Chinese securities regulator in discussions over VIEs with Hong Kong watchdog, financial firms

China Securities Regulatory Commission (CSRC), such as Didi, Megvii

China’s securities watchdog has held discussions with the regulator in Hong Kong, as well as financial firms involved in fundraising deals in the city over variable interest equity (VIE) structures, according to three separate sources.

As part of the discussions – described by the sources as a series of soft consultations – the China Securities Regulatory Commission (CSRC) has over the past few months met the city’s Securities and Futures Commission as well as leading investment bankers, accountants and lawyers on VIEs.

The CSRC denied a Bloomberg report on Wednesday that Beijing was considering banning these structures.

“That it is clear from the history of government regulations and pronouncements regarding the VIE structure from the last five years that a sudden ban of all overseas listings of companies using the structure is unlikely,” said Marcia Ellis, global chair of the private equity group at law firm Morrison and Foerster. “The very quick on-the-record denial from CSRC also makes me think there is more going on here than meets the eye,” she added.

VIE structures have been used by Chinese technology companies to bypass Beijing’s restrictions on foreign investment and to access overseas capital markets for more than two decades. Under such a structure, companies form an overseas entity, usually incorporated in a jurisdiction such as the Cayman Islands or the British Virgin Islands, and share the profits or economic benefits of their onshore businesses with foreign investors, who would normally be restricted when it comes to investing in a mainland Chinese company.

The discussions between the CSRC and the watchdog and financial firms in Hong Kong over VIEs were prompted by a lull in initial public offering (IPO) activity in the city.

Uncertainty over VIEs has increased recently, after China started asking that companies with huge troves of personal data of its citizens, such as Didi, seek prior approval from the government, an investment banker said. This has, in turn, led to Hong Kong IPOs by Chinese companies dying down.

While no details of any proposed regulations have emerged from the discussions, the CSRC, which had recently approved a listing by artificial-intelligence company Megvii Technology in Shanghai and a listing by streaming music platform Cloud Village in Hong Kong, had no plans to ban VIEs, the sources said. Both Megvii and Cloud Village have VIE structures.

Beijing wanted to continue supporting mainland Chinese companies raising funds overseas, the sources added.

The structure was pioneered in 2000, when companies such as Sina Corp, the operator of Weibo, NetEase and Sohu.com went public in the United States, but has always remained a legal grey area in China.

And while bourse operator Hong Kong Exchanges and Clearing has a clear guidance on VIE structures, the CSRC and other mainland regulators do not have very clear rules on such types of listings.

“The VIE structure was supposed to be a transitional arrangement during the reform and opening era, so we would not be surprised if it is regulated in the new era,” said Chen Weiheng, partner and head of China practice at US law firm Wilson Sonsini.

“It is possible that the structure will not be banned, but becomes subject to a review or approval process in connection with overseas listings. When there is a PRC regulatory change that affects overseas listings by Chinese companies, it will also cause corresponding comments from US or Hong Kong regulators, and may result in additional disclosures,” Chen said.

Data will be a key issue when it comes to VIE listings, said Morrison and Foerster’s Ellis. “The most recent draft regulations released by the Cyberspace Administration of China make this clear. The focus on data-based reviews will allow the government to take a more selective and nuanced approach to approving or disapproving listings,” she said.

Hong Kong will remain a hub for mainland Chinese firms looking to list using VIE structures, Ellis added. “Many China-headquartered companies will be focusing on listing or relisting in Hong Kong and other markets such as Shanghai and Shenzhen, not just because of the VIE issue but because the US has frankly become a very inhospitable market for these companies,” she said.

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