Offshore/International Commodity Trading Recent Trends & Developments and Competitiveness of Key Trading Hubs

SINGAPORE

An insight into the trends and factors affecting offshore/international trade in commodities and the competitiveness of selected trading hubs

Study of key factors that influence the relative competitiveness of a trading hub This report studies the importance of the following key factors in influencing the relative competitiveness of a location in facilitating international or off-shore trade across four (4) commodity segments (oil & oil products, metals & minerals, agricultural products and rubber) : Market access and supporting infrastructure This relates to the proximity of a location to the supply and demand markets, access to major trade/transport routes, critical mass, talent pool, and supporting physical infrastructure. Tax environment and government policies This pertains to the locations tax regime and administration, incentives, tax treaties, and government policies on trading activities.

Financial and risk management infrastructure This looks at access to capital and financing, and commodity exchanges to support trade operations. In addition to secondary research, interviews were conducted with 25 companies with trading activities in at least one of the following hubs : Shanghai Dubai Singapore Switzerland London This report summarises the key insights on the broad offshore/international trade trends and developments, and the comparative analysis of the above five (5) trading hubs in relation to the key factors. All information in this report is based on information available as at 30 November 2009.

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Offshore/International Trade Developments
Increased trading activity for inter & intra Asia-pacific region Despite the economic slowdown in 2009, Asias export to the world has still been higher than the global average. The growth in Asian trade has been fuelled by continued demand by the Chinese and Indian economies, especially for metals, agricultural commodities and rubber. While Europe largely derives its trade through intra-regional trade (74%), Asian trade is balanced in terms of trade within (50%) and outside (50%) the region. World trade with regard to key commodities such as Oil & Gas, Metals & Minerals and Agricultural Commodities has seen significant but uneven growth especially due to weather anomalies and political factors. Global demand is expected to be slow until 2010 but would recover gradually during 2011 owing to stronger growth consumption expected from China and United States. Given the potential for increased offshore/international trade in Asia, key Asian trading hubs such as Singapore, Hong Kong and Shanghai have put in place strategies to develop a competitive trade infrastructure to position themselves as the leading Asian trade hubs. As offshore trading activities depend largely on the availability of efficient financial, legal and business infrastructure, and friendly tax regimes, trade hubs have begun to focus on enhancing their offerings in these aspects to compete more effectively. On the other hand, onshore trade continues to be important for companies engaged directly in managing the commodity supply chain and/or in value-added activities. Trading hubs with vast land and strong inter-modal networks are able to compete more effectively by focusing on upgrading their physical infrastructure such as transportation networks and storage, refining and/or manufacturing capacities, thus continuing to enjoy a competitive advantage in this regard. Offshore and onshore trading operations still remain closely tied to proximity and access of commodity companies to suppliers and consumers, who are dispersed across the globe. Increasing regional competition Other trading hubs such as Singapore and Hong Kong, due to limitations on physical capacity, have focused on strengthening their financial and business infrastructure in a bid to capture the offshore trade market. Similarly, leading trading hubs in the US and Europe, such as Houston and Netherlands have focused their energies on developing strong physical infrastructure, and cities such as New York, Switzerland and London have focused on their financial and business infrastructure to facilitate offshore trade. With the establishment of marketing, sales and procurement offices across the globe by commodity trading companies, offshore trade, where the goods do not have to pass through the borders of the country from where the order is booked, has grown significantly. This has led trading hubs across the globe to eye this burgeoning market by devising strategies to attract offshore trading companies into their locations. Offshore Vs Onshore Trade and related trade Infrastructure requirements Trading hubs around the world continue to invest significant amounts in upgrading their capabilities in order to compete for their share of offshore/international trade. Upcoming trading hubs such as Dubai, Shanghai and South Korea have plans to further enhance their physical and financial infrastructure (access to trade financing), thereby focusing on onshore trade. The onshore trade is largely driven by demand and supply of commodities by their domestic/regional consumers. Specific activities by key trading hubs

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Offshore/International Trade Developments (continued)
What this indicates is that it is more practical for trade hubs to position themselves as a regional leading hub and it would be difficult for any trading hub to emerge as the sole global leader. Hence competition for offshore/international trade is likely to take on a regional tone as opposed to a hub versus hub model. Network of hubs model allows trading hubs to compete more effectively by leveraging on one anothers strengths Hubs within a country tend to leverage upon each others However, there appears to be a network of hubs across countries as observed in Europe. While Switzerland provides necessary infrastructure for offshore trading companies such as tax incentives and government policies and market access and connectivity, the physical infrastructure is provided by Netherlands, whilst London offers the advantage of a strong legal and financial infrastructure. Trading companies located in this region hence tap into the different Presently, such network of hubs is not apparent within Asia-Pacific. A collaboration of this nature will help Asian trading hubs to mitigate their individual weaknesses by leveraging off one-anothers strengths in drawing trade into the region. capabilities, such as New York, Chicago and Houston. strengths offered by these trade centres to enjoy the full spectrum of trading benefits.

Market Access and Supporting Infrastructure

Market access is an important factor for both offshore and onshore trading. In this regard, trade hubs in advantageous locations will retain a natural advantage over those who are not located as strategically. Within Asia, hubs such as Singapore, Dubai, Shanghai and Hong Kong have traditionally benefited from their strategic locations. These hubs then seek to differentiate themselves by enhancing their trade infrastructure, which includes having access to skilled traders, presence of leading trading companies that create a critical mass to support the trading community, a robust legal and procedural framework, as well as efficient physical infrastructure.

It is noted that Singapore and Hong Kong continue to lead in this regard. Need for China to develop its manpower capabilities to support trading activities Most trading hubs such as Singapore, Switzerland, Houston, New York, and London reported no specific issues with regard to availability of skilled manpower for trading activities. At other hubs, such as Dubai, where local talent is not easily available, survey participants reported no challenges in hiring foreign talent. Shanghai, however, still poses challenges in terms

of making available skilled manpower for the trading sector. Participants in the survey have indicated that despite a large pool of potential local employees, they face challenges in recruiting locals. Hiring of foreign talent also has its challenges due to language barriers as the market is still largely domestic. Leverage on the physical storage capabilities within the region Proximity to physical infrastructure such as transportation, logistic capabilities and storage does not seem to have much relevance for offshore trading companies.

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Market Access and Supporting Infrastructure (continued)
However, it has been observed that companies may also engage in serving the local markets as well as acting as a transhipment hub. In these instances, physical infrastructure becomes particularly significant to trading companies. For trading hubs that also offer refining (E.g. Oil) or processing (E.g. Metals) capabilities, physical infrastructure again becomes relevant and hence hubs catering to these segments need to upgrade their facilities. Most interviewees that are engaged in trade of Oil and Metals have quoted physical infrastructure to be important. Apart from its financial infrastructure, London has also been reported to have strong legal and arbitration facilities. Most survey participants cited London as one of the centres used by their companies for legal and related matters. A contributing London as the model for development of legal and arbitration capabilities for matters related to trading Several participants commented that they would like to have legal disputes resolved within the respective trading hubs territory as it allows for easy execution of rulings and decisions. Therefore, availability of legal and arbitration facilities and expertise are important factors that need to be considered by trading hubs that aim to increase their competitiveness in this regard. Trading hubs that lack domestic market or space for storage expansion would therefore need to work towards leveraging on other neighbouring hubs. factor to Londons prominence as a global legal and arbitration centre is also due to the presence of trade associations (E.g. agricultural commodities based) that mandate settlement of disputes in London.

Proximity to buyers, sellers & trade routes Transportation & Logistics Arbitration Centers Efficiency of legal framework Procedural Framework 1 1

Shanghai

Dubai

Singapore

Switzerland

London

Less competitive

More competitive

Note: The analysis is based on interviews conducted with 25 companies engaged in trade of selected commodities. For factors such as Critical Mass and Physical Security, interview participants reported no concern in any of the identified trading hubs
1

In terms of absolute numbers of arbitration cases processed, Shanghai exceeds London, primarily on account of Chinas market size. However, in terms of reputation, London supersedes Shanghai as the preferred destination for arbitration cases.

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Tax Trends & Developments
Tax is an important factor for offshore trading activities, and there is evidence of significant offshore trading activities being based in countries with more favourable tax regimes. However, recent global tax trends may have an impact on offshore trading activities. Greater scrutiny on transfer With the recovery of the global economy in sight, countries are now placing focus on raising revenue to pay for the economic stimulus packages that were rolled out in the past year. The tools that tax authorities employ to raise revenues include: Now countries need to build up More effective exchange of tax information mechanisms Greater scrutiny on transfer pricing transactions Nationalising overseas profits by making these subject to home country taxation Effective exchange of tax information mechanisms Recent moves by the Organisation for Economic Co-operation and Development (OECD) and the G20 Group of Countries has seen a flurry of exchange of information agreements being signed between countries, partly in response to the threat of sanctions being imposed on countries that fail to establish effective exchange of information mechanisms. Sanctions, if imposed, could adversely affect the operations of offshore trading companies. Tax treaties provide important avenues to prevent double taxation in instances of transfer pricing adjustments by countries. their fiscal position to pay for the economic stimulus measures, and may see tax authorities taking a more aggressive approach in questioning inter-company transactions to protect the domestic tax base. Not only must trading companies ensure that they design transfer pricing policies and documentation that suit the various requirements of tax authorities, but they must also ensure that the country they operate in has an adequate network of avoidance of double taxation agreements (or tax treaties). Most of the companies surveyed have indicated that a favourable tax regime is important for the conduct of offshore trading activity. The table below compares the corporate tax rates of some trading hubs. A number of governments have recognised that tax factors can influence location decisions, and have introduced various tax incentives to promote offshore trading activity. This includes jurisdictions such as Singapore, Switzerland and Dubai. As a result, Tax competition for offshore trading activity It is important for offshore trading companies to monitor developments in these areas and evaluate how these developments will affect their operations. Even before the economic crisis, there has been strong evidence of tax authorities stepping up focus on cross-border inter-company transactions. pricing transactions Such pressures can be expected to increase in the light of the current situation. For example, renewed discussion around worldwide rather than territorial scope of tax, such as the Obama Green Book proposals to reduce tax deferral advantages, could affect companies operating in jurisdictions with favourable tax regimes. What this may mean is that global business activities may gravitate towards operating in countries of substance, rather than operating in tax favoured jurisdictions that offer little by way of substance, if indeed, the threat of sanctions materialise. Countries focus on revenue protection can eliminate advantages of operating in a favourable tax jurisdiction, or introduce pressure on countries offering tax incentives.

Nationalising overseas profits by making these subject to home country taxation

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Tax Trends & Developments (continued)
it is possible to achieve low effective corporate tax rates in these jurisdictions. In Singapore, the Global Trader Programme tax incentive offers a tax rate of 5% to 10%. In Switzerland, effective tax rates of between 5.5% and 11% could be achieved under the tax concessions available at the cantonal and/or federal level. In Dubai, corporate taxes are not generally enforced, and companies operating in the Free Trade Zones in Dubai may be assured of tax holidays of up to 50 years. In China, financial subsidies may be available from the local government to offset corporate and personal income taxes. But beyond corporate tax rates and tax incentives, companies also regard the network of tax treaties, personal tax regime and the tax Comparison of Corporate Income Tax Rates Singapore and Switzerland are regarded as having good quality tax administrations. Survey respondents indicated that the cooperative attitude of the Swiss authorities is one of Switzerlands competitive strengths. On the other hand, some survey respondents reported facing challenges in Shanghai with regard to the local tax administration, and this introduced uncertainty into the tax system. to some extent, may influence key decision-makers in deciding where to base their offshore trading activities. Overall, the Singapore and Swiss tax regimes are regarded by respondents as being more conducive for offshore trading activities. Dubais tax-free environment as well as supportive government policies are its major advantages, but its network of tax treaties is not wide. Despite Chinas wide network of tax treaties and local government financial subsidies, there are concerns about the local tax administration and foreign exchange rules. London, on the other hand, has comparatively higher corporate and personal taxes.

30 25 Rate of Tax (%) 20 15 25 10 5 0 Shanghai

0

administration to be important considerations as well. London, China, Singapore and Switzerland have strong tax treaty networks. Tax treaty networks provide avenues for companies to defend against transfer pricing adjustments. Respondents from companies in Singapore also indicated Singapores tax treaty network has aided offshore trading companies to undertake regional financing and logistical operations from Singapore. Personal tax rates are also considered important, because personal tax circumstances can affect the availability of traders, and

28 21.17 17

Singapore

Countries

Source: KPMGs Corporate and Indirect Tax Rate Survey 2009, except for the tax rate for Singapore, which is applicable for Year of Assessment 2010 onwards.

Switzerland

London

Dubai

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Tax Trends & Developments (continued)

Comparison of personal taxes

(based on married individual with no children on USD300,000 of income)

40
0.8

35 Rate of Tax (%) 30 25 20 15 10 5 0 Shanghai

0.0

2.8 5.4

Effective Employee Social Security Rate Effective Income Tax Rate

35.5

3.5 25.6 15.2

35.1

Singapore

Countries
Source: KPMGs Individual Income Tax and Social Security Rate Survey 2009

Comparison of tax treaty network

Switzerland

120
Number of Tax Treaties

113 86 60 88

Tax Treaties (Others) Tax Treaties (Top 20 Countries by GDP)

100 80 60 40 20

94 70
Data on the tax treaties has been sourced from the public domain (as of 30 November 2009). Where information on the nature of the treaties is available, we have included only comprehensive tax treaties which are in force in our analysis. Due to current and existing negotiations between the authorities of the relevant countries, the number of tax treaties in the table may vary. The Tax Treaties: Top 20 Countries by Gross Domestic Product (GDP) represents the number of tax treaties each jurisdiction has with the top 20 countries in terms of GDP. Tax Treaties: Others represents the number of tax treaties each of these jurisdictions has with countries that are not the top 20 countries in terms of GDP.

66

42

43 29 20 13 17 18 19

0 Shanghai

Switzerland

Singapore

Dubai

Countries

London

London

Dubai

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Financing and Risk Management Infrastructure

Financial Infrastructure is important for trading companies due to the need for frequent trade financing and credit insurance facilities. The ability to raise capital is also necessary especially for companies with fairly independent operations resulting from the regionalisation effort. Despite being a significant factor that can determine the competitiveness of the trading hub, it does not provide a substantial advantage as most hubs either have developed financial facilities or have ambitions to develop them. Most trading hubs have a well developed financial industry setup such as New York, London, Hong Kong or Singapore. Also, upcoming regional trading hubs such as Shanghai and Dubai have announced plans to develop their capabilities as global financial centres. Need for well developed exchanged based commodity trading facilities within the Asia-Pacific region Commodity exchanges are critical for companies that engage in international trading especially for the purpose of setting prices and managing risks through hedging. Leading financial centres such as New York and London offer a well developed platform for trading commodities by offering an elaborate selection of hedging products.

Reporting some of the highest trading volumes, these hubs experience high levels of liquidity with transactions recorded from all over the world.

Strong financial and risk management centres are necessary for hubs with limited domestic market London has been a strong trading

A significant number of companies with offices based in the Asia-Pacific region are currently hedging their risks in these developed exchanges due to relative weaknesses in the Asian commodity exchanges, largely related to a lack of liquidity, or controls over foreign companies. However it has been observed that if Asian trading hubs were to strengthen their commodity exchanges, this would reduce the advantage New York or London hold over them as companies would prefer to obtain risk instruments from within the region. Commodity trading platforms in Asia are still in their nascent stages of development. Trading hubs such as Singapore, Hong Kong and Dubai have recently commenced commodity exchange operations on a small scale. Shanghai on the other hand is the only trading centre with a large and liquid exchange-based commodity trading market. In recent times, Shanghai has been reporting trading volumes that are comparable to New York and London. The market, however, places restrictions on international players which has limited its growth. Shanghai has expressed ambitions to become a global financial player and it may become a formidable player in the electronic trading space.

hub for companies worldwide due to its financial and electronic trading capabilities. The hub, however, offers a less conducive environment for trading companies as it lacks the financial incentives and ease of doing business. There have been recent instances of companies moving out of London to other destinations within Europe such as Switzerland, for its conducive trading environment or to Netherlands, for its massive physical infrastructure and connectivity. Despite all these challenges, London continues to be an important centre for performing higher order financial transactions and electronic risk management for companies based in Europe. So while leading trading companies have setup their offices in Switzerland to take advantage of the incentives, they remain connected to London. Within Asia, leading trading destinations such as Singapore or Hong Kong may have to adopt a strategy similar to London by developing a strong financial and risk management centre. Singapore for instance, should retain its current advantages such

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Financing and Risk Management Infrastructure (continued)

as of ease of doing overall business while offering companies within and around the region a strong financial and risk management centre. This may help to circumvent any existing or future challenges pertaining to its physical constraints.

Financial Infrastructure 1

Commodity Exchange Trading

Shanghai

Dubai

Singapore

Switzerland

London More competitive

Less competitive

Note: The analysis is based on interviews conducted with 25 companies engaged in trade of selected commodities 1 Despite high trading volumes, trading activity is not open to foreign trading companies unless they are engaged in joint ventures with local firms 2 Despite being a pricing centre for commodities such as Oil (Asia) and Rubber, Singapore scores low on volume, liquidity and range of hedging tools 3 Though Switzerland offers a commodity exchange, its proximity to London allows trading firms to easily hedge their risk on the London exchange as the preferred approach. 4 The assessment of Dubais financial infrastructure was completed prior to its financial crisis. Therefore, the competitiveness of its financial infrastructure may have to be reviewed in terms of its ability to correct the structural weaknesses highlighted by the crisis, in terms of debt/credit management.

Contact Us
Chiu Wu Hong Executive Director, Tax KPMG Tax Services Tel: +65 6213 2569 Fax: +65 6227 1297 wchiu@kpmg.com.sg

Lim Yen Suan Executive Director Business Performance Services KPMG LLP Tel: +65 6411 8333 yensuanlim@kpmg.com.sg

2010 KPMG Advisory Services Pte Ltd (Registration No: 198301769C), a Singapore incorporated company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. Printed in Singapore.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.

2010 KPMG Tax Services Pte Ltd (Registration No: 200003956G), a Singapore incorporated company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. Printed in Singapore.