Chinese VIE companies: what lawyers and analysts say about ‘existential risk’ to global stock investors

China exercises great caution when opining on the validity of the VIE structure, given the scale and importance of such entities, law firm says
Beijing is likely to keep allowing the use of the VIE structure in general, while potentially restricting its use in certain limited sectors, brokerage says

China economy

Yujing Liu

Published: 8:30am, 21 Dec 2020

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China is looking to provide more regulatory clarity for the operation of overseas-listed Chinese companies with a variable interest entity (VIE) structure even as its legality has yet to be tested, according to analysts and lawyers.

The State Administration of Market Regulation, the antitrust regulator, last week fined units of Alibaba Group Holding, Tencent Holdings and others for failing to seek approval for past acquisitions involving offshore VIE units. It also said VIE companies are not exempted from antitrust rules targeting online-platform operators.

It was a rare articulation on the legally ambiguous VIE structure, a special arrangement first invented by Chinese internet firms in the early 2000s to circumvent China’s foreign investment restrictions and to raise capital in offshore markets.

To optimists, the statement signalled Beijing’s tacit approval for the arrangement. After all, smart-scooter maker Ninebot became the first VIE-type company to win approval to list the first Chinese depositary receipts in Shanghai.

A typical shareholding and corporate structure of a VIE company

Yet, some legal experts have cautioned about its ambiguous legal standing. The latest Foreign Investment Law, which came into effect on January 1, skipped any mention of it altogether, keeping the “existential threat” alive and evolving to investors.

Melody Yang, a partner at Simmons & Simmons law firm in Beijing, said the most-recent Foreign Investment Law is silent on the legality of the VIE structure, despite an attempt to deal with regulations over it at the consultation stage.

“Juridically, the enforceability of the VIE contracts also remains to be tested,” she said by email.

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Li Rui, a partner at Zhong Lun law firm in Beijing, said Chinese regulators did not validate the legality of the VIE structure, and its action should not be interpreted as such.

“The antitrust regulator clarified that companies with VIE structures have to seek approvals as long as the transaction meets the requirement for merger control review, and if they do not, they will get penalised, the same as other [type of] companies.”

The State Administration of Market Regulation did not immediately reply to a faxed request on Monday for comment on the subject.

As China opens up more areas and industries to foreign investment, it is possible that in the future the VIE structure is no longer needed for offshore investors wanting to share the growth of local companies, said Li, whose firm recently obtained the first unconditional approval for a merger involving VIE-structured companies.

US-base investors likely owned US$700 billion worth of Chinese VIE companies, as estimated by the National Bureau of Economic Research. Photo: AP

It is likely that China will continue to permit the use of the VIE structure in general, while potentially restricting its use in certain limited sectors of the economy, Bruce Pang, head of macro and strategy research at China Renaissance Securities in Hong Kong, said in a December 11 report.

Dan Baker, a senior equity analyst at Morningstar in Hong Kong, said: “We do not see much change in attitude towards VIE structures from [the Chinese or the US] government or investors” while noting the unusual wording of the antitrust regulators last week.

Chinese regulators in general recognise the VIE structure and would exercise a great amount of caution when opining on the validity of the VIE structure, given the large scale and great importance of such entities, said Yang of Simmons & Simmons.

“This explains why this is still an evolving process and Chinese regulators have not formed a clear view on how to regulate the VIE structure,” she added.