The Cyprus Investment Strategy: Competing in the New World
03 December 2019 | Philip Ammerman
The government of Cyprus, in association with the private sector, has been implementing a multi-spectrum, investment-led development policy based on attracting foreign capital inflows.
Whether this relates to incoming tourists, hydrocarbon exploration, citizenship by investment, or investments funds registering in Cyprus, the strategy depends on foreign capital.
But that strategy faces significant challenges in a world where capital access and ultimate beneficial ownership is closely monitored and controlled. It is also challenged by a lack of focus on quality of life, governance and workforce investments.
As a result, investors in Cyprus confront a situation where there is an attractive investment regulatory framework, but where everyday frustrations with low quality banking and other professional and public services detract from the wider success of national policy.
2. The National Investment Strategy of Cyprus
Figure 1: The Cyprus Investment Strategy
The National Investment Strategy depends on three key pillars:
Attracting foreign direct investment into key economic sectors such as shipping, property, finance, energy and technology. These investments are driven not only by economy-wide regulations (such as the 12.5% corporate income tax rate) but by specific sectoral incentives and policies;
Implementing domestic policies that facilitate investments in the public and/or private sectors. Examples here include the university sector, energy and transport, healthcare, information and communications technology (ICT), and the Limassol casino. These investments differ from the classical FDI investments in that they are heavily regulated and often implemented by national license or regulated status;
Improving the public sector, and particularly those aspects of public sector regulation. These include winding down the Cooperative Bank; restructuring non-performing loans (NPLs); managing public debt; and complying with international regulations in areas such as Anti-Money Laundering (AML) or Know-your-Customer (KYC);
Underlying these three pillars are Incentives, Institutions and Regulations. In each case, the activities within each pillar are driven by and affected through activities in these foundations.
Incentives include laws designed to attract high net worth individuals (HNWI); start-ups; shipping firms as well as intellectual property. They include the well-known Investor Citizenship and Investor Residence Programmes;
Institutions include both mainline ministries, especially the Ministry of Finance or the Department of Shipping; agencies such as the Cyprus Securities and Exchange Commission (CySEC) or the Cyprus Investment Promotion Agency (CIPA); and public-private organisations such as the Cyprus Investment Funds Association (CIFA) or the Cyprus Shipping Council. The positive aspect of this institutional framework is the extensive cooperation with the private sector, which enables rapid communications flow and, in some cases, enhanced decision-making. This is very different from some other governments, for instance that of Greece, which views the private sector as a source of evil, and avoids interaction with it at the policy level.
Regulations include the laws as they are formally passed by the Parliament of Cyprus, but also the means by which they are implemented. For some years now, Cyprus has been reacting to international regulatory trends and movements. Examples include the OECD’s Common Reporting Standards (CRS), the upcoming EU 5th Anti-Money Laundering regulation, and other similar regulations which have dramatically changed how business is done in Cyprus, and internationally. The use of nominee shareholders or shell companies is now impossible; the opening and management of bank accounts is difficult; substance requirements mean that real operations must be used. In addition to the formal aspects of regulatory activity, however, there are also informal aspects. The US Treasury, for example, has played a leading role in reducing the activities of Russian investors and bank account holders in Cyprus, and both the government and the banking system have been following this diktat far in excess of what would be expected or warranted.
Let’s look at some of the results of this investment strategy on selected sectors.
3. Shipping and Ship Management
Cyprus has recognized the importance of shipping as a driver of economic development since its independence. In particular over the past 30 years, Cyprus has made a determined effort to attract shipping and ship management companies to Cyprus. This has been done using the mix of incentives and regulatory compliance mentioned.
Cyprus adapted an updated shipping tonnage tax in 2010, assuring compliance with EU taxation policy;
Cyprus has implemented all safety and environmental requirements orginating from the European Union as well as the International Maritime Organisation (IMO) and related organisations.
Moreover, the Cyprus Shipping Chamber (CSC) has played a vital role in promoting the sector international, as has the Department of Merchant Shipping and other public organisations. CSC organises the Maritime Cyprus conference every year, and attends key international conferences such as Posidonia.
The results of this policy are clearly visible. Today:
Cyprus has the 10th largest merchant fleet globally and the 3rd largest in the European Union.
It has attracted over 1,000 ocean-going vessels with over 21 million gross tonnes. It has recently attracted major shipping firms leaving Greece after capital controls were introduced by the SYRIZA government, and from the UK, following the turbulence over Brexit.
It employs some 9,000 people ashore and 55,000 people afloat (CSC)
Ship management revenue rose to € 528 mln in 2018, providing a service export to key markets such as Germany, Greece, Malta, Norway, Russia, and Switzerland.
4. Investment Funds
Cyprus began determined efforts to attract investment funds to domicile themselves in Cyprus following the 2013 financial crash. Significant progress was made with passing the Alternative Investment Funds Law in July 2014 and the Registered Alternative Investment Fund Law in July 2018. In addition, a series of other regulations and laws were passed bringing Cyprus into compliance with key international legislation, including UCITS, AIFM and MiFID.
Cyprus therefore offers a fully-regulated, relatively lower-cost fund management jurisdiction that is fully part of the EU and OECD regulatory space.
In addition to the economy-wide 12.5% income tax rate as well as dividends-tax holidays for HNWI and investors in Cyprus, additional incentives were offered in the form of variable employment remuneration. When index to the carried interest of the fund managing entity, this provides a 10-year tax period during which individual fund managers pay an effective income tax rate of 8%, assuming a minimum tax liability of € 10,000 per year.
The Cyprus Investment Funds Association (CIFA), with Cyprus Investment Promotion Authority (CIPA) and the Cyprus Securities and Exchange Commission (CySEC) have both maintained an active international promotional effort. This once more illustrates the active and generally beneficial cooperation between the public and private sectors in Cyprus.
The results of this effort are clear:
Cyprus doubled assets under management, from €2.1 billion in 2012 to €4.8 billion in March 2018 (CIFA) and to € 6.8 billion by June 2019.
There are now over 425 regulated entities and 80 listed companies in Cyprus.
Bilateral MoU with 19 Regulatory Authorities & 47 Supervisory Authorities for enhanced supervision and exchange of information.
As both residents and visitors to Cyprus can attest, the Cyprus skyline is changing with the additional of residential highrise towers and commercial property investments. There are several main drivers of this:
The Investor Citizenship Programme and the Investor Residency Programme
Bank exchanges of debt-for-property are a factor
There is a high demand for student housing in all four major cities of Cyprus
Seasonal labour housing is in demand, especially for tourism professionals
Additional demand originates in buy-to-rent and tourism market rentals.
Figure 2: Property Transactions in Cyprus, 2013-2018
Source: PriceWaterhouseCoopers: Cyprus Real Estate Market, 2018. Citing Department of Land Surveys Data. https://www.pwc.com.cy/en/industries/assets/real-estate-markets-full-year-mar19.pdf
Many investors have also been investing as property returns are higher than bank deposits and offer a relatively safe haven.
A key driver of activity in this sector is the Investor Citizenship and Investor Residence Programmes. The Investor Citizenship Programme provides multiple pathways to citizenship, but the most commonly-utilised one is an investment of at least € 2 million in property, of which at least € 500,000 must be for the primary investor residence.
This is widely acknowledged to a driving factor behind the highrise tower construction as well as sales of luxury villas.
According to Philenews, a total of 3,255 passports have been granted between 2009-2017.
Total revenue from the programme is estimated at € 4.8 billion from 2014 to 2017, based on an interview provided by Minister of Commerce, Tourism and Energy Lakkotrypis in 2019.
This programme has come under severe criticism from the European Commission, among others, and is discussed later in this article.
Cyprus has made a determined, strategic effort to develop hydrocarbon potential. This has been a long-term effort which illustrates the cooperation between different political administration with the private sector. A brief timeline illustrates this approach:
2007: First licensing round for eleven offshore blocks.
2011: Aphrodite Field discovered by Noble Energy in Block 12; contingent reserves estimated at 5-8 trillion cubic feet (tcf)
2012: Second licensing round consisting of 12 offshore blocks.
2016: Third licensing round consisting of 3 offshore blocks.
2018: Exploration well by ENI Block 6 discovers the Calypso field
2019: Exxon Mobile discovers 5 - 8 tcf potential in the Glaucus-1 field in Block 10
Future development will depend on geopolitical and economic constraints, and regional threats.
7. Tertiary Education
One sector that most analysts overlook is that of tertiary education. Yet this sector illustrates how effective the government of Cyprus can be at taking a systematic approach towards investment driven by structural reforms and correct regulation.
Upon EU Accession, Cyprus adapted the spirit and letter of EU policy on tertiary education. This involved, on the one hand, committing to the true decentralisation of educational institutions. Political interference at all levels has been restricted. On the other hand, this has also meant a drive for quality, and for the international promotion of Cyprus as an educational hub.
The results are clear:
In 2016/2017, Cyprus had 49 public and private higher education institutions, with a total enrolment of 45,263 students (up from 40,347 in 2015/2016) (MOE)
Cypriot students enrolled in Cyprus were 22,507 in 2016/2017
Foreign students enrolled in Cyprus were 22,756 in 2016/2017 (including distance learning)
This is a remarkable development: only 15 years ago, Cyprus had a net service deficit in education, “exporting” thousands of Cypriot students to study in the UK, Greece and other countries. Today, following 15 years of reforms and investment, Cyprus is a net exporter of educational services.
Figure 3: The Times Higher Education New Europe Rankings, 2018
The public sector deficit rose in 2018, largely as a result of the resolution of the Cooperative Bank of Cyprus. In 2019, preliminary estimates are for a government surplus of nearly € 1 billion.
Figure 5: Public Expenditure
Eurostat Public Expenditure Database
Employment in the public sector has been rising. Total public sector employment has risen in 2016, 2017 and 2018, despite the resolution of the Cooperative Bank and other structural reforms.
Figure 6: Public Sector Employment in Cyprus
Cyprus’ ranking in the World Economic Forum rankings has improved, rising to 44th place in 2018, up from 64 in 2015. The 2017 WEF results in Cyprus showed that the greatest barriers to doing business in Cyprus were Access to Financing, followed by Inefficient Government Bureaucracy and Insufficient Capacity to Innovate.
Figure 7: WEF Competitiveness Rankings, 2018
The Cyprus economy remains dependent on foreign capital inflows as well as expertise in key sectors.
Successive Cypriot governments have a strong track record of (a) designing legal incentives and regulatory systems, and (b) attracting significant and tangible foreign investment. When done correctly, this brings strong results.
However, the reform of the wider public sector remains a critical issue. Quality and transparency of governance, strategic planning and move to an internet-based e-government remains a challenge.
This is necessary not only due to the need to continue maintaining a competitive advantage in attracting FDI, but also to minimize the gap between expectations created during investment campaigns and reality.
In addition, there are a number of key risks and negative developments which are probably best illustrated through observations, rather than statistics.
The banking sector remains challenging: Both companies and individual customers face limited working times, low productivity, high fees and a lack of access to finance when dealing with the Cypriot banking sector. In no small part this is due to strong union control over management. It is also due to a potentially overzealous insistence on KYC/AML procedures which goes far beyond what is prudential, particularly for small companies. The difference in fees and service levels between foreign investors, who are forced to register with Bank IBUs, and Cypriot customers, is striking. This is an area where stronger public regulation is potentially needed, but where fundamental issues between the public sector and the private sector remain unresolved.
Successive governments have supported the emergence of monopolies in specific functions and activities. For example, only legal firms can register companies in Cyprus. This is a surprise, given the moves made by countries as diverse as Poland, Greece, Estonia and Ireland to simply register online. Insisting on the current approach adds costs, increases time, and often leads to poor quality service outcomes in a profession that enjoys monopolistic privileges.
High investment in the property sector risks creating a modern version of Dutch disease: an inflationary environment where passive investment crowds out productive investments in other sectors. It is clear that wages have not kept pace with the rapid increase in property prices in key cities. It is also clear that the quality of property is significantly lower than prices would suggest.
Some key aspects of regulation in Cyprus appear to confuse bureaucratization with regulation. This is particularly the case in rapid-moving sectors such as finance, funds or forex, where regulators have neither the staff nor the expertise to implement real regulation. The sources of the next crash in Cyprus will almost certainly be due to a lack of real regulation in key financial segments of the economy, potentially including property.
The Cypriot justice system needs to increase the rapidity and transparency with which it schedules and adjudicates cases, particularly for foreign investors.
Important structural challenges to key sectors and to attracting investors remain. One such challenge is the lack of regular and competitively-priced transport access to and from Cyprus. Especially in the winter months, there is a lack of flights to major destinations and source markets. This is an area where the state should actively promote investments to increase competition.
The structure and operations of the main government ministries require an urgent migration towards productivity and online operation. The Cyprus Companies Registrar, the social security service, the revenue service and the immigration service are all very much behind competing jurisdictions, where companies and individual residents can transact online in real time. This is a real barrier for further development.
The balance between foreign and domestic investors needs to be maintained. Foreign investors are not properly represented in different investment councils, where the pride of place is usually taken by Cypriot developers. Moreover, there needs to be equal access to Cyprus for different investor origins. There is no point in committing to being an international investment hub, and then penalizing Russian investors because they are Russian, or Indian investors because they are Indian.
Similarly, the balance between the public and private sectors of the economy must be retained. It is unacceptable today that public servants enjoy the privileges they do when compared to the private sector. It is also unacceptable that a small number of public monopolies result in such high costs for the economy.
Despite these observations, it is clear that successive governments in Cyprus are doing a successful job of attracting foreign investment. The fact that this occurs irrespective of political ideologies is remarkable.
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Moreover, Cyprus ranks highly in terms of tertiary educational quality. The Times Higher Education rankings for New Europe (which comprises those countries that joined the European Union in 2004) reveals that the Cyprus University of Technology (Limassol) and the University of Cyprus (Nicosia) rank second and third respectively of all the universities from this area. This is no small achievement for a country of the size of Cyprus.
8. Investment Outcomes
The Cypriot economy is heavily dependent on foreign direct investment (FDI) in a number of key sectors. It is interesting to note that this commitment has continued even despite governments of widely different ideological belief.
What is noteworthy about Cyprus is the extent to which elected officials as well as permanent civil service staff are aware of the need to promote investment through this prism. President Anastasiades, for example, has a legal background, and both he and his legal office have worked on key aspects of investments for over 30 years now. This means that in general, investors in Cyprus are assured of a pro-business, pro-investment environment. The main regulatory issues, in fact, do not originate in Cyprus, but emerge from key international organisations such as the European Union or the OECD.
Cyprus has achieved a positive GDP growth since Q1 2015. Figure 4 below shows quarterly year-on-year growth of GDP in current prices (Cystat).
Figure 4: Cyprus GDP Growth per Quarter, Current Prices