The risky loophole that Chinese companies have been using for years

By Charles Riley, CNN Business

When investors buy a stock, they buy a percentage of the company. Right?

Wrong! At least for many Chinese companies listed on the Nasdaq and the New York Stock Exchange.

Indeed, Chinese companies use a structure called a variable interest entity, or VIE, to raise funds from foreign investors.

What is a VIE? The structure uses two entities. The first is a shell company based somewhere outside of China, usually in the Cayman Islands. The second is a Chinese company that holds the necessary licenses to do business in the country. The two entities are linked by a series of contracts.

When foreign investors buy shares of a company that uses a VIE, they buy shares of the foreign shell company, not the company in China.

For example, when American investors buy shares of Chinese rideshare company Didi, which went public in June on the New York Stock Exchange, they are actually buying shares of a Cayman Islands company called Didi Global.

Didi Global does not own the business in China that connects drivers to drivers. But it has contracts in place which entitle its shareholders to the economic benefits produced by this company.

The bottom line: When Americans launch their trading app and buy Didi shares, they don’t get a direct stake in Chinese society. This arrangement is explained in Didi’s prospectus, but not everyone is aware of it. Alibaba, Pinduoduo, and also use VIEs, to name a few.

Why use a VIE?

Chinese companies have used this structure for decades because foreign investors are not really allowed to own stakes in local companies in sectors such as technology. Yet Chinese companies want to raise funds abroad.

Creating an offshore holding company that goes public helps Chinese companies to circumvent these rules. Wall Street and US regulators have long been on board with the deal, giving US investors easy exposure to the dynamic companies that power the world’s second-largest economy.

But there are huge risks. First, it is not clear that the contracts that give foreign investors the right to the economic benefits produced by Chinese companies are enforceable. It is also not clear whether VIEs are legal under Chinese law.

This is what Didi says about the arrangement: Didi says in its prospectus that its legal counsel considers that its VIE “does not violate the mandatory provisions of the applicable PRC [Chinese] laws ”, and that its contracts are“ valid and binding ”.

But it also included a warning to potential investors.

“We have further been informed by our PRC legal advisor that there are substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations,” Didi warned. “The PRC government may ultimately take a stand contrary to the opinion of our PRC legal adviser.”

Think of the problem this way: Chinese companies are basically telling Beijing that they are 100% owned by Chinese citizens. Meanwhile, the same companies tell foreign shareholders that they are the real owners.

After decades of taking a relaxed approach by Chinese and US regulators, there are signs that both are becoming uncomfortable with VIEs.

Hello, regulators: U.S. Securities and Exchange Commission chief Gary Gensler announced new disclosure rules targeting VIEs on July 30, saying Chinese companies need to be clearer with U.S. investors about the risks .

“I am concerned that average investors may not realize that they own shares in a shell company rather than a China-based operating company,” he said.

One of the new SEC provisions will require Chinese companies to disclose “whether the operating company and the issuer, if any, have received or have been denied permission from Chinese authorities to register. on the American stock exchanges “.

This provision seems to target Didi. Just days after its massive IPO, Chinese regulators targeted the company with a cybersecurity probe after it allegedly pursued listing over Beijing’s objections.

“I believe these changes will improve the overall quality of disclosure in the registration statements of offshore issuers that have affiliations with operating companies based in China,” Gensler said.

China is also taking a closer look at foreign quotes. China’s powerful cyberspace administration proposed in July that any company with data on more than a million users seek the agency’s approval before listing its shares overseas.

Investors, beware.

Biden’s EV sales target won’t be too hard to hit

President Joe Biden announced a deal last week to push the U.S. auto industry to sell more electric vehicles. The goals include a “shared aspiration” that 40 to 50% of vehicles sold in the United States will be electric, plug-in hybrids or hydrogen.

It will be a challenge, say some experts – but it’s not really as difficult as it sounds, reports my colleague Peter Valdes-Dapena.

Sales of battery-powered vehicles, including all-electric and plug-in hybrids, are expected to account for just 4.3% of all vehicles sold in the United States this year, according to IHS Markit.

General Motors said a few months ago that it expects to sell only zero-emission vehicles, including electric and hydrogen, by 2035. So at least 40% of its sales could be expected. vehicles to be emission-free by 2030. Stellantis, the company that owns the Dodge, Chrysler and Jeep brands, also recently said it expects 40% of its sales in the United States to be electric or plug-in hybrids by the next year. end of 2025, well ahead of the target set by the Biden administration. . Ford has also already announced that 40% of the vehicles it sells globally will be electric by 2030.

Automakers have set these goals for themselves for a number of reasons. Regulations are already changing in other parts of the world, such as in Europe, where there are plans to ban internal combustion vehicles by 2035. Consumer tastes are also changing – as shown by the Tesla’s growing popularity, said Jessica Caldwell, industry analyst. with Edmunds.

“No one really wants to be seen as the dodger or the dinosaur, the one fighting this progress,” she said.


On Monday: Benefits of Tyson Foods, Air Products and Nutrien

Tuesday: Benefits of Sysco and Coinbase Global

Wednesday: consumer price index in the United States; US crude oil inventory data; Earnings from eBay and NIO

Thusday: jobless claims in the United States; United States producer price index; Benefits of Baidu, Palantir Technologies, Airbnb and Disney

Friday: Consumer sentiment at the University of Michigan

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