When investors buy stock in Alibaba Group, the Chinese e-commerce behemoth, they’re looking to participate in the company’s prosperity and, by proxy, the world’s second-largest economy. Except that a giant company located in China didn’t issue those shares; an affiliate in the tiny Cayman Islands did.
Most US stockholders probably don’t sweat this technicality, but the way those transactions and many others like them are compiled in international statistics can mislead investors and economic policy makers, suggests research by Harvard’s Antonio Coppola, Stanford’s Matteo Maggiori, Chicago Booth’s Brent Neiman, and Columbia’s Jesse Schreger. And the prevalence of such offshore financing could make it hard to size up the risks of a corporate debt crisis or to design policies in response if one occurs, an outcome made much likelier by the COVID-19 pandemic.
Consider the numbers for China. According to official figures for 2017, US investors held about $150 billion in Chinese equities. Yet, this number excludes investments in Alibaba, for example, because the official data consider holdings of Alibaba stock as investments in a Cayman Islands company. Using company-level data to include such issuances by offshore affiliates, the researchers calculate the equity position of US investors in Chinese companies to be closer to $700 billion. Underestimating US equity positions in China creates the illusion of a large and persistent economic imbalance between the two countries.
“There’s this narrative that the US buys China’s goods, they buy our Treasurys, and it’s totally asymmetric,” says Neiman. “The official statistics don’t acknowledge that the US buys a huge amount of equities issued by what are effectively Chinese companies, and it’s just because they’ve been issued indirectly in the Caymans. If you include those positions, it makes the relationship between the US and China look much more symmetric in terms of bilateral investments.”
Tapping foreign markets through offshore subsidiaries is a common maneuver. It helps companies get around regulatory capital controls, attract more foreign investors, and lower tax bills. Global corporations raise nearly 8 percent of their equity and 10 percent of their bond financing via subsidiaries based in foreign tax havens including the Caymans, Bermuda, and Luxembourg, the researchers note.
“The fact that so much cross-border lending is intermediated through tax havens means that, if there ever is a debt crisis, it will be more complicated.”
But all that extra financial scaffolding has a subtle, potentially deleterious effect: it obscures the size and direction of global investment in securities, the researchers find.
Understanding the true financial linkages between countries is important, in part so that investors and policy makers can predict how shocks in other countries will affect their country’s wealth. Further, the global pattern of investment positions can have implications for key macroeconomic values such as the exchange rate. “For decades, there have been dire forecasts of a collapsing US dollar to reconcile US imbalances with China,” says Neiman. “But if, in fact, global holdings of China’s assets are much bigger [than the statistics suggest], the imbalance is a lot smaller.”
To get a clearer picture, the researchers rebuilt the aggregate numbers. Using an algorithm fed by seven commercially available data sets, they matched the universe of traded securities with their ultimate parent companies—not with the subsidiaries, affiliates, and shell companies that issued them. Having established those links, they could then restate the value of the outstanding securities by nationality, rather than by residency.
In some cases, as with China and Brazil, the changes were large. At the end of 2017, the US held $547 billion of common stock in the Cayman Islands and another $195 billion in Bermuda, according to official statistics. Reallocating by nationality revealed that the bulk of those investments were ultimately tied to China. As for Brazil, its corporate bonds appear to be more popular than advertised: after making the nationality adjustment, the researchers observe that 66 percent of all Brazilian bonds held by US investors were corporate bonds, as opposed to the just 25 percent recorded in the official statistics. More visibility helps: if the COVID-19 crisis sparks problems in debt markets in a given country, central bankers and other policy makers will want to know which foreign investors will be most affected.
The prevalence of offshore issuance may also make it less clear in a crisis who gets paid. Warns Neiman, “The fact that so much cross-border lending is intermediated through tax havens means that, if there ever is a debt crisis—and there’s cause to be more worried about this now than during typical times—it will be more complicated. Any resolution would have to involve investors in one country, issuers in a second country, and ultimate parent companies located in a third.”