Applying ESG Factors to investment decisions

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Many families want responsible investing to play an increased role in the design of their investment portfolios. The goal is a greater alignment between their investments and their personal values, promoting outcomes that are financially rewarding while supporting positive social and environmental change.

Investment managers increasingly appreciate the need to accommodate sustainable investing.  Trends supporting interest in ESG include increasing awareness amongst asset managers that (i) sustainability issues do impact financial performance, and (ii) millennials and women, two demographics that will be managing an increased share of AUM going forward, have demonstrated an affinity to responsible investing (potentially impacting manager selection).

However, obstacles to adoption include confusion around terminology, rationale and implementation.

For example, are ESG (environmental, social and corporate governance), sustainable, socially responsible and impact investing different names for essentially similar evaluation frameworks, or would they require substantially different implementations in the eyes of the cognoscenti? 

 We believe that at a broad level, each of these concepts encourage the integration of the clients’ personal values or society’s perceived concerns or an entity’s mission into consideration, alongside traditional criteria, when making investment decisions.


Applying ESG factors to investment decisions likely leads to a more complete analysis of the investment opportunity because it involves analysis that might have been overlooked by traditional approaches.

DWS and the Univ of Hamburg reviewed (in 2015) the conclusions of over 2000 studies and found that the majority of such studies found a positive relationship between ESG factors and corporate financial performance; while relatively few found a negative relationship.

A long-term study by JP Morgan found that stocks with the poorest ESG scores exhibited greater volatility during choppy markets … supporting the view that sustainable investing may help make investment portfolios more durable.  A recent Bank of America study found companies with better ESG performance exhibited lower earnings volatility and higher ROE over the period reviewed.

While not all managers expressly state that they apply ESG factors, good investment analysis necessarily identifies sound corporate behavior and business strategies that serve to protect the company and its stakeholders. It would seem unwise to ignore key sustainability issues when assessing a company’s ability to generate long-term financial returns.


Developing a Framework

There are over 2,000 signatories to the U.N.’s responsible investments initiative, established in 2006 and called the Principles of Responsible Investment (PRI).  Signatories commit to six principles designed to embed ESG considerations into investment decision-making processes and to hold the companies in which they invest to account for ESG failures.

In 2015, the U.N. set out 17 Sustainable Development Goals (SDG) relating to societal challenges including poverty, inequality, climate change, the environment and justice.  Its intention was to redirect investments to address specific problems that may not attract capital purely on expected financial performance metrics, with the goal to achieve a cleaner, healthier and more equitable world.

However, given the broad nature of the goals as well as the implementation language having been prepared for governments rather than investors, it has not been easy for investors to translate these goals to specific practices.

Implementing Within the Investment Processes

JPMorgan estimates $23 trillion of assets are now managed with at least an indication that ESG factors play a part as investment criteria, with over $100 billion invested in ESG Funds.

Managers applying ESG factors to portfolios, funds and sector indices apply a range of approaches including: (i) an exclusionary approach using screens or sector bans; (ii) a “positive” bias designed to include companies with certain performance or improvement scores; and (iii) thematic, or impact, investing.

 1.  Exclusions based on broad failure.

As a first step, responsible investing will look to avoid companies that fail to meet the most basic standards on issues such as corruption, environmental degradation and human rights.

2.   Systematic exclusions.

The early and still a predominate ESG approach is to exclude sectors seen as not meeting society’s priorities. Initially, these tended to be the so-called “sin” stocks (gambling, alcohol and tobacco).

An exclusionary approach has to deal with how broadly a net is thrown. Do you exclude companies that sell alcohol or tobacco (food retailers, pharmacy chains) or just manufacturers?  Do you exclude weapons manufacturers or also those providing components or that have much larger businesses in other sectors (e.g., Boeing or Airbus)? Do you exclude all fossil fuel producers, or only the products with the highest carbon intensity?

This exclusionary approach is sometimes criticized as: being too limiting, potentially hurting returns, (ii) not doing enough to encourage behavioural changes, (iii) not having a strong economic rationale, and (iv) presents a risk of capture by social activist movements.

3.  Screening-based inclusions.

Arguably, a more effective ESG approach goes beyond exclusions as managers become more focused on what to include, as much as what to exclude. Under a best-in-class or positive approach, companies are included or emphasized that have the strongest ESG credentials.

This approach is useful for managers that want to label a fund as ESG based on quantifiable measures (although there are questions about the effectiveness of third-party scoring models).

4,   Integrating ESG factors.

The recent trend is a more comprehensive approach whereby ESG factors are integrated with traditional analysis to improve the investment decision-making process and highlights risk.

For example, a manager with whom we work closely, states that:

“… our approach to investing responsibly and integrating ESG considerations is guided by our mandate to deliver returns that will enable our clients to achieve their long-term investment objectives and our core values.   We believe that companies with sound business practices, including strong corporate governance and responsible management of material environmental and social issues, have better success and deliver stronger financial performance over time.  Conversely, companies that have poor environmental, social or corporate governance practices present risks and controversies that may hinder their financial performance.” 

Under this approach, industry analysts investigate ESG risks as part of their in-house research process and may compliment that work with third-party research. Conclusions are integrated into investment decisions.

This approach can also run alongside an exclusionary framework. For example, the manager cited above excludes tobacco, gaming and thermal coal miners from all portfolios, while its ESG Fund adheres to a much more restrictive investment policy which precludes investments in companies for which ESG information is insufficient or which do not pass certain ESG filters.

5.  Thematic Investing.

Thematic or impact investing generally funds strategies addressing specific environmental or social challenges.  This is often done through investment vehicles that are private and project oriented.

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Emerging Markets Allocations

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The vibrancy and high growth rates of emerging market economies are often alluring for investors looking to add incremental growth and exotica to their portfolios. The high under-lying growth rates, huge population base and a perception that less transparency and analyst attention suggest that these markets are less efficient was the start-point for many fund pitches.

There have been two broad approaches for adding emerging market exposure to segregated portfolios:

  1. indirect exposure, by investing in well-run western companies with significant emerging market businesses; or
  2. direct exposure, through ownership of companies based and operating within one or more emerging economies.

Our portfolios have historically had a mix of the two, with the bias being toward the first approach. Our portfolio manager is dedicated to a detailed, bottom-up analysis of each company that it evaluates.  This approach is often more challenging when it comes to emerging market issuers, in part because of less access to management, frequently the lower quality of financial information, the reticence of EM management teams (that were not used to that sort of due diligence process), and frankly, less confidence in the quality of corporate governance.

However, the balance has been shifting towards direct exposure over the past decade, as these issues are addressed by more and more management teams in the emerging markets. Client portfolios now have direct exposure to emerging markets at, or slightly above, the MSCI ACWI allocation.

However, and as you are no doubt aware, these elevated growth rates enjoyed by emerging economies have not always translated into elevated total returns for minority investors in emerging markets companies. EMs have had periods of exceptional performance and then periods of under-performance, such as we witnessed in 2018.  In addition, volatility has historically been considerably higher than in developed markets, producing unenviable Sharpe ratios (although Bloomberg Markets pointed out last week that short-term volatility in developed markets was currently above that in emerging markets, a very rare event.)

So what changes, other than greater comfort with due diligence processes, give us more comfort with direct EM exposure than was the case historically?

Emerging economies now represent almost two-thirds of total global GDP, while their stock markets represent approximately one-third of global market capitalisation.   Key global indices have an even lower allocation to EM, at around 10%.  As more China-listed companies are included in indices over the next few years, that figure will rise, but it will still remarkably understate the importance of those economies to global growth.

While emerging economies typically exhibited higher growth rates, their economies were not as large and influential to total global growth as were the developed economies. However, whether it’s China, India, southeast Asia or EM as a whole, their absolute scale has become very important, not just their relative growth.

A recent paper from the Brookings Institute estimated that over 90% of the increased spending power of the global middle class will come from China, India and other Asian emerging countries by 2022.  In other words, the impact that these economies have on global growth is now impossible to ignore.

Second, the composition of what drives emerging economies is evolving. In boom periods of the past, growth was led by low-cost, export-driven manufacturing, domestic property development typically fueled by cross-border capital flows and resource extraction industries.  This led to considerable volatility in EM returns during a business cycle.

However, the less volatile and often domestically-oriented sectors such as healthcare, consumer staples and consumer discretionary sectors are becoming more relevant. In most Asian EMs, the technology sector, albeit still export-oriented, is now much more important – although whether the chip makers and components suppliers have managed to reduce cyclicality is currently on trial. The MSCI EM index now comprises over 40% of technology and consumer sectors.

Third, research focused on the increasing integration of ESG issues (environmental, social and corporate governance) into company analysis and investment decisions has highlighted that this approach is particularly helpful in evaluating risks in the emerging markets. Assuming this is true, and we believe that it is, then the detailed, bottom-up style of investment research (as opposed to the use of passive products) should enhance returns over time, relative to the same impact with respect to developed markets.

Finally, from a relative value perspective, EM currently looks very attractive. While the relative value between EM and DM is somewhat cyclical, the end-of-2018 MSCI EM relative to the MSCI World (normalized to early 2008) is extreme, historically.

As 2019 market outlooks were distributed in the first two weeks of January, it is clear that emerging markets are again very much in the conversation. The large sell-side houses seem about equally divided on the attractiveness of the asset class, informed in large part by their outlook for global growth, the likely strength / weakness of the USD and the likelihood of two or more Fed rate increases during the year.

We do not market or promote any fund products, but if you are interested in more information on how our client exposure to emerging markets is expressed within their segregated accounts, please contact us.


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Keelan Chapman spoke to The Globe and Mail

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Since 2016, Keelan Chapman has been actively supporting our clients in his role as Real Estate Consultant at ChapmanCraig Ltd.   Concurrently, Keelan manages the Canadian Real Estate Investment Center (H.K.)  which assists Asia-based investors in making property acquisitions in Canada.  He was recently highlighted in an article penned by Nathan Vanderklippe in the Globe and Mail, one of Canada’s leading business newspaper.  The article, titled “The Re-returnees”, was published on January 13, 2019, and below in italic is an excerpt.

       When Keelan Chapman moved back to Hong Kong three years ago, he didn’t expect to find himself with a front-row seat to a Canadian exodus.

       Mr. Chapman runs the Canadian Real Estate Investment Centre (Hong Kong), a company he created three years ago to help people in Asian buy property in Canada. He figured his clients, who meet him in Hong Kong’s skyscraper forests of buzzy coffee shops and swish boardrooms, would be investors moving cash into Vancouver’s exuberant housing market. 

       What he has found instead is people looking to buy homes for themselves.

      “My main clients in Hong Kong tend to be Canadians looking to return to Canada,” he says.

An active member of the Canadian Chamber of Commerce in Hong Kong, a founding member of the Pearl River Delta Canada Chamber and an engaged member of the Alumni Association of McGill University, Keelan often speaks at conferences on the Canadian Real Estate market, giving specific updates on the Vancouver, Toronto and Montreal real estate markets as well as on recent implementation of various taxes affecting real estate investors.

From his experience, buyers are interested in Canadian properties for three reasons: investment, for a retirement home or for young families returning so their children receive education within the Canadian education system, whether it be secondary, post-secondary or university.

Vancouver and Toronto continue to attract most interest due to strong family ties developed over the years.   However, since the steep price increases and various policies aimed at foreign buyers in these cities,  Keelan has noticed that he is getting more inquires for cities like Montreal (Canada’s second largest city) where prices are affordable, yields are strong and there is a growing dynamic wave coming from high-tech companies that are looking to take advantage of the city’s collection of world class universities.

Keelan is a licensed real estate broker in the province of British Columbia and regularly travels back to Canada to assist his clients in real-estate matters.



Developments in the Vintage Wine Market Oct, 2018

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2018 is turning out to be a very positive year for the vintage wine market with the combination of a broad strengthening of prices, a couple of stunning surprises from recent auctions and a good yielding but high quality harvest.

In France, the 2018 vintage will be a great one in many regions, with the exception of areas which were devastated by hail storms in late May.   Some Bordeaux winemakers are already talking about 2018 being the vintage of a lifetime.  Italy, Spain and Portugal overall had mixed results – an excessively wet spring and very high temperatures during the growing season.

There has been much excitement in the auction market and Burgundy wines have been the undisputed stars.  Two headline auctions took place: Henri Jayer’s sale of his personal cellar in Switzerland in June and the Drouhin family cellars of Domaine de la Romanée-Conti (DRC) in October.   The Jayer collection was comprised of 855 bottles and 209 magnums and sold for US$ 35 million, or an average price of US$ 33,000 per bottle.   Not to be outdone, two bottles of 1945 DRC were  sold in NYC last month for a combined amount of more than US$ 1 million.

The star status of Burgundy wines continues to spill into the general vintage wine market.   However, it should be clearly noted that while the broad vintage wine market is enjoying strengthening pricing, Bordeaux looks to be a laggard after having had a preeminence status for many years.

Below are the returns of various vintage wine indices for the 12 months to end of Oct 2018:

  • Liv-ex 1000   (comprised of 1000 wines from around the world)       +10.4%
  • Liv-ex 50    (comprises the latest 10 vintages of the 5 Bordeaux First Growths)       +1.4%
  • Liv-ex Burgundy 150  (comprises the latest 10 vintages of 15 Burgundy wines incl. 6 Domaine de la Romanée Conti)   + 31.5%

Strong interest in Italian Barolo wine and broad based Burgundies has been a strong support for better pricing in the wider vintage market.

Looking ahead, there are reasons to expect continued stronger prices for leading Burgundy producers other than DRC and Jayer.   Scarcity of Burgundy is a simple fact that we will address in further details in our next update.


Canadian Real Estate Market Update 2018 Q2

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In Q2 of 2018 we saw the condominium market across the major cities continue to flourish, as well as townhomes starting to prosper.  Single detached market prices are experiencing year-on-year declines in Toronto and Vancouver; however, they are soaring in other major markets.  Overall, Q2 saw an increase in prices and sales compared to Q1 of this year


Compared to Q1 of this year, Vancouver’s single detached market prices decreased 2.2% but experienced an increase of 3.1% in condo prices and an increase of 2.7% in townhome prices.  This same trend is reflected in the year-on-year (YoY) prices as single detached home prices decreased 1% YoY, while condo and townhome prices rose 18% and 14% respectively.   The areas which underwent the greatest growth were West Vancouver for condos, Vancouver East for townhomes, and North Vancouver for single detached homes.  Vancouver is currently a seller’s market for condos and townhomes; however, it is a buyer’s market for single detached homes as they are selling below asking price.


The Toronto market grew in all sectors in Q2 compared to Q1, but prices YoY were not as positive.   Compared to Q1, single detached home prices grew 18%, condos grew 13%, and town homes increased 23%.  However, YoY prices saw single detached home prices decreasing 8%, townhomes decreasing 2%, but condos increasing 6%.  As the condo and townhome markets continue to be very active, it is no surprise listings have increased in both markets.   Conversely, listings for single detached homes increased only 1%, reflecting the stagnant market.  The biggest growth in Q2 for single detached homes was Toronto West, Toronto East for condominiums, and Toronto Central for townhomes.

In Q2 Montreal’s real estate market continued its hot streak and has seen price increases both compared to Q1 2018 and YoY.   Single detached homes, condos, plexes grew YoY 9%, 7% and 8% respectively.  Compared to Q1, condos grew the most at 8%, single detached at 4%, and plexes at 1.1%.  An interesting statistic to note is the number of listings for condos decreased 9% between Q1 and Q2.  With sales increasing 21% and listings decreasing during the same period, condo prices will continue to grow as there will be lower supply and higher demand.

Victoria and Whistler both experienced growth in all sectors of the market.  Victoria’s YoY growth increased 9% for single detached, 17% for condos, and 8% for townhomes.  Whilst, Whistler experienced a greater YoY growth as single detached, condos, and townhomes are increased 15%, 33% and 32% respectively.   Compared to Q1, prices for Victoria in all markets grew by 4%, whereas Whistler’s single detached market grew 1%, condo by 8% and townhomes by 12%.

Tax Changes Impacting Ownership of UK Residential Property

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There has been a flurry of changes to UK tax laws that, along with additional proposed changes, significantly impact the ownership of UK residential property through off-shore structures.

The tax exposure of UK non-residents owning UK real estate depends, in part, upon how it is held. Its use remains relevant but will become less so as some exemptions for commercial or investment properties are phased out.  As a result, offshore ownership structures may need to be revisited, if you have not done so already.

Non-Doms and Inheritance Tax (IHT)

UK property owners often used offshore companies to hold property to avoid IHT (amongst other purposes). This may have been advantageous even if it meant losing the principal residence exemption under CGT on sale.  Shares of offshore companies are not caught within the UK’s IHT regime unless the owner is (or is deemed) domiciled in the UK.  [UK domiciles are subject to IHT on their worldwide assets.]

In addition, transfers of shares avoided the stamp duties (SDLT) normally charged on property transfers.[i]

A 3% SDLT surcharge now applies where the buyer owns another residence, including residences outside of the UK. But the surcharge will also apply, even in the case of a first residence, where it is purchased through a company or discretionary trust.

Similarly, individuals that were resident in the UK, but treated as “non-domiciled”, could avoid IHT for certain properties if the settlement of a trust had been properly completed before the individual became UK resident.

Starting in 2017, excluded property trusts will no longer effectively shield a residential holder of UK real estate from IHT because shares of offshore companies that own UK real estate will no longer be considered excluded property.

Additional IHT taxes might also apply on a periodic basis prior to death in certain circumstances. Mortgages on UK property could now be exposed to IHT or be unavailable to reduce IHT liabilities.

In addition, tax changes effective in 2017 shorten the time during which long-term residents will not be deemed to be domiciled for IHT purposes and will treat individuals born in the UK as domiciled as soon as they become resident in the UK, even if they had acquired a new domicile by choice in the interim.

Recent Changes to Capital Gains Tax

UK taxes on capital gains from disposition of property previously applied to i) residents and ii) gains connected to UK real estate. This led some to hold UK real estate within offshore structures.

However, starting April 2015, non-residents (including non-resident companies) disposing of UK residential properties became subject to the non-resident CGT regime (costs rebased to April 2015).

The UK intends to apply the CGT regime to sales, occurring after April 2019, of any UK real estate held by non-resident individuals and companies, including commercial property (with perhaps some exemptions for institutional investors). By April 2020, gains on disposition of UK real estate owned by offshore companies may be taxed under the corporate tax regime, rather than under CGT.

In addition, HMRC had seen some push back from the EU on certain taxes imposed when property ownership was exported from the UK.  Following Brexit, some of those relaxations may be repealed.

Annual Tax on Enveloped Dwellings

ATED was introduced in late 2012 to tax offshore entities that hold UK residential property. The legislation addressed a perceived lack of fairness as to how non-Doms and offshore owners of expensive London properties were being treated, vis-à-vis UK residents.[ii]  Investment (or buy to let) properties were initially exempted from the tax.

Offshore companies holding UK residences worth more than £500,000 now pay an annual ATED charge (a sliding scale depending upon value) and will be responsible for a 28% capital gains tax on dispositions (costs were rebased as of April 5, 2013).

Evolving Registration Requirements

Although many of the tax advantages of owning UK property through offshore structures have been eliminated, one of the remaining attractions was enhanced confidentiality.

However, in January the UK clarified rules requiring offshore entities that own UK real estate to complete a public registration. The registration, expected to be in force by early 2021, will likely require the entity to identify its ultimate beneficial owner(s). While the purpose is to address transparency and money-laundering issues, it is consistent with a policy objective to discourage using offshore companies to own UK residential properties.

Additionally, under new rules, non-resident trusts that hold UK assets (or receive UK-sourced income) will need to register. The deadline for registration depends upon the UK taxes that are payable.

As we discussed last year, investors should be aware that the Common Reporting Standard arrangements, by now in place in most countries, will provide tax authorities with considerably more information than they have had previously with respect to financial accounts held offshore.  The first package of account information will be sent by HK authorities to the UK by October this year, for example.

Investors that have implemented wealth planning that uses an offshore structure to hold, or make loans related to, UK real estate that were put into place some time ago should carefully review their plans with their professional advisors. Some flexibility present prior to April 2017 will have been lost by now; but curing structures that create unnecessary exposure may still be advantageous.


[i] SDLT on residences starts at 2% for a cost of £150,000 and increases with cost up to a maximum of 12%.  There is also a 3% surcharge where the buyer already owns other properties.  Where an entity is the buyer, a 15% supercharge may be chargeable.

[ii] UK had started to expand its reach to offshore companies being used to mitigate CGT and IHT in 2008 through a new section 13 charge, attributing what would normally have been offshore capital gains to shareholders of closely held companies on a proportionate basis.  The EU somewhat dialed back the application of this charge on freedom of mobility grounds, in 2013, prompting further legislation from the UK.

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Will Others Adopt Canada’s CRS Fix for Investment Entities?

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When the OECD drafted the Common Reporting Standard and related Commentary it paid special attention to areas that were likely to be exploited by offshore investors trying to avoid reporting. At the same time, it used definitions and constructs that mirrored those employed in FATCA’s Final Regulations where it could.

Type B Investment Entities

Under both regimes, personal holding companies and trusts earning primarily passive income and managed by financial institutions are themselves classified as financial institutions, as a (type b) Investment Entity.

“Managed by” includes having a professional trust company as trustee or retaining an institutional asset manager on a discretionary basis.

An important result of this classification is the entity’s custody bank does not need to report on that entity’s account (so long as it is not resident in a non-participating jurisdiction – in which case it is treated as a passive non-financial entity (passive NFE)).  However, that entity must report on the holders of its “equity interests” itself – essentially, in the case of a personal holding company, on its controlling shareholders.

This result is rather counter-intuitive. I doubt the owners of a typical BVI holding company, formed to hold an investment account, i) think of themselves as a financial institution, ii) have any idea that they need to report, or iii) know how to report.

I wondered if this was a widespread misinterpretation of the rules and have been curious why this issue is not more discussed online.

An interesting site,, points a flashlight down CRS rabbit holes, highlighting ongoing abuses.  It discusses this issue and how some might be taking advantage (see abuse #5).

IRS Regulations §1.1471-5(e)4(i)B, -5(e)5(i), and 5(e)4(v) Ex 6, appear to validate this interpretation – with my sympathy to compliance officers dealing with these matters.

Many global investment managers use decision trees to help guide clients through the CRS classification maze, and would lead the typical BVI holdco, with a professionally managed discretionary investment account, to the professionally managed investment entity (PMIE) classification.  They leave it there (other than to indicate no reporting will follow).

So, we were comfortable with this counter-intuitive interpretation, but not sure where that leaves such a client completing its CRS self-certification form.

 Canada’s Approach

The Canada Revenue Agency (CRA) has published CRS guidance notes, which on first skim look much like those of other countries.

A CRA form [RC519 E, essentially a CRS self-cert], released a year ago but only brought to our attention recently, takes an unusual twist.

After repeating the CRS definitions, including word for word the definition of a type b Investment Entity, there appears on page five:

A passive non-financial entity is an entity that is:…

…b) an investment entity described in paragraph b) of the definition of investment entity; or … (emphasis added)

 In others words, something is not what it was otherwise defined to be [1].  Curious, but perhaps helpful ultimately.

The OECD has already responded to country-specific entity classifications that it sees as creating avenues for abuse (e.g., exempt pension plans under Hong Kong’s ORSO regime). However, choosing passive NFE means that the bank will report on the account owner and its controlling persons, and therefore does not seem a likely approach for those trying to avoid reporting.  But the OECD drafted the Commentary and Standard deliberately and, I assume, with certain outcomes in mind.


Non-Canadian residents completing CRS self-certs for their offshore holding company (or trust) for a Canadian bank should feel comfortable selecting passive NFE (if they don’t mind the reporting).  Most have been doing that anyway, I suspect.

However, if that entity also has a discretionary investment account booked, for example, in Zurich with Credit Suisse, then they will likely select PMIE on the Credit Suisse self-cert form, which then requires that they think about their own reporting obligations.

We doubt OECD intended the same entity would have different classifications simultaneously; after all, minimizing reporting overlaps was a stated objective.

If the entity, wearing its PMIE hat, reports to its own tax authority, should it report only the accounts maintained in those countries where it has self-certified as a PMIE, or should it report all accounts (to be passed on to authorities in participating countries)?   Should being advised by the CRA that it is a passive NFE be justification for using that classification everywhere?   Given the IRS does not appear to agree with such treatment, how the entity complete its W-8BEN-E for the same Canadian bank?


[1]  This issue is more widely discussed and fuzzy with respect to FATCA reporting because reporting FIs are a narrower concept in Canada’s enabling legislation for FATCA (S. 263(1) of Income Tax Act) than they are in Canada’s IGA or as set out in the FATCA Regs.  Entities are financial institutions if they meet the IGA definition and are included in a list in the ITA.  The key difference in the ITA is a requirement that the entity “is represented or promoted as a collective investment vehicle”.  CRA’s FATCA Guidance suggests that an investment entity that meets the IGA definition but is not listed in the ITA an financial institution should be treated as a non-financial entity.

The language in Canada’s enabling legislation for CRS (and the CRA’s CRS Guidance notes) do not have this second test.  Therefore, the basis for making that assertion in the official form dealing with both FATCA and CRS is not at all clear.

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Spin-Offs Regularly Outperform

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Your investment statements may include a group of companies that share an attribute that has been a reasonably good predictor of out-performance. These are “spin-offs”, and as a broad class have tended to outperform their peers, parents and the broad markets over time.

Recent high-profile spin-offs have included both winners and some that struggled, and include – Baxalta (out of Baxter Int’l); LifePoint (HCA); Murphy USA (Murphy Oil); Adient (Johnson Controls); Marathon Petroleum (Marathon Oil), Phillips 66 (ConocoPhillips); Halyard Health (Kimberly Clark); Cenovus (Encana); AbbVie (Abbot); HPE (HP Inc); Synchrony Financial (GE); Lanxess and Covestro (Bayer); Axalta (DuPont); and Ferrari (FiatChrysler).

There have even been spin-offs out of spin-offs, including DXC Technologies and Micro Focus (HPE). Some may even recall Marathon Oil’s spin-out from US Steel in 2002.

Clients will recognize many of these names as they have been in their portfolios at some point.

Rationales and Results

Broadly, a spin-off is a transaction that separates two (or more) businesses when shares of a controlled subsidiary are distributed to the parent company’s shareholders.

The general bullish argument is that the process releases or enhances shareholder value because the separate parts will ultimately be valued, in sum, higher than would have been the case under the status quo.

For a number of reasons, sometimes related, public company managements have found spin-offs to be an attractive transaction structure. Rationales include:

  1. Separating the underlying business if its risk profile is distracting management or is perceived as detracting from the core business (e.g., Baxalta);
  2. May release value for a subsidiary with a very different growth profile or natural shareholder base, freeing it up to trade at higher valuations as a pure-play (e.g., Autoliv’s spin-out of its auto-driving unit);
  3. If synergies are insufficient to justify a “conglomerate discount” perceived as applying to the whole;
  4. Focus the separate management teams (and the market) on different broad strategies (e.g., Adient), or returning the parent to its core business;
  5. Simplify the story – consolidated financial reporting may be making analysis difficult (e.g., GE);
  6. US parent companies can monetize part of the subsidiary’s value, perhaps facilitate a follow-on transaction (e.g., merger or IPO of the subsidiary) and yet enjoy a tax-free transaction structure; 1
  7. Provides freed-up management with more focus to grow or improve the separated business, with the subsidiary better able to participate in industry consolidation (e.g., Axalta);
  8. Separate the business, but retain some of the upside if less than 100% of the shares are distributed (e.g., Covestro, where Bayer is selling down over time);
  9. Separate a regulated from a non-regulated business, or a specialty business from a commodity business; and
  10. Having failed to find private equity or strategic buyers willing to pay a sufficiently high price, spin it off to shareholders (e.g., Foster’s wine business).

Alternative structures developed in the 1980’s / 90’s, such as lettered stock / tracking shares, often did not achieve the desired results. Tax savings and retained synergies were buried under a confusing structure and uncertainties as to the spill-over of liabilities.

Research estimates that spun-off subsidiaries have out-performed, broadly, the general market by between 2x and 3x, depending upon the period measured and population size.

2018 Activity

A number of significant spin-offs have been announced or are anticipated for 2018, including Akzo Nobel, DowDuPont, Fiat Chrysler, General Electric, Honeywell, Pfizer, and Twenty-First Century Fox.

We expect the frequent use of spin-offs to continue. Large corporate holdings of cash and US repatriation of some of that, suggests 2018 should continue to see robust M&A activity, even at what some see as full valuations in the public markets.

Until P.E. funds become more active putting their historically large funding commitments to work, managements need to look at all alternatives to generate value for unwanted assets or enhance shareholder value.

A US company can essentially put its subsidiary in play, via a spin off, while retaining the tax-free benefits, if properly advised and certain requirements are met.

The potential tax benefits remain significant, even after the TCJA, although the analysis can be complicated.

A spin-off can still be attractive for shareholders even if tax-free treatment is not available (e.g., Adient – a tax-free outcome was not available because JCI, the parent, merged with Tyco in 2016 in an “inversion” transaction, offshoring the company to Ireland.) 2

We believe that active portfolio managers that monitor and assess opportunities for spun-off subsidiaries to out-perform can add materially to portfolio performance.

We have highlighted the exceptional performance of specific spun-off subsidiaries in past client letters.


1      While the US Congress tightened rules surrounding tax-free reorgs in 1996, in response to the Morris Trust judgement, transactions known as Reverse Morris Trusts remain popular, even if complicated (e.g. HPE’s recent spin-off and mergers of its software business with Micro Focus, and its enterprise services business with Computer Sciences to form DXC Tech).

The recent Shire / Baxalta transaction was initially seen as potentially too aggressive. However, it was not attacked by the IRS.  This may help post-spin valuations, where the market perceives the subsidiary as an potential take-over target.

  1. In addition to the roll-over requirements, proposed merger structures need to be mindful of the recently introduced anti-inversion measures (e.g. these complicated the proposed Pfizer / Allergan merger in 2016)


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New Real Estate Policies Introduced by the British Columbia Government

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It hasn’t even been two years since the first Foreign Buyers Tax was implemented in Vancouver on August 1st 2016. To increase their chances of being re-elected, the Liberal party led by then Premier Christie Clark decided to implement drastic real estate policies to tackle the increasing popular issue of housing affordability. The major policy announced was a 15% Foreign Buyers Tax on buyers who are non-Canadian citizens or Canadian residents for properties in the Greater Vancouver Regional District. The tax led to a short-lived cooling period in Vancouver’s red-hot property market. Roughly 9 months after the tax’s implementation, property prices returned to pre-tax highs and a boom was experienced in the condominium market. Toronto was quick to follow and implemented their own Non-Resident Speculation Tax, the outcomes of which have followed the same path as Vancouver’s Foreign Buyers Tax.


In February, the newly-elected NDP government of British Columbia released their provincial budget which includes very extreme real estate policies. Their aim is to implement measures to decrease property values while investing more in public housing. Below are the major real estate policy changes to take note according to the Urban Development Institute – Pacific Region[1].


New Speculation Tax 

  • Beginning fall 2018, the Province will introduce a new speculation tax on residential property.
  • Annual property tax will target foreign and domestic speculators who do not pay income tax in B.C.
  • The Tax rate will be 0.5% of taxable assessed value for the 2018 tax year and 2 per cent thereafter.
  • The tax will apply to Metro Vancouver, Fraser Valley, Nanaimo and Greater Victoria area, and the municipalities of Kelowna and West Kelowna.
  • Primary residences and long-term rentals will generally be exempt; however, second homes and recreational properties in the selected areas will be applicable.


Increased and Expanded Foreign Buyers’ Tax (FBT)

  • Beginning February 21st , 2018, the FBT tax rate will increase from 15% to 20%, and be expanded to include Fraser Valley, Nanaimo, Capital Regional District and Central Okanagan Regional Districts.
  • Within Metro Vancouver the FBT increase will be effective February 21st with no grandfathering provisions for existing contracts.
  • In the new regions, there will be a three-month grandfathering provision for existing contracts.


Increased Taxes on Homes Valued Over $3 million

  • Increased Property Transfer Tax rate from 3% to 5% on the value of homes over $3 million, forecasted to raise $81 million annually.
  • Increasing school tax rate on the value of homes over $3 million


Tax Compliance and Enforcement

  • Legislative changes to require developers to collect and report comprehensive information about pre-sales assignments.
  • Require additional information on beneficial ownership on the property tax form and establish a registry of beneficial ownership in B.C. that will be publicly available.


Canadian Real Estate Market Update 2017 Q4

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It has been a very busy 2017 for Canadian real estate: Vancouver recovered from the Foreign Buyer’s tax implemented in early August 2016; Toronto experienced an extremely hot market, resulting in the implementation of new real estate policies including a Foreign Buyer’s Tax; while Montreal, Victoria, and Whistler experienced price increases across all sectors.


In Q4 of 2017, Vancouver’s condo and townhome prices continue to increase, while single detached home prices declined slightly by 1.6%. By analyzing the Q4 year-on-year (YoY) price growth we believe that the impact of the Foreign Buyer’s tax was a dramatic price increase in condominiums (+24%) and townhomes (+15%), and much smaller price increases for single detached units (+3%).   As the tax made single detached homes a more expensive investment, investors looked to condominiums as a cheaper alternative.


Toronto Q4 2017 average prices did not change much from Q3, decreasing or increasing by 1%.  However, similar to what occurred in Vancouver during the year and a half after their Foreign Buyer’s tax was announced, where condo and townhome prices continued to increase while single detached home prices declined. The YoY price changes reflect the effect of Toronto’s foreign buyer’s speculation tax, as prices declined by 1% for single detached homes but increased by 17% for condominiums and 4% for townhomes.

Montreal experienced a very active 2017 and is now the largest real estate market in Canada without a foreign buyer’s tax.  A main driver of this increased activity was Toronto’s implementation of the Foreign Buyer’s Speculative tax activated in April of 2017, which imposes a 15% tax on the purchase price on foreign/non-Canadian resident buyers. In Q4, prices and sales increased in all sectors, especially in the condo market as average prices increased 8.1% and average sales increased 22% from Q3.   YoY prices increased in all sectors to culminate a very active year as prices for singled detached homes increased 4%, condominiums 10%, and townhomes 12%.

Victoria’s residential real estate market saw a very energetic 2017.  Despite minor price growth for Victoria in Q4, YoY price growth increased in all sectors, increasing 11% for single detached homes, 19% for condominiums, and 13% for townhomes.

Whistler Q4 average prices were roughly flat, despite townhome average prices increasing 24%.  However, YoY prices increased drastically as prices for single detached homes increased 46%, condominiums increased 34%, and townhomes increased 43%.  The largest YoY price increases amongst the 5 markets.