The future of the ‘incubator island' in the wake of September 11th and changing world conditions.
Some years ago I heard Bermuda described as the Switzerland of the western hemisphere. I didn't truly understand it then and I probably still don't. However, as I researched this report, I slowly began to build a hypothesis, which suggests that Bermuda is tending towards the statement.
Many years ago, Switzerland decided to service the international community, both corporate and personal. It consciously decided to maintain a position of tax neutrality, confidentiality, efficiency and innovation, all handled by quality service providers. It never held itself out to be a cheap place to do business profitability. It didn't have self-sufficiency in indigenous GDP so it had to sell itself outside its own borders. Switzerland has always had a stable and sensible government, which created sustainable development long before the phrase became fashionable.
Over the last 40 years, Bermuda has built an impressive array of innovative and profitable business practices. It has steady government and controlling legislation in immigration, real estate and corporate ownership. It has talented people, experienced in the international business world. So does all of this reflect the assertion that Bermuda is the Switzerland of the western hemisphere? The short answer is, no.
Switzerland said, “We will develop a product wanted by the business world and we'll become damned good at it.” But Switzerland had an extra ingredient. It also said, “and then we'll distance ourselves from our competitors so that they will never catch us.” Bermuda now has the opportunity to do precisely the same. Bermuda, through its own efforts over many years, possesses the products and the expertise. As a result of two external and recent phenomena, Bermuda has been given the chance to take hold of the same extra ingredient itself, and by grasping it, Bermuda will open a window of opportunity to indeed become the Switzerland of the western hemisphere and catapult itself out of reach of its competitors.
World shaking events
The horrific attacks in the US on 11 September 2001 will reverberate around the world for years to come. While the human tragedy can only be viewed in unspeakable terms, the ripples of the economic fallout will be felt in every corner of the world, be that the onshore world or the offshore world. Some economies may never fully recover, particularly the tourist-based domiciles, and the gulf between the ‘good' offshore domiciles and the ‘bad' ones will widen. Those offshore governments that baulked at the force thrust upon them by the Organisation for Economic Co-operation and Development (OECD) ‘ain't seen nothing yet', to coin a phrase. If economies are based on shaky tourism but bolstered by international business, those domiciles will come under microscopic attention, overtly and, no doubt, covertly. The September 11th fallout will become an offshore shakeout.
Prior to September 11th, the first phenomenon was the endorsement of Bermuda by such organisations as the OECD and ancillary bodies such as the Financial Action Task Force (FATF). Sensibly, Bermuda recognised that if it wanted to be accepted by the G7 forces, then it had to play by their rules. Sensibly, Bermuda said, “We have well-established laws, regulations and practices which will stand any scrutiny, but we will listen to the changes OECD and others would like us to adopt – we will not roll over and play dead, but we're willing to rationally co-operate.” Smart move.
Yet if Bermuda had to implement or amend certain laws or regulations to comply, it did not have to implement or amend its code of practice. Its conservative and quality business mantra was self-evident. Bermuda's business leaders always have exuded propriety and integrity, and most likely always will. Though some find this surprising in an offshore domicile, in reality it is not at all and certainly comes as no surprise to those with first-hand experience of the Bermuda culture and ethic. The flight to quality has already commenced, and thanks to the ‘OECD catalytic effect', Bermuda has its certificate of airworthiness.
The second phenomenon is technology, especially in its application to business. Bermuda does not possess large amounts of land or vast pools of labour, and has serious concerns over its ability to sustain its development (infrastructure, education, employment, economics, etc.). In many respects its own success has caught up with it. Many of these concerns are being addressed through changes to fiscal policy, but the advent of superior on-island technological infrastructure allied to efficient technical applications will assist that process immensely.
Rather than be forced into importing greater and greater numbers of overseas workers, the use of technology allows Bermuda companies to be set up as holding or parent companies on-island with limited labour needs, then venturing outside Bermuda through acquisition, merger, sub-contracting and so on to ‘run the factory' in less congested locations, be they offshore or onshore.
The possibility of Bermuda and, say, Dublin (with a larger pool of trained people) forming some sort of business alliance, at the macro as well as the micro level, is a real possibility worthy of investigation. Interdependence and co-operation, rather than competition, will prevail between quality domiciles, allowing reliable technology to provide the foundation of the relationship. Bermuda working with Dublin, Singapore, South Africa, Nova Scotia, British Columbia or Brazil all come to mind.
The main geo-economic areas of the world are the US, Europe and Japan, inside of which the multinational enterprise (MNE) sector continues to dominate world trade and still needs support products and services – insurance, banking, stock exchanges, trade financing, international legal services and so forth. While indigenous companies will predominantly require indigenous products and services, the MNE market increasingly needs global infrastructure to conduct its business. Moreover, while companies in one country conduct business with companies in other countries and seek respective support services, in certain cases the need for a neutral jurisdiction is essential. The offshore domicile provides that. As world trade grows and cross-border activity expands, the need for such offshore support will grow in tandem. Consequently, the offshore service industries will grow geometrically, based on several factors.
Firstly, the lack of regulation in the offshore domiciles was always the ‘whipping boy' touted by the traditional markets for not doing business in those jurisdictions. Those days are rapidly diminishing, but only in relation to certain quality domiciles. This is not because the offshore domiciles have built large bureaucracies of regulators all of a sudden, but because the offshore companies – particularly those in the global reinsurance business – have subjected themselves to the most stringent standards of practice, financial (and underwriting) scrutiny and have succeeded in growing with stability. However, this will lead to the large companies in the quality domiciles getting bigger and bigger, faster and faster, leaving competitors behind. Stand up Bermuda.
In addition, economies of scale will increasingly attract the MNEs to Bermuda. For many, bringing the corporate ownership and executive managements under one offshore roof and ensuring superior communication with satellite offices around the world, will make sense in terms of cost containment (both in economic and efficiency terms). In many cases, it does not bring vast amounts of legacy problems, such as information, databases, practices, relationships, etc. with it, and this merely increases the benefit.Market magnetism is an increasing trend encouraging the growth of the offshore services sector. If the business infrastructure of Bermuda continues to expand, Bermuda will see more international companies seeking a presence on the island or new groups of shareholders forming a new company in Bermuda from the outset. Because the combination of innovation, expertise, capital, existing markets (reinsurance for example) and an openness to welcome new business exist – as they indeed do – then likes will attract more likes.
Finally, the issue of tax benefit has always been a complicated one. In the majority of cases, companies, particularly those with US ownership, gain little if any tax benefit from being incorporated offshore, as tax authorities tend to follow their citizens (corporate or individual). Nonetheless, where tax advantage can be established, then corporate taxation policies of global companies will seek to maximise their financial operations through the use of tax-beneficial domiciles. That has been the practice for decades, and, where appropriate, will continue.
However, a new breed of offshore company will develop, the ‘offshore nationality' company, with a status akin to British nationality or US nationality. The ‘ordinary residence for tax purposes' of its shareholders determines taxation of the offshore company, in general terms. However, in certain situations, those rules can be avoided. For example, where there is a significant number of individual shareholders from a given country some tax advantage can still apply. However, we will see brand new companies being formed offshore where their shareholders (especially corporate shareholders) are from a variety of countries, such that no one country will be able to claim that the offshore nationality company is within its reach for tax purposes. Clearly, in this day and age of mega-mergers involving MNEs with varying products and services in varying countries around the world, the trend will be not for those companies to simply merge. Instead, before they merge, they will strip out their (combined) functions which are global in nature (rather than being only sold in the major tax nations of the world) and place those functions into a new company with shareholders of different nationalities and/or public shareholders from countries around the world. The offshore nationality company will therefore have no direct taxable tie to any one country and while it will be incorporated in Bermuda (and be subject to the laws and regulations of Bermuda), it will not be classified as a purely Bermuda company either. Such companies will, however, be free to list on international stock exchanges and to upstream dividends to their respective shareholders, who, at that level, will handle their indigenous taxation issues on the dividends.
Bermuda is ideally suited for the offshore nationality company, based not only on its laws and regulations, but also its reputation for good corporate governance.
Resolution of limiting factors
Bermuda carries some heavy burdens in the overall management of its international business economy. The first step in solving such concerns is to recognise they exist: Bermuda does. The second step is to measure the impact of such concerns: Bermuda is doing that. The third step is to take commentary and suggestions from business leaders and government officials: Bermuda is doing that. The fourth step is to fix them. There is no question that Bermuda is an expensive place to live and to conduct business. Yet thousands of individuals and companies have accepted that already. Nonetheless, the trend of new business coming to Bermuda will simply exacerbate the situation. Bermuda needs the overseas worker to augment the indigenous population in running its international business sector. That trend will continue.
However, if the infrastructure is already bursting at the seams, it can only get worse. Hence we will see tighter immigration controls (limitations on work permits is already a new policy of Government) but we will also see a trend towards single persons being attracted (rather than married couples with families). We will also see a trend towards more one-person accommodation being built, not only in and around the main city, Hamilton, but also in the outlying areas of the island (such as the Baselands area), which will involve persuading the corporate offices to be situated there as well (cutting down on commuter traffic for example), through cost and socio-economic benefits offered by Government. The notion of building a large office complex in the Baselands area with accommodation alongside may seem unusual in today's culture, but as the advantages of such developments filter through to the business decision makers around the world, given the other attractions of Bermuda such a ‘hardship' (though some might say ‘silliness') will slowly become an accepted practice.
As a consequence of September 11th, there will be a flight to quality – or shake out – of senior personnel with experience and maturity who can develop strategy, arrange its financing, staff it and implement it.
The turnaround in thinking and acceptance will take no more than five years from the time a decision to implement such developments occurs to its fulfilment. The creation of a corporate park in the Baselands area will be a major part of those developments.
While capital flows (in large quantities) to the offshore domiciles may have been patchy in years gone by, that is not the case nowadays.
In fact, recently there has been an influx of serious investment capital for new companies either from the private sector (corporates or individuals) or through the IPO/public company approach. In almost every case of a Bermuda company seeking large amounts of capital in the financial centres of the world, the uptake has been solid – almost totally due to the reputation of the domicile and the stringent management and reputations of the principals involved. That trend will not disappear, notwithstanding meltdown in certain sectors of the global financial markets. A well-structured and well-managed deal will always attract quality capital. Bermuda will see new large capital formations in the insurance and reinsurance sector in the wake of September 11th. Estimates of up to $5bn in fresh capital would seem reasonable.
If the offshore nationality company needs funding or the Baselands development needs funding or existing companies need funding for more global acquisitions and the suchlike, the capital markets of the world will agreeably respond.
In the late 1970s and early 1980s, Bermuda saw throngs of insurance managers, brokers, investment managers and the like visiting their Bermuda clients. The theory was that business had to be conducted in person, while the practice was that a few days in the sunshine never hurt anyone. As the 1990s rolled along, there were considerably fewer trips, due in large part to constrained travel budgets. Even so, in some quarters there remains a ‘must go see' mentality.
Yet, mainly through technology, Bermuda's business community (although it still travels far and often itself) has integrated technology into its daily operations, causing the overseas executive to re-evaluate the ‘must go see' need. As a result of e-mail, e-mail attachments on common platforms, websites, bandwidth and video conferencing (although still pricey), the situation is much improved. The need to spend money on travel and hotel costs, which in many corporate accounting offices has been frowned upon of late but was nonetheless essential, became a constraint on conducting business, a constraint now substantially removed due to technology. As more technological advances take place and communication becomes faster, better and cheaper, this will improve significantly, and those improvements are well in hand already.
Over the years, Bermuda has worked very hard to convince the major business nations of the world and their citizens that offshore business can be good business. Even so, the inferior regulation and practices of some offshore domiciles mean that the offshore ‘stigma' sometimes lingers, and, regrettably, can contaminate places such as Bermuda.
The impact of September 11th will cause an even tighter adherence to the ‘know your customer' rules of doing business with new company formations in the offshore world. While some domiciles may be hesitant to respond to such pressures, Bermuda will not. ‘Bad' money will always find a home – there's no reason to believe that will change regardless of attempts by major banking networks to block inter-bank transactions with rogue nations. Bermuda will increase its protective shielding of its reputation and will be widely acknowledged as being part of the financial league of nations.
However, in large part thanks to the good housekeeping seal of approval from such respected organisations as the OECD, Bermuda has weathered the storm, especially in the large corporate world. That trend will continue unabated. Bermuda will continue to protect itself and its worldwide customers from mal-intentioned operations coming to the island. Through a policy of ‘self-policing', the Bermudian legal, accounting, banking and management fraternity has shown time after time that it can, and will, turn away deals of the more unsavoury nature. And then there's the change in attitude from other markets. Evidence the turnaround in the ‘ownership' of entities at Lloyd's of London: where a few years ago, the Lloyd's culture looked scathingly at this young upstart called Bermuda, today the tables have been turned such that around 30% of Lloyd's is owned by Bermuda entities. Changed days indeed.
Insurance and reinsurance
Bermuda's international insurance and reinsurance sector is thriving. However, what we've seen thus far will look pale by comparison to what we will see over the next five years and beyond. The blend of capital, entrepreneurial spirit, expertise and integrity of management of existing Bermuda insurance and reinsurance companies will act as a springboard to significant global expansionism.
Swiss companies such as Zurich Re – now Converium – and Swiss Re established policies of overseas acquisition and merger many years ago, and have been hugely successful in doing so. The Bermuda giants will follow the same flight path. Indigenous insurance companies in countries all over the world will come under the control of those Bermuda companies that have made the decision to expand internationally. In fact, they have already started down this path and there is no reason to believe they will not follow it a long way yet. The principle of a Bermuda headquarters (holding company/parent company) will become more and more attractive. The large Bermuda companies have the capital and the drive and the innovation to prosper. The strength of the Bermuda insurance market will be evidenced in the claims payouts relating to September 11th and will act as a springboard for new companies.
Trends to emerge
Merging insurance expertise with asset management capability
Over the years, particularly in the reinsurance industry, Bermuda has built up an impressive proficiency in quality underwriting and due diligence on risk-controlled risk management within pre-determined and acceptable risk parameters. Apart from a few examples, the mantra was, “We are in the insurance business, not in the asset management business.” As such, external fund managers were hired to look after their investment portfolios, usually within a fixed income culture and under fairly conservative guidelines. Within core businesses, that model has not changed too much over the years, and while more funds will be managed in-house rather than being outsourced, the fundamental principle of asset preservation continues.
However, certain Bermuda companies are now either establishing new subsidiaries or at least investing in new entities seeking to optimise their asset portfolios. Moreover, executives from some of those companies have spun out from the mother ship to go it alone, finding major institutional backers and forming companies within the financial insurance and reinsurance categories of business, such as finite risk, and implementing a more aggressive approach to their asset management. Use of hedge funds is perhaps the clearest example of such aggression. Given the gigantic size of investment vehicles such as pension funds around the world and their ongoing quest to provide better returns for their stakeholders (spurred on recently by the downturn in global markets, principally the technology sector), we will see many more offshore entities (the offshore nationality types) formed to surround the asset base with an insurance product (catastrophe, life, accident and health, et al). Not only does that allow asset management of the initial capital invested, but also generates cash inflows from insurance premiums.
This type of business will flourish in Bermuda because of the pool of experienced and talented people who understand risk management (insurance and asset), i.e. those with a proven track record within an offshore environment.
Securitisation of risk
There is a growing trend to strip out the expected parts of a given (commercial) risk – those parts where the track record indicates a high probability that the claims associated with the risk can be identified, measured and expected to fall within a small band of loss – then place those parts into a securitised investment instrument with an attractive rate of return based on claims mitigation if possible and the timing of actual cash payouts of the losses. The longer the payout, the more time there is to build up investment return. As the financial markets become more familiar with this mechanism, more deals of this nature will occur.
While it may play a part in the investment side of such transactions, Bermuda will see more demand for its services to manage the unexpected parts of the risk – those parts with more underwriting demands and which are more susceptible to loss spikes. The aggregation of those risks into one (or more) new entities, not carrying old claims on the books, will head for places where the risks can be protected by insurance capital and intellectual capital. Therefore the need by some of the large investment houses for Bermuda companies to take the insurance parts ‘off their hands' will rise significantly.
Some of the large Bermuda insurance and reinsurance companies will go on the acquisition trail around the world either to buy indigenous life insurance companies or to separate out the international business of indigenous companies and buy that portion of their business. Regulators around the world will find it hard to stop such acquisitions in the most part, simply because the acquirer has the money, the expertise, the reputation and is located in an acceptable and respected jurisdiction as its principal place of business.
Over the past year or so, Bermuda has also seen a considerable increase in the life reinsurance business. Bermuda has not traditionally been involved with life insurance at the primary level but has always had a handful of companies writing life reinsurance. Now it seems life reinsurance business is on the upswing. As life reinsurance business is fairly predictable from an actuarial perspective, when combined with a sensible asset management programme Bermuda once again seems to be flavour of the month. As more life reinsurance business is attracted here, inevitably, even more business will be attracted here. Trend continues.
The term e-commerce is self-defeating and confusing. It has created befuddled business plans, leaving principals not sure where they are going, how to get there, or what to do if they ever do get to where they might be going. It is little wonder, then, that most e-commerce ventures have failed. Integrating the offshore factor into the equation merely exacerbated the situation.
Bermuda was one of the first countries to enact specific legislation to address e-commerce through the Electronic Transactions Act 1999. It also introduced legislation to allow ‘e-suites' structures to be established in Bermuda, without having to go through the sometimes lengthy and expensive process of full incorporation.
It was intended that the Act and the e-suites structure would act as the catalyst to attract e-commerce business from around the world. It hasn't worked out as well as some would have wished. In fairness, the dot.com crash in the onshore markets has had a knock-on effect in the offshore markets, but the lack of a strategic development plan and policies thereon have hindered the development considerably.
Bermuda was quick to embrace e-commerce as a new sector of its international business community, but perhaps opened its arms too wide. This meant it was open to virtually any and all proposals and suggestions about internet-related business, especially in the business-to-consumer (B2C) category. Attracting new e-commerce companies away from a taxable jurisdiction, for example, proved unsuccessful, not least due to the tax loss carry-forward provisions available to companies in their home countries.
Bermuda did not open its arms to any and all types of insurance business in the early days – it chose to be choosy. It chose to do its homework and identify the sectors of the insurance business which, through adaptation to an offshore environment, could be attracted to Bermuda.
It was a long and arduous process, but was driven by insurance professionals with contacts and knowledge and respected reputations in the global insurance business. People who would be listened to, and if the case proved itself, would be followed. The same has not happened with e-commerce. That is, however, beginning to change.
New initiatives by the private sector have begun to address the need for a more solid business plan approach based on common sense and reasonable projections with sensible capital needs. Also, while Bermuda does have a tax-neutral status which must be factored into business development plans, companies will (thankfully) not be attracted to the offshore domicile just because it is tax-neutral.
There are, however, many specific, or perhaps niche, businesses which sit well within the offshore e-commerce arena. The trend in the use of offshore e-commerce centres will be:
In some cases this decision will driven by tax matters, in some cases it will be driven by economies of scale, and in some cases it will driven by common sense and financial efficiency;
Bermuda in the new world order:1. Bermuda should pause and catch its breath in light of September 11th;2. Bermuda needs to let maturity, experience and common sense prevail and allow the ‘old heads' to help stabilise turbulent waters;3. Bermuda's good housekeeping seal of approval from the OECD and others should act as the foundation going forward, though the island should be prepared to adopt additional standards;4. Bermuda's insurance and reinsurance sector will be at the vanguard of a restructured global industry;5. Bermuda's financial, legal and accounting service sectors will stick to its existing code of practice and will be ready to adapt to even higher and stricter regulations thrust upon them;6. Bermuda's banking sector will be under increasing pressure to know the client and will require a robust blend of technology systems and staff quality to run its business; and7. Bermuda Government's relationship with the business sector (local and international) will have to reach new levels of understanding and co-operation.
The Bermuda international business scene is very much alive and well. In fact, without wishing to appear cold-hearted, the tragedy of September 11th, likely will boost the attractions, cleanliness and effectiveness of Bermuda.
With concentrated, focused effort in certain specific sectors, explanation and examples given by experts in those sectors, additional socio-economic adjustments within fiscal policy and an aggressive marketing plan based on sound business principles, Bermuda will show a clean pair of heels to the chasing pack of offshore domiciles, making it not just the Switzerland of the western hemisphere but, more likely, “la Nouvelle Suisse.