For Once, China and China Hawks See Eye-to-Eye


After years of squabbling over everything from soybeans and viruses to technology and Taiwan, it now looks like Beijing and Washington may be on the same page about one thing: U.S.-listed Chinese companies.

America’s most hawkish China watchers have been banging on about variable-interest entities for years. This mutant corporate structure evolved from a decades-old rule that prevents foreigners from owning various types of mainland businesses, notably in the internet sector. Foreign investors end up holding bits of what amount to shell companies.

Critics, from noted short seller Carson Block to Florida Senator Marco Rubio, have been looking for ways to limit or reform U.S.-listed Chinese companies, most of which use the VIE structure. They often highlight the sketchy relationship between shareholders and the entities they supposedly own. 

Beijing regulators have since come on board, and are also looking to rein in the practice. The China Securities Regulatory Commission is considering revising rules that will force businesses to get Beijing’s approval for a foreign listing, even if it is incorporated abroad, Bloomberg News reported Wednesday. A day earlier, the State Council hinted a crackdown on overseas listings was coming, with companies to be held accountable for keeping their data secure. 

That brief statement was the latest in a series of missives out of Beijing that started with a direct attack on Didi Global Inc. — the ride-hailing unicorn that listed in New York last week — and culminated in its apps being removed from stores in China and the company being put under review for its data practices. Didi’s stock subsequently dropped 27% in three days, falling below its June 30 initial public offering price.

Beijing cites national security as the reason for its recent display of regulatory assertiveness. The ride-hailing operator collates an unprecedented amount of data and the government is increasingly paranoid about that information leaking overseas. Similar concerns are being voiced by U.S. officials — from cabinet members to legislators, who fear that mainland business have too much data on American citizens.

So now we've got both Beijing and Washington viewing U.S.-listed Chinese companies as an issue of national security. The only difference is the nation they’re trying to keep secure.

Rubio is renowned for his hawkish stance, but that doesn’t make him wrong. Most recently, he described Didi’s listing as “reckless and irresponsible.” His complaint is entirely valid, and goes beyond data concerns: “Even if the stock rebounds, American investors still have no insight into the company’s financial strength because the Chinese Communist party blocks U.S. regulators from reviewing the books,” he told the Financial Times in a statement. The VIE structure itself makes it difficult to know exactly what you’ve invested in.

Take Alibaba Group Holding Ltd., the most famous and valuable example. While most shareholders think they own a piece of China’s pre-eminent internet company, what they actually have is an equity stake in a Cayman Islands business with no substantial assets of its own. This offshore entity, domiciled in a tax haven, actually has a contract with the Alibaba Partnership — a collection of a few dozen individuals who together are the true owners of the sprawling e-commerce empire.

Everyone just takes it on faith that the Chinese partner will uphold its side of the deal — to give the tax haven-based company the stipulated residual interest in the cashflows of the business with which they have a contract. And failing that, some court or regulator will step in to ensure compliance to said agreement. Investors also seem to turn a blind eye to the fact that these businesses, by virtue of being Chinese and owned through layers of obfuscation, aren’t subject to audits by U.S. authorities. 

More than $1.7 trillion is tied up in this version of faith-based investing. Of 239 Chinese companies listed on U.S. exchanges, 183 are incorporated in the Cayman Islands and 30 in the British Virgin Islands — most, but not all, are structured around VIEs. And the warning bells have been sounding for a while. Block, the short seller, has been among the most vocal of critics, advocating for reform to the VIE system as far back as 2012 to avert accounting fraud.

There’s no suggestion that Didi has committed any such thing. But Beijing’s concern isn’t about cooked books anyway; it’s worried about national security. That’s a familiar fear. In the final year of his term, President Donald Trump ramped up his invective against Chinese companies, egged on by legislators, over the belief that such businesses were a threat to American interests. He even went as far as trying to force ByteDance Ltd. to halt its TikTok short video service in the U.S., and force it to be spun off from its parent. 

That never happened, and ByteDance is due for an IPO in the next year or so. With many of its investors being foreign venture capitalists, that listing would naturally be made in the U.S. — so they can get their money out — and a VIE is still the likely structure for doing so. 

This puts the Chinese government and the China hawks in unusual alignment. Beijing doesn’t want companies with reams of data listing in the U.S., and the skeptics in Washington (and Wall Street) are making it increasingly clear that opaque Chinese businesses aren’t welcome in its capital markets. 

The two sides may not see eye-to-eye on much, but any common ground makes for a welcome development. Unless, of course, you’re a Chinese company with foreign shareholders.

This doesn't include those listed on over the counter exchanges.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Tim Culpan is a Bloomberg Opinion columnist covering technology. He previously covered technology for Bloomberg News.

©2021 Bloomberg L.P.

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