Merger Control For Funds & Financial Investors: Varying Risk Profiles For VIE Structures In China.

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Merger Control For Funds & Financial Investors: Varying Risk Profiles For VIE Structures In China.


16 July 2020


Asia Pacific Legal Updates


In April 2020, and for the first time, China’s competition law authority (the State Administration for Market Regulation, or SAMR) accepted a merger control filing involving a party set up under a ‘variable interest entity’ (VIE) structure.

Whilst this case was not announced with any fanfare by SAMR (indeed, it only came to light through the standard public disclosure process applicable to all filings made under the simplified notification procedure), it is believed to signify a broad change in SAMR’s stance towards VIE structures.

For foreign investors that have stakes in Chinese businesses through VIE structures, or those looking to invest, this is an important development. In this e-bulletin, we explore what this means for funds and other foreign investors.


What is a VIE structure?


The VIE is a common construct used by foreign-invested companies operating in industries where China has restricted foreign ownership. The VIE structure can be used to circumvent certain restrictions through: (1) an offshore holding company setting up a wholly owned subsidiary (under a wholly foreign-owned enterprise, or WFOE structure) in China; and (2) the WFOE would then control and receive all of the profits of the PRC business through a series of contractual arrangements. The PRC company’s shareholders would remain Chinese nationals (in accordance with the regulations), whereas the offshore holding company would book the revenue and account for the WFOE operations in its financial statements.

The VIE structure allows for domestic Chinese companies in restricted industries to seek foreign venture capital financing, as well as to list in offshore jurisdictions. Many of the offshore-listed tech giants in China have adopted this structure, including Alibaba, Baidu and Tudou.


VIE structures and merger control in China 


Although VIE structures have been widely used for some time, until recently they have not been formally acknowledged by the Chinese government. In particular, it has been standard practice for SAMR (and its predecessor, the Ministry of Commerce) not to formally accept merger control filings involving companies that operate under a VIE structure.

This has led to substantial uncertainty as to the compliance risk for VIE structures. Despite the widespread practice, there is no clear legal basis for SAMR not to accept filings involving VIE structures, nor is there any explicit exemption under the Anti-Monopoly Law (AML) that companies adopting such structures could rely on for failing to notify triggering transactions.

However, this has now changed following SAMR’s recent acceptance of a filing involving a VIE structure. On 20 April 2020, SAMR formally accepted a filing submitted by Huansheng Information Technology (Shanghai) Co., Ltd. (“Huansheng”) and Shanghai Mingcha Zhegang Management Consulting Co., Ltd. (“Mingcha”). Huansheng is reportedly a subsidiary of Yum China, the operator of restaurant chains such as KFC, Pizza Hut and Taco Bell in China.

According to the public disclosure form for this filing, Mingcha is controlled by a Cayman company ‘through related entities based on a series of contractual arrangements’, which shows that this company is set up via a VIE structure. According to recent reports, the review of this transaction has been hindered due to substantive competition law complaints being raised by third parties, which appear to be unrelated to the fact that Mingcha is organised under a VIE structure.


VIE structures now able (and expected?) to file


Following this case, it is clear that SAMR will accept filings regarding transactions involving VIE structures. More importantly, this is likely to mean that SAMR will now expect such filings, and that the involvement of a VIE structure will no longer serve as a reason not to file.

In turn, SAMR may start to pursue VIEs for failing to file transactions. While we cannot rule out the possibility that SAMR will pursue historical transactions involving VIE structures that have not filed due to the previous policy position, certainly attention should turn to future transactions. In particular, for funds and other investors into Chinese businesses organised under a VIE structure, and which have previously disregarded the need to conduct merger control filings in China due to SAMR’s approach, this may mean that a fundamental shift to merger control strategy is required in relation to future transactions. Going forward, it will be essential to consider Chinese merger control even where the deal involves a VIE entity.


Increase in maximum penalties under consultation


In addition to SAMR’S change of approach to VIE structures, the potential risk of failing to file is also likely to increase in the near future. At present, the maximum fines that can be imposed by SAMR is capped at RMB500,000. However, SAMR is currently consulting on various changes to the AML, including a substantial change to its fining powers.

According to SAMR’s proposed amendments to the AML (published for public consultation in January 2020), the maximum fines for failure to notify a transaction in breach of the merger control rules are proposed to be increased significantly from RMB500,000 to 10% of the relevant undertakings’ total revenue in the previous financial year.


This increased cap also applies to other breaches of the merger control rules, including completing notified transactions prior to clearance (ie gun-jumping) or completing a transaction prohibited by SAMR. The proposed increase in fining powers brings the PRC regime in line with other key jurisdictions for merger control, such as the EU. However, it should be noted that merger control filings are triggered more commonly under the PRC regime for various reasons, including substantially lower turnover thresholds and the lack of a “full functionality” criteria in the assessment of joint ventures that exists in the EU regime.

These changes are likely to put merger control compliance under even more of a spotlight in the PRC, particularly given gun-jumping has long been an enforcement priority for SAMR (and its predecessor, MOFCOM).


herbert smith Freehills


For further information, please contact:


Adelaide Luke, Herbert Smith Freehills