On 1 March 2018, China’s National Development and Reform Commission (NDRC) released its Administrative Measures for Outbound Investments by Enterprises, which provided new rules for outbound direct investment (ODI) for the Belt and Road Initiative (BRI). Chinese-controlled offshore private equity funds have been brought within the purview of state control. It is worth considering what advantages onshore Chinese managers can attain with the structuring choices before them.
The initial decision is whether to proceed by using an onshore (i.e. domestic) company or an offshore company. There are several reasons to prefer the use of an offshore company to undertake ODI, including: (1) the ability to more easily partner with a foreign party, which is likely to be advisable or even necessary in many BRI jurisdictions; (2) the ease of financing through an offshore company; (3) tax advantages; and (4) flexibility in amending transaction terms, making tactical changes as the investment proceeds.
The follow-on decision is choosing the offshore jurisdiction. Some jurisdictions, such as Labuan, Samoa, Marshall Islands or Seychelles, promise a low cost of incorporation, but lack an entire ecosystem of advisers (such as accountants and lawyers) who ensure the day-to-day running of corporate matters, as have, for example, the BVI, Cayman Islands and Cyprus. Not all such jurisdictions are accepted for listing vehicles on stock exchanges, if that turns out to be the preferred choice for exiting an investment. And the companies law in many such jurisdictions is either not modern, or is not periodically updated to respond to the needs of investors and financiers. Choosing such an offshore jurisdiction on the basis of initial incorporation costs alone can be “penny wise and pound foolish”.
The BVI and Cayman Islands have established niches in private equity and hedge funds, as well as for IPO listing vehicles on the Hong Kong Stock Exchange. The reasons for the dominance of these jurisdictions for China-focused investments are:
- Their political neutrality: the jurisdictions are largely independent of political, military and trade disputes.
- Their common law legal systems: common law legal systems publish judicial decisions, which provide guidance as to what the likely outcome of a dispute based on similar facts may be.
- Light regulation: the BVI and Cayman Islands have robust anti-money laundering regulation to meet the requirements of big economies, but their populations are small and the financial services industry itself is protected from over-regulation, rather than seen by social pressure groups as a target to regulate.
- Tax efficiency: no extra layer of tax on either income or capital gains is imposed, and in addition, the BVI has no stamp duty on share transfers.
- Confidentiality: the BVI and the Cayman Islands have no publicly available register of shareholders. This has made these jurisdictions especially attractive to hedge funds and private equity funds.
- Flexible companies law that is both modern and periodically updated to meet the needs of investors and financiers: in both the BVI and the Cayman Islands, the companies law is similar to the Companies Act of England & Wales, and is thus a framework that is familiar to many lawyers worldwide due to the legacy of legal systems that modelled their companies act on that of England & Wales. In both the BVI and the Cayman Islands, the companies law is periodically amended to meet the requirements of investors and financiers, who are consulted on necessary amendments.
By contrast, in most countries, the corporate law is a result of balancing competing interests between labour and capital, or ideological factions, or other special interests in society. Further, in the case of the BVI, creditor protections have been designed to make the jurisdiction attractive to lenders (including a statutory security registration regime), which supports raising debt finance to implement an investment strategy; and
- Ability to restructure a company with no court approvals required: agreements to change the relative holdings of debt and equity, or the rights of holders of debt or equity, or even the ability to merge a company, or move it to a different jurisdiction, are all far easier in the BVI and Cayman Islands than in most other jurisdictions.
The BVI and Cayman Islands also make it easier to withdraw equity out of companies by way of dividends. Whereas onshore jurisdictions such as Hong Kong limit dividend payments to being made out of distributable profits, and also the manner in which dividends get approved (generally, by shareholders on the recommendation of directors), in the BVI and Cayman Islands the directors may cause dividends to be paid out as long as the company is solvent.
Corporate governance in BVI companies has also been modified to suit the needs of investors. Unlike the fiduciary duties owed by directors to the company as a whole, directors in BVI companies such as joint ventures are permitted to represent the interests of the shareholder who appointed the director. In the context of ODI for BRI investments, this means the greater scrutiny of China’s regulators can be satisfied for the simple reason that the Chinese investor’s appointees to the board of directors are permitted to act on behalf of the Chinese investor. With ODI expected to resume its growing trend in light of the clarity and focus brought in the past year by China’s regulators, this ensures that investments can always be influenced in a way that the Chinese government may require.