On June 19, 2015, the Ministry of Industry and Information Technology (MIIT) issued Circular 1961 to abolish restrictions on the foreign ownership of e-commerce businesses in China. As a result, 100 percent foreign ownership is now permitted in an e-commerce business.
E-commerce is a sector of China’s Value-Added Telecommunications Services (VATS). Foreign investment in VATS had been completely banned until 2002. Since then, foreign investment in VATS has been allowed, subject to a holding cap of 50 percent. In 2014, as a pilot program in the Shanghai Pilot Free Trade Zone (Shanghai FTZ), MIIT eased the foreign investment restriction in several VATS sectors. The foreign holding cap in the e-commerce sector was increased from 50 percent to 55 percent. In January 2015, MIIT completely abolished the ownership restriction in the Shanghai FTZ for e-commerce businesses. In June 2015, MIIT opened the e-commerce sector for foreign investment nationwide.
Decreased Need for VIE Structures
One of the major impacts of Circular 196 is that it should decrease, but not necessarily eliminate, the need for Variable Interest Entity (VIE) structures in e-commerce businesses.
VIE structures enable many foreign investors to bypass foreign shareholding restrictions in VATS businesses. In a typical VIE structure, (i) a wholly domestic-owned enterprise (Domestic Company) holds the VATS permit issued by MIIT and operates in China, (ii) foreign investors establish a Foreign Company, and (iii) the Foreign Company funds and controls the Domestic Company, not by equity investment/ownership but through a series of contractual arrangements2 (signed with the Domestic Company/its shareholders, often via a Chinese subsidiary as an unregulated business/technology consulting/service wholly foreign-owned enterprise). However, VIE structures could be vulnerable to enforcement risks and regulatory challenges. Circular 196 offers the possibility for e-commerce companies to have foreign ownership with any percentage desired while avoiding the legal uncertainties that come with VIE structures.
That said, there are two likely obstacles to adopting this solution.
First, according to the Provisions on the Administration of Foreign-Invested Telecom Enterprises issued by the State Council in 2008 (2008 Provisions), the major foreign investor in an e-commerce business should have a good track record and experience in operating VATS. Many foreign investors, especially financial investors, may not be qualified to act as the sole or majority investor under the 2008 Provisions due to a lack of VATS operation experience.
Second, VATS operating in sectors other than e-commerce are still subject to the foreign shareholding cap of 50 percent. Therefore, an e-commerce company taking advantage ofCircular 196 for foreign investment of more than 50 percent will not qualify to apply for VATS permits in other sectors. This may create obstacles for business expansion, especially in the rapidly evolving online industry. It is expected that, in light of the recent relaxation on e-commerce businesses, the restrictions on other VATS permits may also be relaxed in the near future.
Delisting from Overseas Stock Exchanges
An increasing number of U.S.-traded Chinese companies have plans to delist their shares from U.S. exchanges, in favor of relisting in China. Circular 196 could accelerate this trend within the e-commerce sector, as foreign shareholding of more than 50 percent has become lawful in China, and the complex VIE structure is no longer the best solution.
Undefined Scope of “E-Commerce”
An added complication is that the definition of e-commerce remains unclear in China. This sector appears to fall under the sub-category of “online data processing and transaction processing business” in the 2013 version of the Classified Catalogue of Telecommunications Services issued by MIIT (Catalogue). However, the Catalogue has not been updated in line with the recent growth of the e-commerce industry. Furthermore, clarification in the definition of e-commerce is not present in Circular 196, either.
The 2013 Catalogue draft for comments describes e-commerce as “transaction-processing businesses” as “utilizing a transaction-processing platform connected to a communications network (including the Internet) to provide […] products and services in relation to e-commerce to the general public.”3 Even with this definition, the scope of e-commerce remains unclear. There is the possibility and hope that a new Catalogue will be issued in the near future that will provide further clarity and guidance for regulatory compliance purposes.