Telecommunications Policy 36 (2012) 929–942

Contents lists available at SciVerse ScienceDirect

Telecommunications Policy
URL: www.elsevier.com/locate/telpol

Deconstructing the myth of Alipay Drama—Repoliticizing foreign

investment in the telecommunications sector in China
Wei Shen n
Shanghai Jiao Tong University Law School, 800 Dongchuan Road, Minhang District, Shanghai 200240, China

a r t i c l e i n f o abstract

Available online 13 November 2012 Alibaba’s dispute with Yahoo and Softbank over Alipay’s ownership in 2011 again
Keywords: brought China’s telecoms law and foreign investment policies into the spotlight.
Foreign investment Although China has officially opened up its telecoms services sector to foreign investors
Alipay dispute according to its WTO Agreement, foreign investors are still experiencing various
VIE structure difficulties when they enter the Chinese market. Recent years have witnessed some
Regulations new regulatory movements tackling the variable interest entity structure (or the VIE
Political economy analysis structure) adopted by foreign investors in investing into China’s telecoms industry. This
article reviews the VIE structure and Chinese regulatory counter measures, and offers a
political economy insight to Chinese telecoms policy changes. In addition, the article
attempts to review the struggles between regulators and regulatees in the business
community through the lens of economic regulatory/development model with Chinese
characteristics.
& 2012 Elsevier Ltd. All rights reserved.

1. Introduction

The People’s Republic of China (PRC or China) became the second largest economic power in the world in 2010 (Pilling,
2010). As the world’s fastest-growing and most populous telecommunications and Internet market, in the first three
quarters of 2011, China’s overall telecoms business revenues reached RMB 734.26 billion (MIIT, 2011), which not only
attracts foreign investors to invest and but also motivates Chinese entrepreneurs to capitalize on the foreign funding
(Einhorn, 2000).
In spite of China’s promise to open itself more in its telecoms industry to foreign investors as per a fixed schedule, foreign
investors still encounter various difficulties in practice. As a result, foreign investors continuously make great efforts to rely
upon creative transactional models to have a bite of China’s lucrative telecoms sector, which in turn attracts increasingly strong
regulatory opposition. The struggle between the regulator and the regulated deserves some attention not only because foreign
investors need to work out reliable and feasible transactional models to access Chinese market but also that the struggle
reflects the problematic sides of industrial regulation and its underlying rationale, which is opposite to the unbundling or
deregulatory trend in the telecoms sector in other jurisdictions (Baldwin, Cave, & Lodge, 2012), and, deep down, demystifies the
extent to which the Chinese government is committed to the rule of law in its governance.
The article is structured as follows. Section 2 briefly examines China’s telecoms laws and policies relating to foreign
investment in the 21st century. Section 3 discusses the use of the VIE structure by foreign investors in order to circumvent
restrictive Chinese laws governing foreign investment in the telecoms sector. This part also looks into the recent dispute
among Alibaba, Yahoo and Softbank over Alipay as a case study and assesses the legality and enforceability of the VIE
structure. Some measures taken by the government in tackling the VIE structure are also discussed in this part. Section 4 offers

n
Tel.: þ86 13122037971.
E-mail address: shenwill2@gmail.com

0308-5961/$ - see front matter & 2012 Elsevier Ltd. All rights reserved.
http://dx.doi.org/10.1016/j.telpol.2012.08.008
930 W. Shen / Telecommunications Policy 36 (2012) 929–942

the rationale for policy intervention with the VIE structure. The policy considerations are grouped under the headings of
economic, industry specific and political perspectives. Section 5 discusses the general defects in China’s regulatory system and
explains the reasons why the business community is discontent with the regulatory regime in China. A tentative conclusion
will be followed in Section 6 with a purpose of envisaging possible evolutions in years to come.

2. China’s telecoms regulatory regime after its WTO’s accession

China’s accession to the World Trade Organization (WTO) on 11 December 2001 marked a new chapter of foreign
investment in China. The significance of this event was to outline a legally binding roadmap for China to further liberalize
and modernize its economy and foreign investment regime. As a result, many restrictions on foreign investment were
removed, the principle of national treatment was more extensively implemented, and the regulation and supervision of
foreign investment activities were more subject to legal rather than administrative means. However, those rules and
regulations in relation to the telecoms industry largely remained unchanged and the administrative supervision and
interference was and is still the habitual practice of the government.
Upon its accession to the WTO, China was obligated to open to foreign investment some sectors of its economy that
were previously closed. Telecoms industry was one of those. Under China’s WTO Agreement, foreign investors shall
immediately be allowed to acquire up to a 25% equity in telecoms businesses. This ratio would be increased to 49% within
three years after China’s accession to the WTO. China also agreed that foreign businesses would be permitted to operate
inter-city networks meaning that foreigners would no longer be limited to furnishing operational activities in China’s
urban areas. In addition, China promised to open its leased-line services market. Since then the State Council, China’s
cabinet, has introduced a number of regulations on the administration of foreign-invested telecoms enterprises allowing
joint ventures to invest and conduct activities in a broad range of areas which are to be phased in over a period of years.
The most influential legislation relating to foreign investment in China’s telecoms industry is the Regulations for the
Administration of Foreign-Invested Telecommunications Enterprises (the Foreign Invested Telecoms Regulations), issued
by the State Council on 11 December 2001 and further amended on 10 September 2008, according to which the ultimate
foreign equity ownership in a value-added telecoms services business must not exceed 50%.
Nevertheless, in practice, it has been extremely difficult for foreign-invested enterprises (FIEs) to obtain telecoms operating
licenses even though the foreign equity is less than 50%. Based upon this author’s anonymous enquiries to MIIT (Ministry of
Industry and Information Technology, the successor of the Ministry of Information Industry, MII), practically speaking, the MIIT
has rarely approved an application for foreign investment into a PRC telecoms business. It was reported that until 2008 China
had granted 22,000 telecoms operating licenses but only 7 of them were granted to FIEs (Kong, 2008). Table 1

Table 1
List of key regulations in the 21st century imposing restrictions on foreign investment in the telecoms sector.

Key regulations Time Key restrictions

PRC regulations of telecommunications
Administrative measures for
telecommunications business operating amended on 1 March 2009
licenses
China’s WTO agreement
Regulations for the administration of
foreign-invested telecommunications
enterprises
25 Sep 2000 Specific procedures for investing and operating in the telecoms business
in the PRC by foreign organizations or individuals as well as organizations
or individuals of Hong Kong, Macao and Taiwan shall be separately
formulated by the State Council.
Promulgated on 26 Dec 2001, An e-commerce service provider must obtain an inter-province value-
added operating license, which is issued by the MII, in order to provide
wireless value-added services on a national basis; or an intra-province
value-added operating license to provide such services within a province.
11 Dec 2001 Foreign investors shall immediately be allowed to acquire up to a 25%
equity in telecoms businesses. This ratio would be increased to 49%
within three years after China’s accession to the WTO.
Promulgated on 11 Dec 2001 The ultimate foreign equity ownership in a value-added telecoms
and amended on 10 Sep 2008 services business must not exceed 50%.

n
Complied by the author.

3. VIE structure—Deconstructing the myth of Alipay drama

3.1. How and why is a VIE structure used?

Foreign investors have worked out an artful transactional model – the VIE structure, – to participate in Chinese
telecoms industry while enjoying various tax, regulatory and legal benefits, among others, probably most importantly,
avoiding regulatory restrictions that prohibit foreign investment from being involved in the sector.1 Many China-based

1
Notice on Strengthening the Administration of Foreign Investment in the Operation of Value Added Telecoms Services (issued by MII in 2006).
 W. Shen / Telecommunications Policy 36 (2012) 929–942 931

Internet search engines or e-commerce sites such as Baidu.com, Sohu.com, Alibaba.com, 51job.com, eLong.com,
KongZhong.com adopted the VIE structure, and these e-portals have been successfully listed in either New York or
Hong Kong.
The essence of the VIE structure is a set of contracts between a foreign entity and a telecoms company in China.
In practice, the VIE structure is a legal device widely used by foreign investors to circumvent the entrance barriers imposed
by Chinese laws in some heavily regulated, highly restricted but lucrative industrial sectors, which have not been entirely
opened to foreign investors. A VIE structure is set up in this way. Foreign investors invest in an offshore special purpose
vehicle (SPV) that channels equity capital into a wholly foreign-owned enterprise (WFOE) while Chinese shareholders of
the local telecoms entity will own shares at the offshore level. Meanwhile, as the WFOE, due to its foreign equity, is not
qualified to apply for a telecoms operating license from the Chinese government authority, it nominates the Chinese
shareholders to own the operating entity that possesses a valid telecoms operating license necessary for a business and
operates telecoms assets in China.
A control mechanism is established based on contracts between the WFOE and the nominee shareholders. These
contracts are entered into so that the nominee shareholders will contractually act on behalf of the WFOE as the
shareholders of the local telecoms company. The WFOE also secures its control over the operating company’s business
operations via various contracts. The nominee shareholders will grant pledges of their interest in the operating company to
the WFOE, as well as proxies and/or powers of attorney for the WFOE to exercise all voting rights that the nominee
shareholders have in the operating company. These contracts are designed to ensure that the WFOE, or the ultimate
shareholders in the SPV, can secure control through contracts and exercise all corporate controls over the operating
company even though a shareholding control is not possible under the current law.
Meanwhile, a cash extraction mechanism is put in place between the operating company and the WFOE in order for the
operating company’s revenue to be channelled to the WFOE, and further to the SPV. Pursuant to a bundle of contracts by
and between the WFOE and the operating company, the operating company engages the WFOE as its exclusive technology
consultant and service supplier to provide the technological consulting, technical training, and other services to the
operating company in return for royalties or licensing fees. Accounting services agreement and know-how or trademark
licensing contract can also be entered into for such purposes.
These commercial contracts can help a WFOE and, more importantly, the ultimate shareholders of the SPV not only
capture the operating company’s profits in the form of service fees and royalties, but also effectively control Chinese
shareholders in exercising their shareholder power in the voting process in the operating company. Because the WFOE
nominates the Chinese shareholders to be the shareholders of the operating entity, this structure is sometimes labelled as
a nominee structure, which is demonstrated in Fig. 1 below.

Fig. 1. VIE (or Nominee) Structure. (designed by the Author)

932 W. Shen / Telecommunications Policy 36 (2012) 929–942

The VIE structure is popular among foreign industrial and private equity (PE) investors. The structure also reflects the
local business community’s preference to be packaged as foreign investment (Sicular, 1998), and the concern that the
government may impose exchange restrictions on residents (Gunter, 1996), even though the Chinese government has
gradually relaxed foreign exchange quotas for outbound investment since 2006 (Shen, 2010). More importantly, the VIE
structure, through the offshore restructuring process, does lend tax, economic and regulatory benefits to Chinese
companies or domestic shareholders. Prior to the promulgation of the uniform Enterprise Income Tax Law, the income
tax rate for an FIE was 15–25%, while a tax rate of 33% was applicable to a pure domestic entity. By adopting a VIE
structure, Chinese shareholders may capture a tax break and enjoy more preferential tax treatment. In other words, the
same business will be subject to a much lower tax rate. Even after the enactment of the new Enterprise Income Tax Law,
the VIE structure still enables shareholders to enjoy more preferential tax treatment. The SPV is only subject to a
withholding tax on the distribution of dividends from the WFOE. The withholding tax rate is 10% depending on the
application of a tax treaty and can be as low as 5% if the SPV is incorporated in Hong Kong. Therefore, the payments of
dividends made to the SPV, and/or capital gains derived from the exiting investment through the sale of shares in the SPV,
are free of PRC tax.
In the VIE structure, both Chinese shareholders and foreign investors can avoid the rigid regulatory regime in China. If a
foreign investor directly invests into a Chinese company and becomes a shareholder afterwards, any amendments to the
articles of association of the company, transfer of equity capital, increase and reduction of the equity capital, and
liquidation and dissolution of the company are subject to unanimous consent of all the board members (appointed by the
shareholders in proportion to their respective equity percentages) and approval of the original approval authority, which is
usually a time-consuming exercise. Exiting through a sale of equity in a company will also trigger approval from the
competent Chinese authority, that is, the Ministry of Commerce (MOFCOM) or its local branch depending on the total
investment amount. However, the amendments to the articles of association of the SPV, transfer of equity capital, increase
and reduction of equity capital, and liquidation and dissolution of the SPV do not require unanimous consent of all
shareholders or the approval of any governmental authority. Chinese companies seeking to be listed abroad generally
prefer to use an offshore holding company (commonly incorporated in Cayman Islands, British Virgin Islands or Hong
Kong) as the listed company due to various tax, legal and regulatory concerns. Then, the SPV in a VIE would be listed so as
to finance from an offshore stock exchange. This can avoid the troublesome securities regulations in China and the
problematic stock exchange in the domestic market.
As a forum shopping strategy, foreign investors land investments into China through offshore vehicles because the
offshore regime is more flexible and has higher standards (in terms of company law and rights protection), thus better
supports multiple rounds of debt and equity financings. The VIE structure, like a locked-in market norm, is the result of
efficient bargaining in a series of transactional events (Gilson, 1984; Ayres & Gertner, 1989). The advantages of this model
are the possibility of avoiding the burdensome Chinese corporate law and regulatory regime and, in spite of the switching
costs, reducing transaction costs. This transactional device, as a type of an informal sanction, has helped more and more
Chinese companies piggyback on more user-friendly offshore jurisdictions in order to facilitate private placement and
future overseas listings in Hong Kong, New York or elsewhere, thereby partially replacing or supplementing formal legal
institutions in China.

3.2. Legality and enforceability of the VIE structure—The Alipay case

As of April 2011, 42% of Chinese companies listed in the United States have used the VIE structure to run an Internet
search engine or an e-commerce platform in China, and thousands of unlisted companies continue to operate through the
use of the VIE structure (Hille, 2011b). While VIEs have been widely used for years in China, the legality, enforceability and
sustainability of the VIE structure remains dubious. To date, the VIE structure has never been tested in a PRC court and
there is therefore no certainty that the legality of such structure will be recognized or that such a structure will not
encounter regulatory scrutiny (or even a crack-down) at a later stage. The Alipay drama is the latest example showing that
the VIE structure is a vulnerable device.
Yahoo! Inc, a 43% shareholder of Alibaba.com Corporation (Alibaba), one of the largest Chinese Internet companies,
disclosed in its quarterly report in May 2011 that Alibaba’s online e-commerce payment processing business, Alipay
(similar to eBay Inc’s PayPal), had been restructured. 100% of Alipay’s ownership was transferred to a Chinese domestic
company.2
Based on the company registry, the sole investor of Alipay is Zhejiang Alibaba E-Commerce Co., Ltd. (Zhejiang Alibaba),3
and the legal representative of Zhejiang Alibaba is Jack Ma,4 holding 80% equity in the company.5

2
SEC Form 10-Q of Yahoo! Inc, 29 April 2011, Retrieved from /http://www.sec.gov/Archives/edgar/data/1011006/000119312511134295/d10q.
htm95/d10q.htmS (last visit on 17 November 2011).
3
The Original source is no longer available on the website of Hangzhou Branch of the People’s Bank of China. For a screen shot, see Alipay
Disturbance a False Alarm?, http://seekingalpha.com (last visit on 17 November 2011).
4
Ibid.
5
Alipay’s Buy-back, Southern China Weekend (in Chinese), 4 August 2011, D17.
 W. Shen / Telecommunications Policy 36 (2012) 929–942 933

In the beginning, Alipay was a subsidiary of Alibaba.6 On 24 July 2009, the board of Alibaba decided by passing board
minutes to transfer 70% of shares in Alipay (then incorporated in Cayman Islands) from Alibaba to Zhenjiang Alibaba.
Nevertheless, Alibaba maintained its control over Alipay through a VIE structure. As such, Yahoo and Softbank controlled
and enjoyed economic benefits of Alipay via various contractual arrangements whereas Alipay would be safe to secure a
valid operating license from Chinese authorities. Zhejiang Alibaba, labeled as a consolidated affiliate of Alibaba in Alibaba’s
2009 Annual Report,7 was under control of Alibaba via the VIE structure until the first quarter of 2011.
The Administrative Measures on Payment Services of Non-financial Institutions, issued by the People’s Bank of China
(PBOC), China’s central bank, on 21 June 2010, effective as of 1 September 2010, require that all online payment service
companies obtain a payment services license.8 It is further required that the applicant for such a payment services license
be a limited liability company or a joint stock company legally incorporated in the PRC.9 In other words, the online
payment services license will only be granted to Chinese-owned entities.
Fearing that Alipay, an FIE, might not be duly licensed, Alibaba then transferred the remaining 30% of equity to Zhejiang
Alibaba on 6 August 2010 so that Alipay was able to secure the license it needed to continue operating. After the spinoff,
Zhejiang Alibaba owns 100% of Alipay, which satisfies the regulatory requirement that Alipay is not owned by any foreign
investor, via equity or contracts. At this point, Zhejiang Alibaba became Alibaba’s VIE, whose beneficiary is Alibaba though
its equity is owned by Jack Ma et al.
PBOC sent a fax to Alipay on 26 January 2011 requesting it to declare whether or not it had a VIE arrangement with any
foreign investor. This fax implicitly indicated that Alipay’s application would not be accepted unless it is a pure Chinese
owned company without any VIE arrangement.10 Consequently, Jack Ma decided to terminate the VIE structure,11 with the
sole purpose of complying with Chinese law, and securing a valid license to maintain the normal operation of Alipay.12
Thereafter, Alibaba, Yahoo and Softbank (a 29.3% shareholder) have been under negotiation to monetise Alipay, and
eventually reached a compensation agreement, under which Alibaba would participate in Alipay’s future profits but limits
the amount of money it could receive in a sale or initial public offering (IPO) of Alipay. Under the deal, Alipay will pay
royalties and 49.9% of its pre-tax earnings to Alibaba in exchange for the licensed patents and technology prior to Alipay’s
IPO. In addition, Alipay will continue to offer payment services to Alibaba on preferential terms. Alibaba will receive
between $2 and $6 billion in proceeds from an IPO or any other type of liquidity event (that is, the evaluation of Alipay is
$1 billion, or the sale of entire Alipay’s assets).13 The amount to be paid to Alibaba in such events will be calculated by
multiplying Alipay’s equity value by 37.5%. Although there is no visibility into a timeline for Alipay’s IPO, Yahoo, as a major
shareholder, is entitled to force a liquidity event after ten years from now on.
The Alipay dispute again confirms that the VIE structure is not risk free. In the case that the PRC government
determines that the VIE structure does not comply with or has violated applicable laws and regulations, it indeed has the
authority to take remedial measures such as revoking the business and operating licenses held by the onshore operating
company and requiring the telecoms company to discontinue the business operations and contractual arrangements,
which will adversely affect the investors’ rights to collect revenues and entitlements to operate assets located in China. The
local telecoms company will be subject to severe economic and administrative penalties. The loss suffered by Yahoo and
Softbank may happen to every single foreign investor who invests into the PRC telecoms companies via a VIE.
Any further tightening on foreign investment policy could seriously impact Chinese telecoms companies which utilize
the VIE structure. The Alipay drama alerts that the VIE structure is not safe, and the risk surrounding the use of the VIE
structure is real and pressing.

3.3. China’s recent regulatory measures to tighten up the VIE structure

It is common practice for Chinese telecoms companies and their foreign investors to rely upon the VIE structure to walk
their way around the Chinese regulatory restrictions. The tactic has worked for some time in the market place. The only
reason that the VIE structure can still be used is the continuous tolerance of Chinese regulators. There is a tendency
(or path dependency) among telecoms companies and foreign investors to gamble on whether the Chinese government
will strictly enforce the rules. On the other hand, Chinese authorities have gradually been tightening up the regulatory
loopholes in the past several years. PBOC’s new regulations are one of these attempts. This sub-section outlines major
regulatory measures the Chinese authorities have taken in recent years.

6
Jack Ma’s interview with China Entrepreneur Magazine. Retrieved from /http://www.slideshare.netS (last visit 8 December 2011).
7
Alibaba.com Limited Annual Report 2009, 82, Retrieved from /http://img.alibaba.comS (last visit on 17 November 2011).
8
Administrative Measures on Payment Services of Non-financial Institutions, Article 3.
9
Ibid, Article 8.
10
Termination of VIE Structure Not Necessary for License, But Different for Alipay?, iChinastock, 15 June 2011, Retrieved from /http://news.
ichinastock.com/2011/06/termination-of-vie-structure-not-necessary-for-license-but-different-for-alipay/S (last visit on 17 November 2011).
11
Jack Ma’s interview with China Entrepreneur Magazine. Retrieved from /http://www.slideshare.netS (last visit 8 December 2011); Jack Ma
Terminated Alipay’s VIE Structure in Q1 2011, iChinastock, 15 June 2011. Retrieved from /http://news.ichinastock.comS (last visit on 17 November
2011).
12
Alibaba Group Clarification with respect to Alipay Status and Related Statements by Yahoo!, Alibaba News, 15 May 2011. Retrieved from
/http://news.alibaba.com/article/detail/alibaba/100474800-1-alibaba-group-clarification-respect-alipay.htmlS (last visit on 17 November 2011).
13
Ibid.
934 W. Shen / Telecommunications Policy 36 (2012) 929–942

3.3.1. MII rules on value-added telecoms businesses

The MII on 13 July 2006 issued the Circular on Strengthening the Administration of Foreign Investment in and
Operation of Value-added Telecommunications Business, which prohibits domestic telecoms services providers from
leasing, transferring or selling their telecoms business operating licenses to any foreign investors in any form, or providing
any resources, sites or facilities to any foreign investors for their illegal operation of telecoms business in China. This
Circular sent a strong signal to the market that the MII did not welcome foreign investors using any indirect way to
circumvent existing legal restrictions. The most devastating rule in the Circular is that the telecoms enterprise which plans
to list overseas needs to secure the MII approval in the first place, which may give MII a mandate to enforce the Circular
and exercise unlimited discretion.

3.3.2. M&A rules on offshore restructuring

The most influential piece of legislation which had an immediate and wide-spread effect on the VIE structure is the
Provisions on Acquisitions of Domestic Enterprises by Foreign Investors (M&A Rules)14 promulgated by MOFCOM, State
Administration of Foreign Exchange (China’s watchdog in the field of foreign exchange) and four other government
authorities. Restoring a higher level of scrutiny and streamlining the approval procedure, the M&A Rules require domestic
companies to disclose the offshore shareholding structure to and obtain approval from MOFCOM before setting up an
offshore SPV.15 A domestic company intending to establish an offshore SPV must first complete verification and approval
procedures with MOFCOM for outbound investment.
Under the M&A Rules no trusteeship, holding and through agency or other means is allowed to be used to circumvent
these procedural requirements.16 After receiving MOFCOM’s preliminary approval a domestic company is entitled to
submit application documents for the overseas IPO by the SPV to China Securities Regulatory Commission (CSRC), China’s
securities regulator. Following CSRC approval, the domestic company is required to apply to MOFCOM for an FIE approval
certificate – bearing the legend equity held by an overseas SPV – valid for one year from the date of issuance of the
business license. The domestic company must submit both a report of its overseas IPO through an SPV and the IPO
proceeds repatriation plan to MOFCOM within 30 day following the IPO. The M&A Rules make the entire registration/
approval regime more clumsy, burdensome, uncertain, time-consuming and costly. Under the M&A Rules the VIE structure
is overall unworkable. As a matter of fact, MOFCOM and CSRC have not approved any related transactions and overseas
IPOs since the promulgation of the M&A Rules.

3.3.3. Online games rules

The Notice on Further Strengthening of the Administration of Pre-examination and Approval of Online Games and the
Examination and Approval of Imported Online Games, issued on 28 September 2009, is another piece of regulations which
brings a direct impact on the VIE structure. Foreign investors are not permitted to invest in online game operating
businesses in China via FIEs. In addition, foreign investors are barred from gaining control over or participating in domestic
online games operators through indirect means, such as setting up other joint ventures, signing relevant agreements or
providing technical supports. From a regulatory perspective, the Online Games Notice is a further step the Chinese
authority takes to suppress the VIE structure.

3.3.4. New national security review rules

MOFCOM’s new national security review rules,17 effective on 1 September 2011, clarify national security reviews of
foreign investments in Chinese companies and bar them from using arcane investment structures or techniques such as
multi-level reinvestment, nominee shareholders, and control by agreement to evade China’s security review process even
though a clear mention of VIEs is not made.18 The rules take a substance over form approach in determining whether the
merger and acquisition transactions fall within the scope of national security review.19 Although the rules are worded in a
vague manner for application, they implicitly target the VIE structure and explicitly leave regulators more discretionary
powers.20 The industrial players and foreign investors should no longer base their business operations and deal designing
on the assumption of Chinese government’s tacit approval of the VIE structure.

14
The M&A Rules came into effect on 8 September 2006, and were further amended by MOFCOM in 2009 in order to make it compatible with the
PRC Anti-monopoly Law. Retrieved from /http://www.gov.cnS.
15
SPV is defined as any overseas company controlled, directly or indirectly, by a domestic company or Chinese natural person inside China for
overseas listing of its/his/her share interests. M&A Rules, Chapter IV.
16
M&A Rules, Article 15.
17
The State Council released the Notice on Establishing National Security Review Mechanism for Mergers and Acquisitions of Domestic Enterprises
by Foreign Investors on 3 February 2011. To specify the implementation procedures of the national security review, the MOFCOM promulgated the
Interim Rules on Issues Related to the Implementation of the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign
Investors on 4 March 2011.
18
Ministry of Commerce’s Regulations on the Implementation of the Security Review System for Mergers and Acquisitions of Domestic Enterprises
by Foreign Investors, Announcement [2011] No.53, Article 9. Retrieved from /http://www.gov.cn/gzdt/2011-08/26/content_1934046.htmS (last visit on
12 December 2011).
19
National Security Review Rules, Art. 9.
20
National Security Review Rules are wide enough to cover all merger and acquisition deals such as (i) foreign investors purchase equity interests of
domestic non-foreign invested enterprises or subscribe for capital increase of domestic non-foreign invested enterprises, which convert such domestic
 W. Shen / Telecommunications Policy 36 (2012) 929–942 935

4. Repoliticizing foreign investment—A political economy interpretation of China’s recent telecoms industrial
policy swift

Responding to Chinese authorities’ tightening on regulation, the international investment community raised legitimate
concerns that foreign investment would be gradually squeezed out of Chinese telecoms sector if the Chinese government
continues to clamp down on VIEs. This section tries to rationalize Chinese policy changes on VIEs from perspectives on
economy, industry and politics.

4.1. Economic perspectives on policy shift

Judging from recent events, it appears clear that regulatory restrictions curbing foreign investment may remain in
legislation and practice. It is not promising, at least in a short term, that foreign investment and financing will find its way
into China sooner or easier than expected. This makes economic sense. The whole foreign investment environment is
changing: China is no longer desperate for cash. Rather, the European Union and other developed countries turned to China
for possible funding of the Eurozone bail-out fund (Dinmore, Dickie, & Sanderson, 2011). This well explains why the wide
speculations or predictions that China sooner or later would liberalize its telecoms market and open up to foreign investors
to gain more funding for industrial expansion (Zhang, 2001; Yan & Pitt, 2002) have yet been materialized. Foreign
investment nowadays may contribute to inflation, trade imbalance and local corruption. Correspondingly, the pro-foreign
investment atmosphere has changed, which can be observed from the recent tension between the US and China over
Google’s business operation in China (Hille, 2010a) 21 as well as that between Australia and China concerning Rio Tinto’s
four employees arrested on charges of taking bribes and stealing commercial secrets (Waldmeir & Smith, 2010;
MacNamara & Waldmeir, 2010). The less favorable foreign investment policy towards VIEs is in line with a rising chorus
of complaints from the foreign business community concerning China’s protectionist regulatory environment and
increasingly hostility to foreign multinationals (Dinmore & Dyer, 2010; Anderlini, 2010; Beattie & Anderlini, 2010;
Dyer, 2010).22 The proposition made by Mueller and Lovelock (2000) that Western notions of liberalization and
privatization fail to capture the policy-making process in China is and will be still valid for a while.
The VIE structure is a variation to the round-trip investment model (Allingham & Sandmo, 1972; Sandmo, 2005), which
involves the transfer of capital – or assets – of Chinese residents being routed to another jurisdiction, typically a tax
heaven, and then being re-invested back to the operational company in China through an offshore SPV.23 These
transactional models assist foreign investors in finding inroads into China. There are, however, side effects. Essentially,
Chinese and foreign businesses utilize these models as a cover to enjoy tax breaks and more preferential tax treatments
intended for foreign investors, to take advantage of incentives and policies favouring foreign direct investments (FDIs), and
to circumvent various Chinese regulatory restrictions. The broad use of these transactional models has had a damaging
impact on China’s tax pool, state-owned assets, and regulatory efficiency. In addition, these devices have been used in
money-laundering activities speculating on Renminbi-denominated assets.24 In short, these transactional devices are
typical examples of how business firms exploit market impediments through tax and regulatory arbitrage.
Table 2 is a breakdown of these utilized inbound investments by country of origin indicating that foreign investment
inflows from Hong Kong and British Virgin Islands are far more than those from the United States and Japan, which are
traditionally treated as the major investors into China. On the other hand, bilateral FDI stocks from Hong Kong to China
were the second largest (in the amount of US$241,573 million) against the eighth largest stocks from China to Hong Kong
(in the amount of US$164,063) in the world in 2005 and round-tripping FDI accounted for a large share of these flows
(UNCTD, 2007). The shares of small economies such as British Virgin Islands and Cayman Islands, which have risen over
the past several years, can account for some of the round-tripping flows. As a tax heaven, incorporation regime, and
offshore financial centre, at least a substantial portion of capital flows from the Cayman Islands, British Virgin Islands or
Hong Kong may be derived from round-tripping activities. If this analysis holds, a share of 25% to 50% of all inbound
investment to China may be the round-tripping investment (World Bank, 2002; Xiao, 2004; Dollar & Kraay, 2006).

(footnote continued)
enterprises into foreign invested enterprises; (ii) foreign investors purchase equity interests of domestic foreign invested enterprises owned by Chinese
shareholders, or subscribe for capital increase of domestic foreign invested enterprises; (iii) foreign investors establish foreign invested enterprises and
purchase assets of domestic enterprises via agreements by such foreign invested enterprises and then operate these assets, or purchase equity interest of
domestic enterprises by such foreign invested enterprises; and (iv) foreign investors directly purchase assets of domestic enterprises and establish
foreign invested enterprises through such assets to operate such assets.
21
Google v China, Financial Times, 23 March 2010, p.14 (remarking Google’s closure of Google.cn and debate on Internet freedom with China).
22
Meanwhile, the Western countries such as the United States have been hostile to Chinese telecoms players who have been trying to make huge
strides into these markets. For instance, US diplomats tried to stop sensitive technology being acquired by Huawei, the key Chinese telecommunications
equipment maker, by putting pressure on European suppliers such as Spirent Communications in the UK and Philips in the Netherlands. Martin Arnold
and Stephanie Kirchgaessner, US ‘Tried to Press Huawei Suppliers’, Financial Times, 15 February 2011, p.17.
23
The round-tripping investment also appears in other jurisdictions, and is a highly litigated or arbitrated issue. See Tokios Tokeles v. Ukraine, ICSID
Case No. ARB/02/18, Decision on Jurisdiction (29 April 2004).
24
Round-trip Investments Key to Reversing FDI Decline. Retrieved from /http://www.chinalawandpractice.com/article/2194941S.
936 W. Shen / Telecommunications Policy 36 (2012) 929–942

Table 2
FDI inflows to China from major originating countries. This table is prepared by the author. Data from 1994 to 2003 are from CEIC database and data from
2004 to 2008 are from http://www.fdi.gov.cn/pub/FDI/wztj/wstztj/lywzfgbdqtj/t20090122_101099.htm. Data for Australia during the period from 2004
to 2008 are not available and are grouped into the others. Note that data for 2009 are not available at the time of finalizing this article. (% share).

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Total 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100
Hong Kong 58.2 53.4 49.6 45.6 40.7 40.6 38.1 35.7 33.9 33.1 33.71 29.75 32.37 37.05 44.41
Virgin Islands – – – – 8.9 6.6 9.4 10.8 11.6 10.8 6.05 14.96 17.74 22.14 17.27
Japan 6.1 8.2 8.8 9.6 7.5 7.4 7.2 9.3 7.9 9.4 7.91 10.82 7.23 4.8 3.95
Korea 2.1 2.8 3.3 4.7 4.0 3.2 3.7 4.6 5.2 8.4 12.88 8.57 6.07 4.92 3.39
United States 7.4 8.2 8.2 7.2 8.6 10.5 10.8 9.5 10.37 7.8 8.99 5.07 4.56 3.5 3.19
European Union – – – – – 11.1 11.0 8.9 7.0 7.3 5.55 8.61 8.26 5.13 5.41
Taiwan 10.0 8.4 8.3 7.3 6.4 6.4 5.6 6.4 7.5 6.3 9.17 3.57 3.39 2.37 2.05
Singapore 3.5 4.9 5.4 5.8 7.5 6.6 5.3 4.6 4.4 3.8 2.93 3.65 3.74 4.26 4.8
Australia 0.6 0.6 0.5 0.7 0.6 0.0 0.8 0.7 0.7 1.1 – – – – –
Western Samoa     0.3 0.5 0.7 1.1 1.7 1.8 1.81 2.26 2.46 2.9 2.76
Macau     0.9 0.8 0.9 0.7 0.9 0.8 1.64 1 1.03 0.85 0.63
Others 12.0 13.4 16.0 19.3 14.7 6.5 6.7 7.9 8.9 9.2 9.36 11.74 13.15 12.08 12.14

In addressing at least some of these side effects, the State Administration of Foreign Exchange (SAFE), China’s foreign
exchange watchdog, has been attempting to subject these transactions to tougher scrutiny. SAFE issued two sets of rules in
January and April 2005, respectively: the Circular on Relevant Issues in Perfecting Foreign Exchange Control in Mergers
and Acquisitions by Foreign Investors (Circular 11) and the Circular on Relevant Issues in the Registration of the Offshore
Investments of Individual Domestic Residents and Foreign Exchange Registration in respect of Mergers and Acquisitions by
Foreign Investors (Circular 29). These two Circulars required Chinese residents, for the purpose of making an investment in
China through an offshore holding company, to carry out approval and registration formalities with the foreign exchange
authorities. These two Circulars, therefore, made the VIE structure or the round-tripping model more difficult if not a
mission impossible. The involvement of the SAFE in regulating the round-trip investment or the VIE structure
demonstrates China’s underlying policy to tighten capital control over foreign exchange to fight hot money involved in
more cross-border transactions (Neumann, 2011; Reuters, 2011).

4.2. Industry specific concerns in policy shift

Competitive intensity is of great relevance for the level of investment and vice versa (Bauer, 2010). Competition, that is,
entry by new non-state firms including private and foreign investors, has been seen as conducive to more investment.
Trade liberalization measures such as reducing barriers to domestic entry and enhancing the flow of information will
actually be more effective than legal regulation through prohibitions and penalties.
China has tempted to use competition policy as a regulatory tool. However, in China, most telecoms services providers
are government-backed. Mobile operators in China, for instance, are 70% State-owned (Zhang & Prybutok, 2005). These key
players, as de facto apparatus of the Chinese government, were established or chosen by the government rather than the
market force and their market shares and competitiveness were pre-set by regulators (Fu & Mou, 2010). Further, these key
players more often abuse their monopolistic positions in the market. For example, China Netcom and China Telecom
entered into an agreement not to compete for landline customers in each other’s territory.25 They are so dominant and
influential that the value-added services (VAS) providers and content/application providers such as Sohu.com Inc. and Sina
Corp can only make profits after they cooperated with China Mobile which saved these VAS providers from the dot-com
crash (Zhang & Liang, 2011). These facts confirm State-owned players’ advantageous positions and the lack of playing field
in the marketplace.
Telecoms sector is not only one of the least competitive industries in China due to the lack of privatization (Fu & Mou,
2010) and dominance of State-owned enterprises (SOEs), but also subject to considerable regulatory barriers to entry and
restrictions on operations. Following accession to the WTO, the Chinese government declined to offer further concessions
in the area of market access on the ground that it had already complied with WTO commitments (Dreyer, 2002).
In industries that are key to China’s national security and economic development, the Chinese government tends to retain
or enhance its dominant or influential role.
The Anti-Monopoly Law, for example, singles out foreign companies in a provision requiring national security review in
mergers and acquisitions of domestic companies by foreign companies.26 The concept of national security, together with
other notions such as public interest and national economic development may have a wide ranging effect on the market
competition, that is, a danger of an over-inclusive or an under-inclusive application of the competition law. Likely, Chinese
regulators may exercise their discretionary powers in determining the application of these norms in reality. The

25
China Telecom and China Netcom Reaching Agreement Not to Compete for Landline Customers, Beijing Morning Daily, 27 February 2007.
Retrieved from /http://tech.sina.com.cn/t/2007-02-27/01011391578.shtmlS.
26
PRC Anti-Monopoly Law, Art. 31.
 W. Shen / Telecommunications Policy 36 (2012) 929–942 937

government in 2004 forced American manufacturers to embed WAPI, a Chinese-designed data encryption technology, on
all WiFi equipment sold in China by arguing that the equipment is needed to make China’s wireless networks safe for users
(Kshetri, Prashant, & Dai, 2011).
A more restrictive approach taken by the Chinese government towards the VIE structure is related to or reflective of the
Chinese government’s national security concerns.27 Chinese telecoms industry, though making great progresses in the past
decade, still lags behind advanced global standards. Due to lax corporate governance and managerial system as well as
weak intellectual property protection system, Chinese telecoms companies are often criticized by Western observers as
mere clones of their Western peers (Barber & Hille, 2011). Arguably, to protect China’s own telecoms industry is one major
motivation the Chinese government has in imposing restrictions on foreign investment. Therefore, in Chinese regulatory
context, it appears difficult to defend, as Yan and Pitt (2002) did, that Chinese telecoms regulations were to facilitate
competition and break monopoly. The Chinese government lists the telecoms industry as one of seven strategic
industries,28 and has planned to maintain absolute control over these key industries by SOEs.29 Needless to say,
competition in the Chinese telecoms sector is not sustainable and may at most be characterized as managed competition.
Without an appropriate level of competition, there will be no effective market and sufficient protection for consumers’
rights (Taylor, 2003). China, in rebalancing the economy, needs to transfer resources from the all-powerful state sector to
private ones (Rafferty, 2012).

4.3. Political perspectives on policy shift

The more hostile the policy towards the VIE structure and foreign telecoms investors, the more sense it makes
politically. The tightening regulatory regime of the VIE structure is due to Chinese authorities’ ideology-based way of
looking at the telecoms sector.
Contemporary society is an information society, in which information access touches upon every aspect of our lives.
Along with China’s telecoms sector’s unprecedented growth in the past three decades, the tele-density in China already
rose from 0.38% in 1978 to more than 26% in 2008 (MIIT, 2009). By 2011, China has had the largest online population that
doubled that of the US and reached some 420 million users (CNNIC, 2010; Hille, 2010c), 46% of whom are social
networking site users reaching some 176 million (East–West Connect.com 2010). Thus, the regulation of the exchange and
dissemination of information has become an important part of overall governmental control and societal management.
This is particularly true in China as maintaining social stability and national security and controlling the flow of
information is the priority of the Chinese government. Arguably, curbing foreign investment participation in the operation
of the telecommunications industry is an inherent part of this policy strategy.
Chinese government’s repoliticizing approach to tackling the telecoms industry has been consistent and long standing.
For example, as early as on 25 September 2000, the State Council issued the Administrative Measures on Internet
Information Services,30 which specify that the Internet information services regarding, among others, news, publication,
education, medical and health care, pharmacy and medical appliances are required to be examined, approved and
regulated by the relevant authorities. ICP service providers are prohibited from providing services beyond what are
included in the scope of their ICP licenses or the registration information. Furthermore, the Measures specify a list of
prohibited content. ICP service providers must monitor and control the information posted on their websites. If any
prohibited content is found,31 they must cease dissemination of the offending content immediately, keep a record, and
report to the relevant authorities. To the extent that PRC regulatory authorities find any content displayed on or through
the website objectionable, they may require ICP service providers to limit or eliminate the dissemination or availability of
such content on the website or impose penalties, including the revocation of operating licenses or the suspension or

27
This may be very different from the US0 s security concern over the sale and disperse of telecommunications technology, equipment and products
for military applications, which also frustrates commercial transactions. Stephanie Kirchgaesner, Huawei Confident of US Plans, 15 November 2010,
Financial Times, p.22. Chinese companies’ plan to inroad into the American market also encountered similar barriers. The Committee on Foreign
Investment, the US body that scrutinizes cross-border deals for potential national security implications, refused to endorse Huawei’s $2 million
acquisition of patents from 3Leaf. Kathrin Hille and Paul Taylor, Relief for Huawei after It Settles Suit with Motorola, Financial Times, 14 April 2011, p.16.
28
State Assets Supervision and Management Commission, Guidance on the Restructuring of State Capital and State Owned Enterprises (18 December
2006). Retrieved from /http://finance.sina.com/g/20061218/11133173443.shtmlS.
29
Id.
30
These Measures in particular regulate ICP services. Commercial ICP service operators must obtain an ICP license from the relevant government
authorities before engaging in any commercial ICP operations within the PRC.
31
Providers of ICP services (that is, the value-added telecoms business, a business that provides telecoms and information services by using the basic
facilities of public networks such as Internet information services) are required to monitor their websites in accordance with relevant PRC laws and
regulations, including but not limited to the Internet Measures. They may not produce duplicate, post or disseminate any content that falls within the
prohibited categories and must remove any such content from their websites, including any content that opposes the fundamental principles stated in
the PRC constitution; compromises national security, divulges state secrets, subverts state power or damages national unity; harms the dignity or
interests of the state; incites ethnic hatred or racial discrimination or damages inter-ethnic unity; undermines the PRC0 s religious policy or propagates
heretical teachings or feudal superstitions; disseminates rumors, disturbs social order or disrupts social stability; disseminates obscenity or pornography,
gambling, violence, murder or terror or incites the commission of a crime; insults or slanders a third party or infringes upon the lawful rights and
interests of a third party; or is otherwise prohibited by law or administrative regulations.
938 W. Shen / Telecommunications Policy 36 (2012) 929–942

shutdown of online operations. In addition, the costs of compliance with these regulations may increase as the volume of
content and users on the website increases.
Chinese authorities no longer merely regard the Internet sector as an industry or business generating lucrative profits.
Rather, the Internet and websites are powerful forms of media, which China always controls tightly and leaves no space for
foreign investors to participate in or intervene with. For young netizens per se, microblog (Weibo platform, a Chinese
substitute for Twitter) or QQ (the instant messaging tool)32 is much more powerful and influential than conventional
newspapers, State-run TV and radio programs. In the eyes of the Chinese government, a sharper economic slowdown and
double digit inflation may lead to serious domestic social unrest including labor strikes over lay-offs, unemployment or
cuts in overtime, and outbreaks of violence caused by land confiscations or police abuses (Jacob, 2011), which could pose
risks for the Chinese Communist Party’s (CCP) ruling and spark large-scale political protests (Pilling, 2011). Modern
technologies such as mobile phones and QQ have been recently used as a useful public forum to coordinate and organize
labor strikes in southern China (Lau & Waldmeir, 2010).
This political or ideological element triggers much heavier regulatory scrutiny and policing response than before.
For instance, the State Administration of Radio, Film and Television (SARFT), China’s broadcasting watchdog,33 has recently
stepped up censorship and control of local television programs by warning local TV stations to focus more on quality,
responsibility and values rather than exclusively on entertainment. (Hille, 2011a) This is only part of SARFT’s series of
regulatory efforts to tighten its censorship in the broadcasting sector. SARFT, with the mandate to monitor the harmful
information on the Internet and harmful SNS with information security technology and the network platform, and punish
those websites that run illegal businesses or spread harmful information,34 also plays a role of being a special consent
regulator in the Internet sector. As early as in 2006, SARFT issued the regulations on online video and program by
strengthening the licensing system.35 SARFT issued the regulations to control Internet video clips in 2006 requiring
registration before they can be published on the Internet (Goldkorn, 2006). Tudou.com and 56.com suffered temporary
shutdowns in 2008 due to their failure to comply with SARFT’s registration requirements (Kuo, 2008).
Other actions taken by the Chinese government may indicate the inherent consistency of Chinese policy move. Some
bloggers and Internet activists campaigning social justice through Internet and online messaging have been sentenced to
imprisonment for the charge of provoking quarrels and creating disturbance. Activist Zhao Lianhai who helped parents
whose children fell ill after drinking formula milk tainted with the industrial chemical melamine and called on supporters
to protest via Internet was sentenced to two and a half years jail (Yu, 2011). Notably, the Chinese government has applied
the real-name registration requirement to microblog (Weibo) accounts as an instrument to increase the government
monitoring and censorship. In the near future, China may grow more heavy-handed in policing the telecoms sector to
maintain social stability given its social management and political governance system.
Currently, censorship over media content is a state policy in China where foreign social networking sites such as
Facebook, YouTube and Twitter are blocked (Hille, 2010c) since they are viewed by the Chinese authorities as potential
vehicles for fomenting opposition to the CCP ruling (Jacobs, 2011). To this end, the Chinese government mandated that all
computers sold after 1 July 2009 contain the Green Dam filter, a software patch that could be used to monitor a user’s
online movements. The plan was put off due to a great hue and cry from the public (Watts & Branigan, 2009). Moreover,
both local and foreign researchers and technology companies have been engaged to tailor hardware and software such as
the Great Firewall program used for Internet blocking and surveillance (Menn, 2011). It was reported that 30,000
government censors use the Great Firewall to monitor the content of blogs, chatrooms, emails and web pages (Zittrain,
2008). The primary goal of the tightened censorship program and the Great Firewall obviously is to choke the free spirit of
the Internet and eventually to create a clean virtual sphere. In this sense, China’s regulatory approaches to the virtual
world are essentially the same as its conventional policing measures of the real world, that is, placing more weights on
political considerations rather than commercial ones.
China’s strict Internet censorship system has caused crowding-out effects (or entry barriers) and kept many Western
Internet competitors out of the Chinese market. The most dramatic and high profile case is Google, which relocated its
China search service from its mainland website to its Hong Kong website in 2010 arguing that it could no longer put up
with growing censorship demands from Chinese authorities (Hille, 2010b). Broad restrictions and constraints on the
telecoms sector have the effect of preventing free trade both for Internet companies and companies that rely on the
Internet for customer services, and favoring local players (in particular SOEs) under the guise of censorship. For instance,
Baidu alone accounts for more than three quarters of the Chinese online search market after Google’s relocation out of
mainland China (Barber & Hille, 2011). As to the online third party payment processing business, there is a stronger reason
to see the Chinese government take a more intrusive measure as the business may be more related to sensible financial
information and financial security.
Close scrutiny of the telecoms sector is underway featuring tightening regulations on the use of VIEs as well as micro-
blog services. The VIE structure per se is a vivid example illustrating how the cultural, commercial and political discourses

32
QQ is a very popular and convenient messaging tool. Tencent’s QQ, for instance, has 638 million active accounts at the latest count. Kathrin Hille,
Social Networks Steer China Web Evolution, Financial Times, 30 November 2010, p.22.
33
SARFT is also an ideological regulatory organ, directly under the supervision of CCP0 s Propaganda Department.
34
Opinion of the General Office of CCP Central Committee and the State Council on Further Strengthening the Management of the Internet (2004).
35
Measures for the Administration of the Publication of Audio-Visual Programs Through the Internet or Other Information Network (2004), Art. 5.
 W. Shen / Telecommunications Policy 36 (2012) 929–942 939

merge in China’s media sphere, and how the repoliticizing approach has been internalized on apolitical discourse.
As long as the Chinese government’s way of viewing the telecoms sector remains unchanged, more government oversight
will continue to be a strong tendency in years to come. It is worth noting that the more rigid Chinese regulatory regime in
the telecoms industry differs from a recent shift in the thrust of public policy in the United States and Australia which are
taking some forms of state intervention (Bauer, 2010). Ideological intervention is a unique phenomenon in China which
often distorts market mechanisms.

5. Struggles between regulators and regulatees—Old problems or new challenges?

Much of the story of VIE structure has involved a process by which regulatory institutions attempt to manage the
interplay of formal and predictable regulation with informal and flexible business strategies. Business opportunities drive
economic actors to seek more predictability or feasibility through technical reliance on legalized process for managing
transactions. The efforts made in this legalizing process are to challenge the indeterminism of regulatory restrictions and
to seek more formal limits on arbitrary state power. Commercial interests of market actors are unlikely to be satisfied by
bureaucratic reliance on regulatory litanies that are unresponsive to the practical realities of economic behaviors and
market forces. As rightly pointed out by Yan and Pitt (2002), China’s centralized system with a planning tradition and
fortress mentality are naturally against market liberalization and foreign investment. Influenced by various conflicting
forces from multiple agencies and vested interests, there lacks effective regulation or governance which is supposed to
ensure market efficiency and legal certainty. Against this backdrop, commercial interests have been often ruined by the
exercise of state power. For instance, Sina’s popular microblogging service suffers a loss in share price (Hille, 2012a) from
the real-name registration requirement, which made Sina more difficult to monetize Weibo through the revenue-
generating plan (Hille, 2012b). The Chinese experience appears to counter the empirical proposition made by Friederiszick,
Grajek, and Roller (2007) that there is no relationship between regulation and investment.
In China, market economy is a managed one, not simply about commercial interests, business opportunities and market
actors. Political intrusion is deeply entrenched in the legal and regulatory system. In the area of economic regulation,
political institutions have created profound influences on every economic and socio-cultural aspect in the Chinese society
(Xia, 2011b). Accordingly, the theme of law as an instrument of the CCP policy remains powerful. This policy orientation
and (re-)politicization that accompanied it often led to arbitrariness in the creation and application of law, which in turn
increases rigidity in governance divorced from justice in a substantive sense while lending the appearance of legality to the
process of administration. As a result, regulatory space becomes tighter due to the involvement of ideological or re-
politicizing elements, and creates more hurdles to the market efficacy. These Chinese characteristics lead to an open
question whether CCP’s power and state authority can be effectively maintained in the midst of economic development in
a long run.
The role of law in China’s economic regulation suggests a range of dilemmas such as the changing imbalances between
state intrusion and market forces driven by the needs of government regulation and market players, the increasing
tensions between political transformation and market liberalization or economic growth as policy priorities, as well as the
dynamic struggles between a top-down bureaucratic process in an authoritarian regime and a bottom-up process in a
more decentralized socialist market economy. The center of these dilemmas lies in the effectiveness of public
pronouncements about reserving the socialist character of China’s legal or regulatory system, which has been heavily
tainted by regionalism, departmentalism and factionism. Essentially, China’s over-regulation over VIEs and, in a wider
sense, the telecoms sector, does not match the de-regulative rhetoric in the field of public law (De Streel, 2008) but does
imply Chinese authorities’ tendency to take a hands-on approach to increasing their own influences. The popularity of VIEs
and the subsequent regulatory crack-down is a good example of these dilemmas.
Whilst legislative and regulatory initiatives indicate the continued prominence of state supervision to protect public
interest (which is often intentionally and confusingly mixed together with CCP’s interests), market players may require
broader autonomy through restraints on state intrusion. These have all challenged the supremacy of patrimonial
sovereignty as the basis for the exercise of power and driven more demands for responsible agency on part of the
government. The Chinese government occasionally tried to justify its prohibitive policy with the defensive weapon of
protecting the State’s sovereignty36 as foreign dominance in the telecoms industry may bring negative impacts to China
and foreign countries are likely to impose political pressures on the Chinese government under the excuse of the so-called
freedom of Internet (Ma, 2010). One distinctive feature of the Chinese concept of sovereignty is its faithful adherence to
the principle of inviolability of state sovereignty (Kim et al., 2011). China’s sovereignty-centered thinking and obsession
with the inviolability of sovereignty doctrine remain unchanged whenever issues such as territorial sovereignty and
integrity, humanitarian intervention and universal human rights are concerned. In these scenarios, China more often sticks
to its long standing on sovereignty in general (Wen, 2004). This is a stark contrast to China’s standing on economic
sovereignty which departs away from the traditional concept of inviolable sovereignty.

36
Sovereignty can be divided into internal sovereignty and external sovereignty. Elihu Lauterpacht, Sovereignty: Myth or Reality, (1997)
International Affairs (73)1, 138. As one of the largest developing countries in the world, China strongly believes that it should follow its own model
of development and place great emphasis on equality and mutual respect for sovereignty in foreign relations and are particularly sensitive to criticisms
for the Chinese state and its handling its internal affairs.
940 W. Shen / Telecommunications Policy 36 (2012) 929–942

The Chinese government has limited ability to foresee the feasible forms that economically beneficial transactions may
take. Therefore, the law should provide necessary default rules so that the parties can enjoy much flexibility. There is a
strong economic argument in favor of minimizing state interference in contracting commercial activities if economic
growth is the goal to the transacting parties. The government should be more tolerant to the growth of non-legal
institutions that promote the beneficial exchanges the law does by providing information and facilitating the free flow of
capital, goods and services. Economically, over-regulation may impose welfare costs due to the delayed deployment of
innovative technologies and reduction of the investment size (Alesina, Ardagana, Nicoletti, & Schiantarelli, 2005), which
may eventually affect social welfare and long-run economic development (Roller & Waverman, 2001). Alternatively, the
government may converge regulator responsibilities and authorities into an integrative platform so as to ensure
coordinated and effective regulation in the telecoms sector (Xia, 2011a).
The fate of the VIE structure does help explain how China’s compliance with international norms remain contextualized
to domestic conditions and local imperatives. While policy makers and law reformers are sensitive to a variety of local
institutions and circumstances, they should be aware of what are generally considered best practices in law. As far as
business practices are concerned, the uniqueness of the Chinese market is two folded. First, the state-ownership-
dominated market structure may and will profoundly influence business culture and practices in the telecoms sector as
SOEs have to simultaneously serve political, economic and social goals and a pure maximization of economic benefits or
social welfare is not their sole target (Xia, 2011b). Second, Chinese laws and policies often lag behind business practices
partly due to the fact that governments or business institutions at lower levels are more adaptive and pragmatic to central
policies (Xia, 2011b) and in part because enforcement mechanisms for formal laws and institutions are weak and
dysfunctional (Murphy, 2007). The VIE structure can be viewed as a self-enforcing informal substitute filling the gap
between formal law and business practices. The ups and downs of the VIE structure offer insights into the process through
which China has attempted to join on its own terms the international political economy.
One of the major regulatory challenges both China and others are facing is creative compliance. The problem is no
longer non-compliance but a lawful form of compliance through which the regulated resists regulation not by bluntly
breaking the law but by fragrantly using it. Investors find imaginative means to interpret rules or package deals such that
their activities can be categorized to comply with regulations at the same time as avoiding any disadvantageous impact or
consequence they would otherwise have swallow. The use of the VIE structure is creative compliance as it involves
advantageous interpretations of grey areas, seeking out loopholes in specific rules, complying with letter not spirit, with
form not substance, or dreaming up devices which regulators had not even thought of, let alone regulated. From a
regulatory perspective, it would be more effective if the regulators would take a truly responsive approach, that is, a
target-analytic approach. This could entail investigating into and tailoring regulatory measures on the basis of the
regulatees’ own operating and cognitive settings, the broader institutional environment of the regulated industry, the
differing logics of regulatory tools and strategies, and even the regime’s own performance and functioning (Ayres &
Braithwaite, 1992; Sparrow, 2000; Black, 1997). The Alipay drama provides a rich variety of policy implications concerning
the struggles between regulators and regulatees. Policy issues for regulating a modern telecoms industry in China,
particularly relevant to the VIE story, are the top-down structure and restrictive approach tackling the market entry, which
have indicated a strong re-bundling trend with a repoliticalized focus, instead of an optimal or efficient institutional
design.

6. The way forward—Is there a bright future for foreign investors in China?

China, the world’s second largest economy, needs to pay more attention to how it relates to or interacts with the rest of
the world as the development success symbolized by its rise in its GDP rankings means its economic policies have global
implications and there is a reasonably high expectation from the international community that China will assume more
responsibility and act according to rule of law on the world stage.
The possible entire abolishment of the VIE structure by the Chinese government may fundamentally damage the
Chinese government’s credibility and harm its image, which the Chinese government is unlikely to risk. A pragmatic
solution to tackling the dilemma between tightening up the regulatory regime for the telecoms industry and maintaining
its stance of being welcoming to foreign business is therefore to keep the official attitude and policy towards the VIE
structure vague. Likely, the current restrictions limiting foreign investors from participating in China’s telecoms sector may
remain unchanged in the near future. In the 3 G era, as China is unlikely to realize its promise under the WTO Agreement
of 50% foreign ownership of equity in the next few years (Fu & Mou, 2010), foreign investors need to be more cautiously
creative in designing transactional models in order to successfully access the Chinese market.
While it is hard to predict the ultimate destiny of China’s economic and institutional reform at this stage, it seems safe
to say that marketization of the economy would continue to widen the scope of private sectors in China’s economic growth
and business ecosystem (Moore, 1993; Adner, 2006) to the extent that the CCP’s political monopoly is not adversely
affected. Chinese regulators, in repoliticizing industrial laws and policies, need to strike a balance between short-term
static and long-term dynamic aspects of regulatory and market efficiency. Market players, in particular, foreign investors,
should get themselves more familiar with those idiosyncratic features attached to China’s economic, political, social and
legal systems.
 W. Shen / Telecommunications Policy 36 (2012) 929–942 941

Acknowledgements

The author wishes to thank three anonymous referees’ as well as Yu Baolu and Hou Liyang’s comments on earlier drafts
of this article. The author also wishes to thank Shanghai Education Commission for a research grant under the Eastern
Scholarship scheme. All the errors and omissions are the author’s.

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