On November 14, 2019, the U.S.-China Economic and Security Review Commission (USCC) released its 2019 Report to Congress (2019 Report). In the report, the USCC recommends, among other things, that “Congress enact legislation to preclude Chinese companies from issuing securities on U.S. stock exchanges if: … [t]he company utilizes a variable interest entity (VIE) structure….” Many potential issuers and investors raise concerns in this regard. We have received various related questions recently. This Update summarizes our views. As each individual case has its own characteristics, please feel free to contact us if you have specific questions.
What does the 2019 Report mean?
The USCC is a congressional commission created through a congressional mandate in October 2000 and is responsible for monitoring and investigating national security and trade issues between the United States and China. The USCC holds regular hearings and roundtables, produces an annual report on its findings and provides recommendations to Congress on legislative actions related to China. As a policy think tank, the USCC has no direct legislative power although it can make recommendations for legislation.
In its 2019 Report, the USCC did not conduct any in-depth analysis on why it made the VIE-related recommendation. The report summarily concluded that because the VIE structure has been viewed as “unenforceable” within China’s legal system because it was often used to circumvent foreign direct investment restrictions, investments in U.S.-listed Chinese companies with VIE structures are inherently risky.
Will VIE structures not be allowed for listings in the United States?
Our view is that the likelihood that the U.S. Congress will enact legislation to implement the USCC recommendation in short term is low for these reasons:
- The concerns about VIE structures expressed in the 2019 Report are legitimate in principle. However, such concerns have existed for decades in both United States and Chinese capital markets’ legal practices. The Chinese government and regulatory authorities have never formally challenged the legality of the VIE structure, and the structure has become a prevailing choice for China-based companies seeking listing overseas. During these decades, China-based companies using VIE structures have been welcome to list in the U.S.
- The recommended legislation, if ever implemented and depending on the actual provisions of such legislation, will have fundamental and far-reaching effects on many China-based companies currently listed or contemplating listing in the United States. The economic and capital market impact will be immense. The exclusion of quality companies from the world’s second largest economy will not only have a considerable negative effect on the activity, reputation and competitiveness of the U.S. capital markets but will also cause substantial losses to American investors.
- As stated above, the USCC has no legislative power. Whether Congress will act on its recommendations depends on many factors. The need to balance consideration of many political and economical forces, as well as the inherent uncertainty and procedural complexity of the U.S. legislative process, should make the U.S. government, including the Congress, prudently approach the proposed legislation.
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