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The first module of this session sort
of at the end of Mateo's slides here
introduced the importance of tax havens.
And how it's showing up in many parts of the literature and
is a first order issue when trying to understand data on capital flows and
international investment positions.
And so that's what I'm going to be starting.
This will be a two module sequence.
I'll try and give a very quick 13, 14 minute intro and save a minute or
two for questions, but then Mateo will build on that.
And after those two sessions, we'll have more time for Q&A.
But let me just start with a simple schematic.
I know at least how I prior to starting this project,
which is with Antonio Coppola and Matteo Maggiore and Jesse Schrager.
How I started, I would have thought of international capital flows.
We talk about why countries should open up to foreign investments?
And I would have thought to myself a country like Brazil is a perfect example
where presumably a capital intensive giant energy firm, like Petrobras here,
would be borrowing directly from Americans and directly from Europeans.
And I figured that would look like an American over here buying securities
issued directly by this Brazilian for more Europeans over here doing the same.
But it turns out when you actually dig into the data and
the data that we use is what Jesse, for example, just presented these position
level data on mutual fund and ETF holdings in the US and in the EMU.
It's actually striking you see basically no direct
holdings of securities issued by the Brazilian Petrobras
parent firm held by American and EMU investors' funds.
Now, it's not that you don't see any interaction between these entities.
It's just that you find that they're intermediated through offshore
affiliates and quite typically in tax havens which will be the focus here.
So what this slide is showing you is that you do see big flows from the US to
a company called Petrobras International Finance Company.
That's what Jesse just talked about in his example in the last module as well.
And this is of course a Cayman Islands resident firm,
an affiliate of the Brazilian company, but not the Brazilian company.
And this affiliate in the Cayman Islands of course gets a whole bunch of money
from the Americans.
It gets a whole bunch of money from the Europeans.
And it's not just this Cayman Islands affiliate, you actually see the same kind
of intermediation routing of this funding through tax havens.
If you look at Petrobras Global Finance and Global Trading, which are affiliates
of Petrobras, but that happened to be located in the Netherlands, okay?
And so, as a practical matter when we think of companies opening up,
particularly emerging markets opening up to foreign capital, one thing that
this work and others is showing is that what that means in practice,
to a large extent, is foreigners developed country investors
are buying securities issued through these tax havens.
So, Jesse introduced what a CUSIP was, I think of it as a barcode for a security.
And this is just one example of such a CUSIP,
where the immediate issuer happens to be that
TIFF code at Petrobras International Finance company in the Cayman Islands.
And one reason why this configuration that we just showed is
of interest of importance as it can wreak havoc on the international
statistics that we rely on to understand what global portfolios look like.
So in most official data sets, and I'll get to this a little later,
most organize the statistics following what's called the residency principle.
Which means that you associate a bond issuance with the geography,
with the location of the most immediate issuer.
And so in this case, that transaction I showed you earlier would look like
an American investment or a European investment in a Cayman Island bond.
And in particular in a financial sector Cayman Island bond.
Whereas for most purposes, for most deep economic questions when we want to
understand that flow, we would rather associate it as a position
taken by American or European investors in the Brazilian energy sector.
So, let me elaborate a little bit now and just note that it's going to be quick.
So the deeper material and most of the analysis underlying what I'm about to
talk about comes from this joint work with Antonio, Jessy, and Mateo.
So, first question that all this might raise is why are these firms doing this?
Why does Petrobras or other firms issue in tax havens?
And the first thing I want to be clear on is there's many different reasons.
And it might be, for example, it might be that firms are trying to avoid taxation.
And that could be legally doing so which would just be tax minimization,
it could be illegally doing so which would be tax evasion.
Both motives might lead a firm to try to issue through a tax haven affiliate.
It might be that the firm's trying to avoid capital controls.
It might be that the firm wants to avoid regulation or minimize regulatory costs,
or even access a different investor base than what they could otherwise access.
Let me take you through these four examples just giving you
a simple example relevant for each of these four.
But what I want to claim is that depending on the purpose of your analysis or
depending on what one's research question is,
the distinction across these four motivations may or may not be important.
For example, many questions most questions I would argue of economic
interest doesn't care which of these four motives would cause
a company to issue through the Cayman Islands, let's say.
Because most analyses would never want to associate that capital raise with
the Caymans itself.
Since the Caymans is such a tiny country
with very little economic activity in the GDP, on the order of $2 billion.
Let me give you an example on this avoid taxation.
It's perhaps the most natural thing people think about when you think about
the desire to issue through a tax haven.
And what I'm showing here is just an illustrative plot.
The blue line just shows the total US holdings of
equity positions of firms that are considered Irish.
And the red.dot is our estimate of the holdings that in fact are firms that
are US firms in the sense that that's where their operations are,
that's where their sales are, that's where their employment is.
But where they've switched their headquarters company, excuse me,
their headquarters location to Ireland to save on corporate taxes on their profits.
Now that's not the only form or
way in which a company would use a tax haven to minimize taxes.
It's also the case that they are withholding taxes,
withholding requirements and the payment
of dividends to foreign bondholders in an interest to foreign bondholders.
So for example,
in the same way that the University of Chicago withholds some of my labor income.
And the basis that it needs to be used toward my labor income taxes.
Companies have to withhold interest payments to foreign bondholders on
the basis that they're withholding as part of that bondholders capital income tax.
And certain countries have more onerous rules that others,
tax havens of course have very easy lax rules.
Oftentimes a withholding rate requirement of zero.
And so another reason to issue through offshore affiliates and
tax havens is to minimize the tax exposure or
the withholding taxes on behalf of your bondholders, your investors.
I won't dig into much detail here.
I'll instead let Mateo do so in the next module.
But another major category of firms that issue through
tax havens like the Cayman Islands are going to be Chinese firms
that actually issue equity through affiliates that are offshore.
And they do so to avoid capital controls.
For instance, if I want to as an American buy an equity
share in a firm in China that's operating in a strategically
designated industry where that's not under normal structures required,
there's been this devise this structure, I shouldn't say required, allowed.
There's been this structure that they've devised called a variable interest
entity structure whereby I can do it.
I can buy a share in a Cayman Islands located offshore affiliates.
That is in a circuitous way but linked to the onshore operations in China.
That's another big category of these offshore issuances.
Another is just to avoid regulation, to give you sort of a picture of this.
You can see there was an example, a market abuse regulation passed in
2016 that applied to most European jurisdictions but
not the channel Islands which are constituted by Guernsey and Jersey.
And what the plot is just showing you is that a bunch of firms that issue high
yield bonds, that's denoted in the red line.
That basically didn't use the channel Islands at all, either to locate there or
to issue their securities began to do so sharply after that
regulation that came into place because it was a way to avoid it.
And then finally, and this is not causal evidence, but
it's suggestive that firms that are issuing in emerging market or
firms that are located in emerging markets.
Maybe are able to get developed market investors to buy their securities
if they issue them through foreign affiliates including those in tax havens.
One way to try to see this let me just aggregate across
all the Brazilian corporates but
you can see how it also holds for most of these five large Brazilian corporations.
If here you look at the breakdown of their total bonds that are issued
and you'd see that 58% are issued in the name of the Brazilian parents itself.
Whereas about 35% is issued by a subsidiary or
an affiliate in a tax haven, another 7% elsewhere.
If by contrast you then look at from our data developed market investor
holdings of bonds issued by those Brazilian Corprates,
you can see that 70% vastly in excess way disproportionate to
the 35% universe is actually buying their tax havens subsidiary issued bonds.
So this again, maybe another reason why firms do this.
And is it just these few examples I've given?
Well, no, here I showed you Petrobras that we talked about, but Gaz capital,
so Gazprom has an affiliate Luxembourg it uses to issue securities.
Alibaba is one of the examples of the capital control cases where
they issue securities through the Cayman Islands.
Medtronic Is an example of one of those Irish or US Texan versions to
Irish to Ireland, or it's largely a US firm that issues there.
And so, what our work does is it basically looks across a number of
commercial sources, tries to glean information that allows us
to associate the location of an immediate issuer in a tax haven.
Like Petrobras International Finance in the Caymans or
like Gaz capital in Luxembourg, and to associate it with the parents nationality.
To associate TIFCO with Petrobras in Brazil, or
to associate Gaz Capital with Gazprom in Russia.
How big a deal is all this when we aggregate up?
It's pretty massive.
So what this slide shows you is just as a share of total corporate bond and
equity financing worldwide.
What share can be attributed to the issuance through these tax havens?
In other words,
if I add up the value of all corporate bonds issued in what we call tax havens.
And I divided by the global value outstanding of all corporate bonds issued,
you'll see that the number is something like 10% here in 2017.
And not so much smaller would be the equivalent calculation for equities.
So this is really a big massive deal.
Okay, I want to make sure I'm clear on terminology before turning over for
the next module to Mateo.
The slides have already used the term residency and nationality.
What do these things mean?
Like I said, residency is going to capture
the location of the immediate issuer of the security.
Nationality is going to try to trace it all the way back to the ultimate parent.
And there are plenty of cases in which residency and
nationality might and will coincide.
So let me just give you an example.
Let's say we're thinking about a Brazilian government bond.
And that could be a bond issued in New York.
It could be a bond denominated in US dollars.
None of that matters because the immediate issuer
is always the government of Brazil, which is always Brazilian.
The nationality and residential concepts will coincide there.
Brazil never issues a bond in the name of a different
foreign subsidiary that government bond and therefore these concepts are the same.
Now there's plenty of cases where the concepts are different, but
it's not obvious which one would prefer.
So for example, take Toyota Motors North America as an example.
Toyota Motors North America issues a bond that
by residency would be considered American, a US issued bond.
By nationality,
you would associate Toyota Motors North America with its Japanese parents.
And so that would be associated of course with Japan.
Let's say you want to study how the capital is deployed.
And let's say Toyota North America raises
financing in North America deliberately to spend it in North America.
Well, then maybe the residency concept is the more relevant one.
Alternatively, maybe you want to think about control and
you want to think think about the Japanese parent controlling and
deciding how to allocate the capital raised by that North American subsidiary.
Well then, nationality in Japan might be the right concept.
So do you want to be clear?
Depending on the particular question of economic interest, the right notion of
statistic that you want to look at might change, it might vary.
But what our first paper really focuses on at least is a case where I think
the nationality basis is almost always more informative than the residency basis.
And that's when there are these tax haven issuances.
Because, again, when a company like Petrobras issues in the Cayman Islands,
it's almost never something that's of economic interest.
In that case for almost all questions that one would ask.
Being able to associate it with Brazil would be more useful.
And this is something that we'll talk about a little more later.
But there's many plausible notions of nationality one might want to consider.
One might want to think about the sales distribution of firms or
the geographic distribution of who's guaranteeing the bonds.
And this is something that Mateo will spend time on in the next session.
Let me wrap up here and just allude to the slides.
So you can sort of see some summary statistics,
if you happen to want after the session to check on your own.
But again, just to give you some of the names,
who are we talking about when we're talking about really large tax havens?
Well, by equity we've got Bermuda and the Cayman's, the Channels,
Luxembourg, Panama, Hong Kong.
And it's common to find issuances worth trillions,
literally at least on the equity side when aggregating across these tax havens.
And here's an equivalent snapshot of who is issuing and
in which tax havens when it comes to bonds.
So if you want to get a feel for
the basic summary statistics here they are at the end of the deck.
Finally, I just want to wrap up by noting that
tax havens have really become quite interesting to study for many reasons.
So, there's really interesting work looking at
transfer pricing in tax havens as a way to shift profits.
There's people who've studied
wealth accumulation by particularly wealthy households using tax havens.
And one thing that that we're trying to emphasize is that yet
another complimentary way to think about tax havens is as a way a conduit for
firms to raise capital.
Particularly emerging market firms raising capital from
foreign developed market investors.
And to get a very broad sense of
sort of the literature in the state of play of research on tax havens.
Here's a reading list to get you started.
That includes some of the seminal work there.
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