Striking The Right Balance – Responding To Global Regulatory Challenges
In the wake of the global financial crisis, an unprecedented wave of regulation has swept through the financial services industry, impacting market participants at every level. As the industry grapples with the challenges and costs of implementation, it is an opportune time to pause and reflect on initiatives undertaken in the Cayman Islands to implement global regulatory changes in an innovative and balanced manner.
As a preeminent international financial centre, the Cayman Islands faces unique challenges implementing regulatory reform as it does business with every recognised financial centre globally. Accordingly, it is subjected to regulatory reforms originating from numerous international regulators.
These global regulatory initiatives have, for the most part, focused on two key themes:
- enhancing financial stability in the wake of the financial crisis; or
- raising revenue for fiscally challenged governments.
The Cayman Islands is also subjected to international regulatory reform across a number of industries. More than 40 of the world’s top 50 banks are licensed in the Cayman Islands, and liabilities on deposit total US$1.4 trillion, making it the world’s fifth largest financial centre in terms of cross border liabilities. The Cayman Islands is also home to over 11,000 registered hedge funds which comprise the majority of the estimated US$2.9 trillion hedge fund assets under management globally, as well as thriving captive insurance and structured finance markets. All of these industries have attracted the attention of global regulators, looking to address one, or both, of the objectives described above.
All of these factors combine to create a challenge for Cayman Islands regulators: how to create a framework where businesses, and the jurisdiction as a whole, are able to comply with these regulatory changes while maintaining a competitive environment where capital can be allocated efficiently across the globe.
A look at the Cayman Islands’ track record in response to recent regulatory challenges shows good results to date.
A Collaborative Approach
The Cayman Islands government has demonstrated a willingness to collaborate with the financial services industry to ensure that an optimal outcome is achieved when formulating policies in response to international regulatory changes. An extensive industry consultation exercise was undertaken for both the US Foreign Account Tax Compliance Act (FATCA) and the Alternative Investment Fund Managers Directive (AIFMD). By undertaking industry consultation and acting to implement the legislation and associated tax information agreements quickly, the Cayman Islands government has demonstrated its commitment to implementing solutions that balance the needs of the local financial services industry with the broader international regulatory agenda.
Bank Specific Regulations
The implementation of Basel II provides an example of the financial services regulator, the Cayman Islands Monetary Authority (CIMA), undertaking industry consultation, in this instance with the Cayman Islands Bankers Association, to ensure appropriate feedback and resolution of issues prior to the implementation of the Basel II framework.
Banks are required to report prudential, statistical and financial information to CIMA as below:
- annual audited financial statements within three months of the bank’s financial year-end;
- quarterly Locational Banking Statistics Survey;
- quarterly Basel II and Quarterly Prudential Reports (“QPR”) Form; and
- annual Basel II – Pillar II Internal Capital Adequacy Assessment Process (“ICAAP”).
CIMA also recognises that many banks licensed in the Cayman Islands are regulated by another regulator in the home country of the bank. In this instance, CIMA will ensure that the licensee is subject to effective supervision as part of the home country regulator’s supervision of the overall group. Such supervision must be conducted under an internationally recognised regulatory framework that is acceptable to CIMA. In this way, banks operating in Cayman remain under effective, consolidated supervision by the home regulator, while not overly burdened with redundant supervision by CIMA.
Flexibility of Licensing
The Cayman Islands offers a flexible range of bank licensing options, depending upon the nature and extent of the operations the bank will undertake. The categories of licenses can be paraphrased as:
Class A – allows the licensee to carry on banking services within the Cayman Islands as well as internationally.
Class B Unrestricted – allows the licensee to carry on unrestricted banking services internationally. Making loans to and accepting deposits from residents of the Cayman Islands is specifically prohibited.
Class B Restricted – allows the licensee to carry on banking services outside the Cayman Islands only with persons listed in the license application. This is typically used to facilitate the treasury functions of large corporations.
Banking in Cayman
The different licensing options provide banks with the ability to cost effectively execute their strategy through a structure that is tailored for their needs. The licences allow them to operate out of a jurisdiction with a legal system that is both traditional and robust yet flexible and conducive to business. Of the 229 bank licences issued as of Q1 2015, the vast majority (183) were Class B. For the large international banking groups, operating out of many markets, the domestic restrictions are not relevant, as their Cayman branches or subsidiaries interact with other entities within its group, or with international clients, in order to set out their financial transactions in the most efficient manner.
Many bank licences in Cayman are issued to banks in developing countries, which allows them to offer certain products and services that they would be unable to do in their home countries, where foreign exchange controls limits access to global markets. Trade finance instruments, such as letters of credit, that smooth the process of international business are important in this regard. Banks also trade Eurobonds through Cayman for their own treasury operations or those of their customers.
Capital Adequacy Requirements
CIMA has set minimum capital adequacy requirements of 12% for subsidiaries of foreign banks that are subject to consolidated supervision, as described above, and 15% for locally incorporated banks. Branches (rather than locally incorporated entities) of foreign banks do not need to meet the above capital adequacy requirements subject to the overall bank group meeting the capital adequacy requirements of its home jurisdiction.
Evident of the high esteem in which international banking clients hold the Cayman Islands, a recent survey in The Banker magazine named the Cayman Islands as the world’s best Specialist Financial Centre, which was the sixth consecutive year in which Cayman had topped the rankings in this particular survey. This shows how the industry professionals in the Cayman Islands are consistently providing high levels of service and really underscores how Cayman is perceived as the leading international financial centre in terms of providing specialized financial products.
The industry is represented domestically and abroad by the Cayman Islands Bankers Association (CIBA), which was formed in 1979. In addition to playing a role in shaping new legislation and the implementation of international regulation, through its work with government and the various legislative committees, CIBA is active in supporting training and industry relevant education in the areas of banking, trust administration and fiduciary practices.
Innovative Solutions to Strike the Right Balance
As the global regulatory reform process continues, CIMA, the Cayman Islands government and the financial services industry will need to adapt to the challenges of new regulation. Given the recent history of industry consultation, a willingness to implement legislative changes and the adoption of innovative solutions, the financial services sector in the Cayman Islands is well-placed to strike the right balance between maintaining an efficient model to facilitate the global allocation of capital and conforming to ever-changing international regulation.