0000029161 00000 n Inside Alibaba Group Holding Ltd.’s filing on Tuesday for a U.S. initial public offering are three words well-known to China-focused investors but alien to many others: variable-interest entity. 0000008458 00000 n Ma and Xie are then under contract to turn profits over to the Cayman entity. 0000004270 00000 n 4 Feb. 0000001691 00000 n To get around this, tech firms opted to avoid owning these mainland assets outright, and instead to bundle them into legal entities called VIEs, in turn owned by individuals in China (usually the bosses of the firms and their associates). 0000003188 00000 n the variable interest entity (VIE) with a disproportional control structure.2 VIEs involve a complex set of financial arrangements that enable foreign investors to circumvent the … 0000010154 00000 n The structure dates back to the early 2000s, when Chinese technology companies wanted to tap global capital markets in New York and Hong Kong and to set up international holding companies domiciled outside of mainland China. China’s Variable Interest Entity Structure Explained in 100 and 1,300 words. In 2005, Yahoo! 0000034523 00000 n 0000004986 00000 n startxref And Meituan was down more than 12%, the biggest intraday decline since November 2018. 0000002644 00000 n U.S.-listed Chinese internet companies such as search giant Baidu (BIDU) and e-commerce giant Alibaba Group Holding (BABA) utilize a corporate structure called a variable interest entity… The VIE structure employed for the Alibaba’s IPO is organised as follows. They worry about the company’s VIE (variable interest entity) structure or the so-called “trade war” or accounting fraud elsewhere in the country and dump BABA stock. The idea is that if anyone gets run over by a bus, then the scheme will not be disrupted, because nominal control is spread among a wider group of people. 0000006538 00000 n trailer The new approach is far from perfect but it is an improvement. xref 0000009109 00000 n The variable interest entity ("VIE") has long been a popular structure for foreign parties to invest in sectors which are restricted by China’s industrial policy to foreign investment. Alibaba has taken advantage of an obscure and complex investment vehicle called the Variable Interest Entity, or VIE. So the VIE is listed in the U.S., not Alibaba itself. 0000022944 00000 n They may also require companies that operate a so-called Variable Interest Entity ... Alibaba and Tencent were both down more than 4% in Hong Kong, hurt also by a broader tech selloff. China talks a good game about financial reform but its fiddly rules and opaque decision-making are a source of risk and ambiguity—even for its most successful companies. 0000000016 00000 n When Xiaomi floated in Hong Kong in June its plan was that they could buy stock in two ways. 0000029336 00000 n Alibaba's Regulatory Work-Around to China's Foreign Investment Restrictions many of its economic sectors.5 To work around these restrictions, China's In-ternet companies utilize a complicated and highly risky investment method known as a Variable Interest Entity ("VIE").6 A VIE is a company that is included in consolidated financial statements because it is controlled through contracts, rather than the more conventional control that is obtained through ownership. Due Diligence. After the restructuring, the two men will no longer be the dominant counterparties. %PDF-1.7 %���� 0000001036 00000 n 0000014823 00000 n invested in Alibaba through a variable interest entity (VIE) structure, buying a 40% stake in the company for US$1 billion. Alibaba is a Variable Interest Entity(VIE), which means it’s registered in the Cayman Islands and makes 90 % revenue in mainland China. Central to the issues is the corporate structure for Alibaba. This was disclosed about a … 0000006001 00000 n Instead the VIEs will be owned by two layers of holding companies, which will sign contracts with Alibaba. 0000007002 00000 n 0000010827 00000 n In 2011, after a series of public events, the variable interest entity ("VIE") structure re-attracted a lot of attention and concerns from the PRC authorities, entrepreneurs, investors and other market participants. These holding companies will ultimately be nominally owned by a broader group of Alibaba’s senior Chinese staff. Third, VIEs allow China’s leading tech firms to be listed abroad, preventing mainlanders from easily owning their shares and participating in their success. It is now the favorite way for companies to list in the United States. 0000001582 00000 n The gist is that the Chinese internet giant is reforming its legal structure, which uses a fragile and ingenious device known as a variable interest entity (VIE). An ADR is a stock that trades in the U.S. but represents a specified number of shares in a foreign corporation. Alibaba tweaks a controversial legal structure. Written By Ashford Bain. The gist is that the Chinese internet giant is reforming its legal structure, which uses a fragile and ingenious device known as a variable interest entity (VIE). The ADRs represent interest in a Variable Interest Entity (VIE) that has contracts with Alibaba, not ownership interests of the company. If all goes to plan it will be completed by 2019. “This is a watershed moment,” said Ma … that utilize a variable interest entity (VIE) structure to evade Chinese regulation on foreign ownership to list equity in the U.S. If the people with nominal title die, divorce or disappear, it is not certain that their heirs and successors can be bound to follow the same contracts. Copyright © The Economist Newspaper Limited 2020. Ma, who said he plans to retire from Alibaba next year, is surrendering control over the variable-interest entities, or VIEs, that hold the company’s business licenses. Alibaba’s proposed change is aimed at tackling the first problem, key-man risk. For example, Alibaba, the world's largest retailer and e-commerce company, uses a VIE structure allowing U.S. citizens to purchase VIE shares in Alibaba on the New York Stock Exchange (NYSE). 3. 0000001713 00000 n VIEs are ubiquitous, especially among the country’s internet firms, which have a total market capitalisation of over $1trn. 0000004425 00000 n 0000002120 00000 n h�b```c``�d`e`H�`�g@ ~��$�7]_��x_Z=��tɭ�K��s�]��(k]^��zf���U�v�ڵzՊ���*�iY)�v. Other tech firms may feel pressure to follow. 0 This approach remains popular. At the moment four of its five VIEs are nominally owned by Jack Ma, the firm’s leader, and Simon Xie, a co-founder and former employee. 0000003450 00000 n Many of those investments—by some estimates most—are illegal under Chi-nese law. They could purchase depositary receipts (which give the rights to the underlying share) that would be listed in Shanghai, or they could buy shares in Hong Kong through “stock connect”, a programme allowing a limited volume of trading between the mainland and Hong Kong. variable interest entity or VIE. The contracts attempt, often imperfectly, to mimic the control and economic interest of direct ownership. <<07E525CAECA3B2110A00B0A88DC4FD7F>]/Prev 871096>> Alibaba is using a straightforward V.I.E. 0000034339 00000 n And mainlanders cannot own shares easily. Many of the largest and fastest growing technology businesses reside in China and present tremendous long-term opportunities to investors, benefitting from the same structural tailwinds as the FANG stocks. They go … 152 0 obj 0000009484 00000 n <>stream Take “variable interest entities” (VIEs), a kind of corporate architecture used mainly by China’s tech firms, including two superstars, Alibaba and Tencent. 0000023660 00000 n 0000002915 00000 n The use of the VIE structure is not only questionable under Chinese laws but also exacerbates the agency costs within the firm. 0000014643 00000 n 152 37 In a securities filing in July, Alibaba Group disclosed that executive chairman Jack Ma will be stepping away from the company’s variable interest entities. endobj Variable interest entity is a term used by the United States Financial Accounting Standards Board in FIN 46 to refer to an entity in which the investor holds a controlling interest that is not based on the majority of voting rights. %%EOF Alibaba stands as China’s underdog success story in the e-commerce industry, yet much remains unexplored about the consequences of its unique Variable Interest Entity (VIE) structure. First, key-man risk. Jack Ma’s role in the firm’s “variable interest entities” will be reduced. 188 0 obj Gordon Chang believes that the Variable Interest Entity may not offer reasonable protection for U.S. based Alibaba shareholders. A variable interest entity (VIE) refers to a legal business structure in which an investor has a controlling interest despite not having a majority of voting rights. 0000002379 00000 n This legal structure is called “Variable Interest Entity” (VIE), which essentially employs two Special Purpose Vehicles (SPVs) and a series of entangled contractual agreements that artificially replicate an equity position. 0000007522 00000 n There are three problems with VIEs. Chinese e-commerce companies turned to the VIE structure as a means to circumnavigate China’s restrictions against foreign ownership. China’s courts have set few reliable precedents on VIEs and the official position is one of toleration rather than approval. China’s Variable Interest Entity Problem: How Americans Have Illegally Invested Billions in China and How to Fix It Samuel Farrell Ziegler* ABSTRACT U.S. investors have invested over $70 billion in Chinese companies. Then mainland regulators decided that firms with dual share classes, including Xiaomi, would not be eligible for stock connect (the Chinese authorities and Hong Kong’s exchange are holding negotiations to try to resolve this). 0000036022 00000 n Related: Alibaba is not the Amazon of China. 0000003722 00000 n 0000005485 00000 n Alibaba set up a variable interest entity (VIE) in the Cayman Islands to get around restrictions from the Chinese government on foreign stock … Unfortunately the listing of depositary receipts fell through, for reasons that remain unclear. All firms still carry warnings in their annual reports that the legality of VIEs is uncertain. The other two problems with VIEs remain, however. Yet their sensitive internet assets, such as licences, may not be owned by foreign entities, according to Chinese law. Second, it is not clear if the structure is even legal. Those same policy rationales should also prompt reexamination of the disclosure being provided concerning, and associated governance risks posed by, the “variable interest entity” or “VIE” structures that are widely used by China-based firms (including Luckin) listed on U.S. exchanges. <> 0000007941 00000 n JD.com Inc. dived as much as 8.9%, its steepest intraday fall on record. IF YOU want to study how the legal title to assets worth many billions of dollars changes hands in China, then peer carefully at page 116 of Alibaba’s new annual report. 0000003996 00000 n The VIEs and these individuals sign contracts with the international holding company, handing over to it control of the VIE as well as its profits. First, a lesson on what is an ADR and VIE. The other concern is that Alibaba is listing as a variable interest entity (VIE). Can SAP’s new boss reset its business model. Renren and Baidu, for example, are variable interest entities. This article appeared in the Business section of the print edition under the headline "Enigma variations", Sign up to our free daily newsletter, The Economist today, Published since September 1843 to take part in “a severe contest between intelligence, which presses forward, and an unworthy, timid ignorance obstructing our progress.”. Alibaba’s attempt to make its VIEs safer is to be welcomed and will be watched closely by China’s richest entrepreneurs, many of whom use them, too. Alibaba stock represents shares of a variable interest entity (VIE) that is headquartered in the Cayman Islands, not China. In addition the VIE structure has also been used as a means by which Chinese domestic entities could list offshore on international capital markets. "VIEs operate using contractual arrangements rather than direct ownership, leaving foreign investors without the rights to residual profits or control over the company's … Alibaba Group Holding Inc., which conducted a $25 billion initial public offering (still the largest ever) … The text is dense and you may have to put a cold towel on your head and read it several times. 0000023118 00000 n VIE structure relies on a … For example, it is being used by Xiaomi, a tech firm which did a blockbuster initial public offering in Hong Kong this year. This business structure, called a variable-interest entity, became common among Chinese companies because Beijing restricts foreign investment in certain sectors, such as the internet. All rights reserved. Vies will be completed by 2019 not only questionable under Chinese laws but also exacerbates the agency within. Is not the Amazon of China VIEs are ubiquitous, especially among the ’. 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