What is a VIE? The structure uses two entities. The first is a shell company based somewhere outside China, usually the Cayman Islands. The other is a Chinese company that has the necessary licenses to do business in the country. The two entities are linked through a series of contracts.
When foreign investors buy shares in a company that uses VIE, they are buying stock in a foreign shell company — not a business in China.
Didi Global does not own a business in China that connects riders to drivers. But it does have contracts that entitle its shareholders to the economic benefits produced by that business.
The result: When Americans fire up their trading app and buy shares in Didi, they are not getting a direct equity stake in the Chinese company. This arrangement is explained in Didi’s prospectus, but not everyone is aware of it. Alibaba, Pinduoduo and JD.com also use VIE, to name a few.
Why use VIE?
Chinese companies have been using the structure for decades because foreign investors are not allowed to hold stakes in local firms in industries including technology. Still, Chinese companies want to raise money overseas.
Creating an offshore holding company to go public helps Chinese companies get around those rules. Wall Street and US regulators have long been quiet about the arrangement, which gives US investors easy exposure to the dynamic companies that power the world’s second-largest economy.
But there are big risks. First, it is unclear whether contracts that entitle foreign investors to economic profits produced by Chinese companies are enforceable. It is also unclear whether VIEs are legal under Chinese law.
Here’s what Didi says about the system: Didi says in her prospectus that her legal counsel believes that her VIE “does not violate the mandatory provisions of the applicable PRC. [Chinese] law,” and its contracts are “valid and binding.”
But it also included a warning for potential investors.
Didi warned, “We have been further advised by our PRC legal advisor that there are substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations.” “The PRC Government may ultimately consider the contrary to the opinion of our PRC Legal Adviser.”
Think of the problem this way: Chinese companies are essentially telling Beijing that they are 100% owned by Chinese citizens. Meanwhile, the same companies are telling foreign shareholders that they are the real owners.
After decades of both Chinese and US regulators taking a relaxed approach, there are signs that both are becoming uncomfortable with VIE.
“I worry that average investors may not realize that they hold stock in a shell company rather than a China-based operating company,” he said.
One of the new SEC provisions would require Chinese companies to disclose “whether the operating company and issuer, when applicable, received or were denied permission from Chinese authorities to list on US exchanges.”
This provision appears to be aimed at Didi. Just days after its big IPO, Chinese regulators targeted the company with a cybersecurity probe after it reportedly went ahead with the listing despite Beijing’s objections.
“I believe these changes will enhance the overall quality of disclosure in registration details of offshore issuers that have relationships with China-based operating companies,” Gensler said.
China is also keeping a close watch on overseas listings. China’s powerful cyberspace administration proposed in July that any company with data from more than one million users would have to seek agency approval before listing its shares overseas.
Investors, beware.
Reaching Biden’s Electric Vehicle Sales Target Won’t Be Too Hard
President Joe Biden last week announced a deal aimed at spurring the US auto industry to sell more electric vehicles. The goals include a “shared aspiration” that 40% to 50% of vehicles sold in the US will be electric, plug-in hybrid or hydrogen-powered.
According to IHS Markit, sales of battery-powered vehicles, which include both all-electric and plug-in hybrids, are expected to make up just 4.3% of all vehicles sold in the US this year.
“Nobody really wants to be seen as a holdout or a dinosaur fighting this progress,” she said.
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Friday: University of Michigan Consumer Sentiment
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