Compromise over delisting may signal China-US thaw
A dispute that could lead to the delisting of Chinese firms from US stock markets shows signs of resolution
Chinese regulators have this month issued draft revisions to their rules on compliance with foreign auditing requirements, potentially offering a way out of a standoff that threatens to remove Chinese firms from US exchanges. Chinese regulations prevent Chinese firms listed on US exchanges from complying with US auditing regulations, leading to US threats to delist them. Among the 200-plus Chinese companies exposed to this threat are many large Chinese technology businesses.
What next
This episode provides a first, tentative sign of detente in US-China tensions related to the technology sector, which have only ratcheted upward so far. Whether it is a temporary lull before further escalation will not be settled in the stock markets or the tech sector alone but depends on the broader political context. In the short term, this points to compromise on the Chinese side but potentially a tougher line from the United States.
Subsidiary Impacts
- Washington may seek to leverage this issue to pressure China to refrain from supporting Russia in its war with Ukraine.
- China wants its tech firms to list at home, to capture more of the returns as they grow, and reduce vulnerability to US pressure.
- New York will remain important for Chinese firms, since Chinese stock markets cannot match it for investor interest and liquidity.
Analysis
In the past few years, economic interdependence became weaponised in the growing tensions between the United States and China. One relatively new component in this process concerns stock markets, and more specifically, the listing of Chinese companies on US exchanges.
Chinese constraints
The Chinese government has taken several measures to limit such listings, most notably in the aftermath of the listing of ride-hailing service Didi Chuxing last year (see CHINA: Didi debacle shines light on new normal - August 2, 2021 and see UNITED STATES: Uncertainty clouds IPO ebullience - October 14, 2021).
Companies holding significant amounts of either personal information or important non-personal data must now pass a government cybersecurity review before listing. More broadly, Beijing has sought to incentivise listings domestically or in Hong Kong, partially to mitigate geopolitical concerns, but also to retain a greater share of the value added of private companies for Chinese investors.
There are, however, a considerable number of Chinese companies already registered on US stock exchanges, many of them through the Variable Interest Entity (VIE) structure that has remained in legal limbo for years, but seems to have been legitimated and recognised late last year. However, these have come to face increasing regulatory scrutiny by US securities regulator.
US legislation
In late 2020, the Holding Foreign Companies Accountable Act was passed, reflecting concerns over access by the Public Company Accounting Oversight Board to foreign -- mostly Chinese -- auditing information.
Chinese regulations had prohibited companies listing overseas from disclosing sensitive financial information to foreign regulators. This led to a stand-off which reached a high point in March of this year, when the Securities and Exchange Commission (SEC) identified a first batch of five Chinese companies that would be delisted from the New York Stock Exchange in 2024 if they did not provide proof of audit compliance. These were Yum China, ACM Research, BeiGene, HutchMed and Zai Lab. In total, over 200 Chinese listed companies would potentially be vulnerable to similar measures.
The announcement by the SEC caused a further drop in Chinese company stocks, many of which had already lost significant value due to China's regulatory offensive targeting the platform economy, the surge of Omicron infections in China, and geopolitical instability due to the Ukraine crisis. The Nasdaq Golden Dragon China Index lost over 10% in a single day, while in Hong Kong, where many of these companies have secondary listings, the Hang Seng Tech Index registered a drop of over 4%.
Finding a way out
Initially, the Chinese response was truculent, with the China Securities Regulatory Commission (CSRC) stating its opposition to the "politicisation of securities regulation". Even so, it rapidly became clear that the CSRC would be willing to work with US regulators in order to find a solution.
China has sought to increase domestic funding streams for domestic high-tech companies, both to support the sector's development and to increase China's share of the resulting gains. However, Hong Kong, Shanghai and Shenzhen cannot match the investor interest and liquidity available in New York, meaning US capital markets are still of great importance for Chinese businesses.
Since last summer, CSRC chairman Yi Huiman and SEC chairman Gary Gensler held repeated meetings on cooperation in auditing oversight, and both confirmed progress had been made.
Subsequently, in early April, the CSRC released a revision draft of its auditing regulations, which dropped the requirement that the inspection of financial statements of Chinese companies listed abroad must be conducted predominantly by Chinese regulators.
This draft, which is likely to be passed in a few months' time, already goes a considerable way towards assuaging US requirements, although the SEC has reserved judgment until the final rules emerge and it is clear that compliance with US audit regulations is fully possible.
US regulators are reserving judgement till China's amendments are finalised
Even so, stock markets reacted positively to the news, while several Chinese companies, such as Alibaba and Tencent, implemented high-value share buybacks, reflecting confidence in their share value.
Political context
A five-yearly Communist Party Congress is due in the autumn at which President Xi Jinping almost certainly intends to begin a third five-year term as leader and fill yet more of the Party's senior positions with his affiliates.
Xi is not in a strong position to escalate tension with Washington
Unfortunately for Xi, several recent developments reflect poorly on his leadership: a severe wave of COVID-19 combined with a zero-COVID policy has prompted costly and disruptive regional lockdowns; an ongoing crisis in the property sector is dragging down economic growth; and the Russian invasion of Ukraine, which Xi failed to prevent and even appeared to encourage, has put China in a position in which it has no good options.
In this context, Xi is unlikely to want to play hardball on the issue of stock market regulation, since this would result in further damage to the share prices of Chinese companies and any benefits would not be visible until later.
