to remain indefinitely in the Cayman Islands.

The seven-year term limit, or “the rollover policy”, came into effect on 1 January 2004 through amendment to the Immigration Law. It required most expatriate workers to leave Cayman after seven years. Some foreign workers, if deemed to be vital to a company, were allowed to be made exempted employees, a term that was later changed to key employees.

Key employees were given the right to get up to nine work permits, long enough to qualify to apply for permanent residence, which, if granted, would give them the right to live and work in the Cayman Islands for the rest of their lives.

Businesses discovered quickly, however, that getting key employees wasn’t going to be as easy as they thought.

Leader of Government Business McKeeva Bush, who became Cayman’s first premier on the commencement of a new Constitution in November 2009, vowed that his government would implement the Immigration Law differently, particularly with respect to the rollover policy.

However, as the decade came to a close, there was still much uncertainty in the financial services sector on the issue of which expatriate employees would be allowed to remain in the Cayman Islands.

Global Economic Slowdown

In January 2008, noted economist Nouriel Roubini told a packed audience attending the Fidelity Business Outlook conference in Grand Cayman that a major economic storm was approaching.

Known as Dr Doom for his pessimistic forecast, Roubini spoke about the US housing bubble, of over-leveraging of US household debt, of the default of tens of thousands of ‘sub-prime’ mortgages that had been repackaged as asset-backed investment vehicles throughout the world’s financial world and of a severe impending credit crunch. He said he thought a severe and prolonged recession had started in the US in December 2007 that would affect the entire global economy.

Dr Doom was dead right.A plummeting US stock market fell 45 per cent from 2007 highs by November 2008 and Americans had collectively lost more than a quarter of their net worth.

Cayman began to feel the effects of the economic crisis in late 2008, but the harshest effects weren’t felt until 2009, when company registrations, hedge fund registrations and other income-producing transactions fell sharply.

Although Cayman was facing a multitude of issues in 2009, including the OECD grey listing and internal difficulties relating to immigration, crime and budget woes, people like Ridley believed the contraction of business in Cayman was predominantly due to the global financial crisis.

“The hedge fund industry and the debt/capital markets have run into significant problems worldwide, not just Cayman,” he said.

As the decade came to an end Ridley said it was too early to tell how things would work out in hedge fund and debt/capital markets.

“But I think that certainly business will come back quite soon, the markets will settle down and we shall then see what the markets demand and need and we can take action accordingly,” he said.

When the dust settles from the economic crisis, Ridley believed Cayman could still be a leader in providing offshore financial services.

“Cayman will have a valuable role to play in the allocation of world capital to where it can best be used,” he said. “But we need to be innovative, nimble, flexible and to recognise that the world out there is a very competitive place.”

The PR Battle

One thing learned during the decade was that the Cayman Islands needed to foster a better image of itself as a legitimate offshore financial centre. Politician McLaughlin noted that the United Kingdom was not inclined to help Cayman with its image problem, even if Cayman was one of its overseas territories.

“I don’t think we have ever got an unequivocal statement out of the UK endorsing Cayman’s anti-money laundering efforts,” he said. “Absence of that has been key as to why we get treated so badly by the EU and the OECD.

“But the UK is always more worried about its place in Europe and with the OECD than it is with the overseas territories.”

McLaughlin said that in private meetings with UK technocrats, they “heap accolades on Cayman”, but won’t say so publicly.

That’s a phenomenon that Ridley noticed with government agencies everywhere, including the US. He wrote about it in an article in Cayman’s monthly business newspaper, The Journal.

“All too often, those overseas agencies that are willing privately to compliment the Cayman Islands on their achievements and cooperation are the very same agencies that are not willing to make those comments publicly for fear of being seen to break ranks with their counterparts elsewhere…”

To fight the battle of perceptions, Cayman’s private sector started several initiatives.

The first came shortly after the FATF blacklisting in 2000. Eduardo Silva said an ad hoc organisation called the Cayman Islands Private Sector Trust was formed and funded by private sector entities.

“That was the first incarnation of the private sector trying to do some PR work,” he said, noting the trust engaged Hill and Knowlton, one of the world’s largest public relations firms, to help mitigate the damage of the FATF blacklisting.

After a successful three-year campaign, the remaining funds in the trust were used to create the Cayman Islands Financial Services Associations, to carry on the task of promoting the good image of the financial services sector.

However, without a specific cause to fight, funding for CIFSA was minimal, Silva said.

But by the end of decade, with the OECD and G-7 governments bashing offshore financial centres including Cayman, the private sector revitalised CIFSA, changed its name to Cayman Finance and started funding it properly.

Silva said Cayman Finance had some victories very early on.

“To a certain extent, the new structure of Cayman Finance is putting the right image forward,” he said. “But I don’t think we are winning the perception battle yet.”

Silva said he hopes Cayman’s private sector has learned that it will have to do its part in the promoting Cayman’s good image on a permanent basis, partially because he thinks the PR battle will be long.

“I think we’ll live in permanent crisis mode for quite some time,” he said.