An Update on China's Variable Interest Entities - Navigating Regulations and Mitigating Risks for 2013

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For more than a decade, variable interest entities (“VIEs”) have been used as investment vehicles for foreign companies to indirectly invest in China’s restricted and prohibited industries as well as for Chinese domestic companies to acquire offshore financing or listing. For many years, Chinese regulatory authorities have turned a blind eye on the use of VIEs, fueling the growth of certain restricted and prohibited sectors, such as telecommunication, internet, and media – the most notable example being Sina’s NASDAQ listing in 2000. Recent government actions, however, indicate the Chinese government’s intention to crack down on VIEs, highlighting the unreliability of using such vehicles. This article will outline the background for VIEs, reasons for their employment, recent developments on VIEs, and actions foreign companies can take to mitigate their risks in light of China’s current regulatory environment.

I. Background -

A. What Are VIEs?

VIEs are investment vehicles used by foreign invested entities to control an operating company through a series of contractual arrangements, rather than through equity ownership. Under the VIE structure, the foreign investor establishes an offshore vehicle with a domestic partner to directly or indirectly own a wholly foreign-owned enterprise (“WFOE”) in China. The domestic partner establishes a subsidiary operating company to apply for all the relevant operating licenses and permits.

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