Winners and losers at the new foreign investment law - Paul Gillis

+Paul Gillis 

The proposed law for foreign investments is up for discussion, and offshore VIE companies controlled by Chinese would be treated as domestic companies, legalizing current practices. Accounting professor Paul Gillis lists the winners and losers of the proposed law on his weblog.

Paul Gillis:

But there is a twist. If Chinese individuals or corporations control the foreign company (parent companies of overseas listed Chinese companies are typically incorporated in the Cayman Islands) then the foreign company will be treated as a domestic company for purposes of the foreign investment rules. That would mean the VIE is treated as being controlled by a domestic company and would not be subject to the foreign investment rules. 

Companies that are controlled by Chinese will have their existing VIE arrangements validated. That means that existing VIE contracts should be enforceable. At present, Chinese law will not enforce contracts where an illegitimate purpose is concealed under the guise of legitimate acts. The proposed law will legitimize foreign investment through a VIE when the company is controlled by Chinese. That should make the contracts enforceable. The new law will create winners and losers in China. 

Winners 

Alibaba, Baidu and other companies with dual class share structures or other arrangements that keep founders in control. These companies can continue to use their VIEs. Hopefully, they will be allowed to transfer the VIE to the public company structure so that it becomes a WFOE. That would remove many of the operational difficulties associated with VIEs and provide some better legal protection for shareholders. 

Ant Financial Services Group (ANT), Alibaba’s finance arm formerly known as Alipay. Alipay was a former VIE of the Alibaba Group that was taken out of the group in 2011 by Jack Ma much to the chagrin of Yahoo! investors. Alipay has been the poster child for VIEs gone wrong. The new law may allow ANT to be listed in a U.S. IPO, since the new rules would appear to allow a company like ANT to have foreign investment provided it remained Chinese controlled. 

US Exchanges. Few stock markets permit the use of control structures that allow unders to remain in control of their companies even when they sell down their shares below 50%, but the US exchanges do. Those control structures usually involve two classes of shares – a Class A owned by founders with full voting rights, and a class B owned by public shareholders with identical rights as class A except for no right to vote. Alibaba achieved a similar result using the Alibaba partnership. Hong Kong and China do not permit companies to list with control structures, insisting on one share/one vote. The Hong Kong Stock Exchange lost the Alibaba IPO because of its unwillingness to change its rules. 

Losers Tencent,

 CTRIP, and other companies that are not controlled by Chinese. Some overseas listed Chinese companies have not used the control structures. Their VIEs are likely to be treated as foreign invested enterprises, and will need to comply with the negative list. The regulator could give special permission for these companies to continue to use their VIEs, and I expect they probably will.  An alternative may be for these companies to move their VIE to the Shanghai Free Trade Zone, which has indicated it intends to allow wholly owned foreign investment in e-commerce.  

Multinational companies (MNCs). Many MNCs use the VIE structure although this is rarely disclosed (Amazon is an exception, disclosing use of a Chinese VIE).  These VIEs will be subject to the negative list. I am less optimistic that MNCs will be able to obtain special permission, and may need to rely on using the Shanghai Free Trade Zone.  

Hong Kong Stock Exchange. Hong Kong does not allow companies to list using control structures to keep founders in control. The Hong Kong Stock Exchange lost the Alibaba IPO over this rule, and stands to never see another IPO of a Chinese company in a restricted sector if they do not change their rules.

More at ChinaAccountingBlog.

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´ request form.

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Now China needs an audit regulator - Paul Gillis

+Paul Gillis 

The Chinese Securities Regulatory Commission (CSRC) will in 2015 drastically change the way how IPO´s take place in China. The government will step back, leaving decision making to the market. To facilitate that change, China needs an audit regulator, writes accounting professor Paul Gillis at his weblog.

Paul Gillis:

As regulators step back, it is critical that other institutional players, particularly auditors, lawyers, and investment bankers step up. They will become the prin-cipal gatekeepers to the market. Without increased professionalism by these players, the Chinese stock markets could become increasingly dangerous for investors. Too many auditors have been willing to sign off on numbers that magically meet CSRC IPO requirements. The Big Four are not major players in the domestic IPO market, which is dominated by local firms. Although some large local firms have emerged, they do not dominate the local stock markets like the Big Four dom-inate most markets around the world. Hopefully, investors will start paying more attention to the audit firms selected by Chinese concerns, and that will lead to larger, higher quality accounting firms dominating the market. 

The CSRC has promised to tighten post-IPO supervision and to punish those who violate the rules. That is laudable, but the devil will be in the details. For the auditors, I suggest that China put in place an independent audit regulator that would be eligible to join the International Forum of Independent Audit Regulators (IFIAR), a group that now includes regulators in 51 jurisdictions.Hong Kong is currently deciding on necessary reforms that would allow it to join IFIAR. An independent audit regulator with the funding to do its job and the willingness to take on recalcitrant accounting firms is now the global standard for securities markets.

More at the ChinaAccountingBlog.

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´ request form.

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Hong Kong needs to strengthen its accounting rules - Paul Gillis

+Paul Gillis 

Fishy listings from Chinese firms have become a problem for the Hong Kong stock exchange. Hong Kong needs to strengthen its rules to get their act together, says accounting professor Paul Gillis at WHEC.com. Its new 2012 rules might not be enough. Chinese companies have to be forced to tell the whole story.

WHEC.com:

Hong Kong created new rules in 2012 that tightened requirements for investment banks' due diligence and gave regulators the ability to hold IPO sponsors criminally liable for stock issuers' misstatements. Espinasse said the changes have had a positive effect. 

Hong Kong regulators may have further to go, especially in regard to forcing companies to disclose their past and present ties with the Chinese government, said Paul Gillis, an accounting professor at Peking University's Guanghua School of Management. Given concerns about corruption in China's transition to a market economy, he said, investors should know how and when ownership of companies passed into private hands. 

"I've never seen that story told properly in a Hong Kong prospectus," Gillis said. "That's one of the reasons these companies tend to list in Hong Kong instead of the U.S., because I don't think the SEC would tolerate this."

More at WHEC.com.

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Alibaba IPO pushes Hangzhou up - Rupert Hoogewerf

Rupert Hoogewerf

Alibaba´s IPO might have made a lot of people and banks more wealthy, especially Hangzhou - the birthplace of the eCommerce giant - will benefit. Rupert Hoogewerf, founder of the Hurun rich list, expects more expensive sport cars in the Hangzhou streets, he tells in USA Today.

USA Today:

China's newly prosperous typically rush into real estate, cars and luxury items such as expensive watches, said Rupert Hoogewerf, the Shanghai-based publisher of Hurun, China's best-known "Rich List." "Inevitably, more sports cars will be sold in Hangzhou than before," said Hoogewerf, who expects Hangzhou may rise from fifth place on Hurun's ranking of Chinese cities with most millionaires, based on U.S. dollars. 

"The biggest challenge to somebody who got rich overnight is the change in lifestyle. Some turn to gambling, others live a lifestyle not commensurate to their wealth," he said. "But these tech people are slightly different. They put a lot of heart and soul into the business," said Hoogewerf, who expects that many Alibaba millionaires will buy property but also re-invest a significant amount in other start-ups.

More in USA Today.

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Why Alibaba is not yet a global player - Shaun Rein

Shaun Rein at WSJ

Despite its close to US$22 billion IPO at the New York Stock Exchange today, business analyst Shaun Rein does not see in Alibaba a real global company. "Its model is not scalable in other large market like the US and Indonesia", he says at has much work to do at home, especially on mobile where it is lagging.

Shaun Rein is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´ request form.

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Why Alibaba is not going international soon - Joel Backaler

+Joel Backaler 

Will Alibaba use the capital gained from its IPO to expand fast internationally? China consultant Joel Backaler, expert on China´s outbound investments, does not think so, and explains in Forbes why Alibaba will be tied up at the domestic market at least in the short run.

Joel Backaler:

Alibaba is the unmatched e-commerce market leader in China. It holds roughly 95% of China’s C2C market (Taobao Division), and more than 50% of the B2C market (Tmall Division). With new Chinese consumers shopping online every day, potential growth in this sector remains tremendous. For this reason, Alibaba is unlikely to risk losing domestic market share by expanding aggressively into international markets after its IPO – especially as domestic competition continues to heat up. As recently as last month, Baidu , Tencent and Dalian Wanda all teamed up to create a competitive new e-commerce firm. 

Moreover, Alibaba’s NYSE listing does not necessarily mean it intends to ramp up business operations in overseas markets like the U.S. – just look at Chinese internet firms such as VIPShop, Baidu and Youku Tudou YOKU +0.4%. All three built their businesses focused on the Chinese market, and they continue to do so today even after going public in the U.S. And as Jack Ma has said himself, for Alibaba’s e-commerce business: China is the “main course,” while developed markets like the U.S. are merely “dessert... 

In the short-term, Alibaba is likely to continue focusing its efforts within China, where it is already a market leader and the growth potential is enormous. But as the domestic business environment grows increasingly competitive, Alibaba’s globalization strategy is not a question of ‘if’, but ‘when’. When Alibaba does ultimately expand aggressively into overseas markets, it will be ready. Alibaba has as much experience as its global competitors and it is run by internationally exposed leadership. Although Alibaba currently lacks significant international offices and dedicated platforms for markets outside of China, its founding model – connecting buyers and sellers around the world – makes the nature of its business inherently global.

More in Forbes.

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Joel Backaler is based in Washington, but will be visiting Europe in October. You can check out his schedule here.

Risks and challenges of the Alibaba IPO - Ben Cavender

Ben Cavender

After Alibaba filed this week its paperwork for its upcoming IPO. Business analyst Ben Cavender looks at its great profitability, but also risk from competition in e-commerce and fear for pressure fro the big Chinese banks.


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Raising the standard of Chinese law firms - Paul Gillis

Paul Gillis

The China Securities Regulatory Commission (CSRC) has fined three Chinese law firms for their shoddy legal work in IPO´s. A positive development in trying to raise the standard of Chinese law firms, writes professor Paul Gillis at his China Accounting Blog. "It´s about time." 

Paul Gillis:

The IPOs in question were all on China’s stock exchanges, and accordingly come under the regulatory authority of the CSRC. It is about time that the CSRC has taken action to raise the standards of legal practice on listed companies. The first crackdown on the accounting profession took place in 1997 and it was brutal. A quarter of Chinese CPAs faced discipline or eviction from the profession in the 1997 rectification. The legal profession is overdue for rectification. 

The CSRC’s jurisdiction does not extend to overseas listed Chinese companies. Overseas listed Chinese companies of any meaningful size tend to use well-known international law firms. But these international law firms are not allowed to opine on matters of Chinese law, so local firms are used for this purpose. 

Some local firms are well known for their willingness to issue clean opinions on variable interest entity (VIE) structures even in the face of considerable doubt as to whether the agreements that underpin these structures are enforceable. Many Chinese lawyers do not believe these agreements are enforceable, but those lawyers are not engaged to issue opinions on VIEs. The SEC has been tough on companies using the VIE structure, but is not in a position to challenge Chinese lawyers on matters of Chinese law. The CSRC does have that power, but it lacks jurisdiction over these companies. That is one of the things that the Singapore Solution can fix.

More at the China Accounting Blog.

Paul Gillis is a speaker at the China Speakers Bureau. Do you need him at your meeting or conference? Do get in touch or fill in our speakers´request form.

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