On 19 June 2015, the Ministry of Industry and Information Technology (MIIT) of the PRC promulgated the Circular on Relaxing Restrictions on Foreign Ownership Ratio in Online Data Processing and Trade Processing Services (Operational E-commerce) (the Online Circular). The Online Circular removes restrictions on foreign ownership in a category of online businesses that includes e-commerce platforms. The new rules will allow 100% foreign ownership of online data processing and trade processing services businesses (‘operational e-commerce businesses’) throughout China. The circular has immediate effect.
This briefing provides an overview of the potential impact of the Online Circular on foreign investors as well as on the variable interest entity structures (VIE) commonly used by Chinese e-commerce companies to list overseas and by some foreign investors to access sectors of the Chinese economy that would otherwise be off limits to them.
Historical regulatory development
Before China joined the WTO in 2001 foreign investors were prohibited from investing in companies offering value added telecommunications services (VATS), which includes e-commerce businesses. This restriction has been gradually relaxed over the fifteen years since WTO accession.
In December 2001, the State Council issued the Administrative Provisions on Foreign Investment in Telecommunications Enterprises (the Administrative Provisions). The Administrative Provisions allowed up to 50% foreign ownership of operational e-commerce businesses (from 2003 onwards). Following the release of a MofCom Circular in August 20101, MIIT no longer requires foreign-invested entities that operate a website selling only their own products to obtain a licence to conduct VATS activities. However, the restrictions remained in place on foreign companies operating e-commerce platforms on which third party goods are sold.
The 50% foreign ownership ratio was increased slightly to 55% in the Shanghai Free Trade Zone (SFTZ) in January 2014 under an Opinion2 issued jointly by MIIT and Shanghai Municipal People's Government. One year later, on 13 January 2015, a further MIIT Circular3 completely lifted the restriction on foreign ownership of e-commerce businesses within the SFTZ.
The Online Circular has now expanded this relaxation nationwide, allowing full foreign ownership in all forms of e-commerce business throughout China.
Policy to further strategic foreign investment in operational e-commerce businesses
The Online Circular reflects the Chinese government’s latest push to develop the internet and e-commerce sector, which has exhibited enormous growth in recent years and already occupies a key position in the Chinese economy. Wholly foreign-owned entities can now apply for a VATS licence not only within the SFTZ but nationwide to operate online data processing and trade processing services, including e-commerce. The huge potential of the Chinese e-commerce market will no doubt attract more foreign investment into this field.
However, the Online Circular will likely benefit strategic foreign investors more than financial investors. Article 10 of the Administrative Provisions stipulates that the main foreign investor that invests in a VATS business must possess relevant industry experience and display an operational track record in the relevant field. Companies such as Amazon.com and eBay would clearly not have any issue in demonstrating that they fulfil the track record requirements, whereas controlling investments from overseas private equity firms or investment funds might face an obstacle.
A mitigant to proposals to possibly outlaw VIEs
Many foreign investors are known to have bypassed restrictions under the current Foreign Investment Law in China by putting in place structures where the Chinese partner is the legal owner of the shares in the relevant Chinese companies, but where the foreign partner effectively controls the onshore vehicle through a set of contractual arrangements and is able to extract the profit from the business. The structure is known as a VIE structure. Many Chinese e-commerce companies have also adopted VIE structures when listing on overseas exchanges through non-Chinese vehicles (typically a Cayman Islands or BVI vehicle), in order to continue to operate the business in China within a VATS sectors. Historically the Chinese authorities had broadly tolerated these VIE structures, but new rules proposed in the draft Foreign Investment Law earlier this year would limit the scope of foreign investors to employ VIE structures in future.
The draft Foreign Investment Law provides that any investment within a ‘prohibited’ category of a proposed new negative list made through a VIE structure will be viewed as a prohibited foreign investment. The draft law puts forwards three options as to how existing VIEs might be dealt with, ranging from grandfathering of pre-existing VIEs controlled by “Chinese investors” (subject to notification) to a requirement for all pre-existing VIE to seek explicit foreign investment approval based on all relevant factors, which will include the identity of the de facto controlling entity. The proposed Foreign Investment Law therefore stands to have a major impact on foreign investment across a range of restricted sectors in China, including VATS.
The Online Circular offers a solution for companies operating in online data processing and transaction processing businesses, including e-commerce, to now convert their VIEs into fully foreign-owned entities.
Likely to encourage return of China concept stock companies
The relaxed foreign ownership policy could also potentially result in further delistings of Chinese e-commerce companies from overseas stock exchanges and the relisting of those companies in China. This is an ongoing trend across multiple sectors already. Eleven U.S.-traded Chinese companies have announced plans to delist their shares from U.S. exchanges during 2015. Recent take-privates have included data-centre firm 21Vianet Group and social-networking company Renren. The Online Circular may accelerate this trend within the VATS sector by making it easier for these businesses to prepare for re-listing in China. Potentially online businesses will now be able to re-list in China without needing to first dismantle the overseas portions of existing VIE structures (subject to the prevailing rules of the China Security Regulatory Commission).
It is not clear at this stage how the telecoms authorities in China will apply the Online Circular. Both MIIT and local telecoms authorities have generally adopted very stringent criteria in reviewing foreign investors’ VATS applications. As a result, only a very limited number of foreign invested enterprises have been able to obtain a VATS licence (in sectors that had already been opened up to foreign investment and ownership).
It also remains to be seen whether any other pilot programs in the SFTZ involving the VATS sector will similarly be expanded nationwide in the months to come.