Friday, December 05, 2008Demystifying Financial Services

Elise DonovanGetting to Understand the BVI's Biggest Industry

On my first trip to South Africa in 1995, I developed an appetite for one of the country’s popular soft drinks – tizers. These were essentially carbonated juices; much like the American cider, but in soda can size portions. My favourite was the red grapetizer, so I perused the can to find out as much as I could about this refreshing drink that was not available in the United States. Much to my surprise and delight, the company that produced the tizer was registered in the British Virgin Islands. That was the first time that I started to seriously contemplate the global reach of the BVI financial services sector and how a delicious juice drink in a far away country like South Africa could be owned by a British Virgin Islands company.

Seven years later at the World Social Forum in Brazil, I’m marching and singing “Um Outro Mundo é Possivel” translated “Another World is Possible” along with more than 51,000 people from 131 countries. We were there as a counter to the World Economic Forum to protest, discuss, debate and present alternative perspectives to the existing system of economic globalization that continued to widen the gap between the ‘haves’ and the ‘have nots’. Tracy Champan’s lyrics, “Why do the babies starve, when there’s enough food to feed the world?” weighed on my conscience.

In one workshop which sought to explain the answer to the big ‘Why’, the presenter outlined how some countries were providing avenues for people to hide money thereby fostering the great economic divide. The British Virgin Islands was the case study. But unlike my delight in South Africa, I was dismayed and embarrassed, trying to sink a little lower into my seat, as he explained how my beloved British Virgin Islands was one of those nefarious countries that sought to distort the global economy by allowing African dictators and corrupt officials to steal and launder money from their struggling people and the wealthy to hide money that should go toward taxes to help feed some of those starving babies. My knowledge of the BVI’s financial services industry was not sufficient to challenge the presenter, so I sat quietly and listened.

Today I’m more informed about the BVI’s financial services industry, and while I may not always be in a position to challenge the Territory’s critics, this article would seek to answer how a BVI company could own a delicious soft drink across the world and further explain BVI’s, not nefarious, but vital role in the global economy.

The BVI financial services sector was, like many major economic shifts, birthed out of necessity. The end of the double taxation agreement with the United States, the world’s leading economy and one of BVI’s most important trading partners, left the BVI without a clear viable alternative to its over-reliance on tourism. The passing of legislation in 1984 that allowed for the registration of international business companies was the start of a bright and prosperous future for the BVI in the world of international finance. The timing of the legislation, some experts argue, allowed BVI to take advantage of the instability of Panama during and immediately after the Noriega era. Many of the Panama service providers established operations in the BVI as a stable and low cost alternative to Panama and marketed the Territory as such.

At the same time the United Kingdom was seeking to decrease the burden of its overseas territories on its Treasury and therefore actively encouraged them to develop financial centres. With few natural resources to diversify its economy, financial services appeared a very attractive option for the Territory. Whatever the impetus, it propelled BVI, along with other overseas territories like Bermuda and the Cayman Islands, into the world of international financial services and the Territory is now regarded as an industry leader globally.

Earlier this year BVI’s status as a leading international financial centre was confirmed by the Territory’s inclusion for the first time in the Global Financial Centres Index published by the City of London. The BVI entered the list of top centres in 27th place among 69 leading international finance centres. The index is based on nearly 19,000 assessments from business professionals worldwide. The same index also placed BVI among the world’s most stable finance centres, just behind jurisdictions such as Zurich, Hong Kong and Geneva.

BVI’s accomplishments in financial services are not the result of any one or series of events or just luck. “Luck is what happens when preparation meets opportunity,” say industry leaders. Mr. Robert Mathavious, who many credit as being the father of the BVI financial services industry, has three words as his mantra – “preparation, preparation, preparation.” In a submission to the UK Treasury Committee inquiry into offshore financial centres this year, the Financial Services Commission, of which Mr. Mathavious is CEO and Managing Director, said, “Through hard work, prudential management and supervision, regular legislative reviews and the enhancement and strengthening of its legal and judicial systems, the Virgin Islands was able to develop a niche market in financial services.”

Governor David Pearey, the United Kingdom’s official representative in the BVI, agrees but also credits BVI’s strong relationship with Britain as one of its overseas territories as the foundation on which investors rely. “The rule of law, a respected legal system and political stability based on strong democratic principles are all assured by the British connection. When sheer beauty of the Territory and the warm welcome of the population are added to the mix, the reasons for doing business in the BVI become irresistible,” says Mr. Pearey. While the British connection may provide some assurance, it is noteworthy that the BVI is the only British overseas territory in the Caribbean to which the British Government has devolved overall responsibility for developing and managing its financial services industry.

There is general agreement that BVI’s ascendancy in international finance was not an overnight phenomenon, it took time and hard work. In 2001, the BVI established a fully independent financial regulator, the Financial Services Commission, to succeed its Financial Services Department. The Commission is responsible for regulating all financial services business operating in and from within the BVI. In addition to enforcing all financial services regulation and laws, the FSC promotes accountability, transparency and good governance. It is answerable to Cabinet (Executive Council before 2007) and the House of Assembly through the Minister of Finance. The Board holds annual formal dialogue with the Cabinet to discuss matters regarding its performance, initiatives and direction.

The Financial services industry seems to be one of the few areas where the views and policies of successive governments converge. They agree that the industry is paramount to the Territory’s well being and see no need to tamper with a working formula. For the last two and half decades successive governments have provided the necessary legislation, training and other resources to fuel the industry, but have adopted a hands-off approach otherwise.

Financial services is now one of the twin pillars of the BVI’s economy and is credited with making the BVI, with a GDP per capita of $41,546 (2007), one of the most buoyant economies in the region. Financial services surpassed tourism as the BVI’s breadwinner and accounts for about 57 percent of BVI’s Government’s annual revenues (2008 budget estimates), while tourism revenues decreased to below 40 percent. But unlike tourism which attracts largely unskilled labour, workers in the financial services industry are very skilled and highly compensated - many with annual six figure salaries. The large salaries also net considerable sums for payroll taxes. According to BVI labour statistics, some of the highest paid workers are in the financial services industry which makes up a sizable portion of the BVI labour force.

Labour in the financial services sector is multifaceted. Director of the BVI International Finance Centre, Mrs Lorna Smith, government’s marketing arm for the industry, says “BVI is not a one-trick pony. BVI’s financial services brand is built on a strong reputation in a range of services in company registration, captive insurance, mutual funds, fiduciary, trust formation, corporate business and recently registration of ships.”

Registration of companies, however, is the industry’s mainstay. BVI began offering offshore registration to companies wishing to incorporate in the islands, and incorporation fees now generate substantial revenues. Roughly 77,000 companies were registered alone in 2007. It costs up to US $1,100 to register a company and license fees due annually to the Companies Registry go as high as $1,100. Companies also pay varying annual maintenance fees to private registered agents.

With more than 830,000 companies registered in the BVI, the territory ranks highest globally in terms of company registration. More than half of companies registered come from Asia and Europe. BVI registered companies in 2007 were the second largest source of foreign direct investment (FDI) in China with US$12.914 billion. BVI also ranked second in FDI in Vietnam with US$3.5 billion invested from companies. BVI is also among the top three jurisdictions for outward FDI for Indian corporations. Worldwide BVI was ranked fourth in terms of leading captive domiciles. Other markets for the BVI include Russia, and Miami and New York, especially with hedge funds.

Flexibility, costs, privacy, quick and easy set up of companies, and familiarity of practitioners and their clients with companies are some of the advantages of registering in the BVI. BVI leaped even further ahead of the game when its Registry of Corporate Affairs introduced VIRRGIN, (See article on VIRRGIN in Business BVI 2008 Edition) an online system that provides for companies to be incorporated within 24 hours by a licensed BVI registered agent.

One main attraction for clients registering companies in the BVI is its low tax regime. Tax rates were already low when the tax act was amended in 1987 and corporate income tax for international business companies was zero-rated, while local companies still paid 15 % tax on their income. In 2005, corporate tax was abolished and the new Business Companies Act lowered the income tax rate to 0% for both local and international business companies.

BVI officials say initiatives like its Business Companies Act keeps its financial services industry dynamic. “BVI is different from other financial services jurisdictions and remains ahead of the game because of its leading and cutting edge regulation, its commitment and responsibility, and its success in striking the right balance between enforcing legislative and regulatory conditions that foster innovation from international business, while maintaining the highest standards of business ethics,” says Smith.

Unlike other competing financial centres like the Cayman Islands, the BVI opted not be a banking jurisdiction and has only nine banks. The number and size of financial transactions conducted in the Territory are relatively low. But the Territory still has to contend with the misconception that the BVI is awash with money from tax evaders and money launderers.

Mr. Mathavious says, “In the BVI, we firmly believe that good regulation enhances reputation. To protect our integrity and reputation as a well-regulated international finance centre, the BVI has adapted to the changing global environment and taken the necessary measures to deter and confront financial crime. Our approach meets international standards without damaging the competitiveness of the BVI financial services industry.”

As a major player in the global financial system, BVI was also keen to deter criminal activity from tarnishing its reputation. It established the Financial Investigation Agency in 2004 to investigate suspicious financial transactions. The Agency is responsible for receiving, obtaining, investigating, analyzing and disseminating information relating to money laundering, financing of terrorist activities and other financial crimes. Each year the Agency investigates more than 100 suspicious activity reports.

Earlier this year a high profile case involving the IPOC International Growth Fund, a Bermuda registered Fund came before the BVI court following a lengthy investigation involving local authorities and their Bermuda counterparts. As a result of this investigation local authorities confiscated more than $40 million, the largest seizure of its kind in the Commonwealth. Director of the Financial Investigation Agency, Mr. Errol George, says “It is important that we keep the sector clean and free from white collar criminals. The Agency is committed to that task.”

While BVI has shied away from banking, it actively seeks to establish itself as a leading trust jurisdiction. The Virgin Islands Special Trusts Act (VISTA) (See article on VISTA in Business BVI 2008 Edition) was established in 2004 to appeal to a special clientele. Regular trusts are agreements between an owner of assets and trustees. In these agreements, the trustees undertake that they will administer the trust’s assets with the necessary care to the benefit of the beneficiaries. One of VISTA’s attractions is the fact that company shares can be placed into it without the trustee having to take on management responsibility. Trustees also do not have any fiduciary responsibility over the company’s assets.

The BVI is also one of the leading jurisdictions globally in captive insurance. Essentially, captive insurance companies are insurance companies established with the specific objective of financing risks emanating from their parent group or groups but they sometimes also insure risks of the group’s customers as well. Using a captive insurer is a risk management technique where a business forms its own insurance company subsidiary to finance its retained losses in a formal structure. The term “captive” comes from the fact that the policyholder owns the insurance company, i.e. the insurer is captive to the policyholder.

The new frontier for the BVI finance services is registration of ships. Earlier this year the Virgin Islands Shipping Register (VISR) was upgraded to Category 1 status by the Red Ensign Group of which VISR is a member. Ships flying the flag are entitled to British diplomatic and consular support and Royal Navy protection. With Category 1 register status, the BVI will be able to register yachts of up to 3000 gross tons and other cargo ships of unlimited size and tonnage.

The growth in financial services has also brought about a parallel growth of supporting professional services in law firms, accountancy firms, trust companies and funds, many of which have offices in other parts of the world. Lawyers and accountants make up the largest groups of professionals in the sector. There are an estimated 110 lawyers admitted to practice law in the BVI. Another large number of lawyers serve as in-house counsel to many trust companies and other service providers. Similarly, estimates are that at least 100 qualified accountants practice in the BVI. World-renowned accountancy firms such as KPMG, Deloitte, PricewaterhouseCoopers, and Ernst and Young are among those with BVI branches.

Requiring highly skilled professionals also means that the BVI financial services industry relies on a large pool of expatriate workers. Estimates are that more than 60 percent of workers in the Territory are non-BVIslanders. This is a challenge for the BVI which seeks to attract the most experienced and skilled workers to keep the industry progressing, but at the same time wants to ensure that its nationals maintain a large piece of the economic pie. Some British Virgin Islanders are alarmed by the ratio of expatriate workers to locals, but director of the IFC Lorna Smith says, although we have a deficit of human capital in the industry at the moment we should not be scared by the ratios, “but how we manage those ratios is important.” She says Government has to have strong labour and immigration policies, not extreme ones like other jurisdictions which severely limit the number of years expatriate workers can remain in their territory, but “to make sure that BVIslanders have the opportunity to be leaders in the industry.”

Successive governments have sought to ensure local participation by allocating hundred of thousands of dollars to training locals in the sector. Some work permits are issued with the stipulation that locals be mentored and trained to succeed the work permit holder. Financial services is being incorporated into the national curriculum and a Financial Services Institute was established at the H. Lavity Stoutt Community College as a feeder to the industry. Students and professionals have the opportunity to access relevant training in financial services at pre-community college, community college, baccalaureate and postgraduate levels, as well as specialized topical professional training. The Institute also offers the Foundation Certificate in International Trust Management of the Society of Trust and Estate Practitioners (STEP) and the Introductory Certificate in Compliance and Anti- Money Laundering of the International Compliance Association (ICA), both well-regarded qualifications in the industry. The IFC and its private sector partners have also been marketing the industry’s professions to high school students as good career opportunities.

Getting more local talent in the industry is just one dimension. Another is how to attract and maintain professionals and businesses in the Territory with some of its infrastructural short-comings. For example, the BVI lacks some of the important infrastructure of an international business centre, such as state of the art conference facilities, reliable electricity, air transportation, competitive telecommunications and sufficient educational facilities for professionals with school-age children.

Private developers are leading the charge in getting bigger and more sophisticated buildings to line the landscape of the Territory’s capital. One of these developments, though a Government institution, is the conversion of a building that housed a bank into the territory’s commercial court. The building will house the Commercial Division of the Eastern Caribbean Supreme Court, which governs the BVI judicial system. Litigation specialists in the Territory report that a large amount of their cases involve international business companies and this litigation boom helped pushed the Government to establish the new commercial court, which is expected to boost the jurisdiction’s image and broaden the territory’s foray into the financial services sector.

Remedies to the challenges facing BVI’s financial services industry may not be as easy as improving the infrastructure, especially to those that are externally driven. Whether it’s the U.S. Senate or the European Union that have targeted the finance centres, such as the British Virgin Islands, the attack is persistent and unrelenting.

Over the years, BVI has seen itself as the little David standing up to international giants like the United States and the Organization of Economic Development and Cooperation’s (OECD) initiatives on Harmful Tax Competition and Tax Havens. In 2002, the Territory signed an agreement committing to the OECD’s principles of transparency and effective exchange of information. In this move the BVI averted being put on the OECD’s list of uncooperative jurisdictions and being subjected to defensive measures by OECD countries.

Then Chief Minister Ralph T. O’Neal stressed to the OECD that the British Virgin Islands “has a good track record both in its compliance with internationally established standards, and close cooperation, in financial regulation and the fight against crime generally.” The Territory was also one of the leaders of the charge for a level playing field requesting all OECD members and non-OECD jurisdictions with which the BVI competes in financial services to agree to apply the same measures themselves.

Getting OECD member countries like the US and the UK to compete on a level playing field and apply the same measures to themselves is a major challenge. Possibly the next President of the United States, Senator Barack Obama, was one of the 2007 sponsors of the “Stop Tax Haven Abuse Act” and he has promised to make it a priority in his administration to stop what he cites as the “$100 billion in revenue drained from the U.S. Treasury at the expense of honest, hardworking American families who pay their fair share.

“This is a basic issue of fairness and integrity,” said Obama. “We need to crack down on individuals and businesses that abuse our tax laws so that those who work hard and play by the rules aren’t disadvantaged,” said Obama. One of the other sponsors of the bill, Senator Carl Levin said, “Offshore tax havens have declared economic war on honest U.S. taxpayers by helping tax cheats hide income and assets that should be taxed in the same way as other Americans. This bill provides a powerful set of new tools to clamp down on offshore tax and tax shelter abuses.” The bill lists BVI as one of those tax havens.

Mr. Mathavious says the accusation when it comes to the BVI is simply not true, “BVI will not provide safe haven for any of the ethically challenged,” he asserts. In terms of criminal activities, BVI boasts greater adherence to the rule of law and to the rules and standards of international organizations than most of its counterparts in the international community. The BVI’s Handbook on International Cooperation outlines clearly the channels, regulation, laws and other measures to thwart criminal activity. The Territory partners with countries world-wide, including the United States, to avert financial crimes.

“The issue is one of competition – developed countries want business to stay in their jurisdiction so that they can tax them to the maximum. Yes, they want to put the offshore finance centres (like the BVI) out of business, but it’s ultimately to protect their own business,” says one of the BVI industry leaders.

Although Britain was instrumental in nudging its overseas territories into financial services, it too has been fielding complaints from its parliamentarians on the ‘get rid of offshore centres’ bandwagon. They complain that the British territories, some of whose GDP per capita have outstripped that of the UK’s, are luring British tax payers to their low tax jurisdictions and now siphoning off funds that belong, once again, in the UK Treasury.

UK Parliament’s Treasury Committee earlier this year decided to undertake an inquiry into offshore financial centres as part of its ongoing work into financial stability and transparency. Two questions being asked are why OFCs are important to worldwide financial markets and to what extent do their use threaten financial stability?

Professor James R. Hines Jr. of the University of Michigan and the National Bureau of Economic Research, who specializes in academic research on offshore financial centres, answers these questions. He argues that OFCs play important roles in global financial markets and the world economy. He says they discipline financial markets by limiting banks and other large institution’s ability to exploit local monopolies to the disadvantage of individuals and businesses. OFCs stimulate foreign direct investment in high-tax parts of the world, as is evident by BVI’s international business profile. OFCs also permit governments of large countries to implement the domestic tax policies they want and need in the face of international economic pressures.

Rather than countries with nefarious reputations, the OFC world is actually dominated by countries and territories like the BVI with strong regulation, transparency, accountability, good governance, and clear measures to avert financial crimes. Businesses are attracted to clean and reputable jurisdictions and, conversely, transparent and well-regulated jurisdictions attract clean and legitimate business. It is on this premise that BVI operates as it charts its future in the global finance industry.

Responding to the many inquiries and challenges on the international front, Director of the IFC Lorna Smith says, “We’re prepared for the challenges and changes – We don’t always know where they are coming from, but what is important, is that we are prepared.”

The International Finance Centre recently organized a strategic planning retreat, with high level government and private sector professionals, as the first of several steps to move the industry to the next level. BVI hopes that strengthening its existing base and diversifying its markets will make it less susceptible to some of the external threats.

Plans are on the way to establish a satellite office in Hong Kong to put the BVI closer to its main clients in the Asia Pacific Rim. This will also be helpful as BVI turns it focus on Taiwan whose relationship with mainland China continues to improve. Serious consideration is also being given to the Latin American market as the region gains more economic stability. Particularly, Brazil, the largest economy in the region seems attractive because of its strong economic growth over the last few years.

BVI has also turned its attention to the Middle East, particularly Dubai and Qatar, where the increasing oil wealth has enormous potential for trusts, company incorporations and structured finance estate planning. A delegation comprising government and private sector officials visited these major financial hubs in the Middle East in April to explore opportunities for growth in financial services.

“It is imperative that Government maintains a pro-active approach in the quest to further develop this vital and robust segment of the local economy and at the same time, protect the Territory’s integrity and reputation as a well-regulated international finance centre,” said BVI’s Premier Ralph T. O’Neal, reporting on his first year in office in August 2008.

What is clear is that BVI financial services industry is global, and businesses like the South African juice company are using BVI’s low tax opportunities and financing structures to manage and grow their businesses. And contrary to the views of the presenter I met in Brazil years ago, the growth of BVI and other OFCs contribute to better economic performance in the countries with which they do business. This in turn shrinks the gap between the ‘haves’ and the ‘have nots’. Perhaps BVI helps to make ‘Another World is Possible’.

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