China plans to ban loophole used by tech firms for foreign IPOs

Companies using the so-called VIE structure would still be allowed to pursue initial public offerings (IPOs) in Hong Kong, subject to regulatory approval, the people said.

HONG KONG: China is planning to ban companies from going public on foreign stock markets through variable interest entities (VIEs), according to people familiar with the matter, closing a loophole long used by the country’s technology industry to raise capital from overseas investors.

The ban, intended in part to address concerns over data security, is among changes included in a new draft of China’s overseas listing rules that may be finalised as soon as this month, said the people, asking not to be identified discussing private information.

Companies using the so-called VIE structure would still be allowed to pursue initial public offerings (IPOs) in Hong Kong, subject to regulatory approval, the people said.

Companies currently listed in the United States and Hong Kong that use VIEs would need to make adjustments so their ownership structures are more transparent in regulatory reviews, especially in sectors off limits for foreign investment, the people said.

It’s unclear if that would mean a revamp of shareholders or, more drastically, a delisting of the most sensitive firms – moves that could revive fears of a decoupling between China and the US in areas like technology. Details of the proposed rules are still being discussed and could change.

The overhaul would represent one of Beijing’s biggest steps to crack down on overseas listings following the New York IPO of ride-hailing giant Didi Global Inc, which proceeded despite regulatory concerns.

Authorities have since moved swiftly to halt the flood of firms seeking to go public in the US, shuttering a path that’s generated billions of dollars for technology firms and their Wall Street backers.

It’s all part of a year-long campaign to curb the breakneck growth of China’s Internet sector and what Beijing has termed a “reckless” expansion of private capital.

Banning VIEs from foreign listings would close a gap that’s been used for two decades by technology giants from Alibaba Group Holding Ltd to Tencent Holdings Ltd to sidestep restrictions on foreign investment and list offshore. It potentially thwarts the ambitions of firms like ByteDance Ltd contemplating going public outside the mainland.

The China Securities Regulatory Commission didn’t immediately respond to a request for comment.

While a universal ban on the VIE structure isn’t being contemplated, a halt on foreign listings and additional review for Hong Kong IPOs would mean the model will no longer be a viable way for many startups to tap capital markets.

Some investment banks have already been advised by regulators to stop work on new deals involving VIEs, a person familiar with the matter said.

The demise of the VIE route would further threaten a lucrative line of business for Wall Street banks, which have helped almost 300 Chinese firms raise about US$82bil (RM345.84bil) through first-time share sales in the US over the past decade.

VIEs have been a perennial worry for global investors, given their shaky legal status. They have never been formally endorsed by Beijing.

They have, nevertheless, enabled Chinese companies to bypass rules on foreign investment in sensitive sectors including the Internet industry. The structure allows a Chinese firm to transfer profits to an offshore entity – registered in places like the Cayman Islands or British Virgin Islands – with shares that foreign investors can then own. ― Bloomberg