The next question is, will China disallow the corporate structure that underpins listings in its tech economy?
A cold front has descended over China’s listed private companies. Even Tencent, which has always managed to run under the political radar, is affected. The next question is, will China disallow the corporate structure that underpins listings in its tech economy? Overseas-listed Chinese companies, from Alibaba (BABA US) to Tencent (700 HK), Didi (DIDI US), and New Oriental EDU (EDU US), are almost all proxy vehicles for Mainland businesses, established in Caymans, BVI, Seychelles, Bermuda, and elsewhere. A revocation of the rights of Variable Interest Entities (VIEs) would instantly destroy these companies and with them, China’s internet and tech sectors. The VIE structure is clearly illegal. China’s law makes it clear that domestic companies in restricted sectors may not write profit-sharing agreements with foreign-owned entities. The VIEs generally duck this requirement by stipulating that a certain payment—exceeding expected profit—be made from the VIE to the wholly foreign-owned entity, and any overcharge be racked up as an account payable. The structure is highly vulnerable. And it is likely to be attacked. It seems likely that, if the VIE structure is attacked, China will require restructuring to allow continued market listings, so as not to alarm the market too much. It will be just the start of a process. China has relied on a patchwork of special legal and territorial concessions for really all of its modern history—the Maoist era excepted—to enable economic growth and international exchange without changing the core institutions that manage most of the Mainland’s territory. The VIE structure that facilitates offshore listings in restricted sectors is one part of the “one country, two systems” formula. So is Hong Kong. Like the VIE carve-out, the autonomy of Hong Kong has been critical to Chinese economic success.
