Offshore fund lawyers and administrators are talking about the industry in a very different way than they were in 2009 (or even later). Back then there was considerable concern within the offshore community that international bodies like the Organization for Economic Cooperation and Development (OECD), a club of rich countries, were ready to clamp down on offshore activity, in response to the global banking meltdown and shrinking state coffers prompted calls for higher tax and transparency standards.
Subsequently, the introduction of regulations like the FATCA in the US and the AIFMD in Europe gave the sense that mainland governments would make it too difficult, or at least less attractive, to move fund activity offshore.
But today, places like the Caymans and the Channel Islands are feeling more confident than ever about their long-term viability. Not only have they escaped the crisis with their reputations intact, but regulations built in response to the crisis do not appear to be having any significant effect on their private fund business.
“AIFMD has had some impact; but as a basic rule, I would say that those who were previously offshore have stayed offshore and those who were previously onshore are staying onshore,” says Jason Glover
, a leading private funds lawyer based in Simpson Thacher’s London office.
Nonetheless, it seems that on a moment’s whim – and especially during times of recession –mainland governments remain eager to bang the drum on tax avoidance.
The OECD every now and again hypes up its blacklist of offshore centres said to skirt international tax norms – which critics contend is vague and arbitrary about who gets included. France shocked some when it placed Jersey, a long-standing and reputable offshore finance centre, on a list of non-cooperative states in 2013, only to remove it earlier this year after it had satisfied some tax-related enquiries from the French government.
So if big governments do want to act, what could they do, exactly? What are the main threats to the offshore model?
Legal sources say OECD states have limited options – and those that are available require significant political will, making their likelihood of happening fairly low.
“The problem any regulator may find – say if the EU really wants to shut down offshore funds – is that offshore jurisdictions are very flexible and can move very quickly,” says David Williams, a London-based funds partner with Simmons & Simmons who has also spent time working from the other side as an offshore lawyer. Jersey’s construction of a fully compliant AIFMD vehicle is evidence of that assessment.
One option, though, would be for governments to impose a tax on the end recipient of offshore investment returns. A 30 percent tax, say, could be imposed on any profits received from offshore vehicles if it ends up in the hands of an onshore individual or business.
Or alternatively, lawyers say, governments could mandate that certain investors only park cash in locally regulated products. One could imagine, for instance, the EU making it too expensive for insurers covered by Solvency II to invest in non-AIFMD products by raising the costs of capital for offshore vehicles.
But a big factor preventing OECD blacklists and other state action from beating back the success of offshore centres is the lack of alternative options. Offshore centers are in part a success because they offer GPs a tax-neutral platform for funds comprised of investors from all over the world. It’s difficult envisioning how onshore governments escape that drawback while convincing GPs to stay local.
The bottom line then is that the next recession shouldn’t pose a serious risk to the sustainability of the offshore model. If the Channel Islands can weather something like AIFMD, and Cayman all the scrutiny that came when presidential contender Mitt Romney was found to use its shores for tax purposes, the long-term sustainability of the offshore model looks stronger than ever.