Beijing is scrambling to keep the U.S. from kicking Chinese firms worth $1.4 trillion off Wall Street. But Congress is in no mood for compromise
For 20 years, Chinese companies listed on U.S. stock exchanges—which now number 261—have existed in a state of limbo. They are subject to U.S. rules requiring they show their books to U.S. regulators, but Beijing has denied inspectors access, casting the two sides into a decades-long impasse. Washington had largely let Chinese firms’ noncompliance slide so American investors could tap into the riches of some of China’s most successful enterprises. But now U.S. lawmakers are demanding an end to the standoff with a law that would boot $1.4 trillion worth of Chinese stocks from American exchanges if Beijing continues to keep regulators at bay.
That prospect wiped hundreds of billions of dollars from the value of U.S.-listed Chinese firms and spooked Beijing. Earlier this month, China’s securities commission announced that foreign regulators may “request to investigate…or inspect” overseas-listed Chinese firms and their auditors. The obscure accounting matter had turned into a test of wills, and Beijing had blinked.
The Chinese government is now racing to convince Wall Street that its concession has resolved the matter and that its homegrown giants are investable once again. But even Beijing’s forfeit—a rare admission that its instinctive desire for secrecy threatens its financial system—may not be enough to persuade an increasingly hawkish Washington to drop the threat of a mass delisting that could pummel a Chinese economy already on the ropes.
In December 2020, the U.S. Congress passed the Holding Foreign Companies Accountable Act (HFCAA). The act—largely directed at Chinese enterprises—goes further than past efforts to audit U.S.-listed companies that are based overseas. It stipulates that if a company’s auditor doesn’t comply with U.S. inspectors for three consecutive years, the company will be delisted from U.S. exchanges. It also requires U.S.-listed firms to prove that they’re not state-controlled. State-run firms will be subject to tougher disclosure requirements, like identifying any Chinese Communist Party members who sit on their boards of directors.
The act, a rare bipartisan feat in Washington, sent a clear message and hard deadline to U.S.-listed Chinese firms: fall in line by 2024 or be booted from American exchanges.
The U.S. Securities and Exchange Commission (SEC) started making good on that ultimatum last month when it published a provisional list of firms that would be kicked off of U.S. exchanges if the companies refused to comply. The list of 11 firms—which includes Chinese giants like internet behemoth Baidu, digital brokerage Futu, and fast-food chain Yum China—is valued at a combined $110 billion.
The SEC’s move triggered an immediate market selloff. The Nasdaq Golden Dragon Index, which tracks U.S.-listed Chinese stocks, plunged 20% the next working day after the SEC’s announcement.
Beijing took action.
On April 2, China’s securities commission said it would remove a rule that prevents U.S. regulators from accessing the books of U.S.-listed Chinese firms. Beijing said the rule, implemented in 2009, had become “outdated.”
Nasdaq’s Golden Dragon Index jumped 12.4% following the commission’s announcement as investors interpreted Beijing’s move as a significant policy shift that could solve the delisting dispute.
American investors stand to lose if a mass delisting comes to fruition, since U.S. and global investors are the ones who hold Chinese American depositary receipts, a type of security that allows U.S. investors to buy stakes in foreign companies. U.S. institutional investors alone hold $200 billion of exposure to Chinese ADRs, according to Goldman Sachs.
But Beijing faces even higher stakes. Beijing conceded, in part, because its rocky economy would struggle to endure another blow. China is staring down its worst COVID-19 outbreak since the pandemic began. It’s still reeling from property market woes—a sector that makes up one-fourth of its economy. Its digital firms are finding their footing after Beijing’s tech crackdown erased hundreds of billions of dollars in corporate value. The slump in Chinese firms’ stock prices after the SEC published its list of delisting targets was another alarm bell and a signal to Beijing that it may have miscalculated its stance in the auditing showdown.
Beijing expects China’s economy to grow 5.5% this year—much lower than 2021’s 8.1% growth—but analysts estimate that the country’s actual growth will hover around 5%. From its weak bargaining position, Beijing is keen to reach “some form of accommodation” to save its homegrown companies from a mass Wall Street delisting, says Jeremy Mark, senior fellow at the Atlantic Council and former International Monetary Fund (IMF) official.
Cinching a deal
China in recent weeks has suggested that a deal is imminent. As early as last month, Beijing announced that talks with its Washington counterparts were progressing smoothly.
Beijing has budged on the issue, but there is “still quite a distance” between the two governments’ positions, says Jay Ritter, a finance professor at the University of Florida who focuses on initial public offerings (IPOs).
China is seeking a compromise that will allow most private sector firms to open their books to American regulators, but it still wants to prohibit U.S. audits of state-owned enterprises (SOEs) and tech companies that are deemed to hold sensitive information, says Adam Montanaro, investment director of global emerging-markets equities at Abrdn.
The Chinese securities commission’s recent revision stipulates that overseas-listed companies must first receive Beijing’s explicit approval before opening their books to U.S. regulators and outline any “sensitive information” or “state secrets” that will be shared with foreign authorities, two terms Beijing has yet to define. For now, China remains unwilling to grant American regulators full access to all listed firms over concerns of revealing classified information, says Liqian Ren, director of modern alpha at WisdomTree Asset Management.
If the U.S. accepts a distinction between private and state-run or sensitive firms—rather than applying its rules wholesale—China could avoid a mass delisting, says Brendan Ahern, chief investment officer at Krane Funds Advisors, the investment manager for the China-focused KraneShares exchange-traded funds. Most private sector firms are “highly unlikely” to hold sensitive information; they could comply with U.S. audit rules and remain listed, Ahern says. The delisting damage would be largely confined to U.S.-listed Chinese state enterprises, of which there were eight in March, according to the U.S.-China Economic and Security Review Commission.
But it’s unclear whether Beijing’s work-around will be palatable to Washington. The agency overseeing listed companies in the U.S. recently reiterated that Chinese firms must provide “full access to relevant audit documentation” to remain listed. “This is not negotiable, even with respect to [companies] in sensitive industries,” it said. SEC Chairman Gary Gensler has said that only full compliance with U.S. rules will suffice. Beijing may have made a concession, but Washington’s regulators “clearly won’t give an inch. There is no compromise to be had. The Chinese side [must] do all the conceding,” Trivium analysts wrote in a note last week.
Whether Beijing goes far enough to be deemed in full compliance with U.S. rules is “in the details,” says Ritter.
U.S. regulators want “unencumbered access” to the Chinese auditors that are reviewing the books of U.S.-listed firms, says Bruce Bennett, New York–based capital markets partner at law firm Covington & Burling. Washington regulators are using a list of noncompliant auditors to designate firms for potential delisting. Still, the U.S.’s current rules point to a “company-by-company evaluation,” meaning the 261 Chinese firms could face varying outcomes, Bennett says, though he cautions that the SEC could ultimately interpret the rules differently.
Beijing understands that the “clock is ticking” and wants a quick solution as the delisting risk moves closer to materializing, says Bruce Pang, head of macro and strategy research at China Renaissance Securities.
Some Chinese companies interpreted Beijing’s concession on audits as giving them the go-ahead to allow U.S. inspections, according to the Wall Street Journal. Several firms—like the Nasdaq-listed biotech BeiGene and coffee chain Tims China, which will go public later this year—are now granting U.S. regulators access to their books and hiring U.S. accounting firms as their primary auditors.
But a formal Beijing-Washington consensus may be more difficult to come by. China still has restrictions on transferring audit paperwork overseas, and it’s unclear how bilateral access will actually work, Montanaro says. The Chinese securities commission’s recent proposal is still a draft and “should be read in this context,” he says.
China’s “long-standing obstinacy” on the auditing issue gave Washington’s animosity toward Beijing years to fester, Mark says. It only got worse during former President Donald Trump’s anti-China administration and after high-profile scandals at U.S.-listed Chinese firms like Luckin Coffee, where executives and staff fabricated hundreds of millions of dollars in sales. Capitol Hill has become so opposed to the Chinese Communist Party that both houses of U.S. Congress unanimously passed the Holding Foreign Companies Accountable Act over objections from investment banks and institutional investors, Mark says. “Communist China” continues to exploit the U.S.’s capital markets, and bipartisan Washington is “finally waking up to the China threat, and it’s time for Wall Street to do the same,” Chris Iacovella, CEO for the American Securities Association, an industry body representing small and midsize financial services firms, said when the Senate passed the legislation.
Beijing is now seeking a compromise from stubborn China hawks in the U.S. who have little political incentive to give in—despite the damage delistings could inflict on American investors and institutions.
Senators Chris Van Hollen (D–Md.) and Marco Rubio (R–Fla.) have both cautioned that Chinese companies must fully comply with U.S. rules if they want to remain on U.S. exchanges.
Any formal Sino-U.S. deal must avoid “enormous loopholes that make it meaningless,” Rubio said.
The “complex web of regulatory coordination…and questionable levels of political will still very much cloud the future of U.S.-listed Chinese stocks,” Trivium analysts wrote.
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