Eyeing home and looking beyond quick fixes
280-odd troubled US-listed Chinese companies pin hopes on solutions for the long term
When Chinese beverage chain Luckin Coffee was ejected from Nasdaq in June 2020 after it had admitted a couple of months earlier that it had cooked its books, little did market mavens realize the development will not only have serious implications for the 280-odd US-listed Chinese companies but cast a shadow on bilateral trade, economic and diplomatic relations.
In the last 12 months, the Nasdaq Golden Dragon China Index, which tracks US-listed Chinese companies, plunged more than 60 percent. This, market insiders said, reflects downbeat investor sentiment made further dour by the US Securities and Exchange Commission’s penchant to subject such companies to potential punitive measures like delisting, for allegedly failing to meet the local regulator’s audit requirements.
Altogether 128 US-listed Chinese companies, including restaurant chain Yum China Holdings Inc and technology giant Baidu Inc, have been put on the provisional or conclusive lists of issuers identified under the Holding Foreign Companies Accountable Act (HFCAA) so far, with 23 of them already placed on the conclusive list, a prelude to eventual delisting.
All this has forced market people to ponder the future. Consensus is fast emerging that things need to move beyond quick fixes like eyeing secondary listings in China and toward long-term solutions like solid bilateral agreements.
Only that, experts said, can help undo the damage inflicted by the June 2020 memorandum, issued by former US president Donald Trump, on “protecting United States investors from significant risks from Chinese companies”.
That memo led to the HFCAA, which became law on Dec 18, 2020. Even since, the law has been invoked mainly to prevent Chinese mainland companies from listing on US exchanges and to target US-listed Chinese companies, for allegedly not complying with the audit requirements of the Public Company Accounting Oversight Board, which oversees the audits of all US-listed companies.
Han Hongling, a professor from the School of Management at Zhejiang University, said although US regulators have not exactly been neutral in their financial supervision, the Chinese authorities concerned have consistently displayed steely resolve to find workable and mutually fair long-term solutions.
For instance, the China Securities Regulatory Commission, the country’s top securities watchdog, said in mid-March that agreements for cooperation should be forged as soon as possible to protect the lawful rights and interests of investors worldwide.
During the Boao Forum for Asia Annual Conference 2022 in April, CSRC Vice-Chairman Fang Xinghai said the PCAOB in the US will be able to conduct inspections in China of Chinese accounting firms that audit US-listed Chinese companies in a reasonable, rational and legal manner. A bilateral cooperation agreement is about to be reached in the near future, he said without specifying a time frame.
Experts said the need of the hour is the establishment of institutional mechanisms to create clarity on cross-border supervision.
But that is not a terribly new idea because way back in April 1994, China and the US had signed a memorandum of understanding regarding cooperation, consultation and the provision of technical assistance through exchange of information and securities materials. The larger idea was to facilitate the implementation of securities laws of the respective markets. But not much happened after that — no detailed regulation was drafted, said Han of Zhejiang University.
China and the US should, therefore, roll out a road map under which comprehensive cooperation in cross-border supervision over securities trading can be made possible, he said.
The first step China should take is to sign the Enhanced Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information, which was released by the International Organization of Securities Commissions in 2017 to offer securities regulators worldwide new enforcement powers for crossborder cooperation.
Supervision over auditing should kick in for the next phase of China-US cooperation. The Chinese regulators can assist in providing audit working papers, conduct joint inspections into audit firms’ programs, or jointly look into the overall service quality of audit firms.
By taking such smaller steps, the bilateral audit supervision agreement may be reached, upon which an overall cross-border securities cooperative agreement for the long term can be built, he said.
Until that becomes reality, US-listed Chinese companies have no other alternative but to look for short-term solutions as the time is ticking for them on the US bourses.
Such companies will consider going private, returning to the A-share market or listing in Hong Kong.
Going private may be least welcome to listed companies as it indicates they will have to give up the financial market in general. Morning Whistle Group, a Shanghaibased industrial investment services provider, estimated that 48 relatively smaller US-listed Chinese companies may opt to go private.
As categorized by CITIC Securities analysts, companies having major information security risks will return to the A-share market or the Hong Kong stock market at a faster pace, including those related to national defense, military and energy. Companies possessing public data, covering sectors like finance, logistics, ride-hailing, biology and medicine, will also find a quicker way back.
One possible choice is to list part of the company’s business or assets on the A-share market, which is allowed according to the Shanghai and Shenzhen exchanges’ regulations.
Or, these companies can seek a complete return to the A-share market. It has been made possible by the adoption of the registration-based IPO mechanism in July 2019, as requirements on shareholding structure, profitability or sales revenue have been largely relaxed.
With the registration-based IPO mechanism, returning companies do not have to change their “redchip” shareholding structure — it helps them to hold or control onshore assets either directly or indirectly through the use of offshore special purpose vehicles incorporated outside the Chinese mainland — to make an IPO or issue depositary receipts on the A-share market. They need to obtain approvals from the CSRC and other government departments such as the National Development and Reform Commission and the Ministry of Commerce.
China Resources Microelectronics Limited, which went public on the STAR Market in Shanghai on Feb 27, 2020, is the first returning company that did not have to change its red-chip structure. Ever since, five other hitherto US-listed companies returned to the A-share market treading the same path, with telecom juggernaut China Mobile being the latest.
The problem, however, is that less passive investment will be directed to such returning companies. Although the A-share market has been included in the world’s major indexes such as the MSCI and FTSE Russell, and some investment products do passively follow their choices of stocks, a limited number of Ashare companies have been selected so far in such indexes.
At present, the A-share market’s weighting in the MSCI Emerging Markets Index is about 4.2 percent, equal to $157 billion worth of foreign capital inflows into the A-share market since the inclusion three years ago. International investors, however, currently hold about $1.8 trillion worth of shares of US-listed Chinese companies, said Han of Zhejiang University. Insiders are not sure if the A-share market can attract that level of investment if US-listed Chinese companies return home.
In this context, the Hong Kong stock market is perhaps better placed. As calculated by UBS, 19 US-listed Chinese companies have made a secondary listing in Hong Kong, and their combined market value is as much as 60 percent of the total market value of all US-listed Chinese companies.
Another 50 companies of the kind are expected to return to the Hong Kong bourse this year. Based on that, the 70-odd returnees will likely account for 97 percent of the market value of all the US-listed Chinese companies.
The size and liquidity of the Hong Kong stock market have been frequently questioned. Its daily trading value is only one-eighth of its US counterparts. But a “dynamic” perspective should be taken to understand the current difference, said Hu Yifan, regional chief investment officer and head of macroeconomics for Asia-Pacific with UBS Global Wealth Management.
If investors still hold a positive outlook on China’s economy and wish to continue their investment in US-listed Chinese companies, they will come to the Hong Kong market anyway, said Hu.
The current average daily trading value of the A-share market is about $200 billion, which is quite considerable. Although the returned US-listed Chinese companies are not included in the stock connects linking Shanghai, Shenzhen and Hong Kong at present, it will not take long to make that change. The capacity of the Hong Kong market will be thus increased, she said.
The Hong Kong bourse effected a revision at the beginning of this year, allowing non-innovative Chinese mainland issuers without a weighted voting rights structure to make secondary listings under more relaxed requirements.
As an international hub, Hong Kong is ready to welcome quality US-listed Chinese companies, said Hong Kong Secretary for Financial Services and the Treasury Christopher Hui Ching-yu in early April. The market choices will be thus enriched and liquidity will be increased, he said.
But once the regulatory disputes are settled by China and the US, the outbound reach of Chinese companies will resume.
The Chinese government will continue to support various enterprises seeking overseas listings, the Financial Stability and Development Committee under the State Council, China’s Cabinet, stated at its March 16 meeting, which was presided over by VicePremier Liu He.