VIE-structured companies have existed in China for more than 20 years, and there have been continuous and endlessly discussions for VIE related issues. It is also commonly viewed that relevant Chinese regulators as well as judiciaries were reluctant in general to provide feedback on matters involving such structures. Even the new Foreign Investment Law which was issued by the National People’s Congress on March 15, 2019, chose to lay aside the VIE issue, taking a big step back from the 2015 Exposure Draft1. Recently, many of our clients have been asking us: has the State Administration for Market Regulation (the ”SAMR”, Chinese Anti-monopoly Authority) started to review merger filings involving VIE-structured companies, and if not, what’s the possibility for the SAMR to conduct such review? This article would like to, from the perspective of anti-monopoly review, share some thoughts on these issues and give some advice for VIE-structured companies that are active in M&A market.
Has the SAMR started to review merger filings involving VIE-structured companies?
On April 4, 2019, the SAMR published the list for unconditionally approved merger filings in the first quarter of 2019. With this list, some organizations or scholars suggest that the filing for a proposed joint venture by Yonghui Superstores, PARKnSHOP and Tencent Mobility (the “Yonghui transaction”) is the first publicly known transaction involving internet giant (Tencent) that adopts a VIE structure, while in the past, it appeared that VIE-structured companies had, one after another, chosen to ignore the merger filing requirement or had encountered difficulties in completing the filling.
However, after a closer look at the “Yonghui transaction”, the governance structure of the proposed joint venture seems to show that Tencent Mobility would possibly not be one of the controllers2 of the joint venture, and as the list has also demonstrated, only Yongui Superstores3 and PARKnSHOP are “undertakings participating in concentration”. According to relevant Chinese rules on merger filings, it can be inferred that the SAMR did not even need to focus on Tencent Mobility, not to mention its VIE structure. Therefore, even though a VIE-structured company was involved in the transaction, the filing and the review for the “Yonghui transaction” very possibly did not genuinely touch upon the Internet giant nor relevant VIE issues.
When we are talking about VIEs, what are the relevant issues?
The VIE structure was created mainly to circumvent relevant Chinese regulatory requirements regarding foreign investment. Meanwhile, as the VIE structure is set up through a series of agreement (“control through agreement”), which is different from control through stocks or assets, it is not directly covered or regulated by the Provisions on Merger and Acquisition of Domestic Enterprises by Foreign Investors (“No.10 Regulation”)?. Therefore no prior approval by the Ministry of Commerce (“MOFCOM”) or the China Securities Regulatory Commission ("CSRC") would be necessary for relevant transactions conducted through this approach.
Thus, it can be concluded that there are two main legality issues for VIE structure: whether the structure itself is valid (the “validity issue”), and whether the investment itself is in compliance with relevant industrial policies (the “compliance issue”). We will then analyze how a merger filing review could touch upon the above two issues.
The SAMR is not in the position to opine on the “validity issue”, and therefore an anti-monopoly approval does not equal to an acknowledgement of the legality of the VIE structure.
The SAMR was established in March 2018, and it has an integral and all-rounded market regulation function. From the perspective of anti-monopoly, the anti-monopoly law enforcement responsibilities of the three agencies - the National Development and Reform Commission (NDRC), the Ministry of Commerce (MOFCOM), and the State Administration for Industry and Commerce (SAIC) are now gathered under the same roof.
As the predecessor for performing the merger filing review function, the MOFCOM on the other hand is also the authority that promulgated the No.10 Regulation, and it is known that so far, no “M&A with related party” (usually the preparatory process in offshore listing) as stipulated in the NO. 10 Regulation has been approved by the MOFCOM, and therefore the VIE structure was adopted as an alternative. Consequently, assuming that a merger filing involving VIE-structured companies is presented before the MOFCOM, there would be concerns about whether an approval would constitute an acknowledgement of the validity of VIE structure from the MOFCOM’s standpoint. This is also showed in the filing review decision for the August 2012 Walmart/Niuhai Holding transaction, where the MOFCOM carefully expressed, that “WalMart is not allowed to use its VIE structure to engage in the value-added telecom services currently operated by Yishiduo E-Commerce (Niuhai Holding’s subsidiary controlled through VIE agreement)”. It is clear that the MOFCOM merely reiterated relevant requirements? in the 2011 Industrial Guide for Foreign Investment (effective at that time) for value-added telecom services, while in the other parts of the decision, it evaluated the competition concerns arising out of the transaction and adopted remedy measures to prevent the possible anti-competition effects similar to other high-profile cases. Following the opening up of foreign investment in value-added telecom services, especially in e-commerce, this barrier as well as other barriers for this transaction has been removed in May 2016 by the MOFCOM.
However, the new SAMR could, from a relatively pure market regulation’s perspective, review merger filings either involving companies in general sense or VIE-structured companies, and evaluate the competition concerns without much regard for the external form of the filing parties. More importantly, different from the MOFCOM, the SAMR is not the competent authority to opine on the “validity issue” of the VIE structures, an anti-monopoly approval only means that the SAMR recognizes the concentration would likely not harm competition in relevant market, but it does not acknowledge the legality of the VIE structure. With this in mind, it is suggested to think twice when evaluating whether to file for merger review or not for transactions involving VIE-structured companies.
The SAMR is also not in the position to opine on the “compliance issue”, and therefore an anti-monopoly approval does not equal to an acknowledgement of the compliance of the foreign investment.
Except for the validity issue, another main difficulty is that the filing party shall commit in the merger filing form that it shall comply with Chinese laws and regulations. While the VIE structure remains in the grey area of law, some people argue that an approval by the SAMR could be viewed as an acknowledgement of the compliancy of the structure.
The 2015 Exposure Draft of the Foreign Investment Law sought to address the compliance issue of VIE-structured companies. For example, the Draft included relevant legal liabilities for making investment, through VIE or other methods, in prohibited industries or in restrictive industries without approval, and it also provided some available methods to deal with the preexisting VIE structures. However, given that there are a great many of domestically-operated companies notably in Internet, education and media industries, adopting VIE-structures and active in foreign capital markets, making enormous contribution to the development of Chinese economy, it is relatively difficult to figure out a satisfying way to handle the compliance issue from the general foreign investment regulation’s perspective?. What’s more, the SAMR or other administrative regulators-the governmental agencies in charge of the regulation of a company’s general matters such as its establishment or change of company form- are not the competent authorities to solve this issue. Rather, industrial regulators-the governmental agencies in charge of the regulation of a company’s operation in a specific industry- would be in a better position to fill in the blank. This is also reflected in China Supreme People’s Court’s ruling in Changsha Yaxing v. Beijing Normal University Anbo, a contractual dispute case?, in which the court opined that “for foreign equity’s participation in or de facto control over private schools that engage in compulsory education... it is the education administrative department’s duties to regulate such behavior.” Given that the SAMR is not an industrial regulator, it is not the one to examine the compliance issue for such investment, and thus, a decision issued by the SAMR does not mean that the structure adopted by the filing party is necessarily “whiter or darker”.
On the other hand, with the degree of market concentration continuously increasing in some industries, there have been voices raised against either specific transactions that might threaten or have already dampened competition, or the somehow established “no response” practice, especially when the law enforcement agency has the obligation, according to law, to investigate the transaction if the transaction has or may have anti-competition effect?. As long as the SAMR figured out its position for the “validity issue” and “compliance issue”, it is foreseeable that it would at some time eventually step in to review such filings so as to ensure the fair market competition.
Other administrative regulators have already touched upon the VIE-structured companies. Let’s wait for a little bit longer for the SAMR.
After discussing about the “validity issue” and “compliance issue”, it seems that there is no material barrier for the SAMR to complete review of merger filings involving VIE-structured companies. Moreover, if the SAMR were to review such filings, it would not be the first one to touch upon the VIE-structured companies. Other administrative regulators such as the State Administration of Foreign Exchange (“SAFE”) and the CSRC have already expressed their attitude to VIE-structured companies in relevant rules and regulations. Let’s take a closer look and analyze the takeaways therein:
As early as 2005, the SAFE issued No. 75? rule (now nullified), which stipulated “a round-trip investment means direct investment activities in China by a domestic resident through a special purpose company by means of, but not limited to... establishment of a foreign investment enterprise within China so as to purchase stocks in or ‘control through agreement’1? over domestic assets.” Then in the subsequent No. 3511 rule, the SAFE stipulated “’control’ in this rule shall mean business management rights, right to earnings or decision making rights of a special purpose vehicle obtained by a Chinese resident through acquisition, trust, holding on behalf of others, voting rights, buyback, convertible bonds, and etc.” It can be seen that from the perspective of foreign exchange regulation, stock holding, VIE-structure, or others are just different means of exercising control. In fact, the regulator does not focus on how the control is exercised, but how these relevant activities would need to follow the foreign exchange regulation rules.
Similarly, VIE-structure or more generally, the “control through agreement” also appears in recent Chinese security regulation rules. In March and June 2018, the General Office of the State Council and then the CSRC issued rules12 regarding domestic issuance of shares or depositary receipts by innovative enterprises. These rules stipulate “if an overseas underlying securities issuer has different voting rights of shareholders, VIE-structure or similar special arrangements, it shall fully and elaborately disclose relevant information, especially risks and corporate governance at notable places in its prospectus and other public offering documents...” Then in January 2019, the CSRC’s rules13 regarding China’s new Science and Technology Innovation Board further indicated, that Red Chip companies in accordance with relevant rules can apply to be listed on Science and Technology Innovation Board. These security regulation rules show that as long as the legitimate rights and interests of investors are properly protected, the CSRC welcomes all kinds of existing form of companies including VIEs or other special arrangements to Chinese capital market.
To sum up, though the “validity issue” remains untouched in Foreign Investment Law, and different industrial regulators may have evolving opinions on the “compliance issue” for foreign investment in specific sectors along with China’s opening up process, administrative regulators such as the SAFE and the CSRC possess a relatively open attitude to VIE-structure companies as long as regulation rules for relevant necessary purposes are met. Therefore, if the SAMR were to review filings involving VIE-structured companies, it can adopt a similar approach or just ignore this external structure. After all, the SAMR could simply focus on the competition law issues for a transaction in its anti-monopoly review.
Looking forward and beyond: some initial advice for VIE-structured companies in merger filing review in China
As previously demonstrated, though the SAMR has not genuinely touch upon VIE-structured companies in the “Yonghui transaction”, this article believes that there is no material barrier for the SAMR to review filings involving VIE-structured companies. Moreover, as the SAMR is not the competent authority to examine the “validity issue” or “compliance issue” of VIE-structured companies, a review decision by the SAMR is not equivalent to an acknowledgement of the legality of the structure nor the compliancy of the foreign investment. As other administrative regulators such as the SAFE and the CSRC have already went a step further, it is believed that the SAMR would, quite possibly, be more proactive to review merger filings involving VIE-structured companies in the very near future.
Above all, it is suggested that relevant parties to the transaction have a merger filing lawyer to evaluate whether the VIE-structured company would be one of the “undertakings participating in concentration”, whether the transaction needs to file for merger review, the time and strategy for conduct the filing, and etc., so as to minimize the anti-monopoly risks therein. For VIE-structured companies that are active in the M&A market, it is highly suggested to keep a critical mind when adopting the former “no filing strategy” for merger review in China.
1.The 2015 Exposure Draft of Foreign Investment Law made it clear that it would like to address the legal ambiguity for VIEs by requiring the identification of the de facto owner of the domestic entity, therefore bringing contractual or trust arrangements as well as VIE structures into the scope of regulation.
2.According to announcement of Yonghui Superstores which could be found at http://www.cninfo.com.cn/new/disclosure/detail?plate=sse&stockCode=601933&announcementId=1205530367&announcementTime=2018-10-25, Tencent Mobility would hold 10% stocks in the joint venture, and would only have 1 seat in the BOD with 6 members.
3.According to public information, Linzhi Tencent, also a subsidiary of Tencent, is one of the shareholders of Yonghui Superstores, and it is unlikely that the SAMR would look at Linzhi Tencent when evaluating Yonghui Superstores’ turnover or market shares, since Linzhi Tencent is only a minority shareholder. Moreover, though Tencent also holds stocks in JD, another minority shareholder of Yonghui Superstores, it is likely that the SAMR mainly focused on Yonghui Superstores’ actual controllers, two natural person, similar to its disclosures in the annual report.
4.In No.10 Regulation, Article 11 stipulates that “where an domestic company, enterprise or natural person carries out an M&A of a domestic company that is related to itself, in the name of an overseas company duly established or controlled by such company, enterprise or natural person, an application shall be submitted to the MOFCOM for review and approval.”
5.In 2011 Industrial Guide for Foreign Investment, foreign entities shall not hold more than 50% stocks in Chinese entities engaging in value-added telecom services.
6.For example, when the Ministry of Justice released the 2018 exposure draft for the implementing regulation for the Law on the Promotion of Privately-run Schools, in which it clearly stipulated that “companies that are de facto controlled by foreign entities shall be prohibited from exercising de facto control over private school that engage in compulsory education in China.” Though this is in line with regulations in the 2018 foreign investment negative list, price of shares of US listed companies, TAL and New Oriental Company, dropped down correspondingly.
7.长沙亚兴置业发展有限公司与北京师大安博教育科技有限责任公司合作合同纠纷上诉案[Changsha Yaxing v. Beijing Normal University Anbo on contract disputes] (2015)民二终字第117号,(The Civil Division II of the Supreme People’s Court, Jul. 2nd, 2016) CLI.C.9036337.
8.Article 4 of Rules of the State Council on Declaration Threshold for Concentration of Undertakings.
9.Notice on Issues relating to Foreign Exchange Administration for Financing and Round-trip Investments by Domestic Residents through Overseas Special-purpose Companies.
10.Though VIE is an accounting term, and “control through agreement” is a legal term, there is no significant difference for these two terms for the purpose of this article.
11.Notice of the State Administration of Foreign Exchange on Issues Relating to Foreign Exchange Control for Overseas Investment and Financing and Round-tripping by Chinese Residents through Special Purpose Vehicles.
12.Notice of the General Office of the State Council on Forwarding the Opinions of the China Securities Regulatory Commission on Launching Pilot Projects for the Domestic Issuance of Shares or Depositary Receipts by Innovative Enterprises, March 2018; Administrative Measures for the Issuance and Trading of Depositary Receipts (for Trial Implementation), June 2018.
13.Opinions on setting up the Science and Technology Innovation Board and experiment of registration-based IPO system in Shanghai Stock Exchange, January 2019.