Banking + Basel III + Insurance + Solvency II = Cayman opportunities, says Paul Peene of Caledonian Global Financial Services.
On the horizon
Global and regional regulators are quite busy these days with various mandates to decrease the possibility of institutional and systemic risk. These oversight bodies are deploying various tools and initiatives, and for those who are going to be expected to implement these changes, the future is clear: More regulation, more buffers and higher prices borne by the ultimate end user - the consumer.
Within the banking industry, the Basel Committee on Banking Supervision is responsible for developing international standards for banking supervision and will be expecting banks to move towards their updated Basel III framework by 2015. The Basel III accord will require that banks set aside more capital reserves while increasing their liquidity in the attempt to mitigate the potential unfavourable effects from losses due to loans and counterparty exposures, as well as respective investment holdings. In addition and for US-regulated institutions, Dodd Frank is striving to segregate deposit taking institutions from investment banks on the premise that an institution will have to choose to be either one or the other but not both. Add FATCA into the recipe and we have several material challenges and stormy clouds ahead.
In the insurance sector and in Europe, the European Commission is leading the Solvency II initiatives, which will bind 30 European Economic Area countries in their attempt to strengthen the quality of capital and tie the quantity of capital more closely to the risks of each insurer.
What to expect onshore
The impact for both onshore banking and insurance industries will simplistically be lower margins, higher operating expenses, less flexibility, and more onerous processes. For onshore bank customers, this will mean reduced lending capabilities at higher pricing. For onshore European insurance companies, one can project higher capital costs and greater risk diversification through less large exposures, also resulting in higher pricing and less options for the end user.
Where does Cayman stand in the mix?
Will Cayman follow suit with “more + more = better or less risk”? Eventually perhaps, but it does not appear that we will adopt either Basel III or Solvency II in the near term. And therein are the potential opportunities for Cayman to capitalize on.
For the time being, Cayman’s banking industry will remain under the Basel II accord. This will allow Cayman-domiciled banks and Cayman subsidiaries to continue to offer competitive long duration pricing and to remain flexible in our approaches when compared to those under Basel III.
It is noteworthy as a sidebar that, by continuing with the Basel II regime, it should not be construed that Cayman institutions will be, therefore, more risky than those firms under Basel III. Cayman already has risk mitigation tools in place in addition to Basel II. One example is that Cayman’s current minimum capital requirements set by the Monetary Authority are already materially higher than most other jurisdictions. Hence, it could be argued that other countries under Basel III are now just reaching Cayman’s risk mitigation under Basel II. The benefit for Cayman in this instance is that, while the cost of capital will inevitably rise for other nation institutions, the cost of capital domestically should remain largely unchanged.
Cayman’s insurance industry in turn has adopted a “wait and see” approach to Solvency II whereas Bermuda has committed itself to its implementation. There are still many questions around the potential effectiveness of Solvency II, but most importantly is: are these changes appropriate for self insured vehicles? It may be too soon to make a meaningful determination but a deferral on additional compliance, cost, and other capital constraints, without a full appreciation or track record as to the risk mitigating effects, makes this approach quite appealing.
Add into the mix that the quality of Cayman clients and structures is of a higher concentrated nature than found in other more “diversified” traditional jurisdictions and product lines, it would therefore not be a stretch to conclude that reduced operational expenses arising from credit and claims losses is risk mitigation in another form, further negating the knee jerk movement towards “more + more = better”.
How will it all shake out?
As in many aspects of life and business, the contender is hedged by the jurisdiction/ entity/ individual that can deliver a nimble, flexible and reasonable approach - whether it is providing financing, advisory, issuing letters of credit, collateralizing investment holdings or providing other legal, financial or banking options for our clients.
With this, I believe Cayman will remain competitive and continue to distinguish and differentiate itself. No doubt there will be a few speed bumps along the way, just to make it interesting, but I believe we continue to position ourselves nicely.