The year ahead

38 January 2013

KEEPING US AWAKE IN 2013A Plus asks Institute members and other professionals to identify the big issues that will dominate accounting, business and the economy in Hong Kong, China and around the world this yearIllustrations by Alan Ho

January 2013 39

hina’s economy avoided a major slowdown last year, and the country’s new leader, Xi Jinping, said last month that the economic goals for this year would be to achieve sustainable develop-ment and social stability.

“Such priorities bode well for consumption and for a move to a more sustainable growth driven by the services sector and domestic de-

mand,” says Dariusz Kowalczyk, senior economist at Crédit Agricole Corporate and Investment Bank in

Hong Kong.However, other analysts doubt such a rebalancing of

China’s economy is practicable in the near term. “There has been a recalibration of China’s prospects,” says Ken DeWoskin, the head of the China Research and Insight Centre, a Beijing economic think tank, and a senior adviser to Deloitte. “You can’t count on consumption as a major driver of growth anytime soon,” says DeWoskin.

Economists cite a number of reasons why the Chinese popula-tion is unlikely to spend more, including a historically high sav-ings rate, elevated levels of inflation, recent economic volatility and persistently low consumer confidence. The recent govern-ment leadership change is also likely to inspire caution among

consumers.Some economists are even more bearish on the Main-

land’s prospects, given the slowing growth and reduced de-mand for exports. “We think the best days are over for the China growth story,” says John O’Connell, global head of research at Macquarie Bank in Sydney.

O’Connell fears that China is approaching a middle-income trap, referring to the economic stagnation that

can occur – as happened to Brazil and South Africa – when countries reach a middle level of income and

are unable to compete with either advanced economies in high-skill innovations or with

low-income economies in cheap pro-duction. “The shift to consumption

needs to be managed carefully to avoid the middle-in-

come trap,” he adds.Part of China’s

problem lies

40 January 2013

The year ahead

off its own shores, analysts say. Among its significant developed export markets, the euro zone remains in a slump and the United States continues to struggle. Among key emerging markets, former high-flying economies such as Brazil and India have posted sluggish growth.

Besides, O’Connell notes that China has a blunter competitive advantage than it used to when it comes to manufacturing. “Given China is already seeing strong wage growth, and is likely to face labour shortag-es, we believe companies will look to locate new plants elsewhere.”

China’s manufacturing costs have risen relative to those of Mexico, which has a large and growing pool of workers, close proximity to U.S. export demand and exten-

sive trade agreements. “Mexico will gain at China’s expense as it becomes the destina-tion of choice for manufacturing fixed-asset investment,” says O’Connell.

AccountingFor accountants, 2013 may be a year of re-flection. Hans Hoogervorst, chairman of the International Accounting Standards Board, said last month that stakeholders want a period of relative calm for a few years, to “let the dust settle” and allow ev-eryone to get used to rules made effective over the past couple of years.

In Hong Kong, 2013 kicked off with three inter-connected standards: HKFRS 10 Con-solidated Financial Statements, HKFRS 11 Joint Arrangements and HKFRS 12 Disclo-

sure of Interests in Other Entities.“Accountants will be making sure this

consolidation package is given proper at-tention,” says Catherine Morley, head of the technical department at KPMG and deputy chairman of the Institute’s financial report-ing standards committee, on the three new standards.

“It’s a new mind set,” Morley adds, de-scribing the new standards as cause for careful thought by executives as well as auditors. “Whether you’re the auditor or the CFO, think about the entities you’re in-volved with – for example, you might call them associates but you need to have a de facto control discussion,” she advises.

“Similarly, you’re quite happy with the phrase ‘joint venture’ but IFRS 11 makes a

“ Mexico will gain at China’s expense as it becomes the destination of choice for manufacturing fixed-asset investment.”

January 2013 41

distinction between joint operations and joint ventures and if it has an impact, it could be quite pervasive across the balance sheet,” she adds.

“We may see a new revenue standard be-fore the end of 2013, although it will have a long effective date,” says Morley, referring to IAS 18. “And we might have another ex-posure draft of the leasing standard to think about,” referring to IAS 17.

She adds that auditors and company secretaries need to start thinking about the new Companies Ordinance, provisions of which will come into force in 2014. “This year is a year of preparation,” she says.

In the U.S., CPAs see an uncertain time for the profession. “I hope the Securities and Exchange Commission will provide some

clarity on incorporation of International Fi-nancial Reporting Standards in 2013,” says Barry Melancon, president and CEO of the American Institute of CPAs. He also expects the Public Company Accounting Oversight Board to complete its review of mandatory audit firm rotation this year.

Capital marketsFunds raised through initial public offer-ings in Hong Kong should reach HK$125 billion in 2013 after hitting a four-year low in 2012, according to KPMG forecasts. This, however, may depend on whether China’s economic slowdown has bottomed.

“We expect a better outlook in 2013,” says Ringo Choi, Asia-Pacific IPO leader at Ernst & Young and an Institute member. “Many

new supportive policies will start to take effect,” he adds, referring to selective mon-etary easing and measures to boost capital markets activity from Mainland companies.

For example, E&Y expects to see more H-share IPO offerings in Hong Kong follow-ing the introduction of policies that allow small- and medium-sized privately owned enterprises from the Mainland to list in Hong Kong. “IPO activities in the latter half of 2013 are set to improve, suggesting that it could be the right time for companies currently in the pipeline to list this year,” says Choi.

KPMG agrees that Mainland private-sector enterprises will be a key driver of Hong Kong IPOs, some of which have been waiting for the market to recover. “We expect that while market volatility will

“ Whether you’re the auditor or the CFO, think about the entities you’re involved with – for example, you might call them associates but you need to have a de facto control discussion.”

The year ahead

persist, there exists a backlog of deals to be launched as market sentiment improves,” says Paul Lau, a China partner with the firm and an Institute member.

China’s domestic IPO market also stalled in 2012, and that undermined sentiment for IPOs of Mainland companies in Hong Kong. More than 800 applicants on the China Se-curities Regulatory Commission list are projected to raise about 500 billion yuan, compared to total funds of 103 billion yuan raised by A-share IPOs in 2012, according to Patrick Law, an assurance partner at E&Y. A revival in China’s domestic market could boost success rates for new overseas listings in 2013.

Not everyone is convinced, however, that the domestic market is ready for a large recovery. Domestically listed A-shares re-main in a bear market – they now trade more cheaply on average than their H-share counterparts in Hong Kong.

China’s stock markets will remain prob-lematic, according to UBS chief economist Wang Tao. “Issues include problems in the IPO process, insufficient transparency in company disclosures, inadequate investor protection and insider trading,” she says. “The government often sees the stock mar-ket more as a source of financing for the economy than as a way to improve capital allocation.”

Mergers and acquisitionsThe value of global mergers and acquisi-tions deals in 2012 was barely half the amount made five years ago at the begin-ning of the global financial crisis, accord-

ing to Ernst & Young. M&A value totalled US$2.25 trillion last year, against US$4.3 trillion in 2007, E&Y data says.

However, Chinese acquirers are increas-ing their activity. Chinese investors made direct investments in 2,163 overseas enter-prises in 116 territories in the first half of 2012, according to Mergermarket, a Lon-don-based data provider. Total non-finan-cial direct investment overseas amounted to US$35.42 billion in 2012, a year-on-year rise of 48.2 percent. This momentum is expected to continue, partly fuelled by a stronger yuan, especially against the euro.

“In the eyes of some Chinese investors, the ongoing euro zone uncertainties im-prove their chances of striking good deals with debt-ridden European companies,” notes Allan Zhang, a director at Pricewa-terhouseCoopers who advises on outbound China deals.

The U.S. is also becoming a favoured destination for Chinese investors. “It is a good market,” says Anthony Root, who heads the Asia corporate practice of law firm Milbank, Tweed, Hadley & McCloy in Hong Kong.

Root says that as recently as two years ago, Chinese in-vestment in the U.S. was fo-cused on natural resources. “Since then it has evolved beyond natural resources into infrastructure, brand-ed consumer products, air-craft parts and automotive parts,” he adds.

Despite increased regu-

42 January 2013

“ The government often sees the stock market more as a source of financing for the economy than as a way to improve capital allocation.”

January 2013 43

latory scrutiny from Washington, Chinese companies remain committed to expanding their investment in the U.S. market, which is generally viewed as a bargain, with many assets having deflated in value in the past few years because of poor economic growth.

Private equityVenture capital and private equity deals should reach record levels in terms of the number of deals and their overall value, an upbeat PwC forecasts. According to a report released last month, China-focused venture capital and private equity compa-nies raised US$35.8 billion in the first three quarters of last year, close to the amount for the same period in 2011.

“We believe that 2013 will be a record year for the market in China, and its devel-opment in the mid-term will be strong,” says Vincent Cheuk, leader of the north China private equity group at PwC and an Insti-tute member.

Cheuk forecasts that deal activity will strengthen from the second quarter of this year, as “global economic conditions be-come more settled, pricing expectations adjust, IPO markets re-open and the leader-ship transition takes effect.”

TaxationIn China, indirect tax reform will continue, with more provinces joining the pilot value-added reform scheme following the issu-ance of Circulars Caishui [2011] Nos. 110 and 111 by the Ministry of Finance and State Administration of Taxation.

The scope of services being covered un-der the pilot scheme is likely to be expanded to real estate and construction, entertain-ment, post and telecommunications and fi-nancial services.

Beijing is also likely to close foreign-investment tax loopholes. “We expect to see more rigorous enforcement of anti-tax avoidance provisions against foreign inves-tors [such as Circular Guoshuihan [2009] No. 698, on indirect disposal of China invest-ments, and Circular Guoshuihan [2009] No. 601], on beneficial ownership for the claim-ing of tax treaty benefits,” notes Ayesha Lau, a partner at KPMG and an Institute member.

Back in Hong Kong, legislation is expect-ed to amend the Inland Revenue Ordinance and the Stamp Duty Ordinance to provide a taxation framework for Islamic bonds, known as sukuk, to put it on par with that for conventional bonds.

Hong Kong is negotiating tax agreements with several countries. This year, double-taxation avoidance agreements with South Korea, Finland, India, Italy and South Africa are expected.

Another possible change would allow Hong Kong to enter into standalone tax in-formation exchange agreements, Lau fore-casts. Such agreements allow territories that have signed them to share information about taxpayers and transactions unhin-dered by bank secrecy or other confidenti-ality laws. Hong Kong’s present legislation does not allow for standalone tax informa-tion exchange agreements to be established with jurisdictions that do not also have a double-taxation avoidance agreement.

“ We believe that 2013 will be a record year for the [private equity] market in China, and its development in the mid-term will be strong.”