A employee uses his mobile phone as he walks past the company logo of Baidu at its headquarters in Beijing, August 5, 2010. Baidu, China's biggest web search engine, may make more overseas investments in the future, its chief executive said on Thursday. REUTERS/Barry Huang (CHINA - Tags: BUSINESS SCI TECH) - RTR2H2B7

Chinese authorities are considering a new law that would legitimise massive foreign shareholdings in the country’s technology companies, which have seen billions of dollars pour in from abroad despite a ban on foreign ownership.

This has been achieved via a semi-legal — and risky — regulatory loophole known as Variable Interest Entities, or VIEs. Regulators have turned a blind eye to the practice, but investors are fearful that this could change.

VIEs are offshore companies that are generally based in tax havens, and are used by groups such as Alibaba, Tencent and Baidu.

In the words of one lawyer, they “simulate ownership” by giving shareholders a contractually agreed cut of revenues. However, shareholders technically have no ownership rights to the assets of the company and in a dispute with Chinese investors, their shares could be invalidated if they were to sue in a Chinese court.

The new law would offer foreign investors more comfort by legitimising the VIE structure.

It would also help Beijing ensure that foreign-listed companies remained in Chinese hands by allowing a VIE with majority Chinese ownership or control by other means to be declared a Chinese-invested company, rather than foreign-invested, and thus be accorded full rights. “This should allow foreign investors to have more direct control over the assets of these companies,” said Lester Ross, a lawyer at the firm Wilmerhale in Beijing.

The new rules would not overturn the legal prohibitions on foreign investment in strategic sectors such as the internet and education.

“Making the VIEs legal is a big step forward for investors, because when its legal, those contracts should actually become enforceable,” said Paul Gillis, professor of economics at Peking University.

This would give foreign investors legal options in a dispute with Chinese principals, and decrease the risk associated with equity investments.

The new rules are unlikely to be passed into law before next year.

The limits of the VIE were demonstrated graphically in 2011 when Jack Ma, chairman of ecommerce giant Alibaba, was accused of stripping assets such as payments service Alipay out of Alibaba’s VIE structure and putting them under his personal control.

“If this rule had been in effect when Jack Ma took Alipay out of the group, I think the shareholders would have had a basis to try to enforce those contracts, and make him give back the company” said Prof Gillis.

Of over 200 Chinese companies to list in the US since 1999, roughly half have used VIEs, according to Fredrik Oqvist, a Beijing-based accountant.

Robin Li, chairman of Baidu, spoke up for such a law last March, when he told a conference that the lack of a law on VIEs hindered mergers and acquisitions by Chinese companies. “Domestic limitations for VIEs has had a direct impact on thousands of billions of investment and thousands of technology companies, restricting the companies’ development and may even impede overall economic development,” he said.

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