Frank S. Hong

Why China turns a blind eye to VIE tech firms and their foreign investors

As long as variable interest entities continue to raise foreign capital to boost China’s economy, without threatening it or Beijing, there is no danger of a regulatory crackdown

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Since Sina Corp first went public using the VIE structure on New York’s Nasdaq in 2000, hundreds of Chinese firms have taken the same path. Photo: Bloomberg

Frank S. Hong

Published: 1:30am, 30 Dec 2020Updated: 2:04am, 30 Dec 2020

Since Chinese variable interest entity (VIE) companies made their debut in the early 2000s in the first wave of the internet economy, once in a while, international lawyers and investment bankers get anxious and ask: when is China going to crack down on VIE structures?

This is not so much about a US$4 trillion ticking time bomb – the capitalisation in the MSCI China Index estimated to be held by more than 100 VIE companies – as a hammer in search of a Chinese nail to hit. Yet Western professionals are not equipped to make a prediction.

For economic and ideological reasons, China fiercely protects its internet business from foreign influence or competition. By law, foreign investment in the internet sectors is restricted. Yet hundreds of such internet companies in the education and media sectors are listed on the US or Hong Kong stock exchanges, thanks to the regulatory workaround of VIEs.

Under this structure, the revenues of Chinese-owned VIEs, under service contracts, can flow into wholly foreign-owned entities, benefiting international investors.

The contracts are essential. Without them, international investors cannot reap the financial benefits of the Chinese businesses they have put money in. The contractual facade lets Chinese regulators look away as the entities that directly conduct business in the restricted domains are companies owned by Chinese nationals.