Frances Woo examines how Asian financial centres have gone from strength to strength in recent years through facilitating global trade and investment.
The global financial crisis and its aftermath have brought a great deal of focus, controversy and hype regarding offshore finance in Europe and the US, where those governments are running significant budget deficits. Erosion of tax base and loss of tax revenue were determined as the primary culprits but interestingly, public overspending, systemic banking risks or other factors are muted. This characterisation together with pressures to enhance tax harmonisation, especially in the EU, has led to a surge in new regulations and a sustained media campaign against international finance centres (IFCs). It has been populist and simplistic to malign the IFCs without a full understanding of their important role in the efficient movement of capital and aiding of developing countries. The distinction between tax avoidance and tax evasion has also been blurred.
This stands in marked contrast to Asia, where IFCs such as Hong Kong and Singapore have thrived over the last decade and are now ranked alongside London and New York as among the best in the world. In tandem, the use of pure offshore IFCs in the Atlantic/Caribbean and Europe has also steadily increased – these would include Bermuda, the Cayman Islands, the British Virgin Islands, Jersey, Guernsey and the Isle of Man. Asian countries and their governments are all developing at different rates and maintain their own fiscal sovereignty. Tax rates are generally lower in Asia than in Europe and the US. Asian growth is also highly dependent on international cross border investment and deal flow and requires efficient access to capital. IFCs help to facilitate and intermediate and provide a familiar, comfortable and stable platform for investors moving into an often opaque and fast-moving regulatory environment in the emerging Asian nation.
There is less friction for IFCs in Asia and as a result we have witnessed a re-alignment in the Asian strategies of IFCs, with Cayman and the BVI seeking to bolster their already well-established reputation in Asia, and newer Asian players such as the Channel Islands – who are facing increased hostility from European governments and the UK – aggressively pursuing a piece of the market in China and India. Mauritius continues to play a strong role for India and increasingly is seen as the gateway to continental Africa.
So why is it that IFCs and offshore finance more generally have faced such significant challenges in the West, but been more welcome for their role in the economic prosperity of the East – so much so, indeed, that some established European IFCs have shifted focus from their traditional markets in the City of London and Europe and have headed to Asia? The answer is, of course, multi-faceted.
Hong Kong and Singapore’s relationships with China and South East Asia respectively is not unlike that between the Channel Islands and the UK, Switzerland and Europe or the Atlantic/Caribbean jurisdictions and the United States (US). Hong Kong was a refuge for Chinese business since the 1930s, with many individuals shifting their wealth there before the revolution. Likewise, Singapore has always been a home for wealthy individuals from Malaysia, Indonesia and India.
But as the years passed – and countries in Asia opened up and have grown prosperous themselves – this relationship has shown remarkable improvement, whereas in the West, regulations from the UK, Europe and the US have hit their own offshore finance centres hard, persuading them to look to Asia. Bermuda has had a presence in Hong Kong as far back as the 1980s, quickly followed by Cayman and the BVI, and Switzerland’s links with Singapore remain very strong.
The first point to note is that IFCs have always provided a service that China, India, Indonesia and other South East Asian countries cannot – namely a well-regulated, simple, stable and efficient business environment. China, for all its growth in recent years, still suffers from often opaque regulation and long standing bureaucracy, a less than open capital market and an almost non-existent wealth management platform.
Although China’s business and regulatory environment continues to develop and evolve and it has matured and grown rapidly over the past decades, there continue to be barriers to trade and investment and the free convertability of capital. Restrictions and control remain, as illustrated by the Shanghai Free Trade Zone (FTZ) established in August last year. In the run up to the launch there was talk of corporate income tax concessions, the opening of China’s capital account and freer conversion of the Renminbi (RMB) – to date, the status remains unclear. What is clear is that China is not yet ready to establish its own City of London on the mainland and, as a result, IFCs will likely continue to play significant roles in China’s outgoing investment.
India, Indonesia and much of South East Asia share China’s problems but to an even greater degree as they are at earlier stages of their growth, with undeveloped domestic banking systems, a myriad of red tape and protectionist attitudes towards the domestic economy. It is therefore of little surprise that citizens of these countries prefer to bank in Singapore.
Wealth management aside, it is in the realm of corporate finance and investments that IFCs have excelled in Asia and as a result, made offshore finance a major part of Asian growth. The number of Chinese/Asian companies using offshore vehicles to list in international markets in London, New York or Hong Kong has continued to rise – as has the number of Western firms looking to access Asia through similar structures.
A recent report by Offshore Incorporations Limited, Offshore 2020, found that expectations for more outbound business from China is increasing, as China remains the most significant driver of offshore activity in Asia. It had Chinese outbound M&A activity jumping five-fold between 2005 and 2011 to US$63 billion.
What is more, as Appleby noted in its Q3, 2013 offshore M&A report, two of the largest outbound deals last year had an offshore element to them. Firstly, Shuanghui International’s US$7 billion purchase of US pork producer Smithfield Foods: Shuanghui International is the Cayman Islands-incorporated arm of China-based Shuanghui, the country’s largest meat producer.
And while China is concerned about tax revenue, it is also cognisant of the role offshore plays. State Owned Enterprises have definitely benefitted from offshore vehicles facilitating investment outside of China, which play an important role in the economic growth of the country. China National Offshore Oil Corporations (CNOOC) US$15.5 billion buyout of Nexen, the Canadian oil and gas company, is a good example of this; structured, as it was, through its network of offshore entities.
These illustrations show the importance of IFCs as a conduit of capital from East to West, assisting Chinese companies to gain access to Western capital or technology through foreign listings or acquisitions. Equally, IFCs permit Western companies to invest in Asia simply and efficiently, bypassing the complex bureaucracy and language barriers of going directly to Beijing, Jakarta or Mumbai.
The question now, of course, is whether Asian governments such as China will continue their entente cordiale with IFCs and offshore finance in the years ahead. After all, the economic outlook for Asia is, according to many analysts, less positive than it was and China’s GDP growth has been revised downwards compared to years past.
Firstly, taking China, 2013 was a bit of a bumpy ride and a slowdown is expected in the first quarter of 2014, but a predicted 7.5 per cent growth for 2013 – according to official Chinese figures – is still pretty healthy. Since it first brought in market reforms in 1978, Chinese GDP growth has averaged around 10 per cent a year and the country is predicted to be the world’s largest economy by 2020.
Meanwhile, the world’s fourth largest economy, India, narrowly beat analysts’ growth forecasts in the third quarter of 2013, with economists polled by Reuters putting the figure at 4.6 per cent. It is true that Indian growth has been disappointing since its nine per cent 2010 heyday, but Goldman Sachs recently claimed that an improvement and increase in investment demand would see the 1.2 billion-strong country bounce back in 2014.
Many are less bullish on Indonesia, where growth was down last year, to 5.6 per cent in the third quarter of 2013 compared to 5.8 per cent in the second. The country was hit by a global trend in 2013 of investors withdrawing money from emerging markets. The World Bank, in its most recent report on Indonesia, said that the country needed to focus on increasing foreign direct investment and bolstering exports.
But despite mixed results in Asia, it is likely that the service that IFCs and offshore finance have provided to countries such as China, India and Indonesia will remain an asset.
China continues to open up its economy. There are predictions for free convertibility of the RMB by 2020 which is heavily debated. Whenever this occurs, this is only one step and as international and western financial banks/institutions were not created overnight, it too may be decades before the domestic Chinese banking system will offer sophisticated and tailored wealth management options in any way comparable to those in Singapore or Hong Kong or other IFCs.
Other than the Shanghai FTZ, Shenzhen set up its special economic zone in Qianhai a few years ago to assist with the internationalisation of the RMB. The BVI has very recently announced the signing of a memorandum of understanding with Qianhai to promote cooperation in the financial industry. This development provides the ability to increase international investment in the region through the BVI, both to facilitate and intermediate foreign inward capital as well as outbound capital.
For Chinese companies looking to invest abroad, IFCs will continue to be invaluable – as the recent Shuanghui and CNOOC deals show. The only question will be whether firms opt to adhere to the favoured structures in the BVI and Cayman, or put their faith in new players like Jersey and Guernsey.
There is certainly a precedent for these Asian new kids on the block. Since global commodities giant Glencore raised over US$10 billion in a joint initial public offering (IPO) in London and Hong Kong in 2011 using a Jersey company, capital markets has been a growing area of interest for Jersey and Guernsey. Since then, Jersey and Guernsey companies have now been used by organisations as far afield as Russia and China and list on a range of global bourses, including the London Stock Exchange (LSE) main market and Alternative Investment Market (AIM) and the Hong Kong Stock Exchange (HKSE).
Much will depend on the needs of Asian companies. As they grow in sophistication, they will gravitate to those IFCs that best suit them, investors, regulators and the environment they are targeting.
Finally, many in the offshore world are suggesting that IFCs look to the successes of Hong Kong and Singapore in the face of the on-going crackdown from Europe and the US. Both cities have not only sold themselves for their low tax policies but on their effectiveness as business hubs, combining the offshore with the onshore, while maintaining good relations with the countries that surround them.
Hong Kong, Singapore and Asia more generally are not immune to the anti-tax avoidance agenda, and the recent crackdown by Chinese tax authorities on multinationals avoiding tax in China demonstrates that the authorities are conscious not to let things get out of hand. The South China Morning Post reported in December that unpaid taxes worth RMB34.6 billion were recovered in 2012. There have also been developments on tax information sharing. Beijing and Washington have agreed to negotiate an intergovernmental agreement (IGA) that would enable compliance with the US Foreign Account Tax Compliance Act (FATCA) and require higher due diligence and disclosure requirements. Further, both Hong Kong and Singapore have too signalled their intention to enter IGAs.
However, on balance China and other Asian nations still do not have large fiscal deficits and there is not the same need to bring in tax revenue to balance budgets. Asian affluence continues to grow and its middle class, prominent drivers of consumption and growth, as well as its younger populations, are powerful forces. The United Nations estimates that the middle class will grow to 3.2 billion by 2020 (from 1.8 million in 2009) and that Asia is almost entirely responsible for this growth. By 2030, Asia’s middle class is predicted to be 10 times larger than North America and five times larger than Europe.
As long as the offshore world continues to facilitate trade and investment and adapt to increasingly more highly-regulated environments, it will continue to find a home in the Asian economic landscape.
Partner and Global Chairman
Bermuda, British Virgin Islands, Cayman Islands, Guernsey, Hong Kong, Isle of Man, Jersey, Mauritius, Seychelles and Shanghai.