In this post I’m back onto the subject of VIEs, or more specifically VIE disclosures. Previously I’ve focused on US-listed companies using VIEs, this is not only because many of the bigger companies using VIEs are listed there, it’s also because of the sometimes lacking disclosure we find on other exchanges.
Professor Gillis had a good post on this earlier where he discussed the disclosures we find in Hong Kong, with many companies reporting VIEs as wholly-owned subsidiaries without any added information to guide investors. The standard statement for this reads:
The consolidated financial statements incorporate the financial statements of the Company and entities controlled by the Company (its subsidiaries). Control is achieved where the Company has the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.
This is something of a weakness that’s available for companies under IFRS, and it is severely inhibiting investors from gaining a proper understanding of the risks involved in their investments. The lack of information can easily lead to investors not properly examining the company’s VIE structure, it’s also entirely possible for even professional investors to completely miss the fact that a VIE structure is in use.
I would like to add to Professor Gillis’ statement regarding the dangers present in Hong Kong and draw attention to the fact that this also goes for other exchanges operating under IFRS. Most notably, perhaps, Singapore and London.
Needless to say, investors on these exchanges looking at Chinese stocks will have to be extra careful when researching new investments, and looking over the old ones might not be a bad idea. The potential economic downside to missing a VIE structure, or even not seeing the entire picture could be massive, as we’ve seen in recent times.
I personally believe that anyone investing in a VIE structure needs to do extra due diligence to map out the possible effects it might have, and what the company has done to mitigate risks and plan for worst-case scenarios. This need is only amplified by the current lack of information normally provided under IFRS.
As there is sometimes no disclosure, investors have few options other than even more extensive DD for finding out how well planned these structures are, and it would certainly be much easier to hide an ill-made VIE structure under these circumstances.