.Whether they are referred to as ‘offshore centres’, ‘tax havens’ or their own preferred self-description of ‘international financial centres’, islands that are homes to financial industries – often of sizes beyond natural expectations – are in the news as never before.

While the economic recession has led politicians in the US, UK and EU to lead an attack on the jurisdictions as a populist vote winner, the bleak financial landscape has also fuelled increasing competition between island economies.

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As financial conglomerates look to minimise costs, the focus on operations and increasing back-office efficiency through selecting the best jurisdictions to domicile and service investments is very much on the agenda for banks and international financial services players.

“Our costs of operating are favourable compared to the Caymans, Dublin and the City of London, and we can still bring people in when we need to,” says John Spellman, director of Isle of Man Finance. The windswept island, situated off England’s north-west coast, has been carving itself a dual niche of fund administration and as an operations and asset management centre for hedge funds. It boasts ‘alternatives’ managers such as Charlemagne Capital and Bridge Asset Management. Funds managed from the island have shot up from $7bn 10 years ago to $43bn today, peaking at $53bn in 2008.

“There was some concern that when you do back-office activity, you are too susceptible to market swings and changes,” reveals Mr Spellman. “But in the current environment, diversification into fund administration is seen as very positive.”

Major fund administrators on the island include BNP Paribas, HSBC and Fortis.

 

Caribbean competitors

Many hedge fund managers feel they are badly serviced in the European time zone, and welcome the emergence of European island centres to rival Caribbean favourites such as the Caymans and the British Virgin Islands. Fund houses are also comparing islands on costs, quality of service and transparency.

The notion of regulatory arbitrage, with island economies racing to outdo each other by installing user-friendly financial regulations, has come under fire of late. “Your legislation should be fit for purpose and reflect your niche,” rather than just chasing the latest trends, says Mr Spellman. “The islands that go for new rules, when operating on the edges of regulation, always run the risk of a loophole being closed. It is better to establish a long-term competitive advantage and leverage it.”

Financial services is playing an increasingly important role in the economy of the Isle of Man, a semi-independent island of 80,000 people, now accounting for 36% of its GDP. It has long ago overtaken tourism, a previous success story based on the unlikely combination of kippers, motorcycle races, tailless Manx cats and a strong local folklore, where motorists wave to invisible ‘fairies’ when they cross a particular bridge.

Locals were aggrieved when their country was dismissed by UK chancellor Alistair Darling as a “tax haven sitting in the Irish Sea”. Mr Spellman had the unenviable task of calming down members of the Tynwald, the island’s ancient parliament, so they would not add to the political storm.

“Mr Darling’s remark caused a huge amount of resentment on the island,” he recalls. “People were going out to Douglas Head and looking at the names of all the seamen buried there who had served in the UK’s Royal Navy, and they just could not believe the disrespect.”

 

Boosting asset management

The Isle of Man, Jersey and Guernsey are all perceived as reasonably well-regulated British-connected offshore centres. But all three are striving to boost asset management and asset servicing businesses. This will help replace any offshore banking or Trust businesses, which may be eventually edged out by UK regulations or G-20 pressure.

A draft code of practice, being drawn up by the UK government, may ban banks operating in the UK from using tax havens. The code will reportedly give the UK tax authorities final discretion over whether a particular transaction is structured in such as way as to avoid tax. This threat further steps up the race between the islands to spruce up their brands in order to attract politically acceptable business.

“We are facing huge amounts of competition and it is getting more hectic by the day,” says Peter Niven, chief executive of Guernsey Finance. International financial centres are offering “much of a muchness”, although each has a speciality niche in terms of products and regulation, he believes. He gives the example of the Protected Cell Company (PCC), introduced by Guernsey legislation 11 years ago.

Now the PCC is being deployed not just for captive insurance, for which it was designed, but in a modified form in the fiduciary, private wealth and investment fund sectors. “That ability to adapt puts us ahead of the game,” claims Mr Niven. Guernsey is now moving to establish wealth management product Foundations, alongside Jersey.

The island is also improving the quality of practitioners through chartered qualifications for non-executive directors and other financial training tie-ups with the universities of Bournemouth and Strathclyde on the UK mainland.

Mr Niven’s department is working on two priorities. The first is introducing businesses interested in joining established Guernsey-based players, such as subsidiaries of Credit Suisse, Kleinwort Benson and Rothschild. The second is combating the anti-tax haven rhetoric, which he feels built up ahead of the London G-20 summit at the beginning of April.

 

Greater transparency

Despite attacks about lack of transparency, he maintains Guernsey has signed tax information exchange agreements with 13 jurisdictions, including the US, UK, France, Germany and the Netherlands. As requested by the OECD, the agreements all address tax evasion.

“The US government has come to us with a handful of requests, which we have helped them with,” says Mr Niven. Critics “need to do their homework” before they speak out, he adds.

Neighbouring Jersey has in recent years specialised in attracting specialist property and private equity-related fund work. Island representatives say its 13,000 employees working in the finance industry is considerably more than many competitors.

In order to increase business, Jersey is targeting companies in China and India to highlight the capabilities of its finance centre as a “gateway” to European investment and wealth management.

A recent visit to India showcased Jersey’s expertise in capital structuring for Indian business expansion into Europe, the use of Jersey funds for inward investment into India and private client wealth management, particularly the new Foundations offering.

The island plans to open a Hong Kong office later in 2009 to provide Jersey’s finance industry with a permanent presence in China. Its international reputation and standing is clearly vital to its practitioners and regulators. Rob Kirkby, technical director at Jersey Finance, says: “The growth of Jersey’s fund industry has been driven by investors and promoters seeking a jurisdiction offering stability and a good reputation, combined with suitable legal structures and local expertise.”

Alongside the Isle of Man, Guernsey, the Caymans and the British Virgin Islands, Jersey would be one of the ‘usual suspects’ on the shortlist of clients looking to set up an efficient fund structure, says Olga Boltenko, international tax counsel at London law practice Hogan & Hartson.

Differentiating between them can often be like “choosing between shades of grey”, she says. “With all offshore jurisdictions, the point is that the quality of work is not as good as it would be onshore,” adds Ms Boltenko, saying that clients expecting London or New York-style services are being unrealistic. “The demand for services is typically very high,” notes Ms Boltenko. “These are relatively unsophisticated people charging very sophisticated prices.”

 

Maltese magnetism

One country currently enjoying a good press is Malta, an historic island to the south of Sicily and north of the African continent. “Since we joined the EU in 2004, there has been a new perception of Malta; we are more on the radar,” reveals Professor Joe Bannister, chairman of the Malta Financial Services Authority. But 10 years previously, Mr Bannister and his Maltese colleagues had begun to smooth the way by ditching the ‘offshore’ tag when helping redraft financial services legislation. “I can assure you,” he smiles, “we are not on any list of tax havens”.

Today, Malta promotes itself as a hedge fund administration and European regulated crossborder fund (Ucits) domiciliation centre to rival Luxembourg and Dublin. “In this turmoil, a lot of hedge fund managers are creating Ucits funds. We expect to see quite a number of these,” he adds.

Now companies are relocating to Malta from other jurisdictions. Butterfield Bank moved its trust business from Jersey, citing Malta’s more palatable cost structure.

Numbers employed by the financial sector have trebled from 2500 people 10 years ago to 7500 today. Malta’s latest labour survey shows 15,000 island residents, mainly married women, officially “under-employed”, following the downsizing of schools and government offices. In order to meet expansion needs, the Malta Financial Services Authority proposes to retrain these workers for part-time jobs.

Mr Bannister dismisses calls for a new ‘Finance City’ to rival the construction of the Arab-financed ‘Smart City’, which aims to house Malta’s growing IT sector and which is already coming under criticism for increasing costs to proposed tenants. “I say let companies set up where they wish – they can build office space all over the island,” he says. “They should not be clustered in one place, where people need to travel up to an hour to get to work.”

 

Yuri Bender is editor-in-chief of PWM.