Is the “Variable Interest Entity” a Viable Model for Doing Business in China?

The Variable Interest Entity (VIE) structure has been accepted by foreign investors as a mode of investment in sectors that are restricted for foreign capital in China. The structure allows Chinese domestic entities to list on foreign capital markets. In scenarios where VIEs are the only preferred vehicles for investment to either meet the purpose of complete management control or invest in foreign restricted sectors, it is necessary to evaluate regulatory scenarios and comply with a structure that does not have questionable motives. From a regulatory perspective, there is neither any clear endorsement nor any specific prohibition of the VIE structure by Chinese authorities. Hence, the VIE structure has remained a grey area within the Chinese legal system. Though the VIE structure permits both foreign and domestic investors to work within the framework of governmental regulations and reviews, but without a clear endorsement of the VIE structure by regulatory authorities the structure poses several legal and regulatory risks. Consequences of much future regulation that might impact VIE structures are yet to be observed, professional advisory and legal services are recommended to make immediate corrective measures to sustain business operations running on such models, while at the same time maintaining a positive association with Chinese authorities. Immediate takeaways from the current analysis suggest the avoidance of foreign intervention in the operational control of Chinese VIE functions, making sure that investors in VIE structures are either Chinese or are registered as Chinese investors and correction of any security concern that the business structure might have been causing.

Professional advice is recommended to safeguard each party’s interests and to ensure that returns are maximized in VIE business model operations. It is also necessary to map the interests of parent company management with those of Chinese VIE operators for mutual benefit to avoid scenarios of conflict. Moving operations that run on VIE structures to China’s Free Trade Zones, which have lower restrictions on wholly-owned foreign investment, is also an option in scenarios where VIE structures cannot be made to comply with imminent regulations. However, a complete business structure evaluation is necessary to gauge the impacts on investor returns, multiple management entities’ functions and the interests of Chinese authorities.

The main forms of options available to Foreign Investment Enterprises (FIEs) in China are

• Operations involving Chinese partners
  • Joint Ventures – Equity Joint Venture (EJV) or a Cooperative Joint Venture (CJV)
• Operations without partners
  • Wholly Owned Foreign Enterprises (WFOE)
  • Representative Offices (Rep Office)

The current analysis explores the options that are available to foreign investors in China and explores why VIEs have been the preferred vehicles of investment. The article discusses possible regulations that may affect the legitimacy of VIE business structures and Recommendations on reinvestment of returns within China and the transfer of valuable assets to WFOEs while having VIEs maintain control of required licenses.