Commentary
Since 2000, Chinese issuers have widely used variable interest entity (VIE) structures to raise funds from American capital markets. The structure is often employed in industries where foreign ownership would be restricted or outright prohibited by Chinese regulators.
“Investors really are just playing fantasy football with the Chinese companies because they actually don’t own anything,” said Kyle Bass, founder and CIO of Hayman Capital Management, in a Nov. 22 report.
A common VIE structure would utilize a package of contractual agreements to link a Cayman-incorporated listed shell company with a China-based operating company. The terms of the contracts would provide for the distribution of revenue from the China-based entity to the Cayman-listed VIE. When American investors purchase shares on U.S. exchanges, they only buy the Cayman Islands company shares.
Neither the VIE holding company nor its U.S. investors own any equity interest in the Chinese operating company. And the investors who hold shares in the VIE do not hold shares or have a direct investment in the Chinese operating company. Ironically, the tech sector is one of the areas where Beijing is most in need of foreign investment, but it is also one area where foreign ownership is banned. Consequently, large Chinese tech companies such as Alibaba and JD.com use a VIE structure to list in the United States. Said another way, American investors who believe they own Alibaba shares do not.
