Investors may finally be learning that China is no place to invest

We should have never started conducting business in mainland China. Communist countries are closed boxes where everything is owned by the government regardless of how much they make it appear they do not. An article in the Wall Street Journal lays out how the Chinese government changed their regulations making it impossible for one type of industry to seek foreign investors.

Beijing has in mind something called the variable-interest entity, or VIE. Many big-name Chinese companies that have sold shares in foreign markets (including Hong Kong) over the past two decades have done so only quasi-legally at best. Beijing prohibits foreign ownership of large sections of the Chinese economy, and especially the most profitable parts involving digital technology and data. The workaround was to create an offshore holding company or VIE. The Chinese operating company would bind itself contractually to remit its profits to the offshore entity, which could then sell shares to foreign investors.

The Western investor doesn’t own anything, since ownership of the VIE does not translate into a claim on the assets of the operating Chinese company. The Western investor can make no demands on the management of the Chinese company because absent an equity stake there is no mechanism by which to influence or change management. In the event of a dispute, no one can guarantee a Chinese court would enforce the contracts binding the operating Chinese company to the VIE that Western shareholders do own.

Oh, and Beijing could decide at a stroke that it no longer is willing to tolerate this obvious thumbing of noses at black-letter prohibitions on foreign ownership. Which is exactly what the Chinese government said last weekend when its new rules for online-tutoring companies prohibited the firms from listing abroad using the VIE method.

Wall Street Journal

This spooked foreign investors in China’s tech sector causing a sell off. They took our money and have sufficient economic power all over the world to challenge the United States.

Giving credit where it’s due, Beijing has played foreign investors like a fiddle. It induced them to finance the expansion of the riskiest parts of its economy while distracting them from asking why China couldn’t use its enormous financial resources to back unicorn tech companies itself. This funded national champions to compete with the Western giants, while insulating domestic middle-class investors—a politically sensitive cohort if ever there was one—from the risks. For whatever inscrutable reason, Beijing now appears to be deciding its interests lie elsewhere.

Wall Street Journal

Now that they believe they don’t need us they are taking steps to make sure we can’t influence their people in any way. What did they think would happen?

Image by 文 邵 from Pixabay