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Key Takeaways

• The U.S. dollar has further consolidated its position as the dominant currency in global bond finance, gaining ground over the euro and other currencies.
•  At the end of 2020, 67 percent of cross-border corporate bonds positions were in bonds denominated in U.S. dollars, as compared with 42 percent at the end of 2007.
• Exposures of developed countries’ investors to China through stock and bond ownership have increased: Thirteen percent of the U.S. external equity portfolio is invested in China.
• These exposures to China predominantly occur through offshore vehicles in the Cayman Islands, and they are even larger when accounting for indirect exposures via firms’ final sales to Chinese consumers.

Transparency into international financial connections is crucial to understanding the global economy. How money is borrowed, transferred, and invested explains the relationships among governments, businesses, and banks that underpin markets around the world.

Corporations often borrow from investors, especially foreign investors, via subsidiaries in tax havens such as the Cayman Islands, Bermuda, and Ireland. These countries’ liabilities to the rest of the world vastly exceed economic activity that actually takes place locally. Clearly, the capital is being used somewhere else.

Our research conducted as part of the Global Capital Allocation Project[1] provides publicly available estimates of the scale of these financing operations, and it also shows which investors buy these offshore assets. The estimates cover bilateral investment positions for most countries in the world and unravel the capital flows that occur through this web of offshore subsidiaries.

We also provide estimates that classify the geography of investment in bonds and equities in proportion to where the issuing firms make their sales, rather than classifying firms as belonging to a single country.

Figure 1. Currency composition of global cross-border corporate bond holdings

Dominance of the dollar

Throughout the pandemic, firms and governments have issued large amounts of bonds in global markets. The dollar has maintained its dominant position as the currency of choice for corporate bonds held across borders, even when neither the holder nor issuing entity is American.

Starting with the 2008 global financial crisis, there was a broad shift in global bond portfolios away from the euro and into the dollar (Figure 1). Fifteen years later, that shift has proved very persistent.

This concentration of global portfolios into a single currency makes the current dollar strength and higher U.S. interest rates likely to affect corporations worldwide. For example, foreign borrowers that issue debt in dollars are impacted by Federal Reserve policies through their effect on the cost of capital, as well as through the real debt burden changes induced by movements in the dollar exchange rate. Interestingly, investors keep focusing on the dollar despite increased debt-to-GDP ratios in the U.S. and a shrinking size of the U.S. economy compared with the world.

Exposure to China

Exposure to China is much larger than commonly understood. Figure 2 shows that in standard (residency-based) data, China constitutes a small and constant fraction of U.S. residents’ foreign equity holdings. These estimates count only equities issued by China-resident corporations.

The red dotted line additionally includes equities issued by Chinese companies’ affiliates in tax havens such as the Cayman Islands. Alibaba, Baidu, and Tencent all issue equity in this way. Under this more comprehensive (nationality-based) view, 13 percent of U.S. residents’ equity portfolios were invested in China in 2020, leaving them vulnerable to the subsequent tumble in Chinese stocks, particularly in the Chinese tech sector.

The pattern is even more pronounced when accounting for firms’ final sales. Further exposure to China arises from Western multinationals making a large fraction of their final sales in China.

Figure 2. U.S. portfolio equity exposures to China

Figure 3. Portfolio exposures to China occur through offshore vehicles

Funneling capital to China

The difference between the residency-based and nationality-based estimates of developed countries’ exposures to China is the result of the use of offshore financing vehicles by Chinese firms.

In Figure 3, we show the substantial use of offshore venues by Chinese firms to raise capital (bonds and equities) from developed countries’ investors. The direct holdings of securities issued in China are small compared with these indirect holdings.

The Cayman Islands play a major role in this flow of capital from Western investors to Chinese corporations. Chinese companies establish affiliates in these tax havens to elude China’s restrictions on raising capital — especially equity capital — from foreign investors. These so-called variable interest entity (VIE) structures have grown enormously in size and present specific risks for investors. The investor protection afforded by these structures is uncertain, as it is unclear whether the ownership and legal rights of U.S. and global investors would hold up if tested in China’s court system.

These unconventional corporate structures have recently been under scrutiny by the U.S. Securities and Exchange Commission. The TICKER Act, a bipartisan initiative of Congress, was recently proposed to protect American investors from risky VIE investments, as recommended by the U.S.-China Economic and Security Review Commission. The TICKER Act would require special trading symbols and risk warning labels when VIE investment products are sold.

Technical notes

The estimates presented in these notes are updates based on the articles “International Currencies and Capital Allocation” (Journal of Political Economy, 2020) and “Redrawing the Map of Global Capital Flows: The Role of Cross-Border Financing and Tax Havens” (Quarterly Journal of Economics, 2021), copies of which are available on . These articles and their appendices contain additional technical details and information on the data sources.

. Please consult the accompanying documentation for a user guide.

Figure 1 is based on corporate bonds held across borders by investment funds. Figure 2 is based on U.S. Treasury official data (blue line), our estimates of holdings of Chinese firms’ securities by nationality based on holdings of U.S. domiciled funds and insurance companies (red dotted line), and our estimates of exposures to China in the holdings of U.S. domiciled funds and insurance companies based on issuers’ final sales (green dotted line). Figure 3 estimates are for December 2020 and based on IMF CPIS data, U.S. Treasury data, and holdings of insurance companies and investment funds for the U.S. and investment funds for rest of the countries. The EMU estimates are more uncertain due to sectoral composition and holdings in the Netherlands, Luxembourg, and Ireland being domestic. See the .

������� the Authors

• Antonio Coppola is a �������postdoctoral fellow and an incoming assistant professor of finance at the Stanford Graduate School of Business. His work focuses on international macroeconomics and finance.
• Angus Lewis is a PhD candidate at the Stanford Graduate School of Business.
• Matteo Maggiori is a �������senior fellow and the Moghadam Family Professor of Finance at the Stanford Graduate School of Business. His research focuses on international macroeconomics and finance.
• Jesse Schreger is the Class of 1967 Associate Professor of Business at Columbia Business School. His research is primarily on international finance and macroeconomics, focusing on sovereign debt and exchange rates.
• Ziwen Sun is a research fellow at the Stanford Graduate School of Business.
• Serdil Tinda is a research fellow at the Stanford Graduate School of Business.