Many Chinese internet tech giants employ a variable interest entity (VIE) business structure to navigate China's foreign shareholding limitation and get listed in overseas bourses. Surprisingly, the VIE structure has been in use for nearly 20 years in China, but never with regulatory approval. Now, high-profile overseas IPOs have drawn increasing scrutiny, and upheaval lies ahead.
Sina Corporation was first to tap into VIE for initial public offering (IPO) back in 2000. VIE enables Chinese enterprises to transfer profits to an offshore company – often an enterprise entity registered in the Cayman Islands or the British Virgin Islands. And it lets them hold shares as a foreign investor, controlling business operations and profits through agreement rather than equity. Then, the companies can launch an IPO in foreign markets.
Almost all the household names of internet tech companies have used VIE for overseas IPOs. But with shifting international relations and enhanced government supervision, platforms that acquire vast amounts of consumer data face greater scrutiny.
Take Didi, for example. Its recent IPO in America reminded Chinese regulators their supervision over internet companies listed overseas was inadequate. Therefore, the General Office of State Council (GOSC) and the China Securities Regulatory Commission (CSRC) immediately responded to strengthen scrutiny over China Concepts Stock.
GOSC's official document states China will do the following to strengthen cross-border oversight of law-enforcement and judicial cooperation:
Improve relevant laws and regulations to data security, cross-border data flow, confidential information management and others;
Make provision for strengthening efforts in confidentiality and archive management related to overseas securities issuance and IPOs, holding Chinese companies launching IPO overseas accountable;
Promote the standardized management of the cross-border information provision mechanism and process;
Adhere to the principle of law and reciprocity, and further deepen cross-border audit and supervision cooperation.
Apparently, China is improving regulation for overseas IPOs and China Concepts Stock, increasing scrutiny of relevant enterprises involving national and public safety.
People familiar with the matter said Chinese companies still wanting to be listed overseas through the VIE structure as an offshore entity will be subject to supervision by the CSRC. That is to close the regulatory loopholes Chinese tech companies have used for so long.
The CSRC is reportedly leading the revision of overseas IPO rules so that Chinese companies using VIE must seek approval before getting listed in Hong Kong or the United States. Companies registered in the Cayman Islands or elsewhere are not mentioned.
Over the past decade, Chinese enterprises have raised more than $76 billion through IPOs in the US. With the stricter supervision pending, Chinese companies planning overseas IPOs, such as Byte Dance, face mounting pressure. And those investment managers who have funded Chinese internet companies see a dim future for their cash-out, too.
Nevertheless, many investors believe clarified supervision is not a bad thing for the market in the long run – at least the VIE structure is now officially legitimate with clear laws and regulations to follow. That said, more supervision over VIE and overseas IPOs means that the overvalued companies in China's primary market are bound to face tougher exits.