Mofcom’s VIE mention overhyped

Author: Ashley Lee | Published: 6 Sep 2012
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While the Ministry of Commerce of the People’s Republic of China’s (Mofcom) recent mention of the variable interest equity (VIE) structure is important, its implications have been exaggerated.

VIEs are popular with foreign investors looking to circumvent Chinese restrictions on foreign investment in value-added telecommunications businesses (VATB), which comprise a wide range of services such as e-mail and data storage. But investors fear that the structure violates the spirit of Chinese law and is increasingly scrutinised by Chinese regulators.

Mofcom’s mention of VIEs in its review of American retailer Wal-Mart’s acquisition of a further 33.6% stake in Niuhai Holdings is a first for a PRC authority. Since the review was released on August 13, investors have been puzzled by what the VIE mention could mean for the structure’s future.

Foreign investment restrictions for VATBs

But counsel told IFLR that Mofcom’s VIE mention means that the structure is not immune from merger control.

Mofcom reviewed Wal-Mart’s latest acquisition because it increased its shareholding in the target to 51.3%. Niuhai, through its wholly-owned subsidiaries Newheight HK and Niuhai Shanghai, owns Yishiduo’s popular online shopping platform, Yihaodian. With the purchase, Wal-Mart would control the online direct shopping business of Yihaodian, but must not participate in its consumer-to-consumer platform, similar to that of eBay, Amazon or Tmall.

The review specifies three conditions. Firstly, the acquisition must be limited to the direct retail business. Second, Niuhai Shanghai must not utilise its self-owned network platform to provide network services to other transaction parties.

A Hong Kong-based lawyer at an international firm said that condition two specifies that once Niuhai has been acquired, Wal-Mart will not be able to participate in its VATB. For example, Wal-Mart would be unable to run a data storage platform that allows sellers to store and display photographs of their wares.

The third provision: closing a loophole

But the third condition is the most questionable. It has been translated as: ‘After the completion of this transaction, Wal-Mart shall not carry out through VIE structure the VATBs currently operated by Yishiduo’.

The Hong Kong-based lawyer said that condition three is Mofcom’s confirmation that Wal-Mart will not come through and bypass conditions one and two by using a VIE structure to invest in Niuhai’s VATB services.

Herbert Smith partner Michelle Chan and associate Peggy Chow agreed. They noted that Mofcom’s main focus was still on Wal-Mart’s potential dominance in the VATB market and any anti-competitive effects if its acquisition was allowed to proceed. “In the absence of Wal-Mart having obtained the requisite foreign investment approval, the potential dominance in the VATB could still be achieved if Wal-Mart adopted the VIE structure to indirectly control the VATB operated by Yishiduo,” they said.

Further, the VIE mention has little bearing on Mofcom’s review condition that Wal-Mart cannot operate a VATB service.

A Shanghai-based partner at a US law firm stressed that it does not matter whether Wal-Mart uses a VIE structure or some other framework: if Wal-Mart controls Yishiduo’s VATB services, together with its current business and competitive advantages, Wal-Mart may ultimately be able to restrict competition in China’s VATB market.

Implications on VIE structures

Counsel are skeptical that Mofcom’s review has any bearing on the legality of VIE structures. The Hong Kong-based lawyer said: “If I were a corporate partner advising on VIE structures, I would ignore this decision because there’s nothing that helps me understand Mofcom’s position better.”

Sources agreed, and generally doubted that Mofcom tried to signal what can and cannot be done through a VIE. Though it consulted with relevant government agencies, industry associations and companies, this review focuses on competition rather than structuring.

If anything, Mofcom may have specifically mentioned VIE structures to emphasise that it is not immune to merger control. “The anti-monopoly law specifically says that if there is a change of control through contract or equity agreements and the turnover thresholds are reached, Mofcom must be notified, and VIEs are not exempt,” said the partner.

However others are more optimistic about the review’s implications. Some said that the ruling seems to suggest – although it can’t be verified – that PRC authorities will tolerate VIEs in respect to existing investments. However, it is unlikely that Mofcom will grant unconditional clearance to proposed transactions involving VIEs.