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Oh the VIEs

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Wei Gu
Last Updated : Jan 21 2013 | 12:12 AM IST

China M&A: New M&A rules add clarity to the way China treats stock listings and takeovers. The Ministry of Commerce says from September 1, foreign investors can't use arcane and legally uncertain structures such as control agreements to sidestep supervision by the authorities in Beijing. As a result, mainland Internet firms may have to change if they want to be listed in China, or even to secure their domestic operating licenses.

The fresh framework ends a decade of official silence about corporate structures that enabled private Chinese companies to raise money abroad. The foreign acquisition rules are designed, in the main, to extend state influence over deals that affect national security, such as energy and agriculture. Yet, national security in China can be broadly defined and may well draw in Internet firms.

The new rules suggest Beijing will adopt a tougher stance on so-called variable interest entity arrangements - VIEs. These put a fence around companies' operating licences, often owned by Chinese citizens such as a founder or a relative. They give foreign-invested holding companies significant influence without outright ownership.

Companies including Sina and Baidu use such control agreements to give investors in holding companies listed offshore contractual rights to the domestic licences, and the earnings from them. Beijing hasn't definitively outlawed the practice, but it is clear the authorities are increasingly twitchy about these. Especially as the Internet starts to exert significant political and economic influence in China.

In the worst case, the tougher stance could cost Chinese Internet firms their valuable operating licenses.

Authorities are certainly likely to scrutinise deals in this sector, including the most recent stake purchase by Sina in online video firm Tudou, much more closely. Recent spats between Yahoo and Chinese e-commerce partner Alibaba over their online payment system highlights the Chinese regulatory risks faced by foreign investors.

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At the very least, the new rules could make it harder for these companies to obtain mainland listings. Baidu is among those to have expressed interest in being listed on Shanghai's international market once it opens. They want to raise capital as well as profile at home.

But there is a catch: foreign companies aren't supposed to get Chinese Internet licences. If they want to be listed at home, they are likely to be forced to buy out foreign investors. That could prove unaffordably expensive. China's Internet darlings need to tread very carefully.

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First Published: Sep 02 2011 | 12:26 AM IST

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