2017: The view from offshore | Asian Legal Business

The past year was a somewhat sluggish one for offshore legal counsel in Asia, although it also did not have the distracting volatility that reverberated from China in 2015. As the region looks forward to what 2017 has in, there are also questions on the horizon: China’s struggle to maintain its “new normal” of more than 6 percent growth, the impact of King Bhumibol Adulyadej of Thailand’s passing, and an uncertain future for the Philippines under President Rodrigo Duterte, to name a few.

Let’s start with the big question: How does 2017 look for Asian markets from an offshore law firm perspective?

“The Asian legal market place will continue to remain competitive for offshore law firms in 2017. There have been several new entrants looking to break into the market, largely based on price, and we think that pricing pressure will continue into 2017,” says Nicholas Plowman, a partner at Ogier.

“We feel China will continue to be the strongest market for offshore law firms in the region next year, and we would like to think that Japan’s economy will turn a corner in 2017, with an uptick in new work coming through in their asset management space. Southeast Asia remains a challenge for the offshore law firms, with the market remaining fickle and over-lawyered.”

Jonathan Culshaw, managing partner at Harneys Asia, says that 2016 was actually quite good for his firm, with both transactional and litigation revenues up quite substantially over 2015. “Having said that, offshore services the general Asian economies, and [it] has been hit by diminished M&A activity across the region, some weakness particularly in ASEAN markets, and the tightening of currency restrictions in PRC following market shocks there earlier in the year,” Culshaw says.

Partners at Maples and Calder have different takes on what to expect in the coming year. “On the finance side, China seems to be revving up,” says Mark Western, joint managing partner in Hong Kong. “Indonesia and Malaysia continue to be slow, but Korea [outbound capital] and Japan [unit trusts] are showing more signs of life. The Philippines and Myanmar are the jurisdictions to watch for opportunities next year.”

Anthony Webster, partner and head of investment funds in Hong Kong, has a fund-focused view of the near term. “The volume of new funds being formed – in both the hedge fund space and private equity space – has been on a steady increase with sponsors from Hong Kong, Japan and the mainland PRC continuing to start fundraising and form new vehicles,” Webster says.

“For corporate, the outlook remains pretty much the same, with the various macro-economic factors exerting some negative drag on confidence but the underlying trend remaining upwards,” says Greg Knowles, Maples and Calder partner and head of corporate in Hong Kong.

Acknowledging China’s continued central role in the region, Knowles explains there are additional sources of offshore work in the coming months. “In terms of other areas, we see potentially continuing consolidation in the TMT space providing M&A opportunities as well as a continuing need for capital giving rise to bond issues and other debt-raising,” he says.

“International PE houses will continue to invest strategically and opportunistically in growing PRC sectors such as technology, Internet, healthcare, consumer, etc.”

STILL DOMINANT

As Asia’s largest economy and its most significant driver of demand for offshore legal counsel, China is of course on everyone’s mind. A high debt-to-GDP ratio, lacklustre trade figures and a weakening renminbi may be a source of concern in other sectors, but offshore firms are generally sanguine about the short-term future of Chinese offshore demand.

“China’s growth rate is predicted to slow from 7 percent to 6.3 percent in 2017,” says Christopher Bickley, a partner and head of the Hong Kong office at Conyers Dill & Pearman. “This is attributed to the construction slowdown, stagnant industrial and mining sectors, and slow investment and GDP growth.

Policy support from the government [i.e. fiscal stimulus] is anticipated to mitigate harm. Moody’s is expecting a gradual slowdown and rebalancing rather than a large disruption and does not expect significant impact on global economic growth.”

“We expect that the introduction of the Shenzhen-Hong Kong Connect scheme later in the year will boost the attractiveness of the Stock Exchange of Hong Kong by allowing PRC investors further trading access to shares of Hong Kong listed companies,” Bickley adds.

Knowles at Maple and Calder says he sees China’s underlying strength and the direction of its economy primed to generate more corporate work moving forward. “China should continue to deliver opportunities for us in the offshore sector,” he says. “Cayman [Islands] and BVI [British Virgin Islands] continue to be the preferred [offshore] choices for significant corporate transactions in the PRC for all the usual reasons: investor recognition, service levels, political stability, legal infrastructure, value, [and the] ability of service providers to deliver work product in Mandarin in the Chinese business day. There is no reason for PRC companies to go elsewhere for offshore product.”

Knowles and his colleagues will end 2016 on a high note with the recently announced ZTO Express initial public offering, where the firm acted as Cayman Islands counsel. The offering was expected to raise as much as $1.5 billion, which would make it the largest U.S. IPO of 2016 and also the biggest by a PRC company after the $25 billion IPO of Alibaba Group Holdings in 2014.

The ZTO Express IPO represents a very significant capital raising in the U.S. And it is interesting to note that the U.S. capital markets and a Cayman vehicle were selected rather than domestic ones. This IPO is the latest example of a PRC company listing in the U.S. to avoid the red tape associated with launching IPOs in mainland China and to make it easier for existing shareholders to monetise their stakes, Knowles says.

“We think U.S.-listed Cayman companies [that] might profit from a return to the PRC will have made that move by now and we expect a slowdown in that type of transaction,” he adds. “There may very well be a return to U.S. capital markets using Cayman vehicles and the ZTO Express IPO may be a weathervane for that.”

The introduction of the Delaware-style LLC in Cayman will also increase its attractiveness, Knowles adds. “Other jurisdictions will continue to struggle in terms of legal infrastructure profile with no ability to offer a real price advantage,” he says. “Ireland’s DTT with China and low tax regime make it a good base for China outbound deals, especially into Europe.”

Knowles’ colleague Webster says that in the funds space, he anticipates continued growth in the alternative investment space in China. The renminbi’s internationalisation combined with market expectations of increased RMB volatility and high asset prices in mainland China relative to overseas assets should continue to drive demand from PRC for foreign currencies and foreign assets, he noted. That would be beneficial to the Hong Kong and offshore fund industry.

Maples and Calder also expects more additional funds will be established to target the increasing flow of monies from Chinese private or high-net worth clients. Some of these new funds may offer access to either other funds that would normally be offered only to institutions or to high-profile capital market or private equity deals.

According to Knowles, some of the allocators that have traditionally fuelled the funds market in China – particularly on the PE side – are not investing in the same volume as in prior years. However, there is slow-burn consolidation in certain segments of the market as well as interest in investing in China from other places, including Japan, he says.

In addition, Maples’ Western sees possibilities in business aviation, a rapidly growing industry that still has plenty of room for expansion. On one hand, China’s domestic business jet market is expected to develop steadily for several years to come. On the other hand, ambitious global acquisitions by Chinese companies on every continent are driving demand for mid- and long-range aircraft.

“In finance, Chinese aircraft lessors will continue to be very acquisitive and ambitious, and that will also drive business in the offshore markets as they look for the most tax-efficient ways to deploy aircraft,” points out Western.

WALKING A TIGHTROPE

With regard to capital outflows and international investment, Chinese regulators are walking a tightrope by simultaneously encouraging China Inc’s global buying spree while also doing everything possible to curb unwanted capital flows.

Ogier’s Plowman notes that this poses a challenge to offshoring, but it will be mitigated by other industry staples. “The restrictions on outbound capital flows in China have put pressure on the ability to establish new offshore structures from within the PRC. However, we remain confident that China will continue to grow in 2017, even if that is at a gradually slower pace,” Plowman says. “Dispute resolution, corporate, and asset management work remain the service lines that will be the strongest for the offshore law firms, and Ogier is well positioned to deliver in these areas with our Chinese language capability.”

Harneys’ Culshaw says he doesn’t see China’s importance in Asian offshore waning anytime soon, while noting the important role that Hong Kong can still play. “China, including Hong Kong, is by far the most important market for offshore in Asia, and I don’t see that changing any time soon,” Culshaw says. “This is partly a function of the size of its economy relative to other economies in the region, but [it] also reflects how embedded offshore is in usual business dealings here – it is rare to see any material transaction without an offshore element.”

Culshaw says he anticipates the number of instructions coming from PRC itself relative to Hong Kong to continue to grow, driven by increasing interest in offshore fund products in key financial markets within mainland China, along with an increase in the sophistication and number of outbound transactions where offshore structuring can often play a useful role. “Of course, the amount of work coming out of China will, to some extent, depend on the strength of underlying economic activity,” he says. “Should markets take a turn for the worst, we are hedged by having the largest offshore restructuring and litigation teams in Asia.”

BOOM OR BUST?

The other Asian region where there is significant offshore interest is the ASEAN, which launched the ASEAN Economic Community (AEC) a year ago to cautious optimism. The 10-nation unified market is not as unified as perhaps anyone would like at this point in time, and although it boasts a total population of 600 million people – slightly less than half of China’s population – it is far from being viewed as a bloc by offshore firms.

Two different groupings have emerged in ASEAN. One comprises the large, fast-growing economies of Indonesia, the Philippines and Vietnam, while the other includes the so-called “frontier economies” of Myanmar, Cambodia and Laos. Different types of investment favour different markets, but in general, the higher the population, the higher the interest. And for the second grouping, Myanmar is attracting more attention than Cambodia or Laos.

Singapore’s role as a regional finance and legal hub makes it an ideal conduit for offshore work in these growing markets. Meanwhile, Thailand is suffering from investor doubts due to political questions raised by the rule of the current junta government and the forthcoming year of mourning, while Brunei is struggling to wean its economy off of its petroleum dependence in the face of low oil prices.

“Offshore is not quite as embedded in ASEAN economies as it is in China, with some of the economies not generating much sophisticated cross-border activity, local funds markets much smaller than China and offshore more infrequently used as a listing vehicle of choice,” Culshaw says. “Having said that, our Singapore office saw an increase in workflows in 2016, and we are hopeful of that continuing into 2017.”

Similarly, Plowman at Ogier also sees consistent work coming from the region, although with some significant caveats beyond the region’s control.

“We don’t feel ASEAN will surge, but there will likely continue to be a steady flow of work for the offshore law firms from the ASEAN countries,” he says. “However, if interest rates rise at the end of 2016 or early 2017 and there continues to be a squeeze on liquidity generally, this will naturally have a bigger impact on the developing ASEAN economies where capital is likely to retreat more quickly.”

Michael Gagie, managing partner at Maples and Calder’s Singapore office, described ASEAN as a market where offshore is more likely to operate through back doors – namely, Singapore or Hong Kong. “It is difficult for us to have a clear view on this, given the jurisdictions that we practice in Southeast Asia as typically, for inter-ASEAN deals, there will be no “offshore” aspect – such as BVI or Cayman – to the structure and therefore, [we] are unlikely to be advising on those deals,” Gagie says. “What we do see though is an expectation among lawyers in the region that there will be an increase in transactional activity over time. One trend that we have observed is the increasing use of Singapore- or Hong Kong-domiciled vehicles as the conduit through which investment is being made between businesses in different Southeast Asian countries.”

The geographical proximity of those jurisdictions, coupled with confidence in their legal systems and the potential benefits of a double-taxation treaty network, are all reasons why those jurisdictions are being used, according to feedback received by Maple and Calder, he added.

SEEKING ACTION

There is also a diversity of opinions when it comes to which practice areas will be hot in 2017, as well as the kind of work that offshore law firms can expect to get.

“I would expect to see dispute resolution and restructuring and insolvency work continue to remain strong for the offshore law firms as we see disputes rise, with the stress placed on existing offshore structures in Asia,” says Ogier’s Plowman. “I would also expect the asset management industry in China to continue to evolve and grow as Chinese asset managers and brokerages look to build out their asset management platforms.”

Corporate work should remain steady in the region, Plowman adds, with the possibility of private work coming back on stream as valuations for Asian companies listed on foreign exchanges continue to reduce and make it less viable for these businesses to remain publicly listed.

For its part, Conyers Dill & Pearman noted that that although Asia is experiencing slow growth, the firm continues to see a large volume of work from the M&A, capital markets and banking sectors, and it expects this trend to continue in 2017.

“We advise nearly 60 per cent of the Cayman companies listed on the Stock Exchange of Hong Kong and provide Corporate Services to over 70 per cent of those companies,” says Bickley. “We also advise on the buy side in a high percentage of all public company M&A transactions, including the largest to date, the take-private of Qihoo 360 Technology Company.”

Culshaw at Harneys sees the cornerstone policy of China’s president, Xi Jinping, as a major catalyst for workflow in 2017. “We are expecting offshore funds work sourced from China to start to pick up again to 2015 levels and beyond, and are hopeful that the continued liberalisation of the Chinese economy, and focus on increased outbound activity under the ‘One Belt, One Road’ policy, will lead to increased transactional offshore work sourced from China,” he says.

Maples’ Western provides a shortlist of where he sees the action taking place in 2017, including “IPOs, as the logjam built over the last year is released, aircraft financing – driven by both the order books of the airlines in the region and the growth of Chinese lessors – and securitisations, if the pricing for unsecured corporate bonds increases.”

INTERESTING TIMES

Similar to Harneys’ Culshaw, Western’s colleague Webster also sees an upward trend in fund work as being likely in the coming year. “In the funds space, we anticipate that 2017 will see significant activity across a number of product types, and in a number of jurisdictions in Asia, with no particular space taking a dominant position,” he says.

“With the economic climate in Japan, the very low or negative interest rates are causing banks and pension funds to rebalance their massive portfolios in a search for yield. We have already seen the early stages of this with these Japanese institutional investors moving away from holding low-yielding government debt and investing instead in higher-yielding alternative assets, using offshore investment vehicles in order to obtain such exposure, and we expect this trend to continue in 2017. This has been reflected with a number of large fundraises in the PE space from Japanese sponsors which we see continuing well into 2017.”

In Hong Kong, Webster says he is seeing early signs of an increase in new hedge fund managers coming to the market, with existing players also set to raise funds in 2017. “We see no signs of a slowing in the number of new players starting up fund management business in Hong Kong, which will continue to be fuelled by mainland PRC managers setting up shop in the SAR,” he adds.

Like any predictions or prognostications, these views on how 2017 will play out for offshore in Asia are likely but far from guaranteed. There are numerous external variables – most notably the outcome of the U.S. presidential election – that could affect regional and global investor sentiment as well as the Fed’s posture.

That said, Asia looks likely to stay on a steady course, with the possibility of some interesting surprises. – Christopher Horton

U.N.: COMPANIES PUT $221 BILLION INTO LOWTAX JURISDICTIONS IN 2015

Companies put $221 billion into countries with low tax last year, chiefly Luxembourg and the Netherlands, while $72 billion of investment went into two British tax havens – the British Virgin Islands and Cayman Islands, the U.N. has revealed.

However, they took billions out of Luxembourg and the Netherlands in the final quarter of 2015 after the two countries imposed new EU rules to crack down on abusive tax practices.

The flows into the British Virgin Islands and the Caymans were roughly in line with historical averages but their source has shifted from rich to developing countries in recent years, the U.N. think tank UNCTAD’s report said.

From 2010 to 2014, Hong Kong, the United States, Russia and China were the top four sources. Companies shuffling money between jurisdictions to save on tax remained “a key concern for policy makers”, the U.N. report said, noting that firms from a sample of 26 developed countries registered more profits in Bermuda than in China in 2014.

The report said companies’ “special purpose entities” (SPEs) were typically subsidiaries that had little connection to the local economy but held assets or liabilities or raised capital.

Quarterly flows to the SPEs in the Netherlands reached $148 billion in the third quarter, the highest since 2007, driven by investment from Luxembourg and Britain, but then sharply reversed.

Flows to Luxembourg, associated with funds financing investments in the United States, surged in the first three quarters of 2015, triple on the same months of 2014, but turned negative with a net divestment of $115 billion in the final quarter.

“The tight interrelation between SPE flows in Luxembourg and the Netherlands highlights the existence of dense and complex networks of these entities in both countries, with capital flowing rapidly among them in response to financing needs and tax planning considerations,” the report said. – Wakako Sato and Junko Fujita of Reuters