VIEs In The New Foreign Investment Law

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Includes: BABA, BIDU, TCEHY
by: Paul Gillis
Summary

The proposed new foreign investment law is considerably briefer than a similar law that was floated in 2015 but withdrawn.

The 2015 version was tough on VIEs, but provided a way out.

The new law does not discuss VIEs, and I do not think that portends a coming crackdown.

Bloomberg has an article out Thursday reporting on China's new foreign investment law that has been working its way through the National People's Congress the past couple of weeks. The article suggests that the new law lessens concern about a crackdown on VIEs.

The proposed new foreign investment law is considerably briefer than a similar law that was floated in 2015 but withdrawn. The 2015 version clearly stated that the VIE structure could not be used to circumvent the foreign investment law. That provision has been removed from the 2019 version. The new version is much shorter than the 2015 version and some of the new provisions included are likely designed to reduce trade tensions with the US.

The 2015 version was tough on VIEs, but provided a way out. All overseas listed companies other than state-controlled companies use foreign (typically Cayman Islands incorporated) parent companies. The 2015 proposal said that if a foreign company was ultimately controlled by Chinese then the rule forbidding use of VIEs would not apply. Most, but not all, overseas listed Chinese companies use some form of control structure (most commonly two classes of shares). I believe what that meant was the companies that use control structures to keep Chinese founders in control (like Alibaba (NYSE:BABA), Baidu (NASDAQ:BIDU) and most other private Chinese companies) would not be treated as foreign. I believe this meant that not only would VIEs be permissible in these situations, but they might be unnecessary, since the company could directly own businesses in restricted sectors.

The 2015 version was withdrawn. Although it likely fixed the VIE problem for most overseas listed Chinese companies, it did not work for Tencent (OTCPK:TCEHY). Tencent listed in Hong Kong, which at the time did not allow control structures. I believe that is what killed the 2015 version - while it fixed most of the problems, it created an unsurmountable one for Tencent. Hong Kong now allows control structures for new unicorn listings, but the relaxed rules do not appear to apply to Tencent. The 2015 proposal was a great idea for Alibaba, Baidu and many other U.S. listed companies, but there was no apparent way to apply it to Tencent.

The new law does not discuss VIEs, and I do not think that portends a coming crackdown. I think it just continues the status quo, where the government turns a blind eye towards the structure. I would also observe that there have been statements that companies with VIEs and control structures will be allowed to issue Chinese Drawing Rights (CDRs) on the new Shanghai Technology Board. That is about as close to official acceptance of VIEs that we are likely to see.

I think Chinese regulators would like to fix the VIE problem, since it makes a mockery of the rule of law, but a workaround has proven elusive. These companies are now a big part of China's economy, and I find it inconceivable that the government is going to shut them down.

Seven years ago I wrote a summary of VIEs for Forensic Asia that became the most cited work on VIEs. I just updated that article together with Fredrik Oqvist, and GMT Research, successor to Forensic Asia, has distributed it to their subscribers. I will make it available here in a month or two. Our key point is that as VIEs mature they are becoming increasingly unworkable because of the difficulty in moving cash into and out of the VIE.

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.