Shortly before the Covid- 19 pandemic began to wreak havoc on the global economy, the Virgin Islands quietly reached its own troubling economic milestone: New company incorporations, long viewed as the bread and butter of the financial services industry, hit a 20-year low of 26,150 in 2019, falling to about a third of their 2007 peak.

This year, they are on track to drop even further, with just 10,000 companies incorporated through the end of June, down 3,579 from the same period in 2019.

Industry stakeholders argue that new incorporations don’t tell the whole story — renewals are also key, they stress — but the total number of active companies also hit at least a 13-year low last year, falling to 387,344 after peaking at 481,002 in 2011. And government revenue from the sector is projected to fall to a decade low of $168.9 million this year despite a steep fee hike three years ago that boosted 2018 revenue to an all-time high of nearly $232 million. If projections hold true, fees from financial services will contribute less than 50 percent of government revenue this year for the first time since before 2007.

Stakeholders blame the drop on various factors, from ever-increasing regulatory pressures to a global economic slowdown sparked by the United States-China trade war.

But as new rules increase the difficulty of registering companies in the VI, practitioners tend to agree that the territory needs to rethink how it does business if it is to remain competitive in financial services.

“I don’t think anyone seriously expects a return to the sort of the heyday of high incorporations,” said Peter Tarn, partner and global head of banking and finance at Harneys. “You’re never going to get a free ride [with] a revenue stream for a long, long period without either somebody deciding they want to cut it off somehow, or somebody deciding they’d like a piece of it. Do I believe business is sustainable and profitable if there were, say, 200,000 BVI companies? The answer is actually yes, as long as one is actually servicing them in an efficient way and adding value.”

The boom

After the runaway success of the 1984 International Business Companies Act, which gave birth to the VI’s signature brand of corporate vehicles, the financial services industry rapidly grew to become the largest single source of government revenue for the territory, and incorporation numbers have been used as a bellwether for the industry’s health ever since.

Between 1980 and 1990, fees from the industry helped government revenue more than triple from $14.4 million to $47.2 million. By 1994, they directly contributed more than a third of government revenue by pumping $34 million into the public coffers.

In 2000, the territory reached a milestone of 250,000 active companies, and by 2007 that number had ballooned to over 400,000, with financial services levies accounting for an estimated $160 million, or about 61 percent, of the total government revenue of $275 million that year.

But the booming growth was not without pressures. Though the VI has long contended that it is a well-regulated jurisdiction that provides legitimate services, it has also faced accusations from abroad that it has enabled tax avoiders and criminals, in large part by refusing to publicly disclose information about company owners.

Regulators in Europe, the United Kingdom and the United States have responded by requiring new regulations that almost always have been adopted here in spite of frequent criticism from the VI government and other stakeholders.

Global recession

Following the 2007-2009 global recession, these pressures ramped up. To track tax avoiders and facilitate cross-border information sharing, large countries implemented measures like the US Foreign Account Tax Compliance Act in 2010 and the Organisation for Economic Cooperation and Development’s Common Reporting Standard in 2014.

Under such tightening regulations, the casual ease with which clients previously incorporated here gradually evaporated, explained Robert Briant, partner and head of the corporate division at Conyers.

“I think the most significant reason [for the drop in new incorporations] is the information 20 years ago that was required was the names of directors, an email or fax, and that was it,” he said. “So back then, I saw a company being incorporated very quickly for potential transactions because we’re very [low cost], very easy to do.”

Renewed pressures followed two major investigations by the International Consortium of Investigative Journalists — Offshore Leaks in 2013 and the Panama Papers in 2016 — both of which exposed abuses carried out by some VI companies.

Amid the resulting political pressure, the UK passed a law in 2018 effectively requiring OTs to implement public company registers by 2023. At the end of the same year, the threat of European Union blacklisting forced the territory to again bolster its regulatory regime by passing economic substance legislation, further complicating the process of registering a VI company.

2007 peak

As the industry grappled with these post-recession pressures, the annual tally of new incorporations never returned to its 2007 peak of 77,022. In spite of some fluctuations since then, the tally saw a long-term decline culminating in the 20-year low of 26,150 last year.

However, the number of total active companies fared better, growing slowly during the post-recession years to peak at 481,002 in 2011 before falling into a fairly steady downward slide to 387,344 last year.

The industry’s direct contribution to government revenue also continued to increase for a while after the recession: From nearly $160 million in 2007, it rose steadily to almost $185 million in 2013 before trending downward for the next three years to about $170 million in 2016.

Following a $5 million bump the next year, incorporation fees were raised, and industry fees contributed an all-time record of nearly $232 million to government in 2018.

But in 2019 the contribution dropped back to about $199 million, and it is projected to fall further this year to a decade-low of $168.9 million, making up about 47 percent of expected government revenue.

If the projections hold true, 2020 will be the first time in more than 13 years that direct contributions from the industry have fallen below 50 percent of government revenue.

The picture is not expected to brighten any time soon, according to government’s 2020 Budget Estimates.

“In the medium-term (2020-2022), growth in the financial services industry is anticipated to continue to decline as the industry is faced with an unprecedented level of uncertainty,” the estimates state, citing “a combination of factors, including [the] economic substance requirement and the approaching 2023 deadline regarding the public registers of beneficial ownership.”

Other causes

Experts also pointed to the China-US trade war as a cause of the economic slowdown that may have contributed to the drop in numbers.

BVI Finance CEO Elise Donovan said 42 percent of the VI’s financial services business comes from Asia.

“Specifically, 35 percent comes from China, and that includes Hong Kong and Macau,” she said. “So, whenever you have any instances or anything that is happening in those economies, I think you would see a sort of correlated relationship with the impact in the BVI business. It’s kind of what I guess some people will call the perfect storm in terms of the global economy.”

Mr. Briant spoke similarly, explaining that the fall in the numbers may be mostly due to factors outside the territory’s immediate control.

“Overall, global economic activity has had more of an influence on BVI numbers than any of the factors that we worry about,” he said.

Company longevity

Industry practitioners also cautioned against putting too much stock in the steep drop in new incorporations.

Just 13 percent of corporate service provider revenue comes from new incorporations, while 75 percent comes from the administration of the nearly 400,000 companies that are still incorporated here, according to a 2017 report commissioned by BVI Finance from research firm Capital Economics.

The remaining revenue stems from the establishment and administration of trusts and funds, according to the report.

“You have to look at renewals as well as … the plethora of activities that have taken place by the companies that are incorporated in the jurisdiction, and those activities have certainly continued and still thrive. And so the BVI companies have longevity, and that’s part of the whole built-in resilience,” Ms. Donovan explained.

Mr. Tarn, the Harneys partner, said he doesn’t “get terribly excited about the number of new incorporations,” explaining, “The overall number of companies matters much more.”

And although that number is dropping too, its fall has been much less dramatic, suggesting that many existing VI companies may be here for the long haul.

Twenty years ago, Mr. Briant explained, “A quarter of corporations were disposed of overnight, or were used on a temporary basis, or just because it was convenient. Over the years, the formation decreased or it’s become more difficult to form a company.”

This change is largely because of “know-your-customer” requirements, which generally call for multiple forms of identity verification for clients who want to incorporate, he said.

“Now, it’s passport photos and utility bills and everything,” Mr. Briant explained. “And so the decision to incorporate is not made until it’s determined that the company is absolutely required.”

Some clients, he added, already have a large number of companies.

“And so the need to incorporate a new company disappears because they just use [an existing company] for the next matter,” he explained.

Longer ‘shelf life’

Regulations such as KYC, he said, are all likely to have a disproportionate impact on certain types of companies designed to be used for a limited time, for a limited purpose, and then discarded just as quickly.

Such companies, Mr. Tarn added, often bring in minimal fees.

“A company that is incorporated and essentially sits there doing nothing has significantly less value than one which is an active participant in a market, requires legal advice [and other services],” he said.

Ms. Donovan added, “The companies that maybe we had, say, maybe 10 or 20 years ago, they may have had a shorter shelf life as far as the jurisdiction is concerned. But when you talk to people in the industry and certainly when we get down to the sort of granular level looking at the figures, even though we have [fewer] companies we have companies that probably have a longer shelf life in terms of longevity in the jurisdiction.”

Mr. Briant said that the new KYC requirements may hurt business in the short term, but they make sense “for the long-term health of the jurisdiction.”

However, the loss of those disposable companies does add up, in the form of the $450 fee each would have paid to the government to incorporate.

“Frankly, that is lost revenue,” he said.

Challenges

Although the VI has always faced competition, it’s no worse now than it has been in previous years, at least within other well-regulated jurisdictions, the stakeholders said.

However, this may also soon change.

In September, Premier Andrew Fahie abruptly changed the government’s longstanding stance and agreed to work with the UK toward enacting public registers of beneficial ownership here by 2023.

Dominic Thomas-James of the University of Cambridge, and a Global Justice Fellow at Yale University, said that the public registers could have a serious effect here.

“A significant concern is that if only a small number of jurisdictions implement publicly accessible registers, then it may encourage a race to the bottom for suspect wealth transiting into jurisdictions which do not require beneficial ownership disclosure, or where regulation is lax and international cooperation weak,” said Dr. Thomas- James, who studies financial services in the UK overseas territories. “While there is momentum towards public registers, they are far from globally normative.”

Competitors, which reportedly already have drawn business away from the VI, include onshore jurisdictions such as the US state of Delaware, which does not have a public ownership register and so far has proved uninterested in signing on to any agreement requiring one.

Mr. Fahie also warned in his November budget address that the threat of public registers is just one of the “attacks” that are “slowly chipping away at the features that give our offerings competitive advantage. And the price for these actions is the loss of jobs for Virgin Islanders, loss of business and loss of revenue to the territory.”

What’s next?

Practically, however, there may not be much the VI can do to promote growth of in- corporations under its traditional model.

“I don’t see how, as it currently stands, BVI could improve its core products of companies and incorporations,” Mr. Briant said.

Nevertheless, he added that there are opportunities to boost the ease of doing business here in general.

In terms of economic substance, a better picture of how the VI is faring may emerge at the start of the New Year, when “99 percent” of companies whose activities fall within the scope of the new Economic Substance Act have their filing deadlines, Mr. Briant explained.

“They have an option to bring their substance here or they can leave the jurisdiction,” he said. “They still are in scope [of the legislation] for the time that they were here. And they could face sanctions as a result. But it is an option to continue out of the jurisdiction.”

He added that immigration, labour and trade licensing reforms could all help attract companies to physically locate here, especially in light of the economic substance requirements. Government has paid lip service to those measures over the years, but insufficient action has resulted, Mr. Briant said.

“I’ve attended too many committee meetings to count [on this matter], whether it’s law firms or more accounting firms or other value-added services [trying to relocate here], and it ties into the usual issues of work permits and trade licences,” he said. Additionally, complaints of slow, expensive internet service — coupled with the limited options for convenient, direct travel to the territory — are frequently heard from practitioners attempting to do business here.

Government is well aware of these shortcomings. A 2014 report by international consulting firm McKinsey & Company, for which the government paid $1.15 million, included suggestions for improving financial services such as reforming immigration and labour processes; improving telecommunications and transportation infrastructure; and establishing a Delivery Unit to cut through bureaucratic red tape. However, efforts to implement these recommendations largely have been lacklustre, and some of the work that did get under way was set back by Hurricane Irma in 2017.

‘Mindset shift’

Mr. Tarn suggested that “a mindset shift” is needed in recognising the true economic value of the financial services industry.

According to the Capital Economics report, tourism accounts for one in four jobs in the territory, while financial services accounts for one in 10. But total value should be considered too, Mr. Tarn explained.

“There may be less [employment] in pure head cap, but in terms of the salary bills that are paid each month, they go directly in supporting other jobs within the BVI,” he said.

Ms. Donovan explained that the industry’s economic impact isn’t limited to the fees that make up as much as 60 percent of government revenue each year.

“A large percentage of the government revenues comes from incorporations and renewals, but business is also coming from payroll taxes from the financial services industry,” she said. “So it’s important for us to have the sector active, and people working, because there’s a multiplier effect in terms of business, whether it be simply buying stuff in the store or for rents of residential as well as commercial spaces. I want us to, when we are looking at a picture, to … look at it from a wider lens.”

Going forward, she and other stakeholders suggested it may be time to recalibrate how the VI measures the health of its financial services industry.

Mr. Tarn agreed.

“Government does have to wean itself off the drip feed of incorporation numbers,” he said. “It’s incredibly difficult to do — I recognise that — but it has to be done.”