#TBCInsider #VIEs #Investment
Ahhh, VIEs. You thought the last word had been uttered on these squishy, slippery things, but alas, that isn’t the case. I’m not one of those people who have been proclaiming the death of the VIE — but I’m also not as optimistic as the lawyers I’ve spoken to who make their living on VIEs and cling onto the status quo. “The government will never do anything about it,” they say, “deaths of the VIE come around every few years and it’s never been overturned.” It’s thus perfectly safe, they reason. But is it really? Let’s look at what the new rules actually say:
- On December 24, 2021, CSRC and State Council came out with two documents:?
- CSRC:?Administrative Measures for the Recordation of Overseas Issuance of Securities and Listing by Domestic Enterprises (in Chinese), a draft document out for comment that formalizes the process by which Chinese companies must seek parallel permission from the CSRC before listing overseas. Specifically, they are to hand in materials to the CSRC within 3 working days of publicly applying for an overseas IPO, including?applicable opinions, filings or approvals by industry authorities.?This doesn’t just include initial public offerings but other securities offerings, including issuances for purchasing other assets. Assuming materials are complete, CSRC is to give a response within 20 working days and publish the results thereof on its website.
- State Council:?Administrative Provisions of the State Council on the Overseas Issuance and Listing of Securities by Domestic Enterprises (in Chinese), also a draft document out for comment. While the above document is about?process, this document outlines (albeit somewhat vaguely) which types of companies are actually allowed to apply for listing overseas. Here are the prohibited enterprises:?
- Explicitly prohibited by law
- Threatens or endangers national security
- Significant disputes in equity, assets, core technologies
- Controlling interests have had corruption, bribery, etc. other criminal offenses within the last 3 years or have other investigations ongoing
- Directors, supervisors or senior management have been punished or are currently under investigation for crimes
- Other (clearly a catch-all for anything else they haven’t thought of)
- Once you do list overseas, you still have to comply with national security laws, and furthermore, any securities firms involved in the transaction later to be found lacking in due diligence or engaging in fraud will be fined or prohibited from undertaking future business.
- On the same day, CSRC said officially that domestic companies with VIE structures?can list overseas?as long as they comply with related requirements.?This is not listed anywhere in the draft documents but instead put forward in an “answering the press”?article?published on the CSRC website.
I’m no legal expert but just taking the documents at face value, it is pretty clear that while the regulators left the door open, so to speak, for domestic companies, including VIEs, to list abroad via what seems to be a clearly articulated process,?they left in plenty of uncertainty regarding how wide this opening really is.?An actual legal expert, Mr. Li of Dentons, thought much more pessimistically and detailed it in this?opinion piece?on his Weibo account, which was subsequently?re-published?by Caixin. The crux of his argument goes thusly:
- CSRC does not control the VIE structure or any of the restrictions that may pertain to it — that is the responsibility of the NDRC and MOFCOM. They only control the process of listing. Thus all they can say is that listings are not banned,?provided you collect approvals from all relevant industry authorities.?This is as far as they can go, but what does it actually promise? Nothing, really.
- As we know, the NDRC regularly updates its list of industries that prohibit or restrict foreign investment. (The?latest?was released on December 28, 2021.) In Section 6, the NDRC said a variation of the same thing as the CSRC:?
- Domestic enterprises engaged in businesses in areas prohibited by the by this list that issue shares overseas and are listed for trading?shall be reviewed and approved by the relevant competent authorities of the state. There are two restrictions: that foreign investors cannot exceed the equity ownership restrictions and cannot be involved in operations, but that’s it.?Again, the ultimate responsibility is kicked down to the “relevant state authority” level.
- Furthermore, it can be interpreted that this “open door” from the NDRC is really directed towards H-shares (domestic companies looking to list in Hong Kong) and not VIEs. This is because the approval talked about here is only granted at listing time, not at fundraising time, which makes a lot more sense for H-shares than VIEs.?
- That is, the greenlight for foreign capital is at the IPO stage, but nowhere does it say it is OK before then. This is important to distinguish because a large draw of VIEs in the past was the ability to list abroad, but now that you can list abroad with a domestic structure, as long as you have the necessary approvals,?then the only advantage of VIEs is to fundraise foreign capital before listing, which may or may not be necessary, in today’s market conditions.
- Supposing you do go the way of VIEs for fundraising USD or other currencies though, you will then run the risk of?not getting approval from the relevant industry authorities to list abroad.?Because there is no clear legal basis for them to approve (assuming you were using VIEs to skirt foreign investment restrictions), it is really impossible to predict what will happen. Certainly no lawyer should be issuing opinions at fundraising rounds guaranteeing future IPO approval. You see, prior to these rules, the uncertainty around VIEs were about whether or not the Chinese government would somehow render them illegal. The new regulations don’t exactly answer that question but instead poses a?new one, but only one that can be?answered at IPO. Is that really better??Or it’s just a different kind of risk??
- In a long?cover story?from Caixin, a more optimistic legal opinion from Hankun, a large law firm in China, thinks that a 70% domestic ownership at the time of IPO will be sufficient to secure approval, based on their interpretation of the spirit of the regulations. But does that really make sense when the listing itself will inevitably introduce more foreign ownership? They don’t have an answer for this, which shows you just how ambiguous everything actually is.
- I still subscribe to the belief that whether or not VIEs are truly “safe” vehicles to invest in is going to, in at least some part, depend on factors that have nothing to do with legal arguments, and is going to be all about US-China relations. Unfortunately, that is a dynamic, unpredictable situation. So while I can understand the interpretation of the newest rules as being “favorable” to VIEs, I think it would be irresponsible to point out that they in fact?actually guarantee nothing.
Pretty much every year for the last ten years, lawyers, analysts and experts have been predicting that a new structure will eventually replace the VIE, and that the Chinese government will have to clarify its stance instead of keeping mum. Well, in this case, they managed to calm investors down emotionally without actually committing to anything. Brilliant, eh? Maybe that’s the best policy for now, I don’t know. Pass the hot potato and worry about it later. Don’t close the door entirely, but definitely don’t leave it wide open either. What are you thinking?
- Do these rules apply to companies who’ve already publicly filed for IPO abroad? Unclear.
- These rules are still draft, when will they come into effect? Comments are open through 1/22, so it’s possible the final draft will be clearer, but I’m not holding out hope, mainly because of the CSRC’s limited scope in this matter as discussed above.