Mapping cross-border capital flows

Antonio Coppola, Matteo Maggiori, Brent Neiman, and Jesse Schreger have a very good paper that documents the true picture of cross-border capital flows of all kinds.

Their work is an example of a global public good in the context of detecting global tax avoidance and cross-border capital flows monitoring.

In this paper, we develop a new... algorithm that combines information from seven main commercial sources to associate subsidiaries with their ultimate parent firm and with their ultimate parent firm’s country. Each source uses its own methodology to form these matches and to assign firms to particular countries, and we establish majority and priority rules to resolve disagreements across sources... Our final dataset covers the universe of traded securities – bonds and equities – globally... We find that the scale of portfolio investment from developed countries to emerging market companies is vastly understated when foreign issuance is not taken into account. Further, we demonstrate how the pervasive use of corporate subsidiaries to raise money overseas is important for assessing the scale of global imbalances, the currency composition of emerging markets’ external liabilities, the nature of foreign direct investment (FDI), and the growth of financial globalization.

Their algorithm is available here and is replicable for any country. They have documented for eight developed countries. 

Some of the findings of the paper,

First, we highlight that the nationality-based positions involve significantly larger portfolio investments from developed markets to large emerging markets, with the difference primarily reflecting issuance in tax havens. For example, whereas the national statistics for 2017 list the United States as holding $160 billion in Chinese equities, we find the position to be worth about $700 billion. These positions are largely associated with Variable Interest Entities (VIEs), structures designed to avoid China’s capital controls that restrict foreign ownership in key industries... Second, in our restated data, foreign-currency corporate bonds account for a greater share of portfolio investment from large developed countries to large emerging markets (compared to sovereign borrowings)... Our nationality-based statistics imply the corporate bond positions are in fact worth more than twice the positions in government bonds... The greater weight of corporate bonds on a nationality basis, together with the fact that foreign-held corporate bonds are overwhelmingly denominated in foreign currency, leads to a marked increase in the foreign currency share of external portfolio liabilities of emerging economies. For example, switching from residency to nationality reduces the local currency share of external portfolio debt from 70 to 34 percent for Brazil and from 71 to 41 percent for Russia... Third, the nationality-based data show that a portion of foreign investment positions in the residency-based data should, under nationality, not be considered foreign investment at all. For the United States, we find that 7 percent of all foreign common equity holdings and 11 percent of all foreign bond holdings in official statistics are actually domestic investments. These investments largely reflect the issuance in the Cayman Islands of collateralized loan obligations (CLOs) backed by U.S. assets as well as tax inversions into Ireland by U.S. firms. 

And this on the over-statement of China's net creditor status is important,

We show that due to Chinese companies’ reliance on equity issuances via foreign affiliates, China’s reported net foreign asset (NFA) position is roughly twice as large as its true value. When foreign investors take small equity positions in a country’s companies, these positions constitute a portfolio liability in the country’s external statistics such as its NFA and its balance of payments (BoP). By contrast, if those foreign investors buy shares in offshore affiliates that themselves have a majority stake in a country’s companies, then the affiliates’ positions constitute an FDI liability in the country’s NFA and BoP. Whereas the value of portfolio liabilities in these external accounts typically moves together with market prices, BoP accounting rules grant countries more options in how they estimate the value of FDI liabilities. Additionally, the complex series of corporate linkages embodied in the VIE structure used for China’s offshore issuances further distances the entity listed on public markets from onshore operations in China. As a result, China’s NFA does not reflect significant changes in the market value of its listed companies. For example, we show that when China’s offshore listed companies increased in market value by nearly $1 trillion during 2016-2018, China’s FDI liabilities barely moved. Our analysis suggests that, due to this issue, China’s true NFA position is $1.1 trillion smaller than the $2.1 trillion officially reported. This large reduction in China’s net creditor position – one of the world’s largest – is of first order importance for both policymakers and academics. A large literature has emphasized how capital flows between the United States and China only go in one direction, namely official Chinese purchases of U.S. Treasury bonds. Our work highlights the comparable scale and under-appreciated importance of flows in the other direction, namely private U.S. holdings of Chinese corporate securities. Our estimates strengthen the view of the United States as a world banker.

The source was this FT article on the concerns with EM debt,

TIC data show that US ownership of Brazilian bonds at the end of 2017 amounted to $8bn, based on the residency of issuers. But restated by nationality, the total rises to $68bn. For Chinese bonds, the total rises from $3bn to $55bn... What is also striking is the role played by tax havens such as the Cayman Islands. In the TIC data, of Brazil’s $59bn in reallocated bonds, $42bn were issued in tax havens. Of China’s $52bn, $44bn were issued in tax havens. 

This may be a useful tool for India to unpack opaque corporate ownership chains and clarify the true exposure of its businesses to Chinese investors, an issue that has come to salience in recent times and given the widespread use of off-shore and on-shore havens to route foreign investments into the country. 

This type of work has relevance also in mapping trade flows. How about an algorithm which matches the data of trade invoicing of the firms at both sides of a transaction (under/over-invoicing among firms and transfer pricing within the same MNC entity)?

Update 1 (15.07.2020)

Interesting factoid about India's FDI inflows,

FDI inflows from the Cayman Islands have been rising rapidly in the last few years — from about $1 billion each in 2017-18 and 2018-19 to $3.7 billion in 2019-20. Why have FDI inflows from the Cayman Islands gone up so sharply? The Netherlands with its low tax rates is treated by many as a tax haven and FDI inflows from this European country have also been rising steadily — from $3.87 billion in 2018-19 to $6.7 billion in 2019-20.

It is useful to analyse the real sources of these investments. It could be round-tripping of MNC or domestic corporate capital, Chinese capital, or even questionable capital.