It just got a lot riskier to own U.S.-listed shares of Chinese companies

In Tuesday’s Eastworld, I posited three possible explanations for China’s cybersecurity watchdog’s surprise crackdown on ride-hailing giant Didi Chuxing: 1) the agency was punishing Didi for rushing to list shares on the New York Stock Exchange last week in defiance of regulators’ warnings to slow down; 2) the agency was serving notice to all Chinese companies seeking to list on U.S. exchanges that it’s tightening rules for data security and setting stricter limits on what they can—and can’t—disclose to U.S. financial authorities; or 3) Beijing was invoking data security concerns to halt the horde of Chinese firms stampeding to Wall Street and divert them to exchanges in Hong Kong and China’s mainland.

In the two days since, it has become clear that all those explanations have merit—and that the Didi data probe is part of a fundamental rethink of how Chinese regulators should monitor and control companies seeking to sell shares overseas.

Moments after we published Tuesday’s newsletter, China’s State Council, the nation’s highest governing body, issued a brief but sweeping statement vowing to tighten supervision of data security and overseas listing for all Chinese companies.

On Wednesday, Bloomberg, citing “people familiar with the matter,” reported that regulators in Beijing planned rule changes that would “allow them to block a Chinese company from listing overseas even if the unit selling the shares is incorporated outside China.”

Per Bloomberg, the China Securities Regulatory Commission is rewriting overseas listing rules to require any firm using a corporate structure known as a ‘Variable Interest Entity’ (VIE) to win approval from regulators in Beijing before going public in Hong Kong or the U.S.

As Fortune’s Eamon Barrett explained today, Chinese tech giants have used VIEs for two decades to evade regulatory scrutiny (and taxes) when they list offshore. If Beijing is serious about closing that loophole, the change would be monumental.

In essence, a VIE is a legal dodge that lets Chinese companies sell shares to foreigners even if those companies operate in industries in which China prohibits foreign investment. A Chinese company sets up a shell company in an offshore jurisdiction with lax incorporation laws and minimal taxes—typically the Cayman Islands or British Virgin Islands—and agrees to transfer a percentage of profits earned in China to the offshore entity in exchange for a promise of investment. Foreign investors buy a piece of the shell company but have no claim on the underlying Chinese business.

Sina Corp. pioneered this workaround for its 2000 IPO. Since then, virtually every major Chinese Internet company, including Alibaba Group and Tencent Holdings, has used the framework. It’s a nifty trick that has made Chinese tech titans and their bankers enormously rich.

But for global investors, there’s a catch: no Chinese regulatory body has ever approved the structure, so it’s not clear what foreigners who hold Chinese VIE shares actually own.

The prospect that Chinese regulators will impose a new layer of oversight on VIEs—or even ban them outright—induced palpitations on Wall Street this week. Shares in Didi Global, the company’s NYSE trading name, have lost nearly 25% since Monday. Invest Golden Dragon China ETF, which tracks U.S.-listed companies headquartered in China, has lost a third of its value since its February high.

The immediate risk is that new rules could freeze, or at least chill, the pipeline of Chinese companies planning to list in the U.S. On Thursday, Chinese medical data group LinkDoc shelved its upcoming U.S. IPO because of the crackdown, Reuters reports. In the first half of 2021, 34 Chinese companies raised a record $12.5 billion in U.S. IPOs; more than 20 companies have filed to list in the second half of the year, and another dozen are said to be waiting in the wings.

“Global investors are already hyper-nervous at this point and fearful the worst is yet to come,” Primavera Capital founder Fred Hu told Hong Kong’s South China Morning Post. “Every single Chinese tech company planning to list in the U.S. will have to think twice and most likely be forced to abandon the plans altogether.”

The larger fear is that Beijing will put similar pressure on Chinese companies already listed on U.S. exchanges. As Hu Qimu, chief research fellow at the Sinosteel Economic Research Institute, told China’s state-owned Global Times on Tuesday: “Many Internet technology companies have been listed overseas, giving foreign investors greater access to the core of their operations and easier access to relevant data. Under such circumstances, the economic and national security risks arising from cross-border flow of data, a major product of the digital economy, cannot be ignored.”

Foreign Policy‘s James Palmer argues that “China’s anti-Didi action…signals further economic decoupling from the United States. U.S. listings were once prestige moves for Chinese firms, tacitly encouraged by authorities since Western businesses and financial sectors were among Beijing’s biggest boosters and apologists for decades. But that’s no longer the case.”

A full equity decoupling—in which the nearly 250 Chinese companies traded on U.S. exchanges with more than $2 trillion in market capitalization all delist and return to Hong Kong, Shenzhen, or Shanghai—seems far-fetched. That outcome would be hugely disruptive to both economies.

And yet, the reality is that, should Chinese companies be forced to return to Chinese exchanges, they will find it far easier to raise capital here now than even four or five years ago.

American lawmakers have stepped up their campaign to kick Chinese companies off U.S. exchanges unless they disclose more about their business operations. And now Beijing is digging in its heels, insisting that Chinese companies already disclose too much—and vowing to punish firms that fail to comply with China’s stricter data security rules.

The likely outcome? Fewer Chinese companies will trade on Wall Street. And for investors, the risk associated with owning shares of those that remain just went way up.

More Eastworld news below.

Clay Chandler
– clay.chandler@fortune.com

This edition of Eastworld was curated and produced by Yvonne Lau. Reach her at yvonne.lau@fortune.com.

EASTWORLD NEWS

Olympic emergency

Japan declared a new state of emergency for Tokyo and said it will likely ban all in-person spectators from the Tokyo Olympic Games. Japanese cabinet minister Yasutoshi Nishimura said on Thursday the new state of emergency would run from July 12 to August 22, covering the whole duration of the Games. Japan is battling rising COVID-19 infections—cases surged to 920 on Wednesday, the highest daily number in nearly two months. Three athletes from the Ugandan and Serbian Olympic teams have tested positive for the virus since arriving in Tokyo. Two Olympic Village staff members have also contracted COVID. Bloomberg

Students vs. censors 

China’s most popular messaging app WeChat deleted dozens of university student-run LGBT accounts, fueling concerns that government censors are clamping down on gay Internet content. Several LGBT group members say their accounts were blocked on Tuesday and their content was later deleted without any warning. In May, sources told Reuters that members of the university groups met with the Communist Youth League, a branch of the Chinese Communist Party, and were asked if they ever received foreign funds or held any anti-China or anti-Party beliefs. Reuters

Coal mine clampdown 

The Federal Court of Australia ruled that the country’s environment minister must consider the health risks that coal mines pose to children, a judgment that could mark a shift in fossil fuel regulation in Australia. Environment Minister Sussan Ley is currently assessing Whitehaven Coal's application to continue its mining operations in the state of New South Wales. Whitehaven, a coal producer, said its project will mine "high quality coal," 60% of which will be used for steel making. Eight schoolchildren and a nun originally sought a federal court order to stop Whitehaven's expansion. The Guardian

Shaky skyscrapers

China on Tuesday banned the building of new skyscrapers over 500 meters tall, known as 'super skyscrapers,' due to safety and infrastructure quality concerns. Over half of the world's 100 tallest buildings are located in China, where the construction of skyscrapers has boomed in the last three decades. In May, videos surfaced on Chinese social media that showed pedestrians fleeing a wobbling skyscraper—the 72-story SEG Plaza in Shenzhen. The SEG Plaza is still standing but has been closed-off since the wobbling occurred. South China Morning Post

MARKETS AND MOVERS

Zomato – Indian food delivery app Zomato is looking to raise $1.3 billion in an initial public offering amid positive investor sentiment in India. Zomato is targeting a $10 billion valuation given the rapid growth of India's food delivery sector in the last 18 months. Zomato's backers include Jack Ma's Ant Group, Singapore state-owned investment firm Temasek, and American investment group Tiger Global Management.

Binance – Changpeng Zhao, founder and CEO of popular cryptocurrency exchange Binance, said the company is expanding its compliance teams as it comes under regulatory scrutiny. Domiciled in the Cayman Islands, Binance is currently under investigation by U.S. regulators and has received warnings from regulators in the U.K., Japan, Singapore, Thailand and the Cayman Islands for unauthorized operations. 

Bianlifeng – Chinese convenience store chain Bianlifeng has filed for a U.S. IPO worth up to $500 million, even as Beijing tightens supervision of overseas listings. The 4-year-old firm operates tech-enabled shops that don't have cashiers; customers purchase goods by scanning QR codes. 

AirAsia – Malaysian budget airline AirAsia is exploring a $300 million U.S. SPAC listing for its digital business. Pandemic travel curbs have hit AirAsia hard; it posted $71.4 million in airline revenue in the first quarter of 2021, a 87% year-on-year drop. The company's non-airline revenue fell 36% in the same quarter. The company is looking to raise up to $600 million to mitigate the business slump.

Xpeng – Chinese electric vehicle maker Xpeng made its Hong Kong debut on Wednesday. Its shares closed flat at $21.24. Guangzhou-based Xpeng is the first mainland EV maker to complete what's known as a dual-primary listing, which will subject it to more disclosure and corporate governance standards in Hong Kong. Xpeng first went public on the NYSE last August, raising $1.5 billion. 

FINAL FIGURE

$10 billion 

Indian billionaire Mukesh Ambani is investing $10 billion in renewable energy, a move that could push solar tariffs lower and heat up India's 'green arms race.' Ambani, the chairman of family-run empire Reliance Industries, said the group will fund solar manufacturing units, alongside battery and fuel cell factories. The pledge may also spark a face-off between Ambani and fellow billionaire tycoon Gautaum Adani. Both are vying to position themselves as the leader of India's green initiatives. Prime Minister Narendra Modi wants to boost the country's green energy capacity to 450 gigawatts—a fourfold increase—by 2030. Reuters