Who owns what?

OWNERSHIP is rarely straightforward in China. After Mao Zedong died and land was opened up for commercial development, each plot came with only a 50-year government lease. No one knows what will happen when those leases expire. Yet building projects continue apace.

Foreign investors face a similar conundrum. Several Chinese industries, such as mining, steel, education, telecommunications and the internet, are both capital-hungry and politically sensitive. They need foreign investment, but the law bans foreigners from owning stakes in them.

Eager investors and canny locals have found ways around the rules. Perhaps the most important is the creation of a complex investment vehicle called a “variable interest entity” (VIE). It works like this: valuable Chinese assets are placed in a Chinese company. This entity, the VIE, must be run by a Chinese citizen. A series of contracts are then arranged, shifting the returns from the VIE first to a foreign-owned company registered in China and then to an offshore company, perhaps in the Cayman Islands.

This structure—a Chinese-owned company in China, a foreign-owned company in China and an offshore parent—is known as the “Sina” model, after the first Chinese internet company to be listed overseas. It is used by about half of the Chinese companies listed in America, says Paul Gillis, a professor at Peking University. Numerous other unlisted companies use it as well. It allows Western companies to invest in China without breaking local ownership restrictions.

There are signs, however, that the Chinese government has begun to frown on VIEs. In 2006 the Ministry of Information, which regulates internet firms, said it was taking a look at them. In 2009 three other ministries announced that VIEs were banned for companies involved in internet games.

Berating Buddha

In March, says Thomas Shoesmith, an attorney with Pillsbury, a global law firm, a $38m bond offering in America for a company called Buddha Steel was withdrawn after authorities in Hebei province blocked its VIE with a local steel plant. Officials said that the very existence of a VIE contravened Chinese management and public policies. An anxious debate followed: was this the random act of a single region, or a wake-up call from Beijing?

A dispute between Alibaba, a Chinese internet group, and Yahoo!, an American firm that owns 43% of Alibaba through a VIE, suggests the latter. The Alibaba VIE recently transferred a valuable asset (Alipay, an online-payments firm) to a local Chinese company controlled by Jack Ma, Alibaba's chairman. Yahoo! was outraged. Alibaba claims it had no choice. It says it was warned by China's central bank that Alipay would not be allowed to operate if it was, in effect, partly foreign-owned.

In theory, the same problem could afflict the rest of the Alibaba Group. But Alibaba says its other operations will be unaffected because they fall under a less fussy regulator, the Ministry of Information.

Perhaps so, but Mr Gillis, who has long blogged about the potential pitfalls of VIEs, is suddenly getting lots of attention. Alibaba is not unique. Other firms with VIE structures are also involved in electronic payments. At least one has a foreign partner. Now that the issue is in the news, China is under pressure to spell out what is permissible, and what is not. The risk that big foreign firms will suddenly find that their investments in China are illegal or worthless is surely remote. Or is it?