China Outbound: To infinity and beyond – Offshore

Rio Tinto held a majority stake in the joint venture company while the remaining interest was held by Chinalco through a subsidiary. As part of this deal, convertible bonds were issued to Chinalco in each of Rio Tinto plc and Rio Tinto Limited for a total consideration of US$7.2 billion. If converted, these bonds would increase the shareholding of Chinalco to 19% in Rio Tinto plc and about 15% in Rio Tinto Limited. It is expected that the joint venture company will become active some time this year.

For the purposes of this transaction, a Jersey joint venture vehicle was used. Jersey has always been a popular offshore jurisdiction for European investors or investors looking to invest into Europe. Reasons for this popularity include Jersey's reputation for high regulatory standards giving investors confidence in investing in a Jersey vehicle. In addition, there are tax efficiencies in the use of a Jersey vehicle, especially for investors in the UK, since Jersey has entered into a double taxation treaty with the UK. Also, Jersey signed a tax information and exchange agreement with China in October 2010 further bolstering its position as an offshore centre from China's perspective.

Another notable deal relating to investment into the Chinese natural resources sector was the 2010 acquisition by Sino-Forest Investments Limited (an indirect subsidiary of Toronto Stock Exchange listed company Sino-Forest Corporation) of Mandra Forestry Holdings Limited, a Chinese group that owns a substantial area of land in China and operates a number of forestry plantations. As part of this acquisition, Sino-Forest Corporation issued more than US$187 million of high yield notes. This acquisition added 155,600 hectares of trees that are located in eastern China and extended its geographical reach eastward. The plantations of Mandra Forestry Holdings Limited will be sustainably harvested, while generating sustainable cash flow.

Both Sino-Forest Investments Limited and Mandra Forestry Holdings Limited are companies incorporated in the British Virgin Islands. There were also a number of other BVI companies utilised in this acquisition.

In addition to Jersey, the BVI is a well established offshore jurisdiction for the incorporation of investment holding companies and joint venture companies. The BVI is tax neutral and its ease of administration as well as the low costs of maintenance make the use of a BVI company very efficient. The BVI is also a recognised and approved domicile for many of the world's largest stock exchanges, including Nasdaq, the London Stock Exchange (and the Alternative Investment Market) and the Hong Kong Stock Exchange, Asia's second largest stock exchange behind Tokyo.

China goes global

In 2009, global outbound direct investment volume amounted to US$1.1 trillion and 5.1% of this was contributed by China. China is now the fifth largest global investor in terms of outbound direct investment and is the largest among the developing nations. Its outbound direct investment grew 1.1% in 2010 from a year earlier to US$56.53 billion. This is impressive when viewed against a backdrop where foreign investment globally decreased by almost 40% in 2009. In terms of geographic spread of Chinese outbound investments in 2009, approximately 71%, 6% and 4% of such direct investments were invested in Asia, the EU and Oceania (including Australia) respectively. In 2010, China's outbound direct investment in the financial sector increased by a staggering 43.9% while in June alone China made foreign investments of US$8.91 billion. It is estimated that the bulk of China's outbound direct investment is made by Chinese state-owned enterprises.

These impressive statistics support China's rising economic power and the increase in its outbound direct investment activity is expected to continue in the near future. It is anticipated that the growth rate for China's outbound direct investment in the next few years will be much higher than previous years.

There are various reasons for such an increase. Firstly, the global financial crisis has provided enterprises in China with a good opportunity to expand and invest in foreign ventures at a comparatively lower price than before because of the generally lower asset valuations. The appreciation in the Chinese yuan against the US dollar also adds to its economic power.

Secondly, many large and medium sized enterprises in China are looking to expand into the global market through the use of established global operations and worldwide brands. Similarly, Chinese enterprises also wish to acquire information technology and technology know-how through their outbound investments. Acquiring, for example, a Canadian or a US company is one strategy that Chinese enterprises can utilise to reach these two goals and with the lower asset valuations, many consider the timing to be ripe to crystallise this strategy. In 2010, Chinese outbound acquisitions that targeted Canadian and US entities have, compared to 2009, increased 81% to US$6.8 billion. The energy and resources sector accounted for about 70% of this increase.

Some of China's outbound direct investment took the form of acquisitions of foreign companies and China's outbound M&A activity for the first six months of 2010 exceeded US$1 billion. This represented an increase of more than 50% compared to the first half of 2009. Ninety-nine deals in total were announced, showing unabated growth in China's outbound activity since 2008.

Tapping natural resources

While the high technology, automotive and services industries are gaining more attention from Chinese investors, most of China's outbound direct investment has been targeted at the natural resources sectors such as mining and energy and resources. This trend is mainly driven by China's need for resources to fuel its economic growth and there were 14 M&A deals announced in the first half of 2010 relating to Chinese outbound natural resources investments.

As China's booming economy has averaged an annual 9% growth for the last two decades, it requires massive levels of energy to sustain its growth. Although China relies on coal for most of its energy needs, it is the second-largest consumer of oil in the world behind the US. The International Energy Agency projects China's net oil imports will jump to 13.1 million barrels per day by 2030 from 3.5 million barrels per day in 2006. China imports about half its oil supplies from the Middle East, and that percentage is projected to grow in the coming decades. Yet the extent of the country's energy demand has also compelled China to push into new markets, particularly Africa.

Into Africa

It has been estimated that 85% of Africa's exports to China come from five oil-rich countries (Angola, Equatorial Guinea, Nigeria, the Republic of Congo, and Sudan), according to the World Bank report.

In the first half of 2010, one of China's largest state-owned refiners and the biggest refiner in Asia by capacity acquired a majority stake in Angola Block 18, a world class deep-water oil asset considered to possess the highest reserves and production volume. The completion of the acquisition strengthened the scope of the Chinese refiner and also enabled its remaining proven reserves of crude oil to be bolstered by 102 million barrels.

Certain entities involved in this particular acquisition are companies incorporated in the Cayman Islands. The popularity of the Cayman Islands as a jurisdiction stems from several factors including: flexibility in the Cayman Companies Law over the use of share premium accounts; Cayman's acceptance as a domicile for companies listing on the world's top stock exchanges; and its tax neutrality. The Cayman Islands is a popular choice for the formation of investment holding companies in Asia and over 50% of the companies listed on the Main Board of the Hong Kong Stock Exchange are set up in the Cayman Islands. Cayman is also the most popular jurisdiction of incorporation in Asia for mutual funds and there are over 9,500 mutual funds regulated in the Cayman Islands.

Chinese interest in Africa extends beyond oil. China now ranks as the continent's second-highest trading partner, behind the US and ahead of France and the UK. From 2002 to 2003, trade between China and Africa doubled to US$18.5 billion; by 2007, it had reached US$73 billion. Much of the growth was due to increased Chinese imports of oil from Sudan and other African nations, but Chinese firms also import a significant amount of non-oil commodities such as timber, copper and diamonds.

China recently began to import some African-manufactured value-added goods, such as processed foods and household consumer goods. Experts say Chinese companies see Africa as both an excellent market for their low-cost consumer goods, and a burgeoning economic opportunity as more countries privatise their industries and open their economies to foreign investment. Some Chinese textile manufacturers, for example, are reportedly investing in African factories as a way to address the US and European quotas on Chinese textiles. For example, Chinese investment into Mauritius in the three years from 2007 to 2010 has been very substantial. During President Hu Jintao's visit to the country in 2009, he promised US$260 million to redevelop the island's international airport. Meanwhile, the US$730 million Shanxi Tianli Enterprises Park (a special economic zone in the Indian Ocean to service Beijing's expansion in Africa, Financial Times, January 25 2010), in development near the capital of Port Louis, represents the largest ever foreign direct investment into Mauritius.

Given Africa's richness in natural resources, it is a magnet for increasing levels of Chinese outbound investment. A typical structure used by Chinese companies investing into Africa would involve the set up of a Mauritius or a Seychelles vehicle. This is held by the Chinese company with the Mauritius or Seychelles vehicle then making the investment in Africa.

There are specific advantages for setting up and administering investment vehicles in Mauritius and Seychelles for investment in Africa. For example, capital gains tax, where imposed in Africa, is generally levied at a rate ranging from 30% to 35%. Nevertheless, the double taxation agreements in force in Mauritius or Seychelles restrict taxing rights of capital gains to the country of residence of the seller of the assets. Since there are no capital gains taxes in Mauritius or Seychelles, the potential tax savings for the Mauritius residence entity is significant. Also, Mauritius has signed investment promotion and protection agreements with 15 African member states (the agreement with South Africa already being in force). An investment promotion and protection agreement typically offers the following guarantees to investors from the contracting states: (a) free repatriation of investment capital and returns; (b) guarantee against expropriation; (c) most favoured nation rule with respect to the treatment of investment, compensation for losses in case of war or armed conflict or riot etc; and (d) arrangement for settlement of disputes between investors and the contracting states. Therefore, much of the increase in foreign direct investment into Africa has been routed through Mauritius and Seychelles domiciled investment vehicles.

Mauritius and Seychelles are becoming increasingly popular (in particular for investments into Africa). This is because they combine the traditional advantages of an offshore financial centre in the Indian Ocean (no capital gains tax, no withholding tax, no capital duty on issued capital, confidentiality of company information, exchange liberalisation and free repatriation of profits and capital etc) with the distinct advantages of being treaty based jurisdictions, with a substantial network of treaties and double taxation avoidance agreements. Both Mauritius and Seychelles have signed double taxation agreements with China, making these jurisdictions more attractive for Chinese investors.

Into Latin America

China is not only focusing its attention on the traditional markets of the US and Canada, and developing nations such as Africa, but is also expanding its reach into new markets such as Latin America. China has not limited itself to natural resources but has looked further afield into other industries such as the finance sector.

In the middle of 2010, China's sovereign wealth fund China Investment Corporation led a consortium of international investors to acquire the shares of Brazilian investment bank BTG Pactual. This represented an approximately 18.65% interest and was valued at US$1.8 billion. Founded in 1983, BTG Pactual is the leading investment bank, asset manager and wealth manager in Brazil. This deal represents the first investment of this size being made in Latin America by a consortium of investors consisting of several sovereign wealth funds. Other than CIC, the consortium consisted of affiliates of the Government of Singapore Investment Corporation, Abu Dhabi Investment Council, RIT Capital Partners and J.C. Flowers & Co. LLC.

Through this acquisition, the consortium of investors has started to build a long-term partnership that will assist with the development of their access to investment opportunities in Brazil. The acquisition will also enhance the consortium's deal-making and execution ability in the Brazilian region.

The offshore connection

The use of vehicles formed in offshore jurisdictions is almost customary in many transactions involving Chinese investments, whether it is inbound or outbound. One of the many attractions is investor and regulator familiarity worldwide (including US, Canadian and European investors), and acceptance of the use of offshore vehicles. In most cases, vehicles formed in these offshore jurisdictions are more easily administered and more flexible compared with vehicles formed in certain onshore jurisdictions. This means that the use of vehicles formed in these offshore financial centres will introduce greater efficiencies. Lastly, there are tax efficiencies to be gained from the use of offshore vehicles as these offshore jurisdictions are either tax neutral or have entered into double taxation treaties with China. This makes the use of vehicles domiciled there an attractive option compared with using vehicles formed onshore.

To infinity and beyond

It can be expected that China's outbound direct investments will continue apace in the coming years and that these investments will not be limited to natural resources. Given China's drive to become more of a consumer-based economy, her appetite will no doubt expand to all industries and sectors globally. We are likely to see greater focus by Chinese enterprises on the EU given favourable asset valuations resulting from the European debt crisis. The traditional offshore jurisdictions of Jersey, Guernsey and Isle of Man will feature prominently in these deals.

With substantial growth in Chinese outbound investments almost a certainty, offshore jurisdictions such as the BVI, the Cayman Islands, Mauritius, Seychelles, Jersey, Guernsey and Isle of Man will continue to have an important role in facilitating transactions.

FRANCES WOO

MANAGING PARTNER – HONG KONG

Tel: +852 2905 5720 Email: [email protected]

Frances Woo is Managing Partner of the Hong Kong office and Local Practice Group Head of both the Corporate and Commercial and Private Client and Trusts Practice Groups. She practises a full range of corporate and commercial law particularly specialising in mergers and acquisitions, advising on public and private offerings of debt and equity, restructurings, structured and other finance matters and funds work (mutual funds, unit trusts, limited partnerships, private equity). Clients include global and regional financial institutions, multinational organisations, listed entities and private equity houses.

Frances is fluent in English, Mandarin and Cantonese. Prior to joining the group in 1994, Frances practised corporate and commercial law in Toronto, Canada. She became a partner of Appleby in 1997 and managing partner of the Hong Kong office in 2000.

Frances was born and educated in Toronto, Canada. She holds a B.Sc. Honours Degree from the University of Toronto graduating in 1987 with distinction. She went on to study law at Osgoode Hall Law School, York University obtaining a LL.B. degree in 1991. Frances is a barrister and solicitor in Canada, a solicitor in England and Wales (now non-practicing), Hong Kong and in the British Virgin Islands and is registered with the Bermuda Bar.

Malcolm Moller

MANAGING PARTNER – MAURITIUS AND SEYCHELLES

Tel: +230 203 4301 Email: [email protected]

Malcolm Moller specialises in advising financial institutions on financial institution M&A, financial regulation, regulatory capital issues and insurance related transactions. He advises on private equity funds, hedge funds, derivatives transactions and securities offerings, as well as a range of corporate and corporate finance transactions.

Malcolm has extensive experience representing corporations, financial institutions and other principals. His experience spans public and private M&A, credit, restructuring, bankruptcy, capital markets, fund formation and winding up and a variety of strategic and advisory corporate assignments.

Malcolm's experience in credit transactions has included representing both banks and borrowers in multi-billion dollar secured, unsecured and commercial paper facilities for companies. In addition, his experience has included advising on strategic, regulatory, corporate governance, and director and officer liability issues for clients.

As a regular contributor on Mauritius-related articles, Malcolm's writings have featured in numerous publications, including The Lawyer, The American Lawyer International Investment and Investor Services Journal. Malcolm also provides commentary to publications, including Legal Business and The Lawyer. He also regularly speaks at conferences and events.

Tiffany Chan

Associate – Hong Kong

Tel: +852 2905 5721 Email: [email protected]

Tsen Ting Chan (Tiffany) is an associate of the Hong Kong office. She practises in the areas of corporate finance, debt capital markets, as well as funds and investment services. Tiffany joined Appleby in February 2006 having previously worked as a trainee solicitor in a law firm in London. She was admitted in England and Wales in January 2006 and is fluent in English and Cantonese.