China opens escape route for VIEs | China Accounting Blog | Paul Gillis

China opens escape route for VIEs

Yesterday the Ministry of Industry and Information Technology (MIIT) issued a pronouncement (2015) 196 announcing a pilot program that appears to allow 100% foreign ownership of e-commerce businesses.

I had anticipated this development as a way to let foreign companies using the VIE structure to operate e-commerce a way out of the proposed crackdown on VIEs under the new foreign investment law. The proposed law may limit the use of VIEs to situations where the foreign parent company is ultimately controlled by Chinese. Many of the overseas listed companies have Chinese control of the offshore company, either through stock ownership, dual class share structures, or special control arrangements. MNCs operating in restricted sectors would not be able to restructure to be controlled by Chinese, and face a possible ban from China.

The new MIIT rule provides an escape valve. It appears limited to companies operating in online data processing and transaction processing (operating e-commerce). It is unclear to me how far that definition will stretch.

Many foreign multinationals operate in China through the VIE structure. Only a few have disclosed this fact, since disclosure is only required when the VIE operations are material to the company as a whole. Amazon, CBS, and Pearson Education have disclosed the existence of Chinese VIEs. The new rule seems to help Amazon, and it is less clear whether CBS or Pearson Education will be able to take advantage of it.

The law might also be used by some of the overseas listed Chinese companies that will have difficulty complying with the new foreign investment law. Tencent cannot put in place the control structure required because the Hong Kong Stock Exchange does not allow it. Ctrip does not have a dual class share structure or sufficient Chinese ownership to demonstrate Chinese control, and the new rule might provide an out for them.

It is also unclear as to which businesses will qualify for the new rule. Such is the nature of Chinese regulation; implementation details will take some time, even though the new rule is already effective.

Many overseas listed Chinese companies are in the process of going private from the US exchanges with the intent to relist on China’s frothy boards. I believe this trend is less motivated by changes in VIE rules than the high valuations currently available on Chinese exchanges.

Copyright 2015 Paul L. Gillis all rights reserved