Why a freely convertible Yuan is needed fast - Paul Gillis

Paul Gillis

Relaxing capital controls is needed fast, argues Beida professor Paul Gillis at his accounting weblog, as he analyses the position of Chukong Holdings Limited. They filed last week for a US IPO, but also use a so-called variable interest entity (VIE) structure, a source of many problems, argues Gillis.

Paul Gillis:

I suspect that Chukong is actually burning cash in its VIE. That would make sense, since 89% of revenues and presumably most of the business is in the VIE. It also appears that company got the cash to burn by selling preferred shares in the Cayman Islands parent company, and then somehow transferred that cash to the VIE.

Chukong carefully explains in their filing that they may not be able to convert the proceeds of their offering into RMB and to capitalize PRC operations. That is because China has strict capital controls. With proper approvals, Chukong would have been able to contribute the proceeds from the preferred stock sales as capital (or made a loan) to its Chinese subsidiaries, known as wholly foreign owned enterprises (WFOE). But getting the money from the WFOE to the VIE is where it gets tough. SAFE Circular 142 says that the RMB obtained from a capital contribution cannot be used for an equity investment in China. SAFE Circular No. 45 prohibits converted funds from being loaned to another company through entrust loans. Direct company-to-company loans (commercial paper) are not allowed in China, so entrust loans, with a bank in the middle, get around the prohibition. But entrust loans cannot be made from converted contributed capital. So how did Chukong get the funds into the VIE? Lots of ways have been invented to circumvent China’s capital controls, but all of them have one thing in common – they are illegal.

Chukong dutifully explains that all these rules may continue to limit the use of proceeds of the offering. That gets to the principal accounting issue – Is Chukong a going concern? Auditors have to assess whether a company has the financial wherewithal to survive another year. If they conclude that it is more likely than not that the company won’t make it, they are to issue a going concern opinion and the offering would likely be doomed. ...

Readers know I have a poor opinion of the VIE structure. This is just another example of the deepening contradictions of it. This problem will be relieved when China relaxes capital controls, but a comprehensive solution to the VIE problem is needed.

More at the China Accounting Weblog by Paul Gillis.

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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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.

Are you a media representative and do you want to talk to one of our speakers? Do drop us a line.

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The Singapore solution for China´s stock woes - Paul Gillis

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Getting listed is notorious difficult for Chinese companies, because getting permissions in mainland China is tough. But there is hope, writes professor Paul Gillis in the Wall Street Journal, as regulators in China and Singapore recently signed an agreement to let private companies list directly. Now such an agreement is needed between China and the US.

Paul Gillis:

The problem is that so many Chinese companies are forced to list overseas because it is still so difficult to win permission to issue shares on the mainland. That makes the deals a lose-lose for investors everywhere. Chinese citizens can’t buy offshore shares be- cause of the mainland’s capital controls. Meanwhile,foreign investors technically don’t buy the company, either.To circumvent foreign-ownership restrictions, Chinese firms use the so-called variable-interest entity (VIE) structure. With the VIE structure, offshore shell companies have contractual claims to the revenues from, but no actual ownership of, the Chinese firms. 

Fortunately,a solution is finally coming into sight, from an unexpected quarter: Singapore. The China Securities Regulatory Commission (CSRC) in November reached an agreement with Singaporean authorities to allow Chinese companies to list directly in the Lion City without first setting up an offshore holding company. If this becomes atemplatefor other jurisdictions—and aseed of further reforms in China—investors everywherestand to benefit.

More in the Wall Street Journal

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.

Are you a media representative and do you want to talk to one of our speakers? Do drop us a line.

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