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Tax Havens Obscure $1.4 Trillion of Foreign Investment in China

U.S. and European investors’ holdings of assets controlled by Chinese companies but issued offshore are worth nearly three times as much as direct investments in companies registered in China.

By Tom Hancock & Spe Chen

U.S. and European investment into mainland China has largely been channeled through offshore vehicles set up by Chinese companies in tax havens, according to newly published research. This suggests that foreign exposure to Chinese assets is much larger than official statistics imply.

U.S. and European investors’ holdings of equities and bonds that were issued by offshore vehicles and are controlled by Chinese companies such as Alibaba Group Holding and Tencent Holdings reached $1.4 trillion at the end of 2020, according to new estimates from the Global Capital Allocation Project based at Columbia and Stanford universities.

That is almost three times the amount investors from those countries held directly in companies registered in China.

The data shows the depth of the financial links between the world’s second-largest economy and the major developed economies, making any decoupling a challenging prospect. Those links also mean that foreign companies are more exposed to China than previously thought, and U.S. and European governments will need to pay greater attention to potential risks from investment in Chinese companies routed through these offshore entities, the researchers suggested.

“The sums involved, the involvement of retail investors and mutual funds, and the shaky shareholder rights these structures imply, clearly point to a need for regulation,” the researchers said.

This data also means efforts to regulate global tax havens will need to take into account the interests of Chinese companies. The amount Chinese-controlled offshore entities raised from US and European investors almost tripled from 2016 to 2020, according to the Project.

“There has been a lot of attention and policy effort on regulating tax havens’ activities. Our work points to the growing importance of China in these jurisdictions, and this is likely to make global coordination on policy efforts more important but also more difficult to achieve,” the researchers said.

Chinese companies tend to use tax havens less for tax avoidance and more as a means to circumvent Chinese government restrictions on foreign ownership in some sectors—and because foreign investors often see foreign courts as more reliable than China’s, the researchers said.

This research is the only publicly available resource that “looks through” investment in companies registered in tax havens to where the invested capital is ultimately used. Most official statistics look at investment by residency, counting an investment in a Chinese-controlled Cayman Islands company as an investment in the Cayman Islands.

The project’s data covers investment from residents in the United States, the Eurozone, the UK, Canada, Switzerland, Norway, Denmark, and Sweden. It is lagging due to the time required to work out the ultimate controllers of companies registered in tax havens.

The researchers found that U.S. ownership of stocks and bonds issued by Chinese companies was $922 billion higher at the end of 2020 than the U.S. Treasury figures for investment in China. “Under this more comprehensive view, U.S. residents’ portfolios were much more exposed to China up to 2020, leaving them exposed to the subsequent tumble in Chinese tech stocks,” the researchers said.

The research also has implications for global financial balances. China is recorded in official statistics as a large net creditor to the rest of world, in part because its companies have relatively few liabilities to overseas investors. China’s creditor position is “much smaller” when the liabilities of Chinese-controlled companies registered outside China are included, the researchers said.

The value of foreign investors’ holdings of Chinese stocks and bonds has almost certainly fallen since the end of 2020, as increased regulation and crackdowns on tech companies, strict pandemic controls, and a property-sector slump led many foreign buyers to sell their holdings. The value of all foreign holdings of mainland stocks and bonds is down almost 20 percent from the peak at the end of 2021, according to the latest data from the People’s Bank of China.

“We’d expect losses to have occurred and the positions to have shrunk due to lower stock prices for many Chinese tech companies, like Alibaba and Tencent. Even at these lower valuation levels, positions including Chinese companies’ offshore affiliates are going to be higher than positions that only include investments in China-resident entities,” said the researchers.

Despite the market volatility, China has continued efforts to further open its onshore bond market to foreign investors and has passed a new derivatives law that makes it easier to hedge investments. “It remains to be seen whether foreign investors will trust these policies and re-enter the market,” the researchers said.

—With assistance from Jin Wu.


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