International financial centres (IFCs) stimulate investment activity between 'onshore' economies – particularly where international investors from developed and emerging markets need to come together to do business.
The BVI, for example, provides the neutral platform and infrastructure required for investment, offering modern, flexible company law, a respected commercial court and an experienced body of professionals. Its proximity to the USA and the relationship between the two jurisdictions not only promotes use by American businesses but also facilitates the export of Anglo-American legal values and financial services industries abroad, through BVI and American firms' involvement in cross-border transactions.
The economic benefits deriving from this interaction between IFCs and onshore jurisdictions are the subject of a growing body of academic commentary.
Debunking the 'Offshore' Myth
This symbiosis between smaller IFCs and onshore economies is well known to persons in the industry and is increasingly being more formally recognised as such. This is a welcome development and should encourage more informed perspectives regarding the role IFCs play in the global economy, which the vituperative public debate about IFCs often lacks.
It accompanies growing recognition amongst policymakers that more sophisticated distinctions must be drawn between 'offshore' jurisdictions. In September 2013, the UK Prime Minister, David Cameron, acknowledged the efforts of the Overseas Territories (OTs) and Crown Dependencies (CDs) to ensure "fair and open tax systems" and that "focus should now shift to those territories and countries that really are tax havens".
Most practitioners would admit that the so-called 'tax havens' should really be divided into three quite separate categories: (i) 'secrecy jurisdictions'; (ii) 'tax treaty jurisdictions', on which recent debates have predominantly focused; and (iii) 'neutrality jurisdictions'. The OTs and CDs, including the BVI, fall squarely in the neutrality jurisdictions, and are not tax havens or tax treaty jurisdictions.
Indeed, since the late 1990s, the BVI has demonstrated its commitment to international initiatives promoting transparency and cooperation regarding anti-money laundering / counter terrorism financing (AML/CTF) and taxation. Anyone incorporating a BVI company in the last decade will have encountered rigorous know-your-client (KYC) and due diligence requirements imposed by the BVI's AML/CTF laws. The information obtained is readily available to policing, regulatory and taxing authorities. Indeed, The Economist recently suggested that the BVI and other IFCs now lead many onshore jurisdictions in their consistent implementation of OECD and FATF AML/CTF recommendations.1 Furthermore, the BVI has no tax treaties but has 25 tax information exchange agreements (TIEAs), which are in fact tools enabling the proper authorities to root out tax evasion.
This commitment continues. This June, the BVI signed its intergovernmental agreement regarding the USA's Foreign Account Tax Compliance Act (FATCA), following a similar agreement with the UK in November last year. Despite the costs, most practitioners welcome the fact that FATCA "follows the money" and will assist in further combating tax evasion and money laundering. The BVI has also committed itself to early adoption of the OECD's Common Reporting Standard, a standardised automatic information exchange model inspired by FATCA.
So the BVI should remain confident of its place alongside the major onshore jurisdictions in the global economy. But what is the business model of the BVI (and other IFCs) and how is it symbiotic with the world's largest markets – and, in particular, that of the USA?
A Neutral Territory
It is worth remembering that the BVI probably owes its existence as an IFC to the USA. Readers may recall the genesis of the BVI International Business Companies Act, 1984, building on the strength of the Delaware statute. The IBC Act married the best innovations of Delaware law with the tradition of English common law, introducing improvements which would not appear in the UK until much later – if at all. The marriage was very fruitful – new incorporations saw nearly 50 per cent year-on-year growth from 1989 to 1997. The success of the BVI's incorporations statute (today, the BVI Business Companies Act, 2004) is attested to by the fact that the BVI is by far the leading IFC for incorporations and the third largest in the world after Hong Kong and Delaware.2
The BVI's relationship with onshore jurisdictions accounts both for the supply of, and also demand for, its incorporation product. The popularity of BVI holding companies with overseas investors – particularly from Russia and China – is explained by the fact that they offer a cost-effective, quality product compared to domestic corporations. Legal certainty is the prevailing benefit of a BVI company, as the rule of law is maintained by experienced lawyers and a respected commercial court, applying developed principles of English common law. Academic studies highlight the importance of such "sophisticated, robust and efficient institutions" in IFCs, such as the BVI, which provide infrastructure to enable investment in developing markets where conditions for secure investment might not otherwise exist.4
A BVI company also avoids limitations on domestic vehicles when raising capital and implementing financing structures – for example, restrictions on the ability to give credit support.3 IFCs reduce geo-political risks involved in foreign investment. As regards the USA, BVI companies are frequently used in asset financing – for example, aircraft financings, which benefit the American aviation industry.
The BVI is also the leading IFC for cross-border joint ventures (JVs) – its modern company law allows investors flexibility to structure JV arrangements in a neutral jurisdiction, where neither has home-field advantage. When disputes arise, which they do from time to time with JVs, both parties can be certain that the rule of law will prevail in a neutral environment. Investment through a neutral vehicle also ensures that each investor and the operating business need only have regard to its own taxation and regulatory laws.5 This is important for investors from the USA and other jurisdictions, where a domestic (eg, Delaware) entity might be unsuitable. However, JVs are just one example of multi-shareholder structures which require a neutral vehicle. Hedge funds and private equity funds, which are discussed further below, are established in the BVI and other IFCs to allow investment managers to attract investors globally.
The recent sale of TNK-BP to Rosneft for US$55 billion in 2012 by Access Industries and Renova (AAR) and British Petroleum (BP) exemplifies the attractiveness of the BVI as an international joint venture vehicle. Not only was TNK-BP, the joint venture between BP and AAR, established in the BVI, but AAR itself, a consortium of Russian investors, was a BVI joint venture vehicle. This example exemplifies both the benefit of the BVI for joint venture vehicles between parties from different jurisdictions, and the benefit of BVI for investors from the same jurisdiction but where the rule of law may not be the strongest.
Mutual Benefits
There is an established body of academic research examining the mutual benefits that IFCs and onshore jurisdictions, such as the USA, derive from one another. The evidence suggests that, far from diverting activity, IFCs enhance economic activity in onshore jurisdictions by increasing the cost-efficiency of both inbound and outbound cross-border capital flows.
The BVI allows mobile international capital to be pooled and invested that might otherwise not be the case. Fund managers from the USA typically establish feeder funds in an IFC to pool foreign investors' capital where the use of a vehicle incorporated in the USA would be an unattractive prospect. Overseas investors may be unfamiliar with the USA's complex and burdensome taxation and regulatory regimes as compared with the BVI's light touch regulatory laws, which are recognised by global securities regulators, and neutral tax regime. A significant number of funds – particularly UK and USA private equity and hedge funds – are domiciled in the BVI, which is home to approximately 10 per cent of the world's hedge funds, by number and by assets under management, making it the third largest market after the Cayman Islands and Delaware.7 The ability to attract capital flows boosts the USA's funds industry, increasing employment and management activity within the USA and thereby contributing to its domestic tax base.
The BVI also facilitates outbound investment from the USA. Academic studies suggest that the use of IFCs enables multinational corporations based in the USA to increase their overseas investment, which acts as a fillip to economic activity and therefore domestic GDP and employment.8
From the perspective of investors from the USA, the BVI provides a neutral and efficient jurisdiction for investments in developing markets – particularly where JVs are involved. The involvement of American businesses in cross-border transactional work has cemented the BVI's relationship with the USA and other onshore jurisdictions. As a firm, we regularly work closely alongside leading American and international firms on significant M&A and capital markets transactions involving the USA and onshore jurisdictions. The BVI's popularity as a leading incorporation jurisdiction facilitates the export of American financial and legal services abroad, particularly since New York law is, with English law, one of the two legal systems that govern the majority of transactions. Again, this has a beneficial impact on the USA's financial services industry and its domestic tax base.
Recent studies also suggest that IFCs are beneficial for developing economies. In providing infrastructure for foreign investment, IFCs compensate for institutional deficiencies in developing economies. Professor Sharman suggests that a key factor in the development of the fastest-growing economies has been "the relative openness of developing economies to IFC-mediated flows of capital from both domestic and foreign investors".9 In other words, the symbiosis extends to developing economies too.
Conclusion
'Neutrality jurisdictions', such as the BVI, stimulate economic activity in major jurisdictions such as the USA and facilitate investment in developing economies. The BVI offers a neutral platform for investment and, by virtue of the volume of cross-border transactions routed through the jurisdiction, encourages the export of Anglo-American legal systems and financial services.
The mutual benefits deriving from such interactions between IFCs and onshore markets, which also extend to developing economies, are increasingly being recognised by academic studies. This symbiosis, coupled with the BVI's ongoing commitment to transparency, presents a challenge to more critical preconceptions and assumptions regarding the role played by IFCs in the international economy.
As originally posted on the IFC Review website.
Footnotes
1. "Onshore financial centres: not a palm tree in sight", The Economist (February 16, 2013).
2. "Storm survivors", The Economist (February 16, 2013).
3.P Arsenault et al, "China", The Private Equity Review 172 (2012), 158-176.
4.J Sharman, "International Financial Centres and developing countries: providing institutions for growth and poverty alleviation", Commonwealth Secretariat research paper (2010).
5.G Jalles, "Efficient capital flows", Cayman Financial Review 31 (2013), 22-23.
6.Ministry of Finance (China), "2009 statistical bulletin of China's outward foreign direct investment" (2010).
7.S Jaecklin et al, "Domiciles of Alternative Investment Funds", Oliver Wyman research paper (2011).
8.M Desai et al, "Do tax havens divert economic activity?", Journal of Public Economics 90 (2006), 219-224.
9.Sharman, "International Financial Centres", 35.