Most power is still found in the Western world. Over the last few centuries, Western countries proved themselves to be top-notch in terms of economic development, technology, education, and political power. However, this might soon to come to an end, especially economic-wise. Over the past decades, Asia has become a booming continent. Gideon Rachman (the Chief Foreign Affairs Commentator at The Financial Times) wrote an entire book, named Easternisation (2016), about the major transition of power from West to East. Whats is going on? Asia, and particularly China, is on the rise but does not have the intention to harm the outside world. The currently established power (the US) is challenged by China. According to Rachman, this is referred to as ‘the Thucydides trap’, predicting that the US will start a trade war because they are afraid of China. The US should have found a way to co-exist with China. However, they have been busy in the Middle East. Historically, Western countries have always determined developments and decision-making on the other continents. Just look at the colonial times, when Europe almost ruled the majority of the world’s surface. This way of ruling slightly changed as the US gained more power, especially after the Second World War. However, this is all coming to an end. The main reason for this is economic development, which is clearly visible in Asia, especially over the last decades. Asia’s wealth has been rapidly increasing in the last few years, and China has made great improvements in this area as well. This change in wealth led to pressure on Japan and the US. It seems that the established power (the US) is focusing on the wrong area. Economically speaking, the interference of the US in the Middle East possibly resulted in some crucial consequences. This meddling behaviour led to war, terrorism, and the rise of the immigrant stream to Europe. Consequently, this immigrant stream negatively impacted the entire European economy. Additionally, the economic crisis, Greece, Brexit, a potential Frexit, and the situation in Ukraine are considered to be other factors that had a huge impact on the overall economy in Europe. This clearly shows the highly unstable situation in the Western world, and a country like China can make use of this. Europe and the US are relatively lacking in terms of political and economic power. It is expected that China will make a huge impact because the country counts over a billion of people. China in more detail The Chinese economy has been growing already at a high rate since the 1980s. A historical moment occurred when China became the largest economy in 2014 in terms of purchasing power. This was already the first sign of power shifting. Moreover, three out of the four world’s largest economies are now in Asia. More specifically, this is also true at a city level. According to research conducted by Oxford Economics, Asian cities will be among the top performers in the world in terms of GDP contributions by 2030. It is expected that this economic development will continue at a fast pace in the near and long term future. The main reason for this growth is the division of the world’s population. In about ten years, it is expected that the majority of people will live in Asia. Furthermore, this majority of people will be more wealthy and can have an even more positive impact on the global economy. Many people have pointed out that the growth rate in China is plummeting, but it is still quite steady at approximately 7%. Asia, and particularly China, will defeat North America and Europe in terms of overall power relative to GDP and population. The process of Easternisation is clearly on its way. The Chinese NASDAQ Recent accessibility changes are also clearly seen in the way foreign investors can invest in China and its surroundings. Last week, a stock link was created between Hong Kong and Shenzhen, providing easier access to the Chinese stock market. It is expected that this access channel will bring in $29bn in inflows. At this moment, more international investors, who only count for 2% of the overall market capitalisation of $3.4trn, will enter this enormously large untapped market. This will change the proportional numbers related to national and foreign investors because no clear regulatory constraints are put in place. In the end, this stock link is not a capital flight approach, and cash can only be taken in the currency that was invested in the beginning. In the end, this new opportunity is an attractive one for investors and another sign that China is really on its way in terms of economic power. $3.4trn is the total Chinese market capitalisation However, there was also some downside news, recently. Some exchange controls were put in place that had an impact on foreign corporations. Dividend payments abroad could not be made. At this moment, China wants to control the capital outflows. China wants to grow its foreign investment reserve, and this is one of the consequences since the reserve has been drying up in the recent period. This is clearly linked to the renminbi currency that went down by 6% against the dollar since the start of this year. At the moment, dividends of foreign companies are stuck in the Democratic People’s Republic until further notice. How far is China going and what will the reaction be of Europe and the US? The US is already reacting. The dollar just hit its strongest level in about 13 years since President-Elect Donald J. Trump is on board. This even strengthens the capital outflow described earlier and puts enormous pressure on the Chinese economy. Moreover, investors are even offloading assets that were valued in renminbi, mainly because the currency looked promising, but hit its’ eight-year low versus the dollar, recently. Is implementing exchange controls China’s answer to the outcome of the US election? And is China on its way to internationalising the country’s currency? It is quite obvious that the high growth potential country is having some issues on the rising path. How dependent is China on its foreign partners? Japan, the “Western Ally” of the US Japan is doing a good
The impact of Trump’s Tax Plan
For many decades, US multinationals avoided paying income taxes. Transfer pricing and tax avoidance activities are still common practice in most of these organisations. However, some changes have been seen in the past few months. First of all, large multinationals like Starbucks, Google, and Fiat were called out for having so-called ‘illegal’ practices. The European Commission investigated those firms but, in fact, their practice was found to be completely legal. However, it could be considered unethical by society. The Current Situation President Trump has proposed a new tax plan, which completely changes the tax climate in the US. Currently, large multinationals (income above $18.3m annually) pay approximately 35% in corporate income taxes (if the fair amount of tax is paid), which is considered to be one of the highest tax rates in the world. Therefore, the US is an unattractive country for domestic investments from that perspective. A logical result is that companies try to find ways to legally reduce the tax amount paid. It is quite often the case that companies are “tax shopping”, trying to look for regions (e.g. Europe or the Bermuda triangle) where a flat tax percentage is applied. From this perspective, it is tax behaviour that is natural and legal and companies should not be blamed for this. Trump’s Proposed Solution This situation can change entirely under the proposed plan. Trump proposes a corporate income tax structure that results in a 15% flat tax rate, which also includes certain limits on interest deductibility. It is assumed that only half of the expenses on interest can be deducted under the new plan when calculating the taxable income. New investments might be expensed, and accordingly, the depreciation amount is not deductible. Consequently, a drop in revenue is expected for a short period, before this decline will change positively as new capital insertions will result in more income. 15% is Trump’s proposed corporate tax level Additionally, it can be concluded that the proposed rate applies to both smaller and larger companies. Hereby, President Trump eliminates the classification between firm sizes. Moreover, a single tax rate of 10% is proposed for offshore cash profits flowing into the US. Other offshore earnings will be taxed at 4%. More Cash Flowing Into The US? This could possibly result in more profits coming to the US, which is, in the end, more beneficial for the companies, since it is a one-time 10% tax rate for offshore firm profits. Furthermore, the entire country will benefit, because more corporate profits are taxed. Moreover, offshore profits in tax havens, which were stuck before, will flow to the US and will potentially be better spent by companies. In the end, this also results in better employment opportunities for American people. However, there are still tax climates that are significantly more beneficial for multinationals to relocate into or include in the tax structure. The 15% flat tax rate, which is included in the proposed tax plan, will possibly result in a better situation for America overall. Nevertheless, there is still considerable uncertainty about the consequences of the proposed plan (for instance, the impact of the proposed tax plan on the movement of corporates in Europe or other regions in the world). Will Trump make America great again? Yes, he will. A lot of Americans and corporations will benefit from the tax changes.
Long-term shareholdership
Can you please tell something about yourself, your career and about your function as CIO at Kempen Capital Management? My name is Lars Dijkstra, Chief Investment Officer at Kempen Capital Management for the last 11 years. I previously worked for the Philips Pension Fund in Eindhoven for 14 years, making a total of 25 years in asset management. The content of these jobs is not that different if you compare the two. However, the job I have now is in a more commercial environment, where we need to work hard to earn every single client. Education wise, I studied macroeconomics in Groningen and completed an internship at Oyens en van Eeghen in Amsterdam. At Kempen Capital Management, I am in the management team responsible for the investment teams. This involves all of our niche product strategies, which started with the small caps Kempen Orange Fund 25 years ago and has grown to include active strategies such as high dividend equity (Europe and global), listed real estate, credits and hedge funds. We also offer a fundamental indexation and smart beta strategies in a few areas of the market. Basically, we focus on the less efficient parts of financial markets, where we have a higher chance of adding value for our clients. Here at Kempen Capital Management we do not run two hundred different investment funds; we are not a supermarket of funds. We are very focused on a few niche areas and that is what I believe in. Can you briefly explain ‘long-term shareholdership’, does it involve more than holding stocks for longer timeframes? There are a lot of ways to explain what it is. I wrote an article on the topic a year ago titled ‘Rekindle the spirit of Keynes’. Keynes invested this way in the 20s and 30s, followed by Benjamin Graham, and then Warren Buffet after that. All these men did this ‘long-term engaged shareholdership’ a long time ago; it is not a new concept. However, the change in our industry since the 80s and 90s is that benchmark investing has become the goal instead of the mean. Shareholders, companies, pension funds, they all have a twelve months or even shorter time frame, which leads to the question: What is more important short-term profit or long-term value? The average turnover of a share on Wall Street is less than twelve months, so the horizon has become very short. According to a global survey of McKinsey 80% of CFOs cancel their investment plans if it will negatively impact the next quarterly earnings figure. Short-termism is one of the main reasons that in the developed world we are now at a 40-year low of private investments (CAPEX) around the globe and at the same time an all-time high of share buybacks. There is a lot of evidence that the world has become too short-term and it is getting even worse. To counteract this, we think we should look five to ten years into the future when making an investment decision, focusing therefore on companies instead of stocks. It seems a subtle difference, but I think it makes a huge difference. It is about focusing on long-term sustainable cash flows of companies instead of the noise of the stock market (going up and down) and the last quarterly earnings figure. Another way of saying it is that it is also a transformation from the focus of sell side to buy side. A good example in the Netherlands is Unilever. Paul Polman actively promotes to talk only with long-term buy side shareholders instead of the sell side analyst, who is on the phone for last quarterly figures and next quarterly outlook. It is about the long-term horizon, but this is not the same as saying buy and hold. We are not saying you should buy and look ten years later at what happened. Yet, I think with this way the average turnover of the portfolio will be much lower than normal. I heard that Kempen Capital Management is changing their focus towards long-term shareholdership. What will be the major difference in business under this strategy? As I earlier said, small caps are our roots. The philosophy has always been long-term shareholdership there, so in that sense we are not changing anything. What is new is that we are applying this now also to large caps. In small caps you could say: ‘in this fund we take a five percent stake in companies, meaning we own five percent of each company’. So by definition, we have a longer term view, as you cannot trade daily in and out. You have more dialogue with management, and more influence as well. That is the whole long-term small-cap engaged shareholdership idea. But transforming this to the large cap world is more difficult, as you cannot normally own a five percent stake. However, we think that large cap companies are more and more, like the example of Unilever, interested in listening to smaller shareholders, granted they are interested in the long-term strategy of the company. A different way to characterize this is focusing more on stakeholder value over shareholder value. Out of a recent Harvard research paper of Professor Eccels et al., companies mainly driven by stakeholder value decisions not only had share prices of four percent better per year over the twenty year period, but also higher return on equity, return on assets, lower employee turnover, and other real economic measures, compared to companies taking shareholder oriented value decisions. Who holds the most power in shifting towards long-term investing: the asset owner, asset manager, or companies? I think it is difficult to say who has the most power. It is really about all three of them. But go one-step back, and think ‘why are we in business?’. For asset managers it is because the savings of our clients today need to be efficiently allocated in productive capacity for the future. Basically, the investment value chain is formed because these savings needs to go, in our
Impact Brexit II
In this part James Knightley talks about another concern related to the UK leaving the EU. Furthermore, he explains what the consequences will be if the UK leaves the EU and what the consequences will be for the banking sector. In the end, he will give a general advice to students from Tilburg University. Another concern is that the UK would no longer be under the EU umbrella when we trade with countries like the US, Japan, Canada or Mexico, so we need to agree on individual deals with these countries. The US trade negotiator already suggested that they are busy negotiating trade deals with China, Mexico, and Brazil. They do not really want to sit down and negotiate with the UK as well, so there is a lot of uncertainty there. But also my big concern is that on the investment side the UK is a particularly open economy to foreign investments. In most normal European economies, foreign investment accounts are about 5-10% of total investment spending in their economy, in the UK’s case it is approximately 20%. The UK is a very popular destination for foreign businesses to put infrastructure, investment, and factories. Anything that could make the UK less appealing, such as this uncertainty is going to harm jobs and it is going to harm investments in the UK economy over that window of uncertainty. What might be the consequence(s) if the UK would leave the EU? A lot of people come up with provocative statements, but the thing is we just do not know how the negotiations are going to go, so those people are sort of pre-empting. Because of this, my concern is that the economic risks are largely stemming from political uncertainty. Due to the possible French and German elections next year and the people that we were negotiating a deal with may no longer be in power and they might want something else. They would then have to go back to the start on negotiations and this creates a hugely unsettling period. A lot of people have been suggesting that if the UK votes to leave it can bring Europe actually together. Europe can work together more easily without the UK; if the UK leaves, that is going to make things easier. However, I guess a concern is that if the UK leaves, this could result in more fragmentation in the European Union. It could be the start of a broader breakup if the worse case scenario does hit. So the major risk is not only for the UK, but also for the European Union itself. The big issue for the UK economy is that if the UK leaves this will be a catalyst for Scotland pushing for a second independence referendum, because the people of Scotland are much more pro EU than the people of England are. So the Scottish government has suggested that if the votes on June 23rd do come out that the UK is leaving, while, the Scottish majority had voted to stay, they could use that as their campaign point for a second referendum on independence. In terms of the Scottish independence agreement it would be a real risk. The UK would then not just have to be negotiating with the EU, but would probably have to negotiate a second divorce with Scotland. The political and business capital that has been used in these negotiation processes means terrible news of sentiment and it would be a massive debt to the UK’s growth prospects, which would feed into the European growth prospects. We also think in this environment that the sterling is going to fall substantially and very sharply indeed and that would make it even more difficult for European companies that export to the UK. This is because you have weaker demand coupled with the fact that you have become much less competitive against the UK because of the currency strength of the euro versus sterling. What would be the impact of a Brexit on the banking sector in Canary Wharf London and on the UK in general? At the moment, it is all relying on the UK banks getting this EU passport to continue operating in the EU if we do vote to leave. There have been suggestions that a lot of banks would look at reweighting where their workers are based, and there is the real threat that business does move. It comes down to the negotiations that you would imagine the EU is going to campaign quite hard for, if the UK does vote to leave. The EU will try to take much more of the Eurozone business and have it done in the Eurozone, so the UK is probably going to have some business gone if that is the case. It would be very interesting to see what the negotiations would entail, but certainly there is the potential for London to take a big hit as a global financial center. The idea that we have one center is probably misplaced. What would be the consequence(s) for the trade relationship between the United Kingdom and the Netherlands if a Brexit is the outcome in June 2016? The Netherlands is the UK’s third biggest trade partner, so it is a very important relationship that ideally would continue, so that is why we would need to see a deal done very quickly. Obviously, we are going to see that a lot of Dutch companies are going to be very concerned. And the deal needs to be done very quickly if the UK does vote to leave, so it could cause significant pain, if there are any barriers to trade or tariffs. And that is clearly not going to be positive for building growth or expanding the relationship. What advice would you give students from Tilburg University? In terms of careers, I would always suggest to do what interests you. Do not feel compelled to follow everyone else and take the regular line. Do what interests you, because your career is
Future of European tax system
On Thursday 11th February, we travelled to beautiful Maastricht where we had an interview with Professor Dr. Hans van den Hurk at Maastricht University, Faculty of Law. The future of the European tax system was the central point of discussion during this interesting interview. Could you explain something about yourself, your education and about your career? I studied fiscal economics at Tilburg University and I have been working in the field of direct taxes and European law in Tilburg. As a student, I started the smallest tax advisory office in the world from my living room and earned money as an advisor. Later on, I started working for the biggest advisory firms in the world, namely PwC and Deloitte. Currently, I am working independently as an independent consultant for legal and accountancy firms as well as large Dutch and American multinationals. My work therefore, involves advising on international fiscal law as well as on international strategy and policy. I also work for government institutions. Besides that, I have been teaching Corporate & International Taxation and International Tax Policy at Maastricht University since 2005. I also taught at Tilburg University for twelve years at the end of the last century. Currently, I am really enjoying teaching at Maastricht University because of the international focus of the university and the fantastic ambience in the most beautiful city of the Netherlands! How do you look towards American multinationals, which are making use of tax avoidance? American multinationals have no other choice, since they pay taxes close to 40% in their own country. As a result, they have become less competitive comparable to European companies that have up to 50% lower average tax burden. The biggest problem of the United States is that they are aware that their system needs reform, but politically this looks impossible. From the moment, American companies set-up their headquarters in the Netherlands, there are no issues so long as they use the tax treaties. However, if they set-up a trust company that executes the orders from the management of the holding company, then this becomes a sensitive matter. In what sense can a trust officer execute a partnership on his/her own accord? If the trust company really serves a role in the company, if it really directs activities independently, then this is fine. However, if the trust company gets directions from the headquarters to be executed on its behalf, then this can become challenging. In its Foreign Direct Investment Report of 2015, the United Nations said that developing countries would be the main victims if we put an end to the letterbox company industry. The tax pressure, for example in Europe, would be higher. This could effectively lead to a shortage of FDI available for investing in developing countries. Such shortage could be as much as seven times the required amount. This should not be forgotten if we really wish to have a discussion on fair taxation. It may be fair for us as it may lead to increase in Dutch taxes but it is not fair for developing countries. What is your view regarding the fine imposed on Starbucks and Fiat, Finance and Trade Unit by the European Commission (led by Miss Vestager)? Miss Vestager has to examine the state aid rules from the The Functioning of the European Union (TFEU) treaty. She has to follow the rules, like they are written down in the treaty, but she is not doing this. She created an extra criterion, which was not embodied in the treaty. The fiscal world knows two important model treaties. The OECD Model treaty and the United Nations Model treaty. Besides that, both organizations have determined transfer pricing guidelines. These guidelines provide definitive directions for companies to apply for determining the correct price in case of an internal transaction between group entities. These are the only controls the world actually has. Miss Vestager says that she does not buy that. She wants to do an independent investigation and apply EU-rules with additional criterion to the transfer pricing rules that reaches far beyond what EU stands for. This leads to a double taxation for the companies. America along with many other countries, applies the OECD rules. If the taxes in Netherlands are increased, they will not agree to any additional Dutch tax because it would be wrongly charged. Furthermore, it is annoying that Miss Vestager is moving ahead of the crowd. OECD is presently busy with the Base Erosion Profit Shifting (BEPS) and the world is waiting to see what they will cover. Actually it has to be said: Europe, please wait for a moment! The European Commission strives for an equal tax base throughout Europe as a solution to the problem. How would you solve this problem? We are really not ready for an equal corporate tax base in Europe, because we still have to cope with the issue of differences in governance across European countries. For example, I helped the Portuguese government with a tax reform. In Portugal, a tax inspector is totally autonomous. If the law states that A should be enforced, and s/he thinks it is B, then B will be applied. You can then protest against it, but can you really give any evidence to the contrary? In Italy, it is even worse. Imagine a company has indicated a profit of €1 million in Italy, however, it is possible for it to receive a recovery surcharge equivalent to €10 million profit. Subsequently, this company may appeal against the decision, but the appeal process will take at least a decade and no company would want that. So, they would rather prefer to settle behind the scenes with the tax authorities whereby they state: “You know what, we will declare €1.5 million profit, but then we agree that you will not go into the mutual agreement procedure as stated in the tax treaty.” So in the end, the company will in any case pay far more in Italy than required under the law.