Concetta notes

DEALTALK-China’s US companies mull restructuring as crackdown looms


* Companies preparing reorganisations for worst-case scenario* Move seen as hint China wants more companies to list at home* Telecoms and internet firms affected, shares declineBy Rachel Armstrong and Stephen AldredSINGAPORE/HONG KONG Oct 12 (Reuters) - A looming Chinese government crackdown on a corporate structure used by almost half of all U.S.-listed Chinese stocks coupled with growing investor uncertainty has prompted companies to mull major restructuring plans.New rules expected to apply to variable interest entities, a structure used by several of China’s internet giants, are not only forcing executives to consider various options, the rules are rattling investors as well.Shares in China based, U.S. listed internet companies Sina Corp and Baidu Inc have slumped around 26 percent and 12 percent since Reuters reported on Sept. 18 that the China Securities Regulatory Commission (CSRC) had suggested the government take action against VIEs.Any new rules from the Chinese authorities are not expected to shut-down existing VIEs, but lawyers say that the ongoing uncertainty is pushing several companies to investigate contingency plans.”We’re hoping we will never have to use them, but we are working on plans for unwinding existing VIE arrangements and making new investments using alternative structures to prepare for the worst case scenario,” said Marcia Ellis, a partner at Ropes & Gray law firm in Hong Kong.VIEs, (Variable Interest Entities) get around official restrictions on direct foreign investment into sectors deemed important to China’s interests. Forty-two percent of China companies listed in the U.S. use the VIE structure, according to researchers at Peking University.They are particularly popular in the internet sector, where foreign investors are barred from commercial activities, as VIEs give investors the earnings flow and control of a domestically-owned company through a series of service contracts rather than equity ownership.But now a crackdown on VIEs is looming, after a raft of accounting scandals involving overseas listed Chinese companies erupted on North American stock exchanges.Alibaba Group’s acrimonious and public dispute with Yahoo also put the structure in the spotlight when the group’s chief executive Jack Ma allegedly transferred its lucrative online payment platform Alipay to a separate VIE without the approval of the group’s major shareholders.Mainland Chinese media reports say the CSRC is suggesting that companies already using the structures will be exempt from most of the new rules, but international lawyers say that doesn’t mean China’s authorities will give them an easy ride.”Historically, even when the Chinese government makes regulatory changes that grandfather existing companies, they still make it very difficult for them to prosper in the future unless they conform to the new regulatory environment,” said Lester Ross, a partner at WilmerHale law firm in Beijing.Reuters reached Baidu, Sina and Alibaba, three of the most well known companies that use the VIE structure if they had looked at restructuring. Baidu and Sina both declined comment, while Alibaba referred to a recent speech made by their chief executive Jack Ma during a speech at Stanford University in the U.S. in September.”The VIE is a great innovation,” but “we’ve got to make the VIE really transparent,” he said, adding that he didn’t expect the government to shut the entities down.Last week, the Public Company Accounting Oversight Board, a U.S. accounting watchdog, warned auditors that companies may assume they can consolidate the financial results of a VIE into their own balance sheet “even though there might be significant uncertainties regarding the economic substance of those arrangements.”Online video company Tudou Holdings Limited showed how VIE contracts can leave investors vulnerable when it was looking to list on the Nasdaq late last year.The offering was delayed eight months after Tudou’s founder Gary Wang, who had a 95 percent interest in Tudou’s VIE, was hit with a lawsuit filed by his ex-wife. His former wife was demanding a portion of his VIE holding and if she had been successful, she could have, in theory, kept a significant part of its earnings that would otherwise have gone to Tudou’s shareholders.Wang eventually settled with his ex-wife, but the case delayed Tudou’s IPO from December 2010 to August 2011.RESTRUCTURING OPTIONSThere is no one-size-fits-all alternative to a variable interest entity structure, which is why the structure has been so popular. Any restructuring would involve changing the nature of the relationship between the foreign investors and the Chinese owners of the onshore licensed operations.Some companies operating in sectors with no, or relatively few restrictions on foreign ownership, could dismantle the VIE and instead form an onshore joint venture.Other companies in sectors that have tougher laws on foreign ownership would face a more complicated task, but lawyers are advising that investors need to review their VIE contracts and see if they can enact stronger corporate governance controls.”While there isn’t necessarily a ‘silver bullet’ solution for every investment, hence the long-standing popularity of VIEs, developing contingency plans for the next-best alternatives is clearly preferable to getting caught completely off-guard if the regulatory winds shift direction,” said Ropes & Gray’s Ellis.In the long term it is expected that any changes to VIEs, which would be likely to come from the Ministry of Commerce and Ministry of Industry and Information Technology as well as the CSRC, would be accompanied by an effort from the authorities to coax overseas-listed Chinese companies back to the domestic market.”I think what the CSRC wants to do is encourage these valuable companies to list within China so that they have a better control over them,” said Virginia Tam, a partner at White & Case in Hong Kong.New rules will take time though, meaning investor uncertainty is likely to linger.”The Chinese government isn’t in the business of issuing press releases that would be helpful to private businesses,” said Howard Wu, a Shanghai-based partner at Baker & McKenzie.”I think it’s unlikely you’re going to get some official government pronouncement anytime soon. It is a very complicated issue.”



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