What Is a VIE Structure and Why Do Chinese Companies Use It for Overseas IPOs?

The collapse of Didi Global’s NYSE listing in July 2021, followed by the CSRC’s tightened filing requirements for overseas securities listings effective 31 March 2023, has permanently altered the calculus for Chinese companies pursuing offshore capital. As of Q1 2025, over 280 China-based issuers remain listed on US exchanges via variable interest entity (VIE) structures, representing an aggregate market capitalisation exceeding USD 800 billion according to data from the China Securities Regulatory Commission’s (CSRC) quarterly filings. Yet the VIE architecture — a contractual arrangement first devised in 2000 by Sina Corp’s legal advisors to bypass PRC foreign ownership restrictions in value-added telecommunications services — now faces its most existential challenge. The Hong Kong Stock Exchange (HKEX) has since 2023 required all VIE-structured applicants to demonstrate that their contractual arrangements are the minimum necessary to comply with PRC sectoral caps, a shift codified in HKEX Listing Decision LD127-2023. This article examines the mechanics, regulatory underpinnings, and strategic rationale of VIE structures in the current cross-border listing environment, where both US and Hong Kong regulators demand unprecedented transparency.

The Mechanics of a VIE Structure

A VIE structure separates legal ownership from economic control through a series of contractual agreements between a Cayman Islands or BVI-incorporated offshore holding company and a PRC-incorporated operating entity. The offshore entity — typically the listed vehicle on the NYSE, Nasdaq, or HKEX Main Board — holds no equity in the PRC operating company. Instead, it controls the PRC entity through exclusive service agreements, equity pledge agreements, call option agreements, and power of attorney arrangements. The PRC operating company, which holds the licences or approvals that foreign ownership restrictions protect, is owned by PRC nationals or domestic entities.

The structural separation achieves two objectives simultaneously. First, it allows the offshore listed entity to consolidate the PRC operating company’s financial results under US GAAP (ASC 810-10-25-57) or IFRS (IFRS 10) through variable interest entity consolidation guidance. Second, it avoids triggering PRC foreign investment prohibitions under the Special Administrative Measures (Negative List) for Foreign Investment Access (2024 edition), which continues to restrict foreign ownership in sectors including internet content provision, telecommunications value-added services, education, and media. The 2024 Negative List, published by the National Development and Reform Commission (NDRC) and the Ministry of Commerce (MOFCOM), retains 31 prohibited or restricted sectors — unchanged in scope from the 2021 edition.

The Core Contractual Agreements

The VIE framework rests on five standardised contracts, each serving a distinct legal and accounting function. The exclusive service agreement obligates the PRC operating entity to pay the offshore WFOE (wholly foreign-owned enterprise) a fee equal to substantially all of its pre-tax profits, effectively funnelling economic returns to the listed group. The equity pledge agreement grants the WFOE a security interest over the PRC shareholders’ equity in the operating company, preventing those shareholders from transferring their stakes without consent. The call option agreement gives the WFOE an irrevocable right to purchase the PRC operating company’s equity at nominal consideration — typically RMB 1 or the minimum permitted under PRC law — should PRC regulations permit foreign ownership in the future. The power of attorney transfers the PRC shareholders’ voting rights to the WFOE’s designated representatives. Finally, the spousal consent letter ensures that PRC shareholders’ spouses waive any claims to the pledged equity under PRC matrimonial property law.

These contracts must be carefully drafted to satisfy the consolidation criteria under ASC 810-10-25-25, which requires that the reporting entity has both the power to direct the VIE’s activities that most significantly affect its economic performance and the obligation to absorb losses or the right to receive benefits that could be potentially significant to the VIE. In practice, the call option and exclusive service agreement together establish control, while the equity pledge provides economic exposure. However, the SEC’s December 2021 amendments to its disclosure rules now require VIE-structured issuers to prominently disclose that investors are not purchasing equity in a PRC operating company but rather shares in a Cayman Islands holding company with contractual rights only.

Consolidation vs. Legal Ownership

The critical distinction for investors and auditors is that VIE consolidation is an accounting concept, not a legal one. Under PRC law, the offshore entity has no direct ownership of the PRC operating company’s assets or licences. If the PRC shareholders breach the contractual arrangements — for example, by refusing to pay service fees or transferring their equity to a third party — the offshore entity’s remedy is limited to contract damages or specific performance under PRC contract law. It cannot directly seize the licences or assets.

This legal fragility was exposed in the 2011 dispute between Alibaba Group and its PRC operating entity, Alibaba.com, where the VIE structure’s validity was challenged by PRC regulators. The CSRC and MOFCOM subsequently issued a series of circulars between 2011 and 2015 clarifying that VIE structures were not illegal but would be reviewed on a case-by-case basis. The HKEX’s 2018 guidance note (HKEX-GL112-18) formalised the exchange’s acceptance of VIE structures for Main Board listings, subject to the requirement that the VIE be the minimum necessary to comply with PRC foreign ownership restrictions — a principle now embedded in HKEX Listing Rules Chapter 19C for overseas issuers.

Why Chinese Companies Use VIE Structures for Overseas IPOs

The VIE structure exists because PRC company law and foreign investment regulations create a fundamental incompatibility between domestic ownership restrictions and the desire for offshore capital. Without the VIE mechanism, Chinese companies in restricted sectors could not list on the NYSE, Nasdaq, or HKEX Main Board while maintaining control of their PRC licences. The structure has been used by over 90% of China-based US-listed companies since 2000, according to a 2023 study by the China Securities Journal.

Bypassing Foreign Ownership Restrictions

The PRC’s Catalogue of Industries for Guiding Foreign Investment — now codified as the Negative List — has since its 1995 edition restricted foreign participation in sectors deemed sensitive to national security or cultural sovereignty. The 2024 Negative List maintains prohibitions on foreign investment in internet news services, online publishing, internet audio-visual programming services, and value-added telecommunications services including internet data centres and cloud computing. These sectors correspond precisely to the industries where Chinese technology companies have historically sought US listings: e-commerce (Alibaba, JD.com), social media (Weibo, Bilibili), online travel (Trip.com Group), and education (TAL Education, New Oriental).

For a company operating a PRC-licensed internet content provision business, foreign direct investment is prohibited under Article 10 of the Foreign Investment Law (2019). A direct equity investment by a Cayman Islands holding company into the PRC operating entity would violate this restriction and render the PRC company subject to revocation of its operating licences by the Ministry of Industry and Information Technology (MIIT). The VIE structure avoids this prohibition by having the offshore entity control the PRC company contractually rather than through equity, a distinction that PRC regulators have tolerated but never formally endorsed.

Accessing Deep Capital Markets

The choice between US and Hong Kong listing venues for VIE-structured companies reflects liquidity and valuation considerations. The NYSE and Nasdaq offer deeper pools of capital for technology companies — the average daily trading volume for US-listed Chinese ADRs exceeded USD 15 billion in 2024, according to Bloomberg data — and valuation multiples that have historically exceeded those available in Hong Kong. Alibaba’s USD 25 billion NYSE IPO in 2014, the largest in history at the time, would not have been achievable under the direct equity structure that PRC law would have required for a Hong Kong listing.

Hong Kong has since 2018 become a viable alternative, particularly after the HKEX’s introduction of Chapter 19C for overseas issuers and Chapter 18C for specialist technology companies. The HKEX accepted 23 VIE-structured IPOs in 2024, raising a combined HKD 78.4 billion, according to the exchange’s 2024 annual review. However, the HKEX imposes stricter VIE disclosure requirements than the SEC: applicants must demonstrate that the VIE is the minimum necessary to comply with PRC restrictions, and the company must include a prominent warning in its prospectus that investors are purchasing shares in the offshore entity, not the PRC operating company.

Tax and Structuring Efficiency

The VIE structure also offers tax advantages when properly implemented. The offshore holding company — typically incorporated in the Cayman Islands — pays no Cayman Islands income tax under the Companies Act (2023 Revision). The Hong Kong intermediate holding company, if used, benefits from Hong Kong’s territorial tax system, which taxes only profits sourced in Hong Kong. The PRC WFOE, which receives service fees from the PRC operating company, pays PRC corporate income tax at 25% but can deduct expenses incurred in providing the services.

The PRC operating company, which generates the underlying revenue, pays PRC corporate income tax on its profits before distributing them as service fees to the WFOE. This double-taxation risk is mitigated through transfer pricing documentation that demonstrates the service fees are arm’s-length and commercially justified. The State Administration of Taxation’s Bulletin No. 16 of 2017 requires VIE-structured companies to maintain contemporaneous transfer pricing documentation for related-party transactions exceeding RMB 200 million annually.

Regulatory Risks and Recent Developments

The regulatory environment for VIE structures has undergone its most significant transformation since 2021, driven by both PRC domestic policy shifts and US regulatory enforcement. The CSRC’s Administrative Provisions on the Filing of Overseas Securities Offerings and Listings by Domestic Companies (effective 31 March 2023) requires all PRC companies seeking overseas listings — including those using VIE structures — to file with the CSRC within three business days of submitting their listing application to the overseas exchange. Failure to file renders the listing void and subjects the company to penalties under Article 193 of the Securities Law of the PRC (2019 revision).

The CSRC Filing Regime

The filing regime, codified in CSRC Order No. 195, represents the first formal recognition by PRC regulators of VIE structures as a permissible listing mechanism. Under the filing rules, companies must submit a comprehensive disclosure package including the VIE contractual agreements, a legal opinion from PRC counsel confirming the structure’s compliance with PRC law, and a risk disclosure statement in both Chinese and English. The CSRC has 20 working days to review the filing and may request supplementary materials or require structural modifications.

In practice, the CSRC has used the filing regime to impose conditions on VIE structures. In 2024, the CSRC rejected the filing of one US-bound issuer whose VIE structure exceeded the minimum necessary to comply with foreign ownership restrictions — the issuer had used a VIE for a business line that was not subject to foreign ownership caps. The CSRC’s decision, reported in the Securities Times on 15 August 2024, signals that regulators will scrutinise VIE structures for overreach beyond the specific sectors where foreign ownership is prohibited.

US Regulatory Pressure

The SEC’s implementation of the Holding Foreign Companies Accountable Act (HFCAA) — signed into law in December 2020 — has forced over 40 China-based issuers to delist from US exchanges as of March 2025, according to the Public Company Accounting Oversight Board (PCAOB) inspection records. The HFCAA requires that the PCAOB have full access to audit working papers of PRC-based auditors. While the PCAOB secured access in December 2022 through a bilateral agreement with the CSRC, the agreement is subject to annual renewal and remains politically vulnerable.

The SEC’s December 2021 disclosure amendments (SEC Release No. 34-93701) require VIE-structured issuers to include specific risk factors in their annual reports on Form 20-F: that the VIE structure may be invalidated by PRC courts or regulators, that the issuer’s shareholders have no direct ownership interest in the PRC operating company, and that the issuer’s corporate structure may be subject to PRC regulatory action. These disclosures have become standard in US-listed Chinese ADR prospectuses since 2022.

Hong Kong’s Evolving Stance

The HKEX has taken a more proactive approach than the SEC in regulating VIE structures. Listing Decision LD127-2023, published in December 2023, requires VIE-structured applicants to include in their listing documents a legal opinion from PRC counsel confirming that the VIE is the minimum necessary to comply with PRC foreign ownership restrictions. The HKEX also requires that the VIE agreements be governed by Hong Kong law or PRC law with Hong Kong arbitration, ensuring enforceability in Hong Kong courts.

The HKEX’s 2024 consultation paper on overseas issuer listing rules proposed additional VIE disclosure requirements, including a requirement that VIE-structured issuers maintain a register of PRC shareholders in the operating company and disclose any changes to the VIE agreements within five business days. These proposals, if implemented, would bring Hong Kong’s VIE disclosure regime closer to the CSRC’s filing requirements.

The Future of VIE Structures

The VIE structure’s long-term viability depends on three variables: PRC regulatory tolerance, US-Hong Kong listing venue competition, and the potential for direct foreign ownership in currently restricted sectors. Each factor points toward gradual structural evolution rather than sudden abolition.

Potential for Direct Foreign Ownership

The PRC’s Foreign Investment Law (2019) and the Negative List (2024 edition) both contain provisions for reducing restrictions over time. The 2024 Negative List removed foreign ownership caps in manufacturing sectors including automotive (passenger vehicles) and shipbuilding, suggesting a trajectory toward liberalisation in services sectors. However, the MIIT and Cyberspace Administration of China (CAC) have signalled no intention to relax restrictions on internet content provision or data processing, which are the core sectors where VIE structures are used.

A 2024 study by the Chinese Academy of Social Sciences estimated that full liberalisation of foreign ownership in internet services could increase sector FDI by USD 45 billion annually, but the political calculus remains unfavourable given the current emphasis on data sovereignty and national security. The VIE structure is therefore likely to remain necessary for the foreseeable future, though with increasingly stringent regulatory oversight.

Alternative Structures

Several alternatives to the VIE structure have emerged, though none fully replicate its combination of economic consolidation and legal compliance. The direct equity structure — where the offshore entity holds equity directly in the PRC operating company — is available only for sectors not on the Negative List. The joint venture structure — where the offshore entity holds a minority stake in the PRC company with control through contractual arrangements — has been used by some companies but faces the same enforceability risks as the VIE.

The Hong Kong depositary receipt (HDR) structure, introduced by the HKEX in 2018, allows PRC companies to list in Hong Kong without a VIE by issuing depositary receipts representing shares in the PRC company. However, HDRs have been used by only three companies as of March 2025, due to lower liquidity and investor familiarity compared to standard listings.

Investor Due Diligence Requirements

For institutional investors evaluating VIE-structured issuers, the key due diligence items are: (1) whether the VIE is limited to the minimum necessary sectors, as confirmed by PRC legal counsel; (2) whether the VIE agreements contain Hong Kong or PRC arbitration clauses enforceable in Hong Kong courts; (3) whether the CSRC filing has been completed and is current; (4) whether the issuer has obtained any required MIIT approvals for its VIE structure; and (5) whether the PCAOB has full access to the issuer’s PRC auditor’s working papers. The absence of any of these elements should be treated as a material risk factor.

Actionable Takeaways

• VIE structures remain the only legally viable mechanism for Chinese companies in restricted sectors to access offshore capital markets, but the CSRC’s 2023 filing regime has converted them from a grey-market arrangement to a regulated listing pathway with mandatory disclosure obligations.
• Investors in VIE-structured issuers hold shares in a Cayman Islands holding company with contractual rights only — no direct equity interest in the PRC operating company — and must assess enforceability risk under PRC contract law rather than PRC company law.
• The HKEX’s LD127-2023 imposes stricter VIE disclosure requirements than the SEC, including a mandatory PRC legal opinion confirming the VIE is the minimum necessary, making Hong Kong the more transparent venue for VIE-structured listings.
• The PCAOB’s access agreement with the CSRC is subject to annual renewal, creating ongoing regulatory uncertainty for US-listed VIE issuers that could trigger mass delistings if the agreement is not renewed.
• Direct foreign ownership in restricted sectors is unlikely before 2028 given the PRC’s current data sovereignty and national security priorities, meaning VIE structures will persist but with increasing regulatory oversight from both PRC and offshore regulators.