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Part 1 | 'Owning Chinese Companies Is Complicated'

Bloomberg

Malcolm Riddell

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CHINADebate

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Matt Levine | Bloomberg

Part 1 | 'Owning Chinese Companies Is Complicated'
Part 1 | 'Owning Chinese Companies Is Complicated'
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Interview
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VIEs
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Interview

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VIEs
3

VIEs

3

BIG IDEA | ‘ “Variable interest entities”(VIEs): The problem with this is that it sort of sounds like you’re kidding. But this is a standard method for mainland Chinese internet companies to go public, and the market has come to accept it.’

‘Under Chinese law, it is somewhere between “complicated” and “forbidden” for foreigners to own certain big important Chinese tech companies.’

  • ‘This is a problem for those companies if they want to raise capital from foreign investors and list their stocks on foreign stock exchanges.’
  • ‘But there is a solution: ‘ “Variable interest entities”(VIEs).’

‘The VIE framework has never been formally endorsed by Beijing.’

  • ‘It has nevertheless enabled Chinese companies to sidestep restrictions on foreign investment in sensitive sectors including the Internet industry.’

‘Pioneered by Sina Corp. and its investment bankers during a 2000 initial public offering, the structure allows a Chinese firm to transfer profits to an offshore entity - registered in places like the Cayman Islands or the British Virgin Islands -- with shares that foreign investors can then own,’

  • Here’s how it works:

‘ “Ownership” of a company is a complicated notion, a vague jumble of rights to elect directors and approve mergers and claim a residual interest in the company’s cash flows.’

  • ‘You could break those things up and sell them separately.’
  • ‘Write some contracts that, bundled together, look like ownership, but aren’t ownership.’

‘Write a contract that says:’

  • ‘ “A will pay B all of A’s profits after expenses for the next 100 years, renewable at B’s option,” and hey that’s a profit-sharing contract, residual claim on cash flows.’
  • ‘ “B will provide management services to A and A will follow B’s instructions,” hey that’s basically control.’
  • ‘ “B will have the right to appoint a majority of A’s board of directors,” put it in a contract, it’s not actually stock ownership. Etc.'
  • 'With Chinese companies this sort of thing is generally called a “variable interest entity.” ’

‘You set up a company in the Cayman Islands that can be owned by anyone.’

  • ‘The Caymans company enters into a series of contracts with the local Chinese company, giving it, not ownership, but certain carefully curated economic interests and control rights over the Chinese company.’

Then you list the Caymans company in the U.S.,’

  • ‘And people buy its stock, and they sort of pretend that they’re buying stock in the Chinese company — they sort of pretend that the Chinese company is a subsidiary of the Caymans holding company — even though really they’re only buying an empty shell that has certain contractual relationships with the Chinese company.’

The problem with this is that it sort of sounds like you’re kidding.’

  • ‘But this is a standard method for mainland Chinese internet companies to go public, and the market has come to accept it.’
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