I am pleased to turn the blog over to Fredrik Öqvist for this post. Fredrik was an exchange student from Sweden at Peking University last year and, like many exchange students (and more than a few readers I bet), he has stayed on in Beijing. Anyone who needs a good VIE analyst can drop Fredrik a note at: freppas@gmail.com.
Paul Gillis
In this post I will present statistics about the usage of variable interest entities (VIEs) by US-listed Chinese companies. In preparing this information, I have reviewed the annual SEC filings of 230 Chinese companies listed on the NYSE, NASDAQ and the ASE. I have not included any OTCBB companies in this analysis, although many of these companies also use the VIE structure.
Table 1 illustrates that 42% of U.S. listed Chinese companies use the VIE structure. The VIE structure is used by more than half of NASDAQ listed companies, with fewer companies on the NYSE and ASE using this structure.
A separate analysis of 2010 listings indicates that the use of VIEs is increasing. 47% of 2010 NYSE listings (9 of 19) used VIEs, while 65% (10 of 16) of 2010 NASDAQ listings used VIEs.
Table 2 breaks down the usage of VIEs by industry, using two digit Standard Industry Classification (SIC) codes. VIEs are used in a broad range of industries, yet they are highly concentrated in Business Services, hardly surprising since this code includes internet companies.
The use of the VIE structure is most apparent in industries that have restricted foreign investment. This makes sense, since the VIE structure was invented to address the restrictions on foreign investment in the internet sector, but its use has spread to include companies in other industries that are restricted to foreign investment, such as education, financial services and real estate.
I examined the annual filings for the companies using a VIE structure to determine whether they explained why the VIE was used. Chinese prohibition against foreign investment in the sector is the primary reason given. Five companies, including four listed in 2010, cited restrictions on Chinese companies listing abroad as a reason for the use of VIEs. This indicates that Chinese companies are increasingly using the VIE structure to get around recent rules restricting offshore listings. Also, a surprisingly large number of companies failed to give any reason for their structure in the annual reports.
I also examined how companies using the VIE structure disclosed the risk that is associated with the structure. Of companies with VIE structures, 81% (79 of 97) refer to a legal opinion that concludes that the VIE agreements are enforceable under Chinese law. Of those reporting a legal opinion, 71% (56 of 79) report that there is substantial uncertainty about how Chinese courts and regulators might view the agreements. None have a going concern qualification related to this uncertainty in the auditors opinion on their financial statements.
Fredrik Öqvist
p.s. Over at the China Hearsay blog, lawyer Stan Abrams has written an amusing and informative screen play about VIEs.
Also in this series:
Emperor's new suit: VIEs in China
PRC challenge to VIE structures