Asia Review 2011

IFC Review

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Asia Review 2011

IFC Review

A S I A R EV I EW4 Rising in the East……………………….......….…..........Ciara Fitzpatrick

5 What’s up, Doc? Asian Regulation in the Chinese Year of theRabbit .............

................................................................................................Alan Ewins

7 Private Equity – China Takes Centre Stage in Asia....................Denise Wong

9 � e Challenges of Turning Shanghai into an International Financial Centre

......................................................................................................Sonny Gao

11 Hong Kong as a Private Client Planning Centre ..........................................

..........................................................Mary Ellen Hutton & Philip Munro

13 Intellectual Property: Making a Move to Hong Kong............Debbie Annells

15 Mid-Shore Rising............................................................Martin Crawford

17 Taking the BVI Public: Using BVI Companies for IPOs.........Michael Gagie

19 � e Growth of Islamic Finance in Asia........................................Aderi Adnan

21 Appendix................................................ � e Global Financial Centres Index

3Asia Review 2011

Contents:

IFC Review

EDITORCiara Fitzpatrickciara@ifcreview.comCOMMISSIONING EDITORDan Tonereditorial@ifcreview.comDESIGN AND PRODUCTIONColin HallidayFrancesca Hammondproduction@ifcreview.comBUSINESS DEVELOPMENTLuke Quinnads@ifcreview.comADMINISTRATIONKellie Simpsonadmin@ifcreview.comACCOUNTS Fiona Brennan accounts@ifcreview.comWEBMASTERMichael McMeekin mike@ifcreview.comPUBLISHER & CHIEF EXECUTIVE Robert Ayresrob@ifcreview.comIFC Review78 York StreetLondon, W1H 1DPTel: +44 (0) 20 7692 0932Fax: +44 (0) 20 7692 0933Email: info@ifcreview.comWebsite: www.ifcreview.comSUBSCRIPTION RATEGBP160

© 2011 IFC Review. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means without the prior written consent of the Publishers. Whilst every eª ort has been made to ensure the accuracy of the information contained within the publication, the IFC Review cannot accept responsibility for any mistakes or omissions or the content of advertisements published in this review. � e opinions expressed are strictly those of the authors.

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4 Asia Review 2011

Rising in the East

It can no longer be Ignored – Asia is shifting into the spotlight, nudging the US and Europe out of the

way on the apex of the financial pyramid.The main financial centres in the region

have always been in the stable of successful IFCs but now the leviathan that is China, combined with the efforts of over indulgent regulators in the West, has encouraged the flow of wealth to initially ebb and now gush towards the East.

The credit crisis of 2008 caused a seismic shift in the wealth of the world and now those minor characters in the international financial world have become major players creeping up the index of global financial centres – Hong Kong in third place, Singapore in fourth place. Four Asian centres in the top 10, and Singapore, Shanghai , Shenzhen, Beijing and Seoul all tipped to become ‘more significant’ in the coming years. See Appendix, p 21.

The number of high net worth individuals has risen in the region and as a natural extension to this, the demand for services that fulfil the needs of high net worths has also increased, with, for example, Singapore touted as the Switzerland of the East for the private client. It has been this ability to adapt to suit the circumstances that has been cited as one of the reasons that the region has had a robust recovery following the global recession. And while the traditional financial centres struggle to lift themselves out of the post credit crisis malaise investors are looking elsewhere to cut their deals.

There has been a great deal of scape-goating and wringing of hands in the West over the credit crisis, offshore jurisdictions have been blamed, hedge funds have also been labelled as the reason for the calamity, bank secrecy, bank bonuses, an ever increasing list of reasons for the credit meltdown, and as a result the regulators have been busy trying to control these wayward jurisdictions, regulate the bankers,

regulate the hedge funds, regulate the flow of money, do away with secrecy etc, etc, and meanwhile investors have been looking elsewhere to do business.

Not only is Singapore stepping into Switzerland’s wealth management shoes, Hong Kong is becoming a private equity hub, while Shanghai is aiming to be the region’s main international financial centre by 2020. A concerted effort is underway in the region to become the elite in the industry and to attract specialised talent from Western markets.

At the IFC Review we have pulled together some of that talent in a series of articles that will highlight why Eastern financial centres are becoming the mainstay for investors.

Alan Ewins compares regulation in Asia with that of rest of the world. Of Western regulatory changes he states: “All of the major (regulatory) changes... can very much be viewed as addressing what are principally Western problems, created out of the rolling crises of sub-prime, credit crunch and sovereign fragility”, but he acknowledges that Western regulation will have a knock on effect in Asia and stresses the need for Asia “to take a firm position as part of the overall global process to ensure that it has one voice with which to influence the nature and speed of change, rather than a collection of local voices, which would carry significantly less weight.”

Denise Wong meanwhile examines the “hotbed of activity” that has been the private equity market in Asia in 2010, while Mary Ellen Hutton and Philip Munro examine Hong Kong’s reputation as a private client planning centre and commends the Hong Kong Government for being committed not only to the preservation of Hong Kong’s favourable tax regime but also to legislative reform.

Sonny Gao examines the challenges of turning Shanghai into an international finance centre, while Aderi Adnan from Labuan IBFC outlines the reasons for the

growth in Islamic Finance in the region. Michael Gaige looks at the use of BVI companies by Asian and cites the region as “the single biggest market for the jurisdiction’s corporate offering.” He also analysis the impact of the primary listing on the Hong Kong stock exchange of a BVI company – Winsway Coking Coal Holdings Ltd.

Debbie Annells looks at the increase in intellectual property holdings in Hong Kong, while Martin Crawford proffers an interesting commentary on Singapore and Hong Kong as “mid-shore” jurisdictions – as opposed to off- or on-shore centres: “With regulators placing ever more emphasis on substance as means of qualifying for tax treaty benefits, Hong Kong and Singapore are the onshore element that enables investors to fully leverage the benefits of offshore structures. This is the essence of mid-shore.”

Asia is broadening its appeal to investors the world over, it currently offers a degree of stability in a generally unstable global financial climate, financial centres in the region are honing their skills and preparing to step in to the shoes of their struggling Western counterparts.

At the recent Asian Financial Forum, Hong Kong SAR government executive council member, Ronal Arcull, said: “The world is now repositioning itself and the economic centre of gravity is fast shifting away from the West towards emerging markets, in particular Asia…the world no longer sees the West as a natural safe haven or good role model of growth.”

And as the dust settles on the global economy a new financial world order will come into view.

For further commentary and analysis on developments in Asia see our archive of articles at www.ifcreview.com

Ciara FitzpatrickEditor

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5Asia Review 2011

What’s up, Doc?Asian Regulation in the Chinese Year of the Rabbit

As the YeAr of the tiger prowls off into the distance and becomes the Year of the Rabbit, it

is important that the swirl of international financial regulation does not become a rabbit stew. Driven by the powerhouses of the US and Europe, there has been a significant move in the international financial community towards heavier and stricter prudential regulation. The banks have become subject to the groundwork for Basel III, to build up capital buffers and liquidity; shadow banking has started to come into the light with the emergence of the SIFI concept, covering systemically important financial institutions to be carefully monitored and controlled.

The alternative fund management industry now has to get to grips with a more settled form of fund manager legislation for Europe, and Dodd Frank in the US is in the midst of the mammoth rule making process, which will be the true measure of its worth. Mandatory derivatives clearing is one of the highly significant changes being made under that legislation, and broadly mirrored in Europe. And what else? The Foreign Corrupt Practices Act is being ever more enthusiastically enforced, and the UK Bribery Act with its even tougher strict liability corporate offence for allowing bribery to happen on the corporate’s watch is set to cause serious day-to-day concern in the board rooms of corporations in April, when it is due to go live.

Coupled with all of these things has been a desire in the G20 and other international fora for countries and regulators to be seen

to be tough on breaches of regulation and on the causes of breaches of regulation. There is a clear global political momentum to be seen to be doing the right thing, or at least supporting or being seen to support that it is done. The right thing, of course, means many different things for many of the Western jurisdictions.

Ultimately, there is a need for the international changes in regulation to be implemented in ways that not only accord with the overall consensus but also work for the purposes of local domestic and regional requirements. This is where there is some difficulty in the global model. All of the major changes referred to above, and they do amount to huge changes in the way that markets will be operated and will co-exist going forward, can very much be viewed as addressing what are principally Western problems, created out of the rolling crises of sub-prime, credit crunch and sovereign fragility.

Asia had its crises at the end of the last century (in the imaginatively named Asian Financial Crisis, and then SARS in the early 2000s), and clearly learned from the problems, including the high capital maintained by most Asian banks and their relatively strict lending policies. No major banks, brokers or clearers failed in Asia during the Global Financial Crisis, and that can be traced to a great extent to the developments from those earlier crises.

The Asian part of the GFC has principally been in the context of mis-selling of structured products, ie, the aftermath of Lehmans. That has generated a wave of

substantial reforms of sales regimes for those types of product, including the introduction of a shortform  summary document requirement in Hong Kong, and similar developments in Singapore and Malaysia; Korea has also followed the product regulation path, and the other major Asian jurisdictions have tightened up their respective regimes. The Europeans are now grappling with a similar concept (KIDs), in many respects mirroring the Asian developments.

So how does and will the various swathes of changed and changing regulation affect Asia? The product sales regulations are now becoming more settled after the initial flurry of major concern and indeed, particularly in Hong Kong, novelty.

But there are two main sets of the international regulatory regime changes that will have major impact on Asia.Firstly, those which the Asian jurisdictions are adopting as a result of the drive for cooperation and consistency (and the threat of being viewed, otherwise, as a maverick state). This includes the regulation of credit rating agencies (Hong Kong – a new regulated activity); bankers’ pay in Hong Kong (banking regulator pronouncements), Singapore (via the corporate governance requirements), China (including Draconian clawback provisions); and hedge fund monitoring and increased regulation. The implementation of the Basel III requirements for banks is another form of international harmonisation, notwithstanding that there are arguments that from an Asian perspective it will make

IFC Review

By Alan Ewins, Partner, Allen & Overy, Hong Kong

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6 Asia Review 2011

under Dodd Frank for the structures essentially to need blessing under the US regime before players in those markets would be e� ectively recognised for US purposes. With CCPs comes the need for inter-operability among those markets to provide a degree of utility for multi-national market participants.

As an overlay to all of the above is the increased level of supervision and enforcement, including a distinct gearing up of cross-border cooperation between regulators. Indeed, 97 per cent of IOSCO members have formally agreed to cooperate more actively with each other in relation to pursuing rogue market participants. � ere has been a distinct change in tone among the regulators, and in Asia it has become clear that the main jurisdictions have by no means lagged behind in aggressively attacking market misconduct. � e Hong Kong SFC’s successes in relation to market misconduct have been a prime example of this.

little di� erence. � e second category is the increased extra-

territoriality of certain types of Western legislation. � at includes the cross-border e� ect of the FCPA and Bribery Act reaching out into Asia, potentially a� ecting activities in Asian jurisdictions with only a limited connection with the US or the UK. Also, the Dodd Frank requirements in relation to mandatory clearing of derivatives come into play in respect of Asian jurisdictions. Early movers have been Singapore and Japan in the race to secure market share for those jurisdictions in relation to central counterparties; Hong Kong is set to follow, and China and India have taken steps in the direction of clearing of, in particular, interest rate swaps. It is the more complex derivative products such as credit default swaps which pose the greatest challenges in this space.

� e regional markets are wrestling with these concepts, in the same way as their Western counterparts, with the potential

Heavier regulation, stronger supervision and more hard-line enforcement activity have been evident in Asia, and have been indicative of a truly global phenomenon. In the coming year, we can expect to see more of the same, particularly as the pieces of Dodd Frank take further shape, the UK Bribery Act takes up station and the other regulatory developments continue to work through the G20 and beyond.

Financial institutions in Asia need to be mindful of the international developments which will push into the local markets and shape the international regime going forward. Asia will need to take a � rm position as part of the overall global process to ensure that it has one voice with which to in� uence the nature and speed of change, rather than a collection of local voices, which would carry signi� cantly less weight.

Staying for a moment  with the Rabbit metaphor, the carrot of more cohesive international � nancial regulation beckons.

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IFC Asia 24pp_Ewins_7-8_rev.indd 6 09/02/2011 09:23

7Asia Review 2011

Private Equity –China Takes Centre Stage in Asia

In contrast to the perIod dIrectly followIng the global economIc crIsIs, private equity

(PE) has been a hotbed of activity in Asia in 2010, as exit opportunities have increased and the mergers and acquisitions (M&A) wave continues. The major players in the industry have introduced RMB-denominated funds in order to invest in China, while the latest developments point to the introduction of international capital in RMB funds. On a wider basis, investing in Asia presents its own distinct challenges and certain sectors such as infrastructure and resources are running particularly hot at the moment.

Anyone participating in these markets recently could not fail to notice the voracious appetite with which China is buying assets in the region at the moment. One particularly significant development has been the emergence of the China ASEAN Investment Corporation Fund, established by a number of China’s state owned enterprises in April 2009 in order to invest in ASEAN countries with a target size of US$10 billion.

Aimed at promoting economic cooperation between China and the rest of the ASEAN region, the fund had its first closing in April 2010 and already has US$800 million committed. Key sector focuses for the fund are infrastructure, energy and resources, including toll roads, airports, ports, power generation, renewable energy, oil pipelines and telecommunications. With Asia acting as a growth engine for the global economy and the strong population growth in the region, the activities of the China ASEAN Fund is a key dynamic in the private equity industry

in Asia, particularly with high demand for infrastructure resulting in significant opportunities for private capital.

As Asia is such a diverse continent, infrastructure specialists see a great range of opportunities and significant potential in this area. However, there are challenges due to the sheer number of countries which are at different stages of development, while different regulatory frameworks compound the issue. For example in some countries, such as Cambodia or Vietnam, there is a need for power plants while other countries need to build toll roads, meanwhile projects in more developed countries like Singapore and Malaysia include oil storage developments and metal mining. Elsewhere, the investment of choice in Hong Kong is probably real estate and this is likely to continue over the next couple of years, particularly the commercial sector including offices and shopping centres.

Many of the leading private sector names have been looking at outbound M&A in the current market conditions, with favourable exchange rates providing an opportune time for portfolio companies in buyout funds to invest in bolt on acquisitions of undervalued European or US companies. There is a feeling among the industry leaders that such ideal conditions to acquire expertise or market share may not come around again for some time, with the enterprise value of target assets now at a fraction of the levels they were two years ago, while Chinese operations are holding significantly more cash than they were in 2008. German, South African and Japanese assets are all in the frame, however managers are always conscious of the potential integration issues with cross-border M&A.

The point has also been made that in this post-Lehman Brothers world, private equity funds are picking up just the kind of assets that would have previously been looked at by the investment banks.

From Walkers’ perspective in Hong Kong, we have seen a significant increase in private equity work across the region. Fund formation has come back strongly since late 2008/early 2009 and the fundraising which had stalled has now managed to make progress with some closings. There have also been some significant new entrants to the market such as the China ASEAN fund. In terms of downstream investments there has been significant activity in pre-IPO equity as well as debt financing, in addition to mergers and schemes of arrangement. Aside from traditional sales and purchases we have also seen clients taking advantage of the merger regimes in the Cayman Islands and BVI, allowing statutory mergers where one or more entities can be merged into, or consolidated with, existing or new entities.

As for inbound investment into China, the topic creating significant interest in the industry in recent months is Circular 698, the new tax law which took effect from January 1, 2008 and was applied retroactively. Circular 698 covers the indirect transfer of shares in an offshore holding company that holds an underlying PRC investment and where the offshore SPV is located in a jurisdiction that has an ‘effective’ rate of taxation below 12.5 per cent or does not tax its residents on overseas income. The traditional offshore private equity investment structure had a private equity fund set up a Cayman Islands or BVI holding company with a wholly-owned Hong Kong subsidiary, which in turn owns

IFC Review

By Denise Wong, Partner, Walkers, Hong Kong

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8 Asia Review 2011

Asian PE circles has been the proliferation of RMB funds, which have been established by a greater number of the key PE players. In considering the role that o� shore funds will play in the midst of this development, one of the key issues for investors has been deal allocation. With both onshore and RMB funds investing into China there is a need to take into account the rights of investors to have their fund invested in a particular opportunity. Some players have argued that there is still demand for foreign capital to support expansion and internationalisation, and for such sponsors o� shore funds are still preferred. Of course for PE houses working on inbound M&A to China, RMB funds can be very useful because when deals are based in China it is a natural progression to tap into that liquidity and RMB funds can provide that platform. Overall, RMB funds are a very important development in China in terms of driving the private equity industry forward, but the choice between o� shore and domestic funds depends upon the asset class, the stage the fund is at and

the underlying PRC businesses. A transfer of shares in such o� shore holding company will now attract a capital gains tax of 10 per cent whereas traditionally, the sale of a Cayman Islands company had not given rise to any PRC tax.

On a practical level, funds investing in the PRC are having to factor Circular 698 into their pricing, while advisory boards and LPs are now aware of the issue and understand the implications. A view among leading funds is that overall, LPs are not too concerned with a 10 per cent capital gains tax providing that the overall investment strategy and the quality of the investment are good. It is a case, therefore, of pricing the tax into the exit price and IRR and factoring it into a deal structure. Elsewhere, managers are examining the structure of Hong Kong and o� shore companies to ensure that a substantive business exists, although this may present practical di� culties as typically holding companies are established for each investment to avoid cross contamination.

Also generating signi� cant attention in

what investors are looking for. At this point in time it seems there is room for everyone.

A particularly interesting recent development in this sphere, meanwhile, is the prospect that international capital will be permitted to participate in RMB funds, which will signi� cantly increase the range of investment opportunities for overseas investors, while at the same time providing new capital sources for RMB funds. It is understood that local pilot programs are being developed with Chinese authorities in Beijing, Shanghai and Tianjin under the ‘Quali� ed Foreign Limited Partners’ (QFLP) regime. Initial details indicate that international institutional investors that meet certain criteria will be allowed to invest as limited partners or shareholders in RMB funds. � is regime will go some way to alleviating the potential con� icts of interest regarding deal allocation, potentially allowing the combination of international and domestic capital into one vehicle, so this is certainly an area to keep an eye on in 2011.

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9Asia Review 2011

The Challenges of Turning Shanghai into an International Financial Centre

Shanghai iS deSignated by China’S Central government to become a top-tier international

financial centre (IFC) by 2020. Last year, China’s State Council, the cabinet, formally approved Shanghai’s plans to become an IFC, directing the country’s ministries and regulators to open the way for the transformation. While Shanghai will gain in importance, it is facing many challenges in achieving the goal of becoming an IFC.

The first obstacle is the inflexible regulatory structure in China. China has a clear regulatory division across different sections of the financial market. Bond issuance, for instance, falls under the authority of the PBOC, the China Securities Regulatory Commission, the National Development and Reform Commission, and in some cases, the China Banking Regulatory Commission, the State-owned Assets Supervision and Administration Commission or the China Insurance Regulatory Commission.

So far Shanghai has not been granted the authority to enact legislation concerning the financial industry, the lack of which is a constraint to the development of Shanghai as a financial center. The scale and roles of Beijing and Shanghai mean that getting coordination right is quite difficult. By

comparison, Hong Kong and Singapore, with their highly centralised regulatory overseers, are considered more transparent and investor friendly.

The second obstacle is the issue of full convertibility of the RMB and the relaxation of controls allowing the free flow of currencies in and out of China. Without a global currency, the talk of building an international financial centre makes limited sense.

For now the Chinese government has allowed a limited amount of foreign investment in local markets through its Qualified Domestic Institutional Investor programme and has permitted external flows through its Qualified Foreign Institutional Investor programme. The restrictions have limited the number of international financial institutions choosing to locate in Shanghai. By the end of 2009, Shanghai had only 17 foreign banks, about one eighth of the number in Hong Kong.

The capital market in China is relatively immature and Shanghai has a number of important gaps compared with global and regional norms. For example, compared to the equity market, the fixed-income market in China is underdeveloped. The size of China’s RMB bond market as of March 2010 was US$2.65 trillion, only around

three per cent of global issuance. Financial innovation in China is

hampered by the government’s measured and conservative approach to financial reform. Many products that are common in other financial centers are lacking or underdeveloped in Shanghai. For example, China has been slow in introducing stock index futures, which are a common hedging product in most markets. Shanghai’s CSI 300 equity index was launched in April 2010 after a three-year pilot program. The Singapore exchange, in contrast, has allowed trading of contracts on the FTSE/Xinhua A50 China index since 2000, allowing indirect access to the A-share market for offshore investors.

Finally, the lack of top financial professionals with international experience might become a problem for Shanghai. Making Shanghai an attractive city for international financial experts to live and work in is a big challenge. For example, taxation on individual income can be up to 45 per cent in Shanghai - in contrast, income tax in Hong Kong is capped at 15 per cent. To address this, Shanghai officials floated the idea last year of tax breaks and incentives for financial professionals. However, because central government recently made the reduction

IFC Review

By Sonny Gao, Director, Business Development, ATC, Shanghai

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10 Asia Review 2011

of income inequality a priority, the idea of providing tax breaks to wealthy bankers has, unsurprisingly, not gained much traction at cabinet level.

However, the picture is far from doom and gloom overall. Despite the obstacles to be overcome, the financial markets in Shanghai have made impressive progress, largely as a result of the strong growth in China’s economy. At the end of 2009 the Shanghai Stock Exchange was the world’s third-largest exchange by turnover (US$5.1 trillion) and the sixth largest by market capitalisation (US$2.7 trillion). The turnover value of China’s futures markets (including Shanghai, Dailan and Zhenzhou) in 2009 was more than RMB 100 trillion. The Shanghai futures market is now ranked 10th in terms of volume traded on global exchanges, while it was ranked only 29th in 2000; that is a significant leap in only a decade.

Furthermore, China remains one of the most attractive destinations for foreign direct investment. The continual inflow of international capital brings into China advanced financial concepts, techniques and talents, making the financial markets in China more international. More progress in Shanghai is expected, particularly if China’s economy keeps growing as it has been.

In the 1930s, Shanghai was the famous financial hub in Asia. It had the region’s largest stock exchange and largest concentration of international banks (27 international banks in 1936). The history of being an important financial centre in Asia serves as a positive reinforcing factor in Shanghai’s current bid to return to its former glory.

In sum, China will continue to open its financial markets gradually and with great care. Other financial centres in Asia, such as Hong Kong and Singapore, will have to continue to move forward on financial innovation and product offerings as they compete with Shanghai. Shanghai’s future depends on the pace of financial reform, particularly the liberalisation of China’s foreign exchange regime, and how well it can attract international talent. Based on developments in recent years, it seems a return to Shanghai’s former reputation as a leading financial centre cannot be far away.

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11Asia Review 2011

Hong Kong as a Private Client Planning Centre

Hong Kong Has a longstanding reputation as the global financial and trade centre

of choice within Asia. This has continued since its 1997 return to Chinese sovereignty in part due to China’s ‘one country two systems’ rule, which has preserved Hong Kong’s favourable tax regime and separate legal and courts system. These factors have made Hong Kong an important centre for the management of private wealth. The Hong Kong Government has, over recent years, shown a commitment to maintaining Hong Kong’s position as a centre for private wealth with there being a number of likely developments in the future that will only increase Hong Kong’s attractiveness as a forum for private client planning.

At the heart of Hong Kong’s attractiveness as a centre for the management of private wealth is its tax system. Hong Kong is not a tax-free jurisdiction as some traditional ‘offshore centres’ essentially are; that said, it operates a ‘territorial principle’ of taxation under which only income arising in or derived from Hong Kong is taxable. In the commercial investment context, this principle produces some very favourable results. For example, dividend income received by a Hong Kong parent company from a foreign subsidiary is not taxable

income in the recipient’s hands, interest on a loan made from Hong Kong to an overseas borrower is not taxable in Hong Kong and gains on the disposal of foreign real estate by a Hong Kong entity are not taxable in Hong Kong. Further, dividends and interest gains, even if they have a Hong Kong source, are not taxable. These principles are also attractive in the private wealth context because while the profits of trade will be taxable in Hong Kong, returns from long-term investments should not be.

Revisions to Hong Kong’s tax regime have further increased its attractiveness. Hong Kong used to levy tax on certain types of Hong Kong source interest. This tax on interest was abolished with effect from 1 April 1989. In an attempt to further enhance its position as a jurisdiction for wealth management, Hong Kong abolished estate duty with effect for deaths from 11 February 2006: estate duty had previously applied to holdings of Hong Kong situate assets on death such as Hong Kong securities, real estate and bank deposits.

Hong Kong has further encouraged inward investment through its policy of entry into double tax treaties. Hong Kong was traditionally limited in its ability to enter into comprehensive treaties because Hong Kong law did not allow Hong

Kong to exchange information with other jurisdictions. In 2009, the position changed with an amendment allowing tax information exchange being made in accordance with the Inland Revenue Ordinance. Hong Kong has been actively pursuing a policy of entry into double tax treaties now that it has the legislative framework to do so, and at the end of 2010, Hong Kong had a number of treaties with jurisdictions including France, the Netherlands, Switzerland and the UK.

Not only was Hong Kong’s Government actively pursuing double tax treaty negotiations in 2010, it was also beginning to implement the revision of the Hong Kong Trustee Ordinance. This statute contains much of Hong Kong’s trust law. It is, for the most part, modelled on the English Trustee Act 1925, which has led to a decline in the popularity of Hong Kong trusts with Hong Kong’s trust law needing significant modernisation. It was, however, announced in 2008 by Professor K C Chan, Hong Kong’s Secretary for Financial Services and the Treasury, that the Ordinance would be revised to simplify trust administration and to create a regime more suited to modern financial markets. One of the stated aims of the review of the Ordinance that he announced was to

IFC Review

By Mary Ellen Hutton, Partner, Facey & Co in association with Withers, and Philip Munro, Associate, Withers, Hong Kong

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12 Asia Review 2011

Accumulations Ordinance be amended to repeal the rule limiting accumulations of income (except in relation to charitable trusts) for trusts created after the effective date.• Settlor reserved power trusts and forced

heirshipIt is proposed that the Trustee Ordinance be revised such that trusts with limited settlor reserved powers are expressly provided not to be voidable; and that forced heirship rules do not affect the validity of a Hong Kong trust.• Trustee duty of careIt is proposed that a statutory duty of care for trustees will be incorporated into Hong Kong law as was implemented in England and Wales in the Trustee Act 2000. The 2000 Act introduced a duty of care that requires regard to be had to any special knowledge or expertise a trustee has or holds himself out as having or, where a trustee is a professional, knowledge or experience that he might reasonably be expected to have. Trustees and settlors are able to opt out of

promote the use of Hong Kong’s trust law by non-Hong Kong residents with a view to enhancing Hong Kong’s position as a major asset management centre.

The Hong Kong Government began a public consultation on the review of the trust law on 21 June 2009. The consultation came to an end on 21 September 2009 and consultation conclusions, and proposals for legislative reform, were issued in February 2010. Draft legislation is presently being prepared to go before the Hong Kong legislature. If passed, the draft legislation will significantly increase Hong Kong’s attractiveness as a trust planning jurisdiction.

Key proposed changes include:• Rule against remoteness of vestingIt is proposed that the Perpetuities and Accumulations Ordinance be amended to repeal the existing rule against perpetuities for new trusts. This is in line with a trend in other modern trust law jurisdictions. • Accumulations of incomeIt is proposed that the Perpetuities and

this statutory duty of care and agree to a lower standard of care.

Singapore revised its trust law in 2005 and experienced an increase in new trust business; Hong Kong will be hoping also to see an increase in trust business following the revision of its Trustee Ordinance. As the proposals look set to significantly change the Trustee Ordinance such that it contains typical ‘offshore’ provisions, Hong Kong will not only be in an improved position to offer trusts to Asian families but it should attract more international trust business from families with no Asian nexus.

Generally, Hong Kong’s tax system and its commitment to developing a full double tax treaty network make it an attractive jurisdiction for the management of assets. The Hong Kong Government has shown itself not only to be committed to the preservation of Hong Kong’s favourable tax regime but also to legislative reform where this will improve Hong Kong’s position.

IFC Asia 24pp_Hutton_13-14.indd 12 09/02/2011 09:16

Asia Review 2011

Intellectual Property: Making a Move to Hong Kong

In the last year we have seen a number of international groups structuring the ownership of  new intellectual

property (IPR) holdings into Hong Kong companies, or indeed,   re-registering their IPR  into  Hong Kong  companies, and away from the old favourite jurisdictions of Holland, Luxembourg, Cyprus and Ireland.

All these latter countries happen to be in the EU and their VAT systems have moved adversely against IPR taxation since the substantial VAT changes within the EU, effective from 1 January 2010.

But first some background on Hong Kong, which is still incorporating companies at a rate of over 100,000 per year, despite the financial crisis.

The Hong Kong tax system has a number of commendable features including:

Maximum effective profits tax rate of 16.5 per cent. In reality many businesses pay a lower effective tax rate than this or pay no tax if an ‘offshore profits’ claim is made.

Maximum effective Salaries Tax rate of 15 per cent. In reality most individuals pay a lower effective tax rate than this.• Tax-free capital gains.• Tax-free dividend income.

• Tax-free offshore source income.• No withholding tax on dividends and

interest.• No withholding of tax on salaries.• Minimal capital duty on authorised share

capital increases or reorganisations.• No exchange controls.• No VAT • No arm’s length pricing requirements,

although benchmarking for a suitable ‘cost plus’ profit margin is advisable.

• Tax-free interest on income for businesses since 22 June 1998, if interest is received from a Hong Kong financial institution and the deposits is not collateral for another loan.

• Simple formula for annual tax reporting requirements for businesses and employees.

• Advance tax rulings are available to clarify treatment of any uncertain tax areas including offshore taxation or tax-free status claims.

• Withholding on royalties is typically a maximum of  4.95 per cent although this is often reduced by a double tax treaty.  Hong Kong has the best double tax treaty with the PRC.

The reason Hong Kong is now a jurisdiction of choice is because of the sudden upsurge in the number of modern Double Tax Treaties signed since 1 January 2010, and the fact there is no VAT in Hong Kong.

Double Tax Agreements with Hong KongDuring 2010, Hong Kong has trebled the number of jurisdictions with which it has signed comprehensive Double Tax Agreements (DTAs). It had previously only signed agreements with The People’s Republic of China, Belgium, Luxembourg, Thailand and Vietnam.

Countries/regions that Hong Kong has now signed tax agreements with are as follows: Brunei, The Netherlands, Indonesia, Belgium Thailand, Mainland China, Mexico, Luxembourg, Vietnam, Austria Czech Republic, Ireland, Italy, Kuwait, Japan, France, UAE, Switzerland and the UK.

These are mostly expected to come into force from 1 April 2011. 

A full list is available on the HK Government website.

IFC Review

By Debbie Annells, Managing Director, Azure Tax Ltd, Chartered Tax Advisers, Hong Kong

13

IFC Asia 24pp_Annells_15-16.indd 13 09/02/2011 09:15

14 Asia Review 2011

subject to VAT in the countries where these European companies are situated.

If these companies qualify as entrepreneurs for VAT purposes, the EU company can apply the reverse charge mechanism, meaning that the EU company can charge the royalties without VAT and that the European companies must report the royalties in their local VAT returns. Usually, these companies should be able to claim back the VAT, in which case the VAT liability will on balance be nil. For many groups, however,  this could result in irrecoverable VAT at the operating company level if they provide exempt services. Irrecoverable VAT is tax deductible in the country concerned thus reducing the effective VAT cost.

If the recipients do not qualify as entrepreneurs for VAT purposes, any EU conduit company must charge EU VAT and this VAT cannot be claimed back.

Analysis A Hong Kong company owning or purchasing IPR can now deduct 100 per cent of the costs of that purchase against its Hong Kong source taxable profits. In effect the Hong Kong tax liability of the company will be controllable by a variety of legitimate techniques. There is no VAT in Hong Kong; indeed Hong Kong entities can recover VAT incurred by their businesses in many EU and other countries.

Value Added Tax / Indirect Tax IssuesThe European VAT system recently changed substantially with respect to services that are rendered in a business-to-business situation. As of January 1, 2010, such services are in principle subject to VAT in the country where the recipient of the services is situated. Royalties that are charged by an EU conduit or holding   company to European companies are thus in principle

However; these services will not then be subject to the ‘reverse charge’ mechanism in each operating company, in the EU. In essence VAT will arise adding to the tax costs of any royalty conduit ie, in the Netherlands, Luxemburg etc. It is for this reason that IP holding companies are now being located in non EU jurisdictions, especially if there is likely otherwise to be irrecoverable VAT on royalties.

Transfer PricingBased on international transfer pricing practices, a royalty conduit company must receive an arm’s length remuneration for the services rendered. The arm’s length profit margin must be determined for each specific case based on the facts and circumstances, and transfer pricing/ benchmarking studies can be undertaken to demonstrate the arm’s length pricing/ royalty rates.

For example, discussions with tax authorities   indicate that conduit   companies must be remunerated on the basis of the actual functions carried out. Basically, if the conduit company plays an active role in the financing or  licensing activities of the group and bears the risks that are associated with this, one would expect this company to receive a certain margin over the interest or  royalty  paid. However, if the conduit company merely has an administrative function (eg, if the company only handles the royalty charges, but has no employees, is not involved in the decision making process and does not bear any real risks, etc), the remuneration could be even as low as the operational costs plus a certain profit margin (of eg, two – five per cent).

Azure Tax Limited have access into royalty databases and are experienced in benchmarking and drafting of transfer pricing documentation.

ConclusionThere are a number of interesting opportunities for multinational groups to explore - using Hong Kong companies as holding companies for treasury purposes and for holding IPR, or for using Hong Kong as a conduit  for paying royalties tax efficiently. This all came into place on 1 January 2010.

www.azuretax.com

IFC Asia 24pp_Annells_15-16.indd 14 09/02/2011 09:15

15Asia Review 2011

Mid-Shore Rising

Drawing on their international creDibility and skilled workforces, Hong

Kong and Singapore are a bridge between the onshore and offshore worlds in Asia. The rise of these two jurisdictions will not come at the expense of others; but all international financial centres must re-examine the role they play in increasingly complicated offshore structures.

International financial centres seem to be in a constant state of change. In an industry built on reputation – with efficiency, regulatory flexibility, low costs and high levels of service the foundation stones – jurisdictions are under pressure to stay competitive. Over the years, factors ranging from political instability to legislative laziness have seen certain financial centres stand still or retreat, allowing others to gallop past.

The renewed drive for greater tax transparency has fundamentally altered the competitive landscape. Jurisdictions, especially those that have emerged on the back of zero-tax policies, must ask themselves how they can stay relevant in an era of greater information exchange. Service providers, for their part, are reorienting tried and tested structures so that they strike

a balance between the needs of clients and regulators.

The industry is changing to the point that the word ‘offshore’ is in some cases no longer a fair reflection of the preeminent structures or jurisdictions’ marketing strategies; investors are increasingly open to incorporating an onshore element into their business plans.

In Asia, which is emerging as the principal driver of the industry as a whole, Hong Kong and Singapore are uniquely positioned to take advantage of the new environment. Not only are they offshore financial centres complete with business friendly tax policies, but they also boast robust onshore financial services industries.

Hong Kong and Singapore therefore represent a bridge between the onshore and offshore worlds – they have become, in part by design and in part by default, Asia’s ‘mid-shore’ jurisdictions.

Hong Kong and Singapore already occupy a niche in the financial services industry. Like many other jurisdictions, they offer strong legal systems, high levels of service, relatively painless bureaucracy and attractive tax policies (although they are low-tax rather than zero-tax). But Hong Kong and Singapore differ in that they are

genuine trade hubs: they are plugged into financial and logistical networks that extend all over the world.

Other countries want to do business with Hong Kong and Singapore and this explains the relative ease with which they have accumulated double tax treaties, now a key selling point for international financial centres.

A clear derivative benefit is talent. Hong Kong and Singapore’s economic advantages translate into better incomes and higher standards of living for all involved. As long as they remain the preeminent places to live and work in Asia, they will continue to attract skilled workers. Offshore service providers, wealth management firms and private banks are beginning to pay more attention to the Asian market and they are setting up offices everywhere from Shanghai to Mumbai to Manila – but none of these could serve as a regional headquarters.

It is important to note that this is no zero-sum game. While Hong Kong and Singapore are seen to have their respective competitive advantages – mainland China access and funds management in the former, private banking and wealth management in the latter – if anything, business is dividing along geographical lines: Hong Kong is

IFC Review

By Martin Crawford, Chief Executive Officer, Offshore Incorporations Limited

IFC Asia 24pp_OIL_17-18.indd 15 09/02/2011 09:14

16 Asia Review 2011

Appendix 1: Jurisdictions of importancestrongest in north Asia, and in particular mainland China, and Singapore takes the lion’s share in south Asia.

Importantly, the rise of these two jurisdictions is not going to come at the expense of the long-standing tax neutral o� shore locations.

OIL Group recently commissioned a survey (entitled O� shore 2020: An Asian Perspective) of industry participants in Asia in order to get a sense of how the investor preferences are changing in Asia. Asked to score jurisdictions in terms of importance (see appendix 1), respondents came back with a fairly predictable set of rankings, with the British Virgin Islands (BVI) and the Cayman Islands sitting atop the list, followed by Hong Kong and Singapore.

Respondents were then asked to score the jurisdictions based upon their expectations for the industry in � ve years time. � e most startling gains were made by Hong Kong and Singapore, but no one expected a corresponding decline in the importance of BVI and Cayman – or Mauritius, Bermuda, Samoa and Seychelles, for that matter.

As investment structures become increasingly multi-layered, jurisdictions are performing di� erent roles along the chain based on their respective competitive advantages – be they tax neutrality, tax treaty access, administrative simplicity or basic geographical convenience.

For example, a private equity fund may be registered in Cayman and set up a structure in Hong Kong that in turn holds assets in China. A Netherlands trading company may channel its business via Seychelles, with the ultimate owners managing their business through a Singapore entity.

In each case, Hong Kong and Singapore function as the staging posts for investment going into or coming out of Asia: they have the credibility, infrastructure and talent pools to cope with sophisticated demands and they o� er proximity to funding sources or targets.

With regulators placing ever more emphasis on substance as means of qualifying for tax treaty bene� ts, Hong Kong and Singapore are the onshore element that enables investors to fully leverage the bene� ts of o� shore structures. � is is the essence of mid-shore.

Luxe

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IFC Asia 24pp_OIL_17-18.indd 16 09/02/2011 09:14

17Asia Review 2011

Taking the BVI Public: Using BVI Companies for IPOs

The BVI Is The largesT offshore corporate domicile in the world, with over 800,000

companies incorporated in the jurisdiction since 1984. In the first half of 2010 alone, just under 30,000 new BVI companies were incorporated.

BVI companies are listed on the world’s largest international stock exchanges. At the time of writing, there are approximately 31 BVI companies listed on the NASDAQ and NYSE and approximately 36 listed on AIM and the LSE. In addition, BVI companies can be found on the TSX, the SGX and the ASX. In 2010, the most exciting development for the BVI in the context of international listings was the primary listing in October 2010 of Winsway Coking Coal Holdings Limited (‘Winsway’) – on the Hong Kong Stock Exchange (HKSE) – the first HKSE listing of a BVI company following the HKSE’s decision to add BVI to its list of ‘approved’ jurisdictions.

It is estimated that Asia is home to approximately 50 per cent of all BVI companies incorporated and, as a consequence, it has been for sometime, the single biggest market for the jurisdiction’s corporate offering.  One of the factors that has helped the BVI’s popularity in Asia has been the appetite for its companies in the Hong Kong marketplace.  There are a number of incorporation agents – ie, intermediaries through whom you can purchase a BVI company - with a physical presence both in Hong Kong and elsewhere in the region and the ‘real time’ availability of those services has helped BVI to establish dominance not just in Hong Kong but in greater China as the first choice for an offshore corporate domicile.

  In a commercial context, as we will see below, for a business, there are a number of very real advantages afforded by the BVI’s corporate legislation (to being incorporated in the BVI).  For many years now, we have seen both foreign investors into Asia and “domestic” Asian businesses utilising the BVI

Business Company for joint ventures, private equity structures and for international listings.  The prospect of now being able to list BVI companies in Hong Kong is yet a further validation of the jurisdiction’s role in the Asian context.  We can now take a closer look at the practical implications of the legislation.

BVI Benefits to Consider Pre-IPOThe BVI Business Companies Act, 2004 (as amended) (the ‘Act’), is the statute that governs the operation of all BVI companies. Whilst the attractions of using a sole director/sole shareholder BVI company for holding company purposes and using BVI companies for joint venture vehicles are well known (particularly in Asia and in Russia), many who are familiar with the BVI have under utilised other advantages afforded to their companies by domiciling in the jurisdiction. A number of these advantages have relevance to a business with an eye on a future equity listing.

No par value shares and no share capital The Act abolished the concept of share capital for BVI companies and therefore the need for par value shares. Whilst an off the shelf BVI company can still be purchased with par value shares (50,000 shares of US$1 each being the default position), a potential difficulty for a company of having par value shares is that as a matter of law, the directors of that company cannot issue the company’s shares for less than their par value. From a fund raising perspective, particularly whilst in the start-up phase, this may hamper a company’s ability to bring in new investors. No par value shares give a company the freedom to set the subscription price for shares at any level determined by the directors with no ‘backstop’ or minimum threshold. In the IPO context, this may provide an advantage when it comes to determining the price at which individual shares are to be marketed and offered.

The other advantage that the abolition of share capital provides to BVI companies is that all subscription monies received by

the company upon the issuance of shares is available to apply to the business of the company - there is no requirement (or need) for the directors to segregate the subscription monies received into share capital or share premium accounts.

Ability to merge BVI companies with other BVI companies and with foreign BVI companies Whilst this is not an advantage that is unique to the BVI, the ability to merge BVI companies with other BVI companies and with companies incorporated in other jurisdictions (subject only to local law restrictions in those jurisdictions), does provide flexibility that is not available to some of the jurisdiction’s contemporaries. Whilst the Cayman Islands has recently introduced merger provisions into its corporate law, the voting thresholds and the mechanics involved are different to those in the BVI.

As practitioners, we often see clients who have incorporated multiple companies to hold separate businesses within their group structure - resource related companies are a good example of this where the various licences and related rights for each individual project are often held through separate legal entities. The ability to merge companies easily is an advantage to a business undergoing a pre-IPO reorganisation or restructuring.

Fiduciary duties of the directors of a BVI company The Act provides that the directors of a joint venture entity can, when making decisions, act in the best interests of the shareholder or shareholders who appointed them even if the decision may not be in the best interests of the BVI company of which he is a director.

This statutory deviation from the common law position regarding a director’s duties should prick the ears of any private equity investor. The BVI corporate regime, at law, endorses the

IFC Review

By Michael Gagie, Partner, Maples and Calder, Hong Kong

IFC Asia 24pp_Gaige_19-20.indd 17 09/02/2011 09:13

18 Asia Review 2011

can also factor into the M&A any market standard requirements that investors in the relevant investment market or more broadly, the industry sector in which the company operates would expect to see. On the flipside, the founders of the company can look to limit the changes to the corporate governance regime only to those that the market requires, thereby retaining some of the flexibility that the BVI has in comparison to other potential domiciles.

Distributions to shareholders and reduction of issued shares / repurchase of own sharesThe abolition under BVI law of the concept of share capital may offer a significant advantage to a BVI listed company, both in terms of its potential ability to make dividend payments to its shareholders and to its ongoing ability to repurchase its own shares.

Under BVI law, in order to effect either a dividend or a repurchase of shares, the directors of the company must satisfy themselves that immediately after payment of the dividend amount or the purchase price for the shares, the company is able to pass the following solvency test:• the value of its assets exceeds its liabilities;

and• the company is able to pay its debts as

they fall due.The absence of a requirement to maintain

a share capital account or equivalent and a determination of the position via a straightforward balance sheet stress test gives the directors of a BVI company, in a commercial context, the opportunity to consider the demands for a return required by the company’s investor base against the cash and other ongoing financial requirements of the company’s business.

Statutory shareholder protectionsFrom an investor protection perspective, the Act has, since its full introduction in 2006, provided for greater statutory minority shareholder protections than the majority of the jurisdiction’s offshore contemporaries.

The Act provides for the following range of shareholder remedies:• Compliance orders – the ability for a

shareholder (or a director), where the company or a director is engaging in or is proposing to engage in conduct that contravenes the Act or the constitution of the company, to apply to the BVI court for an order restraining such conduct or

commercial position that in reality all businesses with a financial backer represented at board level are likely to find themselves in. Whilst any preference share arrangement pre-IPO that an investor may agree with a business is likely to have a number of matters requiring the investor’s consent and/or covenants or undertakings on the part of the founders of such business to procure that the company and/or its board effect certain decisions only with investor consent, the BVI position – which must be specifically provided for in the memorandum and articles of a company - adds further weight to the investor position and is an advantage not currently found in the corporate regime of any of the other comparable offshore jurisdictions.

Advantages of Using a BVI Listing Vehicle‘Scalability’ of corporate governance requirements One of the greatest strengths of the BVI as a corporate domicile is the flexibility which the Act affords to the owners of BVI companies as regards the everyday operation and management of a company. The Act provides a framework of corporate governance which is geared in favour of the directors of a BVI company - the approval of the directors (by way of a resolution of a simple majority) is all that is required to effect almost all business decisions. Under the provisions of the Act there are really only three key decisions which, as a matter of law, require the directors to seek a shareholder approval - exercised by way of shareholder vote - and those are: (i) a disposal of in excess of 50 per cent of the total assets of a company; (ii) a merger or consolidation of a company; and (iii) a voluntary winding up of a company.

Clearly for a listed company, the checks and balances imposed on the board of directors will be greater than those provided for above and that is where the real advantage of the Act lies because the legislation provides throughout that the default position (provided for under the Act itself) is always ‘subject to’ the specific provisions of the constitution of the company itself - its memorandum of association and articles of association (M&A).

The effect of being able to ‘opt out’ of the statutory default position means that a BVI company can tailor the provisions of its M&A to fit the requirements of the particular equity market or markets that it is seeking to raise funds through. This means that not only can the company provide all necessary comfort to the regulator of the relevant exchange on which it is seeking to list its shares, but its advisers

an order directing compliance with the Act or the constitution of the company;

• Derivative actions – whereby the BVI court may grant a shareholder leave to bring proceedings in the name and on behalf of the company or to intervene in proceedings to which the company is a party for the purpose of continuing, defending or discontinuing the proceedings on behalf of the company; and

• Unfair prejudice remedies – the ability to apply to the BVI court for a wide range of potential remedies where a shareholder considers that the affairs of the company have been, are being or are likely to be conducted in a manner that is, or any act of the company has been, is or is likely to be oppressive, unfairly discriminatory or unfairly prejudicial.The BVI court is expressly empowered to

grant interim as well as final orders and to grant such consequential relief as it thinks fit.

Application of the ‘BVI advantage’ by WinswayWinsway’s recent listing in Hong Kong demonstrated the use of a number of the advantages discussed above. Perhaps the most note worthy was Winsway’s use of no par value shares making BVI only the second jurisdiction (after Singapore) to have a Hong Kong listed company with this type of share structure.

In relation to the shareholder protections discussed above, the benchmark which the HKSE requires all ‘approved’ jurisdictions to judge themselves against (for the purposes of obtaining their ‘approved’ status) is the position of shareholders under Hong Kong companies legislation and whether the jurisdiction of the listing vehicle offers equivalent or better statutory protection for shareholders than that offered under Hong Kong law. Given the substantive statutory protection provided for under the Act, the BVI ticked all of the required boxes.

ConclusionGiven the BVI’s long standing popularity in Asia, we expect in 2011 to see more BVI companies following Winsway to a primary listing in Hong Kong – a second BVI company has recently obtained a listing (a listing by introduction). Increased appetite from global investors for China related businesses may also result in an increase in BVI companies listing on other international exchanges.

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19Asia Review 2011

The Growth of Islamic Finance in Asia

In recent years IslamIc fInance has emerged as one of the most rapidly expanding sectors of the global

financial industry, with expectations that it will play an increasingly more important role in the years to come.

The size of the global Islamic banking industry is believed to have grown from about US$820 billion at the end of 2008 to more than US$1 trillion in 2010, while latest studies indicate that the steadily growing Islamic banking system could reach US$1.5 trillion in 2012 and US$3 trillion by 2015.

The global economy is gradually recovering, this coupled with an improvement in market conditions and investor sentiment, has meant that in the first nine months of 2010, total Sukuk (Islamic Bonds) issued globally increased further to US$27.9 billion, 62.3 per cent higher than the similar period in the previous year and surpassing 2009 full year issuance of US$24.7 billion.

A Growing Demand for Islamic Finance Products The underlying concept fundamental to Islamic banking and finance is justice, which is accomplished through the sharing of risk.

Stakeholders are under an obligation to share profits and losses derived from financing transactions and to refrain from dealing at usurious interest rates, which are unacceptable in Islam. This principal of ethical finance is proving increasingly more attractive to non-Muslims.

The Islamic financial system also practices a strict prohibition of investments in risky instruments such as toxic assets and derivatives, which have adversely affected their conventional competitors.

Islamic products enable the issuer to reach cash-rich investors and ethical investors

world wide. This is evidenced by the growth of Islamic finance in both Muslim and non-Muslim communities alike.

Buffered from the Global Financial Crisis Islamic finance is not immune to the global financial crisis but has proved to be less affected by the economic down turn due to its requirement for asset backing coupled with ethical financial principles.

The crisis exposed the loopholes and weaknesses within the conventional system, allowing Islamic products to become more popular because their principles have shielded them from the sub-prime crisis. Debt-selling (derivatives), the primary cause of the crisis, is not allowed in Islamic finance.

Increasing demand and popularity for Sharia compliant products and structures post the global financial crisis will form a strong demand base for Islamic financial instruments, especially for Sukuk.

Islamic financing has gained in popularity as various initiatives are taken by non-Muslim jurisdictions to develop legislative and regulatory frameworks which embrace Islamic finance into their financial system. This has resulted in significant efforts by a number of international business and financial centres to attract foreign investments from cash-rich Muslim investors and ample liquidity within the Islamic capital market.

Conventional players are starting to look into the ‘ethical financing’ philosophy, much of which a term from Islamic finance.

Islamic Finance as an Alternative to ‘Conventional’ Finance?Banks and financial institutions that comply with Islamic law (Sharia) showed impressive resilience during the financial crisis that hit the world economy at the end

of 2008, knocking out a substantial number of conventional banks, particularly in the United States. This encouraged countries with Muslim minorities, such as Britain, Germany, the US and France, to increase the proportion of Islamic banks within their conventional banking industry.

Islamic banking is gaining ground with non-Muslims worldwide due to its strict and ethical lending principles. Sharia finance is a blend of Islamic economics and modern lending principles and its products are well received by non-Muslims, since the onset of the global credit crisis, which cast doubt on many Western risk management practices.

Labuan – A Hub for Islamic FinanceMalaysia is among the pioneering jurisdictions that have successfully developed and incorporated Islamic finance into its modern financial system. The Islamic finance infrastructure that Malaysia has, coupled with Labuan IBFC’s regulatory strength and conducive business environment for Sharia-compliant business, paved the way for Labuan IBFC to expand its Islamic finance market.

The Legislation in Labuan IBFC provides a facilitative and flexible framework for industry players to be innovative and create new products for their clients. Continuous reviews have been undertaken to enhance the regulatory and business framework in order to meet market demands whilst ensuring market practices are at par with international standards.

Labuan IBFC collaborates with and compliments the Malaysia International Islamic Financial Centre (MIFC) to promote Islamic financial products and services to an international audience.

Labuan IBFC is offering the following attractions to Islamic entities established in

IFC Review

By Aderi Adnan, Islamic Finance and Banking Advisor, Labuan IBFC, Malaysia

IFC Asia 24pp_LOFSA_21-22.indd 19 09/02/2011 09:11

20 Asia Review 2011

issuance, trust and fund management.The LIFSSA provides a greater degree of

comfort for investors in Islamic financial activities as it is a dedicated piece of legislation that serves to ensure compliance with Islamic Sharia principles.

The legislation has introduced changes to Sharia governing system in Labuan by establishing the Sharia Supervisory Council (SSC) to replace the Sharia Advisory Council (SAC). Among the key function of the SSC is to ascertain the Islamic law in relation to any businesses regulated by the Labuan FSA in Labuan. All rulings made by the SSC can be used as reference by the court in arriving at a decision.

Doing Business in LabuanAs previously outlined, Labuan’s strong regulatory framework ensures that Islamic financial transactions can be completed effectively. The Labuan taxation framework creates a level playing field for conventional and Islamic financial transactions.

Financial centres with fiscal systems developed within a framework of conventional financing have found it necessary to introduce specific measures to enable the matching of profits with Islamic finance. A number of financial centres such as the United Kingdom have made a start on this process and others like Japan are considering doing so. Korea, on the other hand, recently rejected making any changes.

These issues arise because the making of interest is prohibited under Sharia law and in general this results in Islamic financial products being ‘equity’ based as opposed to the debt based approach of conventional financing.

Tax law always treats equity and debt differently and therefore Islamic finance transactions may be disadvantaged as follows:• An exposure to multiple transfer taxes on

transfers of property and the creation of leases.

• Profits might be subject to an upfront taxable capital gain.

• The ‘finance cost’ of the issuer might be regarded as a distribution of profit and non-tax deductible.

• The ‘finance return’ to the investor might be made from ‘after-tax’ income thus reducing the return on investment.In an international context there may be

additional issues. Since the ‘finance return’ is not interest, it may not enjoy the reduced rate of withholding tax for interest under tax treaties and with some Islamic finance

the centre:• Competitive overhead and operation

cost as compared to other international financial centers in Europe, GCC, South East and Far East Asia.

• A competitive tax rate. Under the Labuan Business Activity Tax Act, non-trading companies pay no tax at all while trading companies can opt to pay tax each year at the rate of 3 per cent of the net audited profits or a flat rate of RM20,000. Alternatively, companies can opt to be taxed at the standard rate under the Malaysian Income Tax Act.

• Malaysia has signed 73 comprehensive double taxation treaty agreements and 2 limited shipping agreements, making its Double Tax Treaty Network the most extensive in the region. Individuals or companies established in Labuan IBFC can enjoy access to the majority of them. Companies opting to be taxed under the Malaysian Income Tax Act instantly have the benefit of all of Malaysia’s Double Taxation Agreements.

• Comprehensive legal framework with better clarity for Islamic finance with international recognition.

• Continuous innovation on Islamic capital market products supported by Bank Negara Malaysia, the Central Bank of Malaysia.

• Ample talent pool of Islamic finance expertise.

• Endowment fund allocated by the Central Bank of Malaysia to develop and promote Islamic finance.

• Flexibility to collocate in any other parts of Malaysia.

• The Malaysia government has amended its taxation framework to create a level playing field and unbiased market for Islamic finance transactions.

The Labuan Islamic Financial Services and Securities Act 2010 The Labuan Islamic Financial Services and Securities Act 2010 (LIFSSA ) has clarified, streamlined and consolidate all Islamic finance related issues in Labuan and sets new standards for the jurisdiction.

LIFSSA signifies a landmark achievement for Labuan IBFC as a major business and financial centre that caters to the specific requirements of Islamic finance industry, covering banking, takaful, retakaful, Sukuk

transactions taking the form of a partnership, a cross border transaction may create a taxable presence in a foreign location.

Yet the simple and straight forward Labuan tax system has the following features that overcome all of the issues: • No tax on profits from passive investment;• No capital gains tax; • No withholding taxes; and • No transfer taxes.

Further, Labuan has no exchange control restrictions and a Labuan entity that is tax resident in Malaysia may access the majority of Malaysia’s extensive tax treaty network. This would be beneficial because the tax treaty may prevent a taxable presence being created in the foreign treaty party’s location and Malaysia’s more recent treaties replace the ‘Interest’ article with a ‘Finance Cost’ article to ensure Islamic finance transactions benefit.

It follows therefore that conventional and Islamic finance transactions both enjoy ‘tax neutrality’ via Labuan, which when factored into the pricing of the products, allows for competitive pricing between the two.

The Future for Islamic Finance in AsiaIt is anticipated in 2011 that demand for Islamic finance products will continue to grow due not only to the recovery in global economic activities, but also due to more accommodative monetary policies, more sovereign issuers to tap the Sukuk as governments will continue to raise funds to support economic growth and fund fiscal deficits, and also due to the emerging market players as well as new non-Islamic issuers tapping the Sukuk market, with potential debuts from Thailand, Indonesia and Japan.

In ensuring Islamic finance grows further moving forward, globally accepted standards and terminology on Islamic finance are required. Innovation around risk sharing products needs to be escalated while ensuring ample liquidity is available at competitive price.

Moving on as one of the leading Islamic finance hub, Labuan IBFC will continue to develop across all four main sectors of Islamic finance, namely Islamic banking, takaful, Islamic funds and Islamic capital markets.

Labuan IBFC is committed to further enhance the breadth and depth of the Islamic finance sector in Labuan by creating greater linkages with the international financial system.

IFC Asia 24pp_LOFSA_21-22.indd 20 09/02/2011 09:12

21Asia Review 2011

Appendix – The Global Financial Centres Index

The Global Financial cenTres index (GFCI) provides profiles, ratings and rankings

for 75 financial centres. See Table 2. The main findings from the latest GFCI

(GFCI 8), published in September 2010, are as follows:• There remains no significant difference

between London and New York in the GFCI 8 ratings.

• Hong Kong is now within 10 points of New York and London (having been 84 points behind in March 2009). Ten points on a scale of 1,000 is not significant and indicates that Hong Kong has joined London and New York as a genuinely global financial centre. Singapore may well join this trio soon.

• Confidence amongst financial services professionals has fallen since GFCI 7.

• Asia continues to exhibit enhanced competitiveness with Shanghai entering the top 10 and Seoul moving into the top 25.

• When questioned about which financial centres are likely to become more significant in the next few years, the top five centres mentioned are all Asian: Shenzhen, Shanghai, Singapore, Seoul and Beijing.

• Other notable changes include a rise of 25 for Shanghai and a rise of 21 for Hong Kong

IFC Review

London 1 772 =1 775 - 3

New York 2 770 =1 775 1 5

Hong Kong 3 760 3 739 - 21

Singapore 4 728 4 733 - 5

Tokyo 5 697 5 692 - 5

Shanghai 6 693 11 668 5 25

Chicago 7 678 6 678 1 -

Zurich 8 669 7 677 1 8

Geneva 9 661 8 671 1 10

Sydney 10 660 =9 670 1 10

Frankfurt 11 659 13 660 2 1

Toronto 12 656 12 667 - 11

Boston 13 655 14 652 1 3

Shenzhen =14 654 =9 670 5 16

San Francisco =14 654 =15 651 1 3

Beijing 16 653 =15 651 1 2

Washington D.C. 17 649 17 647 - 2

Paris 18 645 20 642 2 3

Taipei 19 639 21 638 2 1

Luxembourg 20 634 =18 643 2 9

Vancouver 21 627 23 623 2 4

Jersey 22 626 =18 643 4 17

Melbourne 23 622 =26 617 3 5

Seoul 24 621 =28 615 4 6

Montreal 25 617 =26 617 1 -

Guernsey 26 616 22 632 4 16

Munich 27 610 33 610 6 -

Dubai 28 607 =24 618 4 11

Dublin 29 605 =31 612 2 7

Osaka 30 601 34 606 4 5

Edinburgh 31 600 =28 615 3 15

Isle of Man 32 598 =24 618 8 20

Amsterdam 33 595 35 604 2 9

Qatar =34 592 36 600 2 8

Hamilton =34 592 =31 612 3 20

Cayman Islands =34 592 =28 615 6 23

Stockholm 37 587 38 595 1 8

Wellington 38 585 44 582 6 3

Madrid 39 584 =45 581 6 3

BVI =40 582 37 596 3 14

Brussels =40 582 39 591 1 9

Bahrain 42 578 =41 587 1 9

Milan 43 577 47 579 4 2

Sao Paulo =44 573 40 590 4 17

Table 2 | GFCI 8 Ranks and Ratings 1–44 The Global Financial Centres Index 8 9

GFCI 8 GFCI 8 GFCI 7 GFCI 7 Change ChangeRank Rating Rank Rating in Rank in Rating

GFCI 8 GFCI 8 GFCI 7 GFCI 7 Change ChangeRank Rating Rank Rating in Rank in Rating

IFC Asia 24pp_ Appendix.indd 21 09/02/2011 09:09

22 Asia Review 2011

The Global Financial Centres Index 8 17

Although GFCI 8 ratings have generally declinedsince GFCI 7, Asia is the one region to buck thistrend. As can be seen in Table 11 below, of thetop ten Asian centres, six have shown ratingimprovements with Hong Kong and Shanghaiboth showing significant improvements.

Singapore was six points behind Hong Kong inGFCI 7 and there is now a significant gap of 32points. Tokyo, despite gaining five points in theratings has slipped further behind Hong Kong.These changes are shown clearly in Chart 8.

Regarding profiles, Hong Kong and Singaporeare Global Leaders. They are well knownglobally, and have a rich environment ofdifferent types of financial services institutions.Beijing and Shanghai are well connected andare assigned the profile of Global Specialists –they do not yet offer a sufficiently developedand diversified service to be Global Leaders.Seoul and Tokyo are assigned the profile ofTransnational Leaders although Tokyo is veryclose to becoming a Global Leader and wewould expect them to attain that status soon.

Asian Centres

GFCI 8 Rank

GFCI 8 Rating

GFCI 7 Rank

GFCI 7 Rating

Change inRank

Change in Rating

Hong Kong 3 760 3 739 - � 21

Singapore 4 728 4 733 - � 5

Tokyo 5 697 5 692 - � 5

Shanghai 6 693 11 668 � 5 � 25

Shenzhen =14 654 =9 670 � 5 � 16

Beijing 16 653 =15 651 � 1 � 2

Taipei 19 639 21 638 � 2 � 1

Seoul 24 621 =28 615 � 4 � 6

Osaka 30 601 34 606 � 4 � 5

Kuala Lumpur 48 569 51 571 � 3 � 2

400

450

500

550

600

650

700

750

800

GFCI 8

GFCI 75

GFCI 7

GFCI 65

GFCI 6

GFCI 55

GFCI 5

GFCI 45

GFCI 4

GFCI 35

GFCI 3

GFCI 25

GFCI 2

GFCI 15

GFCI 1

Hong Kong ■

Singapore ■

Tokyo ■

Shanghai ■

Chart 8 | Leading Asian Centres over GFCI editions

Table 10 | Top 10 Asian Centres

The Global Financial Centres Index 8 17

Although GFCI 8 ratings have generally declinedsince GFCI 7, Asia is the one region to buck thistrend. As can be seen in Table 11 below, of thetop ten Asian centres, six have shown ratingimprovements with Hong Kong and Shanghaiboth showing significant improvements.

Singapore was six points behind Hong Kong inGFCI 7 and there is now a significant gap of 32points. Tokyo, despite gaining five points in theratings has slipped further behind Hong Kong.These changes are shown clearly in Chart 8.

Regarding profiles, Hong Kong and Singaporeare Global Leaders. They are well knownglobally, and have a rich environment ofdifferent types of financial services institutions.Beijing and Shanghai are well connected andare assigned the profile of Global Specialists –they do not yet offer a sufficiently developedand diversified service to be Global Leaders.Seoul and Tokyo are assigned the profile ofTransnational Leaders although Tokyo is veryclose to becoming a Global Leader and wewould expect them to attain that status soon.

Asian Centres

GFCI 8 Rank

GFCI 8 Rating

GFCI 7 Rank

GFCI 7 Rating

Change inRank

Change in Rating

Hong Kong 3 760 3 739 - � 21

Singapore 4 728 4 733 - � 5

Tokyo 5 697 5 692 - � 5

Shanghai 6 693 11 668 � 5 � 25

Shenzhen =14 654 =9 670 � 5 � 16

Beijing 16 653 =15 651 � 1 � 2

Taipei 19 639 21 638 � 2 � 1

Seoul 24 621 =28 615 � 4 � 6

Osaka 30 601 34 606 � 4 � 5

Kuala Lumpur 48 569 51 571 � 3 � 2

400

450

500

550

600

650

700

750

800

GFCI 8

GFCI 75

GFCI 7

GFCI 65

GFCI 6

GFCI 55

GFCI 5

GFCI 45

GFCI 4

GFCI 35

GFCI 3

GFCI 25

GFCI 2

GFCI 15

GFCI 1

Hong Kong ■

Singapore ■

Tokyo ■

Shanghai ■

Chart 8 | Leading Asian Centres over GFCI editions

Table 10 | Top 10 Asian Centres

• Asia dominates these tables also. GFCIrespondentshavebeenpredictingtheriseto prominence of Shanghai for the pasttwoyears.

Asian CentresAlthough GFCI 8 ratings have generallydeclined since GFCI 7, Asia is the oneregion to buck this trend. Of the top10 Asian centres, six have shown ratingimprovements with Hong Kong andShanghai both showing significant

improvements.SeeTable10Singapore was six points behind Hong

Kong in GFCI 7 and there is now asignificantgapof32points.Tokyo,despitegainingfivepointsintheratingshasslippedfurtherbehindHongKong.SeeChart8

Regardingprofiles,HongKongandSingapore are ‘Global Leaders’. Theyare well known globally and have arichenvironmentofdifferenttypesoffinancialservices institutions.Beijingand Shanghai are well connected and

Table 4 – Centres where new offices

will be opened

Financial Centres Number of Mentions

Shenzhen 73

Shanghai 57

HongKong 49

Beijing 31

Singapore 29

Seoul 21

Table 3 – Centres likely to become

more significant

Financial Centres Number of Mentions

Shenzhen 121

Shanghai 119

Singapore 71

Seoul 61

Beijing 52

HongKong 48

are assigned the profile of ‘GlobalSpecialists’ – they do not yet offer asufficiently developed and diversifiedservice to be Global Leaders. Seouland Tokyo are assigned the profileof ‘Transnational Leaders’ althoughTokyo is very close to becoming a‘Global Leader’ and we would expectthemtoattainthatstatussoon.

Extracts from The Global Financial Centres Index 8 courtesy of Z/Yen Group.

IFC Asia 24pp_ Appendix.indd 22 09/02/2011 09:10

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