On January 13, 2015, China’s Ministry of Industry and Information Technology (the “MIIT”) announced that wholly foreign-owned enterprises (“WFOEs”) are now allowed to operate “online data processing and transaction processing (operational e-commerce)” within China (Shanghai) Pilot Free-Trade Zone (the “Shanghai FTZ”). The Shanghai Communications Administration (the “Shanghai MIIT”), the local counterpart of the MIIT, is authorized to carry out the pilot program implementing the foregoing decision. E-commerce companies incorporated in the Shanghai FTZ can conduct their business nationwide. This is a significant opening up in this area and we expect future foreign investments in China’s e-commerce space to gradually abandon use of the variable interest entity structure (the “VIE Structure”) in favor of simpler deal structures.
Evolution of China’s Regulation of E-Commerce Businesses
Historically, foreign investors were required to form joint ventures with local partners to invest in e-commerce businesses in China and the foreign investors’ shareholding in the businesses could not exceed 50%.
In an August 2010 notice (the “2010 MOFCOM Notice”), the Ministry of Commerce began to allow duly approved foreign-invested manufacturing enterprises and commerce enterprises to conduct online sales without being subject to any shareholding restrictions, and the related enterprises only needed to file with the MIIT. However, according to the 2010 MOFCOM Notice, a foreign-invested enterprise that uses its own online platform to provide network services to third parties must obtain an operational internet content provider license (the “ICP License”) from the MIIT. MOFCOM distinguishes between two types of e-commerce businesses under the 2010 MOFCOM Notice and regulates them differently: (i) enterprises that sell their own merchandise or buy and resell third-party merchandise (i.e. holding inventory) (“Retailing E-Commerce”); and (ii) enterprises that offer platform services to merchandise distributors and retailers (“Platform E-Commerce”). Since MIIT was not a party in issuing the 2010 MOFCOM Notice, there has been lingering doubt in the market with respect to how MIIT will regulate the aforementioned two types of e-commerce businesses. In early 2012, O’Melveny helped a leading e-commerce enterprise restructure its businesses using a WFOE structure and successfully raise capital from leading private equity investors. We believe this was the first leading e-commerce business in the market to adopt a WFOE structure.
On January 6, 2014, the MIIT and the Shanghai Municipal Government jointly issued an opinion, according to which foreign investors’ shareholding restrictions for investment in “online data processing and transaction processing (operational e-commerce)” businesses formed in the Shanghai FTZ was increased to 55%. MIIT’s January 2015 announcement further relaxed foreign investors’ shareholding requirement for investment in China’s e-commerce businesses. After the issuance of the MIIT announcement, we consulted Shanghai FTZ and learned that a WFOE structure is allowed for both Retailing E-Commerce and Platform E-Commerce. This is a significant development for foreign investments into e-commerce businesses in China. As China starts to expand its free trade zone experiment nationwide and amends its current foreign investment catalogue, we expect a complete opening up of e-commerce businesses to foreign investment soon.
End of VIE Structure for E-Commerce Businesses?
For the past 15 years, the VIE Structure has been the typical structure used for foreign investment in China-based e-commerce businesses. The VIE Structure has many widely known risks, uncertainties and limitations. With the deregulation of China’s e-commerce businesses and China’s proposed amendment of its entire foreign investment regulatory system, including regulation of VIE Structures (please see our prior alert on this subject at here), we expect existing e-commerce enterprises to gradually unwind their VIE Structures and new foreign investments in China-based e-commerce businesses to adopt simpler WFOE structures.
However, it is worth noting that many e-commerce businesses in China have complex and multifaceted business models. In addition to the typical Retailing E-Commerce business and Platform E-Commerce business, many e-commerce businesses in China also have other businesses or provide other services (such as internet and mobile social networking services or online payment services) that fall within the definition of value-added telecommunication service, which are still subject to foreign investment restrictions. These e-commerce businesses will still need to utilize creative structures (possibly including VIE Structures) for such restricted activities.