Three significant events affecting investment in Cuba occurred towards the end of 2013. First, the Cuban government announced it would phase out the long-reviled dual-currency system in force since 1983. Second, tax benefits for foreign investors in a special economic zone were announced. And third, legislation was passed to boost cruise and marina-based tourism by permitting foreign-flagged vessels used for recreational purposes to remain in the country for five years.

So, is it time to catch the next wave of foreign direct investment into Cuba? After all, Cuba offers a relatively untapped market and sophisticated consumers, with its gradual reform and deregulation by a formerly orthodox communist regime. Dreams of a miniature China or a tropical Hungary animate fact-finding trips by real-estate developers and consumer products manufacturers. Others look to the low-cost labour pool and proximity to the US and see a future Dominican Republic (exporting garments) or even a nascent Costa Rica (shipping middle-level technology commodities such as chips).

Unfortunately, despite these recent developments and Cuba’s many advantages as a market or production base, there is no reason for investment except by the most adventurous. The two dominant negative factors are the US and Cuban governments.

Economic embargo

The US maintains its economic embargo of Cuba. The embargo is enshrined in a piece of legislation called the Helms-Burton Act, as well as complex regulations issued over the past 50 years that are now administered by the Office of Foreign Assets Control of the US Department of the Treasury. A few loopholes exist: agricultural exports from the US are permitted, Cuban-Americans may visit family and send remittances, and ordinary Americans can travel on ‘person-to-person’ tours. But other than these and other specific exceptions, the law prohibits US citizens, US corporations and foreign entities owned by US citizens or corporations from investing in Cuba or doing business with Cuban entities anywhere in the world.

Early in its tenure, president Barack Obama's administration took executive branch measures to widen some of the loopholes in the embargo. And most independent observers believe the embargo should be modified or lifted entirely. Opinions vary as to whether it is significant economically, but it is obviously ineffective in achieving the policy goal of regime change in Cuba. However, the Helms-Burton Act cannot be changed without a majority of the US House of Representatives and the US Senate agreeing. And it seems highly unlikely that the Republican-controlled House of Representatives will liberalise the act. The level of passion was illustrated just last December at Nelson Mandela’s memorial service when President Obama was savaged by right-wing critics for shaking the hand of Cuba’s leader Raúl Castro.

Yet, even if the US embargo was magically to disappear, the case for investing in Cuba would still be weak because Cuba’s laws and their implementation (or not) provide powerful disincentives for foreign investors. That is why even foreign companies with no connections to the US and its Helms-Burton Act have been slow to act.

There are multiple hurdles for foreign investors in Cuba. Among the most important are:

• a highly ‘political’ approval process;
• the near impossibility in practice of a 100% ownership interest;
• difficulty in obtaining majority control of a local joint venture;
• limitations of local sales (whether of local or foreign products);
• a communist model for employing local staff;
• capricious enforcement of laws; and
• risks of leakage for intellectual property and confidential financial information.

Approval and control

Law number 77 (1995) is the main legal authority governing investment in Cuba. Although Article 13 of the law permits a foreign investor to own 100% of a Cuban entity, this has almost never been granted. Therefore, investors must find a Cuban entity with which to form a joint-venture company. Finding a partner is difficult in every country, but in Cuba the choice is very limited. Almost all Cuban entities with any degree of market presence or expertise are owned by the state or ‘co-operatives’. Not surprisingly, such Cuban partners often have different business goals and are subject to different outside pressures than the foreign investor.

In theory, the foreigner may control the joint venture, but in reality this is not encouraged. In fact, the website of the Ministry of Foreign Affairs says Cuba only accepts the foreign investor having majority control in “justified cases”, but does not expand on what this would entail.

Moreover, the approval process for an investment is complicated and lengthy. It typically takes 18 months or longer (even though the law says a decision should be made in 60 days). The application requires the foreign investor to provide lots of confidential information about the proposed operations. Even more troubling, if the foreign investor has a proposed joint-venture partner (as it almost always will), the foreigner must give all that confidential information to the Cuban partner before knowing whether the investment will be approved. As the Cuban partner may well be a competitor (at least in Cuba), the foreigner risks ending up with no approved investment, no partner and a competing Cuban company with proprietary or confidential information about the foreigner’s business. This information could include know-how, production costs and financial margins.

Finally, an analysis of projects that have been approved by the Cuban government shows it is advantageous if the foreign entity is itself a state-owned entity, a quasi-public entity or a ‘national champion’ from a country with its own dirigiste mentality. For example, among the major projects now in progress is construction of a major port facility by Brazilian conglomerate Odebrecht, which is supported by Brazilian government credits.

Cuba is still far from welcoming capital for capital’s sake. As Cuba’s Ministry of Foreign Affairs states on its website: “It [cannot] be said that in Cuba the foreign investment opening is part of an ongoing privatisation process… national policy is aimed at defending the prevalence of state property in all forms of joint ventures.”

Currency challenge

Cuba has a dual-currency system, similar to that used by China in the past. One currency, the convertible peso (CUC), is freely convertible into dollars, euros or other hard currencies. The other, the Cuban peso (CUP), is not. So, CUCs are needed for buying foreign goods. A CUC is 25 times the value of a CUP. 

If foreign investment is approved and made, day-to-day operations in Cuba present additional challenges. Selling products in Cuba (whether imported or manufactured locally) is difficult. All distribution of goods is controlled by state-owned companies. The manufacturer would have to find one of those state-owned companies to purchase the goods. The law (Article 26) requires a foreign-invested entity to transact business only in CUC, but most local wholesalers and purchasers will not have CUC. And if they do have CUC, they would rather use it to purchase imports than locally produced goods.

Labour regulations are another challenge. By law (Article 33), the foreign-invested entity must hire all its Cuban employees through a government employment agency. This means it cannot freely hire the workers with necessary skills. It also means that if it trains workers in the essential skills, there is no guarantee they will remain as the government employment agency is free to substitute workers.

Finally, even after an investment is made, foreigners find navigating policy and politics tricky. Anglo-Dutch food giant Unilever left Cuba in 2012, after a 15-year joint venture expired and new terms could not be agreed. The Financial Times reported that the total number of joint ventures decreased from 258 in 2009 to fewer than 240 in 2012.

Slow progress

What, then, of the three green shoots mentioned above? The market’s excitement about the elimination of the dual-currency system was soon tempered by former minister of economy and planning José Luis Rodríguez. In November, Mr Rodríguez, now an advisor to Cuban academic institution Centro de Investigaciones de la Economía Mundial, wrote in magazine Cuba Contemporánea that “the adjustment will possibly take three years or more”. He went on to say that “the currency reunification must guarantee the highest possible economic stability and security for all members of society. Therefore, we should expect the step-by-step introduction of different exchange rates by sector. This, in turn, will bring about a complex process of creation of financial reserves, accompanied by transformations of the legal, accounting and statistical framework”. In layman’s terms, given the economic dysfunctionality created by the dual-currency system, it will take time and be complicated to unwind.

The introduction of tax preferences in a special economic zone may prove a sufficient lure for some foreign businesses. But a lower tax rate is of no use if there are no profits. And profits only come if there is investment approval and then successful operation of the business. It remains to be seen whether the tax incentives are a sign of desperation or a crack in the door to a more welcoming environment for foreign investors.

And the new rules for recreational vessels? Expect some cheap cruises by European ship lines to be tacked onto the package holidays in Varadero enjoyed by budget holidaymakers. Perhaps sunblock would be the best sector for investment in Cuba.

William A Wilson III is the managing partner of Wilson International Law, a law firm focusing on crossborder debt and equity transactions.