Originally published in the Cayman Financial Review
Storm clouds gather
With triple-digit drops in the Dow one day and double-digit jumps the next, frightened investors seem to have made peace with the fact that their money may be safer under their mattresses than left to the volatility of the market.
As of 10 August 2011, investors could only stand back and watch as the S&P 500 Index continued a 20-day trading sell-off resulting in a 14 per cent loss.
In Europe, the continuing debt crisis appears to have shaken the very foundation of the Euro. German chancellor Angela Merkel and French president Nicolas Sarkozy have recently expressed their vision for economic unity in the European continent, a move that they see as critical to stabilising the Euro. Their plan for a new European transaction tax was met with universal disapproval by the markets sending traders scrambling and crushing European indices.
Meanwhile, fears of inflation spurred by out-of-control government spending and high energy prices further hasten investors' flight to safety.
This seemingly perfect storm of worldwide uncertainty and volatility has seen investors rushing for safe haven investments such as gold, the historical touchstone for asset safety.
Yet, even in this darkening storm there is a silver lining. Mergers and acquisitions (M&A), a core strategy employed by businesses to shore up earnings and consolidate markets in times of slowing growth and economic recession, continues en masse. According to Allen & Overy's 2011 M&A Index, there were 1,206 deals in the first half of this year, a 9 per cent increase in volume on the same period last year. Energy and natural resources was the most active with 232 deals in the first half of 2011 as the global rush to secure precious natural resources continues. Abundant reserves and soft prices are driving activity in that market, particularly coal assets. Demand for coal assets has reached a new high, with targets in India, Indonesia and Australia attracting intense interest, mostly due to demand for high-quality coking coal for use in steel production. In North America, oil and gas exploration and development have been the key drivers of M&A activity.
Recent data from Ernst & Young shows that mining M&A deals doubled in the first half of 2011. To put things in perspective, US$113.7 billion worth of mining deals were generated in the whole of 2010 – a figure almost reached in just the first six months of 2011. Ernst & Young believes transactions in the mining sector could top US$200 billion by the end of the year, although concerns over global macroeconomics and resource nationalism could temper the pace of deals.
Recently announced mega-acquisitions such as the US$12.5 billion purchase of Motorola Mobility by Google Inc. demonstrate that, even in a down economy, cash-rich companies are ready and willing to put some of their excess capital to use if they spot a good deal.
In the Asia Pacific region the demand for Liquefied Natural Gas from both conventional gas resources located primarily in offshore Western Australia and coal seam methane deposits located in Queensland jumped dramatically following the Fukushima Daiichi Nuclear Power Plant disaster and the rise of anti-nuclear sentiment around the globe. As a result, M&A activity in this space has been red-hot as of late.
Cayman marches on
Whilst the developed world has been in crisis, emerging markets have been thriving. Given the relative strength of many emerging economies paired with the market dislocation in the developed world, many countries are expanding globally and taking advantage of favourable valuations. Although investments in emerging markets are on the rise, such countries sometimes suffer from political instabilities, uncertain regulatory and legislative climates and unfamiliar legal systems.
To mitigate such risks, investors generally avoid operating through entities established in these emerging markets, instead opting for vehicles incorporated in traditional offshore jurisdictions. Cayman continues to be the jurisdiction of choice for many crossborder holding structures due to the flexibility and convenience offered by the Islands legislative regime and regulators in addition to the Islands' tax-neutrality. Unlike the unfamiliar and at times unpredictable legal systems of some emerging market countries, the Cayman Islands' legal system is based on common law with a right of appeal to the Cayman Islands' Court of Appeal and then to the Privy Council in London. This provides a familiar more predictable legal system with a well-developed body of case law ensuring both certainty and consistency. Sophisticated investors and blue-chip multi-national conglomerates alike continue to be attracted to the Cayman Islands' sophisticated regulatory regime. The Islands' flexible and continually evolving legislation, sophisticated work force and infrastructure is a source of both competitive advantage and new business – especially in terms of M&A transactions and insurance business.
Mergers and acquisitions
Recent changes to the Cayman Islands' Companies Law permitting Delaware-style mergers have allowed the Islands to benefit from this global uptick in M&A activity. Cayman companies may now merge into foreign companies with the foreign company as the sole survivor and the merger process is succinct, relatively flexible and efficient.
This modification of the Companies Law, coupled with the popularity of the Cayman centred offshore holding structures, has led to a marked increase in merger activity involving Cayman exempted companies. Many multi-national conglomerates base their offshore corporate structures around Cayman vehicles. These sophisticated parties appreciate the flexibility afforded by the governing legislation that allows them the freedom to structure transactions to satisfy any commercial nuances no matter how complex and reflect market conditions. The Cayman Islands' stable government and responsible approach to regulation coupled with its extensive network of Tax Information Exchange Agreements provides an attractive platform for these complex cross-border transactions.
Credit must be given to the Cayman Islands Monetary Authority for the role they continue to play in attracting new business to the Islands. CIMA's foresight in, thus far, not embracing the European 'Solvency II' directive is making the Cayman Islands the beneficiary of insurance business from other jurisdictions which have already adopted the regime. Although Solvency II's anticipated improvements to risk and market sensitivity, supervision of groups and transparency must be applauded, the Cayman Islands' insurance market – and in particular, captive insurance, simply does not bear the same systemic risk as their commercial counterparts or reinsurers. In maintaining their flexible, risk-based, case-by-case approach to supervision, CIMA has created a competitive advantage for the Cayman Islands in continuing to attract quality captive insurers versus other financial centres. It should be noted that CIMA was also instrumental in leading the development of the new insurance law in October 2010 that, when combined with existing practices, fully meet the overall guiding principles of risk-based supervision as well as the principles of the Solvency II regime, should this directive ever come into force in the Cayman Islands.
Business as usual
As can be seen, the Cayman Islands have fared well and, in some cases, thrived, despite global economic turmoil and uncertainty. With its stable government, legislative flexibility and responsiveness, the Cayman Islands are well-placed to remain the leading offshore financial-services centre, whatever sea-change the markets encounter.
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