Reading The VIE Tea Leaves


Photo: p22earl via Flickr

David Wolf at Silicon Hutong ventured into the prognostication biz this morning with a post on our old friend the variable interest equity, or VIE, structure (see this earlier post for a definition). David sees the recent fun and games with Alipay as a warning of things to come:Sometimes, when the Chinese government is considering or planning a policy change, they will make some sort of formal announcement in advance. But not always: often, they will signal their intentions more subtly.

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Xinhua may have issued such a warning to foreign investors in Chinese online companies a few weeks ago. In an article examining the Yahoo!-Alipay dispute, Xinhua suggested that the structure Yahoo! used to invest in Alibaba – and that is used my a number of overseas investors to circumvent laws restricting foreign investment in the Internet – may no longer escape government scrutiny.

The issue for David seems not to be whether the government is signalling a crackdown on VIE structures, but when the hammer will actually fall.

His conclusion? The government regulators will always catch up to dodgy structures eventually, and foreign investors may want to dust off their exit strategy plans before it’s too late.

Is he right? Well, I’m going to come out with a very firm “Not necessarily.” As @sagebrennan noted during a brief Twitter conversation on the topic this morning (come to think of it, all Twitter conversations are brief), assessing risk in this area is tough, given the large number of variables involved.

Indeed. To me, it all comes down to government motivation. I don’t really agree with David that the government regulators will eventually come for you with this kind of stuff. They may or may not, it depends on what’s in it for the government and the industry they are trying to regulate.

These VIEs, or “Sina Structures” as I still insist on calling them, have been around for a decade in one incarnation or another. The government has known about them for probably 9.5 years and has continued to look the other way thus far. Why? Because Beijing saw the Internet as a key industry that could use access to foreign capital. Expediency, man, it usually explains a great deal.

But that was then, how about now? China’s Internet industry is not as beholden to foreign cash as it used to be, so the government doesn’t need to keep those capital channels open as wide as they used to be. Moreover, now that China’s Internet industry has “grown up” and is even more powerful than Beijing would have thought possible a few years ago, reasserting domestic control is a relatively significant policy goal.

Look at other industries: automobiles, telecom, clean energy. Look at China’s tech transfer policy. Look at China’s economic strategy since 1978. See a pattern? Open up, allow in cash and tech, learn and grow, foster domestic alternatives. It’s been a wonderful development strategy.

Arguably, China has been successful in tapping foreigners for cash and tech in the Net sphere and now has the luxury of pulling back and asserting control.

But back to David’s prediction. Given that the government, and Chinese Net firms, do not need foreigners as much as they used to, does that necessarily mean a crackdown on VIEs? I don’t think so.

Here’s a provocative way to look at this, which may sound a bit like a conspiracy theory:

The whole VIE fictional ownership deal is actually pretty good for the government, all things considered. Instead of looking at it as something that canny foreigners (and lawyers) dreamed up to sidestep government restrictions, I also can see it as a handy way for the government to maintain ultimate control over foreign investment.

Think about the government’s options. It could have aggressively enforced foreign ownership restrictions from the beginning. Result? No foreign investment and arguably a much slower growth in China Net firms.

Second option: completely open the Net industry to foreign investment. Result? Bigfooting big time, by Microsoft, Yahoo, Google, etc. Would have been difficult for the Sinas, Sohus, and Baidus to overcome market barriers.

Third (middle) option: allow foreigners to invest, but do it in such a way that the government will maintain ultimate control. How to do it? Sucker them into investing through illegal structures. If and when the government decides to rein in de facto foreign ownership, it merely needs to start enforcing laws that are already on the books.

Perhaps foreign investors have fallen into this neat trap?

In reality, I don’t think the government necessarily drew it up this way from the beginning, but the result is the same. They are in the driver’s seat here and have been for some time. Will they pull out the rug from under foreign investors? Again, look to expediency and big picture economic development goals (also with the Net, security concerns). If we get to the point where China’s Net industry no longer needs foreigners, and the government believes foreign investment is now a liability, then it’s time to worry.

Are we there yet?

You can find more noncommittal predictions at China Hearsay. Also look for me on Google+ and Twitter.

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