Vietnam's retail sector is among the fastest growing in Asia, with increasing disposable incomes, rapid urbanisation, rising living standards and a relatively young consumer base. These factors have, together, fuelled double-digit growth and lead to Vietnam's rise to eleventh place on the A.T. Kearney 2016 Global Retail Development Index. Vietnam now ranks in the top 30 emerging retail markets worldwide, and should be an attractive proposition for foreign investors. A good proposition for private equity investors with funds to deploy in the retail sector perhaps? Our post looks at the hurdles to private equity investment in the Vietnamese retail sector and how to structure your transactions to take advantage of this flourishing market.
Restrictions on foreign investment
Although the retail sector was opened to foreign investors under Vietnam's World Trade Organization (WTO) commitments in January 2009, Vietnamese law continues to treat foreign investors less favourably than domestic investors for the purpose of engaging in retail activities. For example, foreign retailers are prohibited from selling certain types of goods, including among others rice, sugar, pharmaceutical drugs, books and cigarettes. Of greater concern to all foreign retailers is Vietnam's reservation at the time of its accession to the WTO of an "economic needs test" (ENT) requirement for foreign-invested retail and distribution activities. The much-maligned ENT is a time-consuming and highly subjective test that will apply on the establishment of each retail outlet beyond the initial one. The ENT, which only applies to foreign-invested retail companies, purports to assess the need for additional retail outlets on the basis of criteria such as the population density and current number of retail outlets in the locality where the outlet will be opened, as well as any social benefits the outlet may bring. Notwithstanding recent steps taken by the authorities to relax the ENT requirement – for example, certain outlets of less than 500 m² are no longer required to undergo the ENT analysis – the ENT requirement remains a thorn in the side of foreign investors and has historically served as a barrier to entry for direct foreign investment in the retail sector.
Greater scope for foreign investment - changing definition of foreign investor
Revisions to Vietnam's Law on Investment however, effective from the middle of last year, have provided greater clarity around what constitutes a 'foreign investor'. This in turn has facilitated greater flexibility to structure investments so as to practically eliminate the disparate treatment of foreign investors in the retail sector.
Previous definition of foreign investor
Prior to enactment of the revised Law on Investment, there was some disparity between Vietnamese regulators as to the level of foreign ownership that would result in a domestically-incorporated company being treated as a foreign investor for the purposes of licensing and restrictions on permitted business activities. Whereas some regulators required majority foreign ownership, others, more typically, found even 1% foreign ownership to be sufficient. The latter interpretation was also carried over into laws governing specific business sectors, with some regulators taking the position that the ENT requirement applied to a retailer with any foreign shareholding, no matter how nominal.
New definition of foreign investor
Under the revised Law on Investment, a Vietnamese company with less than 51% of its charter capital (i.e. share capital) held by foreign entities and/or individuals is treated as a domestic investor for the purpose of investing in another Vietnamese company. This allows foreign investors to utilize a holding company structure to invest indirectly in sectors such as retail where a direct investment at the operating company level would be restricted or subject to additional and burdensome conditions.
So long as foreign investors as a group hold less than 51% in aggregate of the charter capital of a Vietnamese holding company (with the remainder held by Vietnamese investors), that holding company will be treated as a domestic investor for the purpose of its investment in a subsidiary operating company, which (assuming no direct foreign ownership exists at the operating company level) will in turn be treated as a wholly domestic entity (neither foreign nor "foreign-invested").
Furthermore, because the 51% threshold relates to the company's total charter capital (as opposed to voting capital only), it is possible for a foreign investor to secure majority (or even sole) control over the holding company while holding less than 51% of its total equity capital and maintaining its treatment as a domestic investor for the purpose of its investment in other Vietnamese companies.
In the 18 months since these changes were introduced, a number of high profile foreign acquisition transactions in the Vietnamese retail sector have been carried out. In many of these cases the foreign investor in the holding company, no longer burdened by onerous ENT requirements, was free to announce aggressive expansion plans that included the opening of a number of new stores throughout the country. It is hoped this new investment structuring option will encourage additional foreign investors to invest in the Vietnamese retail sector and play their part in its continued development.
