Narrowing an IPO loophole may be Beijing’s latest effort to wean firms off foreign capital—even if it sacrifices future growth
On Wednesday, China’s securities regulator poured cold water on a Bloomberg scoop that Beijing plans to close a decades-old legal loophole used by hundreds of Chinese tech companies to sell billions of dollars worth of stock on overseas exchanges.
On Tuesday, Bloomberg, citing anonymous sources, reported that Beijing will ban Chinese firms from establishing offshore corporate structures known as “variable interest entities” (VIEs), thereby eliminating a legal workaround that has enabled Chinese companies like Alibaba Group Holding, Tencent Holdings, and Didi Global to sidestep domestic restrictions on foreign ownership of Chinese companies in e-commerce, ride-hailing, online gaming, and a host of other sectors Beijing deems vital to the national interest.
But the China Securities Regulatory Commission today dismissed the Bloomberg report. “We have noticed the reports,” the agency said in a statement published on its website. “This news is not true.”
The brevity of the CSRC’s denial left global investors scratching their heads. The Bloomberg report claimed the ban is “among changes included in a new draft of China’s overseas listing rules” and could be finalized as soon as this month. The report suggested companies already listed in the U.S. and Hong Kong via VIEs would be able to keep existing ownership structures in place but would “need to make adjustments” to render them more transparent to regulators.
Was none of that true? Some of it? Markets were left to wonder.
A VIE ban would be a big deal, significantly escalating Beijing’s year-long campaign to tighten its grip on China’s largest Internet companies and curb other manifestations of what President Xi Jinping has deplored as “disorderly capital.”
The idea of using VIEs to end-run Chinese restrictions on foreign investment was hatched by Sina Corp and its investment bankers in 2000. In essence, the strategy involves setting up an offshore shell company, typically in the Cayman Islands or the British Virgin Islands. Foreign investors purchase a stake in the shell company, which strikes an agreement with the Chinese company entitling the former to a share of the latter’s revenues. In theory, the arrangement grants foreign investors an indirect claim on the Chinese company’s earnings without violating the letter of Chinese law by granting them a direct ownership stake.
But the arrangement has always had one enormous caveat: Chinese regulators never explicitly endorsed the VIE structure as legal. Then again, neither did they come right out and oppose it. And so over the past decade, with the sword of a possible ban dangling over their heads, foreign investors have forked over more than $80 billion for shares of nearly 300 Chinese companies employing the VIE gambit—generating billions of dollars in listing fees for Wall Street investment banks in the bargain.
Is the sword now about to fall? The Bloomberg report suggests Beijing isn’t contemplating a total ban on variable interest entities. Rather, it states that companies using the VIE structure would still be allowed to list in Hong Kong “subject to regulatory approval.”
The report, which has been updated to acknowledge the CSRC disclaimer, is worded in a way that seems to imply that what the agency is denying is a universal ban—without disputing that the proposal will put a halt to VIEs for companies seeking to go public on U.S. exchanges.
The VIE kerfuffle is one of a host of matters in which Beijing seems to be signaling that it is willing—perhaps even eager—to wean Chinese firms off their dependence on foreign capital. Chinese leaders have demonstrated almost complete indifference to the fact that the past year’s regulatory blitz has wiped out more than $1.5 trillion dollars in the market capitalization of Chinese companies. Meanwhile, finance regulators seem to have few qualms about the prospect that foreign bondholders will be the biggest—and perhaps only—losers in the event of a default by one of the nation’s troubled property developers.
Investment strategist Russell Napier makes the case in today’s Financial Times that China is more dependent on foreign portfolio investment than ever. He argues that, while “the consensus among professional investors is that foreign ownership of Chinese portfolio assets can only continue to rise,” that’s no longer a foregone conclusion.
China’s leaders may discover to their dismay that enticing foreign investment is, instead, an equation with many tricky “variables.”
More Eastworld news below.
This edition of Eastworld was curated and produced by Grady McGregor. Reach him at email@example.com.
On Thursday, Steve Simon, CEO of the Women’s Tennis Association (WTA), announced that the WTA will pull out of its tournaments in mainland China and Hong Kong over the Chinese government’s treatment of tennis star Peng Shuai. Early last month, Peng accused former top government official Zhang Gaoli of sexual assault, but her initial post and discussions of her accusations have since been scrubbed from the Chinese Internet. Simon says failure to investigate her claims and ongoing concerns about Peng’s safety and freedom pushed the WTA to leave China—a sacrifice that few foreign businesses have been willing to make. Fortune
The European Centre for Constitutional and Human Rights, a non-profit advocacy group, is suing apparel brands like Nike, Patagonia, and C&A in the Netherlands of profiting off the alleged use of forced labor in China’s western Xinjiang province. The ECCHR argues that through using Chinese suppliers the firms are violating Dutch forced labor law, and previously raised similar lawsuits in France and Germany. C&A denied it sourced fabrics from Xinjiang to the SCMP, while Nike and Patagonia did not respond to the SCMP’s request for comment. SCMP
India was set to fully resume international flights on Dec. 15, ending a 21-month ban on most foreign arrivals in a potential boon to the country's struggling tourism sector. But this week India's aviation regulator announced it will postpone its full reopening—India currently allows fully vaccinated citizens and select foreign nationals to enter its borders from 28 countries—due to the emergence of the Omicron variant although the country has yet to detect any cases. The decision has flummoxed tourist operators. “There is no medical logic that says I can allow some flights to come but not others. So why not allow all flights to come with the same protocols?” Rajeev Kohli, managing director at Creative Travel, tells Fortune.
On Thursday, the Japanese government said it withdrew its request for airlines to stop taking reservations for inbound travelers, reversing one of the world’s strictest travel bans put in place to stop the spread of the new Omicron variant of COVID-19. The World Health Organization has urged countries not to impose blanket travel bans, and Prime Minister Fumio Kishida said Japan reversed its decision amid criticism that Japanese citizens would not be able to travel home. Nikkei Asia
Markets and movers
Kaisa – The Chinese property developer is undergoing a firesale of its assets as it attempts to meet a $400 million bond payment deadline by Dec. 7. Offshore bondholders rejected a proposal this week to extend the maturity of its debt, which could deepen a crisis at the indebted firm.
Canada Goose – The Canadian down jacket maker is under fire in China after a customer’s complaints about Canada Goose’s no-refund policy went viral on Chinese social media. On Thursday, China’s top consumer protection organization warned it against bullying customers in China over its no-refund policy.
Grab IPO – The southeast Asian ridehailer, food delivery app, and mobile payments firm will make its stock market debut on the Nasdaq on Thursday via a merger with Altimiter Growth, a SPAC already listed on the exchange. The SPAC-IPO raised proceeds of $4.5 billion and Altimiter says it expects Grab’s valuation to hit $40 billion.
Cloud Village – The music streaming unit of gaming giant Netease raised $442 million in its IPO in Hong Kong on Thursday at a valuation of $5.84 billion. Cloud Village is Chinese tech giant Tencent’s top music rival in China with a 20.5% share of China’s music streaming market compared to Tencent Music’s 72.8%.
Meta — The owner of social media giant Facebook removed 500 accounts linked to an online disinformation network largely based in China. The accounts promoted claims of a fake Swiss biologist called “Wilson Edwards,” whose criticisms of the U.S. government were often promoted by Chinese state-owned media platforms.
Serum Institute of India – The Indian vaccine maker sent its first doses of Novavax’s COVID-19 vaccine to Indonesia, India’s government announced Wednesday. The Serum Institute is producing the U.S. pharmaceutical firm’s protein-based vaccine, but Indonesia and the Philippines are the only countries to approve the jab so far.
Sensetime – The Chinese artificial intelligence and facial recognition firm is running into problems with a flagship casino project. Genting’s Resorts World Sentosa hired Sensetime to build out a comprehensive surveillance system using A.I. technology to prevent fraud, but sources tell the Financial Times that SenseTime’s system has run into a range of technical hitches. Sensetime declined to comment on the matter.
Uber – The U.S. ridehailer will soon allow users in India to book trips via messaging service WhatsApp, Uber announced on Thursday.
South Korean inflation surged at the fastest pace in nearly a decade, with consumer prices rising 3.7% in November compared to one year ago, according to the Bank of Korea. The figure beat analyst expectations of 3.1%, with analysts attributing the surge to rising oil and food prices. Ongoing global supply chain disruptions are considered a root cause of the rising commodity prices. But consumer demand is also surging in South Korea after the country recently relaxed some social distancing curbs.
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