7 November 2005
Asian interest in offshore vehicles - both in structured finance transactions and in the use of offshore companies and partnerships for investment vehicles - has grown dramatically over the last two years. The region has grown in popularity as a result of its diverse investment opportunities, high savings rates, growing foreign investment and the fact that it provides investors with diversification opportunities in contrast to the relatively stale growth prospects of the US and Europe.
China has been a key driver for this growth. With a large population and growing technology-based economy, China is methodically implementing fund investment policies aimed at attracting major players in the international funds arena. Mainland Chinese cities such as Shanghai have become regional financial centres, attracting many global financial institutions. The Beijing government has shown a commitment to developing its macro-economic policy and, as a result, has taken active measures to attract more foreign investment and encourage exports and domestic consumption to support the economy.
Similar themes are reflected throughout Asia. For example, the regulatory authorities in Singapore and Hong Kong continue to slowly but steadily modify their fund investment laws, which traditionally have not favoured foreign fund investment activities. These efforts at improving their respective fund investment policies are geared towards attracting many more foreign investment players to their countries and the region overall. As a result, these financial centres have enhanced further their reputations as sophisticated jurisdictions able to provide top-quality service providers to international investors and financial institutions. Having these services available is essential to attract foreign investment groups to establish a presence in their countries. The diversity of service providers in such centres allows competition, which is undoubtedly good for foreign fund companies seeking to expand into the Asian market.
Asian-focused hedge funds have grown from 13.8 billion in 1999 to approximately 65 billion today. Offshore funds have been growing in popularity generally over the last 10 years. Mutual funds and private equity funds were reasonably popular up until the Asian financial crisis, but the deteriorating market conditions which emerged after that, as well as low interest rates and a dearth of IPOs, increased the popularity of hedge funds.
In Japan, twice as many institutional investors use hedge funds as US institutions, contradicting their reputation for being among the most conservative investors and suggesting continued growth in the region. Greenwich Associates found that, at the end of last year, 55 per cent of Japanese institutions had invested in hedge funds, against 28 per cent in the US and 10 per cent in the UK. In 2003, hedge fund investment accounted for 4 per cent of assets under management, but that figure now stands at 13 per cent. According to Eurekahedge, there are now some $24bn (£13.48bn) invested in hedge funds with Japan-focused strategies. In addition, there are billions of dollars invested by Japanese investors in hedge funds globally.
Having disappointed investors in the past, the last two years have seen private equity investors setting up funds at an unprecedented level and going on to achieve internal rates of return to rival or even surpass competitors in the US and Europe. It is estimated that the region saw $6.5bn (£3.65bn) worth of commitments by private equity funds in 2004 - up 50 per cent on the previous year.
Earlier this year, private equity players had grown concerned about the flurry of notices issued by the People's Republic of China (PRC) State Administration of Foreign Exchange on the approval requirements and registration procedures for foreign investments made by domestic residents of China, as well as mergers and acquisitions of domestic enterprises by foreign companies established or controlled by such domestic residents. Such notices contained many uncertainties and implementation difficulties, which potentially created significant problems for offshore joint venture vehicles to be established between overseas investors and individual residents of China (a mode of investment into China favoured by most foreign investors). However, a new regulation released in October 2005 effectively scrapped the provisions of such notices, which had been blamed for a 5 per cent drop in the value of China-related M&A deals in the first half of 2005 to $26.2bn (£14.72bn).
When the investment structure calls for an offshore vehicle, the Cayman Islands are particularly attractive for Asia-focused funds because the regulatory and legal framework mandates transparency and disclosure - a critical need for institutional investors and high-net-worth individuals - over and above even what the US currently requires.
As a British Overseas Territory, Cayman offers all the security and stability traditionally associated with the UK and has an independent legal and judicial system based on English common law, with a right of final appeal to the Privy Council in London. Cayman is responsible for its own internal self-government, while the UK remains responsible for external affairs, defence and the courts. The jurisdiction benefits from advanced telecommunications, infrastructure and support services, as well as an educated and well-trained workforce. Cayman government law and regulation have been developed in close partnership with the private sector to ensure that they meet the needs of the financial community. Through this partnership, the government has established sophisticated and efficient supervision and regulation to safeguard the jurisdiction's integrity, while creating an operating environment that is highly attractive to private enterprise.
This popularity is clear just in terms of listed companies. Analysis of the Hong Kong marketplace and statistics produced by the Hong Kong Stock Exchange found a 165 per cent increase in investment companies based there over the last three years - with the overwhelming majority originating in Cayman. In 2004, there were 28 investment companies, 21 of them originating in Cayman, compared with 17 investment companies in 2001, 11 of which were from Cayman.
The sustainability of growth in Asia is, however, the subject of some debate. Revaluation of the yuan is of particular interest and many commentators believe that gambling on Asian currencies rising against the dollar over the coming months, as China further revalues the yuan, is unlikely to be as profitable as many hedge funds expect. Many are of the view that the Beijing government will control speculative activity to prevent any destabilisation of China's economy and that it is likely to move slowly on revaluation.
Nevertheless, there is a general recognition that Asian currencies will strengthen across the board and that Asian markets are likely to show a positive return for the remainder of 2005, as it becomes clearer that the growth environment remains solid and that concerns over rising interest rates and inflationary pressures are subsiding.
Vicki Hazelden is a partner at Walkers