## IMF assessment of Cyprus offshore financial sector (Module 2, March 2001)

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### IMF Mission and Scope
- In July 2000, the IMF Executive Board approved a program of assessments of the extent to which certain offshore financial centers had implemented international standards of supervisory and regulatory practice.
- The Central Bank of Cyprus (CBC) invited the IMF to carry out an assessment in March 2001 of the extent to which Cypriot supervisory arrangements for the offshore financial sector complied with certain internationally accepted standards.
- The assessment used the “Module 2” approach and comprised:
  - A Basel Core Principles assessment of supervision of the offshore banking sector.
  - An assessment of the provision of company services to International Business Companies (IBCs) registered in Cyprus.
  - Informal reviews of offshore insurance and investment supervision (full IOSCO and IAIS assessments were not attempted because those sectors are currently small).
- The assessment team was led by Mr. Peter Hayward; the report was prepared by Ms. Nirmaleen Jayawardane. The team included staff from the Monetary and Exchange Affairs Department, the Legal Department, an expert from the Bundesaufsichtsamt für das Kreditwesen, and the Assistant Registrar of the Jersey Financial Services Commission. Mr. Dimitri Demekas of the European I Department participated in discussions.

### Key findings (Executive Summary)
- Factors facilitating offshore sector development:
  - Geographic location, a preferential tax regime, an extensive network of double tax treaties (particularly with Eastern European and former Soviet Union countries).
  - Legal and accounting framework based on U.K. law and practice.
  - Availability of a well qualified labor force with accounting and legal skills, reliable telecommunications, liberal immigration and visa requirements, and ready supply of office and residential accommodation of a high standard.
- Exchange Control Law role:
  - Enabled the CBC to attach conditions to permits issued to nonresidents, restricting nonresident-owned companies to providing services exclusively to other nonresidents and thereby directing tax preferences without affecting the domestic economy.
- Size and composition of the offshore sector:
  - The Cypriot offshore financial sector is not large compared with other offshore centers and contributes less to employment, foreign exchange earnings, and government revenue than tourism.
  - Offshore services are more restricted than in other centers: limited number of banks, some insurance services, and relatively small-scale fund management and advisory business.
  - Banking is the most important offshore activity with assets of $10.8 billion; these activities are small relative to some other jurisdictions and do not create significant risk for the international financial system.
  - A more extensive network of nonfinancial companies is registered in Cyprus; only a minority have a physical presence.
- Supervision and regulatory observations:
  - Supervision was generally effective and thorough, but resources were somewhat scarce, limiting the amount of onsite supervision.
  - The approach to EU accession has driven a large volume of legislative changes to align Cyprus with EU requirements.
  - Cyprus has licensed institutions from countries often regarded as high-risk; in some cases supervisory action has been taken. Customers do not appear to have experienced significant losses to date, but continued vigilance and high standards of supervision are necessary.
  - Anti-money laundering framework as applied to the offshore sector and measures by the CBC, the Securities and Exchange Commission, and the Superintendent of Insurance appear adequate; scope remains to improve beneficial owner identification and reporting of suspicious transactions, especially for nonresident-controlled companies.
  - Regulators and financial institutions rely to some extent on accounting and law firms; neither profession is externally regulated, and provision of company services through limited liability companies owned and managed by accounting and law firms is not effectively regulated.
- Structural reforms and future direction:
  - Winding down the Exchange Control regime in advance of EU accession is a major challenge.
  - Cyprus committed to the OECD that, if the OECD tax initiative proceeds, Cyprus will abandon, by 2005, the existing framework of tax preferences in favor of offshore businesses.
  - Authorities are drafting a new Financial Services Bill to extend supervision to all provision of investment services in Cyprus, including some domestic businesses currently outside the scope of the current supervisory framework, eliminating differentiation between onshore and offshore financial business.
  - Envisaged reforms aim to create a financial system free to do business at home and abroad while allowing foreign businesses, especially from the EU, ready access to Cyprus’s markets.
- Recommendation:
  - Given the likely disappearance of the onshore/offshore distinction, a full assessment of the entire financial sector under the IMF’s Financial Sector Assessment Program would be beneficial and would aid Cyprus’s accession to the EU.

### Macroeconomic context and structural reforms
- Recent macroeconomic performance:
  - Annual real GDP growth averaged nearly 5 percent during 1998-2000, driven by booming tourism that contributed over 20 percent of GDP and 40 percent of current account receipts.
  - Unemployment averaged 3.5 percent during 1998-2000.
  - Annual increases in consumer prices averaged 2 percent during 1998-99; inflation accelerated in 2000 due to higher energy prices, a weaker exchange rate to the U.S. dollar, and a rise in the value-added tax rate from 8 percent to 10 percent on July 1, 2000.
  - GDP per capita in 2000 reached $13,154. The population in 2000 was estimated at 670,000.
- Structural and legal reforms in preparation for EU membership:
  - Withdrawal of the Exchange Control Law over the medium term is expected as Cyprus complies with EU requirements on freedom of capital flows; a new Financial Services Law is under preparation.
  - CBC capital account liberalization measures (selected):
    - Abolition in December 2000 of restrictions on domestic banks extending loans in Cyprus pounds to nonresidents who are economically active in Cyprus.
    - Abolition on January 1, 2001, of restrictions on domestic banks and IBUs/ABUs extending medium-term (over two years) and long-term loans in foreign currencies to residents.
  - Law on the Liberalization of Interest Rates repealed the legal interest rate ceiling at 9 percent a year; law enacted in December 1999 and came into effect on January 1, 2001.
  - Monetary policy governance: Monetary Policy Committee set up in December 2000; new CBC Law expected around mid-2002 to strengthen statutory independence, prohibit monetary financing, and remove the Governor before expiry of term.
  - Tax treatment and OECD commitment:
    - IBCs are subject to a profit tax rate of 4.25 percent.
    - Domestic companies are taxed at a rate of 20 percent, or 25 percent for chargeable income over C£ 40,000.
    - Government committed to remove restrictions on the ability of Cypriot entities, including offshore companies, to do business in Cyprus and to abolish “ring-fencing” of offshore entities by 2005 conditional on OECD initiative proceeding by end-2003.

### Fiscal and external indicators
- Fiscal adjustment targets and outcomes:
  - Strategic Plan for Fiscal Adjustment 1999–2002 aimed to reduce fiscal deficits to 2 percent of GDP by 2002.
  - Fiscal deficits narrowed to 4.1 percent of GDP in 1999 and 2.7 percent in 2000 (below the 2000 target of 4 percent of GDP).
- Balance of payments and exchange rate:
  - Exchange rate fluctuation bands widened to 15 percent around the central parity with the euro on January 1, 2001, although the CBC intends to keep the exchange rate within the narrow 2¼ percent bands.
  - Current account deficit rose to 5.1 percent of GDP in 2000 after narrowing in 1999; improvement in the invisible surplus (mainly tourism) was more than offset by deterioration in the trade balance as imports surged by 23 percent.
- Treatment of IBCs in balance of payments:
  - Balance of payments statistics treat the 1,080 IBCs with a physical presence as nonresidents; foreign exchange received by Cypriot residents from these IBCs is recorded as credits in other income in the invisible balance, while IBCs’ transactions with nonresidents are not captured.

### Domestic financial sector — structure and key statistics
- Banking sector:
  - Domestic banking sector consists of 12 domestic banks; two large banks (Bank of Cyprus and Popular Bank) together accounted for 65 percent of total deposits at end-2000.
  - Total domestic banking assets amounted to US$12 billion (229 percent of GDP) at end-2000.
- Cooperative credit societies:
  - Around 360 cooperatives; assets held by credit cooperatives are about one third of those held by domestic banks.
- Banking assets and liabilities (In millions of Cyprus pounds):
  - Assets: 1999 = 10,447; 2000 = 12,491.
  - Lending (of which): 1999 = 5,933; 2000 = 6,768.
  - Lending in Cyprus pounds: 1999 = 5,316; 2000 = 6,143.
  - Lending in foreign currencies 1/: 1999 = 617; 2000 = 625.
  - Liabilities: 1999 = 10,447; 2000 = 12,491.
  - Deposits: 1999 = 8,438; 2000 = 9,992.
  - Deposits in Cyprus pounds: 1999 = 5,969; 2000 = 6,488.
  - Deposits in foreign currencies 2/: 1999 = 2,469; 2000 = 3,504.
  - Assets and liabilities (In percent of GDP): 1999 = 209; 2000 = 229.
- Insurance sector indicators (In percent of GDP):
  - Domestic insurance companies: 1997 = 4.3; 1998 = 4.4; 1999 = 8.7.
  - Life insurance: 1997 = 2.3; 1998 = 2.4; 1999 = 6.8.
  - Non life insurance: 1997 = 2.0; 1998 = 2.0; 1999 = 2.0.
  - International insurance companies (1999) = 1.6.
  - Captive (1999) = 0.1.
  - Noncaptive (1999) = 1.4.
- Securities market and equity:
  - Tax incentives for newly listed companies introduced in 1998.
  - 168 IPOs are awaiting regulatory approval as of February 2001 (IMF staff).
  - CSE general index (March 1996=100): 714 at end-1999; almost halved by mid-2000; about 200 by March 2001.
  - Equity market capitalization reached 152 percent of GDP at end-2000; about 27 percent of market capitalization was accounted for by the two largest domestic banks.
  - Securities intermediaries: 42 brokering firms, consisting of 125 individual members as of February 2001 (IMF staff).

### Capital account liberalization (December 1999–January 2001) — timeline highlights (CBC)
- December 1999: Abolition of restrictions on use of credit cards by residents for payments abroad.
- January 2000: Liberalization of inward FDI from EU member states; relaxation of restrictions on outward FDI; relaxation of equity participation in CSE-listed companies from EU member states (except banks where limit remained 50 percent).
- August 2000: Relaxation of equity participation in CSE-listed companies (except banks) from third countries with a ceiling of 49 percent maintained.
- September 2000: Relaxation of restrictions on investments in foreign stock exchanges by CSE-listed investment companies.
- December 2000: Abolition of restrictions on domestic banks extending Cyprus pounds loans to nonresidents economically active in Cyprus.
- January 2001: Abolition of blocked accounts by nonresidents for local funds; abolition of restrictions on medium-term (over two years) and long-term borrowing in foreign currencies by residents.

### Offshore financial sector structure and statistics
- CBC permits and IBCs:
  - CBC has issued 47,465 permits since 1976. It is estimated roughly half of the IBCs that have received permits to date are still operating.
  - Entities maintaining a physical presence in 2000: 1,080 (262 established 1976-90; 818 established 1991-2000).
  - The CBC issued 5,713 permits and revoked 1,937 permits in 2000.
  - Of new entrants in 2000, 66 percent were in trading, marketing, and distribution; 81 percent came from Europe, half of which from EU countries (IMF staff).
- IBC employment and expenditures:
  - IBCs employed 5,864 people in 2000 (expatriates 3,111; locals 2,753), roughly 2 percent of domestic employment.
  - Local expenditures and new registration fees (In millions of Cyprus pounds):
    - Total: 1998 = 200; 1999 = 234; 2000 = 258.
    - Local expenditures of IBCs with physical presences: 1998 = 154; 1999 = 184; 2000 = 202.
    - Local expenditures by IBCs: 1998 = 111; 1999 = 143; 2000 = 147.
    - Local expenditures by expatriate staff: 1998 = 43; 1999 = 41; 2000 = 55.
    - New registration fees and others 1/: 1998 = 46; 1999 = 50; 2000 = 56.
    - Memorandum item — Tourism credit: 1998 = 878; 1999 = 1,022; 2000 = 1,194.
- Offshore banking (IBUs/ABUs):
  - Offshore banking sector comprises 31 Banking Units: 29 are IBUs and 2 are ABUs (source notes indicate 27 IBUs in operation due to one revocation and one not yet commenced).
  - Total assets of IBUs and ABUs at end-November 2000 amounted to US$10 billion.
  - IBUs and ABUs (In millions of U.S. dollars, end-November):
    - Assets: 1999 = 8,239; 2000 = 10,838.
    - Of which lending (net of provisions): 1999 = 2,515; 2000 = 2,485.
    - Amounts due from affiliated banks: 1999 = 2,907; 2000 = 3,854.
    - Investments: 1999 = 916; 2000 = 1,703.
    - Liabilities: 1999 = 8,239; 2000 = 10,838.
    - Of which deposits: 1999 = 1,938; 2000 = 2,112.
    - Amounts due to affiliated banks: 1999 = 3,475; 2000 = 4,912.
    - Assets and liabilities (In percent of GDP): 1999 = 94; 2000 = 131.
  - IBUs in subsidiary form are required to have paid up capital of at least US$5 million.
- Offshore insurance and investment:
  - 28 licensed foreign insurance companies offering services to nonresidents: 11 captive and 17 non-captive.
  - Total gross premiums in 2000 amounted to 1.6 percent of GDP, of which 0.1 percent was captive.
  - International Financial Services Companies (IFCs): 106 at end-2000 (67 offering services to the public, 39 to experienced professional investors).
  - CBC authorized nine IFCs to act as managers of overseas collective investment schemes, and one IFC to act as manager of an International Collective Investment Scheme (ICIS) under the ICIS Law of 1999.
- Offshore trusts and service providers:
  - Offshore trusts formed under the International Trusts Law of 1992; registration of trusts not required so total number not known.
  - International Trustee Services Companies (ITCs): 12 at end-2000.

### Regulatory and supervisory framework — architecture and capacity
- Main supervisory authorities:
  - CBC is the main regulatory and supervisory authority for the offshore financial sector and supervises IBUs/ABUs, IFCs, ICISs, ITCs and other IBCs.
  - Other authorities include the Superintendent of Insurance and the Registrar of Companies.
- Governing laws for offshore sector include: CBC Law, Banking Law, Exchange Control Law, International Trusts Law, International Collective Investment Schemes Law, Companies Law, Income Tax Legislation, and the Prevention and Suppression of Money Laundering Activities Law.
- Supervision details:
  - IBUs are exempt from most regulations applicable to domestic banks that relate to domestic monetary policy (e.g., minimum reserve requirements and restrictions on holding foreign assets).
  - ABUs must have day-to-day administration carried out by an administering bank licensed by the CBC.
  - Offshore insurance companies are supervised by the Insurance Companies Control Service (ICCS) in the Ministry of Finance under the same regulations as domestic insurers.
  - CBC has authority to conduct onsite and offsite reviews of IFCs through Exchange Control permit conditions and ICIS authorizations.
  - ITCs are supervised by the CBC under the Exchange Control Law and guidance notes; the CBC issued “A guide to prospective applicants on the establishment of international trustee services companies” with eligibility criteria and fit and proper tests.
- Resources and institutional autonomy:
  - IMF staff identify a general need for additional supervisory capacity across agencies; reputational risks from offshore business make adequate resourcing particularly important.
  - CBC controls its own budget and faces no apparent external constraint on adding resources or reorganizing; IMF staff recommend adopting a more formal risk-assessment basis for prioritizing supervisory resources.
  - Superintendent of Insurance is described as more heavily constrained in resources (ICCS currently consists of only eight professional staff and four clerical staff).

### Anti-money laundering (AML) framework and prudential aspects
- Legislative framework:
  - Prevention and Suppression of Money Laundering Activities Law enacted in 1996 and amended in 2000 to define predicate offences as those punishable by a maximum prison sentence exceeding twelve months.
  - The Law establishes money laundering as a separate offence, expressly covers extraterritorial predicate offences, and provides for confiscation of proceeds and instrumentalities; assessment of benefits related to a laundering offence provides for reversal of the burden of proof.
  - No provision in the Law for loss of authority to do business as a sanction for money laundering (such action possible for banks under the Banking Law).
- Supervisory coverage and professions:
  - CBC supervises persons licensed to carry on banking business and offshore financial services. Securities Exchange Commission, Superintendent of Insurance, and Superintendent of Cooperative Companies supervise their sectors.
  - Council of Ministers designated the Cyprus Bar Association and the Institute of Certified Public Accountants of Cyprus as supervisory authorities for lawyers and accountants; chapter recommends extending supervisory duties to all activities of these professions and that provision of services to companies and trusts be an activity subject to external supervision.
- Customer identification and trustee/nominee accounts:
  - The Law sets customer identification procedures but does not define satisfactory evidence of identity; CBC Guidance Note stipulates expectations for obtaining satisfactory evidence of identity at account establishment and before transactions. Chapter recommends making these expectations statutory.
  - An exemption for customers "reasonably believed to be engaged in financial activities" weakens the framework because there is no requirement that the customer be actually bound by Section 58.
  - CBC Guidance Note (November 23, 2000) on correspondent banks requests banks to communicate information on accounts maintained for banks incorporated in certain jurisdictions and to refer future account-opening applications from such banks to the CBC; attached list should be revised to include jurisdictions regarded by FATF and some supervisory authorities as having deficient AML frameworks.
  - CBC Guidance Note warns of extremely high risks if banks open accounts in name of trustees or nominees when beneficial owners have not been identified; conditions for opening such accounts include an estimate of likely turnover, subsequent monitoring, investigation if turnover is exceeded, and an undertaking by trustee/nominee to establish and provide beneficial owner identity on request.
- Record keeping, internal reporting, and the Unit:
  - Record-keeping: evidence of identity or sufficient information to enable recovery of identity details and details of all transactions must be maintained for five years.
  - Internal reporting: a compliance officer must be designated to receive reports of proven or suspected money laundering offences; employees discharge disclosure duty by reporting to the compliance officer who communicates suspicions to the Unit.
  - Chapter notes a small number of internal reports and suspicious transaction reports and recommends CBC, SEC, and Superintendent of Insurance significantly step up efforts to encourage compliance and develop employee training programs based on actual transactions.
  - The Unit for Combating Money Laundering Offences is responsible for gathering/analyzing money laundering-related information, conducting investigations, and cooperating with foreign units; Unit has signed MoUs with CTIF (Belgium) and TRACFIN (France) and is a member of the Egmont Group.

### Assessment of banking supervision against Basel Core Principles
- Overall compliance status (offshore sector):
  - Compliant with 18 of the Basel Core Principles (six parts of the first principle considered separately).
  - Largely compliant with 8 other principles.
  - Materially non-compliant with 2 principles.
  - 2 principles deemed not applicable.
- Supervisory strengths:
  - Good and flexible legislation and use of directives.
  - Well-educated supervisory staff with average experience of 15 years in banking supervision.
  - Active staff training programs with foreign and domestic courses.
- Identified supervisory weaknesses and recommendations (selected):
  - Independence and resources:
    - Current CBC IBU supervisory group staffing: 12 persons responsible for supervision of 31 IBUs/ABUs, 116 IFCs, and 12 ITC IBUs; four vacancies.
    - Targets for onsite reviews: once a year for locally incorporated banks and once every two years for branches of foreign banks; some banks have not had a full review in more than three years.
    - Recommendation: Amend CBC Law to provide greater security of tenure for the Governor; fill vacancies to meet onsite review targets.
  - Consultation with Minister:
    - Banking Law requires consultation with the Minister on certain remedial actions (section 30(3)); CBC Law permits Minister’s representative to suspend Board decisions for five days (sections 12(6) and 13(1)(a)).
    - Recommendation: Remove requirement for consultation before corrective action to avoid delays.
  - Loan classification and provisioning:
    - CBC has developed no generally applicable criteria for classifying losses and provisioning; examiners review more than 50 percent of balance sheet value via biased samples.
    - CBC does not follow Basel recommendation regarding 90 days past due rule; collateral valuation issues and guarantees frequently not honored.
    - Recommendations:
      - Develop generally applicable criteria for loan classification and provisioning.
      - Adopt more conservative stance and require banks to demonstrate deviations from the “90-day-rule” are supported by high net realizable collateral values.
  - Market risk and capital adequacy:
    - Prudential systems lack comprehensive supervision of market risks (interest rate risk, securities positions); CBC intends to implement EU Capital Adequacy Directive by end of year.
    - Recommendation: Implement Basel Core Principles requirements, imposing limits or specific capital charges or both for market risks.
  - Offsite/onsite supervision:
    - Insufficient resources prevent on-site examinations at planned frequency.
    - Recommendation: Increase resources to allow planned frequency of onsite examinations.
  - Reporting of material changes:
    - No mandatory reporting requirement for all significant issues (e.g., dismissal of a senior officer).
    - Recommendation: CBC should require supervised institutions to report any material adverse changes in condition as early as possible.
  - Country risk:
    - Cross-border exposure monitored monthly; no formal country limits set.
    - Recommendation: Require banks or head offices to set formal country limits or ensure head offices do so and notify the CBC.
  - Licensing and fit-and-proper checks:
    - CBC conducts fairly extensive background reviews but relies on private investigations in some cases.
    - Recommendation: Conduct more comprehensive investigations into character and reputation by accessing records of foreign law enforcement agencies and judicial systems.
  - Companies, trusts, and service providers:
    - Estimated active IBCs: in the region of 20,000; number with physical presence at end-2000: 1,080.
    - Tax and fiscal advantages preserved (exact statements):
      - IBCs are taxed at 4.25 per cent of their net profits.
      - Branches of IBCs are totally exempt from corporate or income tax.
      - Shareholders of IBCs are not liable for additional tax on dividends or profits over and above the amount paid or payable by the respective IBC.
      - Expatriate employees of IBCs living and working in Cyprus are taxed at half the rate of local employees; if employees work outside Cyprus, they are exempt from local income tax so long as they are paid through a bank in Cyprus.
      - There is no capital gains tax on the sale or transfer of shares of an IBC.
      - There is no inheritance tax on the transfer of shares of an IBC.
      - In some cases, IBCs and their employees may acquire duty-free items such as office equipment, household equipment, and motor cars.
      - IBCs investing through the Cyprus Stock Exchange are not liable to income tax for any profits realized.
    - Formation requirements include disclosure of ultimate beneficial owners to the CBC (identities not public record but maintained on file and releasable to relevant authorities pursuant to a court order).
    - Recommendation: Consider adopting external regulation and supervision of company and trust services providers (possibly through the new Financial Services Law), with powers to license, monitor, enforce, and exchange information, and to undertake supervisory responsibilities under the money-laundering law.
- Insurance sector supervisory issues:
  - Small ICCS within Ministry of Finance supervises insurance; ICCS severely understaffed (eight professional staff including only three certified accountants; no legal staff; no in-house actuarial staff).
  - New insurance law drafted to harmonize with EU directives; Superintendent’s operational powers to increase but licensing/ revocation decisions still subject to appeal to the Minister.
  - Recommendations:
    - Extend Superintendent’s operational autonomy, provide financial resources to hire actuarial services on a contract basis, and consider making Superintendent’s decisions directly reviewable by the Courts or through other judicial arrangements, together with enhanced accountability.

### Recommendations — prioritised actions
- Adopt a more formal risk-based supervision approach to concentrate resources on high-risk institutions or activities.
- Increase supervisory staffing and training; fill vacancies and consider human resource management reforms to retain specialist skills.
- Amend CBC Law and Banking Law to remove requirements for Ministerial consultation that could delay enforcement action and to provide greater security of tenure for the Governor.
- Develop and apply generally applicable criteria for loan classification and provisioning; adopt conservative stances on restructuring/refinancing and collateral valuation.
- Require mandatory early reporting by supervised institutions of material adverse changes in condition.
- Implement market-risk capital charges or limits in line with the EU Capital Adequacy Directive and Basel Core Principles.
- Strengthen AML implementation: make CBC Guidance Note customer identification expectations statutory, remove weakening exemptions, improve beneficial owner identification and suspicious transaction reporting, and step up supervisory reviews and staff training.
- Consider external regulation and licensing of company and trust service providers under the forthcoming Financial Services Law to address conflicts of interest and improve supervision.

*Source: International Monetary Fund staff assessment (Module 2, March 2001).*

### Preface......................................................................................................4

### PREFACE

### IMF Mission and Scope
- In July 2000, the Executive Board approved a program of assessments of the extent to which certain offshore financial centers had implemented international standards of supervisory and regulatory practice.
- The Central Bank of Cyprus (CBC) invited the International Monetary Fund to carry out an assessment in March 2001 of the extent to which Cypriot supervisory arrangements for the offshore financial sector complied with certain internationally accepted standards.
- The assessment used the “Module 2” approach and comprised:
  - A Basel Core Principles assessment of supervision of the offshore banking sector.
  - An assessment of the provision of company services to International Business Companies (IBCs) registered in Cyprus.
  - Informal reviews of offshore insurance and investment supervision (full IOSCO and IAIS assessments were not attempted because those sectors are currently small).
- The assessment team was led by Mr. Peter Hayward and included staff from the Monetary and Exchange Affairs Department, the Legal Department, an expert on Banking Supervision from the Bundesaufsichtsamt für das Kreditwesen, and the Assistant Registrar of the Jersey Financial Services Commission. Mr. Dimitri Demekas of the European I Department participated in discussions. The report was prepared by Ms. Nirmaleen Jayawardane.
- The team received cooperation from the Governor and staff of the CBC, other regulatory bodies, and private sector bodies.

### Key Findings from the Executive Summary
- Factors facilitating offshore sector development:
  - Geographic location, a preferential tax regime, an extensive network of double tax treaties (particularly with Eastern European and former Soviet Union countries).
  - Legal and accounting framework based on U.K. law and practice.
  - Availability of a well qualified labor force with accounting and legal skills, reliable telecommunications, liberal immigration and visa requirements, and ready supply of office and residential accommodation of a high standard.
- Exchange Control Law enabled the CBC to attach conditions to permits issued to nonresidents, restricting nonresident-owned companies to providing services exclusively to other nonresidents and thereby directing tax preferences without affecting the domestic economy.
- Size and composition of the offshore sector:
  - The Cypriot offshore financial sector is not large compared with other offshore centers and contributes less to employment, foreign exchange earnings, and government revenue than tourism.
  - Offshore services are more restricted than in other centers: limited number of banks, some insurance services, and relatively small-scale fund management and advisory business.
  - Banking is the most important offshore activity with assets of $10.8 billion; these activities are small relative to some other jurisdictions and do not create significant risk for the international financial system.
  - A more extensive network of nonfinancial companies is registered in Cyprus; only a minority have a physical presence.
- Supervision and regulatory observations:
  - Supervision was generally effective and thorough, but resources were somewhat scarce, limiting the amount of onsite supervision.
  - The approach to EU accession has driven a large volume of legislative changes to align Cyprus with EU requirements.
  - Cyprus has licensed institutions from countries often regarded as high-risk; in some cases supervisory action has been taken. Customers do not appear to have experienced significant losses to date, but continued vigilance and high standards of supervision are necessary.
  - Anti-money laundering framework as applied to the offshore sector and measures by the CBC, the Securities and Exchange Commission, and the Superintendent of Insurance appear adequate; scope remains to improve beneficial owner identification and reporting of suspicious transactions, especially for nonresident-controlled companies.
  - Regulators and financial institutions rely to some extent on accounting and law firms; neither profession is externally regulated, and provision of company services through limited liability companies owned and managed by accounting and law firms is not effectively regulated.
- Structural reforms and future direction:
  - Winding down the Exchange Control regime in advance of EU accession is a major challenge.
  - Cyprus has made a commitment to the OECD that, if the OECD tax initiative proceeds, Cyprus will abandon, by 2005, the existing framework of tax preferences in favor of offshore businesses.
  - Authorities are drafting a new Financial Services Bill to extend supervision to all provision of investment services in Cyprus, including some domestic businesses currently outside the scope of the current supervisory framework, eliminating differentiation between onshore and offshore financial business.
  - The envisaged reforms aim to create a financial system free to do business at home and abroad while allowing foreign businesses, especially from the EU, ready access to Cyprus’s markets.
- Recommendation:
  - Given the likely disappearance of the onshore/offshore distinction, a full assessment of the entire financial sector under the IMF’s Financial Sector Assessment Program would be beneficial and would aid Cyprus’s accession to the EU.

### Background — Macroeconomic Developments
- Recent macroeconomic performance:
  - Annual real GDP growth averaged nearly 5 percent during 1998-2000, driven by booming tourism that contributed over 20 percent of GDP and 40 percent of current account receipts.
  - Unemployment averaged 3.5 percent during 1998-2000.
  - Annual increases in consumer prices averaged 2 percent during 1998-99; inflation accelerated in 2000 due to higher energy prices, a weaker exchange rate to the U.S. dollar, and a rise in the value-added tax rate from 8 percent to 10 percent on July 1, 2000.
  - GDP per capita in 2000 reached $13,154. The population in 2000 was estimated at 670,000.
- Structural reforms in preparation for EU membership:
  - Withdrawal of the Exchange Control Law over the medium term is expected as Cyprus complies with EU requirements on freedom of capital flows; a new Financial Services Law is under preparation to fill the gap.
  - The CBC embarked on capital account liberalization measures beginning in 1999; recent measures include:
    - Abolition in December 2000 of restrictions on domestic banks extending loans in Cyprus pounds to nonresidents who are economically active in Cyprus.
    - Abolition on January 1, 2001, of restrictions on domestic banks and IBUs/ABUs extending medium-term (over two years) and long-term loans in foreign currencies to residents.
  - The Law on the Liberalization of Interest Rates repealed the legal interest rate ceiling at 9 percent a year; the law was enacted in December 1999 and came into effect on January 1, 2001.
  - Statutory independence of the CBC is being strengthened: the Monetary Policy Committee was set up in December 2000 and will become the decision-making body on monetary policy when the new CBC Law is enacted (expected around mid-2002). The new CBC Law will prohibit monetary financing and the removal of the Governor before expiry of his or her term.
  - A new insurance companies law to harmonize regulations with EU directives was expected to be enacted in 2001.
  - The government has made an advance commitment to remove restrictions on the ability of Cypriot entities, including offshore companies, to do business in Cyprus and to abolish the “ring-fencing” of offshore entities by 2005 in line with OECD recommendations. Current tax treatment:
    - IBCs are subject to a profit tax rate of only 4.25 percent.
    - Domestic companies are taxed at a rate of 20 percent, or 25 percent for chargeable income over C£ 40,000.
  - The OECD-related commitment is conditional on the OECD implementing its proposed measures to eliminate harmful tax practices in member countries by the end of 2003; Cyprus has not decided on the equalized tax level or phasing.
- Fiscal and external developments:
  - The Ministry of Finance prepared the Strategic Plan for Fiscal Adjustment 1999–2002 aiming to reduce fiscal deficits to 2 percent of GDP by 2002.
  - Fiscal deficits narrowed to 4.1 percent of GDP in 1999 and 2.7 percent in 2000 (below the 2000 target of 4 percent of GDP).
  - Extensive capital controls allowed the CBC to pursue some degree of independent monetary policy despite the exchange rate peg to the euro.
  - The exchange rate fluctuation bands were widened to 15 percent around the central parity with the euro on January 1, 2001, although the CBC intends to keep the exchange rate within the narrow 2¼ percent bands.
  - After narrowing in 1999, the current account deficit rose to 5.1 percent of GDP in 2000. An improvement in the invisible surplus (mainly tourism) was more than offset by a deterioration in the trade balance as imports surged by 23 percent due to higher oil prices and wealth effects from the 1999 stock exchange boom.
  - Balance of payments statistics treat the 1,080 IBCs with a physical presence as nonresidents; foreign exchange received by Cypriot residents from these IBCs is recorded as credits in other income in the invisible balance, while IBCs’ transactions with nonresidents are not captured.

### Background — Domestic Financial Sector
- Banking sector structure and size:
  - The domestic banking sector consists of 12 domestic banks and is relatively concentrated: two large banks (the Bank of Cyprus and Popular Bank) together accounted for 65 percent of total deposits at end-2000.
  - Domestic banks mainly serve domestic businesses and residents but have international interests including foreign branches and subsidiaries.
  - Total assets amounted to US$12 billion (229 percent of GDP) at end-2000 (Table 2).
- Cooperative credit societies:
  - Cooperative credit societies play a major role in collateralized lending to individuals.
  - Most of the 360 cooperatives are small, but a few are large and more sophisticated.
  - Assets held by credit cooperatives are about one third of those held by domestic banks.
- Banking licensing interactions with offshore units:
  - One of the IBUs has recently obtained a license to operate also as a domestic bank; accounts and branches of the two operations will be separated.
  - Two domestic banks also have licenses to operate IBUs.

*International Monetary Fund assessment conducted in March 2001 under the Module 2 approach approved by the IMF Executive Board in July 2000.*

### Box 1. Cyprus: Capital Account Liberalization from December 1999–January 2001

### Box 1. Cyprus: Capital Account Liberalization from December 1999–January 2001

### Timeline of policy measures
- December 1999
  - Abolition of restrictions on use of credit cards by residents for payments abroad.
- January 2000
  - Liberalization of inward FDI from EU member states: the CBC abolished restrictions on maximum percentage and minimum amount of inward FDI.
  - Relaxation of restrictions on outward FDI: the CBC abolished restrictions on the amount and sector of outward FDI.
  - Relaxation of equity participation in CSE-listed Cypriot companies from EU member states, except for banks, where nonresidents’ equity participation has been limited to 50 percent since July 1999.
- August 2000
  - Relaxation of equity participation in CSE-listed Cypriot companies (except for banks) from third countries: ceiling of 49 percent participation maintained.
- September 2000
  - Relaxation of restrictions on investments in foreign stock exchanges by CSE-listed Cypriot investment companies.
- December 2000
  - Abolition of restrictions on domestic banks extending loans in Cyprus pounds to nonresidents who are economically active in Cyprus.
- January 2001
  - Abolition of blocked accounts by nonresidents for local funds that previously could not be immediately transferred abroad.
  - Abolition of restrictions on medium-term (over two years) and long-term borrowing in foreign currencies by residents.

### Scope and sectoral specifics
- Equity participation
  - EU member states: restrictions on maximum percentage and minimum amount of inward FDI abolished (January 2000).
  - Banks: nonresidents’ equity participation limited to 50 percent since July 1999 (exception retained in January 2000 liberalization).
  - Third countries: CSE-listed companies (except banks) allowed greater participation in August 2000, with a ceiling of 49 percent maintained.
- Cross-border financing and accounts
  - Use of credit cards abroad by residents no longer restricted (December 1999).
  - Domestic banks permitted to extend Cyprus pounds loans to nonresidents economically active in Cyprus (December 2000).
  - Blocked accounts by nonresidents for local funds abolished (January 2001).
  - Restrictions on medium-term (over two years) and long-term foreign-currency borrowing by residents abolished (January 2001).
- Investment channels
  - Outward FDI restrictions on amount and sector abolished (January 2000).
  - CSE-listed Cypriot investment companies allowed to invest in foreign stock exchanges with relaxed restrictions (September 2000).

*Source: Central Bank of Cyprus.*

### 1996. Tax incentives for newly listed companies were introduced in 1998 and the subsequent

### 073001 - 1996. Tax incentives for newly listed companies were introduced in 1998 and the subsequent

### Equity market developments
- Tax incentives for newly listed companies were introduced in 1998.  
- A wave of initial public listings followed in 1999; 168 IPOs are awaiting regulatory approval as of February 2001 (IMF staff).  
- The CSE general index (March 1996=100) movements:
  - shot up to 714 at end-1999,
  - almost halved by mid-2000,
  - plummeted to about 200 by March 2001.  
- Equity market capitalization reached 152 percent of GDP at end-2000; about 27 percent of market capitalization was accounted for by the two largest domestic banks (IMF staff).  
- Securities market intermediary statistics:
  - 42 brokering firms, consisting of 125 individual members as of February 2001 (IMF staff).

### Banking sector size and domestic financial sector indicators
- Banking assets and liabilities (In millions of Cyprus pounds):
  - Assets: 1999 = 10,447; 2000 = 12,491.
  - Lending (of which): 1999 = 5,933; 2000 = 6,768.
  - Lending in Cyprus pounds: 1999 = 5,316; 2000 = 6,143.
  - Lending in foreign currencies 1/: 1999 = 617; 2000 = 625.
  - Liabilities: 1999 = 10,447; 2000 = 12,491.
  - Deposits: 1999 = 8,438; 2000 = 9,992.
  - Deposits in Cyprus pounds: 1999 = 5,969; 2000 = 6,488.
  - Deposits in foreign currencies 2/: 1999 = 2,469; 2000 = 3,504.
  - Assets and liabilities (In percent of GDP): 1999 = 209; 2000 = 229.
- Insurance sector indicators (In percent of GDP):
  - Domestic insurance companies: 1997 = 4.3; 1998 = 4.4; 1999 = 8.7.
  - Life insurance: 1997 = 2.3; 1998 = 2.4; 1999 = 6.8.
  - Non life insurance: 1997 = 2.0; 1998 = 2.0; 1999 = 2.0.
  - International insurance companies (1999) = 1.6.
  - Captive (1999) = 0.1.
  - Noncaptive (1999) = 1.4.
- The sector including finance, insurance, and real estate business contributed about 20 percent of GDP and 9 percent of total employment in 1999 (IMF staff).

Notes on footnotes in source:
- 1/ Until end-2000, lending in foreign currencies to residents required permits from the CBC.
- 2/ The bulk of the foreign currency deposits is from nonresidents.

### Market regulation, weaknesses noted, and remedial actions
- During the 2000 Article IV consultations, IMF staff found the domestic securities market broadly compliant with IOSCO’s principles but identified some weaknesses (IMF staff).  
- Remedial actions planned or underway:
  - Increase regulatory staff to ease shortage of experienced staff.
  - Enactment of a mutual fund law to provide a legal framework for regulation of domestic collective investment schemes (IMF staff; note: the source states this law "has now been enacted").
  - Introduction of a centralized share registry/depository to remedy the poorly functioning clearing and settlement system.
  - Address overlap in responsibilities between the Securities and Exchange Commission (SEC) and the CSE; the Cyprus Securities & Exchange Commission (Establishment & Power) Law was enacted on April 20, 2001 to enhance SEC independence and supervisory powers and to delineate responsibilities between the SEC and the CSE, and to empower the SEC to license domestic market services firms, including investment advisors.
  - Step up supervision of market risks in 2001 to bring Cyprus into compliance with the EU Capital Adequacy Directive (CAD).

### Offshore financial sector structure and key statistics
- Definition: “offshore” used to define businesses owned by nonresidents providing services primarily to nonresidents (IMF staff).  
- Factors facilitating offshore development: location, preferential tax regime, extensive double tax treaties, legal/accounting framework based on U.K. law/practice, skilled labor force, reliable telecommunications, liberal immigration/visa requirements, available office/residential accommodation (IMF staff).  
- CBC permits and IBCs:
  - The CBC has issued 47,465 permits since 1976.
  - It is estimated that roughly half of the IBCs that have received permits to date are still operating.
  - There are 1,080 entities maintaining a physical presence in 2000.
  - Of those with physical presence: 262 were established during 1976-90, and 818 were established during 1991-2000.
  - The CBC issued 5,713 permits, and revoked 1,937 permits in 2000.
  - Of new entrants in 2000, 66 percent were in trading, marketing, and distribution businesses.
  - Of new entrants in 2000, 81 percent came from Europe, half of which from EU countries (IMF staff).
- IBC employment and expenditures:
  - IBCs employed 5,864 people in 2000 (including expatriates and local staff), constituting roughly 2 percent of domestic employment.
  - Employment by IBCs (1999, 2000):
    - Total employment 1999: Expats 2,662; Locals 2,565; Total 5,227.
    - Total employment 2000: Expats 3,111; Locals 2,753; Total 5,864.
  - Local expenditures by IBCs and new registration fees (In millions of Cyprus pounds):
    - Total: 1998 = 200; 1999 = 234; 2000 = 258.
    - Local expenditures of IBCs with physical presences: 1998 = 154; 1999 = 184; 2000 = 202.
    - Local expenditures by IBCs: 1998 = 111; 1999 = 143; 2000 = 147.
    - Local expenditures by expatriate staff: 1998 = 43; 1999 = 41; 2000 = 55.
    - New registration fees and others 1/: 1998 = 46; 1999 = 50; 2000 = 56.
    - Memorandum item — Tourism credit: 1998 = 878; 1999 = 1,022; 2000 = 1,194.
- Offshore banking (IBUs/ABUs) and assets (End-November):
  - Offshore banking sector comprises 31 Banking Units: 29 are IBUs and 2 are ABUs (source notes indicate 27 IBUs in operation due to one revocation and one not yet commenced).
  - Total assets of IBUs and ABUs at end-November 2000 amounted to US$10 billion.
  - Table of IBUs and ABUs (In millions of U.S. dollars, end-November):
    - Assets: 1999 = 8,239; 2000 = 10,838.
    - Of which lending (net of provisions): 1999 = 2,515; 2000 = 2,485.
    - Amounts due from affiliated banks: 1999 = 2,907; 2000 = 3,854.
    - Investments: 1999 = 916; 2000 = 1,703.
    - Liabilities: 1999 = 8,239; 2000 = 10,838.
    - Of which deposits: 1999 = 1,938; 2000 = 2,112.
    - Amounts due to affiliated banks: 1999 = 3,475; 2000 = 4,912.
    - Assets and liabilities (In percent of GDP): 1999 = 94; 2000 = 131.
  - IBUs in subsidiary form are required to have paid up capital of at least US$5 million.
- Offshore insurance and investment:
  - There are 28 licensed foreign insurance companies offering services to nonresidents: 11 captive and 17 non-captive.
  - Total gross premiums in 2000 amounted to 1.6 percent of GDP, of which 0.1 percent was captive.
  - International Financial Services Companies (IFCs): 106 at end-2000 (67 offering services to the public, 39 to experienced professional investors).
  - CBC authorized nine IFCs to act as managers of overseas collective investment schemes, and one IFC to act as manager of an International Collective Investment Scheme (ICIS) under the ICIS Law of 1999.
- Offshore trusts and service providers:
  - Offshore trusts formed under the International Trusts Law of 1992; registration of trusts not required so total number not known.
  - International Trustee Services Companies (ITCs): 12 at end-2000.

Notes on footnotes in source:
- 15/ There are 27 IBUs in operation. The CBC revoked the license of Beogradska Banka from Yugoslavia in May 2000 because of its insolvency; the High Court upheld the CBC’s decision in December 2000, subject to appeal. The CBC licensed Mega Euro Bank A.D. from Yugoslavia in 1998 but has not issued a “letter of commencement of business.”
- 16/ IBUs/ABUs are licensed to operate primarily on an international basis, and are confined to dealings in foreign currencies mainly with nonresidents. Since January 1, 2001, IBUs have been allowed to offer medium- or long-term loans or guarantees in foreign currencies to permanent residents, as part of financial liberalization.

### Regulatory and supervisory framework for offshore and domestic sectors
- Main supervisory authorities:
  - The Central Bank of Cyprus (CBC) is the main regulatory and supervisory authority for the offshore financial sector and supervises IBUs/ABUs, IFCs, ICISs, ITCs and other IBCs.
  - Other authorities include the Superintendent of Insurance and the Registrar of Companies.
- Laws governing the offshore financial sector include the CBC Law, the Banking Law, the Exchange Control Law, the International Trusts Law, the International Collective Investment Schemes Law, the Companies Law, the Income Tax Legislation, and the Prevention and Suppression of Money Laundering Activities Law (IMF staff).
- Supervision details:
  - IBUs are exempt from most regulations applicable to domestic banks that relate to domestic monetary policy (e.g., minimum reserve requirements and restrictions on holding foreign assets).
  - ABUs must have their day-to-day administration carried out by an administering bank licensed by the CBC.
  - Offshore insurance companies are supervised by the Insurance Companies Control Service (ICCS) in the Ministry of Finance under the same regulations as domestic insurers.
  - CBC has authority to conduct onsite and offsite reviews of IFCs through Exchange Control permit conditions and ICIS authorizations.
  - ITCs are supervised by the CBC under the Exchange Control Law and guidance notes; the CBC issued “A guide to prospective applicants on the establishment of international trustee services companies” with eligibility criteria and fit and proper tests.

### Prior assessments and international reviews
- Council of Europe (June 9, 1998): found Cyprus vulnerable to international money laundering due in part to geographic location; described anti-money laundering law as “a very comprehensive legal framework” but recommended stronger use of restraint and confiscation and further international cooperation, including ratification of the European Convention on Mutual Legal Assistance (IMF staff summary).
- Financial Stability Forum (FSF) (May 26, 2000): included Cyprus in Group III of OFCs, “jurisdictions generally perceived as having legal infrastructures and supervisory practices, and/or a level of resources devoted to supervision and co-operation that are largely of a lower quality.” The FSF noted its categorization reflected impressions at a particular point in time and did not constitute judgments about adherence to international standards (IMF staff).
- Financial Action Task Force (FATF) (June 22, 2000): found that “Cyprus has a comprehensive anti-money laundering system” but raised a specific issue of concern on customer identification in respect of trusts; welcomed Cyprus’s intention to supervise lawyers and accountants when engaged in financial activities (IMF staff).
- OECD Initiative on ‘Harmful Tax Practices’: Cyprus made an advance commitment to the OECD to eliminate ‘harmful tax -2005’ conditional on the OECD initiative proceeding; if implemented, this would remove one of the main factors distinguishing offshore from onshore activity (IMF staff).
- U.S. Department of State (2001 report): noted need for the central bank to focus on increasing supervisory challenges of the offshore sector and increasing offshore sector transparency; recommended ensuring beneficial owner identities are easily accessible and changing guidance that allows banks to open accounts for all forms of trusts without identifying beneficiaries; recommended ensuring all financial and nonfinancial institutions report suspicious transactions to the financial intelligence unit as required under the Prevention and Suppression of Money-laundering Activities Law (IMF staff summary).

### Assessment of general issues: independence, responsibilities, and resources
- Legal autonomy and responsibilities:
  - The CBC supervises the offshore sector mainly by virtue of its roles under the Exchange Control Law and the Banking Law; these laws give the CBC wide powers to attach conditions to permits issued to nonresidents (IMF staff).
  - The Banking Law has been amended to ensure compliance with EU directives and provides comprehensive supervisory authority for banks, domestic and offshore.
  - The CBC enjoys considerable autonomy; proposed amendments to the CBC Law would make it more difficult for the Government to terminate the Governor’s appointment.
  - The Exchange Control Law is assumed to cease to be available at the end of 2002 for planning purposes as controls are removed to comply with EU free capital movement requirements; authorities plan to prepare a new Financial Services Bill that would subject provision of all financial and investment services (excluding banking and insurance) to supervision by the SEC. Supervised services would include fund management and provision of advice.
  - The Banking Law currently obliges the CBC to consult the Minister on certain matters (but does not require Ministerial consent) regarding termination of bank authorization; IMF staff recommend removing the requirement for consultation in relation to actions on individual institutions.
  - Other supervisory offices (Superintendent of Insurance and Registrar of Companies) have statutory operational autonomy though some decisions are subject to administrative review on appeal to the responsible Minister; in practice, decisions have normally been upheld.
- Resources and capacity:
  - IMF staff identify a general need for additional supervisory capacity across agencies; reputational risks from offshore business make adequate resourcing particularly important.
  - The CBC controls its own budget and faces no apparent external constraint on adding resources or reorganizing to concentrate on higher-risk areas; IMF staff recommend adopting a more formal risk-assessment basis for prioritizing supervisory resources.
  - The Superintendent of Insurance is described as more heavily constrained in resources (IMF staff).

*Source: IMF staff report and Fund staff estimates as presented in the cited IMF publication.*

### Chapter V, and it will be important that the Minister of Finance allows the employment and

### Chapter V

### Staffing, Financial and Operational Autonomy
- The Superintendent’s responsibilities are being considerably enhanced and the Minister of Finance should allow the employment and training of sufficient staff to enable the Superintendent to carry out her responsibilities.
- Recommendations for Superintendent empowerment:
  - Endow the Superintendent with financial responsibility for recruitment and retention, including responsibility for pay scales and the hiring of specialist skills on a contract basis.
  - Provide responsibility for investment in new technology as an alternative to more labor intensive methods.
  - Accompany additional financial and operational autonomy with enhanced accountability.
- Registrar of Companies:
  - Although the Registrar of Companies is not a supervisor, releasing this department from civil service management and pay arrangements may yield efficiency gains.

### Cross-Border Cooperation (CBC)
- Licensing and supervisory information exchange:
  - The CBC exchanges information with foreign supervisors in the framework of the licensing procedure and during ongoing supervision.
  - When a foreign-located institution applies to establish a subsidiary or branch in Cyprus, the CBC contacts the home supervisor asking for its views and approval of the establishment.
  - The CBC has held meetings with representatives of some supervisory authorities before granting a license to banks from those countries.
- International standards and information exclusions:
  - In general terms, the CBC complies with accepted international standards for the exchange of information and cooperation with other supervisory agencies.
  - The CBC may provide to the supervisory authority of the home country information which, in the opinion of the CBC, enables the home supervisor to exercise its consolidated supervisory functions.
  - Information relating to any individual deposit account is excluded from disclosure under the Banking Law.
  - The chapter notes that depositor information is often important for supervision of liquidity, identifying related-party transactions, and for money-laundering issues, and recommends seeking an opportunity to amend the legislation to remove the exclusion.
- Memoranda of Understanding (MoUs) and on-site inspections:
  - MoUs have been signed with the banking supervisory authorities of Russia, Belarus, Bulgaria, and Ukraine; these MoUs expressly exclude information about transactions, accounts and deposits of customers from exchange.
  - Negotiations on MoUs have been started with Austria, the Czech Republic, France, Greece, Romania, and the U.K.
  - The CBC has rejected banking license applications from banks in two countries due to conflict undermining supervision and bank soundness.
  - The CBC allows foreign home supervisors to conduct on-site inspections in Cyprus; on-site examiners are allowed to see any files including documents on individual deposit accounts.
  - On-site reviews in Cyprus have been carried out by the Central Banks of Lebanon, Jordan, Russia, Bulgaria, and Yugoslavia.
- International participation:
  - The CBC is a member of the Offshore Group of Banking Supervisors and IOSCO, attends Council of Europe PC-R-EV committee meetings, and has staff participation in FATF and Council of Europe evaluations.
  - The Superintendent of Insurance is a member of the IAIS.
  - The Unit for Combating Money Laundering Offences is a member of the Egmont Group.

### Prudential Aspects of Anti-Money Laundering Efforts
- Legislative framework and supervision:
  - Cyprus enacted in 1996 the Prevention and Suppression of Money Laundering Activities Law (the “Law”).
  - The Law was amended in 2000 to provide that any criminal offences punishable by a maximum prison sentence for a period exceeding twelve months as a result of which proceeds were generated shall be defined as a predicate offence.
  - The Law establishes money laundering as a separate offence and expressly covers predicate offences committed extraterritorially.
  - Penalties include confiscation of proceeds and instrumentalities; assessment of benefits related to a laundering offence provides for the reversal of the burden of proof.
  - There is no provision in the Law for loss of authority to do business as a sanction for money laundering (such action is possible for banks under the Banking Law).
  - Restraint orders, charging orders, and realization of confiscated property by a receiver are provided for.
- Supervisory authorities and coverage of professions:
  - The CBC is the supervisory authority for persons licensed to carry on banking business and offshore financial services.
  - The Securities Exchange Commission, the Superintendent of Insurance, and the Superintendent of Cooperative Companies are supervisory authorities over their sectors.
  - The Council of Ministers designated the Cyprus Bar Association and the Institute of Certified Public Accountants of Cyprus as supervisory authorities for lawyers and accountants.
  - The chapter notes uncertainty whether supervisory duties for lawyers and accountants will be limited to activities defined in the Law or will have a broader scope, and recommends extending duties to all activities of these professions.
  - The chapter questions whether professional associations are competent to supervise non-traditional activities of accountants and lawyers, particularly services to IBCs, and recommends that provision of service to companies and trusts be an activity subject to external supervision (recommended in Chapter VI).
- Customer identification, guidance, and exemptions:
  - The Law sets customer identification procedures but does not define satisfactory evidence of identity; this is done in the CBC’s Guidance Note, which stipulates expectations for obtaining satisfactory evidence of identity at account establishment and prior to transactions.
  - The chapter recommends making these expectations a statutory requirement.
  - Customers reasonably believed to be engaged in financial activities (and thus regulated under Section 58 of the Law) are exempt from identification requirements; the chapter states this exemption weakens the framework because there is no requirement that the customer be actually bound by Section 58, only that he is believed to be bound.
  - CBC issued a guidance note on November 23, 2000 regarding correspondent banks, requesting banks to communicate information on accounts maintained for banks incorporated in certain jurisdictions and to refer future account-opening applications from such banks to the CBC; the attached list should be revised to include jurisdictions regarded by FATF and some supervisory authorities as having deficient anti-money laundering frameworks.
- Trustees, nominees, and beneficial ownership:
  - CBC Guidance Note warns banks of extremely high risks if they open accounts in the name of trustees or nominees when beneficial owners have not been identified.
  - Guidance conditions for opening trustee/nominee accounts include provision of an estimate of likely turnover, subsequent monitoring, investigation if turnover is exceeded, and an undertaking by the trustee/nominee to establish identity and background of beneficial owner and to provide that information on request.
  - The chapter notes these procedures do not always ensure disclosure of beneficial owners unless the bank exercises its right to demand that information.
  - SEC and Superintendent of Insurance guidance notes are silent on trustee/proxy risks but require taking necessary steps to ascertain identity of individuals on whose behalf trustees or proxies act.
- Record keeping and internal reporting:
  - Record-keeping: evidence of identity or sufficient information to enable recovery of identity details and details of all transactions must be maintained for a period of five years.
  - CBC Guidance Note emphasizes including ordering and beneficiary customer information for credit transfers by electronic means.
  - For incoming fund transfers, banks must request information from the originator’s bank or ask for confirmation that the information is available and the transaction legitimate; the discretion does not ensure satisfactory ordering-customer identity is always obtained.
  - Internal reporting: identification of a compliance officer to whom reports of proven or suspected money laundering offences must be made is required.
  - Employees discharge their disclosure duty by reporting to the compliance officer; when a compliance officer determines or suspects money laundering, the information must be communicated to the Unit.
  - The chapter notes a small number of internal reports and suspicious transaction reports and recommends that the CBC, the SEC, and the Superintendent of Insurance significantly step up efforts to encourage compliance and develop employee training programs based on actual transactions.
  - Critical reviews of compliance officers’ reports (stating reasons for not notifying the Unit) are reportedly carried out by the CBC, the SEC, and the Superintendent of Insurance during onsite examinations; given infrequency of onsite examinations, supervisory authorities should undertake these reviews separately.
- The Unit for Combating Money Laundering Offences:
  - The Unit is responsible for gathering and analyzing money laundering-related information, conducting investigations, and cooperating with foreign units by exchange of information and other cooperation.
  - The chapter states it is important that the Unit continues to be adequately staffed and equipped to exercise its responsibilities under the Law.
  - The Unit has signed MoUs with the Financial Intelligence Units of Belgium (CTIF) and France (TRACFIN) and is a member of the Egmont Group.
  - Representatives of the Unit participate in the Council of Europe Committee of Experts on the Evaluation of Anti-Money Laundering Measures (PC-R-EV).
  - The Unit fulfils requests for assistance submitted by rogatory letters through Interpol and by other financial intelligence units.
  - Cyprus has ratified the United Nations Convention Against Illicit Traffic in Narcotic Drugs and Psychotropic Substances; the Council of Europe Convention on Laundering, Search, Seizure and Confiscation of the Proceeds from Crime; the Convention on the Transfer of Proceedings in Criminal Matters; and the Convention on Mutual Assistance in Criminal Matters.

### Assessment of Banking Standards
- Offshore banking structure and liberalization:
  - As noted in Chapter III, there are 31 IBUs and ABUs beneficially owned by foreign banks and licensed to carry on banking business in and from within Cyprus; their licenses stipulate they should primarily confine dealings to currencies other than the Cyprus pound and with nonresidents.
  - As from January 1, 2001, IBUs/ABUs are permitted without restriction to grant medium and long-term loans or guarantees in foreign currencies to permanent residents of Cyprus.
  - The extent of this activity so far is unknown, as the IBUs have not yet filed reports covering a current period.
  - It is expected that in future IBUs will be permitted to carry on additional activities including taking of deposits in local currency.
  - The CBC intends to meet the deadline of December 31, 2005 when all distinctions between domestic and offshore banks will be eliminated.
- Compliance with Basel Core Principles:
  - Cyprus is compliant with 18 of the Basel Core Principles for Effective Banking Supervision (the six parts of the first principle are considered separately) in respect of its offshore financial sector; largely compliant with 8 other principles; materially non-compliant with 2; and 2 were deemed to be not applicable.
- Supervisory strengths and staff:
  - The favorable assessment is attributed to good and flexible legislation and the supervisor’s use of directives.
  - The supervisory regime is enhanced by a well-educated staff with substantial experience; the average experience of the staff related to banking supervision is 15 years.
  - Significant efforts are made to keep staff aware of current developments in international banking supervisory techniques; training programs cover loan analysis, treasury operations, interest rate risk management, foreign exchange risk management, liquidity risk, and other areas, with courses arranged by the FDIC, the Bank of England, the Netherlands Bank, other foreign central banks, and private institutions both abroad and in Cyprus.

*Source: International Monetary Fund chapter content.*

### 1.1 Clear supervisory

### 1.1 Clear supervisory responsibilities

### Findings on supervisory responsibilities
- 1.1: X

### Independence and resources
- 1.2: X
- Reasons for removing the head of the supervisory agency are not in the law.
- A new law is being prepared that will resolve the matter.
- Supervisory resources are inadequate.

### Legal framework and supervisory powers
- 1.3: X
- 1.4: X
- The legal requirement to consult the Minister could delay enforcement action.

### Legal protection
- 1.5: X

*Source: IMF.*

### 1.6 Information sharing X

### 1.6 Information sharing X

### Summary findings
- Cyprus maintains good communication with foreign supervisors; CBC staff have visited some countries to better understand those supervisors’ systems.
- A number of MoUs are in place and some foreign supervisors have conducted onsite reviews in Cyprus.
- The CBC does not follow the Basel Core Principles recommendation regarding the classification of loans 90 days past due as non-performing.
- Market risks are regarded as insignificant and not explicitly taken into account; the Capital Adequacy Directive will be implemented later this year.
- More intensive scrutiny of directors and officers is needed through the use of police reports.
- More onsite reviews with greater attention to IBUs that have not reported any suspicious transactions are recommended; use of law enforcement agencies to assist in verifying customer identity is advised.
- Frequency of onsite examinations has not been maintained at planned levels.
- The CBC does not require banks to notify it of adverse substantive changes in their activities.
- The law provides for consultation with the Minister which could delay needed corrective actions.

### Independence and resources (BCP1.2)
- Current staffing: 12 persons responsible for the supervision of 31 IBUs/ABUs, 116 IFCs, and 12 ITC IBUs; there are four vacancies.
- Targets for onsite reviews: once a year for locally incorporated banks and once every two years for branches of foreign banks.
- Some banks have not had a full review in more than three years.
- Recommendation:
  - The CBC Law should be amended to provide for greater security of tenure for the Governor.
  - Staffing of the vacant positions at an early date would enable the IBU supervisory group to increase onsite reviews and meet targets.

### Supervisory powers and governance (BCP1.4)
- Banking Law (section 41) empowers the CBC to set prudential rules autonomously, except for policy on granting banking licences (sec. 4.5) and certain remedial powers where consultation with the Minister of Finance is required.
- Recommendation:
  - The requirement for consultation should be formally limited to policy issues to ensure full operational autonomy for the supervisor regarding individual institutions.

### Licensing (BCP3)
- CBC conducts fairly extensive background reviews of directors and senior officers but places reliance on private investigations in some cases.
- Recommendation:
  - CBC should conduct more comprehensive investigations into character and reputation by accessing records of foreign law enforcement agencies and judicial systems.

### Loan classification and provisioning (BCP8)
- CBC has developed no generally applicable criteria for classifying losses and provisioning policy and considers each bank individually.
- CBC examiners review more than 50 percent of the balance sheet value of bank loans via biased samples focused on large/problematic loans.
- Many banks are branches or subsidiaries of international parents where home supervisors set loan classification and provisioning.
- Several banks belong to countries without robust regulation and supervision.
- Collateral valuation issues: no market values for much collateral; collateral often illiquid; guarantees frequently not honored when called.
- Recommendation:
  - CBC should develop generally applicable criteria for assessing banks’ loan classification and provision policies to ensure adherence to best international practices.
  - CBC should adopt a more conservative stance and put the onus on banks to demonstrate that deviations from the “90-day-rule” are supported by collateral with sufficiently high net realizable value; refinancing and restructuring would not change loan status.

### Country risk (BCP11)
- Cross-border exposure is monitored monthly; no formal country limits are set.
- IBU/ABUs with exposures deemed excessive are instructed to reduce them.
- Recommendation:
  - CBC should consider requiring banks to set formal country limits or ensure head offices/parent banks do so and notify the CBC.

### Market risk (BCP12)
- Prudential systems do not provide a basis for comprehensive supervision of market risks; arrangements exist for foreign exchange exposures but not for interest rate risk or securities positions.
- CBC intends to implement policies by the end of the year requiring banks to hold capital in relation to market risks to align with the EU’s Capital Adequacy Directive.
- Recommendation:
  - CBC should implement the Basel Core Principles requirement, either by imposing limits or specific capital charges or both.

### Money laundering (BCP15)
- Assessment and recommendations are set out in Chapter III(C) (referenced by the source).

### Offsite/onsite supervision (BCP16)
- Procedures and processes exist, but insufficient resources prevent on-site examinations from occurring at planned frequency.
- Recommendation:
  - Resources need to be increased to allow planned frequency of on-site examinations.

### Understanding banks’ operations (BCP17)
- Banks are expected to report immediately any material change in circumstances; section 40 of the Banking Law requires prompt notification if a bank may face serious difficulties or is about to suspend payment.
- Gap: no mandatory reporting requirement for all significant issues at the earliest possible time (e.g., dismissal of a senior officer).
- Recommendation:
  - CBC should make it mandatory for supervised institutions to report any material adverse changes in condition as early as possible to maximize supervisory options.

### Corrective action and early warning (BCP22)
- Under Banking Law [section 30(3)] CBC must consult the Minister of Finance before taking certain enforcement actions: (i) prohibiting acceptance of deposits or granting credit facilities; (ii) consulting with other banks on actions; (iii) assuming control and carrying on the bank’s business; (iv) revoking the bank’s licence.
- CBC Law (sections 12(6) and 13(1)(a)) permits the Minister’s representative on the Board to suspend Board decisions for five days if deemed incompatible with the Central Bank Law or public interest; Board may appeal to the Council of Ministers.
- Although consultation has not inhibited action historically, consultation could become protracted and delay necessary measures.
- Recommendation:
  - Banking Law should be amended to remove any need for consultation before corrective action is taken.
- Early warning systems:
  - Recommendation:
    - CBC should survey international experience in early warning systems to ensure practices align with best practice.

### Companies, trusts, and company and trust service providers
- Estimated active IBCs: in the region of 20,000; IBCs under Companies Law and licensed under Exchange Control Law.
- Number with physical presence at end-2000: 1,080.
- Employment by these IBCs at end-2000: expatriates 3,111; locals 2,753.
- Main IBC activities: trade, marketing and distribution (42 per cent of total IBCs); ship management and maritime operations (27 percent of total IBCs).
- Total foreign exchange revenue from IBCs and ship owning companies for 2000: C258 million.
- Tax and fiscal advantages of IBCs (exact statements preserved):
  - IBCs are taxed at 4.25 per cent of their net profits.
  - Branches of IBCs are totally exempt from corporate or income tax.
  - Shareholders of IBCs are not liable for additional tax on dividends or profits over and above the amount paid or payable by the respective IBC.
  - Expatriate employees of IBCs living and working in Cyprus are taxed at half the rate of local employees; if employees work outside Cyprus, they are exempt from local income tax so long as they are paid through a bank in Cyprus.
  - There is no capital gains tax on the sale or transfer of shares of an IBC.
  - There is no inheritance tax on the transfer of shares of an IBC.
  - In some cases, IBCs and their employees may acquire duty-free items such as office equipment, household equipment, and motor cars.
  - IBCs investing through the Cyprus Stock Exchange are not liable to income tax for any profits realized.
- Formation requirements: applications filed with the CBC and Registrar of Companies; applicant must be “fit and proper”; ultimate beneficial owners must be disclosed to the CBC (identities not public record but maintained on file and releasable to relevant authorities pursuant to a court order).
- Trusts:
  - International Trusts Law 1992 introduced rules for “International Trusts”; basic requirements include settler not a permanent Cyprus resident; at least one trustee a permanent Cyprus resident; no beneficiary (other than a charity) a permanent Cyprus resident; settled property not to include immovable property in Cyprus.
  - No registrar of trusts; number of international trusts unknown. Number of ITCs currently supervised by the CBC: 12.
- Company and trust services providers:
  - Establishment documentation must be submitted by a practicing Cypriot accountant or lawyer; only a practicing lawyer can file with the Registrar of Companies.
  - Considerable reliance is placed on intermediaries; potential for conflicts of interest among accountants, lawyers, and their service provider functions.
  - Recommendation:
    - Consider adopting a system of external regulation and supervision of company and trust services providers (possibly through the new Financial Services Law) to license and supervise all firms providing such services, with powers to authorize, monitor, require information, enforce compliance, remove licenses, wind up businesses, exchange information, and undertake supervisory responsibilities under the money-laundering law.

### Regulatory authorities and supervisory approach
- CBC responsibilities: licensing and ongoing supervision of IFCs and IBCs through International Banking and Financial Services Supervision Department (IBFSSD) and International Business Department (IBD); recent workflow improvements transferred tasks from IBD to IBFSSD.
- Accession to the EU will require repeal of the Exchange Control Law; a new Financial Services Law is being drafted to ensure continued regulation.
- IBFSSD is finding it difficult to perform authorization, monitoring, compliance, and enforcement equally well; an informal risk assessment process has begun to identify entities requiring more frequent visits.
- Recommendation:
  - Adopt a more formal risk-based supervision approach to concentrate resources on high-risk institutions or activities.
  - Increase staff and training; consider human resource management reforms.
- Reporting and audit:
  - All IFCs required to conduct an annual audit and file auditors’ report with the CBC; auditors must confirm compliance with Exchange Control permit.
  - IBCs (other than IFCs) required to file audited financial statements each year; an annual return to the CBC aids ongoing monitoring.
- Legal framework permits exchange of information provided a court order is obtained.

### Insurance sector review
- Structure:
  - Domestic insurance sector organized on U.K. practice; total companies 52 including 19 branches/agencies of foreign companies.
  - Life sector dominated by five large companies accounting for about 90 percent of premiums; three owned by the two largest banks.
  - General insurance top five companies account for about 50 percent of the market.
  - Network of some 7,000 agents and sub-agents.
- Offshore insurance:
  - Small group of 11 ‘captive’ companies and 17 third-party offshore companies.
  - Captives largely brass-plate companies; two Russian companies among them; captives unlikely to survive removal of tax preferences to be completed by 2005 if government’s understanding with the OECD is fulfilled.
- Supervision:
  - Industry supervised by a Superintendent of Insurance heading a small ICCS within the Ministry of Finance.
  - Service considered part of the Ministry for budget and staffing; fees under the insurance law passed to Government; Superintendent has no financial resources under her control.
  - New insurance law drafted to bring Cyprus into full compliance with EU directives; Superintendent’s operational powers will increase but decisions on licences and revocations will still be subject to appeal to the Minister.
- Capacity constraints:
  - ICCS is severely understaffed: Service currently consists of only eight professional staff (only three certified accountants) and four clerical staff; no legal staff; no in-house actuarial staff; shortage of qualified accounting personnel.
  - For actuarial services, the Service relies on the U.K. Government Actuary largely through correspondence.
  - Recommendation:
    - Extend Superintendent’s operational autonomy to control resources needed to fulfill statutory obligations; consider making Superintendent’s decisions directly reviewable by the Courts or through other judicial arrangements, counterbalanced by greater accountability and annual reporting on use of powers and resources.
    - Give Superintendent financial resources to hire actuarial services on a contract basis and address resource implications of new legislation.

### Investment and securities (collective investment schemes, fund management, advisory)
- Securities market activity concentrated on the CSE; CSE regulated by the SEC; no offshore securities market.
- ICIS Law (1999) allows formation of collective investment schemes in the offshore sector; in the first six months five schemes authorized (all private schemes with less than 100 investors); about six further schemes in pipeline including public offerings.
- ICIS Law requirements: investors and immovable assets must be outside Cyprus; manager and trustee must have a place to carry on business in Cyprus.
- Regulatory responsibilities for ICIS rest with the CBC as regulatory authority under the ICIS Law.
- Review conclusions:
  - Regulatory framework for international collective investment schemes appears broadly satisfactory relative to Principles 17-20.
  - Investment management and advisory (IFCs): authorization relies on references; all IFCs audited with auditors reporting compliance with Exchange Control permit; supervisory process adequate but could benefit from greater use of onsite visits targeted at vulnerable companies.
- Recommendation:
  - Greater collection of information from foreign law enforcement agencies and judicial systems to bolster authorization checks; increase targeted onsite visits for vulnerable firms.

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_Source: https://www.imf.org/-/media/files/publications/ofca/english/073001.pdf_