Review of Financial Regulation in the Caribbean Overseas Territories and Bermuda

Part IV Cayman Islands

This is one of six reports we have issued covering the review of financial regulation in the Caribbean Overseas Territories and Bermuda. This report deals with the Cayman Islands.

The Cayman Islands is a British Overseas Territory situated 268 km north-west of Jamaica in the Caribbean Sea and have an area of about 260 square km. The Cayman Islands have a large measure of self-government. The Governor retains responsibility for the civil service, defence, external affairs and security but not financial services. The Constitution, which came into effect in 1972, provides for a system of government headed by a Governor, an Executive Council and Legislative Assembly. The estimated population of the Cayman Islands in 1997 was 36,600. Its GDP per capita (estimated) in 1998 was US$30,120 with an estimated growth rate of 5.5%. Offshore finance and tourism are the two main pillars of the economy.

1.2  Financial services activity in the Cayman Islands

The Cayman Islands is one of the world's largest banking centres. At present the banking sector in the Cayman Islands comprises over 450 banks from sixty-five countries that hold assets of US$671 billion. 43 of the world's top 50 banks have a branch or locally incorporated subsidiary in the Cayman Islands. There are 430 Category B banks of which 51 have established physical presence in the jurisdiction.

The Cayman Islands have also grown as a centre for insurance and are now the second largest captive insurance centre in the world with 502 captive insurance companies, largely from the US market.

The Cayman Islands is also a significantly large centre for the establishment and administration of mutual funds. There were 2,298 regulated mutual funds as at 7 March 2000, being 603 administered, 1,654 registered and 41 licensed schemes.

As at 31 December 1999, the Cayman Islands had 3,614 resident companies, 11,342 non- resident companies and 34,500 exempt companies.

The Cayman Islands also have significant numbers of trusts and limited partnerships.

In general, the Cayman Islands is one of the more mature of the jurisdictions we have reviewed in terms of regulatory structure and culture.

1.3  Financial services regulation

There are two bodies responsible for financial service regulation in the Cayman Islands. These are the Cayman Islands Monetary Authority ("CIMA") and the Stock Exchange Authority (the "Authority").

CIMA is responsible for the day-to-day supervision of banks, trust companies, mutual funds, mutual fund administrators, insurance and company managers. It is also responsible for the management of the Cayman Islands currency.

The Authority is responsible for the regulation of the Cayman Islands Stock Exchange ("CSX"). The Authority has no full-time staff and its supervisory activities are limited to monthly reports provided by the CSX and review of the CSX annual report before it is tabled in the Legislative Assembly. The Authority also has to review and approve any rules that CSX wishes to introduce.

Since the date of our on-site review, the Cayman Islands Legislative Assembly has passed on 14 July 2000 the following legislation, designed to improve regulatory access to information and international regulatory co-operation and to bring the anti-money laundering legislation into compliance with the 25 criteria introduced by the FATF in February 2000.

The Money Laundering Regulations under the latter legislation were gazetted on 7 August 2000.

1.4  Summary of principal findings

1.4.1  Regulatory authority

By the creation of CIMA in 1996, the Cayman Islands commenced a positive process of developing a structured and resourced regulatory function, and a visible commitment to achieving international standards and good practice. We consider that CIMA, staffed as it is with a number of experienced and skilled regulators, some with international regulatory experience, provides a firm foundation for the attainment of those international standards with which it does not already comply.

Furthermore, the Cayman Islands, with the recent passage of legislation relating to international co-operation and anti-money laundering, have made significant improvements in the area of access by CIMA to information for regulatory purposes and international regulatory co-operation. There are a number of issues where attention needs to be focused The most important of these relate to the current lack of full operational independence for CIMA and the need for significant extra staffing to fulfil all the necessary activities that must be undertaken to fully comply with international standards. We note that the operational independence of CIMA, is being addressed by the Cayman Islands Government but has not yet been resolved.

In respect of the Stock Exchange Authority, although activity to date at the CSX has not resulted in any regulatory problems, we do not consider that a regulator without its own dedicated resource can meet international standards. We believe that action is necessary to provide adequate supervision of the CSX, and have recommended appropriate improvements.

1.4.2  Banking

The Cayman Islands have demonstrated a proactive approach to bank supervision, both generally and particularly in the area of Category "A" (domestic) Banks, and over recent years have significantly increased the quality of banking supervision. This progress is particularly welcome given the importance of the Cayman Islands as a banking centre.

However, CIMA are aware that there are a number of areas of banking supervision, particularly in respect of category B banks, where additional action is needed in order to fully meet the requirements of international good practice as laid down by the Basel Committee. In particular there is a significant need to increase the number of on-site visits, in addition to operational independence and resourcing.

1.4.3  Insurance

Whilst there is a need to expand the enforcement powers available to CIMA in respect of insurance licence holders, we consider that the regulation of insurance is generally in line with international standards.

1.4.4  Securities/investments

The Cayman Islands recognise that they are currently failing to meet international standards as laid down by IOSCO due to the lack of current legislation covering the regulation of securities/investment business beyond that relating to members of the CSX and mutual fund administrators.

This is a weakness which the Cayman Islands is currently seeking to address through new legislation due to be introduced in April 2001.

It should however be noted that, unlike a number of other jurisdictions, the Cayman Islands treats fund administration as a regulated activity. We consider this approach to represent good practice.

We consider that the high priority that Cayman Islands is currently giving to this legislation is appropriate and to be welcomed.

1.4.5  Mutual funds

The existence of a regulatory and supervisory structure for mutual funds in the Cayman Islands is a positive feature of the jurisdiction's regulatory environment. A number of features of the legislation, including the wide ranging enforcement powers, meet IOSCO standards.

Nevertheless, given the size of the mutual fund industry in the Cayman Islands, it is vital that the regulatory and supervisory regime is robust. We consider that a number of matters need to be addressed in order to ensure compliance with international standards.

The principal of these are the lack of regulations relating to the operation of public funds, including the segregation of client monies, together with the lack of a current on-site inspection programme and the limited nature of the off-site review must be seen as priorities for action.

1.4.6  Stock exchange

Whilst the CSX has a trading platform, to date it has provided a listing function only. This acts as a mechanism to provide marketability to mutual funds, derivative warrants and specialist debt. We consider that, given its current functions, membership and listing regulation meet international standards.

1.4.7  Companies

We have not undertaken a detailed review of company law as this is beyond our terms of reference for this review. Therefore our specific comments and recommendations should not be taken as being the only amendments which may be required. We have, however, reviewed those aspects of the legislation which bear directly on our TOR and taken an overview of the legislation for the purposes of comparing it against the OECD Principles of Corporate Governance.

Based on our overview, while provisions exist at common law, we consider that the Companies Law lacks many of the features found in a modern piece of companies' legislation and is in need of review. We recommend that the review should include insolvency provisions, control over the issue of prospectuses, the protection of the interests of minority shareholders, enforcement powers, the disqualification of directors and auditing of public companies.

The issue of bearer shares is particularly important. We note that the Cayman Islands intends to introduce legislation in 2001 to immobilise bearer shares.

1.4.8  Company service providers

The Cayman Islands has a reasonable regulatory structure in place for the supervision of company management and administration. We consider this to be a positive feature of the regulatory structure and one that exists only in a limited number of other jurisdictions.

However, the legislation is effectively limited in scope to those company service providers who provide fiduciary services. Some (the proportionate amount is not discernible) traditional company management business, including the formation of companies and the provision of registered office services, is outside the scope of the legislation and of the regulatory net, as it is in a number of major centres. We do not consider that this meets the international and good practice standards set out in the Guidance Notes.

Furthermore, the current supervisory process is in need of development. In particular, the limited supervisory resources and the lack of on-site supervision is of concern.

1.4.9  Partnerships

We are of the view that the legislation and systems in place in the Cayman Islands concerning limited partnerships meet a number of good practice requirements but do not meet all of them.

Our principal recommendations to overcome the existing weaknesses are:

(2)  apply to the courts for the appointment of an inspector to investigate the activities of a limited partnership.

1.4.10  Trusts

Trust legislation in the Cayman Islands is similar to the trust legislation in a number of other jurisdictions, including England. In general, we do not consider that there are any particular features of the Trusts Law that are likely to lead to trust structures in the Cayman Islands being any more or less attractive to criminals or money launderers than trusts in other jurisdictions.

We consider that the Special Trust Alternative Regime ("STAR") Law provides protection in respect of non-charitable trusts and exceeds good practice standards. In respect of asset or creditor protection trusts and purpose trusts, we consider that the Cayman Islands legislation is conservative and meets good practice standards.

1.4.11  Trust service providers

Unlike a number of jurisdictions, both onshore and offshore, the Cayman Islands regulate the provision of trust services and therefore are already addressing many areas of good practice.

Nevertheless, the current regulatory supervisory regime does need enhancement to fully meet the good practice requirements. The principal areas for improvement are:

1.4.12  International co-operation

The Cayman Islands now has strong international co-operation arrangements and the recent changes to the Monetary Authority Law in particular demonstrate its commitment to developing its level of international co-operation. There remains a need for further improvement in some areas in order to demonstrate full compliance with international standards and good practice and these are detailed in Section 14 Given the extent of the recent legislative developments, the implementation of these changes, as a matter of prudent management, need to be monitored by Cayman to confirm that they provide the desired capability to co-operate in practice.

1.4.13  Anti-money laundering

The Cayman Islands has introduced a number of significant legislative and regulatory provisions designed to bring it into compliance with international standards, including modern "all crimes" money laundering legislation. The legislation taken as a whole is extensive and contains much of the material and covers most of the issues that we would expect in a jurisdiction that is fully compliant with international standards. We consider that this is positive evidence of the Cayman Islands' commitment to prevent money laundering.

Some enhancements are required to the Misuse of Drugs Law ("MODL"). In addition, the Code of Practice now needs to be reviewed to ensure that it takes account of the Money Laundering Regulations 2000.

1.5  Conclusions

The creation of CIMA has made a significant contribution to the improvement of the regulatory regime in the Cayman Islands and demonstrates their seriousness in developing compliance with international standards. Furthermore, the proposal for CIMA to become operationally independent is to be welcomed.

The Cayman Islands have also enhanced markedly their ability to co-operate with regulators and law enforcement bodies in other jurisdictions.

We welcome the recent introduction of legislation to improve assistance to foreign regulators in obtaining relevant information from the Cayman Islands for supervisory purposes and for civil and administrative proceedings as well as to permit regulatory access to specific client files for regulatory supervision purposes. This capability, which was introduced during the course of our review and meets a number of recommendations made in earlier drafts of our report, should, as a matter of prudent management be monitored by Cayman to ensure that it is effective in practice.

The size of the financial sector in the Cayman Islands, in comparison with the current resources of CIMA, means that we consider that CIMA is under resourced and is unable to fully meet the appropriate international standards without additional staff. Such staff will enable CIMA to undertake the necessary additional regulatory activities, including a significantly increased number of on-site visits. We therefore support CIMA's decision to undertake a formal analysis of staffing needs.