Research

Why Islamic Finance and Offshore Financial Centres go Hand-in-Hand

In early 2016, popular opinion on the utility and function of off shore centres (OFCs) or, to use the more inflammatory term, tax havens, must be close to an all-time low. The general view, stirred up by cash-strapped governments and the media, is that the vast majority of the world’s wealth is hidden away in secret island jurisdictions, controlled by shady businessmen and inaccessible to the common man. Hamish Masson writes.

OFCs face a constant battle to justify their existence to the general population, as few non-finance professionals understand their value and contribution to the world’s economic systems. In contrast, knowledgeable and sophisticated clients continue to use jurisdictions such as the British Virgin Islands (BVI) and the Cayman Islands for incorporating their financing entities, as the use of such jurisdictions facilitates and lowers the transaction and regulatory costs of cross-border lending, enabling a wider access to funding.

Islamic banks in particular have recognised the benefit of arranging their financing activities through such jurisdictions. Tax mitigation and privacy are significant factors, but are not the main drivers behind the selection of jurisdiction for Islamic investors and institutions. If they were, we would not see so much business coming out of the Gulf, as the local tax regimes tend to be favourable for local business. So why do we see so many BVI and Cayman-incorporated SPVs in Shariah financings?

Benefits of using OFCs

There are many reasons to use an OFC in a Shariah-based structure, the most important being reliability, efficiency and flexibility. Business-friendly OFCs benefit from having a stable political foundation, a strong regulatory framework and a legal system based on English law; the ultimate recourse is to the Privy Council, which provides comfort that any disputes will be determined fairly. These jurisdictions are also committed to adhering to international standards of transparency, investor protection and anti-money laundering (AML), for example, the BVI proactively participates in international measures relating to AML regulations, information exchange, mutual cooperation and transparency. It has entered into bilateral tax information exchange agreements with 27 countries as well as an inter-governmental agreement with the US to comply with the requirements of FATCA. Finance and legal professionals are knowledgeable and responsive, companies can be set up very quickly and economically and there are few restrictions on company structures and activities. Crucially, foreign ownership and directorship are permitted.

The use of a neutral (not just tax-neutral) OFC in cross-border financing structures is also very much in keeping with the Shariah principles of fairness, equity and risk-sharing. If the relevant entities are incorporated off shore, then disputes as to governing law and differences in interpretation are less likely and lender and client are on a more equal footing. An offshore vehicle is also less at risk from issues arising from political unrest and fluctuating commodity prices; the use of an OFC can provide comfort and certainty to lenders, thus enabling a developing country or a country experiencing other difficulties to attract investment where otherwise it might not be possible. Security interests can be taken over shares in an offshore SPV or monies in an offshore account in cases where the laws in the sponsor’s jurisdiction do not permit this or are otherwise not lender-friendly.

OFCs have the ability to pass legislation to benefit the business community relatively quickly. Onshore financial centres are unwieldy in comparison, requiring a much longer and more complicated process to amend existing laws and respond to market forces. The BVI is constantly reviewing and updating its companies law and recent changes to legislation have been implemented which will, among other things, streamline and provide certainty in lending transactions as follows:

  • The enforcement of share security has been simplified so that registered agents must effect a transfer of ownership of shares in a BVI company when validly instructed to do so by the board, irrespective of the wishes of their ‘client of record’
  • A BVI company may go into voluntary liquidation even if there is a security interest registered against it, but the liquidator will have a duty to apply the BVI company’s assets toward payment of the secured creditor
  • As with the AIFMD code, there will be flexibility to use other non-cash instruments as an alternative to payment in units so long as this provides staff with equally effective incentives.
  • Consent of secured creditors will be required when a BVI company wishes to continue out of the BVI
  • Transaction completions have been simplified by the express authorization to add pre-signed pages to the final form of deeds, and
  • Where the UCITS management company is subject to other sectorial remuneration regimes the manager should assess which sectorial remuneration principles would be most effective in aligning relevant staff interests with those of the fund investors ESMA sees the AIFMD and UCITS remuneration regimes as equivalent so either regime should be adequate. The appropriate treatment for a UCITS management company which is also subject to the BUPRU or IFPRU regime is less straightforward.
  • Changes to a BVI company’s privately-maintained register of charges must be made within 14 days of the change.

The future

The ‘traditional’ OFCs are former British dependencies but such has been their success in attracting non-resident business that many other countries have passed legislation to enable them to compete and keep investment closer to home. Key onshore Islamic jurisdictions such as Malaysia and the GCC have replicated the OFC model by establishing ‘offshore’ free zones where doing business is simpler, less expensive and with fewer restrictions. This trend began with the establishment of the Dubai International Financial Center, with Qatar and Abu Dhabi following suit with the Qatar Financial Center and the Global Marketplace Abu Dhabi respectively. Malaysia has responded with the formation of the Labuan International Business and Financial Center.

  • Details of the remuneration policy, including a description of how remuneration and benefits are calculated, the persons responsible for awarding the remuneration and benefits, including the composition of any remuneration committee.
  • A statement that the details of the remuneration policy are available on a website and by a paper copy.

The prospectus must be updated with the relevant new disclosure requirements by 30 September 2016 (extended to 31 March 2017 for a NURS). There is no equivalent requirement in the AIFMD rules.

The fund’s key investor information document (KIID) must contain a statement that the details of the up-to-date remuneration policy, including certain specified information on the policy, is available on a website and on request. This must be included in the KIID as part of the 2017 annual update by no later than 18 March 2017 (or earlier if the KIID is updated before then and the relevant information is available at the time of that update).

The fund’s annual report must include information on:

  • Total remuneration paid during the fund’s financial year, split into fixed and variable remuneration, paid by the management company to its staff, the number of beneficiaries, and any amount paid by the UCITS itself.
  • The aggregate amount of remuneration broken down by categories of staff that are subject to the remuneration rules.
  • A description of how the remuneration and benefits have been calculated.
  • The outcome of the annual review of the remuneration policy.
  • Details of any material changes to the policy.

Elements of this, notably the description of how remuneration and benefits have been calculated and the outcomes of the annual review, go beyond the requirements for an AIFMD fund report.

Depositary arrangements

The following matters are covered in the as yet unfinalised Level 2 directive:

  • The minimum terms to be included in the contract between the management company and the depositary.
  • Detailed requirements on how the depositary should perform its oversight, cash monitoring, and safekeeping duties.
  • Types of financial instruments that the depositary must hold in custody and how these should be segregated from the depositary’s own assets.
  • Terms and conditions of the depositary’s liability for losses of financial instruments, including the circumstances under which financial instruments are considered to be lost.
  • Terms of the depositary’s delegation of the safekeeping function to third party custodians.
  • Requirements for independence between the management company and the depositary.

Pending finalisation of Level 2 the FCA has said that firms should continue to comply with COLL and CASS until the new Level 2 regulation becomes applicable.

 

Hamish Masson is the senior associate at Harneys.

This article first appeared in Islamic Finance News (3 February 2016, Volume 13, Issue 05, Page 21). For more information, please visit www.islamicfinancenews.com.

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