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.