Foreign policy

Alibaba puts VIEs in spotlight

Who is in control? It is a subject which has taxed Chinese government officials ever since the founder of the Han Dynasty died in 195 BC. Who should officials heed – Emperor Gaozu’s son, Emperor Huidi, sitting before them on the Dragon Throne, or Gaozu’s widow, whom they could hear murmuring behind him, hidden from view by a silk screen?

The woman in question was the Dowager Empress Lu and though forbidden from inheriting the throne herself, she used her son as a front to wield absolute power. She was the first of many female regents to do so.

Modern day government officials have been similarly vexed trying to ascertain whether foreigners are the real owners of companies in supposedly restricted areas of the economy – such as the internet, media and education. At issue is the use of so-called variable interest entity (VIE) structures. Companies have been using them for over a decade to bypass foreign investment laws.

According to Huxiu.com, nearly 300 US-listed Chinese firms have deployed VIE structures to raise capital offshore. The controversy came to a head last autumn when Alibaba brought to market its mammoth $25 billion IPO. Topping investors’ concerns was the fact they were not actually going to own the Chinese operating company. In place of the standard parent-subsidiary relationship was a series of contractual agreements between a mainland China-domiciled operating company and a publicly-listed Cayman Islands entity. This enabled the former to hold all the necessary domestic licences and permits (which foreigners are excluded from owning) while the latter could reap all the profits through the contractual ties between the two.

But what would happen if the operating unit decided to renege on one of the contracts? Would they still be enforceable under Chinese law?

Last week the Chinese government indicated a new willingness to settle the matter. In a move that has been hailed as one of its biggest shake-ups in corporate operating practices for decades, the Ministry of Commerce announced plans to integrate three different foreign investment laws.

According to the Wall Street Journal: “Under the new draft rules, foreign investment through VIEs would be allowed – as long as the companies could show that Chinese people or entities wield ‘actual control’ over the business. That certainty could be comforting to foreign investors.”

Defining control is clearly the billion-dollar question. As Fudan University law professor Gong Baihua tells The Paper (an internet newspaper backed by the Shanghai government), the guidelines do not yet define the criteria. “Is it more than a 50% stake, or the majority of the equity?” he queries.

The issue is of particular concern to companies like Sina Corp because nearly all of its shares are in freefloat. Under US law, public shareholders control the two internet firms.

The Wall Street Journal added: “One solution might be the kind of management structure used by Alibaba, which maintains Chinese control by giving the power to nominate the majority of its directors to a small group of Chinese managers.

“During a Ministry of Commerce briefing for foreign business representatives last week, Huang Feng, deputy director of the ministry’s foreign investment administration, cited Alibaba as an example of a company that would benefit from the new VIE rules, according to someone who attended the briefing.”

That sort of ‘control’ criteria might see Chinese internet tycoons try to establish more voting power, perhaps through introducing dual share structures.

Local newspapers say the Ministry of Commerce will take feedback on the proposed VIE regulations until mid-February. They are likely to become law early next year. The intent looks to be to offer foreign investors more certainty that they will enjoy the economic benefits of their stake; with the trade-off that absolute control over decisionmaking will reside with a trusted Chinese party.

In ancient China, Empress Lu chose far more brutal methods to demonstrate that she was in control. Worried about the influence of her dead husband’s favourite concubine, she had her rival’s arms and legs amputated, ears and tongue sliced off and eyes gouged out. Empress Lu kept her alive in a latrine pot, calling her the “human swine”. When Emperor Huidi realised who it was, he was so sick of his mother’s cruelty that he relinquished his authority, largely withdrawing from public life.

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