Proposed China law threatens foreign internet players

April 20, 2015 08:19
Amazon's China business could be at risk from a proposed change to the variable interest entity  structure. Photo: Internet

Major foreign companies and several Chinese internet firms listed in the United States could be forced to sell controlling stakes to Chinese nationals under a proposed law.

The law prohibits companies from doing business in sectors of the economy where foreign investment is restricted by the Chinese government, the Wall Street Journal reported Monday.

At present, these companies are able to do so under a structure called variable interest entity (VIE) which is common in the US technology sector.

The Wall Street Journal, working with Dow Jones Risk & Compliance, identified companies that appear to be at risk from the proposed law.

These include Chinese operations of Inc., Pearson Plc. and CBS Corp.

Also affected are three major US-listed Chinese internet companies -- Sina Corp., Autohome Inc. and Weibo Corp. which are controlled byu foreign investors.

Most Chinese Internet companies listed abroad such as Alibaba Group Holding Ltd. and Baidu Inc., also use the structure but do not seem to be at risk because they are ultimately controlled by Chinese nationals.

But under the new law, proposed by the Ministry of Commerce in January, they may not be able to continue those operations or may have to sell controlling stakes in the operations to Chinese nationals, attorneys said.

VIE structures are especially common among US technology companies.

“You can’t walk down the street in Palo Alto without tripping over a VIE situation because if you are in the internet space and looking at China you are looking at VIE,” said Tom Shoesmith, head of the China practice at law firm Pillsbury Winthrop Shaw Pittman LLP.

Typically, a company based outside of China sets up what is called a wholly foreign-owned enterprise (WFOE) in China.

The WFOE in turn signs contracts with a Chinese-owned operating company, the VIE, which invests in the restricted sector.

The contracts give the WFOE effective control of the operating company but not ownership.

China has had a number of laws regulating foreign investment.

The newly proposed law would draw a simpler distinction between sectors where foreign investors will get the same treatment as Chinese investors and a “negative” list of restricted and prohibited sectors, where only companies controlled by Chinese nationals could operate, even if structured as VIEs.

Without regulatory relief, “the foreign-controlled VIE entity would have to either sell its controlling stakes in the VIE entity to Chinese nationals [so that the stakes would be controlled by Chinese nationals] or liquidate the VIE entity under applicable Chinese law,” said Winston Zhao, a partner in the law firm of McDermott Will & Emery LLP.

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