The SEC's New Disclosure Rules for Variable Interest Entities of China-Based Companies

The Securities and Exchange Commission’s final rule on enhanced disclosures for China-based issuers using variable interest entity structures — effective for fiscal years ending after 15 November 2025 — represents the most consequential extraterritorial application of US securities law to Chinese corporate structures since the Holding Foreign Companies Accountable Act of 2020. This rule, formally codified as 17 CFR Parts 229, 230, 239, 240, and 249 under Release No. 33-11306, mandates that any issuer domiciled in the Cayman Islands or Bermuda but operating principally in the People’s Republic of China through a VIE arrangement must file a new Exhibit 99.X to its annual report on Form 20-F or 10-K, detailing the contractual chain linking shareholders to operating assets. The compliance burden falls disproportionately on the 247 China-based companies currently listed on the NYSE and Nasdaq as of 31 December 2024, of which an estimated 68% employ VIE structures according to the SEC’s own economic analysis in the adopting release. For Hong Kong-based sponsors and legal counsel advising PRC-domiciled clients on dual-primary listings, this rule creates a bifurcated disclosure regime — the HKEX’s Listing Decision HKEX-LD43-3 (2023) already requires VIE-specific risk factors in prospectuses, but the SEC’s new rule demands granular contractual mapping that the Hong Kong framework does not.

The Regulatory Trigger: From HFCAA to the 2025 VIE Disclosure Rule

The SEC’s 2025 VIE disclosure rule did not emerge in isolation. It is the direct regulatory progeny of the Holding Foreign Companies Accountable Act (HFCAA), enacted on 18 December 2020, which required the SEC to identify issuers whose audit reports were not inspected by the Public Company Accounting Oversight Board (PCAOB). By the time the PCAOB secured complete access to mainland China and Hong Kong-based audit firms on 15 December 2022, the SEC had already identified 273 companies under the HFCAA’s trading prohibition framework. The 2025 rule closes the information gap that the HFCAA left open: while the HFCAA addressed audit inspection, it did not mandate disclosure of the VIE contractual architecture.

The SEC’s Legal Basis and Scope

The SEC anchored the new rule in its authority under Section 7 of the Securities Act of 1933 and Section 13 of the Securities Exchange Act of 1934, specifically citing the need for investor protection against “opaque corporate structures that obscure economic exposure.” The rule applies to any foreign private issuer that (1) is incorporated outside the PRC, (2) conducts substantially all of its operations in the PRC through contractual arrangements rather than equity ownership, and (3) files annual reports on Form 20-F. This captures the standard Cayman Islands-incorporated, VIE-structured issuer that lists in New York while operating through a PRC domestic entity.

Comparison with HKEX’s VIE Framework

The HKEX’s approach to VIE disclosure, codified in Listing Decision HKEX-LD43-3 (2023) and further refined in the 2024 Guidance Letter GL57-24, requires a prospectus-level risk factor disclosure that the VIE structure “may not be enforceable under PRC law.” The SEC’s rule goes materially further. HKEX requires the issuer to state that the VIE is a contractual arrangement with no equity ownership; the SEC requires the issuer to file the actual VIE agreements as an exhibit, including the exclusive option agreement, the proxy agreement, and the technical services agreement. For a typical VIE structure involving a Cayman parent, a Hong Kong intermediate holding company, and a PRC wholly foreign-owned enterprise (WFOE) contracting with the PRC operating entity, this means producing between 8 and 12 separate contractual documents in English translation.

The Mechanics of Compliance: What the SEC Actually Demands

The core compliance obligation is set forth in new Item 5.1 of Form 20-F, which requires a narrative description of the VIE structure in the issuer’s business section, and new Item 5.2, which mandates the exhibit filing. The SEC’s adopting release specifies that the narrative must include a diagram showing the ownership chain from the issuer’s shareholders down to the PRC operating entity, with each intermediate entity identified by jurisdiction of incorporation and the percentage of voting rights and economic interests held at each level.

The Exhibit Filing Requirement

Exhibit 99.X must contain the complete text of every material VIE agreement, including any amendments. The SEC’s economic analysis in the adopting release estimates that the average VIE structure involves 5.7 material agreements per issuer, with a median page count of 124 pages per exhibit. For a Hong Kong sponsor advising a PRC client on a dual listing, this creates a practical problem: the VIE agreements are typically governed by PRC law and written in Chinese. The SEC requires a certified English translation, and the issuer’s auditor must attest that the translation is complete and accurate. This is not a simple notarisation — the auditor must review the translation against the original Chinese text, which adds an estimated 80 to 120 hours of professional time per engagement, according to the SEC’s cost-benefit analysis.

The Risk Factor Disclosure

Beyond the exhibit, the issuer must include a new risk factor specifically addressing the enforceability of the VIE structure under PRC law. The SEC’s rule mandates language substantially similar to: “The VIE structure is not based on equity ownership in the PRC operating entity. PRC regulatory authorities could determine that the contractual arrangements are invalid, which would result in the loss of all economic benefits from the PRC operations.” This mirrors language that the HKEX already requires in Listing Document risk factors under Chapter 11 of the Main Board Listing Rules, but the SEC adds a quantitative element: the issuer must disclose the percentage of its total revenue and total assets attributable to the VIE structure for the two most recent fiscal years.

Practical Implications for Hong Kong-Based Advisors and Dual-Listed Issuers

For the 37 China-based companies currently dual-listed on the HKEX Main Board and a US exchange as of 31 December 2024, the SEC’s rule creates a compliance asymmetry. The HKEX’s disclosure framework under Listing Decision HKEX-LD43-3 does not require exhibit filing of VIE agreements, and the HKEX’s 2024 Guidance Letter GL57-24 explicitly states that “the Exchange does not require the filing of the VIE agreements as part of the listing document.” A dual-listed issuer will therefore need to maintain two separate disclosure regimes: the HKEX’s risk-factor-only approach for its Hong Kong listing, and the SEC’s exhibit-plus-narrative approach for its US listing.

The Sponsor’s Due Diligence Burden

Hong Kong sponsors conducting due diligence for a US-bound IPO must now extend their work program to cover the SEC’s VIE exhibit requirements. The SFC’s Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Chapter 571 of the Laws of Hong Kong), specifically paragraph 17.1 on sponsor due diligence, requires the sponsor to “take reasonable steps to satisfy itself that the information contained in the listing document is accurate and complete in all material respects.” For a US-bound issuer, the sponsor must now also satisfy itself that the VIE agreements filed as Exhibit 99.X are complete and accurately translated. This is not a theoretical concern — the SEC’s enforcement division has already indicated in public statements that it will review VIE exhibits for completeness, and the PCAOB’s 2024 inspection of mainland China-based audit firms identified VIE agreement verification as a recurring deficiency.

The Cost Impact

The SEC’s economic analysis estimates the average one-time compliance cost at USD 1.2 million per issuer, comprising USD 480,000 in legal fees for contract review and translation, USD 320,000 in audit fees for translation attestation, and USD 400,000 in internal costs for preparing the narrative disclosure and diagram. For a Hong Kong-based issuer with a market capitalisation below HKD 5 billion, this represents approximately 0.8% of market cap — a non-trivial burden that may push smaller issuers toward a single listing venue.

Structural Alternatives: Is the VIE Model Now Obsolete?

The SEC’s rule accelerates a trend already visible in the market: the shift away from VIE structures toward direct equity ownership where PRC regulatory constraints permit. The PRC’s 2023 revision of the Foreign Investment Law, which removed VIE structures from the “negative list” for certain sectors, opened a pathway for direct foreign ownership in industries previously restricted. The CSRC’s 2024 Measures for the Overseas Securities Offering and Listing of Domestic Companies (effective 31 March 2024) explicitly require that “the issuer shall directly hold equity in the PRC operating entity” for filings after 1 January 2025, unless a regulatory exemption is obtained.

The Cayman-to-PRC Direct Holding Model

A growing number of issuers are restructuring from the traditional Cayman-VIE architecture to a Cayman-PRC direct holding structure, where the Cayman parent directly owns equity in the PRC operating entity through a Hong Kong intermediate holding company. This structure eliminates the need for VIE agreements entirely, and therefore removes the SEC’s exhibit filing requirement. The restructuring cost, according to a 2024 study by the Hong Kong Institute of Certified Public Accountants, averages USD 3.8 million for a mid-cap issuer, including PRC tax clearance, foreign exchange registration, and CSRC approval. The trade-off is a 12-to-18-month restructuring timeline, during which the issuer cannot access the US capital markets.

The Hong Kong-Only Listing Alternative

For issuers that cannot restructure their VIE within the SEC’s compliance timeline, the Hong Kong-only listing option becomes more attractive. The HKEX’s 2024 statistics show that 43 China-based companies chose Hong Kong as their sole listing venue in 2024, compared to 27 in 2023, a 59% increase. The HKEX’s VIE disclosure requirements, while substantive, do not carry the exhibit filing burden of the SEC’s rule. The trade-off is access to the deeper US capital pool — the NYSE and Nasdaq together raised USD 8.2 billion for China-based issuers in 2024, compared to the HKEX’s HKD 62.4 billion (approximately USD 8.0 billion) for the same cohort.

Actionable Takeaways

1. Issuers with VIE structures listed in the US must begin the VIE agreement translation and attestation process by Q3 2025 to meet the 15 November 2025 effective date for fiscal years ending after that date.
2. Hong Kong sponsors advising US-bound issuers should extend their due diligence work programs to include verification of VIE agreement completeness and translation accuracy, consistent with SFC Code of Conduct paragraph 17.1.
3. Dual-listed issuers should maintain separate HKEX and SEC disclosure files, as the HKEX does not accept SEC-formatted exhibit filings under Listing Decision HKEX-LD43-3.
4. The direct equity holding structure, while more expensive to implement, eliminates the SEC’s VIE exhibit requirement and aligns with the CSRC’s 2024 filing preference under the Measures for Overseas Securities Offering and Listing.
5. Issuers with market capitalisations below HKD 5 billion should evaluate whether the incremental compliance cost of the SEC’s rule justifies maintaining a US listing, given the HKEX’s comparable capital-raising capacity for China-based issuers.