Cayman Island rules are allowing Chinese swindlers to take advantage of Western stock markets, enriching themselves and leaving the losses with UK shareholders, writes Sean Worth
Spying, human rights abuses, intellectual property theft and unfair trade practices – the record of Chinese offences against the United Kingdom is already long. But now you can add robbing pensioners of their hard-earned savings and raiding the endowments of the most cherished British institutions to the list.
The latest transgression is possible due to the seeming inability – and apparent unwillingness – of the Cayman Islands’ legal system to protect minority investors of companies incorporated in the British Overseas Territory, as put on stark display in a Cayman court decision in late November, the implications of which are just becoming clear.
Chinese swindlers have been listing and growing companies on Western stock markets, then selling at well below fair value, only to then relist in China at higher values, enriching themselves and leaving the losses with UK shareholders. Some £100bn of British capital is at risk.
This troubling trend could threaten the Cayman Islands’ status as a preeminent financial centre – key to the Territory’s economy and workforce. It’s not just the jurisdiction’s tax neutrality that has made it a popular domicile for tens of thousands of international companies, but also its well-established investor protection laws.
The Cayman courts have now turned a blind eye to this apparent financial abuse, proving themselves unable to adequately safeguard minority investors. Chinese-controlled companies have successfully exploited loopholes in Cayman law at British investors’ expense.
How are Chinese investors taking advantage of the Cayman legal system?
The troubling practice involves multiple jurisdictions with the Cayman Islands as the key link. In recent years, a large number of Chinese companies listed shares on US stock markets in order to access Western investors including British institutions and asset managers. Many of these Chinese firms – collectively worth more than $1 trillion – are incorporated in the Cayman Islands.
Under a quirk of Cayman law, controlling shareholders can approve a sale of a company if they hold at least two thirds of the votes – at practically any price, whether or not minority shareholders agree. The Chinese controllers take the company private by voting to buy out minority shares far below fair value, then relisting in Shanghai or Hong Kong for full value – making billions in the process.
Take Chinese cybersecurity company Qihoo 360, which was taken private by its controlling shareholder in 2016 at a roughly $9bn (£6.7bn) valuation, only to relist in China soon after valued at more than $60bn. Minority British shareholders were squeezed out – these transactions export capital from UK investors to Chinese corporate interests in a large, eastbound value transfer.
Minority shareholders’ only real protection against a buyout at an unfair price is to “dissent” from the merger by asking a Cayman court to determine the fair value of their shares, similar to procedures found in other mature commercial legal systems. But in the last several years, US politicians, British asset manager Aberdeen Investments and others have raised concerns about the Cayman legal system’s effectiveness in protecting minority investors from abusive transactions. A late-November ruling puts into question whether Cayman courts are even willing to try.
51job Inc sets an unfortunate precedent
In the matter of 51job, Inc, minority shareholders challenged a 2020 controller-led buyout of a US-listed, Cayman-incorporated online classified ads company. They alleged numerous flaws in the deal process, including conflicts of interest. Most significantly, the minority shareholders argued for a roughly $111-per-share fair value, well above the $61 deal price. That gap represented a $1.7bn windfall for 51job’s Chinese controlling shareholders at the expense of minority shareholders, which included the Cambridge University Endowment Fund and other British investors.
Shockingly, the Cayman court set “fair value” at barely half the deal price, which minority shareholders already viewed as a severe undervaluation. The Cayman court relied on just one valuation estimate, in an apparent departure from precedent and the Privy Council’s recent guidance to weigh all available valuation methodologies. The court’s chosen calculation was based on the trading-price history of 51job’s shares – which had been heavily distorted by Covid-19 market volatility.
Instead of finding relief, minority shareholders now could be asked to pay back roughly $600m to the Chinese-controlled company, thanks to the court. In a ruling that appears at odds with the constitutionally protected right to dissent, the Cayman court displayed an aversion to engaging with the necessary complexity of the case. In the opening paragraphs of the ruling, the judge laments: “The lead-in time to trial is too long… Written submissions need to be shorter… Trials need to be shorter. Oral submissions and cross-examinations need to be shorter. Judgements take too long to write and are themselves too long in content.”
A fair appraisal in Cayman court is the last line of defence for minority investors. The decision in the matter of 51job, Inc is likely to have a chilling effect on investors considering becoming minority shareholders in Cayman-incorporated companies. They now have to decide, do they accept a low-ball offer or seek an appraisal in the Cayman courts that could potentially leave them even worse off? Chinese companies, meanwhile, will be further emboldened and incentivised to take advantage of UK investors.
For the UK, the question is what is our government doing to protect pensioners and investors from Chinese hustlers, all under the nose of the courts in a British Overseas Territory? The answer is certainly not enough.
Sean Worth is a former No 10 adviser to David Cameron