Crypto and the Cayman Islands

The AML Intelligence Podcast, tracking the Intel and developments in the world of financial crime. Hello and welcome. I'm your host D. Reddy. The Pirates of the Caribbean movie portrayed the region as a haven for rogue sailors and pirates in the 18th century. More recently, it has been seen as a luxury hideaway for the jets set and their money as told in many novels by the likes of John Grisham. But is this reputation accurate or fair? Elizabeth Lease co-founded Claretas Legal and previously spent over a decade as an in-house lawyer for the Cayman Islands government. She spoke to Collard about the country's ongoing compliance architecture overhaul and its efforts to balance regulation with reputation. But first, cryptocurrencies have suffered from a similarly bad rep. For some, it's digital gold with the promise of huge returns. For others, it's the perfect vehicle for moving, hiding and laundering illegal proceeds. From everything, including scams, frauds, drugs, human trafficking and terrorist financing. The challenge for regulators is how to oversee a financial system that is opaque and anonymous by nature. Carlo Baffa talks to us about the increasingly divergent approaches to digital currency regulation on both sides of the Atlantic. So, Carlo, I think we've learned across the series so far that crypto has become incredibly significant in global money laundering compared to traditional methods like cash, shell companies and offshore banking. Can you put that into a little bit of perspective for us? Who has thus managed to happen in a relatively short space of time? Yes. I mean, how significant crypto is for the global money laundering market, if we can call it like that? Well, that depends a lot on who you ask and which stats you look at. There are those, like for example, the new EU anti-money laundering authority that has promised a laser focus on the sector. And defining it as one of the highest-risk sector for money laundering. And that's because if you look a little bit at the numbers of how much crypto is used to loan their money, you see that they increased between just five years ago and now a chain analysis report says that basically in 2020, they were $11 billion dollars a loan there through crypto. That increased to 154 last year. So the growth is spectacular. Of course, if then you compare it to the global amount of a money laundered in the world, the UN estimates to be $4 trillion. That's just a drop in the ocean. But of course, like when you have such growth, that's something that starts sounding the alarm bells in regulators offices. Absolutely. And look, I think there's a number of aspects to crypto that, you know, anyone listening to this podcast will know make it very obviously attractive to organized crime. It can be anonymous. It can move its speed. It is the ability to move across borders. But can you walk us through the mechanics a little bit if a criminal organization wants to launder the proceeds of crime using cryptocurrency? What would that process typically look like for them? Well, if you take traditional laundering through crypto is not that much difference that from banks is just a user, a criminal, that moves money from one account to the next from one cryptocurrency to the next, meaning from one blockchain to the next. That's not much different from what you would do with a bank account. The added value is exactly what you said. This is much faster like transferring from Bitcoin to Ethereum from one wallet to the next. This is a matter of second. And so this is something that of course is like criminals value when it's faster. It's as you said anonymous and it's cross border. I can send in my money to North Korea something that I couldn't do through my backs, for example. But there are also some specificities to the crypto market. For example, there are things called mixer and tumblers and they're not like those that you might have in your kitchens. But they are basically structures where some users like let's say 10, 15, 20 users send money to this tumbler that pulls it together. So you don't really see who's the owner of this cryptocurrencies and then it sends it back to other wallets. So basically a criminal could send it to the tumbler. It pulls together so no one sees that it's from the criminal and then go and get it from another wallet after it's been tumbled dried or I don't know how you want to call it. But fascinating because you can see just the way you've described it so well there how from a regulation point of view or from a criminal enforcement point of view, just how problematic then that becomes for the people trying to keep tabs on criminal activity and the proceeds of crime. Yes, and you shouldn't forget that different from a bank account even though nowadays we have instant payments, you cannot really block a transaction made on blockchain. So once it's given the go ahead is done. It's not like the bank. I mean banks could have like problems probably to stop an instant payment that needs to be done under 10 seconds, but they could if they wanted with blockchain that you cannot. So let's have a look then about how this is played out in real world terms between you know legislators between regulatory compliance and actual crypto companies. What happened back in 2023 with finance? I mean they're one of the most recognizable names in the crypto industry, but they got into serious hot water. Yeah, so that was a landmark case and and a huge high watering fine for when two billion dollars. I don't even know if their US authorities have ever given such a large fine definitely never for a crypto exchange. And what happened there is that basically by now's didn't have a proper anti money laundering framework in place. So other companies that you see it often they wanted to grow fast. And so they've onboarded customers that they should have not been onboarded and the exchanges was useful all kind of criminal activity sanctioned by staying financial crime proceeds longer through the exchange. The company admitted that there was no framework in place to check what was happening there. What is it framework? I think that a lot of systems like this would use it's the KYC program. Can you explain what that is? Yeah, so basically when you onboard a customer you should check who that customer really is. If it's like using valid document for example and they're important nowadays. It is on one of the sanction lists because of course if you onboard for example, a Russian person and we know that there have been UN EU and US sanctions against fresh that should already bring some alarm bells in the company and they should do more door checks because you come of course from a high risk country. And that's called enhanced due diligence or announced KYC but Binance didn't have these frameworks in place at the time. Now of course they went through some big remediation measures and they themselves said they want to become the most regulated exchange in the world. I'd say if you ask regulators on both sides of the Atlantic they might have different opinions on that but for sure there has been this push to try to clean up at least the image from them. Yeah, because I think it's important to kind of point out that this isn't just a case of lease or kind of lax accounting. Like the real world implications of some of the transactions that were being kind of funneled through Binance you know there was ransomware proceeds, there was dark NAS marketplaces, child sexual abuse material and like some really horrendous stuff that the door was being left open to. Do you think that this was a landmark case because it forced a large crypto exchange out of that sort of you know where the new guys were the kind of the alternative sort of way of financing which obviously is going to be attractive to criminals and into the sort of mainstream of the finance world and with that obviously comes the same checks and balances that other mainstream banks or financial organizations are still going to be attractive to criminals. Yes, that's exactly how you say like crypto from the origins operated into this gray area but once authorities managed to understand what was happening inside and as we said at the beginning with these rate of growth of criminals using crypto firms of course like they started to take some measure to prevent that it became a lot of money. a wild west. And so of course, like they brought it more towards traditional finance and towards the checks and balances that banks, insurances, asset managers apply to their customers. And what ultimately happened there? I know Zhang Peng Zhao, the founder of finance, actually ended up with the prison terms that rice? Yes, exactly. So he was given a four month prison sentence because the prosecutor recognized that as a CEO, he had responsibilities over these failures to have AML framework in place. But CZ was then pardoned by Trump in 2025, showing also how the mood of the U.S. administration changed towards crypto from the Biden administration to the Trump administration. Yeah, there's been a lot in the news about the divergence between U.S. and EU regulators, for example, on a whole heap of topics. Do you think that crypto is probably one of the easiest examples of that to kind of spot where that divergence is starting to happen? And what might we see there in the future? Well, the can I ask you, how much your prime minister has made last year from crypto because Trump has made $1.4 billion from crypto. So I think that tells you already a lot about the difference. Yeah, I take your point, but I mean, I suppose by contrast, the EU is now saying that its regulation with regards to crypto currency are actually among the toughest in the world. Yes, yes, they are among the toughest in the world. And you can see it from the Binance example because while Trump as pardoned its founder, the EU did not even grant a license to operate to Binance yet in the continent. So at the moment, Binance technically could not operate in the EU. So what are the biggest changes under what's called mica, what's the travel rule and the kind of the wider anti-money laundering reforms that we are seeing in the EU currently? So basically, mica first, it asks issuer of cryptocurrencies to keep some money in the EU. So if things goes out, there is some money there. Second of all, as I said at the beginning, there is this big focus by the new anti-money laundering authority on stable coins and crypto exchanges. So they are a focus of the new authority and I think that means that it will be strictly supervised. And that divergence, Carlo, how do you see that playing out? Because presumably if those regulations are that much stricter, big brands like Binance aren't able to operate here in the EU, are we going to see a capital flight of legitimate funds? Ios of the region because the difficulties of accessing the crypto market are just too extreme. Well, I think a lot will depend on who the next US president will be. But I mean, I think that in general, the US will remain a little bit more crypto-friendly than the EU. I think in the EU, authorities need to ask themselves these questions. Like everyone nowadays as internet as a mobile phone. So these platforms, these coins are never going to be out of reach for the EU customers. So the thing that I think authorities have to ask themselves is do you want to try to keep them out? And so minimize the use that EU people will do of them? Or you want to try to bring them in, of course, if they respect all the rules and have a foot in the door in those companies and be able to supervise them and make sure the data by the rules. And do you think with those changes and with what you've said about the US currently, like are EU regulators? Are they facing an uphill battle over the next five years? With everything that we've talked about today, is that divergence essentially mean that there's only so much they can do? Well, I think yes, it is an uphill battle because, I mean, we all have internet. We all have mobile phones. So as you can go and play in a casino online that is domiciled in Palau, you can do the same with cryptocurrencies and crypto exchanges. So here they, you need to take a stance. Do they want to really try to keep all these players out of the market unless they play by the EU rules? Or would they want to integrate them and then have a foot in the door in these companies with supervisors and can try to enforce the rules with their oversight? Fascinating. It sounds like a real fork in the road. Cardo Baffa, thank you so much. I'm my thanks to Cardo Baffa. The Cayman Islands is a British overseas territory whose modern constitutional identity took shape in the 1960s. For decades, the Caribbean ideal was Hollywood's shorthand for tax evasion and in the cultural zeitgeist, the region became synonymous with hidden wealth, brass-bake companies and financial secrecy. That legacy of opacity has bestowed a reputation many modern Caymans would rather leave behind. Behind the scenes, there was a much more complex history at play where post-colonial evolution has informed the Cayman Islands status as a major financial hub. Like many Caribbean territories, a traditional industry faded, offshore finance became a vital engine for economic self-determination. If this is created a delicate dynamic, a former colony operating at the very heart of Anglo-American capital flows. Elizabeth Lease co-founded Claritas Legal and previously spent over a decade as an in-house lawyer for the Cayman Islands government. Elizabeth, thank you so much for joining us on Collard today. Now, the Cayman Islands is a financial hub for both investors and financiers alike, but it's also historically gained a reputation as a tax haven and a hub for money laundering, whether fairly or unfairly. How do you think that that perception of it in the public eye came about and what were the historical factors there? First of all, I would say that is rather unfair and I think a lot of it is to do with perception and perhaps a misunderstanding currently of the situation which I know we'll talk about, but if we look back historically, the Cayman Islands has been tax-neutral since the 1700s, so it's not something that the Cayman Islands sort of developed rapidly in order to gain an advantage. This has been a long-standing piece of the Cayman Islands history and initially it was put in place to attract persons and investment when there was hardly anyone living in the Cayman Islands. So that's been there since then and continued and I think that the misunderstanding comes from the fact that it is tax-neutral and that doesn't make it a tax haven which suggests some kind of negative connotation about hiding assets or avoiding or abiding tax and the Cayman Islands has many many different mechanisms in place to ensure that is not the case. So I think that's partly the misunderstanding there. I also think historically there was the confidential information preservation law in place in the Cayman Islands similar to other jurisdictions and this was brought in around 1976 in order to again make the Cayman Islands more attractive to foreign investors and to reassure them at that time that their information would be secure and confidential at a time when of course IFCs were brand new international financial centres and this concept of money moving as we know it now was new. So that was brought in at that time and one of the aspects of that legislation was that you in fact could be prosecuted if you reach those confidentiality provisions. People had understood them in the banking sense between the banker and the client and it was expanded amongst financial service participants. Now it's right to say that nobody was ever prosecuted but the fact that this law existed and was sometimes referred to as a banking secrecy act perhaps understandably given those criminal penalties probably didn't help the reputation of the Cayman Islands in terms of that secrecy perception. That law was repealed in 2016 and although that law did have gateways of course for law enforcement for the regulator for tax authorities it was replaced in 2016 by a law that had no criminal provisions for breaching confidentiality, very clear whistleblower protections and also clear gateways in all the usual ways to ensure that it was very clear that there would be no breach of any confidentiality. provisions if information was shared with law enforcement, the regulatory to the Cayman Islands monetary authority and others. So I think that was just one example of making sure that the Cayman Islands moved away from this perception of secrecy and a lack of transparency. I think the other item to bear in mind is that the Cayman Islands is an international financial center, a significant international financial center with a small population of some 80,000 people. So when you get this disparity between the figures, the amount of funds and the population, it can lead to questions and questions can be legitimate questions, questions can be people seeking more information. How does that work? Why does it work? Why is Cayman attractive to those who seek to invest there or to establish businesses in that jurisdiction? And of course, there are many legitimate reasons for that. So again, a lack of understanding as to how that can be done properly and for legitimate reasons and the safeguards that Cayman has in place has perhaps led to this perception of the Cayman Islands as illicit or as a secrecy jurisdiction. And there's always a huge sigh in the cinema in the Cayman Islands when whatever film you're watching, the money has gone to the Cayman Islands. I'm sure I can well imagine. And I think, look, a lot of that perception, it does exist in popular culture. So do you think that this really started in 1962 when Jamaica split, again, its independence from the UK and the Cayman Islands made the decision to stay on as a British dependency? And that has essentially factored in to the evolution of not just the cultural perception of the island, but of course the culture and political system itself. Yes, certainly the independence of Jamaica and also the Bahamas around the same time meant that the Cayman Islands in some ways it had to now look after itself because of course traditionally it had been linked to Jamaica. It shared a currency with Jamaica. It then established its own currency and that currency was then shortly there after peg to the US dollar, which of course was again attractive combined with the fact that it was a British overseas territory. It retained that strong common law link to the English system as well as the English governance to some extent. And so it wasn't independent in the same way Bahamas and Jamaica were. What was behind the decision to peg the currency to the US dollar if Cayman was linked politically to Britain? So I think that decision related to probably some foresight at that time in terms of the geographic proximity to the US as well as the nature of the International Financial Center servicing the US. And one of our first treaties in that regard was with the US in terms of drug trafficking and in terms of international exchange of information. And I mean you'd mentioned earlier the 1976 confidential relationships law. Does that kind of play into this notion of financial secrecy? Which many people I think do often associate with the potential for financial crime. Beyond some of the elements that you've spoken about already what has Cayman done to address that perception because it sounds like there's been really robust efforts there. Yes. So in 2016 that law was repealed as I said and the new law, the confidential information disclosure law, deals with setting out those clear gateways and making absolutely clear those neighborhoods of any confidentiality after all if you're complying with a law or regulation. The biggest aspects that Cayman has improved upon in this regard I would say fall into three categories. One is FATF compliance. The second is the tax information exchange regime. And the third which sort of spans both of those is the beneficial ownership regime. Could you explain those three measures a little further? Certainly. So in terms of the tax regime and I think this is where Cayman's tax neutrality is misunderstood. What in fact happens is that if for example a fund is established and incorporated in the Cayman Islands the fund is not taxed. However, the income that is derived from the fund by the individual investors is taxed in the usual way by their home jurisdiction. So whoever invests in the Cayman Islands is not evading tax the profit on that investment will be paid in their home jurisdiction. So how does that work? It works by ensuring that there is a robust tax information exchange regime. The Cayman Islands does this in a number of ways. So we have an automatic exchange of information started with the US under FATCA which is the US Act which applies to US individuals and US entities. And then it was expanded upon by the CRS, the Common Reporting Standard which applies to other non-US jurisdictions. What this means is once a year there is an automatic exchange of information where the Cayman Islands shares information on tax residents over the jurisdictions with these jurisdictions. The Cayman Islands does this by imposing strict requirements on service providers in the Cayman Islands who are required to identify the tax residency of their clients. They must do this to not do this is an offense. They must then file the information with the tax information authority, the Department for International Tax Corporation in the Cayman Islands. If they do that late, if they do it inaccurately, again, it's an offense and there are penalties. And then that information is exchanged. Secondly, we have an economic substance regime whereby certain entities conducting certain business must demonstrate that they have substance in the Cayman Islands. So they can't simply have a name of an office in the Cayman Islands. So it applies to, for example, banks and other industries. And they must have a sufficient amount of resources. They must demonstrate that management is occurring in the Cayman Islands. So again, trying to ensure that persons are not able to simply say that they are resident in the Cayman Islands. If they don't have the substance to back it up, which of course, must be provided by evidence and documentation. The third way is the country by country reporting. So this applies to large multinational organisations who are making somewhere in the region of $800 million per year. If they have a Cayman entity in their structure, that Cayman entity is required to report on the structure and to report on effectively the beneficial owners who owns that. And then to provide various pieces of information about income, about substance. So again, all of that information can be exchanged so that no one-large company can say it's tax resident in one place, actually, be doing business in another place. And to try and control matters in that regard. And then the final item in terms of this tax regime is the exchange of information on request. This is really important because it means that where a jurisdiction is investigating a potential tax-abasion matter, it can write to the Cayman Islands and request banking information, beneficial ownership information. Whatever information it needs in order to further investigate, corroborate or perhaps discount whatever its line of investigation is. And the Cayman Islands has all of those items in place. And I should also say that those regimes are monitored. So the OECD monitors those Cayman has been assessed in relation to CRS and found to be compliant. And also in relation to economic substance. So how well-equipped are local authorities now to police complex fund structures, institutional fraud or digital assets and these highly sophisticated cross-border corporate vehicles that, you know, they present huge challenges to much bigger jurisdictions. I think that's really important. I think that we are seeing globally and increase in the misuse of corporations. As you say, often complex structures, we see it in money laundering, we see it in terrorist financing, we see it in proliferation, financing and the evasion of sanctions to prevent the ultimate beneficially and are being identified as a sanctioned person. And this is why beneficial ownership has been such a key theme of fatif in order to identify whether there are already criminals behind the structures. And this is a key theme of fatif that's being enhanced upon. The Cayman Islands does it really by a two-pronged approach. So one prong, which has been there for a long time. is that the service providers themselves have AML obligations, so customer due diligence, they must identify the beneficial owners. And what's interesting in this regard in the Cayman Islands is that most of our companies are what we call exempt companies. So we have ordinary companies that are based in Cayman, exempt companies are the companies that are doing business elsewhere, not in the Cayman Islands, and the Cayman Islands has identified, perhaps not unexpectedly, that that's where the risk lies. So these companies are required to have a corporate service provider, and that corporate service provider has the AML obligations. They must identify the 10% beneficial owner. That 10% is much more stringent than the FATF 25%. That's of course supervised by the Cayman Islands Monetary Authority. They'll come in, they'll inspect you, they'll do a file check, and you will be subject to fines if you have not complied. The second aspect is the Beneficial Ownership Transparency Act. Now that act requires that both the corporate service provider keeps a beneficial ownership register and that it's filed with the competent authority, which is the register of companies. This limit is 25% which is the FATF standard. And in fact, this was a proactive move by the Cayman Islands to be even more compliant because at that stage we were already largely compliant with those recommendations 24 and 25. In 2021, the Cayman Islands replaced on the FATF grey list. Why was that and what measures did the government and regulators take to address the issues? In terms of FATF itself, when it was placed on the grey list, there were only three actions. So it was an extremely small action plan list. Prior to that, as you said, and as I had said earlier, all the technical compliance recommendations had almost all been complied with. And shortly thereafter, we're all complied with making the Cayman Islands one of the very future restrictions in the world at that time to have met all 40 recommendations. Then in relation to effectiveness, these three actions were placed on the grey list. Those three actions all related to chronologically, the end piece of the AML puzzle. So you've got to have all your preventative measures in place. You've got to have all your resources, all your investigators in place. And these three items all related to enforcement. So the supervisory framework was sound, the investigations was sound, the beneficial ownership was sound. But the three items they wanted to see were more enforcement action by the regulator, more enforcement action in terms to beneficial ownership accuracy. So not just in terms of if you file late, but is the information that you've filed accurate. And finally, which is really hard for any jurisdiction, especially an international financial center, prosecuting money laundering cases in line with your risk pre-file, which of course in the Cayman Islands means there's going to be predicate offending normally in another jurisdiction. And then the money laundering will occur directly or indirectly via the Cayman Islands, which is really difficult because you're relying on mutual legal assistance with those other countries to get the evidence. They'll be complex. There'll be a lot of asset tracing. The funds won't normally be in the Cayman Islands. And in some cases, the other jurisdiction will properly take the lead on the prosecution. And the Cayman Islands will then assist with the international cooperation, which the Cayman Islands has always done really well. That's so interesting and well laid out. It's like a check, check, check list of all the things that needed to be done. But finally, then, Elizabeth, to what extent do you think that larger economies use the Cayman Islands historical reputation as a somewhat convenient political scapegoat to distract from their own domestic money laundering vulnerabilities? I think that there is often a suggestion that the risk and context of the Cayman Islands is different. And I think the Cayman Islands has to accept that it is different. It is an international financial centre. It is dealing with a large amount of funds. But there is nothing wrong with that if you understand the risk and you mitigate the risk. So I think we've talked about perception. There's an element of education and outreach and ensuring that others understand all these pieces that are in place so that anyone who does seek to scapegoat, as you say, the Cayman Islands can be met with the robust evidence of the systems that are in place to ensure there is no misunderstanding about that. And if there are challenges, challenges are welcome. The Cayman Islands welcomes the FATF evaluation, the OECD evaluation because it strengthens the reputation of the jurisdiction when it can demonstrate to these independent processes that, in fact, it is a very well-regulated, well-functioning jurisdiction. So challenges and questions are welcome. And it's hoped that with more understanding of the nature of the industry and all these protections that are in place that there will be less room for any state booting. That's super. Elizabeth Lease, thank you so much for joining us, and Carlo, today. Thank you very much. You've been listening to Collard from AML Intelligence. We'll be back next week with more insights and analysis on the world of money laundering, fraud, and financial crime. Make sure to like and subscribe now so you don't miss any of our upcoming episodes. Until then, thanks and goodbye.