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In recent weeks, a pair of U.S.-listed Chinese companies have opted for secondary listings in Hong Kong, each raking in billions of dollars in capital. Gaming company NetEase and e-commerce giant JD.com, both Nasdaq-listed, debuted in Hong Kong this month, with NetEase raising $2.7 billion on June 11 and JD raising $3.9 billion last Thursday in the second-largest IPO of the year so far.
The trend seems set to continue with search engine Baidu and travel agency Trip.com reportedly considering secondary listings in Hong Kong. New York–listed fast-food group Yum China also is eyeing a secondary listing there, in what would be the first non-tech Chinese firm to join the movement.
The run comes months after Alibaba broke ground with a $12.9 billion secondary listing in Hong Kong in November—five years after its record-breaking initial public offering in New York.
The new “homecoming” secondary offerings look to replicate Alibaba’s success, but they also reflect the renewed rift between the U.S. and China over the coronavirus, trade, and human rights. Proposed regulation and legislation in the U.S. are squeezing Chinese companies, jeopardizing their access to U.S. markets.
The U.S. sees its clampdown as a new broadside in its battle with Beijing, but so far it’s proving to be an unexpected boon for at least one player: Hong Kong. U.S.-listed Chinese firms are looking to Hong Kong to hedge their bets, with the potential to pour hundreds of billions of dollars into the city just as Beijing pulls Hong Kong closer and casts doubt on the city’s future as Asia’s financial capital.
U.S. pressure
Washington has been hunting for ways to bump Chinese companies off the U.S. stock market since June of last year, when a bipartisan group of lawmakers introduced a bill that would exert greater regulatory oversight on Chinese firms. “It’s time for China’s government to play by the same rules as American companies in our financial markets,” said Sen. Bob Menendez (D–N.J.), a sponsor of the bill that, in the end, didn’t get far.
Then in April this year, financial fraud allegations rocked three U.S.-listed Chinese companies. Nasdaq-listed Luckin Coffee was found to have exaggerated sales by $310 million. Days later, NYSE-listed TAL Education Group admitted fraudulent sales. Then short-sellers Muddy Waters and Wolfpack accused Nasdaq-listed video-streaming site iQiyi of fraud, a claim it denies.
The fraud allegations prompted Nasdaq to propose new rules that would make it harder for foreign firms—particularly Chinese ones—to launch on the market. Shortly after, on May 20, the U.S. Senate passed a new bill, similar to Menendez’s, that would give the Securities and Exchange Commission (SEC) greater leverage to remove Chinese firms from U.S. stock exchanges.
If made law, the Senate bill would permit the SEC to delist companies that don’t comply with the regulator’s auditing practices—including providing the SEC with copies of company audit reports. Chinese companies typically don’t hand over these documents because Beijing deems the material state secrets.
The bill’s sponsor, Sen. John Kennedy (R-La.), said the bill would “stop [the Chinese Communist Party] from cheating on U.S. stock exchanges.”
The SEC has pushed for access to Chinese auditors and audits since 2011, when the regulator delisted 50 Chinese companies for fraudulent reporting. But the fresh momentum behind the latest Senate bill shows how politicized the issue has become, says Bob Bartell, global head of corporate finance at financial consultancy Duff & Phelps.
Since the Senate bill passed, Beijing has hinted at making concessions. China Securities Regulatory Commission (CSRC) chairman Yi Huiman said that the U.S. and China could conduct joint investigations of U.S.-listed Chinese companies accused of financial fraud. “As long as the U.S. is willing to sit down and talk, differences will surely be resolved,” Yi told Chinese business magazine Caixin in an interview this week.
Benefit for Hong Kong
Until that happens, the trend of secondary listings in Hong Kong looks set to continue. And it comes at a fortuitous time for the city.
Hong Kong fell into a recession in 2019, bruised by months of anti-government protests and the economic fallout of the U.S.-China trade war. Its economy has continued to contract as the coronavirus struck at the start of this year.
Companies and analysts are questioning its status as an international financial hub ever since the Chinese central government revealed plans for a national security law in the city and the U.S. responded by declaring that it no longer views Hong Kong as autonomous from mainland China, a designation that threatens the region’s special economic status.
The secondary listings could be a financial windfall for the city. A June 11 report from Chinese investment bank China Renaissance estimated that “new economy” stocks—the ones Hong Kong’s exchange hoped to attract to the city with 2018 listing reforms—could account for 30%–35% of Hong Kong’s market cap in the next five to 10 years.
U.S. investment bank Jefferies Group estimated in a recent report that U.S.-listed Chinese companies could bring $557 billion to Hong Kong through secondary listings. The influx of capital will trickle down to Hong Kong’s financial services sector too, providing huge incentives for foreign banks to maintain a presence in Hong Kong—despite ongoing political turmoil.
U.S. banks, like Morgan Stanley and J.P. Morgan, aren’t as important to Hong Kong’s IPO scene as they once were, however. Foreign banks remain major players in Asian equity trading, occupying most of the top 10 spots, according to Dealogic. Chinese banks, meanwhile, underwrote the majority of IPOs in Asia last year and have done so since at least 2017.
Since Alibaba’s secondary offering in Hong Kong last November—which was underwritten by both U.S. and Chinese banks—the e-commerce leader has become the exchange’s most valuable company by market cap, as well as one of its most liquid stocks. Alibaba’s chief financial officer said at the time of the firm’s Hong Kong debut that “we hope our listing encourages other companies to consider listing here.”
“More of these large companies like Alibaba, JD, NetEase listing in Hong Kong does increase the attractiveness of the listings in Hong Kong,” said Michael Wu, a senior equity analyst at Morningstar Investment Management. Wu says the uptick in secondary listings “reaffirms” the status of Hong Kong’s capital markets.
At the same time, though, the influx of Chinese stocks could diminish the market’s independence.
At the end of 2019, mainland Chinese companies accounted for a little over half of all businesses listed on the Hong Kong exchange. As more mainland companies pile into the Hong Kong exchange, it’s feasible Beijing will take a more active interest in protecting the market’s stability.
Mainland China has a “national team” of investment funds the government instructs to prop up domestic markets in times of uncertainty. Some observers speculate this dynamic is playing out in Hong Kong too. When the Hang Seng Index slumped 5.6% after Beijing announced the forthcoming national security law, mainland investors promptly pumped $570 million into the market through stock connect schemes.
Second home
The U.S. Senate bill is “probably the key reason for the recent spate of Chinese companies looking to do a secondary listing in Hong Kong,” said Wu. JD.com named the congressional bill as a risk factor in its IPO prospectus, saying it could hurt U.S. share prices and investor confidence and lead to delisting.
U.S.-listed Chinese companies have considered secondary listings before, Wu said. In early 2018, NetEase founder William Ding expressed interest in a secondary listing in Hong Kong. The offerings are a good way to raise additional capital, and they make shares of Chinese companies more accessible to home market investors. But the recent political uncertainty has turbocharged such nascent plans.
According to Bloomberg, four U.S.-listed Chinese firms have gone private this year, up from zero in 2019. Taking a company private is another way to protect against the whims of U.S. securities regulators. But for supersize companies like Alibaba, with a market cap of $603 billion in the U.S., privatization would be a more cumbersome strategy since the firm would likely have to announce a buyback scheme. Seeking a secondary listing elsewhere is less complex.
What is a secondary listing?
Secondary listings are common, especially for companies outside the U.S. that want to tap investors at home as well as financiers in America. HSBC, consumer goods giant Unilever, and miners Rio Tinto and BHP are all listed on more than one continent. Trading shares across multiple markets gives companies greater access to liquidity and often gives shareholders a boost too, says Clement Chan, managing director of assurance at financial services provider BDO.
“A secondary listing adds more reference points to a company’s shares, providing more information on market sentiment to traders,” Chan said. That additional insight can increase investor confidence and, in turn, drive up the price of shares.
The process for achieving a secondary listing is normally smoother than for launching an initial IPO, because the company has already been vetted by a foreign regulator. However, there are still restrictions.
For a secondary listing in Hong Kong, for example, a company must have either a market cap over $5 billion or a market cap over $1.3 billion plus more than $129 million in revenue for the past year. The company also needs to have traded in its primary location for at least two years.
According to investment bank UBS, there are 42 U.S.-listed Chinese companies eligible for a secondary listing in Hong Kong. For those facing the threat of being delisted in the U.S., a secondary listing would provide a security net against the company’s market cap crashing; the affected company could offer U.S. shareholders the option to swap their stock for an equivalent stake issued in Hong Kong.
“Because of the rhetoric of U.S. politicians, they need to be prepared for delisting in the worst case,” said Xiaoyan Jiang, founder of Prime Number Capital, a boutique investment firm that specializes in advising Chinese companies on listing in the U.S.
Primary and secondary shares are fungible and, theoretically, are valued at about the same price. UBS notes that the cost of trading, however, is higher in Hong Kong, so potentially not all investors would take up an offer to swap U.S. shares for Hong Kong ones.
Why Hong Kong?
For U.S.-listed Chinese firms, Hong Kong is an especially attractive location to launch a secondary offering. For one, the Hong Kong dollar is pegged to the U.S. dollar. Even though a company’s U.S.-listed shares can’t be traded in Hong Kong, nor vice versa, the peg offers greater stability between the relative value of the two share pools. That stability leaves the company less susceptible to arbitrage, in which investors buy and sell shares across the two markets to make a profit on the price difference.
A secondary listing in Hong Kong was not an option for U.S.-listed Chinese firms until recently. In April 2018, the Hong Kong Stock Exchange introduced listing reforms to allow overseas-listed Chinese companies to debut in secondary offerings in Hong Kong. The rule change applies to companies listed on Nasdaq, the New York Stock Exchange, or the main board of the London Stock Exchange. The shift was one in a basket of reforms aimed at making Hong Kong’s bourse more globally competitive after the loss of Alibaba’s original IPO to New York in 2014.
Thanks to a regulation introduced by the HKEX in May, secondary listing companies can be included in the local benchmark Hang Seng Index too. Such inclusion is a prerequisite for trading on the Hong Kong–Shenzhen and Hong Kong–Shanghai stock connect schemes—agreements between the cities’ bourses that allow international and mainland investors to trade in each other’s markets, meaning Hong Kong–listed companies get access to cash flows from mainland China.
There are currently no secondary listings on the stock connect, says Wendy Liu, China analyst at UBS. The CSRC needs to approve a company’s inclusion on the connect, but Alibaba, which is a constituent of the Hang Seng Index, is a prime candidate to be the first permitted. “We’re watching Alibaba as to when it gets into the connect scheme,” Liu said.
Risk to the U.S.
Secondary listings in Hong Kong aren’t an immediate worry for U.S. markets. In fact, U.S. investors are “happy to see” the offerings, says Bruce Pang, head of macro and strategy research for China Renaissance Securities. There’s a cap on how many shares investors can purchase in the U.S., so if a company like Alibaba is listed in Hong Kong too, investors who are tapped out in the U.S. can buy more shares in Hong Kong.
It’s delistings that pose the real risk.
The U.S.-listed Chinese companies that could be covered by the Senate bill have a combined market cap of $1 trillion, which accounts for around 3% of the U.S.’s total equity market cap. On average, they collectively trade around $8 billion per day—6% of total U.S. turnover, according to the China Renaissance report.
Delisting all those companies would represent “a sizable loss” in U.S. market cap and trading revenue for U.S. capital markets, says Pang.
While institutional investors have access to both U.S. and Hong Kong markets, retail investors could potentially have fewer opportunities to invest in Chinese companies directly or potentially though ETFs, says Matthew Kennedy, senior strategist at Renaissance Capital.
“U.S. investors would certainly have less exposure to China if these companies were delisted from U.S. exchanges,” he said.
If the Senate bill becomes law, Pang said, it won’t result in a sudden rash of delistings. First, there will be a three-year grace period after the law is enacted. It would give regulators “time to adjust and negotiate” and reach a compromise about the inspections that would enable some auditing and prevent a mass delisting of Chinese companies, which investors and financial regulators don’t want.
Even with that threat and escalating Washington-Beijing tensions, the U.S. will remain “one of the top preferences” for Chinese companies looking to raise capital overseas, Pang said, citing the demand to raise U.S. dollars as a main driver.
“I’ve been asked by many investors, ‘Do you think that Chinese companies are still going to take the U.S. as one of the major IPO destinations?'” Pang said. “My answer would be yes.”
