China’s President Xi Jinping believes there is already too much foreign influence in Chinese society, meaning that he would like to limit to the greatest extent possible offshore ownership of China’s enterprises. China’s ruler, foreign investors often forget, is willful and will do what he wants. He will likely step up a long-running campaign to harass foreign businesses and begin to force offshore investors out of his country. Pictured: Xi (center) at the military parade for the 70th anniversary of the establishment of the People’s Republic of China, on October 01, 2019 in Beijing. (Photo by Andrea Verdelli/Getty Images)
“What do investors need to understand, for those investors that are thinking maybe I want to dip my toe in investing in Chinese companies?” asked Maria Bartiromo on July 14, during her Fox Business show, “Mornings with Maria.”
The answer is that Beijing is on the road to expropriating the shares held by foreigners in China’s tech companies. The complicated financial structures these companies have used to attract foreign investment are questionable under Chinese law and give Xi Jinping, the Chinese ruler, an excuse now to begin a confiscation campaign.
We begin with Beijing’s stunning regulatory attacks on DiDi Global. The company’s shares started trading on June 30 on the Big Board, where it raised $4.4 billion in an initial public offering. Two days later, China’s Cyberspace Administration halted downloads of DiDi Global’s popular ride-hailing app, DiDi Chuxing.
Then, Chinese regulators started investigation after investigation, coming down hard on the business. For instance, on July 16 the Cyberspace Administration and six other Chinese government agencies—the Ministry of Public Security, the Ministry of State Security, the Ministry of Natural Resources, the Ministry of Transport, the State Taxation Administration, and the State Administration of Market Regulation—began “an on-site cybersecurity inspection” of DiDi Chuxing.
Why target DiDi? For one thing, it has a “variable interest entity” structure, which tech enterprises have used to list on foreign exchanges. VIEs, as they are known, evade Chinese law, which prohibits foreign ownership of Chinese tech companies. Through a series of intricate contractual arrangements, however, these structures effectively give foreigners the economic benefits of ownership.
The prohibition on foreign ownership is why investors, in one of the most anticipated IPOs in history, did not buy stock of the company operating the Alibaba businesses in China. Instead, in 2014 they purchased shares of Alibaba Group Holding Limited, incorporated in the Cayman Islands. Alibaba Group Holding Limited tops a complicated VIE structure.
Alibaba’s VIE was dodgy. China’s Supreme People’s Court, the highest tribunal in the People’s Republic, in 2012 declared the contractual arrangements under consideration in the Chinachem case, similar in effect to VIE structures, to be illegal under China’s Contract Law.
Chinachem, a Hong Kong business, made an investment, indirectly, into China Minsheng Banking Corp. After the value of the Minsheng shares skyrocketed—Chinachem’s ownership interest increased by almost 64 times—the Chinese parties cut out Chinachem, confiscating its interests in the bank.
The Chinachem decision held that complicated schemes will not be respected if they evade the clear intent of Chinese law. China is a civil law jurisdiction, so the decision is technically not precedent, but the court’s reasoning is both sound and consistent with jurisprudence in other countries. Not surprisingly, arbitration rulings in Shanghai on VIE structures have come to the same result.
The Minsheng shareholders are not the only devious actors. Jack Ma, Alibaba co-founder and once its…