What makes the offshore world so appealing for private lenders and borrowers?
The role played by offshore financial centres (OFCs) in shaping global finance is significant and impacts private credit transactions in much the same way that it does traditional institutional lending.
OFCs such as the British Virgin Islands, the Cayman Islands and Anguilla add value to the international financial system and are widely known for their tax neutrality, a business-friendly, well-regulated environment, established legal systems and their efficient financial services.
Part of the value add is their intermediary cost-saving function within the context of financial transactions and the facilitation of global capital flows. This cross-border movement of capital, in turn, supports much needed investment across the globe, in both developed and developing economies.
Filling a gap left by banks
Currently estimated to be valued at roughly US$1.6 trillion, the global private credit market is projected to top out over the coming year at about $2.8 trillion. The rise in global private credit, which refers to non-bank lending to companies, is characterised by private equity funds, alternative investment funds, hedge funds and other entities, who operate as private lenders in a bid to fill a gap left by banks.
Buoyed by large sums of capital, private credit is projected to fund ever-larger deals and will continue to claim a greater share of the global finance market. The strong year-on-year growth suggests longevity for the market, as many of the macroeconomic and regulatory factors that caused it continue to fuel its expansion.
Some of these factors have lowered the risk appetite of banks seeking to conform to capital adequacy and other regulatory requirements, while cost management has restricted lending standards, particularly involving smaller or riskier borrowers. The resulting gap in the lending market has been plugged by an entrepreneurial private credit market.
Convergence of OFCs and the private credit market
The growing importance of private credit to global capital flows seen over the past two decades led to a convergence of OFCs and the private credit market.
The features that made offshore appealing within the context of institutional lending equally apply to private credit lending transactions.
Simple and flexible corporate vehicles, ranging from standard companies to various types of fund vehicles, are a key feature. They are also integral to the service offering of OFCs like the BVI, Anguilla and the Cayman Islands.
The ability to have companies with unlimited objectives and purposes, or with restricted purposes, is central to what makes OFCs attractive for cross-border lending transactions. Flexible corporate features, bolstered by the generally creditor-friendly commercial and legal framework intrinsic to OFCs, are another factor for lenders and borrowers.
The choice of corporate vehicle will typically be informed by the parties’ commercial needs. The majority of transactions will use a company, as this type of entity offers the greatest degree of transactional flexibility while maintaining the separate legal personality, which is fundamental to such transactions.
The legal autonomy enjoyed by companies, with the capacity to contract, sue and be sued in their own capacity is a key feature that is generally attractive to lenders operating in the traditional banking industry. The same holds true for lenders within the rapidly expanding private credit market.
Contracting parties dealing with offshore entities have come to expect a certain degree of contractual certainty. When deals are structured using companies formed in the BVI, Anguilla and Cayman, both on the borrower- or lender-side, the same benefits apply.
The ease with which assets or profits can be distributed by the company to shareholders is another factor, since there is no requirement for companies domiciled in the BVI, Anguilla, the Cayman Islands to have reserves or profits prior to making a distribution (whether in cash or specie).
In addition, the absence of corporate, income or capital gains tax for companies, trusts, individuals or partnerships regardless of tax residence and the absence of withholding tax are important factors that make OFCs particularly attractive to borrowers and lenders when structuring transactions.
The absence of exchange controls and currency restrictions in OFCs like the BVI and the Cayman Islands facilitates the seamless running of cross-border financing transactions. BVI and Anguilla have straightforward registration systems for security interests to determine questions of priority; something which instills confidence in lenders holding security.
Similarly, all contracting parties in OFCs like BVI, Anguilla and the Cayman Islands benefit from well-established jurisprudence, largely based on common law principles, for the resolution of disputes arising from transactions where necessary.
We anticipate on-going interplay between the offshore world and private lending transactions as the demand for flexible financing options among borrowers persists and private credit’s investor-base continues to show an elevated risk appetite in exchange for larger returns.
This investor base has expanded to include institutional lenders well acquainted with the benefits of incorporating OFC corporate vehicles into transaction structures. As private credit continues to shape global finance and OFCs play a pivotal role in global financing transactions, the symbiotic relationship between the two will continue to thrive.
Under the prevailing macroeconomic conditions, the pairing of corporate borrowers in need of financing with non-bank lenders that have lots of money to invest and an appetite to transact is in many ways a perfect match.
Michelle Frett-Mathavious is a partner in Harneys’ BVI Transactional practice group, specialising in Banking & Finance.
