Archive for September, 2011

So the much talked about CSRC paper is finally available for public viewing, albeit through a leak.

Had a quick glance at it and it seems to be pretty much what was reported on. iChinastock has a good run-down of the basics of it, I’ll just be adding some quick comments afterwards:

The report describes Variable Interest Entities (VIEs) as a major threat to China’s national security, but does not suggest that China’s top leaders ban the structure.

iChinaStock has translated four key reforms proposed in CSRC’s report:

1) Chinese companies under the VIE structure must receive approval from by both the Ministry of Commerce (MOC) and CSRC to list overseas.
2) Old rules for old companies (those already listed overseas) and new rules for new companies (those not yet listed overseas). In other words, firms that are already listed overseas would be exempt.
3) Encourage Chinese Internet companies to list on the domestic market.
4) A few companies that have reasons and desires to list overseas, such as the internet companies that are temporarily unable to list domestically, should be able to list directly in foreign markets. Note: the meaning of this “direct listing” is still unclear.

One aspect not mentioned here is that the report also presents foreign ownership as bad for the industry, due to the potential of equity draining from China. The flip side of this is of course that it was foreign investors that helped the companies and the sector grow when it needed capital. One of the biggest issues that still plagues this sector in China is a lack of good financing options available, especially if the VIE window is closed.

Second, you will find an interesting proposal to collaborate with the SEC, and other foreign equivalents, regarding the enforcement of these issues. The basics would likely be that the SEC should check any VIEs being reported on their end with Chinese authorities, this would enable both sides to keep the situation under control.

Apart from these two points the iChinastock article seems pretty bang on to me. So let’s move on to some comments.

There are a couple of things I find rather interesting about this proposal, for instance if we assume that the internet companies allowed to list on foreign markets is likely to be quite few, otherwise why not just declare it an unprotected sector, then there will need to be plenty of action domestically to provide new financing options. If this doesn’t happen the companies which are already listed overseas will have a huge advantage in their access to capital, which would solidify them as the big players for the foreseeable future.

Another interesting thing to consider is what isn’t dealt with in this paper. It doesn’t touch on the current MIIT and GAPP issues, nor does it spell out what should happen regarding the enforceability of the contracts. It seems we could be heading for a rather strange situation where the government will “give the VIEs its blessing”, but still leave the issue of enforceability of the relevant contracts up in the air.

Above all else, the big question seems to be what is meant by allowing some companies to list directly. Allowing some of these companies to list with direct equity ownership would require changing a multitude of laws and edicts, so if this is the plan it’ll certainly be hard to implement.

Let’s not get too carried away here however. We are talking about a leaked research report from the CSRC, not only is it not, as far as we know, officially endorsed by the CSRC, the CSRC is far from the only ministry that would have to sign off on something like this.

It also bears mentioning that even with the government promising to stay out of the listed VIEs, they still aren’t as safe as equity ownership. GigaMedia didn’t need any government intervention to loose its’ China operations.

Other posts on this subject can be found at the China Accounting Blog and China Hearsay.


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Speculation is currently rife regarding the future of VIEs in China, and it seems at first glance as if there are two camps emerging, the tech companies saying the government supports the structure, and the lawyers saying more and stricter regulation is coming.

In the first camp we meet Xie Wen, former head of Yahoo! in China who says that for from banning VIEs the government is in support of them.

Xie said in his Sina Weibo today that Wang Qishan, China’s vice minister, has noted in official documents that the government should admit the legitimacy of the VIEs company structure and take it under current regulation. He also said the Ministry of Commerce (MOC) has issued a regulation basing on Wang’s attitude.

The second camp is reported in Reuters saying more and tighter regulations are coming, this is based on reports from four law firms, who have seen a letter from the CSRC to China’s State Council asking for more regulation.

The move by the CSRC is apparently driven in response to the raft of fraud cases seen recently at Chinese companies listed in North America, many of which used the VIE structure. The CSRC has repeatedly stated that it often has no jurisdiction over these companies, which tend to be incorporated offshore, but the wider impact of the scandals on investor sentiment to China is putting them under pressure to act.

So, who’s right and who is wrong?

While all players on this market are likely to have their own agendas, and perhaps most importantly both of these articles are in fact hearsay only, are the two views really incompatible? I don’t think they are.

The fact of the matter is that while we talk about VIE structures as a group the differences between the structures and the companies in this group can be very vast.

If the government is going to legitimise VIE structures as Xie Wen suggests I doubt this would encompass all current structures. More likely they will legitimise the properly set up ones in certain restricted industries (perhaps accomplished by having a process for approving them). But as for the VIEs which have been set up to avoid M&A regulations and SAFE approvals, the thing that the CSRC is likely to take issue with, I doubt they would be included in such a drive.

Either way, with this level of uncertainty regarding the future availability of a listing to exit investments I wouldn’t be surprised to see a surge of VIE companies pushing through IPOs or RTOs regardless of market conditions in the near future.

For more on the issue check out Stan Abrams on China Hearsay, where you will find a good article regarding the potential crackdown on VIEs.

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