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Key Building Blocks Of A Vibrant Financial Centre: A Case Of Labuan International Business & Financial Centre
Keynote Address
By
 
Dato’ Azizan Abdul Rahman, Director General LOFSA

At

The Fifth Busan International Finance Conference, 16 November 2009
Busan, Korea
Distinguished Guests 

Ladies and gentlemen,

It is my honour and great pleasure to be in Busan today to speak at the Fifth Busan International Finance Conference in commemoration with the 13th APEC Summit Meeting. This Conference signifies an important initiative in bringing together of minds to discuss recent developments and key issues surrounding regional financial centre. I would like to accord my appreciation to the organisers for presenting me with this opportunity to share with you my thoughts and experience on the development of Labuan as a premier international business and financial centre in Asia.

My remarks today will dwell on two main areas. The first is to share selected major developments in Labuan International Business and Financial Centre or Labuan IBFC with an emphasis on the key building blocks of a vibrant financial centre. I will endeavour to provide some highlights on how Labuan has built its strength around these key blocks. Secondly, I will draw attention to some of the major challenges facing financial centres today.

In the 50 years or so since they came into being, offshore jurisdictions as used by corporations have changed in nature and reputation. While there is a belief that offshore financial centres or OFCs provide a refuge for illicit funds from money launderers, corporate fraudsters, corrupt politicians and tax evaders, many OFCs are sophisticated, well-run financial centres. The case for using offshore financial centres for tax minimisation only has evolved as these jurisdictions have now been increasingly used due to their sophisticated, innovative and efficacious business legislation. The growth of OFCs is considered by many observers as the gold rush of the last decade which is hardly a surprise considering that around US$5 to US$7 trillion is estimated to be held offshore.

Unfortunately, offshore centres have always been epitomised as tax havens. The global economic crisis and events such as the recent G20 Summit in London have placed OFCs in the global spotlight and attention on tax haven jurisdictions has gained greater prominence. Let me at this juncture point out that the concept of tax haven is an old and outdated concept. Its usage betrays the fundamental failure to understand the “offshore” world. These two are quite separate and distinguishable. Tax haven is distinctively different from offshore centres on three main criteria namely, lack of transparency, lack of law or administration practices that prevent the effective exchange of information for tax purposes and no substantial activities. In the past, tax haven was also defined as a jurisdiction that imposes no or nominal taxes. However, this criterion is not sufficient by itself to characterise a tax haven. In this respect, I applaud OECD’s decision to recognise that each jurisdiction has a right to determine whether to impose direct taxes and if so, to determine the appropriate tax rate. IMF’s decision to drop the distinction between offshore and onshore financial centres is very welcoming indeed as it implies that it is wrong to distinguish between jurisdictions based on their geographic location or size. The distinction should always be that of well regulated or not so well regulated.


Key Building Blocks in Developing an Offshore Financial Centre: A Case of Labuan IBFC

In the 19 years since Labuan International Business and Financial Centre or Labuan IBFC came into being, Labuan as an offshore centre has changed both in nature and reputation. Starting as an offshore unit under the Central Bank of Malaysia and evolving into an offshore financial centre, Labuan has now matured into an international business and financial centre with the coming of this millennium.

Labuan’s distinct capabilities includes strategic location, wide range of conventional and Islamic financial services and products, a spectrum of service providers, world class infrastructure, low cost of operations, one stop regulatory authority as well as world class regulatory framework which is balanced and business friendly. Based on Labuan’s experience in becoming one of the premier offshore centre in the Asian region, let me reiterate some of the key factors in developing a vibrant offshore financial centre.
 

World Class Regulatory Framework

Regulation is considered as one of the most critical component for success for any offshore centre. As globalization is drawing economies together, the importance of establishing a transparent, flexible and growth-oriented regulatory framework cannot be overestimated. Domestic legal, regulatory and enforcement regimes must be kept current, meet internationally accepted and applied standards (including improved transparency and disclosure of information locally and cross border) and be effectively executed while remaining innovative, competitive and not unnecessarily burdensome.

The challenge here is to find the appropriate regulatory equilibrium where regulation protects investors but at the same time is viewed as a competitive market strength. The regulatory framework should be based, to the maximum degree possible, on familiar global best practices with an eye towards prevailing norms in other major jurisdiction in order to provide confidence and familiarity to the institutions located in the jurisdiction.
In this regard, LOFSA notes the Financial Stability Board’s report on the “Principles for Sound Compensation Practices” which contained proposals for corporate governance reforms, global standards on pay structure and greater disclosure and transparency. The Report also lists the various economic and financial standards that are internationally accepted as important for sound, stable and well functioning financial systems. These standards can be used as points of reference when judging a financial centre’s efficiency, transparency and level of disclosure with respect to macroeconomic policies and data, market integrity, market structure and market safety and soundness.

Regulators must also strive to ensure that prudential practices are on par with international standards. In this sense, the regulatory framework must be constantly re-evaluated with a view to enhance the existing laws and adopt recommendations made by oversight bodies such as the IMF and OECD. Only jurisdictions that have a world class legal framework, transparent operations and independent regulation that will able to attract the attention and confidence of the global investment and business communities.

Another important aspect of regulatory framework which is essential to investor protection, market confidence and attracting investments; is the expeditious and fair enforcement of legal and regulatory requirements. Our experience in Labuan suggests that expeditious and fair enforcement is a competitive advantage for any jurisdictions vying to become a world-class financial centre.

Labuan IBFC has always taken its role as a financial services centre seriously. Since its establishment, steps have been taken to ensure that proper legislation is in placed to manage and regulate its financial services industry and to ensure that the development of products and services are in pace with the global financial marketplace. A world class regulatory and legal financial system has proved critical to Labuan in attracting international players as it affords them confidence and re-assurance that any disputes arising in the jurisdiction will be heard within a familiar regulatory and legal framework. 

Labuan’s success as a business and financial has also been based on its history of promoting commercial certainty for global clientele by way of adhering to recognised relevant international standards – not the absence of regulation – which has helped fuel sustainable growth of its offshore activities. Our strong track record of effectively regulating a full spectrum of financial services measures up with standards found anywhere in the world.

Currently, the legal and regulatory framework is being reengineered to reflect today’s business realities as well as to position Labuan to capitalize on future opportunities. As we speak, a total of 8 new legislations are awaiting for a second reading in Parliament. This recent changes to the legislative frameworks clearly demonstrate the ongoing commitment of Labuan to be a leading jurisdiction when it comes to combat money laundering, the financing of terrorism and tax evasion.
 

Engagement with Regulatory and Enforcement Authorities

There must be engagement between local regulators and international regulatory authorities in developing as well as the implementation of fair international standards. It is essential that regulators work closely with international organisations to achieve improved regulation for the conduct of international financial services on the basis of a level playing field in equivalent standards. Regulatory structure should also be amended to ensure that it is in compliance with international standards. In this regard, OFCs have to commit to international standards and should be seen to be compliant in the application of those standards.
OFCs are now coming under immense pressure from OECD as they are seen by many bureaucrats and politicians in the OECD countries as facilitating criminal activities such as money laundering as well as tax evasion and tax avoidance by residents of high-tax countries.

Labuan is no stranger to the intense scrutiny by OECD. The initial listing of Labuan and several other jurisdictions by OECD as being “uncommitted” is strongly disputed as Labuan has never been involved in any form of tax evasion or money laundering. I am pleased to note here that Labuan has now been re-categorised to Category 2 that is “committed but not fully implemented”. Contrary to the earlier categorization by OECD, Labuan has always been cooperative with other regulatory and enforcement authorities on matters relating to tax and financial crime, in particular money laundering.

Despite our unblemished track record, this does not deter us from entering in any convention or implementing any requirements to meet the OECD standards on transparency and exchange of information. Let me reinforce this by saying that Labuan is committed to work with OECD to improve transparency and establish effective information exchange for tax purposes. In fact, even before the requirements for exchange of information by OECD was imposed, we had already undertaken a review to remove any legal provisions that could impede the free exchange of information. Currently, we are amending legislations to comply with Article 26 of OECD’s Model Tax Convention.

However, this presents a rare opportunity for Labuan to be ahead of the curve by taking innovative steps to make its tax and regulatory regime more attractive, while remaining compliant with the OECD recommendations on transparency and exchange of information. I would like to stress here that Labuan was never designed to be a tax haven. Instead, its establishment was to cater to only legitimate and genuine businesses. As a matter of fact, the conducive tax environment in Labuan is reflective of the efficiency gained from lowering cost of doing business in the jurisdiction.
 

Specialisation/Function Oriented

In today’s global and very competitive markets, success of a financial centre relies more than ever on fundamental strengths which can only be created through specialisation. New entrants have to offer new products or have an advantage over longer established rival centres to attract significant financial activity to their jurisdictions. Resources should be focused on activities that the OFC has a natural advantage on or that capability can be built upon. It is imperative for an OFC to analyse and determine which niche market it can build its strength. The ability of the OFC to define its competitive sphere will almost guarantee the jurisdiction to be “first in the class”. Furthermore, OFCs can also play a key role in new market developments because as niche market operators, they have the ability to be “fleet of foot” and better able to take advantage of new market opportunities as they arise.

Most of the major offshore centres have specialised in certain areas. Bermuda, for example, is a major international insurance and captive centre. Cayman, on the other hand, is a dominant offshore centre in mutual and hedge funds. These jurisdictions market their respective areas of strength aggressively and have created specialised communities of service providers that make it difficult to prise business away from them. Specialisation has also resulted in the establishment of highly skilled expertise and thus giving the jurisdiction global competitive advantage in this particular sector due to the congregation of large numbers of firms and industry professionals there.

However, when promoting the development of specific markets and activities that OFC has stronger growth potential; two important criteria must be taken into consideration. Firstly, it is important to push in the same direction as market forces and not against them. Secondly, the approach to developing
OFC should be to establish a level playing field with transparent rules and the right environment so that market forces can operate and innovation can flourish. Understanding the importance of specialisation in capacity building and sustaining growth, Labuan IBCF has identified four niche markets, namely, captive insurance, Islamic trust and foundation, holding companies and wealth management. In line with this, several new legislations and guidelines have been introduced with the aim of creating a conducive environment for doing business in Labuan. Nonetheless, Labuan IBFC offers a comprehensive range of financial services, both conventional and Islamic, including offshore banking, insurance and captive, trust business, fund management, investment holdings, investment banking, management services and capital market activities.

In tandem with Malaysia’s aspiration to become the international hub for Islamic finance, this sector has been identified as a source of good growth potential and competitive advantage for Labuan. I wish to note that Labuan IBFC has achieved several major milestones in the development of Islamic finance and is continuing to enrich the Islamic financial industry. Labuan IBFC is a pioneer and innovator in the Islamic capital market. The issuance of the world’s first sovereign sukuk by the Government of Malaysia subsequently led to the proliferation of a global sukuk market that we witness today. Other milestones include the issuance of the world’s first Syariah-compliant Exchangeable Trust Certificates which set a new benchmark as Malaysia’s largest exchangeable instrument to be issued out of Asia, excluding Japan; and the issuance of the first international Islamic subordinated sukuk worth US$300 million. This year, Labuan’s status as an innovator and leader in sukuk issuance was once again elevated when Petronas offered the largest ever sukuk worth US$1.5 billion from Labuan.

Syariah-compliant captive and Syariah-compliant trusts and foundations have been identified as new businesses for further development and promotion in Labuan IBFC. The double-digit growth of the conventional captive insurance industry in Labuan coupled with conducive regulatory infrastructure provides a viable environment for the development of a Syariah-compliant captive market. Guidelines on Syariah-compliant Trust have also been issued to cover the creation and recognition of Islamic offshore trusts in Labuan IBFC. Legislation pertaining to the formation of Islamic foundation is awaiting Parliament and once passed would provide clear legal framework for the foundation business to be set up and structured in a Syariah-compliant manner.

Current legislations in Labuan IBFC have also been reviewed to address business and legal impediments facing players in offering a wider range of Islamic financial products and services. Labuan will be the first ‘offshore’ financial hub to have an independent legislation on Islamic finance when the "omnibus" Labuan Islamic Financial Services and Securities Act (LIFSSA). The introduction of LIFSSA will provide legal framework that is needed especially on takaful and re-takaful. It will probably be the first comprehensive Islamic legislation in offshore jurisdiction which sets out what is and is not permissible legally, standardizes criteria such as seed capital, and legally expresses the requirements of the business.


Domestic Participation

OFC should be allowed to capitalise on the domestic demand for its financial services. It would be cavalier, if not negligent, to forego using “home-market advantage”. By allowing local residents to trade in offshore transactions, OFC will have a ready domestic customer base which will provide OFC with a comparative and competitive advantage that can be sustained for the foreseeable future. Attracting business with substantial domestic activity also ensures global competitiveness. The OFC must be allowed to support demands of the domestic economy, especially domestic demand for sophisticated financial services. Expansion of the local businesses abroad for instance requires a complete chain of financial services ranging from advice on the investee company to financing the project in foreign currency.

Several jurisdictions have already allowed the participation of both domestic and foreign players. Offshore banks in Panama are allowed to do conduct transactions with residents and non-residents. Cyprus has also lifted the prohibition for offshore companies to do business domestically. In Bahamas, International Business Companies may do business locally and own local real estate but such transactions are subject to exchange control and stamp duty.

The financial landscape in Malaysia has undergone tremendous changes in recent years including the liberalisation of the domestic financial market. Leveraging on new opportunities created through the recent financial liberalisation, Labuan is geared up to take advantage of the high domestic demand for sophisticated financial services. Under the new financial liberalisation, Labuan offshore companies are allowed to do dealings with residents and own 100% of Malaysian companies.


Review/Ongoing Assessment of Offshore Financial Centres

Another important building block of a successful and vibrant OFC is for these offshore centres to undergo continuous “health checks” in order to ensure the integrity of their regimes. By participating in assessment programmes such as those conducted by the IMF, FATF, IAIS and IOSCO; offshore jurisdictions reassures their financial and business communities of their adherence to the international standards set by these organisations. Independent verification activities provide evidence, assurance and confidence to stakeholders.

Labuan’s financial regime have been evaluated and recognised by many global organisations. LOFSA meets the highest international standards and has received positive assessments by the International Monetary Fund (IMF) under its Offshore Financial Sector Assessment Programme. In addition, the Asia Pacific Group on Money Laundering, an associate of the Financial Action Task Force, has recognized Labuan IBFC as a "low risk" jurisdiction for money laundering.

LOFSA has also subscribed to international best practices and is a member of the fraternity of regulators in various international organisations including the Offshore Group of Banking Supervisors, Offshore Group of Insurance Supervisors, International Organisation of Securities Commissions, Asia Pacific on Money Laundering, International Association of Insurance Supervisors, International Islamic Financial Market and International Financial Services Board. We are expected to go through the second review by IMF by the first quarter of next year.

 
Close Interaction between Regulators and Players

Regulator and players must interact closely, respect and listen to each other and be proactive in moving forward together. Consultation with players is critical to create a healthy and competitive business environment in the jurisdiction. The process of regulatory rules making must provide the financial and business community in the jurisdiction with a meaningful opportunity for “notice and comment” to express their views and concerns on the proposed regulation. This typically improves the quality of the regulation as market participants offer their expertise, advice and even drafting suggestions to regulators.
In formulating regulations and policies, LOFSA has always adopted a consultative and market driven approach. Engaging talks and discussions with players through their respective associations have always been at the heart of formulating laws, policies and guidelines for Labuan. A twice a year meeting with players representatives such as the Association of Offshore Banks, Association of Labuan Trust Company and Labuan International Insurance Association have proven to be effective for LOFSA.


Challenges In Developing An Offshore Financial Centre

Having in placed the key building blocks discussed earlier is daunting in itself, but meeting the challenges in establishing, competing and sustaining growth of an offshore centre is a formidable task. Recognising the challenges and obstacles of establishing and developing an offshore centre is imperative to ensure continuous success.


Greater International Scrutiny

The turmoil within the global financial markets had placed the activities of offshore financial centres under greater international scrutiny. Over the years, OFCs have had to deal with the notable view that they only succeed if they are accretive and non-transparent. Recently, offshore centres have come under attack from various quarters particularly from multinational organizations such as the OECD and the FATF.

Tremendous pressure are being put on offshore centres from standard setting bodies and international supervisory bodies to tighten laws as well as enhance disclosure and transparency standards, particularly from the OECD countries. This mounting pressure alluded is something that OFCs have to confront head on. Offshore centres are being forced to accept costly and burdensome regulations and requirements or become pariah states facing severe economic sanctions.

A 2007 Commonwealth Secretariat paper concluded that OFCs did not show tangible benefits from implementing recent international taxation and anti money laundering initiatives. In fact, the report suggests that these OFCs were distracted away from continuing the innovative development of their jurisdictions. By changing their regulations in response to the international pressures, OFCs are actually altering their competitiveness position and predictably having negative impacts on their profitability.
 

Tougher Regulatory and Disclosure Rules

OFCs are constantly pressured to observe and adhere to internationally accepted standards. Failing to do so would result in dire consequences to the reputation and business of the jurisdictions. In extreme cases of continued non-adherence to international standards, governments or authorities could restrict or even prohibit financial transactions with counterparties located in the problematic OFCs.

The assault on OFCs is not a new phenomenon. Over time, these efforts have intensified as technologies reduced communication as well as cross-border transaction costs and thus, opening doors to increased international competition. A range of methods have been used in the past to pressure OFCs including calls for a level playing field regarding taxation and financial regulation through enforcement of a global financial regulation, threat of treaty suspension to persuade offshore centres to comply with onshore policies and threatening blacklisting and possible sanctions.

Presently, there are too many recommendations that OFCs have to comply with. The activities of OFCs are monitored and their compliance with supervisory standards are assessed by several international regulation and supervision authorities. For example, the FATF requires OFCs to be assessed on their adherence to its 40 recommendations on money laundering through a process of self-assessment and mutual evaluation.

IMF and the World Bank have modules that evaluate the compliance of supervisory and regulatory system with international standards in the banking, insurance and securities sectors. The IAIS and IOSCO use self-assessment techniques for assessing observance with their standards. Hence, the future road of OFCs is meeting increasingly tougher regulatory and disclosure rules from international organisations and governments demanding greater transparency.

I foresee that OFCs will be assessed more rigorously in the coming years. Another great challenge is for OFCs to constantly keep abreast with and conduct self-audit based on international standards and best practices.

 
Blurring Distinction Between Offshore and Onshore

The distinction between offshore and onshore is becoming increasingly blurred by globalisation which had increased the range of cross-border transactions in many financial centres. This was the result of the forces of innovation and technological advancement. In fact, the share of cross-border assets intermediated through offshore centres catering industrial countries has been in decline since the 1990s.

The blurring of distinction is occurring in part because competition is forcing onshore governments to provide the best possible services at the lowest possible cost in taxes and regulations. Onshore countries such as Ireland, Luxemburg and Switzerland have adjusted their tax and legal regimes to try and win some of the business that has traditionally headed offshore.

Furthermore, many of the OFCs are actually situated onshore and the day-to-day relationship between offshore jurisdictions and other major financial centres of the world such as New York, London, Tokyo and Hong Kong is intimate and often mutually supportive. As I had pointed earlier in my speech, the new distinction is now between financial centres that are well regulated and not so well regulated.

 
Intensified Competition Among OFCs

Competition among OFCs takes place at two distinct levels, namely inter-OFC and from other established onshore financial centres. In the inter-OFC level, offshore jurisdictions have to compete vigorously with one another via creative legislation in an attempt to create conducive and attractive business environments. Competition amongst financial centres is likely to intensify as playing field is now becoming more and more level. With increasing competition and dynamic marketing by financial centres, a struggle to balance between supervision and customer service is a formidable task indeed.

In facing the ever increasing competition from both offshore and onshore financial centres, OFCs need to be one step ahead of the rest and to continuously refine its laws and regulations. It also involves creating an edge in product innovation. Innovative solutions are needed to improve the trading capacity of financial products in order to increase liquidity and improve asset-liability management as well as to enhance product features to accommodate changes in market dynamics.

The rapidity of product innovation that has intensified in the past few years has brought about more sophisticated range of products being offered on a global scale. In order to stay competitive and sustain growth, financial centres need to be innovative. Hence, innovation is the key differentiating factor to remain competitive in a highly globalised financial market.

Competition faced by OFCs comes in many shapes and sizes. OFCs not only have to compete for businesses and investments, they also have to compete for skilled people. Finding and retaining qualified professional has become an ever more important factor. Where competition for highly trained and qualified people is especially acute, quality of life has become a key consideration for attracting and retaining international employees.

Apart from a high quality and reliable modern infrastructure which are crucial to attract investment and increase international competitiveness, good infrastructure that can boost quality of life is important too. This includes world class medical care, superior education opportunities for the players’ children, good housing and physical security as well as availability of sophisticated leisure activities. Nonetheless, all these are very costly and support from the government in building and providing such infrastructure is
extremely critical. As such, the establishment of an offshore centre requires full commitment of the government and private sectors. Both parties must devote the necessary resources and energy to the tasks. Those that do shall flourish.


Globalised Clients

Another challenge facing OFCs is that clients are now “globalised” in that they do not need to be incorporated in an offshore jurisdiction which is geographically proximate. Hence, jurisdiction of choice can be anywhere in the world so long as the jurisdiction provides the necessary depth and breadth of professional services that is required. In meeting the demand of an increasingly sophisticated and globalised client base, offshore centres must constantly re-invent themselves and be innovative.

These five challenges point to one direction – that offshore centre will continue to face even more complex and challenging environment and that this environment will continue to shape the advancement of the offshore industry. The success of offshore centre rests on the ability to position itself strategically to meet the needs of the global economy and clientele as well as the ability to be competitive and innovative.


Conclusion

Everywhere, the climate against tax haven and offshore financial centres is hardening as a result of the growing needs for onshore countries to boost tax revenues at a time when recession is cutting their tax take. For offshore centres, even more than in past years, these are challenging, daunting and stressful times.

Due to necessity and market expectations, OFCs must be mature, sophisticated and specialised providers of financial services with sound legal and modern infrastructure in order to succeed and compete with other offshore centres. Nonetheless, the ability to remain competitive depends largely on innovative capability and market orientation. In this respect, OFCs and the players must stay forward-looking and agile as well as constantly promoting new business solutions and technologies. 

I would like to take this opportunity to extend an invitation to all of you to visit Labuan and also share our experiences on how Labuan was developed into a premier business and financial centre in Asia. I would also like to invite the business communities to explore the possibilities of using Labuan in your future business ventures. We would be delighted to provide you with an insight into doing business in Labuan and on how to tap opportunities through Labuan IBFC.

I am looking forward to welcoming you to Labuan and to experience for yourself the many advantages that Labuan has to offer as an international business and financial centre as well as a place to unwind, relax and reconnect yourself with nature. 

With that note, I thank you for your time and attention.

 
Thank you.
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