(Bloomberg) -- China will impose new restrictions on offshore listings by firms in sectors that are off-limits to foreign investment, a move that could plug a loophole long used by the country’s technology industry to raise capital overseas.
Chinese firms in industries banned from foreign investment will need to seek a waiver from a negative list before proceeding for share sales, the National Development and Reform Commission and the Ministry of Commerce said in a statement on Monday. Overseas investors in such companies would be forbidden from participating in management and their total ownership would be capped at 30%, with a single investor holding no more than 10%, according to the updated list effective Jan. 1.
The overhaul represents one of the biggest steps taken by Beijing to tighten scrutiny on overseas listings, after ride-hailing giant Didi Global Inc. proceeded with its New York initial public offering despite regulatory concerns over the security of its data. While regulators stopped short of a ban on IPOs by companies using the so-called Variable Interest Entities (VIE) structure, the new rules would make the process more difficult and costly.
“For companies that seek to list under the VIE structure, the move may affect their decision as to choosing the listing destinations,” said Xia Hailong, a lawyer with Shanghai-based Shenlun law firm. “They used to have no obstacle to overseas listing, but now they’ll surely face much tougher scrutiny and the path to overseas IPOs will be much more difficult.”
VIEs have been a perennial worry for global investors given their shaky legal status. Pioneered by Sina (NASDAQ:SINA) Corp. and its investment bankers during a 2000 IPO, the VIE framework has never been formally endorsed by Beijing. It has nevertheless enabled Chinese companies to bypass rules on foreign investment in sensitive sectors, including the internet industry. The structure allows a Chinese firm to transfer profits to an offshore entity -- registered in places like the Cayman Islands or British Virgin Islands -- with shares that foreign investors can then own.
The requirements apply to new share listings and won’t affect the foreign ownership of companies already listed overseas, according to the nation’s economic planning agency.
The move comes days after the China Securities Regulatory Commission proposed on Friday that all Chinese companies seeking IPOs and additional share sales abroad would have to register with the securities regulator. Any company whose listing could pose a national security threat would be banned from proceeding.
Companies using the so-called variable interest entities structure would be allowed to pursue overseas IPOs after meeting compliance requirements, the securities regulator said, without providing further details.
It’s all part of a yearlong campaign to curb the breakneck growth of China’s internet sector and what Beijing has termed a “reckless” expansion of private capital. Curbing VIEs from foreign listings would close a gap that’s been used for two decades by technology giants from Alibaba (NYSE:BABA) Group Holding Ltd. to Tencent Holdings (OTC:TCEHY) Ltd. to sidestep restrictions on foreign investment and list offshore.
The heightened scrutiny by Chinese regulators has been echoed by their U.S. counterparts. The Securities and Exchange Commission this month announced its final plan for putting in place a new law that mandates foreign companies open their books to U.S. scrutiny or risk being kicked off the New York Stock Exchange and Nasdaq within three years. China and Hong Kong are the only two jurisdictions that refuse to allow the inspections despite Washington requiring them since 2002.
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