Moneyweek Magazine article on VIE risks Tweet03 Nov 2017
The cover story of this week’s Money Week magazine highlights the VIE risks behind the Chinese technology firms.
At the other extreme, the two biggest holdings in the index are the internet giants – Tencent and Alibaba – which combined account for around 30% of the index. The policy risk for these firms is huge: if the government decides that something they do is not compatible with its goals, they can be out of that business – or business altogether – overnight. If you’re worried about the risks for Western tech firms, you should be very worried about them for Chinese ones. In addition, China does not allow foreigners to own businesses in sensitive sectors such as the internet.
When the tech firms listed abroad, they got around this by using a dodge called a variable interest entity (VIE). The underlying assets that make the tech firm valuable are owned by a vehicle (the VIE) that is controlled by the firm’s founders or top management. The firm that is incorporated and listed overseas has contracts with the VIE that supposedly guarantees its control of the firm and profits arising from these assets.
How enforceable this dodge is under the Chinese legal system is questionable and there is a risk that shareholders may be ripped off. In my view, the valuations of these firms do not reflect the risks.
You can read the rest of the article here.