Driving offshore success

  • Author : Frances Woo
  • Date : August/September
ABOUT THE AUTHOR: Frances Woo is Managing Partner of Appleby’s Hong Kong office and Local Practice Group Head of the Corporate and Commercial, and Private Client and Trusts departments

There was a time when offering offshore advice in Asia meant advising Western companies investing in the continent’s emerging markets. But today China’s appetite for investing overseas is going from strength to strength: in 2011 China’s net foreign financial assets hit USD1.77 trillion, up 5 per cent from USD1.68 trillion a year earlier. Of particular interest to the country’s acquirers are major energy assets abroad, because China’s own natural resources just cannot keep up with demand, and the hunger for deals means a growing appetite for offshore vehicles that can maximise the returns on those investments.

Just look at the oil industry and you can see what is driving merger activity. China was the largest oil exporter in Asia until 1993, but that’s definitely a thing of the past. In the past decade the number of cars owned by the Chinese has increased 90 times over, and of the 14.5 million cars sold in China in 2011, nine out of ten went to first-time buyers. That kind of boom requires a lot of energy, and while China relies on coal for most of its needs, it is now the second-largest oil consumer in the world, behind America, and its demands will keep on growing.

The state-owned enterprises (SOEs) of China are leading the overseas investment charge, in large part implementing China’s policies, but also because government approval is needed before Chinese currency can be taken abroad. Many of the targets are to be found in Africa, but Chinese money is slowly moving into most of the world’s economies. The SOEs are setting up offshore vehicles to acquire these assets, and as such the country is now playing a significant role in the development of major offshore centres around the world.

Driving offshore demand

As significant as it is, however, it is not only through its appetite for overseas investment that China is influencing the offshore market. Another major development is the trend towards overseas listings and the ongoing demand by mainland China companies for initial public offerings on the Hong Kong Stock Exchange. For example, at the start of the year Appleby worked as Cayman counsel for real estate developer Kai Shi China on its Hong Kong listing to raise HKD180 million, and there are other, similar deals in the offing.

A third factor is the move toward internationalising the renminbi (CNY). This has resulted in raising Chinese renminbi offshore, using offshore vehicles to issue bonds in Hong Kong that are denominated in the Chinese currency. These ‘dim sum bonds’ have benefited from deregulation in recent years and have become more popular as foreign companies have sought yuan-denominated assets in the face of renminbi appreciation last year. In 2010, CNY35.7 billion in dim sum bonds were issued, and by 2011 that number had more than trebled to CNY131 billion, according to data compiled by Bloomberg.

Centres in the spotlight

Against this backdrop, it is easy to see the influence of China offshore. One of the biggest beneficiaries is the British Virgin Islands (BVI), typically the most popular route for investors coming out of China who use structures that employ BVI vehicles to hold assets. The BVI is the key international centre for asset-holding by Chinese buyers, due to ease of administration, competitive costs and recognition by investors. Some commentators go so far as to say that Chinese investors now use ‘BVIs’ as a synonym for offshore entities (see ‘Private wealth planning’, Marcus Leese, STEP Journal July 2012, page 39).

That said, other centres have appeal for certain sectors, for example the fund-management industry, where players typically opt for the Cayman Islands for establishing private equity or hedge funds. Cayman vehicles tend to be familiar to the banking community in Asia, and the Islands have benefited from the flurry of mainland companies looking to list in Hong Kong, as many of them have been private-equity backed. For the past three years Hong Kong has been the world leader for IPOs, outstripping New York and London, and 42 per cent of the companies that have listed there have been Cayman-registered.

What’s more, Cayman has also been popular with Chinese companies looking to list in the US, particularly in sectors where foreign ownership is restricted in China. In such instances the foreign investors take shares of a company registered offshore, which in turn controls the Chinese business through contractual arrangements.

A final attraction of Cayman vehicles is that they tend to be less expensive to establish and maintain than those in Bermuda, for example, and the Asian market is known for being cost-sensitive. Thus, according to Hong Kong government statistics, the Cayman Islands are the seventh-largest source of foreign direct investment and the sixth-highest destination of outward foreign investments from Hong Kong. However, Bermuda still maintains a major proportion of companies listed in Asia.

I expect to see Mauritius and Seychelles developing as major offshore centres on the back of Chinese demand for African resources, not least because of the double-taxation treaties that exist between China, Mauritius and Seychelles, and a large and growing number of African countries. These allow Chinese residents to acquire assets in Africa and minimise their capital gains tax exposure if those assets are sold in the future. The saving can be substantial, with capital gains tax as high as 30 per cent in some African countries and the use of a Mauritian or Seychelles vehicle bringing it closer to 10 per cent.

Mauritius has emerged as the offshore economy witnessing the greatest growth in activity in the past 12 months. The number of deals involving targets incorporated in Mauritius doubled between the first quarters of 2011 and 2012, up from six to 12, and while the numbers are low in comparison to other centres, they clearly indicate a trend toward accessing African transactions via Mauritius. Much of the activity is around natural resources, with the acquisition of Mauritian aluminium product manufacturer Ekaterina by Sesa Goa of India for USD335 million in the first quarter of this year a case in point.

China has already established several trade zones in Africa to facilitate greater investment into the continent, so I expect to see more SOEs using offshore vehicles to acquire assets there.

Finally, do not overlook the growth of Hong Kong as an offshore centre, with Asian companies often using Hong Kong holding companies or employing them in structures for foreign direct investment that also contain Cayman or BVI vehicles. Hong Kong is the offshore gateway to China, and its network of tax treaties and favourable corporate tax rate make it an obvious beneficiary of the booming Chinese appetite for overseas deals.

China’s special case

Chinese investors are unique in many ways, and one key consideration when dealing with them is the strong relationship between what the investors are looking for offshore and the government’s policy decisions. The Chinese market is highly regulated and government approval is required before currency can be taken out of the country for foreign investments.

With the government playing such an important role, another layer of complexity is added to each transaction. As such, when offshore jurisdictions are looking at the needs of Chinese investors they also need to give a nod to state policy, which for the moment is focused on developing access to natural resources and agriculture, among other things.

While Cayman and the BVI look set to be the obvious beneficiaries of Chinese money heading offshore, European financial centres are also targeting Chinese capital for their own asset-protection products. This is particularly true of the UK crown dependencies of the Isle of Man, Guernsey and Jersey, as well as Switzerland and Liechtenstein, where tax efficiency and confidentiality are being used to woo Chinese investors.

Given the state of the world economy, mainland China provides a rare bright spot of sustainable high economic growth. With cross-border mergers and acquisitions activity otherwise largely in the doldrums, the offshore world must look to Asia, so the unusual requirements of wealthy Chinese corporations will play a significant role in shaping the offshore landscape of the future. It is surely the offshore centres that are most mindful of China’s special needs that will prosper in the years to come.

Why offshore company incorporations are gaining interest in China

Offshore companies are being set up for Chinese clients for many reasons. Demand for offshore corporate domiciles is increasing around five key themes:

  • There is growing demand for the use of offshore vehicles to list China-based assets on overseas stock exchanges as expansionist Chinese companies seek to attract foreign capital.
  • Chinese enterprises are increasingly making use of offshore entities to acquire and hold overseas assets, particularly in the natural-resources sector, where domestic supply is struggling to keep pace with demand.
  • Interest is growing in using offshore entities to raise renminbi in ‘dim sum bonds’, which have gained popularity and benefited from deregulation. There has been strong commitment by Bermuda and Cayman entities.
  • Offshore company incorporations, particularly using Cayman entities and partnership structures, are being employed to raise US dollars offshore.
  • Chinese corporations are using offshore vehicles to open and maintain overseas bank accounts in Hong Kong, where British Virgin Islands or Seychelles entities are typically used.

Offshore entities are increasingly being seen by outbound investors as preferable to China-based or Hong Kong companies for the above transactions. Factors driving this shift include:

  • These offshore vehicles are relatively inexpensive to set up, maintain and wind up, which can be attractive in the cost-sensitive Asian market.
  • The tax neutrality offered by many offshore jurisdictions is compelling.
  • Most offshore corporate entities are internationally recognised by investors, capital markets and investment banks. This can add credibility and familiarity to Chinese transactions.
  • Offshore centres can deliver creditor-friendly, reliable and transparent legal systems that can enhance the feasibility of some transactions.


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