Offshore: The unsilent majority

Among Asia’s competing financial centres, Hong Kong is the essential place to be for leading offshore law firms. Collectively, their local offices have grown significantly over the past few years to around 300 lawyers, making Hong Kong the third most-heavily lawyered jurisdiction by offshore firms after the Cayman Islands and Jersey.

But in early June, the first visible signs emerged of real discontent with Beijing’s increasing threat to Hong Kong’s freedoms: around 3,000 lawyers took part in a silent protest march in opposition to a government bill that would amend the city’s extradition law – the largest-ever protest by lawyers in history. They argued vehemently that the proposed amendment would allow Hong Kong to handle extradition requests from jurisdictions with no prior agreements, most notably China, and would strike a blow to the rule of law. Since that peaceful march, Hong Kong has deteriorated to become a city in crisis. Several months of much larger pro-democracy protests by millions of its citizens have provoked widespread violence and a sustained fall in business activity.

How have these local difficulties affected the international work of offshore firms? Notably, one managing partner declined to answer the question ‘due to the delicate nature of the political landscape there’. But most are willing to offer a view, and in many cases, they are both phlegmatic and relatively sanguine.

Chorus of confidence

Deal flows in Hong Kong have not seen the strong growth that the past few years have each delivered, but neither have they shrunk, according to Edward Mackereth, Ogier’s global managing partner. ‘Although the volume of formation instructions may have decreased slightly, the nature of the work has also changed,’ he says. ‘Specifically, private wealth, finance, restructuring and disputes instructions have become significantly more prevalent than was the case even five years ago, and Hong Kong remains the centre of the Asian funds industry. Private wealth work also continues to be strong and growing with increased sophistication and use of dynastic structuring. Parallel family office structures are being created in the Channel Islands and elsewhere, whereas before they were based solely in Hong Kong.’

At Harneys, chair Peter Tarn offers a robust response: ‘The honest answer is no effect really at the moment. We are not seeing anything tumbling or changing that we would attribute to what’s happening in Hong Kong. It may have an impact in future, but at the moment it hasn’t shown through.’ Christian Luthi, chair of Conyers, concurs: ‘We have not noticed a significant change in the volume of deals or litigation. There is no question that, should the political situation continue to deteriorate over the medium term, this could have significant adverse effects on Hong Kong business and, by implication, deal flow that originates from Hong Kong.’

‘Chinese people with wealth are asking: how do we structure our wealth, do we need to structure it further away from Hong Kong?’
Jason Romer, Collas Crill

Michael O’Connell, group managing partner of Appleby, says Hong Kong and Asia more generally have been subject to a fairly uncertain 2019 so far, but this is not out of step with other key cities globally. He observes that although deal volume and value have been down, Harneys’ Hong Kong office set its highest record yet for total deal value on listing deals during the first six months of 2019. During that period, the team worked on transactions with a value of approximately $2bn. ‘This not only represents a $1.6bn increase compared to the same period in 2018, it also surpasses the total value of deals in the whole of 2018 by $770m.’

Despite this chorus of confidence, evidence suggests business activity is less harmonious than it had been before the protests began. So far, the second half of 2019 has seen large initial public offerings (IPOs) in Hong Kong grind to a halt. In July, Anheuser-Busch InBev (AB InBev) cancelled the $9.8bn listing of its Asia-Pacific unit, Budweiser Brewing Company APAC. A month later, in what would have been the world’s largest IPO this year, expected to raise up to $15bn, Alibaba postponed its highly-anticipated listing due to rising political instability.

By September, companies had raised just $10.8bn so far this year in new Hong Kong listings – far behind the $16.5bn raised between Shanghai and Shenzhen. When AB InBev’s Hong Kong IPO eventually debuted at the end of September, it raised $5bn. ‘In Hong Kong, IPOs are a key part of the finance sector,’ says Mackereth. ‘Cayman vehicles continue to be the default choice for listings on the Hong Kong Stock Exchange. While there are fewer mega IPOs coming out of China, we’re still seeing strong deal flows.’

Alex Ohlsson, group managing partner of Carey Olsen, which opened a Hong Kong office three years ago, paints a nuanced picture. ‘We are certainly seeing activity in the Hong Kong market and yes, obviously there are difficulties and it is affecting confidence,’ he says. ‘But in so far as the business community is concerned, life continues and deals continue, and we’ll see whether there is a long-term impact from this period of loss of confidence.’

A broader perspective is given by Ingrid Pierce, global managing partner of Walkers, which has the largest Hong Kong office of any offshore firm. ‘In the aftermath of the upset, it had an immediate domestic impact. There’s been a tightening of the local economy in property, retail and tourism but also a knock-on effect on some deals.’ On the corporate M&A side, she adds there has been a slowdown in volume, the suspension of some IPOs, and generally deals going on hold. On the other hand, some managers are looking for opportunities that volatility creates from the yield in certain asset classes. There has been some increase in instructions and enquiries on privatisations, mergers, leases, and corporate restructuring.

‘People are looking at Cayman, Jersey, Guernsey and Singapore to structure their wealth for the next generation because of what’s happening with Hong Kong, the PRC and the global economy.’
Tim Pearce, Bedell

The protests are not adversely affecting Hong Kong’s traditional entrepôt role for capital flows, according to Tim Pearce, global managing partner of Bedell Cristin. Although the firm does not have a local office, it receives work from local clients and those who structure their capital flows through Hong Kong into Europe and elsewhere. ‘Even before the recent civil unrest, because there’s been such massive growth in China and other South-East Asian countries, the people who have made money often made it so quickly, they haven’t really focused on traditional wealth-planning strategies,’ he says. ‘Not in terms of spending, but how to plan for the next generation and put some basic financial planning in place.’

As a result, the private client market, whether from the PRC or Hong Kong, is ‘absolutely booming’. But, he notes, there is caution about where to invest. ‘What private capital wants to see is economic certainty and political stability because otherwise, it scares them off. They are looking at places like Cayman, Jersey, Guernsey and Singapore to structure their wealth for the next generation because of what’s happening with Hong Kong, the PRC and the global economy.’

Stephen Baker, senior partner of specialist disputes firm Baker & Partners in Jersey adds: ‘We would expect to become involved in litigation work arising as a result of assets leaving Hong Kong, if that is how it plays out. Capital needs to move around, and it is this movement that typically generates the need for legal services, particularly in dispute resolution and litigation.’

Meanwhile, there is speculation around the structuring of Hong Kong entities, according to Jason Romer, group managing partner at Collas Crill. ‘A fund managed by a Hong Kong manager may be thinking about where the investment manager is based and whether they could be offshore,’ he says. ‘If you have mainland China companies with a Hong Kong presence, they might be looking to shift those offshore – we have had clients interested in exploring that. As events in Hong Kong continue, so Chinese people with wealth are asking: how do we structure our wealth, do we need to structure it further away from Hong Kong? If faced with a genuine choice between Hong Kong and Cayman, then at present there is a preference to be in Cayman.’

Bigger picture

There are, of course, much wider considerations affecting the region. The Hong Kong protests cannot be viewed in a vacuum and the US-China trade war has undoubtedly impacted both deal volume and value across various sectors – this has inevitably, as a consequence, negatively affected the flow of funds. Developments in China over the last few years have had a knock-on effect on multiple aspects of the world economy.

The impact of a protracted trade war between the world’s two economic superpowers is multi-dimensional. Before the Hong Kong problem emerged, China’s extraordinary level of GDP growth was already slowing as Chinese M&A value dropped to a ten-year low of $164bn in H1 2019 with the biggest falls seen in financial services and construction. Meanwhile, Chinese regulators continue to scrutinise companies’ overseas investments amid concerns over excessive capital outflow and a build-up of corporate debt.

‘Offshore jurisdictions’ appeal is likely to increase to global asset managers who find themselves struggling to replicate the double-digit returns of recent years.’
Jonathan Rigby, Mourant

Offshore centres have traditionally provided vehicles for western investment into China. The trade war and a slowdown in not just M&A work but corporate transactional work generally will negatively impact Asian work flow. Says O’Connell: ‘Our longstanding Asian clients and companies can take some comfort from the security that being in an offshore financial centre affords them.’ Mackereth adds: ‘Our business in Hong Kong has been remarkably resilient. While the recent trade disputes have definitely dampened the growth in deal flows, so far we haven’t seen a decrease in absolute terms.’

Asian business keeps flowing. This, according to offshore leaders, is as a result of two factors: one, there just is not the same level of political hostility to offshore centres in Asia that you see certainly in Europe; and two, the economies are growing faster. Tarn says: ‘Whether it’s the Chinese economy, the Vietnamese economy or the Indonesian economy, there is growth everywhere you look.’

Despite the trade war, acquisitions by Chinese companies have remained steady. In a similar vein, offshore companies have been active acquirers of Chinese targets, with the number of purchases steadily increasing. However, both these trends have slowed in 2019 with uncertainty plaguing the M&A environment. $5bn+ megadeals that were a regular feature of the offshore market last year typically originated from China or the US and have been curtailed. A recent increase in control over capital flight out of China has also had a knock-on effect on international real estate investment. Awash with investment cash, private equity-financed deals out of the US or China have yet to reduce.

Walkers has experienced changes since the trade war started. ‘We have seen some increase in debt refinancing and restructuring, and in private equity,’ says Pierce. ‘Those deal volumes are probably increasing everywhere, including in the US as well as in Asia. There is also some increase in deals, particularly for industries that are not affected by the US-China trade war, and are less impacted by exports: domestic consumption, healthcare, and education. There are more opportunities and greater deal flow.’

Of concern to businesses everywhere is how far the global slowdown may progress. Thanks in part to the trade war, the world is now on recession watch, while business investment is slowing and consumer confidence is fragile. At present, most economists expect that growth will continue to weaken slightly without yet predicting that a recession is imminent. Either way, offshore firms are well-positioned.

‘Offshore centres’ swift and positive response to the 2008 crisis is a good template for any future headwinds encountered.’
Michael O’Connell, Appleby

Ohlsson highlights work flowing from the divergent economic position that already exists between the US and Europe. ‘We have seen a US economy that’s been extremely strong and in Europe we have seen some economies that have slowed,’ he says. ‘So, to the extent that the offshore jurisdictions are focusing towards Europe, one is seeing less deal flow, and to the extent that offshore jurisdictions are focusing on the US, one is seeing increasing deal flow. We are also seeing US funds and Asian funds investing in European assets, presumably because they see opportunity at current prices.’

The political and economic stability of the leading offshore jurisdictions mean that they tend to be relatively resilient in a downturn, suggests Jonathan Rigby, global managing partner of Mourant. ‘And, since they offer more cost-effective structuring solutions than onshore jurisdictions, their appeal is likely to increase to global asset managers who find themselves struggling to replicate the double-digit returns of recent years.’

O’Connell adds: ‘Offshore centres are able to adapt very quickly to changes in the world economy and their swift and positive response to the 2008 crisis is a good template for any future headwinds encountered.’ Offshore firms, perhaps even more than their onshore counterparts, are structured flexibly to adapt themselves to changing circumstances, as summarised by Luthi: ‘Historically, and somewhat classically, we have seen that recession tends to lead to a slowdown in corporate work but an increase in litigation and restructuring.’

Whatever direction the global economy takes in the short term, Asia is where most offshore firms continue to see their future development in the long term. According to all the available data, Tarn is right when he says there is growth everywhere you look. LB