“But little girls eat eggs quite as much as serpents doyou know?” said Alice. “I don’t believe it,” said the Pigeon. “But if they do, why they are a kind of serpent. That is all I have to say.” Lewis Carroll, Alice in Wonderland

Misrepresentation, mischaracterisation
Those familiar with the incoherent logic of Carroll’s work will have no difficulty in comprehending the recent mischaracterisation of the Cayman Islands (and other offshore jurisdictions) as the serpent of the current financial crisis. New legislative and regulatory thrusts from the EU have always been presaged by a barrage of distortion only apparent to those actually involved in the relevant industry.

What has made the current EU initiative more problematic is that the US, driven by domestic fiscal crisis, and which has hitherto regarded tax competition as a cornerstone of its domestic and global tax policy, has undergone a radical pro-European shift in socialist thinking. So we now find the full force of the public relations departments of the US and the EU Treasuries combined in a drive that supports the OECD initiative to domesticate and tax all global capital flows. Leaving aside the contentiousness of that objective for the moment, there should be little wonder if, in the face of the concerted G-20 campaign of blame deflection, the truth has been hard to find. However, given the significant regulatory and transparency advances undertaken by the Cayman Islands over the past decade, those who distort the picture can no longer maintain credibility. Even the US General Accounting Office report 2008 fully corroborates the true Cayman Islands’ position – as anyone with access to the internet and the Cayman Islands Monetary Authority website can see. Those who would assert a contrary position should recognise that they cannot defy gravity forever.

How do these distorters of the truth operate?
1. By conflating the Cayman Islands with jurisdictions which should properly be described as “tax havens” as part of a rudimentary PR campaign designed to garner public support for ill-conceived domestic tax reform. Without doubt the rationale for this approach has been to demonise all low-tax jurisdictions, masking the fact that this has as much to do with UK and US domestic tax policy as anything else.

2. As opposed to Switzerland, Andorra, Lichtenstein, Monaco and others, the Cayman Islands has held a full tax information exchange treaty with the US since 2001 and has had full proactive tax reporting on individual accounts with all 27 European Union jurisdictions since 2005. In addition, it holds 12 unilateral tax information exchange arrangements with Japan, South Africa, Switzerland, the UK and others, and is constantly updating its reporting standards. Only the criminally insane would seek to use the Cayman Islands to evade tax. Many of these evidently effective measures have however been dismissed on the hop by the OECD, which has imposed – and promoted – misleading ‘lists’ to fit in with its negative PR drive. As a testament to Cayman’s cooperation and transparency, it now additionally holds 11 bilateral tax information exchange agreements in the OECD model form, and negotiations are ongoing so that it surpasses the 12 treaties required by the new OECD standard.

3. By continually suggesting that there is a greater probability of housing “illegal proceeds” in Cayman than the UK or the US. The 1990 Treaty with the US gives the Department of Justice unrestricted ability to empty any filing cabinet in the Cayman Islands on enquiry in relation to any criminal or money laundering matter. Most notably, this is a power that it does not possess within the US. Interestingly, a 2009 report of the Financial Action Task Force (FATF) which rates the Cayman regulatory system on money laundering compliance as the most robust of any country assessed, including UK and US, has not seen the light of day.

4. By conflating, as does President Obama, illegal tax evasion, legal tax avoidance and tax competition, such that any reference invokes a sense of moral outrage. Debate surrounding the importance of tax competition in regulating state spending and maintaining global capital markets has therefore been almost non-existent. Companies should legally have the right to structure their business such that they can benefit from lower tax regimes in order to remain globally competitive. ‘Avoiding’ tax is not in and of itself morally reprehensible as long as appropriate tax payments are being made in the correct jurisdictions.

When it comes to exchanging information to prevent tax ‘evasion’ another myth peddled is that a low number of enquiries are evidence that the system does not work. The Pigeon would be proud of the logic. In fact the absence of enquiry is evidence of nothing more startling than a transparent well-regulated regime. Compare the Cayman Islands to the now OECD white-listed Switzerland, which has 53,000 Swiss UBS accounts for US citizens that the IRS is investigating. Where is the publicity on the recent FATF report which ranks the Cayman Islands as the leading jurisdiction globally in matters of all crimes and in money laundering compliance?

The OECD initiative is not really then about tax evasion but rather tax competition and an attempt to domesticate and tax international capital pools. In a bid to appear effective in the wake of the financial crisis, the British government – keen on political grandstanding – was happy to be tied in to this unjustifiable assault on the British Overseas Territory with over 9,000 hedge funds and US$3.6 trillion under management.

However the EU has now revealed its second but true target with the introduction of the Alternative Investment Fund Manager Directive and the British Government has been hopelessly wrong footed. It has been left to AIMA industry practitioners and now Boris Johnson to sound the alarm on the threat to the City of London – through which a significant proportion of Cayman Islands hedge fund assets are managed and invested. The fact that it was left to the Mayor of London to articulate the concern is testimony only to the failure of the British Government to protect the vital interest of either the Cayman Islands or the City of London against an ill-founded EU attempt at fiscal manipulation in the guise of a regulatory initiative.

There is something wrong too with Lord Myners’ suggestion that he must now obtain the support of the US in dealing with the European Union threat. Is that the measure of UK influence on this issue in Europe? Less political grandstanding and a good deal more focus on the real fundamental triggers of the global crisis might have avoided this outcome.

Rearguard action
There is at least one inconvenient truth that may be harnessed by way of rearguard action: both the Institute of Economic Advisors and Lord Turner absolve the Cayman Islands from involvement in the global financial meltdown. Indeed the Cayman Islands financial system has remained robust throughout simply because the Cayman Islands Monetary Authority did not allow its regulated banks to lend 40:1 to hedge funds and did not permit impecunious borrowers to purchase homes. It may therefore be legitimately argued that the EU response should be proportionate and properly focussed on the actual causes.

That said, what are the likely consequences of this Directive, assuming (by no means certain) it proceeds in its current form? As with all misguided protectionist legislation, it creates as many unintended as intended consequences. The answer though is nothing like as negative for the Cayman Islands as it might be for the City of London.

Cayman Fund structures remain superior because of a sound legal and regulatory framework and are attractive to investors globally. Cayman Islands hedge funds do not have a UCITS passport and do not market to retail investors in Europe. Denying pan-European marketing therefore effects no fundamental change and not an insurmountable one to a global investor. In addition, the Directive supposes that a fund manager will remain in the City of London and that the Fund must move to the EU. No doubt the Directive is intended to strain the relationship between the Cayman Islands and the City of London but the relationship most likely tested will be that between the hedge fund manager and his or her spouse and family. Hitherto the balance of competing interests has favoured Bond Street, Eton and Harrow and the unquestionable attractions of the Wiltshire weekend house party.

But if the fund manager is now not only subject to the new levels of UK super tax and national insurance contribution but is subject also to restrictions on trading function which substantially reduce pre-tax profit then one likely consequence is that the fund manager may now move out of the EU although not necessarily out of Europe. That is not to say that the economics necessarily dictate an all family exodus. Switzerland is recognised as being a tedious place to live and there will be fine economic calculations to be undertaken balancing the additional UK tax bill, reduced trading profit (given imposed trading restrictions) and the cost of the weekly Geneva-to-London return by NetJets against the possible alimony. But with a non EU resident fund manager, the relationship with the Cayman Islands remains unaffected.

No one should be surprised that the Swiss amongst other obvious jurisdictions will be the net beneficiaries of the Directive in its current form but so too the Channel Islands, Dubai and other non EU locations simply because no fund manager needs to be resident in the EU to trade EU securities. There comes a point, too, where more protectionist regulation from the EU throttles the very markets it is intended to bolster. Thus, the most likely consequence of the Directive in its current form is that UK tax revenue on fund managers will be substantially reduced.

Mayor Johnson is right to be alarmed but the hitherto silent Chancellor of the Exchequer Alastair Darling should be more so.

Anthony Travers is chairman of the Cayman Islands Financial Services Association and was the senior partner of law firm Maples and Calder for 20 years. He was awarded an OBE in 1998 for his services to the Government and the financial sector.