Chinese Stock Delisting
Many Chinese companies have listed on US exchanges because this is a deep pool of capital which helps fund their growth
Listings have slowed down in 2021 due to a clampdown by US regulators but also the Chinese government. Chinese IPOs peaked in Q3 2020, when they raised just under $40 billion. Notice that tech companies as a proportion of new listings, fell dramatically in Q2 2021
This is a problem for US exchanges, where these IPOs are a good source of revenue and also for banks that manage the IPOs
From the US side, the issue is partially transparency but also strategic
The US passed the “Holding Foreign Companies Accountable Act” in December 2020
This requires all US-listed foreign companies to allow the Public Company Accounting Oversight Board (PCAOB) to inspect their audited accounts and disclose any government ownership but China’s accounting firms say that Chinese law bars them from sharing audit work papers with the PCAOB because the documents may contain state secrets
What riled some US politicians is that the Chinese military may benefit from technology developed by some of the companies being funded by US capital
Currently, there’s a three-year window for companies to delist or comply with the US act (the window begins in 2021 and ends in 2024, delisting would happen in 2025)
The US Senate passed the “Accelerating Holding Foreign Companies Accountable Act” but it hasn’t been ratified by Congress. This would reduce the compliance window to two years
The US Securities and Exchange Commission (SEC) suggested a solution where the SEC would allow a “co-audit” where US auditors of Chinese companies listed in the United States would be able to validate their Mainland subsidiaries’ work
From the Chinese perspective, it’s more of a strategic concern
When Didi, which produces apps for ride-hailing, delivery of goods and financial services, was told to de-list it was because of strategically important data on Chinese citizens
The Cyberspace Administration of China (CAC) ordered app stores to remove 25 of Didi’s mobile apps and told the company to stop registering new users, citing national security and the public interest according to Reuters
It announced it would delist on December 2nd, 2021 just five months after listing!
But both sides have an interest in maintaining the ability for Chinese companies to list on US Exchanges
It generates lots of fees for exchanges and US banks
It lets Chinese companies raise capital to grow
How many more companies will be affected?
The Chinese Ministry of Industry and Information Technology (MIIT), which announced that a six-month review of internet companies commenced on July 23, 2021, to deal with issues related to
Cybersecurity
Online education
Data privacy
Consumer protection
Monopolistic behavior
The schedule may coincide with March 2022 which is the time of the final meeting of the five-year session of the 13th National People’s Congress (NPC) in which China will elect government officials for the 14th NPC
Achievements that will be announced include
Easing the financial burden of tutoring, which accounted for a staggering 25% of urban household income
Supporting minimum wage for China’s 200 million gig-economy workers
Addressing income inequality (“common prosperity”)
These regulatory hurdles are nothing new
In 2018 China spent months restructuring its approval process for new media (i.e. games and movies)
It restricted content that was too violent or offensive
After ten months the newly formed Online Game Ethics Committee ended the suspension of new game releases
Tencent’s share price dropped -30% over 2018
Tencent did as it was told e.g. new policies including mandatory identity/age verification and limits on younger users’ playtime then received a wave of approvals on new games & its stock recovered in 2019
Baidu’s (China’s Google) was forced to make its medical advertisements more transparent
This followed the death of a student who underwent an experimental cancer treatment that he found through a non-disclosed advertisement on Baidu’s search engine
Baidu temporarily halted its healthcare advertising and focused on revamping its policies to comply with the new regulations
Baidu’s sales were impacted in the following two quarters as healthcare advertising accounted for 20-30% of its overall search revenue at the time
Baidu eventually recovered its revenue & its share price bounced back
Funds that use Variable Interest Entities (VIE) to buy Chinese stock exposure risk those structures being ended by the Chinese government
A VIE is a Cayman Islands based shell company that lets US investors buy exposure on US exchanges as if they owned the Chinese stock (with currency adjustments from USD to RMB)
At the same time, a VIE avoids rules about foreign investors not being able to own domestic Chinese stocks
This idea is almost a century old and for other countries is called an American Depositary Receipt
KWEB says if the VIE structure is shut down it would switch US-listed Chinese shares to their Hong Kong-listed equivalents, where available
They anticipate that “all names in KWEB will have a Hong Kong listing by the end of 2022, allowing for a full conversion of all US-listed ADRs to their Hong Kong-listed equivalents”
“If we were to convert all the dually listed names today, we could reduce the US-listed weight from 64% to 24%”
The Hong Kong Stock Exchange expects to have a new rule go into effect in January, 2022 that will allow all US-listed Chinese companies to re-list in Hong Kong
Further Research
See our explainer “Funds To Buy The China Dip”
We have a video on Chinese equity funds (Investing In China Stock Market 2021)
The documentary “China Hustle” The China Hustle Trailer #1 (2018) | Movieclips Indie is entertaining and informative. It tells the story of collusion between small US stockbrokers and Chinese small companies in reverse mergers with defunct US companies. Values of the Chinese companies were overstated and eventually, their prices crashed
This highlights the problem that US auditors (even The Big Four accountants Deloitte, Ernst & Young, KPMG and PwC) verified Chinese accounts which later turned out to be works of fiction
It also raises the possibility that bigger companies like Alibaba might be overstating their growth