Legally ambiguous ‘VIE’ structure means foreign investors don’t technically own overseas-listed Chinese stocks – and that could spell disaster

As China reasserts control over its powerful private enterprises, US and Hong Kong investors in Chinese stocks need to be aware of a rarely discussed risk that has the potential to jeopardise their holdings: the fact that they do not technically own the companies.

To skirt China’s restrictions on foreign investment in certain industries and to raise capital from overseas stock markets, many Chinese companies adopted a so-called VIE structure, short for “variable interest entity”. By one estimate, more than 100 VIE companies now command about US$4 trillion of capitalisation in MSCI China Index. US-based investors could hold as much as US$700 billion worth of them, according to a government report in July.

This peculiar corporate structure enables offshore investors to share the profits of some of China’s most successful companies – from Tencent Holdings to Alibaba Group Holding – in some of the most lucrative and fastest-growing sectors, like the internet, e-commerce, media and education.

While this has been working fine for two decades, the issue could explode after China flexed its regulatory muscle by halting Ant Group’s US$39.5 billion stock debut in November, while  distrust between China and the US climbs to an unprecedented level.