Caixin
Jul 15, 2011 03:08 PM

Who Owns the Chinese Internet?

An article recently published in Xuexi Shibao (Study Times), an organ of the Central Party School, has drawn a lot of attention (see here and here). The authors, from the Chinese Academy of Social Sciences, assert (a) that foreigners ("foreign capital" in the article's terminology) have come to control the Chinese internet, and (b) that this is a bad thing. I'm not going to address the second point here; among other things, if the first point is false, then the second point is irrelevant.

I argue here that the article is fundamentally wrong in its understanding of who controls China's internet companies. First, it is wrong in thinking that the contracts subjecting Chinese internet operators to the control of foreign companies are robust and enforceable in China. Second, even if the contracts were robust and enforceable, the "foreign" companies exercising the control may in fact be controlled by Chinese individuals – sometimes the same Chinese that are on the other side of the contracts.

Foreigners may hold at most 50 percent of certain specified value-added telecommunications businesses. And this is only in theory; in practice, it's even more difficult than the rules suggest. Thus, Chinese internet businesses with significant foreign interests – and there are a lot of them – are typically structured through what's called a Variable Interest Entity (explained in detail here and here.) Because foreigners can't own internet operations directly, an offshore entity is set up (the Baidu that's listed on the New York Stock Exchange, for example, is a Cayman Islands company). Typically, the offshore company ("Offco") is the sole owner of a Chinese subsidiary ("Chisub"). Chinese individuals ("Chiparties") – typically, the entrepreneurs associated with the business – also set up a Chinese company ("Chico"). Because Chico is owned by Chinese, it is able to hold the licenses and operating permits needed to run an internet business. Offco raises money through a listing abroad, and either directly or through Chisub lends the money interest-free to Chiparties. Chiparties then use the money to capitalize Chico. Both Chiparties and Chico sign a series of contracts with Offco and/or Chisub pursuant to which Offco, directly or through Chisub, controls the operations of Chico, reaps the benefits, and suffers the losses. Since control and risk-bearing pretty much define what ownership is about, this structure mimics – or at least attempts to mimic – precisely what is prohibited under Chinese law. These contractual control rights alarm the authors.

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