China has announced new rules that reduce restrictions on foreign investments, for example in the internet. The traditional way to avoid those restrictions, VIE´s via Cayman islands and others, will be phased out fast, writes accounting professor Paul Gillis at his weblog.
Steve Dickinson of the China Law Blog says that the proposed rules mean China VIEs are Dead and I Told You So. I think he is right that VIEs are dead. I believe that regulators are going to stop looking the other way on VIEs as they have for the last 15 years.
For many of China’s internet companies and their investors, this is good news. They have been carrying the VIE structure around their necks like a millstone. Besides scaring off investors, VIEs proved to be an inefficient structure that made it difficult to manage taxes and move money around the group. While companies under Chinese control might continue to use existing VIE arrange-ments, I expect most will dump them, preferring instead to operate in wholly owned subsidiaries (WFOE). That will be a big win for shareholders, since they will finally own the assets that they think they own.
There are a number of Chinese internet companies where the Cayman Islands parent company does not have the type of corporate governance arrangement that fits the proposed law. Hong Kong listed Tencent is one, since Hong Kong does not allow arrangements that keep founders in control. I expect these companies will restructure to meet the requirements of the proposed law, or will seek special permission to have foreign control.
Some multinationals have used the VIE structure, and for them the future may be bleak. Some foreign companies, like Amazon and Pearson, have used VIEs to circumvent foreign investment restrictions. I have heard of a few situations where VIEs were used to circumvent investment approvals and to avoid taxes. The future for multinationals that are using the VIE is likely bleak. Steve Dickenson says that these VIEs will be required to either shut down or transfer their assets to Chinese entities. Those Chinese entities will have to be Chinese controlled, which likely leads to Chinese operations being deconsolid-ated. The various US chambers of Commerce have asked China to provide a 25-year grace period for existing VIEs or to grandfather them completely. I think that request will be ignored in the final law. This is a great opportunity for China to bring the internet more completely under Chinese control, and to favor Chinese companies in the process. I don’t see them passing it up.
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