Foreign Investment in China: The Variable Interest Entity

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“The risks of Variable Interest Entities have long been known... however these risks require clarification by China before they are taken seriously”.

To what extent is this accurate and what does it mean for the future of Variable Interest Entities?

Introduction

The Variable Interest Entity (‘VIE’) is a well-established and widely utilised structure of investment employed in foreign investment in China. It entails a succession of contractual arrangements which hold the principal intention of circumventing the investment restrictions China has placed upon foreign ownership in particular sectors of the Chinese market. Consequently, the legal validity of VIEs has been a point of contention since its very inception. The Sina Corporation was the first company to successfully investigate the uncertain environment surrounding the VIE in 2000, through its public listing on the NASDAQ. Here the Chinese authorities in general approved the use of the structure and in consequence the structure has been broadly implemented throughout foreign investment in China. This has aided, among other things, a number of the most renowned Chinese enterprises by facilitating their acquirement of foreign capital and finalising offshore listings, notwithstanding the legal restrictions. Nonetheless, the intermittent public quarrels between the different parties to the VIE arrangement and the unclear and often contradictory approaches of various regulatory bodies highlight the drawbacks associated with VIEs.

At the time of research the relevant parties are still operating upon a basis of speculation. However it has become clear that people are becoming progressively more apprehensive in regard to the underlying legal defects of this structure. Thi...

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...ivate enterprises due to ideological concerns and interference from the government in relation to bank lending and the presence of the local government’s explicit or implicit guarantees for loans to SOEs. Moreover established stock markets in the early 1990s in areas such as Shanghai and Shenzhen were almost exclusively utilised for the reform of the SOEs. Therefore for a long period private entrepreneurs were forced to depend predominantly upon self-financing, what with the restricted access to bank loans and domestic stock markets. At the end of 1999, the private sector was contributing 27% of GDP, however it only accounted for 1% of lending from banks and 1% of listed companies on the domestic stock exchanges. This situation is worsened by the burdensome process of approval, and the complete ban taken against seeking foreign capital in overseas markets.

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