A Study On VIEs' Options Under The Proposed Foreign Investment Law

Variable Interest Entity(VIE)is a business structure often used by Chinese Enterprises with an intention of listing abroad.The contractual arrangements under this structure enables the overseas Listed Company(ListCo)to enjoy an actual control over the Operating Company(OpCo)within China's jurisdiction without owning the latter's equity.The VIE in China is largely a joint product of the difficulties in fundraising for private business in China and the rigid foreign investment restrictions.As VIE allows companies to circumvent China's regulatory restrictions on entities with foreign equity ownership,VIE have become a favored option for Chinese enterprises with a plan of listing overseas.However,according to a draft unveiled by the Ministry of Commerce in 2015,China's Foreign Investment Law is likely to close the loophole.Under the new law,VIEs shall be regarded as "foreign investment" based on the fact that VIEs' actual controllers-the Listed Companies are foreign entities.The VIEs may,thus,been denied their access to operate in industries where foreign investment is forbidden or restricted.In anticipation of such fundamental regulatory changes,the VIEs are mulling over the two options,namely,going private,terminating the VIE arrangements and relisting in China's stock market or maintaining the status quo,counting on the possible grandfathering clauses and the ease of access for foreign investment under the new law.Considering the sheer volume of enterprises with VIE arrangements,and the influence they wield on China's burgeoning technology industry and on the portfolio of international investors,studying the VIEs' options and risks against this new backdrop is of great academic and practical importance.This paper aims to shed lights on enterprises' reasons and risks behind deactivating the VIE or keeping the status quo and it provides advices for businesses in terms of mitigating the risks and adapting to the new regulatory environment.The paper is comprised of five chapters:The first chapter serves as an introduction,providing the research's background and its significance as well as a review of the previous research on VIE.The second chapter after providing a breakdown of the VIE structure,explores why businesses employed this arrangement.It,then,elaborates the major implications which the Proposed Foreign Investment Law will have on VIEs:a uniform regulatory environment;being deemed as "foreign investment";and,for VIEs operating outside the industries named on the "Negative List",receiving national treatment.The third chapter explores Alibaba's reasons for keeping its VIEs:the trust on the validity of the contractual arrangements,the appeals of listing in a well-developed capital market,and the expectation of increasing access for foreign investors in China.After that,the chapter dissects the risks behind maintaining the status quo:losing the VIEs' licenses to operate in certain industry,the structural weakness in VIEs' corporate governance which is prone to moral hazards,breach of the contracts,and crisis of confidence among the parties.An argument is made that the risk of losing business licenses should be given greater attention as its emergence can be a catalyst for other risk events.The chapter also illustrates solutions,which shall help businesses to mitigate the risks,namely,improving corporate governance,and utilizing the grandfathering clauses in the law.The fourth chapter focuses on Qihoo 360's case of dismantling VIE and relisting in China,analyzing the company's motivations behind the decision:the necessity of being a domestically owned entity for operating in certain industries,higher valuation in China's stock market and positive developments in China's reform of its capital market.Besides,the chapter analyzes the risks of this move:the company's over-leveraging due to the high cost of privatization,the possibility of disputing with shareholders during privatization,the increasing tax burden,the difficulties in complying with China's capital restrictions and the hurdles of listing in China.Meanwhile,the chapter also studies on the measures adopted by Qihoo 360 in response to those challenges during the process.The last chapter in this paper provides a comparison on the major risks of the two options and identifies three factors which should help VIEs to find the optimal option:the nature of the industry they operate,the location of their market base,and the costs and returns arising from the dismantling.The chapter,then,reinforces the importance for VIEs to choose an option contributive to their future business development and to identify and control the risks of that option.The paper also suggests regulators to adopt a cautious approach on the treatment of existing VIEs and advises new legislations to ease China's foreign investment restriction and increase financial accesses for private business to cultivate a favorable environment for the phasing-out of VIEs.