US based supermarket conglomerate Wal-Mart Stores, Inc. announced on 23 July 2015 through its official website that it has acquired full ownership in Yihaodian.com, Wal-Mart’s fast-growing online supermarket and shopping mall in China.

Wal-Mart’s earlier investment in Yihaodian attracted much attention due to its receipt of only conditional anti-trust approval by Ministry of Commerce (MOFCOM) based on the VIE arrangements involved1. Although details of the further increased Wal-Mart interest remain undisclosed, the conclusion of this further acquisition seems to indicate that Wal-Mart has finally freed itself from the earlier complications that led to the conditional MOFCOM ruling and now wholly owns its online trading business.

In light of the recent relaxations2  announced by the State Council and Ministry of Industry and Information Technology (MIIT) in respect of online trading based e-commerce business, this acquisition is noteworthy as it signals that foreign investment in online trading based e-commerce business is no longer subject to investment or regulatory restrictions.

The Old Restrictions

The online trading based e-commerce business, in practice, has until now been divided into two categories: (a) a self-operated online trading website which may only involve the provision of self-operated goods/services from the website owner to members of the public, and (b) a third party operated online trading platform through which any business owner may provide goods/services to members of public.

Since 2010 a foreign investor has been allowed to operate a wholly owned self-operated online trading website without regulatory restriction, except for the need to complete an online filing with MIIT in respect of its provision of non-profitable internet content  (ICP Registration).

However, third party operated online trading platforms have remained highly regulated and foreign investors have been restricted to joint ventures with not more than 50 percent shareholding and a Value Added Telecoms Service Operating Permit (VATS Permit) from MIIT or its local branch3. Due to lack of clear interpretation from MIIT, online trading platform operators were previously allowed to apply for the Internet Content Provider licence (in Beijing) or VATS Permit elsewhere in China, each containing the business item of “profitable internet information services” (collectively, “ICP License”) to satisfy this VATS Permit requirement. Such joint ventures have rarely been approved by MIIT. Among the limited number of joint venture value telecoms business operators disclosed by MIIT on its official website, Amazon- Joyo joint venture is the only foreign invested online trading platform having obtained an ICP License from MIIT.  

VIE Arrangement

As an alternative to full compliance, a number of foreign investors (including Wal-Mart) choose to indirectly invest in offshore companies (often established and controlled by the domestic founders) having controlling interests in the online trading platforms established in China through a VIE structure, the key features of which are a series of contracts entered into among a DomCo (which typically holds the required licence to operate in a prohibited or restricted industry), its founding (PRC national) shareholders (Founders) and a foreign invested enterprise (FIE), typically in the form of a wholly-owned foreign enterprise (WFOE). The WFOE is established by an offshore holding company (often established in BVI or Cayman Islands) owned jointly by the Founders and the foreign investors desiring to invest in DomCo. The WFOE works alongside the DomCo and in essence, the VIE arrangement seeks to ensure the WFOE enjoys control while avoiding the application of foreign ownerships restrictions and/or stringent government approval process that apply in China.

Chinese authorities have been aware of the existence of such arrangements for many years, although the law did not until recently specifically recognise them. These structures become the norm for Chinese investors raising funds overseas.

However there exists much higher risk for foreign companies using such structures in order to invest or participate in restricted or prohibited business areas such as online trading platform. In August 2012, in the conditional anti-trust approval issued in respect of Wal-Mart’s acquisition of a 33.6 percent interest in the offshore company holding a controlling interests in Yihaodian, MOFCOM expressly prohibited

Wal-Mart from controlling the online trading platform of Yihaodian through VIE arrangements. As a result, the acquisition allowed Wal-Mart to ultimately own a 51.3 percent interest in Yihaodian to the only extent related to its online supermarket business4.

The New Relaxations

2015 has seen significant new relaxations in the e-commerce business sector. MIIT’s January announcement fully relaxed the foreign shareholding cap on online data and transaction processing (limited to profitable e-commerce) business (i.e., the online trading platform business) in the Shanghai Free Trade Zone on a pilot basis, in a move to further opening up China’s economy to the world. This was followed by the amended Catalogue of Industry Guiding Foreign Investment 2015 which further excluded the e-commerce business from the restricted value added telecom services as a nationwide exercise of MOFCOM in March.

Thanks to the Opinion regarding Further Development of E-commerce Business to Foster New Economic Growth Drivers issued by State Council on 4th May (State Council’s Opinion) which calls for lifting of the foreign shareholding cap in the e-commerce business sector, MIIT as the governing authority of China’s telecoms industry, finally issued the Pronouncement regarding Lifting of Foreign Share Holding in Online Data and Transaction Processing (Limited to Profitable E-commerce) Business on 19th  June (MIIT Circular 196). The MIIT Circular 196, following the request of State Council’s Opinion, provides that foreign stakeholders may take up to 100 percent equity interest in a company engaged in the online data and transaction processing (limited to profitable e-commerce) business.

Related to the relaxation, the VATS Permit required for online trading platform has also changed. An ICP Licence is no longer required and is replaced with a VATS permit specifically issued to the online data and transaction processing (limited to profitable e-commerce) business.

According to publicly available business registration information from government sponsored database to date, Wal-Mart seems to be indirectly holding 50 percent equity interest in Yihaodian through a joint venture VATS company established in Shanghai Free Trade Zone. Through the acquisition of the remaining 50 percent interest in this VATS company (which now is fully permitted as above), Wal-Mart will be able to finally have full ownership of Yihaodian.  

A Free New World to Come?

Foreign investors wishing to participate fully in China’s online trading based e-commerce sector can be reasonably optimistic in view of the relaxations above. It will become much easier for foreign investors to operate wholly owned online trading based e-commerce business after Wal-Mart’s acquisition.

However, the fact that the rules are being simplified does not mean that there are no difficulties or uncertainties. For example, the establishment of a VATS company engaged in online trading is still subject to threshold requirements provided under MIIT Circular 196, which are quite different from those applicable for the Shanghai Free Trade Zone. The main reason is because MIIT Circular 196 requires that all threshold requirements (except for the shareholding percentage) set out in the FITE Regulations should still apply (including the minimum registered capital which remains RMB 10 million, even though the same has been reduced to RMB one million if the business is based in Shanghai Free Trade Zone). In addition, FITE Regulations also require the investor to have sound business records while the relevant Shanghai Free Trade Zone rules only require the investor to remain compliant with China’s telecoms’ regulations. Details of relevant approval and registration procedures remain to be seen.

Therefore, although China turns to welcome foreign investors to find fortune in the e-commerce business sector, it is still a little early to say it is now a free marketplace and future developments can be expected.