15 Nov 2014

Southeast Asia at the Crossroads: Three Paths to Prosperity

By McKinsey Global Institute

The Association of Southeast Asian Nations (ASEAN) is a coalition of ten diverse nations: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam. The region has posted strong growth since 2000, lifting millions out of poverty — but many gaps and disparities remain.

As Southeast Asia pushes to deepen its ties by completing the ASEAN Economic Community integration plan, the region is starting a new chapter in its economic development. But it will take the right set of catalysts to ignite more dynamic and inclusive growth. MGI’s analysis finds that global trade flows, urbanization, and disruptive technologies could provide the keys to unlocking the region’s full potential and creating wider prosperity…

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Knight Frank | 18 Dec 2014

Chinese Outward Real Estate Investment: After the Initial Waves, What's Next?

INTRODUCTION

There has been a tremendous surge in Chinese outward investment in overseas real estate in recent years. What first started as sovereign funds making exploratory investments has proliferated into buying sprees by Chinese developers, banks and institutional investors, such as insurance companies.

This surge has been fueled by a number of key domestic economic and policy factors. We argue that one the most powerful drivers has been the continued consolidation of China’s residential market. Fierce domestic competition, combined with government curbs on home purchases and rising borrowing costs over the past two years, has led to developers’ actively looking elsewhere for new opportunities. Government incentives, such as the relaxation of real estate investment regulations for insurance companies, have also resulted in billions of dollars in extra funding for overseas investment. Meanwhile, mature gateway markets in the UK, US and Australia, with their relatively stable economies, quality products and higher yield returns, continue to attract Chinese investors.

In this report, we focus on these push and pull factors, examining, in particular, issues such as the lasting impact the policy-driven Chinese market will have on outward-looking investors and gateway markets. We also shed light on the next wave of Chinese investors likely to make moves in offshore property markets. In addition we look at the diversification of investors as they move from core and development opportunities into other assets, as well as their move from gateway locations to other higher-yielding cities.

 

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Hong Kong Export Credit Insurance Corporation | 31 Dec 2014

Kuwait: Heavily Rely on the Oil Sector

Highlights

Political	Oil wealth helped Kuwait escape radical political upheaval brought across the Middle East by the Arab Spring However, tensions between the government and parliament have resulted in repeated early elections and cabinet reshuffle The emir holds firmly the power in its hands despite pressure for constitutional reforms
Economic	Proven oil reserves would last about 90 years at the current rate of production Economic growth has recently been constrained by subdued oil production and export growth Progress on economic diversification away from the oil sector has been limited

Country Overview

Kuwait is an Arab country at the tip of Persian Gulf, highly dependent on its oil resources. It has reserves of about 102 billion barrels - more than 6% of world reserves. Oil and gas sector has dominated the economy, making up about 60% of the country’s GDP and about 95% of export revenues. Thanks to its rich oil resources, Kuwait is among the most prosperous country in the world, with GDP per capita exceeding US$40,000. Kuwait has done little to diversify its economy, leaving the country exposed to external conditions. The political turmoil in Iraq and the rise of the extremist jihadi group also represent major concern for Kuwait’s security.

Key Data
Capital	Kuwait City
Population	4.0 million
Area	17,818 sq km
Currency	Kuwaiti dinar
Official language	Arabic
Form of state	Constitutional monarchy

 

Major Merchandise Exports (% of total, 2012)	Major Merchandise Imports (% of total, 2012)
Crude oil (93.3%)	Consumer goods (40.0%)
Non-oil (6.7%)	Intermediate goods (34.0%)
	Capital goods (23.0%)
Top three export countries (% of total, 2013)	Top three import countries (% of total, 2013)
South Korea (15.1%)	China (11.1%)
India (14.1%)	US (10.7%)
Japan (10.8%)	Saudi Arabia (8.0%)

Source: Economist Intelligence Unit (www.eiu.com)

Political Trend

Kuwait is a constitutional monarchy. Although there are no formal political parties, Kuwait has a strong electoral tradition, with a vocal single-chamber parliament made up of 50 members, which can reject government legislation. The current parliament is more balance between supporters and opponents of the government than its predecessor. However, persistent conflicts between the government and parliament could pose larger risks on political stability, and hinder structural economic reforms.

Given Kuwait’s relatively small size, strengthening political and economic ties with its five Gulf Cooperation Council neighbors will remain a key policy objective. Kuwait will seek to continue the policy of building strong bilateral relationships with major Asian powers such as China, Japan, India and South Korea, which are Kuwait’s main trading partners.

Economic Trend

Economic Indicators	2011	2012*	2013*	2014^	2015^
Nominal GDP (US$ bn)	155.0	174.9	173.5	177.3	183.6
Real GDP growth (%)	10.2	8.3	3.0	2.5	3.7
GDP per capita (USD)	41,940	45,750	43,760	43,330	43,510
Inflation (%)	4.8	3.3#	2.6	3.0	3.7
Budget balance (% of GDP)	29.8	25.9	26.0	25.1	22.4
Current account balance (% of GDP)	43.3	45.9	40.8	37.9	34.6
External debt/GDP (%)	24.1	20.2#	19.6#	18.7	19.1

#Actual  * Estimate  ^ Forecast
Source: Economist Intelligence Unit (www.eiu.com)

Kuwait’s oil reserves remain plentiful. It ranks first globally in per capita terms, with about 26,800 barrels per capita. At the current rate of production, proven oil reserves would last about 90 years. Substantial oil revenues have strengthened government finances significantly. Over the past ten years, Kuwait has recorded budget surpluses of 30% of GDP on average, current account surpluses averaged 35% of GDP, reducing the country’s vulnerability to external financial and economic risks to a very low level.

Looking ahead, a gradually rising oil production, and public and private consumption would support a higher growth of around 4% in the near term. However, risks remain predominantly on the downside, given the slower potential growth in advanced economies and emerging markets.

The government has announced a new five-year development plan, for 2015‑19, focusing on economic diversification and the implementation of several strategic mega-projects to boost investment. However, the plan still needs to be passed by parliament. Despite fiscal position is strong, spending rigidities on subsidies and pensions as well as rapid spending increase, which has trebled in the past decade, have also highlighted Kuwait’s fiscal risks.

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Hong Kong Export Credit Insurance Corporation | 31 Dec 2014

Poland: Actively Integrated with EU for Stability

Highlights

Political	Donald Tusk from the Civic Platform resigned from his position of Prime Minister in September, after being selected as next president of the European Council Major challenge for Ewa Kopacz, Tusk’s successor, is to deal with the different factions within the party before the next general election which is scheduled for late 2015
Economic	Polish economy has slowed markedly in the past two years – to only 1.6% in 2013 A continued economic decline in core euro area countries and rising geopolitical tensions represent major downside risks The Russian-Ukrainian conflict has prompted Poland to rethink its stalled euro adoption plan as deeper integration with EU may anchor stability

Country Overview

Poland is the largest country in Central Europe, in terms of both population and area. The accession to European Union (EU) in 2004 has further integrated its economy with Europe and the rest of the world. Helped by a relatively large domestic market, Poland was the only EU country to have avoided recession during the 2008 global financial crisis. Educated and competent human capital helps attract foreign direct investment (FDI) especially in the automotive, R&D, electronic and chemical sectors. Today Poland has joined the group of countries classified as high-income economies by the World Bank. However, its GDP per capita is at just about two-thirds of the EU average.

Key Information
Capital	Warsaw
Population	38.5 million
Area	312,685 sq km
Currency	Polish zloty
Official language	Polish
Form of state	Parliamentary republic

 

Major Merchandise Exports (% of total, 2013)	Major Merchandise Imports (% of total, 2013)
Machinery & transport equipment (34.0%)	Machinery & transport equipment (30.9%)
Manufactured goods (19.2%)	Manufactured goods (16.7%)
Food & live animals (9.5%)	Chemicals & chemical products (13.4%)
Top three export countries (% of total, 2013)	Top three import countries (% of total, 2013)
Germany (24.9%)	Germany (26.0%)
UK (6.5%)	Russia (10.0%)
Czech Republic (6.1%)	Netherlands (5.7%)

Source: Economist Intelligence Unit (www.eiu.com)

Political Trend

Poland is a parliamentary republic. Parliamentary elections are held at least every four years. After being selected as the next president of the European Council, Donald Tusk resigned from his position of Prime Minister in September, and was succeeded by Sejm speaker Ewa Kopacz.

Major challenge for Kopacz is to reconfigure the party and stitch together from various factions that often compete internally. Meanwhile, balancing the goal of public finance reforms and promoting economic growth remained the government’s priority.

In the wake of the Ukraine crisis, Poland has supported increased sanctions against Russia. Currently, Poland relies heavily on Russian natural gas – about 60% of gas demand has been secured by Russian deliveries. Although energy dependence on Russia is unlikely to be reduced in short term, moves to boost its defensive military capabilities have intensified. In early September, NATO agreed on the deployment of a 4,000-strong rapid reaction force to be based in Poland.

Economic Trend

Economic Indicators	2011	2012	2013	2014*	2015^
Nominal GDP (USD bn)	514.9	489.9	517.7	541.6	539.0
Real GDP growth (%)	4.5	2.1	1.6	2.7	3.3
GDP per capita (USD)	13,370*	12,720*	13,440*	14,070	14,040
Inflation (%)	3.9	3.7	0.8	0.2	1.2
Budget balance (% of GDP)	-5.0	-3.9	-4.0	-3.6	-3.0
Current account balance (% of GDP)	-5.3	-3.6	-1.4	-1.2	-1.9
External debt/GDP (%)	62.3*	74.6*	73.0*	73.1	71.7

* Estimates ^ Forecast
Source: Economist Intelligence Unit (www.eiu.com)

In Q2 2014, real GDP grew by 3.3% year-on-year, helped by supportive economic policies and improving conditions in main trading partners. However, the relatively swift pace of expansion observed in the first half of the year appears unlikely to be sustained in the second half. The fragile recovery of the euro area, the dampening effect the Ukraine crisis is having on regional activity, as well as the EU-Russia sanctions are all likely to have negative effect on growth in the second half.

In September, annual inflation rate remained negative for three consecutive months, mostly driven by falling food prices as Russian ban on food imports from the EU has created a domestic surplus in Poland. In an attempt to boost the economy and fight off the threat of persistent deflation, Poland’s central bank cut its benchmark interest rate by 0.5% to a record low of 2% in October.

Following Russia’s annexation of territory in Poland's neighbor Ukraine in March, the country’s political leaders had shown greater appetite on the accession to the euro, seeing it as an additional form of security because it would lock the country firmly into Europe's core. In June, Poland’s president, finance minister and central bank governor agreed that the issue of euro entry should be discussed after the general election next year.

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Hong Kong Export Credit Insurance Corporation | 31 Dec 2014

Turkey: Sacrificing Higher Growth for Lower Deficit

Highlights

Political	Recep Tayyip Erdogan, who has dominated Turkish politics as prime minister since 2003, has become the country’s first directly elected president He has vowed to move Turkey away from its parliamentary system toward a form of government with a more powerful president Prolonged turmoil in neighboring Syria and Iraq represent risk to Turkey’s stability
Economic	Economic growth has been moderating to between 3-4% in recent years, amid high inflation and geopolitical tensions Large current account deficit and its reliance on short-term financing leave the economy vulnerable to capital flows

Country Overview

Turkey, with a population of around 75 million, is situated at the junction of Asia and Europe. Turkey began to open up the economy in the 1980s, expanding production in the automotive, construction, and electronics industries beyond the traditional textiles and clothing sectors. Over the past decade, GDP per capita has nearly doubled and now exceeds US$ 10,000. Although growth has been promising, Turkey's relatively high current account deficit and its reliance on short-term financing leave the economy vulnerable to capital flows. On-going turmoil in neighboring Syria and Iraq, especially the rapid rise of the extreme jihadi group Islamic State (IS), also represents risk to the country’s stability.

Key Information
Capital	Ankara
Population	75.4 million
Area	783,562 sq km
Currency	Turkish lira
Official language	Turkish
Form of state	Republic

 

Major Merchandise Exports (% of total, 2013)	Major Merchandise Imports (% of total, 2013)
Textiles & clothing (18.1%)	Fuel (14.2%)
Transport equipment (12.0%)	Chemicals (13.3%)
Iron & steel (11.5%)	Machinery (9.3%)
Top three export countries (% of total, 2013)	Top three import countries (% of total, 2013)
Germany (8.8%)	Russia (10.0%)
Iraq (7.4%)	China (9.8%)
UK (5.6%)	Germany (9.6%)

Source: Economist Intelligence Unit (www.eiu.com)

Political Trend

In August 2014, Erdogan became the country's first directly elected president, by winning about 52% of the votes in the first round.

While his supporters say he has improved Turkey's economy and given a political voice to the country's conservatives, his critics accuse him of having Islamist leanings and an autocratic style. Externally, Turkey began accession membership talks with the European Union in 2005. However, progress has so far been limited amid opposition from countries like Germany, fearing that cultural differences will make it difficult to integrate.

Economic Trend

Economic Indicators	2011	2012	2013	2014^	2015^
Nominal GDP (USD bn)	774.6	789.1	820.1	796.6	857.6
Real GDP growth (%)	8.8	2.1	4.0	3.0	4.0
GDP per capita (USD)	10,470	10,560*	10,880*	10,480	11,180
Inflation (%)	6.5	8.9	7.5	8.9	7.4
Budget balance (% of GDP)	-1.4	-2.1	-1.2	-2.6	-2.7
Current account balance (% of GDP)	-9.7	-6.1	-7.9	-5.8	-6.0
External debt/GDP (%)	39.4	42.8	47.6	48.0	44.5

* Estimates ^ Forecast
Source: Economist Intelligence Unit (www.eiu.com)

Following a strong rebound in in the aftermath of the global financial crisis, the Turkish economy has been growing at a more moderate pace in recent years. While private consumption remained the major growth engine, high inflation and sluggish wage and employment growth have constrained household spending. In the second quarter of 2014, real GDP growth slowed to 2.1% year-on-year, in the wake of tightening fiscal and monetary conditions. It is expected growth would pick up next year, supported by stronger private consumption and investment.

The country’s chronic current account deficit reflects structural issues related to its heavy dependence on imported energy – almost all oil and gas were imported. Meanwhile, Turkey’s industry imports intermediate goods to produce final goods. The country’s current account deficit could only be narrowed at the expense of higher growth, if a significant change in its trade composition is not to happen. The Turkish government has introduced various measures to address the issue. However, the plan will not have an impact on Turkey’s energy dependency in the short term.

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Hong Kong Economic Journal - EJ Insight | 12 Jan 2015

India Plans New Industrial Revolution of Its Own

India aims to become a global manufacturing power by focusing on “entirely new industries” such as solar technology, LED lighting, small cars, medical appliances and weapons, Financial Times reported, citing Minister of State for Finance Jayant Sinha.

“What we’re trying to do is massively build out India’s productive capacity,” Sinha told the newspaper in an interview.

“That is, in fact, a veritable supply-side revolution because what we are really trying to do is to position India for a decade or more of sustainable, non-inflationary 7-8 per cent GDP growth. It’s only if we can achieve those kinds of growth rates that we will be able to create the millions and millions of jobs we have to create every year.

India is the world’s third-largest economy after the United States and China, measured on a purchasing power parity basis, but manufacturing makes up only 15 percent of the gross domestic product.

Prime Minister Narendra Modi wants to boost its contribution to 25 to 30 percent of the GDP to help create a million jobs a month in a country with a population of 1.3 billion, the newspaper said.

However, his dream is being hampered by clogged transport infrastructure, a shortage of skills, outdated labor laws that discourage investors, and the reluctance of indebted Indian companies to take on new risks, according to FT.

In order to achieve Modi’s grand vision, the government will seek to meet the country’s vast domestic demand for everything from raw materials to vehicles and home appliances, and then develop internationally competitive industries in new sectors, Sinha said.

“When China became a tremendous electronics manufacturing hub, it did that for smartphones, for instance, which did not exist as a product category,” Sinha said. “It did that in laptops, which did not exist as a product category. They didn’t necessarily replicate what Japan was doing in automotive manufacturing.

“Similarly, I think there will be industries where India will become a global leader, but those are entirely new industries, for instance solar appliances, solar lanterns, solar home systems . . . India is already the world hub for small car design and manufacturing.”

Sinha added: “The Indian economic model is not the same as the Chinese economic model. Ours is a much more innovation-driven, bottom-up approach towards economic growth . . . We will rely on our innovative and world-class firms to be able to unlock these new manufacturing industries of the future.”

The first stage of India’s planned industrial revolution is likely to put more emphasis on public spending for infrastructure than on private investment in new factories.

The government plans to boost public investment by US$25 billion to US$50 billion in the 2015-16 fiscal year, while the country’s railway network seeks to invest US$100 billion in the next five years.

Energy Minister Piyush Goyal has launched a US$250 billion plan for power generation and transmission to double electricity output and achieve Modi’s promise of 24-hour electricity for all by 2019, the report said.

Full content of EJ Insight is available at www.ejinsight.com. Copyright Hong Kong Economic Journal Ltd. Republishing and editing are forbidden without authorization from Hong Kong Economic Journal. If there are any questions, please contact Chris Yeung (chrisyeung@hkej.com) for editorial matters and Margaret Lor (margaretlor@hkej.com) for sales and marketing matters.

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China Tax & Investment Consultants Ltd | 24 Feb 2015

What is a DTA and how does it work?

What is a DTA and how does it work?

DTA is short for double tax agreement. It is also called double tax treaty (DTT). Countries or states sign DTA’s in order to achieve the following major objectives: avoidance of double taxation, allocation of taxing rights, and exchange of information. DTA’s are negotiated bilaterally between two states and drafted by reference to the framework under the OECD Model Tax Convention. 

(I) Avoidance of double taxation

A person earning an income is subject to tax in the state of which he is a resident. Alternatively an income may be taxable in the state in which the income generating activity takes place. But by the operation of the domestic tax rules, the income taxed in one state may also be taxed again in another state. Double taxation may arise in any one of the following three ways:

(a)     the conflict of rules adopted by different countries in the determination of tax residence;

(b)     the conflict between residence rule in one country and source rule in the other country, and

(c)     the conflict of rules adopted by different countries on the source of income.

Example - 1

A Hong Kong company assigns a US national, whose wife and kids are working and living in Canada, to work for its subsidiary in Shanghai for two years. In the absence of any DTA signed between respective countries, the same income of the employee may become taxable in four jurisdictions.

First, double taxation arises from the conflicts between residence rules. The above employee is both a tax residence of Canada and the US as per residence rules of each country. One the one hand, the employee suffers income tax due to his family ties with Canada. That is, his family members work and live in that country. On the other hand, he is a tax residence of the US that imposes worldwide tax on its nationals. Second, double taxation arises from the conflict of source rules between Hong Kong and China. The above employee is subject to income tax as he exercises employment in China, while he is also subject to salaries tax in HK because a contractual relationship has been created following the employment agreement concluded between him a HK company. Third, double taxation arises from the conflict between the residence rules and source rules. Where the employee is taxed in Canada because he has family ties with the country, the same income is subject to tax in China because the employee is performing his duty in China.

(II) Allocation of taxing rights between the signing states

(a)       Assignment from HK to China

Let’s study the first example on how the problem of double taxation is solved.

In respect of the double tax claims by the US and Canada, the employee of the HK employer can refer to the Article 4 in the US-Canada DTA to solve the dual residence issue. According to the US-Canada DTA, the employee’s personal and economic relationship (the center of vital interest) with Canada shall take precedence over his US nationality in the determination of residence. In respect of the double tax claims by Canadian and Chinese tax authorities, the employee can avoid double tax as he is entitled under Article 21 of Canada-China DTA to the tax credit in Canada for tax paid to the Chinese tax authority on the income earned in China. Article 21 of Canada-China DTA operates to solve the residence-source conflict. In respect of the double tax claims by the tax authorities in HK and China, the employee can avoid the double tax arising from the clash in source rules by submitting an application for a tax exemption in Hong Kong on the strength of the taxes he has suffered and paid in China on the same income.

(b)       Presence of employees in the host country

A double tax agreement can resolve the issue whether certain activities performed in one contracting state (country) by the employees of a company in the other contracting state, has created a taxable presence in the latter state. That is, whether the former has a permanent establishment in the latter.

Example - 2

An employee of a Japanese company is assigned to work in China continuously in connection with an engineering project of the PRC subsidiary for a period of 180 days.

There is a double tax problem, and the respective taxing rights of Japan and China are allocated in one of the following ways:

(i) As per DTA between Japan and China, the presence of employee does not create a permanent establishment in China if the following conditions are met: the employee stays in China for a period not exceeding 183 days in any 12-month period; and his income is not paid or borne by the PRC subsidiary. In this case, China does not tax the income; or

(ii) The presence of employee does create a permanent establishment in China where the parent company charges back the employee’s salaries to the PRC subsidiary. In this case, China taxes the income.

(c)       Unilateral tax adjustment

Example - 3

A holding company in country A, in order to reduce its taxable income, purchases goods from its subsidiary in country B at a unit price of USD10, which is above the arm’s length price of USD6. The tax authority later adjusts the purchase price from USD10 to USD6 following the completion of a transfer pricing audit. The group as a whole will be subject to double tax of USD4 per unit of the goods sold, in the absence of a corresponding downward adjustment of the selling price for the subsidiary in country B.

To avoid the double taxation arising from a price adjustment, states may adopt article No. 9 (associated enterprise) of the OECD model tax convention, which provides that the other state shall make adjustment accordingly.

(III) Exchange of information

The exchange of information (EOI) article is provided with an aim to the prevention of fiscal evasion on income and capital, which also deals with double non-taxation of income that arises from the interaction of domestic tax rules of two or more contracting states. Specifically the EOI article operates to override the personal scope (Article 1) and taxes covered (Article 2) as provided in the OECD Model Tax Convention.

(a)     Foreseeable relevance

The tax authorities of the contracting state shall exchange such information as is foreseeably relevant for carrying out the provisions of the DTA or to the administration or enforcement of the domestic laws of the contracting states concerning taxes covered by the DTA.

The EOI article is not subject to restriction by the personal scope under Article 1. The scope of information to be exchanged shall include the information in the possession or under control of a person located in the state of the requested authority, who may or may not be the tax resident of either state.

(b)     Secrecy provision

Information shall be disclosed only to persons or authorities (including courts and administrative bodies) concerned with the assessment or collection of, the enforcement or prosecution in respect of, or the determination of appeals in relation to the taxes referred to in paragraph (a).

(c)     Limitation to relevance and secrecy

The relevance and secrecy provisions are subject to restriction in the following way such that there is no requirement to (i) carry out administrative measures at variance with the laws and administrative practice, (ii) supply information not obtainable under the laws or in the normal course of the administration, of that or of the other contracting state, and (iii) supply information which would disclose any trade secret or process, or information the disclosure of which would be contrary to public policy.

Notwithstanding the provisions in the preceding paragraph, the requested state should not refuse to do so even if the information is not relevant or needed in the assessment, collection or enforcement of the taxes at home. Equally, the requested state cannot decline the requesting state on ground that the information is held by banks, nominees, persons acting in an agency or fiduciary capacity, or it relates to ownership interests in a person.

(IV) Definition of a person

The scope of a person is different between the avoidance of double taxation on income and exchange of information under the DTA articles. A person for purposes of (I) and (II) includes a natural persons and legal persons, who are the residents of one or both contracting states. A person for purpose of (III) includes the taxpayers and non-taxpayers, who reside or are present in the state of the requested authority.

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Fiducia Management Consultants | 6 Mar 2015

Update on the Hong Kong-Germany Double Taxation Agreement

We were recently invited to a high level discussion on the planned Double Taxation Agreement (DTA) between Hong Kong and Germany, an important topic for many of our readers. Organised by the German Consulate General in Hong Kong, the event brought together a hand-selected group of business leaders, representing German companies’ interests, and representatives of the German Federal Ministry of Finance. The aim of this meeting was to create an open forum for ideas exchange and feedback relating to the pending DTA. In particular, it was an opportunity to share with the Federal Ministry of Finance any concerns or advice that German companies may have regarding the DTA.

History

Hong Kong already has comprehensive DTAs in place with 32 countries, including Austria and Switzerland. A first round of discussions began in early 2014 to put in place a full-fledged DTA with Germany. The second round of negotiations are concluding today in Hong Kong and if successful, will still be subject to ratification. According to the German Federal Ministry of Finance, the aim of the DTA between Hong Kong and Germany is two-fold: “desiring to further develop their economic relationship, to enhance their cooperation in tax matters and to ensure an effective and appropriate collection of tax,…” and “intending to allocate their respective taxation rights in a way that avoids both double taxation as well as non-taxation...”

What the DTA means for German businesses

- Since several other major European countries have already signed a DTA with Hong Kong, Germany is currently at a disadvantage. Moreover, for Hong Kong to remain a competitive location vis-à-vis other countries such as Singapore, which already have agreements in place with Germany, a DTA would be beneficial.

- A DTA would help with cross-border tax transparency for German citizens with assets at home and abroad.

- In our opinion, a DTA with Germany would only strengthen Hong Kong’s standing as an attractive city for German businesses and individuals. Hong Kong is the gateway to China and Asia, offering a low tax regime, access to international capital markets, and its status as a RMB and transport hub. This, in combination with its sound rule of law and stable financial system, gives the city a distinct advantage over others. A DTA with Germany will only reinforce this standing.

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Bank of China (Hong Kong) | 26 Mar 2015

Effects of CNH Exchange Rate on Offshore RMB Interest Rate

Since November 2014, the exchange rate of offshore RMB to USD (CNH exchange rate) has depreciated while choppy CNH HIBOR led to a significant increase in capital cost. This article will discuss whether this phase of RMB interest rate fluctuation has a causal relationship with the depreciation of RMB and the dynamics of such relationship.

Effects of different sources of funds in offshore markets on RMB interest rates

Interest rate is the cost paid by those who demand capital. Hence, in order to answer the first question, we have to understand the channels for obtaining RMB capital in the offshore market and their impact on interest rates.

Unlike onshore parties who gain liquidity mainly from repurchase agreement (Repo) and the interbank market, parties in the offshore market gained RMB liquidity from the following three ways, namely, CNH swaps, interbank lending and CNH CCS. These three channels have different impacts on offshore RMB interest rates.

CNH swap refers to the use of foreign currency (mainly USD) to swap with RMB, which is similar to using USD as collateral for RMB loans. Currently, RMB swaps average approximately USD 20 billion in daily trading volume, much higher than that of interbank lending (on average USD 5-8 billion per day), and are the main channel for obtaining capital in the offshore RMB market. The “CNH Implied Yield” from CNH swap trading has also become the unofficial benchmark rate in the offshore RMB market.

Interbank lending requires the lender to pre-approve a credit line to the borrower in advance. Since such lending is essentially unsecured loans, there are certain requirements for participating institutions, limiting the capital pool available for interbank lending. Therefore, interbank lending is not as active as CNH swaps. One should also note that the quotations of offshore interbank lending are calculated mainly using CNH Implied Yields of the corresponding tenor. Therefore, price changes in offshore RMB capital will first be reflected in CNH Implied Yield and then be transmitted to interbank lending rates. As shown in the diagram below, CNH Implied Yield and CNH HIBOR Fixing are closely correlated, but the latter one is a bit less choppy as it is merely a daily fixing rate and does not represent actual market transactions.

 

 

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Grant Thornton Hong Kong Limited | 8 Apr 2015

Mergers and acquisitions: Cultural alignment for successful integration

Cultural alignment is a prerequisite, opportunity, and challenge for directors and CFOs to create value and synergies in post-merger integration

Too often companies put together matches look great on paper but are fraught with management and structural problems that end up turning deals into busts. Acquiring companies often underestimate the problems that unalike company cultures can inflict on a merger. In fact, the difference between success and failure of deal-making is often not a matter of strategy or money, but rather of relationships, culture and politics.

Putting two companies together normally gives the combined entity the resources and capabilities to compete with the market giants. It would also create dominant positions in many markets around the world. However, that was not the case for advertising giants Publicis Groupe SA and Omnicom Group Inc. After the merger, the two CEOs, Publicis’s Maurice Lévy and Omnicom’s John Wren, agreed to be co-CEOs for 30 months; while that sounded good, the reality was that they couldn’t agree on a management team, the way of splitting their duties, or even on which firm should be listed as the acquirer from an accounting perspective. The deal was eventually scuttled in 2003.

The challenge of putting the companies together can be further exacerbated if the two companies have vastly different business models and cultures. For example, in Valeant Pharmaceuticals’s long-running hostile takeover campaign of Allergan Inc., the Botox-maker, the company executives of Allergan have expressed their disagreement with Valeant’s proposal to slash the amount of money that the company spends on research, a move that would probably lead to layoffs of hundreds or even thousands of its employees. As such, Allergan has disregarded Valeant Pharmaceuticals’s proposal and instead, agreed to be sold to generic pharmaceutical manufacturer Actavis plc., a company that shares similar values.

How cultural issues affect the success of an M&A transaction

Integration can be defined in general terms as the process of combining two companies into one entity at every level. Post-merger integration, the most often-cited concern that could significantly impact the success of an M&A transaction, is the top concern for directors and CFOs. Post-merger integration has to be multi-dimensional, with inputs from various perspectives, including strategy, new management, organisation, business, finance and accounting, tax and legislation, information system, and human resources. Yet, studies have pointed out that plenty of M&A transactions fail to yield desired expectations or even erode shareholder value. The little secret about M&As is that the human dimensions and culture are at least as important, if not more critical, than the strategy, pricing, and positioning. Cultural unfitness is commonly found to have a direct and indirect linkage to integration failure. Unsuccessful cultural integration could lead to organisation distractions, loss of key talents, and failure to achieve critical milestones or synergies.

Cultural integration is the key to a successful merger

Many studies agree that cultural alignment is critical to a successful merger. Yet, due to the intangible nature of culture and time constraints, management would rather focus on things that are tangible and measurable, such as financial data and legal matters. Cultural integration is then left unattended and postponed to the post-deal phase. Nevertheless, culture is not something that can be changed or integrated without well-organised plans; it requires time and attention to bring two cultures together and blend into a new collaborative environment.

Approaches to cultural integration

So, how can two different cultures be integrated to achieve full value? First of all, we have to understand the term ‘culture’. Corporate culture is the beliefs and behaviours that determine how a company’s management and employees interact and handle outside business transactions. Often, corporate culture is implied, not expressly defined, which develops organically over time from the cumulative traits of the people that the company hires. A company’s culture can be reflected in its dress code, business hours, office setup, employee benefits, turnover, hiring decisions, client satisfaction and other operational aspects. No companies are cultural twins and thus careful attention is required in understanding the cultures of both merging companies and managing the cultural integration process.

Having said that, it is highly recommended to start the cultural assessment early and make sure that the human dimensions of the combination are incorporated into your due diligence and integration planning from the beginning, instead of an afterthought. Organisations can start with cultural assessment during the due diligence stage, which provides preliminary indications on cultural alignment or misalignment of the two merging companies and whether the existing cultures can be aligned with the overall business strategy. With the cultural and strategic alignment assessments, organisations can reach a tailored sale and purchase agreement and formulate integration strategies that facilitate smoother transition and more effective integration to capture post-merger synergies. The time spent on cultural assessment needs not to be long but should be good enough to obtain a basic understanding on the cultural and strategic background of both companies.

Second, more time should be spent on development and management of the action plan. Due to its intangible nature, culture-related issues are likely to be unpredictable and thus addressing the issues can be a challenging task for the management. In most M&A transactions, companies focusing on cultural integration tend to achieve post-merger synergies – apart from analysis of cultural differences, those companies also evaluate the cultural opportunities and obstacles, which guide their efforts to the right directions. The companies would also take initiatives in redesigning the organisational structure, determining leadership assignment, and modifying human resources practices such as compensation and benefits.

This is followed by communication to employees regarding the company’s new directions and meaning of the changes. Changes may create frustration and stress to employees, yet proper communication from management with a clear vision for the integration can relieve scepticism and doubt. Accompanying with employees retention strategies and other team building activities, companies can establish a new culture and concentrate on the post-merger business goals.

Potential value of cultural alignment

“People are valuable assets to an organisation and play an integral part to the success of a business. Effective people management is the key to achieving post-merger synergies so as to maximize the optimal outcome,” says Barry Tong, Transaction Advisory Services Partner of Grant Thornton Hong Kong. As cultural integration is one of the key factors of a successful merger, it is important to have a dedicated team to manage and oversee the whole integration process.

The causes of merger failure can be complex and varied case-by-case, and there is no perfect model to apply. Nonetheless, culture misalignment is commonly considered as a direct and indirect hurdle and mismanagement of any cultural unfitness can hinder the company from realizing synergies during the integration process. Cultural and strategic alignment, active management of cultural integration, as well as proper communication between management and employees, are the suggested measures that ensure smooth cultural integration and contribute to a successful merger.

Conclusion

Cultural compatibility can have significant impact on the ultimate success of an M&A transaction. It is suggested that a separate cultural integration plan be studied, created and worked upon in the early stages of a merger. Proper management of cultural issues is the key to realise successful post-merger integration, especially from a people perspective.

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