Conduits of Capital

Importance of Domestic Flows
– Accessing domestic funds
– Domestic investment opportunities
The weighting of these different criteria will depend on the
nature of the fund, of the potential investors in the fund, and
the primary investment opportunities.
Taxation
Most funds operate in a competitive environment, and for
them the returns paid to investors are crucial. Such funds
seek as low as possible an effective tax rate. Given the
competition from tax havens with zero tax rates, the effective
tax rate needed to secure such footloose funds—i.e., those
that have a wide choice of jurisdictions for registration—is
close to zero.
However, this depends partly on the domestic tax regime
applicable to the investor. If the investor is subject to
domestic taxation—which determines the final tax rate—
then it is not necessary for the fund to have a low tax rate
in its home jurisdiction; what is important is that any taxes
that are paid can be offset against the investor’s domestic
tax liability. Hence a wide network of Double Taxation
Agreements (DTAs) is essential.
For financial centres dealing with mainly international flows
(A-C in Figure 2 above), tax may be levied in the jurisdiction
where the final investment takes place (C), and investors
will be liable for taxation in their home jurisdiction (AC). If
the FC imposes a significant additional layer of taxation,
this is likely to be a disincentive for investment funds to be
domiciled there.
Regulatory Framework
There is a common perception that fund managers seek
jurisdictions with light regulation and that allow a high degree
of secrecy regarding operations and beneficial ownership.
This is not borne out by discussions with managers (although
they might not admit it if this were their objective). What
appears to be more important is a regulatory environment
that is “reasonable,” and most importantly, transparent,
predictable and consistent, with a regulator that is efficient
(i.e., takes decisions and acts quickly).
Also important is the knowledge and attitude of foreign
regulators towards a particular jurisdiction. If a fund is intending
to attract US investors, the attitude of the US regulator
(SEC) and the investors themselves towards the jurisdiction
is crucial.
An important component of the regulatory framework,
although not directly related to financial service operations,
is the extent of exchange controls. Jurisdictions without
exchange controls have a distinct advantage, and investors
are generally reluctant to be exposed to the restrictions
and delays involved in abiding with capital controls, where
they exist.
Support Services, Skills and Infrastructure
Fund managers prefer to have access to a well-developed
network of support services to deal with administrative and
financial management tasks, as well as to manage interaction
with the regulator. Access to skills is essential, and this can
cover a wide range from basic administrative and financial
management skills through to more sophisticated banking,
asset management, investment, financial engineering and
legal skills. Access to the more sophisticated skills may not
be essential in the early stages of developing a financial
centre, however, as it is likely that the operational aspects
of a fund will be located elsewhere. To the extent that more
sophisticated skills are needed and are not available locally
in the financial centre, a liberal and efficient immigration
system is essential to enable access to foreign skills.
The availability of reasonable real estate (office and
residential property), transport and communications are
also essential.
There are many “clustering” advantages in developing
a financial centre, i.e., success tends to be reinforcing.
The establishment of financial service operations in a FC
stimulates the emergence of support services, which then
tends to attract further financial services investment, in a
virtuous circle. One of the main challenges in developing
new FCs is achieving this critical mass. It may be easier
in a larger economy that already has a developed financial
sector servicing the domestic economy than in a smaller
economy that has to do so from scratch.
For funds that intend to undertake a stock market listing
(which may be attractive to investors), a jurisdiction with a
recognised and developed stock market is essential.
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