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China Go Abroad (4th Issue)Key connectivity improvements along the Belt and Road in telecommunications & aviation sectorsSeptember 2016

Contents

21

26

06

12

Chinese capital is competing overseas, and investment will hit a new record this year

1

Analysis of the “One Belt, One Road” initiative – Telecommunications and Aviation sectors

2

Hong Kong: A key platform to explore the opportunities along the Belt and Road

3 EY Overseas Investment Growth Navigator - financing structure

4

1.1 Outbound investment has soared more than 50% YoY and the “going out” is expected to continue

1.2 Manufacturing expansion has accelerated and it is moving up the value chain while Europe and the US remain the main growth engines

1.3 Stimulated by the “One Belt, One Road” initiative, the momentum will be continued

2.1 Connecting the world: Chinese enterprises are dedicated to building the “Information Silk Road”

2.2 Linking the globe: Aviation industry is accelerating its overseas expansion

4.1 Providing market insights and building bridges - Resolving financing difficulties Chinese enterprises encounter overseas

4.2 Proper planning of investment and financing structure: Avoid tax and foreign exchange risks

4.3 Establishing corporate treasury center (CTC) to help enterprises “go out”

4 / Key connectivity improvements along the Belt and Road in telecommunications & aviation sectors

China’s outward FDI is likely to exceed USD170 billion2 for the whole year, another historical high

China’s outward FDI reached USD99 billion in the first half of 2016, a YoY increase of more than 50%1

MOFCOM’s 13th Five-Year Plan for Commercial Development puts forward that accumulated foreign investment is planned to reach about USD720 billion by 2020

China’s outbound M&A announced in the first half of 2016 had surged to USD135.5 billion3, a YoY increase of 2.2 times YoY

Over 70 countries and organizations have expressed their support and participation in the “One Belt, One Road” initiative and China has signed Intergovernmental cooperation agreements with 34 countries5

China’s outward FDI in machinery manufacturing reached USD12 billion in the first half of 2016, a YoY increase of 4.4 times, accounting for nearly 70% of the outward FDI of the manufacturing industry4.

Key connectivity improvements along the Belt and Road in telecommunications & aviation sectors / 5

China’s outward FDI reached USD99 billion in the first half of 2016, an over 50% increase compared with the corresponding period of 2015. It reflected the increasing Chinese interests in internationalization due to the country’s economic transformation and the changes in global markets. However, the desire for expansion poses a critical test on the overseas investment and operating abilities of Chinese enterprises. “Going out” is not the ultimate goal, rather, the key is how far you can go and how successful you become. EY expects China’s outward FDI in 2016 is likely to exceed USD170 billion for the whole year, reaching another historical record high. In the coming years, the tide of China’s overseas investment will continue to rise and maintain a double-digit growth rate. The challenges for Chinese enterprises are to improve their strategic decision-making and operating capabilities, seize the opportunities and generate new drivers for growth in order to survive ‒ and thrive ‒ in the international markets.

Stepping into 2016, Chinese enterprises are performing remarkably well in the global investment market: as a net capital exporter, China's outward investment has exceeded the inward investment. The underlying high growth is the fresh and energetic momentum released by the Chinese outbound investment. A decelerated return growth rate for domestic investment and expectation of renminbi devaluation are the key concerns for capital and funds to look for better alternative opportunities. On the other hand, Chinese enterprises need to accelerate their internationalization process to enhance their competitiveness. In addition, with the implementation of encouraging national strategies such as “One Belt, One Road”, China’s outbound investment is expected to continue to grow in the future.

The manufacturing industry has experienced a remarkable growth in China’s outbound investments. It indicates that the policies to promote the sector’s “going out” and strengthen international capacity cooperation have been successful. Technology-rich assets

Albert NgChairman, ChinaManaging Partner Greater China

Loletta ChowGlobal COIN Leader

1 Source: Data include China’s financial and non-financial outward foreign direct investment (“FDI”). The financial outward FDI was collected from State Administration of Foreign Exchange (SAFE) and the non-financial one was collected from MOFCOM. EY calculated the total number

2 Source: EY analysis3 Source: Mergermarket, including data of Hong Kong, Macao and Taiwan4 Source: MOFCOM5 Source: Ministry of Foreign Affairs6 Note: Please refer to EY’s 3rd China overseas investment report Going Out – the global dream of a manufacturing power, March 2016; download link: http://www.

ey.com/CN/en/Services/Specialty-Services/China-Overseas-Investment-Network/Publications

are the most sought-after currently as Chinese companies move up along the value chain. Thus, European and American countries with advanced technologies, stable economies, and healthy investment environments continue to be the most popular investment destinations.

This year, 2016, is also witnessing China’s continued implementation of the “One Belt, One Road” initiative. Spanning more than 60 countries cross Europe, Asia and Africa, the initiative is fueling this round of outbound investment. In our last China Go Abroad report6, we focused on the rising high-end manufacturing power in China - the “going out” of high-speed rail and nuclear power. In this issue, we will turn to another two important sectors which also play an important role in the “One Belt, One road” strategy - the telecommunications and aviation sectors. From the “Information Silk Road” to the “Aerial Silk Road”, both large state-owned and private enterprises are actively developing their investment blueprints. And we expect to see substantial and robust development of the related investments driven by the “One Belt, One Road” initiative in mid-to-long term. However, careful due diligence and risk assessments will become the key for enterprises in their efforts to succeed due to the unique ‒ and often high risk ‒ investment

environments along the Belt and Road.

Outbound investment requires significant funding and needs to consider many sophisticated factors. A good financing structure will increase the success rate of investment. In the regional analysis of this issue, we will focus on Hong Kong and explore its important role in developing the “One Belt, One Road”. Because of its advantages in policy, talent and international experience, Hong Kong can serve as a strong platform from which Chinese enterprises are able to “go out” more smoothly. Relating to this, the EY Overseas Investment Growth Navigator has been developed to help Chinese enterprises to understand their possible financing difficulties and solutions, and we will look at a tax planning case study showing the importance of thorough investment and financing planning.

For those involved in this new wave of outbound investment, enterprises should not just blindly follow existing trends. Instead, they should foster their own international market perspective and undertake long-term strategic planning. We look forward to seeing Chinese enterprises embrace the world with a better market understanding and show the world a new image of the mature Chinese corporation.


Chinese capital is competing overseas, and investment will hit a new record this year1

1.1 Outbound investment has soared more than 50% YoY and the “going out” is expected to continue

China’s outward FDI reached USD99 billion in the first half of 2016, an increase of 52% year-on-year (YoY). During 2011 to 2015, the CAGR of China’s outward FDI reached 16.9%. The significant increase in 2016 has been not only driven by the implementation of the “going out” policy and the accelerated internationalization of Chinese enterprises, but also by the demand for overseas assets, especially for dollar assets under the pressure of the depreciation of the renminbi. The renminbi has depreciated more than 8% against the US dollar7, since one year after China’s foreign exchange reform (11 August 2015)8.

Source: Ministry of Commerce, State Administration of Foreign Exchange, EY analysis

Outward investment soared more than 50% in first half 2016, expected to achieve another record high in the full year of 2016

EY has analyzed that 2016 China’s outward FDI is likely to achieve another historical high - exceeding USD170 billion for the whole year, driven by the strong momentum in the first half of the year. Chinese enterprises have begun to rapidly increase their global investment to achieve mid-to-long term growth. With the “One Belt, One Road” initiative and other strategies serving as a powerful engine, more Chinese enterprises are expected to invest overseas and, therefore, a double-digit growth rate in China’s outward FDI is expected in the next few years.

Chinese enterprises have entered the phase of rapid growth in global investment in the mid-to-long term. With the “One Belt, One Road” initiative and other strategies serving as a powerful engine, the tide of Chinese enterprises’ overseas investment will continue to rise and maintain a double-digit growth rate. Meanwhile, the movement up the value chain and mid/high-end consumer demand will remain the key drivers of outbound M&A.”

7 Source: China Foreign Exchange Trade System8 Note: PBC’s Announcement on Improving Quotation of the Central Parity of RMB against US Dollar,

11 Aug 2015.

USD billion170

139.5

99.0

123.1107.8

87.874.7

2011

140.0120.0100.0

80.060.040.020.0

02012 2013 2014 2015 2016 1H

Business services

Manufacturing

Wholesale & retail

Mining

Others


1.2 Manufacturing expansion has accelerated and it is moving up the value chain while Europe and the US remain the main growth engines

According to data from the Ministry of Commerce, China’s outward FDI in the first half of 2016 mainly flowed to the business services (24.6%)9, manufacturing (19.8%), wholesale and retail (16.4%) and mining sectors (4.7%). The investment in the manufacturing sector, in particular, increased by 245.6% YoY, of which the outward FDI in the machinery manufacturing sub-sector reached USD12 billion, a YoY increase of 4.4 times. It demonstrates the success of the “Made in China 2025” and the International Capacity Cooperation strategies.

China’s outward FDI (Jan –Jun, 2016, by sector)

Outward FDI in machinery manufacturing sub-sector saw a 4.4 times YOY increase

Source: MOFCOM Source: MOFCOM

USD billion

4.4 times increase

9 Note: According to China’s Classification Standard of National Economy Industry (GB/T4754-2002) in 2002, business services (include leasing industry) mostly contains ten sectors: leasing, business administration, legal services, research and advisory, advertising, intellectual property services, professional intermediary services, market management, travel agency, exhibition, etc.

0 10% 20% 30% 40%

20.0

10.0

0

Business services

Manufacturing

Wholesale & retail

Mining

Others2.2

12.0

2.95.6

1H 2015 1H 2016

Other manufacturing sectors

Machinery manufacturing sector

24.6%

19.8%

16.4%

4.7%

34.5%


According to data from Mergermarket, China’s outbound M&A announced in the first half of 2016 increased to USD135.5 billion, a YoY growth of 2.2 times. The significant increment was mainly due to the announcement of many significant M&A transactions in the period.

Top 10 announced outbound M&As made by Chinese enterprises in 1H 2016

Bidder Target Country Sector Amount (USD billion)

CHEMCHINA Syngenta AG Switzerland Agriculture 43.0

Tencent 84.3% share in Supercell Oy Finland TMT 8.6

Anbang Insurance Group Co., Ltd. Strategic Hotels & Resorts US Real Estate, Hospitality & Construction 6.5

Tianjin Tianhai Investment Company Ltd (a member of the

HNA Group)Ingram Micro Inc. US TMT 6.0

Qindao Haier GE Appliance US Consumer products 5.6

Midea Group 72% share in KUKA AG Germany Industrial products 4.3

Dalian Wanda Group Legendary Entertainment US TMT 3.5

Beijing Jianguang Asset Management Co, Ltd, Wise Road

Capital LTDNXP Semiconductors N.V. (SPB) Netherlands TMT 2.8

Apex Technology Co., Ltd, PAG, Legend Holdings Corporation Lexmark International, Inc. US TMT 2.7

China Molybdenum Co., Ltd 56% share of Tenke Fungurume Mining S.A.

Democratic Republic of

CongoMining & Metals 2.7

Source: Mergermarket, companies announcements, Xinhuanet, etc.

Source: Mergermarket, including data of Hong Kong, Macao and Taiwan

TMT sector is leading in M&A deal quantity

The technology, media and telecommunications (TMT), diversified industrial products (DIP), consumer products and automotive sectors continue to be the popular M&A targets. It demonstrates Chinese enterprises’ growing interest in advanced technologies and services. Currently, moveing up the value chain and mid/high-end consumer demand remain the key drivers of China outbound M&As.

Europe and North America remained the most attractive M&A destinations in the first half of 2016 , accounting for USD78.9 billion and USD37.9 billion respectively, an YoY increase of over 300%. The top 5 destination countries (Switzerland, the US, Germany, Finland and the UK) attracted more than 77% of M&A value. The recent Brexit decision has resulted in a more unstable economic and financial situation in the short-term, and post-Brexit changes in trade and investment conditions may drive enterprises to reassess their investment plans in Europe. However, stable social and economic environment, well-established laws and regulations, advanced technologies and mature markets of European and North American countries will allow them to remain the hot spots for investors.

Chinese enterprises’ M&As in Europe and North America experienced impressive growth

USD billion

Number of deals


1

14

8

8

11

14

15

15

21

30

37

58

4

7

10

14

17

17

20

21

28

34

60

78

0 20 40 60 80 100

1H 2016 1H 2015

0 20 40 60 80

Europe

North America

Asia

South America

Africa

Oceania

TMT

Diversified Industrial products

Consumer products

Automotive & Transportation

Others

Life science

Financial Services

Power & Utilities

Real estate, Hospitality & Contruction

Oil & Gas

Mining & Metals

Agriculture

1H 2016 1H 2015

78.918.8

37.99.412.010.5

2.80.62.03.01.9

0.4


With the further implementation of the “One Belt, One Road” initiative and the landing of a number of benchmarking projects, we predict that asset-heavy projects in sectors such as infrastructure and energy will continue to “go out”, while projects in those asset-light sectors such as culture, tourist, financial services and modern agriculture, abundant overseas investment opportunities will also emerge.

Top 10 outbound M&A destinations of Chinese enterprises in 1H 2016

Country Amount ( USD billion) YoY growth to 1H 2015 Main sectors invested

Switzerland 47.9 3924% Agriculture

US 34.2 495% TMT; Real Estate, Hospitality & Construction

Germany 10.4 4093% Diversified industrial products; Energy

Finland 8.9 No investment in 1H 2015 TMT

The UK 3.6 -33% Life science; TMT

Canada 3.5 98% Energy; Consumer products

Japan 3.4 1032% Consumer products

Singapore 3.1 91% TMT; Diversified industrial products

Netherlands 3.0 45% TMT

Democratic Republic of Congo 2.7 546% Mining and metals


1.3 Stimulated by the “One Belt, One Road” initiative, the momentum will be continued

Main progress of the “One Belt, One Road” initiative

Area Key achievement

International cooperation framework

• Over 70 countries and organizations have expressed their support and engagement in the “One Belt, One Road” initiative• China has signed Intergovernmental cooperation agreements with 34 countries

Financial support mechanism

• Asian Infrastructure Investment Bank (AIIB) started operation at the beginning of 2016, and announced the first four projects in June

• Silk Road Fund launched its first round of investment projects• Countries along the Belt and Road are discussing to establish or expand the various related funds

Interconnectivity of infrastructure

• China has launched all-round investments in infrastructure construction, including transport, energy and telecommunication projects

• With regard to transport infrastructure construction, the Hungary-Serbia railway, Jakarta-Bandung HSR, Moscow-Kazan HSR, China-Laos railway and China-Thailand railway are all progressing well. A number of highway, port and aviation projects are also in process

• Chinese enterprises are expanding projects along energy-abundant areas like west Asia and the Middle East• China is also promoting the construction of a cross-border transmission system along the Belt and Road and improvements

in telecommunication networks

Promotion of the International Capacity Cooperation

• China has signed agreements with 20 countries for institutionalized International Capacity Cooperation, with a number of major projects launched

• Various kinds of multilateral and bilateral capacity cooperation funds set up by China have raised over USD100 billion• China and Kazakhstan have jointly developed phase I- 52 projects, with total investment of USD27 billion in sectors such as

steel, cement, flat glass, and auto manufacturing, establishing an effective model of International Capacity Cooperation

Economic corridors

• China, Russia and Mongolia have reached a consensus on the construction of economic corridors and are facilitating to prepare the planning outline

• The China-Pakistan Economic Corridor has made rapid progress and substantively launched the construction of a number of major projects

• The new Eurasian Land Bridge and Bangladesh-China-India-Myanmar economic corridor are also progressing well

Since the “Silk Road Economic Belt” and “21st-Century Maritime Silk Road” strategic concepts were proposed by President Xi Jinping in September and October 2013, respectively, the government has put great effort to implement the “One Belt, One Road” initiative and achieved considerable progress:

Source: Ministry of Foreign Affairs, China Railway Corporation


Nevertheless, the “One Belt, One Road” initiative is not the main reason for the rapid growth in China’s outward FDI: in the first half of 2016, China’s non-financial outward FDI in 61 countries along the Belt and Road amounted to USD6.9 billion, down 2.7% YoY from 2015. It only accounted for 7.7% of China’s total outward FDI during the period, in sharp contrast to the rapid growth of China’s overall outbound investment11. This decrease was mainly due to some special characteristics related to investment along the Belt and Road:

Firstly, most of the countries along the Belt and Road are rich in resources but have substantial infrastructure weaknesses. The investment and cooperation opportunities presented by these countries and areas to China are mainly in the energy and mining, infrastructure, and manufacturing sectors and in contracted engineering projects, which generally require huge investments and long cycles, and are exposed to higher financing risks and uncertain profitability. In addition, nearly half of the countries along the Belt and Road are considered to be high risk according to statistics. Thus, Chinese enterprises need more cautious business plans for these investments, which further impacts the progress of the projects along the Belt and Road.

Source: MOFCOM


In the first half of 2016, Chinese enterprises signed 3,080 contracting projects with 61 countries along the Belt and Road, with a newly contractual value of USD51.5 billion, up 37% YoY, which accounted for 51.6%10 of the newly signed contractual value of China’s foreign projects in the same period.

Countries along the Belt and Road are the main markets for Chinese contracted engineering projects

China’s M&A in Belt and Road countries, by sector(2005 – June 2016)

USD billion

37%

10 Source: MOFCOM11 Source: MOFCOM

USD billion

1H 2015 1H 2016

100.0

80.0

60.0

40.0

20.0

0.0

37.6

49.1

51.5

48.2

0 10 20 30 40

38.6

14.5

14.3

12.4

11.0

6.7

6.6

5.6

4.9

2.7

2.0

1.8

Other manufacturing sectors

Machinery manufacturing sector

Oil & Gas

Diversified Industrial products

Financial Services

TMT

Power & Utilities

Consumer products

Mining & Metals

Automotive & Transportation

Real estate Hospitality & Contruction

Life science

Others

Agriculture


Nearly half of the countries along the Belt and Road are seen as high risk12

Nevertheless, the investment opportunities presented by the “One Belt, One Road” initiative cannot be ignored: This region covers 60% of the world's population, and makes up about one third of the global economy. Preliminary estimates show that in the next decade, China’s total investment in the countries along the Belt and Road is expected to reach USD1.6 trillion.13

With the further promotion of the initiative and the landing of a number of benchmarking projects, the interconnectivity will be further strengthened and regional cooperation will be further enhanced. We predict that the asset-heavy projects in sectors such as infrastructure and energy will continue to “go out”, while in the asset-light sectors such as culture, tourism, financial services and modern agriculture, abundant overseas investment opportunities will also emerge. We suggest related enterprises follow the government policy, fully understand the investment environment of the host countries, carry out comprehensive due diligence and feasibility studies, and design a dynamic risk prevention and control mechanism so as to secure robust and long-term growth in the markets along the Belt and Road.

Source: Oxford Economics, EY analysis

Risk index‒ (80, 100) (60, 80) (40, 60) (20, 40) (0, 20) Very high High Mid Low Very low

12 Note: Oxford Economics compiled the “OE Risk Index” of world economies based on four dimensions: “sovereign risk rating”, “trading risk rating”, “political risk rating” and “regulatory risk rating”. The data EY refers to in this report is the OE Risk Index in 2016. For more details please refer to Oxford Economics’ website.

13 Source: China International Capital Corporation Limited , https://jw.cicc.com.cn/expertviews/424

Land Silk Road

Maritime Silk Road


2.1 Connecting the world: Chinese enterprises are dedicated to build the “Information Silk Road”

Follow the policies and plan carefully: the “One Belt, One Road” initiative fuels “going-out” of telecommunications enterprises

Information interconnectivity is the basis and a development priority of the “One Belt, One Road” initiative. The Vision and Proposed Actions on Jointly Building Silk Road Economic Belt and 21st-Century Maritime Silk Road explicitly points out the necessity of advancing the construction of cross-border optical cables and other trunk line networks, and creating an Information Silk Road14. The Guideline on Boosting International Cooperation in Production Capacity and Equipment Manufacturing15 also encourages telecommunications enterprises to speed up their global market expansion, increase their outbound investment and establish overseas research and development institutions.

Analysis of the “One Belt, One Road” initiative – Telecommunications and Aviation sectors2

Chinese telecommunications enterprises are “going out” to improve international communications connectivity through the “One Belt, One Road” initiative, which not only highly enhances regional economic integration, but also helps the industry find new growth momentum.

14 Source: Vision and Proposed Actions Outlined on Jointly Building Silk Road Economic Belt and 21st-Century Maritime Silk Road, jointly published by MOFCOM, NDRC and MOFA, March 2015

15 Source: Guideline on Boosting International Cooperation in Production Capacity and Equipment Manufacturing, published by the State Council, May 2015


State-owned operators: Accelerated business plan in line with the “One Belt, One Road” initiative

The top three Chinese state-owned telecommunications carriers have set up international companies in Hong Kong in recent years, positioning Hong Kong as a key platform for their internationalization. Hong Kong has sound information infrastructure, and a large number of international talents in the telecommunications, legal, finance and other business service areas. All these, coupled with Hong Kong's geographical advantages and cultural integration features, make it ideal to connect Chinese enterprises with the global market.

China Mobile International Limited (established in December 2010)

China Telecom Global Limited (established in August 2012)

China Unicom Global Limited (established in July 2015)

• China Mobile established China Mobile International Limited (CMI) by integrating some of the functions of its overseas investment office, global business division (affiliated with the marketing department) and China Mobile Hong Kong Company. CMI, headquartered in Hong Kong, is in charge of China Mobile’s overseas businesses including those in the UK.

• In 2012, China Telecom integrated its international business resources and human resources to found China Telecom Global Limited (CTG), which is headquartered in Hong Kong. Leveraging its abundant resources in mainland China, CTG connects the Asia-Pacific region and the world. CTG has become a world-class integrated provider of communications services including network deployment, service support and product supply.

• By integrating its overseas businesses in Hong Kong, the Americas, Europe, Singapore, Japan, Australia, South Africa and Burma, China Unicom established its wholly owned subsidiary -- China Unicom Global Limited, headquartered in Hong Kong.

• In July, 2015, CMCC initiated the “Join Hands Program”. The program is designed to cooperate with international operators in areas such as data, international voice call and transmission networks, to provide more reliable and faster telecommunications services for the “One Belt, One Road” initiative. Its partners have included VimpelCom, A1, Telenor and other international giants.

• In response to the “One Belt, One Road” initiative, China Telecom has focused on three regions: Eurasia, Greater Mekong and Africa. China Comservice, a subsidiary of China Telecom, planned the “Joint Construction of Africa's Information Superhighway Between China and Africa”, with investment amounting to USD15 billion. The planned length of optical cable is 150,000 kilometers covering 48 African countries.

• China Unicom is expanding the network layout in countries along the Belt and Road, laying optical cables to connect Central Asia, Southeast Asia, Africa and South America. In June 2016, led by China Unicom, China-ASEAN Information Harbor Co., Ltd. was founded to integrate information resources across the regions and establish the Internet plus industrial ecosystem.

Chinese telecommunications enterprises have taken active actions to accelerate their overseas expansion:


Private telecommunications enterprises: Made breakthroughs in outbound M&A with huge potential

• Generally, China’s infrastructure investors are mainly large state-owned enterprises. However, taking advantage of their flexibility and adaptability, private enterprises have risen to be important participants in the overseas expansion in the telecommunications sector

• In April, 2016, Sharing Mobile, a Chinese virtual network operator16, acquired an 80% interest in a Nigerian telecoms operator for USD200 million, showing the ability of Chinese private enterprises to acquire overseas telecoms operators

• China is drawing up regulatory reforms in the telecommunications market. Over the past four years, private investment in the telecommunications market has exceeded RMB100 billion17. As private telecommunications enterprises have flexible mechanisms, low political risk and an innovative spirit, they are expected to become a new force in the overseas telecommunications M&A market

Communications device suppliers: Boosted by the “One Belt, One Road” initiative

• Chinese communications device suppliers, such as Huawei and ZTE, have explored overseas markets for years. The advanced international technologies and experience in the construction of large communications facilities have enabled them to become among the world’s leading communications device suppliers. In 2015, overseas business revenue accounted for 58% of Huawei’s and 47% of ZTE’s total business revenues18

• ZTE has made plans to be involved in key construction areas of the “One Belt, One Road” initiative, including large traffic networks and cross-border e-commerce. As part of actively promoting “Smart City 2.0” strategy, the company has engaged in smart city construction in more than 140 cities in over 40 countries all over the world

Source: Press releases and annual reports of enterprises, Xinhuanet, etc.

Integration and revolution: endogenous impetus of the “Information Silk Road”

Chinese telecommunications enterprises are engaged in “going out” to improve their international communications connectivity through the “One Belt, One Road” initiative, which not only enhances regional economic integration, but also helps the industry find new growth momentum.

Integration: Improved international communications connectivity and promoted regional economic integration

• The level of digital infrastructure construction of many countries along the Belt and Road is relatively low, which implies large opportunities for mobile communications equipment, fixed-line broadband upgrades, internet data centers (IDC) and other areas. Furthermore, the development level of each country’s information industry varies so companies can implement a niche market strategy and expand the profit margin.

• China’s telecommunications industry is relatively sound and capable of providing complete solutions and cost-effective products. It has enterprises with international competitiveness which can be a basis for improving international communications connectivity.

Revolution: Accelerate the transformation of traditional business modes, and be positioned to win in the new digital age

• Influenced by tax and fee regulation changes and the OTT19 cross-sector competition, traditional telecoms services continue to develop; meanwhile, cloud computing, Big Data and other new technologies are accelerating. Overseas markets provide opportunities for information service providers to become internationalized companies in the Internet age.

• The high-speed development of digital technology is creating new lines of business. For example, establishing smart cities characterized with smart technologies will create new markets for communications enterprises to expand overseas and develop a high-end smart industry.

16 Note: A Virtual Network Operator (VNO) is a provider of management services and a reseller of network services from other telecommunications suppliers that does not own the telecommunication infrastructure.

17 Source: Xinhuanet18 Source: Company’s website19 Note: OTT (Over The Top) refers to the business mode through which internet corporations bypass telecom operators and provide various applications

and services to customers based on the internet. Currently the typical OTT businesses include network TV, online audio/video communication, online app store, etc.


Chinese enterprises restart overseas M&As: enhancement of internal strength is the key

In the past decade, many excellent Chinese telecoms enterprises have developed into international industry giants through overseas expansion. This expansion is being achieved via extension of overseas products and technology networks; however, Chinese enterprises have repeatedly suffered setbacks in the M&A market, and recently only a few large M&As have been made. On the one hand, this is because the telecommunications industry involves national security issues and the political risks and invisible barriers of overseas investment are relatively high; and on the other hand, this is also because Chinese enterprises have had an insufficiency of experience in international investment and management, while overseas M&As and operations are difficult. For example, in early 2007, China Mobile acquired a 100% stake in a Pakistani company (Paktel). However the operators have capital-intensive features that generally require heavy asset investment, which, coupled with stringent local regulatory and heavy tax burden, have made China Mobile more prudent in overseas M&As20.

However, recently Sharing Mobile acquired a 80% interest in Nigeria’s mobile operator, GiCell, and Dr. Peng Telecom and Media acquired US broadband provider Giggle Fiber for USD15 million21, representing that private enterprises in virtual network operations and other market segments are beginning to explore overseas markets and carry out international expansion, leading to the belief that China’s telecom enterprises will embark on M&A again.

With the acceleration of internationalization, the markets along the Belt and Road offer huge development potential. Certainly, for many enterprises, the risks from M&A can be substantial, and thus approaches such as the exporting of products and technology, LTE-TDD22 standard output or strategic cooperation and the like may be better alternatives; the enterprises should fully understand the distinctiveness in the industry and enterprise development, and develop rational international strategies from the perspectives of themselves and market conditions.

Actively follow up the "One Belt, One Road" initiative, fully understand and take advantage of policy support; win through innovation based on one’s own situation; and develop an internationalization strategy with the vision of great-leap-forward development

Policy restrictions are stricter in the telecommunications industry, and industrial barriers are numerous, thus enterprises need to understand the market of the host country and strengthen cooperation with the government and authorities

Construction and operation of overseas projects requires more standardized and refined management, especially when the operating model of a cross-border fiber optic cable project is not yet mature, and thus enterprises need to speed up institutional innovation and implement sophisticated operation and management

Integrate industrial chains; enhance cooperation among operators, manufacturers, and Internet companies; seize the opportunity for the development of smart cities; and actively promote the construction and development of cloud computing, Internet of Things

Take advantage of multiple platforms, such as AIIB, Export-Import Bank, Silk Road Fund, local government funds and private capital, to innovate the investment, construction, and operating models; and break through the bottleneck of investment and financing

20 Source:21st Century Business Herald21 Source: CINIC, http://www.cinic.org.cn/site951/txpd/2016-04-29/820175.shtml22 Note: Long-Term Evolution Time-Division Duplex (LTE-TDD), also referred to as TDD LTE, is a 4G telecommunications technology and standard co-developed

by an international coalition of companies. It is one of the two mobile data transmission technologies of the Long-Term Evolution (LTE) technology standard, the other being Frequency-Division Long-Term Evolution (LTE-FDD).

However, regardless of the ways used in the “going out”, all enterprises need to consolidate their strengths in order to better grasp the “One Belt, One Road” investment opportunities:

Follow national policies, do

advanced strategic planning

Implement due diligence, avoid

invisible barriers

Optimize project management

pattern, refine the operation

Innovate collaboratively,

grasp smart city and other opportunities

Make the best of diversified capital,

explore new investment models


2.2 Linking the globe: Aviation industry is accelerating its overseas expansion

Benefiting from the decline of crude oil prices and the rapid development of tourism, after a few years of downturn, China's aviation industry has started to recover. The expansion of air routes and the development of air transport are one of the priority areas of the “One Belt, One Road” initiative. The aviation industry sees an unprecedented growth in demand and the industry’s internationalization is expected to speed up. According to the 2015 Large and medium-sized aviation projects list released by the Civil Aviation Administration of China (CAAC), there are 51 strategic projects directly serving the “One Belt, One Road” initiative, with total investment amounting to nearly RMB200 billion23. In May 2016, the CAAC issued Opinions on further deepening the reform of civil aviation, which proposed to further open up airspace, optimize the allocation of international traffic rights and encourage civil aviation enterprises to “go out” and compete in the international aviation market through the use of capital.

In this context, the number of international routes and international capacity grew rapidly. In 2015, China opened 170 new international routes, an increase of 35% for the year. China is expected to open more than 200 new international routes in 2016, a 76% increase over 2014. Air China, China Eastern Airlines, China Southern Airlines, Hainan Airlines are increasing the transport capacity to serve international markets, and the revenue growth rates of international routes in 2015 surpassed that of domestic routes. At the same time, countries along “the Belt and Road” have also become a focus of this expansion. China has signed bilateral intergovernmental air transport agreements with 61 roadside countries, of which 43 have air links with China. In 2015, the airline passenger turnover of countries along “the Belt and Road” increased by more than 70%.24

China Southern Airlines

Paris

Shanghai

Bangkok

New York

Minsk

Budapest

Addis Ababa

Johannesburg

Sabah

Nairobi

Rome

China Eastern Airlines Hainan AirlinesAir China

Urumqi

Colombo

Bombay

Auckland

Montreal

Havana

San Francisco

St. Petersburg

San JoseBoston

Seattle

Prague

Sydney

Beijing

Hanoi

Krabi

Guangzhou

IslamabadLanzhou Xi’an

ChengduKunming

Ho Chi Minh

Major international routes developed by the top four Chinese aviation enterprises in 2015

Source: Civil Aviation Administration of China

As the expansion of air routes and the development of air transport becomes one of the development focuses of the “One Belt, One Road” initiative, China’s air transportation, aviation infrastructure and aircraft manufacturing are expected to achieve unprecedented demand growth and the industry’s internationalization is expected to accelerate.

23 Source: the Xinhua News Agency24 Sources: Civil Aviation Administration of China


Source: Civil Aviation Administration of China

In 2016, China is predicted to open more than 200 new international routes, and the total number is

76%

Data source: Civil Aviation Administration of China, 2015 annual report of each airline company

In 2015, the top four airlines’ revenue growth rates of their international routes surpassed that of domestic routes

More remarkable is the growing strength of Chinese aviation enterprises. In the past year, HNA Group has frequently appeared in international capital markets and accelerated M&As in aviation sector. It indicates that the airline is expanding its international network by means of M&A, kicking off China’s aviation industry’s expansion overseas. Meanwhile, other airlines also have considered internationalization as an important development strategy. In the future, they are also likely to follow HNA’s steps to accelerate their overseas investment. For example, with a cooperation agreement with Qantas and an investment in Delta Air Lines in 2015, China Eastern has accelerated its internalization expansion.25 Under the impetus of the “One Belt, One Road” initiative, the international expansion of Chinese aviation enterprises is accelerating, and leading to more strategic cooperation and M&As, and a reshaping of the global aviation industry.

25 Source: Company’s website

2014 2015 2016 predict Domestic transport revenue growth

International transport revenue growth

1000

800

600

400

200

0

490660

860

up from that of 2014

30%

25%

20%

15%

10%

5%

0%

-5%

-1.7%

28.0%

Hainan Airlines

0.0%

11.5%

Southern Airlines

3.5%4.2%

Air China

0.6%

9.6%

Eastern Airlines


Source: Company announcements, Sina Finance.

Tips: Airlines need to prepare for risk prevention during expansion overseas

• Market risk: Currency markets and oil prices fluctuate greatly and profit instability increases, resulting in possible constraints on business development

• Financial risk: Large overseas expansion will generate financial pressure, challenging airlines’ capital chains and subsequent asset integration ability

• Integration risk: Domestic and foreign markets and management concepts and the corporate cultures of airlines are quite different, resulting in a need for increased cross-cultural sensitivity

Jul 2016SR Technics ( 80% stake)

SwitzerlandNot disclosed yet

Jul 2016Bought TAP Air Portugal

convertible bonds (13.06% of the economic benefits26)

PortugalEUR30 million

May 2016Servair (a catering company under Air

France-KLM Group) (49.99% stake)France

Not disclosed yet

May 2016Virgin Australia

(13% stake)Australia

USD114 million

Apr 2016Gategroup (a catering company of Swissair)

SwitzerlandUSD1.47 billion

Nov 2015Azul Brazilian Airlines

(23.7% stake)Brazil

USD450 million

Aug 2015Ireland’s aircraft leasing company

Avolon (acquired by Bohai Leasing -a member of HNA Group)

Ireland USD2.64 billion

Jul 2015Swissport (a ground handling

group) (100% stake)Switzerland

USD2.8 billion

Major acquisitions conducted by HNA Group in aviation industry over the past year

HNA Group's acquisitions: HNA Group is engaged in building a complete value chain through strategic international acquisitions: having the aviation industry as its core business, and developing tourism, hotels, entertainment and financial services to extend and integrate upstream and downstream business along the value chain.

26 Note: according to the Hainan Airlines stock exchange announcement, the CBs correspond to 13.06% of the interest in TAP and can be converted to the shares of TAP by 8 March 2026. Upon completion of CB conversion, Hainan Airlines will hold a total of 23% interest in TAP.


Case studyHenan Civil Aviation acquired Cargolux Airlines International: From "outbound investment" to "in-depth integration of global economy"

In January 2014, Henan Civil Aviation Development & Investment Co., Ltd. (“HNCA”) acquired a 35% stake in Cargolux Airlines International (“Cargolux”) for approximately USD216 million. This acquisition created an international first-class all-cargo airline officially in Zhengzhou Comprehensive Experimental Zone. Both parties will endeavour to build an "Aerial Silk Road" connecting China and Europe. Through outward foreign investment and in-depth integration of various resources, HNCA will continue to integrate the local aviation economy into a global one, and help accelerate the opening up of Henan Province.

HNCA, a state-owned and province-governed enterprise established in 2011, is mainly responsible for accelerating the development of the Henan civil aviation industry and leading the development of the Zhengzhou Comprehensive Experimental Zone. The acquisition target, Cargolux, is Europe's largest scheduled all-cargo airline and has a whole industrial chain covering ground handling, warehousing

Source: EY Analysis, Sina.com, Henan Daily and the official website of HNCA

and services. Thus, in this acquisition, HNCA was mainly considering to leverage Cargolux’s strong competitiveness in the international air cargo industry. Henan province, as an important pivot point for the “One Belt, One Road” initiative, connects eastern and western regions of China and has huge potential in trade and logistics. HNCA accelerated the opening-up of Henan province through the strategy of acquisition.

EY believes that “going out” is not the end in itself, but a step towards an enterprise’s road to success. The acquisition is just a starting point for HNCA. After the acquisition, HNCA uses Cargolux’s global route network to integrate with the world economy -- expands its international trade business, deepens industrial cooperation and promotes the development of the regional real economy. It is not only a successful model of overseas investment, but also rationalizes the logical expansion of Chinese enterprise.

Now, HNCA and Cargolux have successfully evolved from transportation interconnectivity to economy and trade cooperation, as well as from aviation logistics to industrial cooperation. It is expected that both parties will increase cultural and educational exchange, enhance cultural tourism in the future and continue to accelerate the construction of the "Aerial Silk Road".

27 Note: The E trade program “Fresh Luxemburg” aims at promoting Luxembourg and Europe’s dairy products, organic food and luxuries into Henan, while boosting Henan’s specialties, high-end manufacturing products and high value-added agricultural products into the European market. The logistics of the program will be supported by the Hang Tou Zhen Pin website.

Milestones of HNCA’s acquisition and integration of Cargolux:

14 January 2014The parties entered into an acquisition agreement

15 June 2014The Zhengzhou-Luxemburg intercontinental cargo route was opened

23 November 2014Cargo volume of the Zhengzhou-Luxemburg route exceeded 10,000 tonnes

23 January 2015 A cross-border E trade program “Fresh Luxemburg”27 was initiated to achieve “Buy & Sell globally”

May to June 2015The “Luxemburg-Zhengzhou-Chicago” cross-ocean route and “Milan-Zhengzhou” route were opened to connect Europe, Asia and Americas

19 June 2015 The parties jointly established two JVs -- Cargo Airline JV and MRO JV in Zhengzhou

23 November 2015Annual cargo volume of Zhengzhou-Luxemburg route surpassed 50,000 tonnes


Apart from the growth of international routes and transport capacity, Chinese enterprises have made all-round investments overseas in areas such as aviation infrastructure, aircraft manufacturing and air services which characterize this round of “flying out”. Since the global financial crisis in 2008, and because some regional governments have been suffering from financial strain, an increasing number of local airports are in desperate need of new investors. By acquiring (or investing in) a number of foreign airports (Parchim International Airport in Germany, Heathrow Airport in the UK, Parma Airport in Italy, Toulouse-Blagnac Airport in France and Tirana International Airport in Albania), Chinese enterprises have seized the opportunity from the market downturn and expanded in the international aviation market. Through investing in overseas airport facilities, Chinese enterprises have established express channels to facilitate logistics convenience between the domestic and international markets, shorten the transportation time from home to Europe and Asia, and lower the cross-border logistics costs thus boosting cross-border e-commerce business.

In January 2015, the plan to expand Nepal’s Gautam Buddha Airport, contracted by China’s Northwest Civil Aviation Airport Construction Group (NCAACG), was officially launched28. In March 2015, Togo International Airport (Phase One) contracted by China Airport Construction Group Corporation of CAAC (CACC) was completed, and the second phase was under construction. In April 2016, the renovation of the only international airport in the Maldives commenced, contracted by Beijing Urban Construction Group (BUCG).

In aviation manufacturing, Chinese enterprises are also actively “going out”: China’s Modern Ark series aircraft29 are operated by more than 300 airlines in 18 countries. On November 2, 2015, after seven years of R&D, China’s first home-made large passenger aircraft, the C919, rolled off the final assembly line, which means China has become one of the few countries that can develop and build large aircraft. By the end of 2015, orders for the C919 exceeded 50030, and apart from the domestic airlines, buyers also come from the US, Germany and Thailand. In addition, Commercial Aircraft Corporation of China (COMAC) signed a 60-aircraft purchase agreement with an Indonesian airline during July’s Farnborough International Airshow in the UK. The airline will extend its fleet with ARJ21, China’s first home-made regional jet. The ARJ21 series is a key product aimed at the international market. The purchase is the first significant purchase of China-made aircraft, and is also a solid global step for China-made aircraft31. Furthermore, a series of significant overseas acquisitions have been made as well. These deals, undertaken to acquire core aircraft engine and aircraft manufacturing technologies in countries such as the US, Germany and Austria, are expected to help China’s aviation industry move up the value chain. Through the acquisitions, Chinese enterprises have improved their R&D, manufacturing, and marketing and sales capabilities. EY believes that aviation manufacturing is likely to become another development opportunity as China’s high-end manufacturing industry continues to “go out”, following the success of the high-speed rail and nuclear power industries.

EY estimates that “Aviation Manufacturing” is likely to become another business card in China’s high-end manufacturing industry “going out” process, following the successes of high-speed rail and nuclear power.

28 Source: Company’s website29 Note: ”Modern Ark” series’ turboprop-powered aircrafts are developed by Xi’an Aircraft Industry Corporation under the Aviation

Industry Corporation of China30 Source: Xinhuanet31 Source: Xinhuanet


Summary of Hong Kong’s investment environment Hong Kong, a Special Administrative Region of the People's Republic of China, was ruled by Britain from 1842 until 1997 when the Chinese Government resumed sovereignty over it on the basis of the “One Country, Two Systems” policy. Hong Kong is located in the southeastern corner of China and connects to several important markets. As it is adjacent to the Pearl River Delta and faces the South Pacific Ocean, Hong Kong has become a critical regional hub for the Asia-Pacific region.

Hong Kong, highly internationalized and generally applying international standards in institutions, talents, cultural environment and other areas, links mainland China and the rest of the globe. Hong Kong is known for its free and open economy, equal society and clean and efficient government, and enjoys multiple advantages, such as judicial independence, low tax rates, a simple tax system, an open trade and investment environment, and smooth flow of information, capital and talent. Hong Kong has been ranked highly in various global competitiveness rankings over the years. Up to 2016, Hong Kong had been selected as the world's freest economy for 22 consecutive years32, and was rated the world's most competitive economy for 201633.

Hong Kong's economy is dominated by the services industry, and has become the most service-oriented economy in the world, as finance and other professional services account for nearly 30% of Hong Kong’s GDP34. As for merchandise trade, Hong Kong ranked seventh in the global trade ranking in 201535, with mainland China being its principal trading partner.

Hong Kong: A key platform to explore the opportunities along the Belt and Road initiative3

Hong Kong's large advantages in systems and policy, talent and international experience make it an important channel for mainland enterprises to “go out”, and also an ideal platform to connect China and the countries along the Belt and Road.

32 Source: Index of Economic Freedom, Heritage Foundation, February 201633 Source: The 2016 IMD World Competitiveness Scoreboard, May 201634 Source: Hong Kong Trade Development Council, Census and Statistics Department

(C&SD), EY compilation35 Source: Ministry of Commerce of the People’s Republic of China Department of Taiwan,

Hong Kong and Macau Affairs


Leveraging three advantages of Hong Kong as a platform for ”going out”

Chart 1: Economic relationship between Hong Kong and mainland China

In 2015, transit goods from mainland China accounted for nearly 61% of Hong Kong's total transit goods; and transit goods destined for mainland China accounted for nearly 54% of Hong Kong's total transit goods.

Hong Kong is an important offshore fund-raising center for

mainland enterprises. At the end of 2015, 951 mainland

enterprises had gone public in Hong Kong, with total market

capitalization of USD1.97 trillion, accounting

for 62.1% of Hong Kong's total market

capitalization.Transit port Offshore market

Hong Kong is the largest

destination for outbound

investments for mainland China. In

2015, mainland China’s non-financial direct investment

in Hong Kong totaled USD58.74 billion, up 24.9%

yoy, and accounting for 49.5% of mainland China’s total non-

financial outbound investment.

Hong Kong is the largest source of inbound foreign investment for mainland China. In 2015, funding from Hong Kong actually used in mainland China totaled USD86.39 billion, up 6.3% yoy, and accounting for 68.4% of total inbound foreign investment.

Hong Kong’s investments in mainland

China

Mainland China’s investments in Hong Kong

Source: Hong Kong Trade Development Council, Ministry of Commerce of the People’s Republic of China Department of Taiwan, Hong Kong and Macau Affairs

expe

rienc

e

Inte

rnat

ional

Talent

Systems and

policy

Hong Kong is one of the cities with the highest level of openness in China. Hong Kong's large advantages in systems and policy, talent, and international experience make it an important channel for mainland enterprises to “go out”, and also an ideal platform to connect China and the countries along the Belt and Road.

1. Advantages in systems and policy

Comprehensive financial system: The financial industry is Hong Kong's business card. There are over 150 international and local banks operating in Hong Kong, and 71 of the world’s 100 largest banks have offices there36, which greatly facilitates enterprises to raise funds globally via Hong Kong. In the first half of 2016, the Hong Kong Stock Exchange was a global leader with funds raised, and 3 of the top 10 IPOs were completed on its Main Board37.

In addition, Hong Kong has its own monetary system. The system has helped enterprises to control risks; reduce the instability of their economic activities; lower the transaction costs in trades, investments and other activities; promote Hong Kong’s trade development and smooth international capital flow. Furthermore, Hong Kong is not subject to foreign exchange controls so capital flows freely in and out, which is helpful for enterprises when building international operating platforms and implementing the “going out” initiative.

The 13th Five-Year Plan38 issued in March 2016 states, “the Government will support Hong Kong to consolidate its pivot status in the global offshore renminbi business and enhance its role as a global asset management center”, further recognizing Hong Kong’s important fundraising and financing functions in China’s “going out, bringing in” strategic structure. Looking forward, the “One Belt, One Road” initiative will continue to assist mainland enterprises to “go out”. As enterprises’ needs for financing increase, and the potential financing needs in the numerous infrastructure projects involved in the initiative appear, Hong Kong’s advantages as mainland enterprises’ offshore financing platform will further stand out, and will provide an outlet for international funding at the same time.

The 13th Five-Year Plan states, “the Government will support Hong Kong to consolidate its pivot status in the global offshore renminbi business and enhance its role as a global asset management center.“

36 Source: InvestHK37 Source: EY Analysis38 Note: The Thirteenth Five-Year Plan for National Economic and Social

Development Of the People’s Republic of China


Establish high-level guiding body

Increase cooperation with countries along “the Belt and Road”

Engage in related work of AIIB

Establish a marketing platform

Promote cultural exchange

• The Belt and Road steering committee

• The Belt and Road office

• Infrastructure financing promotion office

• Free trade agreement• Promote and protect

investment agreement• Comprehensive double

taxation avoidance agreement

• Air services agreement

• Assign a Chinese Delegation member to attend meetings and participate in preparation

• Discuss with the Central Government and AIIB for the specific arrangements for Hong Kong to join as a non-sovereign region

• The Belt and Road information website

• The Belt and Road infrastructure platform (under construction)

• Appropriate HKD200 million to support professional industries to communicate and cooperate with regions along the Belt and Road

• Set up a special scholarship

• Inject HKD1 billion to increase the "specific areas scholarship" quota

• Set the Belt and Road priority theme in "Quality Education Fund"

• The Belt and Road exchange funding scheme trial implementation

Solid infrastructure: As an important communication hub for mainland China, Southeast Asia and other regions in the South Pacific, the Hong Kong Government is constantly improving its sea, air and communications infrastructure. As for air transportation, Hong Kong International Airport, one of the world's best and busiest airports, operates around the clock, with direct flights to 190 regions around the globe40. As for sea transportation, Hong Kong, located centrally in the Asia-Pacific region and the intersection of a number of major routes, is one of the biggest ports in China and a significant global logistics center; and more than 70 international shipping companies operate Hong Kong shipping lanes, connecting approximately 510 regions41. In the future, Hong Kong is also expected to play a significant role in the 21st-Century Maritime Silk Road. As for communications, telecommunications infrastructure and network facilities in Hong Kong are at the forefront of Asia and communications are totally unobstructed. The “One Belt, One Road” initiative is designed to promote the connectivity among the regions along the Belt and Road. Hong Kong’s solid communications infrastructure and unobstructed information exchange are extremely helpful to remove the barriers between different regions, to enhance mutual trust by improving the exchange of information, and to create more cooperation opportunities.

Government policy support: In 2015, the Chinese Government started to promote the “One Belt, One Road” initiative, and the Hong Kong Government responded by initiating top-down deployment. Particularly, the Hong Kong Government established a special steering committee responsible for developing the policies and strategies for Hong Kong‘s engagement, and set up a “Belt and Road” office to facilitate research, and communicate with central ministries and provincial and municipal governments.

Simple tax system: Hong Kong has long been known for low tax rates which are beneficial for mainland enterprises to conduct international business. Currently, in order to facilitate enterprises to carry out international business in Hong Kong and encourage multinational enterprises to establish a group treasury center in Hong Kong, it was officially proposed to Hong Kong's Legislative Council in the 2016-17 Budget that subject to specified conditions, deductions be available for the interest an enterprise’s treasury center has to pay for a related institution’s borrowings.

Sound legal system: Hong Kong’s legal system is independent and complete, and has the forms and content of common law systems (Anglo-American law system), and thus is widely recognized by the international community. In recent years, enterprises from mainland China and foreign enterprises have increasingly chosen Hong Kong law as the law applicable for their transnational contracts, which reflects that Hong Kong law is well recognized. The openness of the Hong Kong legal system allows the parties to a contract to appoint Hong Kong law as the applicable law for their contract by mutual consent, providing flexibility and universality for the countries along the Belt and Road that have different cultures and legal systems. In addition, Hong Kong, with its sound and independent judicial system, has been a hub for regional dispute resolution services, and the Hong Kong International Arbitration Center was rated as the best conciliation location outside Europe39.

Table 1: Hong Kong Government’s deployment for engaging in the Belt and Road initiative

Source: The 2016 Policy Address of Hong Kong Special Administrative Region Government, news.gov.hk, Ecns.cn

39 Source: 2015 International Arbitration Survey, School of International Arbitration, Queen Mary, University of London, October 201540 Source: HKTDC, ”Belt and Road” information website; InvestHK; EY compilation41 Source: InvestHK


2. Advantages in talent

Hong Kong has highly international professional services industries including finance and accounting, project management and law, and access to a large number of international talent. In the finance and accounting industry, for example, Hong Kong applies international accounting standards and enjoys the advantage of its connections to mainland China and foreign countries which bring vast business opportunities. Therefore, Hong Kong has accumulated a large number of international accounting talents. These senior professionals are familiar with all kinds of international financial standards so they can participate in the economic activities under the Belt and Road initiative in an efficient and smooth manner, and provide indispensable professional services for Chinese enterprises to “go out”.

In addition, since the 1980s, Hong Kong enterprises have been engaging in the development, construction and management of projects in energy, electricity generation, highways, railways, ports, and telecommunications at home, in mainland China, Asia and Europe. Not only has Hong Kong applied international design, technology, operations and management standards, it has also attracted and developed a workforce familiar with international standards and rules, market bidding practices, financing, multi-disciplinary project management and operations, all of which matches with the Belt and Road strategy and its demand for talent in the infrastructure sector.

Zhang Dejiang, Chairman of the Standing Committee of the National People's Congress, commented on this year’s “Belt and Road Summit” in Hong Kong: “Previously, a Hong Kong consulting company took charge of the supervision over two capital construction projects in Nepal and Cambodia. The Nepal project remained intact after the recent earthquake, which shows the high quality of Hong Kong’s professional services”42.

3. Advantages in international experience

As a developed export-oriented economy, Hong Kong has accumulated extensive international experience from its interactions with various countries all around the world, which involves economic and trade cooperation, investment pilots, and cultural exchanges. Those “soft powers” enable Hong Kong to provide strong support for the mainland enterprises to “go out”. As an intersection between Chinese and western culture for more than a century, Hong Kong has established legislation, political and economic regimes and value orientation based on modern western civilization; furthermore, Hong Kong shares with mainland China ethnic identity, lifestyle, and cultural origin. So to speak, Hong Kong can understand mainland China deeper than other countries can, and connect with other countries closer than mainland China.

Nowadays, Hong Kong has become the investment pilot for many enterprises to “go out”: Through observing whether their businesses can achieve success in Hong Kong, they can determine their prospects of “going out”. With a mix of western and Chinese cultures as well as a diverse and inclusive society, Hong Kong, as a buffer zone, has the ability to reconcile misunderstandings resulting from inefficient communication and cultural differences between mainland China and other countries.

42 Source: 21st Century Business Herald


• Provide “one –stop” finance, advisory and other professional services from market access to market exit including tax, risk control, financial analysis and enterprise management based on the experience accumulated in the countries along the Belt and Road

• Provide universal legal services which may connect with other countries in the complex political, economic and cultural environment of countries along the Belt and Road

• Expand its role as a hub in providing services for solving regional disputes by virtue of its regional advantage in Asia-Pacific

• Deepen the economic and trade connection with key regions along the Belt and Road and expand transit and logistics business connecting different parts along “the Belt and Road”, to restore Hong Kong as the leading port in China

• Accelerate Hong Kong-ASEAN FTZ negotiation, to forge synergies of political, economic and trade cooperation between mainland China and ASEAN countries

• ‒Connect with the development and management of projects along the Belt and Road (including project design, construction, operation, supervision ,engineering advisor and others) based on international standards

• Eliminate the resulting cultural and cognitive differences during the course of Chinese enterprises’ “going out” and “bringing in” foreign enterprises by virtue of the integrated eastern and western cultures as well as diversified cultures

• Continue to provide international talents for building the Belt and Road as a domestic and international talent exchange and gathering place and promote the connection between people in China and the countries along the Belt and Road

• Provide financing support for the financing gap existing in the regions along the Belt and Road with its highly diversified financial businesses

• Assist mainland enterprises in establishing investment platforms for the Belt and Road by leveraging its internationalization

• Expand Hong Kong’s renminbi cross-border settlement and liquidation business with the internationalization and benefits of the renminbi in the countries along the Belt and Road, and to continue to consolidate Hong Kong’s position as the world’s largest off-shore renminbi market

Source: EY analysis

Connecting Hong Kong’s advantages with the “One Belt, One Road” Initiative, to achieve a win-win situation-Exploring Hong Kong’s future role The “One Belt, One Road” Initiative is a strategy implemented by China in order to respond to the new domestic and international economic situation, and to promote opening-up, strengthen international cooperation and increase China’s international influence. Hong Kong has unique advantages in system design, reserve of professional talents, and international experience so acts as a bridge connecting mainland China with other countries; as a consequence it will play a major role in connecting trade, investment, people-to-people exchanges and other areas between China and the countries along the Belt and Road in the future. In our opinion, Hong Kong will act as a center in five areas in particular for the development opportunities from the “One Belt, One Road” Initiative, developing and upgrading existing competitive industries to inject new energy into Hong Kong’s economy and achieve a win-win situation.

Professional service supporting center

Trade logistics centerTransnational talent

and experience exchange center

Infrastructure project development and management center

Platform of investment and financing center & corporate treasury center for enterprises


EY Overseas Investment Growth Navigator

EY Overseas Investment Growth Navigator financing structure4

4.1 Providing market insights and building bridges: Resolving financing difficulties Chinese enterprises encounter overseas

As large capital is always required for an enterprise’s outbound investment projects, it is important for the enterprise to expand its financing channels and obtain sufficient funding at low cost so as to “go out” successfully. With the fast development of China’s foreign investment and the relaxation of overseas financing regulations, many enterprises have begun to explore various ways of financing, including bank loans, financing leasing, stock and bond financing, industry fund financing, PPP, franchise and other ways of financing infrastructural construction are growing quickly.

Attract talents

Assume social

responsibilities

Introspection

Expand channels

Multi- leveraging

Take precautions

Sound planning

Corporate Culture

Social responsibility

Corporate governance

Financing planning

Strategic cooperation

Risk prevention

International strategy


How do enterprises expand their financing channels?

Strengthening their financing plan and building executive capability • Cultivating positive financing concepts and strengthening their

understanding of various ways of financing as well as domestic and foreign financing markets

• Engaging advanced professionals with extensive financing experience to implement strategic planning and feasibility studies

Enhancing management and establishing international credit• Strengthening management and building internal finance skills

to improve operating capability• Providing financial statements, credentials, feasibility studies

and others which comply with international standards and are recognized internationally to establish enterprise credit

Taking advantage of professional institutes’ experience and networks• Engaging the professional institutes with extensive experience

to develop a financing plan based on the enterprise’s actual conditions

• Taking advantage of the professional institutes’ broad domestic and foreign networks and communicating effectively with financing providers through the professional institutes

However, Chinese enterprises, especially Chinese POEs, generally face difficulties in obtaining financing. According to a survey, 55% of enterprises rely on their own funding to make outbound investment, 21% use bank loans and only 16% use capital market financing.43 This reflects the insufficient domestic finance support: Financial institutions are often cautious about offering loans for outbound investment projects that face higher risk and have longer return cycles, and commercial banks and policy lenders tend to prefer large state-owned enterprises. Therefore, SMEs, especially Chinese private-owned enterprises, have difficulties obtaining financial support; meanwhile, there are insufficient products and experience for China’s domestic financial institutions to support outbound investment and the capital market is not mature so the financing cost is comparatively higher.

Chinese enterprises not only lack sufficient domestic financing support, they also have to face various issues when accessing foreign financing channels. Based on the EY worldwide network’s extensive experience in helping Chinese enterprises obtain foreign financing, we noted that the biggest difficulty for Chinese enterprises to obtain foreign financing lies in “knowing the overseas markets” and “finding bridges”:

• ‒Knowing the overseas market: The laws and regulations as well as financial environments in overseas markets are often quite different, and differences in language, commercial culture and other areas increase the difficulty in understanding those markets

• Finding bridges: Many enterprises have gaps in financial management and financing plans and do not have sufficient understanding of financing channels. It is difficult for them to have effective communication and obtain recognition with their weak overseas credit basis and insufficient partnership experience with overseas financial institutions

As for those issues, we suggest that the enterprises should first begin to improve their own financing management by engaging professionals with extensive experience in international financing to help them understand the market. It is more important to take advantage of the experience and resources from professional third parties (such as investment banks and accounting firms) which have operated in global markets for many years and formed a broad commercial network. These institutions can design a full financing plan for enterprises, assist them in establishing credit in the local market and act as a bridge for effective communication between enterprises and financing institutions.

43 Source: Report on Globalization of Chinese Enterprises 2015, Center for China & Globalization


4.2 Proper planning of investment and financing structure: Avoid tax and foreign exchange risks

In addition to obtaining financing, offshore funds management, cash pooling management, foreign exchange management and cash inflow shall also be taken into consideration when setting up the investment and financing structure. A different management design will have a direct impact on an enterprise’s profitability especially from a tax efficiency perspective. As the foreign exchange risk increases, it is necessary for enterprises to consider tax, foreign exchange and other factors when setting up a reasonable investment and financing structure. This helps reduce financing cost and foreign exchange risk, ensures effective use of capital and obtains legal safeguards. By comparing the taxes under direct overseas investment with that of a financing and investment platform supported by an intermediary holding company established overseas, the importance of selecting a suitable investment and financing structure is demonstrated below:

Direct holding structure Intermediary holding structure and financing arrangement*

Chinese company

Overseas company

Capital injectionDividend

repatriation

Chinese company

ital injection

Equity and debt investment

Dividend withholding tax@0%

Dividend & Interest withholding tax@0%

Dividend

Interest income & dividend

Profit before tax for overseas company 100,000Income tax for overseas company‒34% (34,000)

After-tax cash for dividend repatriation 66,000Dividend withholding tax‒10% (6,600)

After-tax profit repatriated to Chinese company 59,400

Global tax 40.6%

Profit before tax for overseas company 100,000Interest deduction before taxation (20,000)Profit before tax 80,000Income tax for overseas company @34% (27,200)After-tax cash used for for dividend repatriation 52,800Dividend and interest withholding tax (0)Cash reserved in intermediary company for reinvestment 72,800Dividend withholding tax (intermediary company) (0)Cash repatriated to China as dividends 72,800China tax to be paid after foreign tax credit (0)Global tax 27.2%

Source: EY Tax Guide for Investment along the Belt and Road, published in 2015.

Therefore, under the single holding structure, there is less flexibility for the circulation of funds and the tax cost resulting from the flow of capital is higher: if the group needs to use the profit from overseas companies for overseas reinvestment, the profit must be repatriated to domestic companies and the domestic companies need to recognize dividend income and declare or pay the related domestic income tax; meanwhile, the time difference arising from settlement and exchange of funds in and out of China increases the foreign exchange risk. On the contrary, the model adopted by intermediary companies based on debt investment can not only avoid the above-mentioned tax and exchange costs, but also but also getting pre-tax interest expense deduction in the host country by using a reasonable financing arrangement to further reduce the overall effective tax rate.

*Assume that intermediary company does not levy the income tax and withholding tax of dividends and interests. This structure is only an extreme case whose application conditions need to be determined after comprehensively considering various factors

Overseas company

Intermediary


However, the selection of an intermediary holding company structure should be in line with the business purpose of the company along with its cash flow arrangement as well as tax efficiency by comprehensively considering tax, funds, laws and other various factors. We summarize the important factors for Chinese enterprises to consider when making outbound investment and develop financing structure:

• Compatibility with the corporate strategic plan

• Tax efficiency upon repatriation and exit• Extensiveness of tax treaty network• Foreign exchange restrictions‒ Flexible and friendly taxation regime

• Interest expense deductibility upon considering thin capitalization rules and transfer pricing requirements

• Withholding tax, turnover tax and other tax costs arisen from cross border interest payment

• The host countries’ taxation on interest income

‒• Foreign tax credit planning• Foreign exchange control requirements

Other considerations

• Business substance• China CFC rules • China TRE rules• Anti-tax avoidance rules in treaty

shopping

Financing considerationsConsiderations in choosing an intermediary holding company

Source: EY Tax Guide for Investment along the Belt and Road, published in 2015.

With increasing uncertainty in the global business environment and financial market volatility, Chinese enterprises are faced with challenges and opportunities. It is important for Chinese enterprises with extensive overseas businesses to explore financial products in an effort to manage their risks. In this process, a corporate treasury center not only acts as an important remitter, but also as a risk management center. A corporate treasury center can create value by centralizing treasury functions. It can also act as an effective financing platform and provide financial risk management services, and can optimize cash liquidity and financial function management in different regions.

Before establishing a corporate treasury center

4.3 Establishing corporate treasury center (CTC) to help enterprises “go out”

Parent company

Subsidiary 5

Subsidiary 4

Subsidiary 3

Subsidiary 2

Subsidiary 1


After establishing a corporate treasury center: centralize all the financing and treasury activities within the group

Corporate treasury center

Depositor Borrower

Treasury Activities

Asset management/investment of surplus funds

Factoring

Guarantees

Payments and netting center

Working capital management

Cash poolingRaising funds on

behalf of the group

Regulatory captial securities /rating agency (hybrid)

instruments

Forex, commodity and interest rate management

Intragroup lending

Liquidity (buffers)

With Chinese enterprises continuing to “go out”, it is very important to establish a corporate treasury center that can assume liquidity or other risks effectively, reduce income volatility brought by exchange rate fluctuations, and enable subsidiaries to focus on the core businesses. In addition to this a center can also integrate cash management, enhance visibility and cash availability convenience, and optimize the cash and operating capital employment.

To maintain Hong Kong’s competitiveness as a corporate treasury center and its position as a global financial center, the Hong Kong government recently passed a bill aimed at providing tax incentive for a corporate treasury center.

There are 2 key aspects to the CTC reform namely:

1. Interest deduction – Allowing for a deduction for interest paid by a corporation carrying on an intra-group financing business in Hong Kong (including a CTC) to an overseas associated corporation (note that previously this would not have been deductible)

2. Concessionary Tax rate – 8.25% reduced corporate tax rate (as compared with the standard rate of 16.5%) for qualifying CTC income

Source: EY analysis


Chinese outbound investment recorded a new historical high in the first half of 2016, and China has become a net capital exporter. It leads us to think about the underlying reasons and whether such strong growth will be sustainable. The “One Belt, One Road” initiative drives all kinds of cooperation and accelerates the projects' implementation, particularly the Engineering Procurement Construction (EPC) projects. On the other hand, strategies like “Made in China 2025” and “International capacity cooperation” have helped Chinese enterprises transfer overcapacity abroad, and stimulate the innovation capabilities of Chinese companies. Following the success of the high-speed rail and nuclear energy sectors, Chinese enterprises are developing new manufacturing expertise in the information technology and aviation manufacturing sectors. Thus, EY expects China's outward FDI to exceed USD170 billion in 2016, and Chinese outbound investment will enter a period of stable growth, which will keep up the momentum up for China's economy restructuring.

In addition, Chinese enterprises will experience challenges in strategy, financing and operations as they seek to achieve long-term and stable success ‒ especially as unstable factors increase in the global economic and financial markets. Hong Kong, an ideal springboard for business engagement along the Belt and Road, relying on its big advantages in systems, talent and international experience, can not only help Chinese enterprises go faster and go farther, but also go more steadily. Furthermore, Hong Kong’s convenient location and mix of Chinese and Western cultures also make it an ideal platform for Chinese enterprises to “go out".

Conclusion



The China Overseas Investment Network (COIN) links EY professionals around the globe, facilitates collaboration, and provides consistent and coordinated services to our clients with overseas investment from China. Building on the existing China Business Group in the Americas, EMEIA, Asia-Pacific and Japan areas, COIN has expanded our network in 65 countries and territories around the world.

Our globally integrated structure enables us to deploy dedicated teams with strong local experience, and profound industry knowledge to provide our clients with onestop professional service from planning stage to execution stage to integration stage, helping our clients navigate through global markets.

China Overseas Investment Network helps Chinese businesses navigate through global markets

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Our global COIN network For more information on our China Overseas Investment Network, please visit our website at www. ey.com/cn/coin or contact:

Fernanda Chang South America COIN Leader+55 11 9625 2084 [email protected] Paulo‒, Brazil

Shau Zhang Americas Area COIN Market Leader+1 617 375 3792 [email protected], USA

Eric XiaoCanada COIN Leader+1 416 943 [email protected], Canada

Yi Sun Germany, Switzerland and Austria COIN Leader+49 211 9352 20153 [email protected] Dusseldorf‒, Germany

John Li Oceania Area COIN Leader+61 8 9429 2184 [email protected]‒, Australia

Ying HuangJapan Area COIN Leader+81 3 3503 1100‒[email protected], Japan

Qinghua Xu-pionchonEMEIA Area COIN Leader+33 1 4693 [email protected], France

Loletta ChowGlobal and Asia-Pacific Area COIN Leader +852 2629 [email protected] Kong, China

ChinaAlbert Ng Chairman, China Managing Partner, Greater China +86 21 2228 3288 [email protected] Shanghai

Loletta ChowGlobal COIN Leader+852 2629 [email protected] Kong

Walter TongGlobal COIN Tax Leader+86 21 2228 [email protected]

Alex ZhuTransaction Advisory Services Leader, China North+86 10 5815 [email protected]

Erica Su Transaction Advisory Services LeaderGreater China+86 21 2228 [email protected] Shang‒hai

Andrew ChoyInternational Tax Services Leader, Greater China+86 10 5815 [email protected]

Jesse LvCo-Leader, China Tax Outbound Center+86 21 2228 [email protected] Shanghai

Michelle Ho China Overseas Investment Network+852 2846 9660 [email protected] Hong Kong

Lucy C Wang Co-Leader, China Tax Outbound Center+86 10 5815 [email protected] Beijing

Andy NgGreater China Insurance Leader +86 10 5815 [email protected]

Area leaders

• Americas

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About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.

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© 2016 Ernst & Young, China All Rights Reserved.

APAC no.03003758 ED None

This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice.

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