This article first appeared in The Edge Malaysia Weekly on June 15, 2020 - June 21, 2020
THE simmering Cold War between the US and China last month finally spilled beyond trade, national security and the blame game over the coronavirus pandemic into global capital markets. At stake is access to the world’s deepest pool of capital in the US.
In mid-May, both the tech-heavy Nasdaq bourse and the US Congress suddenly made it harder for Chinese firms to list in the US, owing to the growing concerns over accounting practices and shareholder rights. Investors around the world could be the losers as Chinese firms are forced to delist from the New York Stock Exchange (NYSE) and its crosstown rival, tech-heavy bourse Nasdaq.
But as the US denies Chinese companies access to American capital, there is now a boom in the secondary listing of US-listed Chinese firms in Hong Kong. On June 11, Nasdaq-listed Chinese mobile and PC gaming firm NetEase followed in Alibaba Group Holding’s footsteps with its own secondary listing in Hong Kong raising US$2.7 billion (RM11.5 billion). The listing, which was 360 times oversubscribed compared with Alibaba’s 40 times oversubscription late last year, was one of the most successful IPOs in the former British colony’s history. Like Alibaba’s, NetEase’s US and Hong Kong shares are both fungible, meaning the US scrips can be traded in Hong Kong and the other way around.
With the listing of NetEase a roaring success, e-commerce firm JD.com is now set to raise US$4.1 billion in its own secondary listing in Hong Kong next week. Yum China Holdings, China’s largest restaurant operator, which owns, runs as well as sub-franchises KFC, Pizza Hut and Taco Bell outlets in China, is preparing for a listing next month, and search engine giant Baidu and online travel firm Trip.com Group are expected to list over the next few months. Up to 30 US-listed Chinese firms are reportedly preparing Hong Kong IPOs over the next 12 months.
US regulators have long been concerned about financial information that US-listed Chinese companies do not, and, indeed, are often unwilling to share with them. In the aftermath of the Luckin Coffee scandal in April, which I wrote about some weeks ago, Nasdaq sent a delisting notice to the firm, informing it that its stock would no longer be allowed to trade in the US. Nasdaq also moved to amend its overall rules requiring greater transparency of accounting practices before letting any company list, regardless of where it is based.
The tech-heavy bourse also put in new rules on insider control of foreign-listed firms. On May 20, the US Senate passed a bipartisan bill that requires Chinese companies to certify that they are not owned or controlled by their government. The bill also provides for the delisting of Chinese firms if the US Public Company Accounting Oversight Board (PCAOB) is unable to conduct an audit for three consecutive years and gives the US Securities and Exchange Commission (SEC) the right to sue accounting firms that certify accounts of Chinese firms.
The problem with most US-listed Chinese firms is not just that their accounting practices are not up to par with their US counterparts but, rather, that many Chinese firms hide behind Beijing regulators to withhold critical information from regulators. Whenever there is a query from SEC or PCAOB, listed Chinese firms such as Alibaba, Baidu or JD.com just tell SEC or accounting officials that they have been advised by Beijing not to divulge the information because of “national security” concerns.
So, if SEC, Nasdaq or any other US regulator were to query the beleaguered Luckin about something as trivial as the total coffee inventory on its books, the management can just argue that Beijing officials have asked it to withhold such information — and get away with it. Indeed, it does not even have to prove that an actual Chinese official forbade it from giving such information. For US regulators and investors, that creates the impression that the Chinese firms might have something to hide.
Dodging regulators
At least 190 Chinese companies have American depositary receipts listed on either the NYSE or Nasdaq with a combined market capitalisation of US$1.8 trillion. About US$800 billion worth of Chinese firms’ shares or ADRs are held by US shareholders.
About half of the US-listed Chinese firms have brazenly used the excuse that their government bars them from answering regulators’ queries on “national security” grounds. Indeed, the current SEC chairman Jay Clayton and his predecessors have raised the matter directly with Beijing officials, who have effectively said that, since the companies are not listed in China, it is not China’s problem that they are not complying with US regulators.
Chinese officials argue that SEC should deal directly with firms that are not in compliance rather than the Chinese government if it has any corporate governance issues. For their part, the companies say that while they are not listed in China, they are Chinese companies and their top executives are Chinese citizens and, as such, they need to comply with what Beijing tells them to.
Even after the Holding Foreign Companies Accountable Act becomes law, most Chinese companies on Nasdaq or the NYSE will remain listed there for some years. It is likely to take at least a year for the delisting details to be sorted out. There will be a long notice period before they are actually delisted. Moreover, since the delisting will affect the entire US financial ecosystem, Wall Street lobbyists from large US investment banks, hedge funds and insurance firms will seek to rewrite key portions of the law, a process that will be made easier if President Donald Trump loses the November election and Democrats are able to win a majority in the Senate.
Companies are taking the delisting threat seriously. In a pre-listing filing with the Hong Kong Exchange, JD.com noted that US efforts to increase regulatory access to audit information could “cause investor uncertainty for affected issuers, including us” and that “we could be delisted if we are unable to solve the situation”.
Yet, Chinese firms themselves are in “no rush to delist from New York and chose Hong Kong or Shanghai, as the pool of institutional
capital and depth of research is so much greater in the US”, Duncan Clark, head of investment consultancy BDA China and a former Morgan Stanley investment banker, told The Edge in a recent interview. “The closer to China’s shores the listing venue, the more retail-driven the trading, even if the companies get to enjoy a higher valuation.”
Clark recalls that the lure of higher valuations had indeed drawn a handful of marginal players in the past to delist in the US and relist in China, but the results were generally mixed. Indeed, he notes, a few companies that delisted from US exchanges were unable to relist in China quickly because of politics and bureaucracy.
Clark expects more dual listings, rather than delistings, unless things really spin out of control in the US-China relationship. “US pension funds and institutional investors need growth, and the dynamic bits of the Chinese economy like digital technology and consumption are still very compelling,” he argues. “Depriving US investors of access to that growth would be ultimately very costly.” For their part, “Chinese companies want access to the deep pool of capital that they can’t access in China, Hong Kong or, indeed, anywhere else”.
As for Hong Kong, attracting big-name companies such as Alibaba, Baidu and JD.com is one thing; getting enough investors to trade their stocks in high volume is quite another. Any ban on US funds from investing in Chinese IPOs or listings in Hong Kong, on top of the recent White House directive to the body in charge of overseeing billions in federal retirement savings to halt plants to invest in Chinese firms, is likely to hurt liquidity. The average daily turnover on the Hong Kong Exchange last month was US$114 billion, a little more than half of Nasdaq, and less than 25% of the value of daily turnover on the much larger NYSE. Hong Kong turnover in dual-listed Alibaba in recent weeks — some of the most volatile in years — has been a mere fraction of its turnover on the NYSE.
For now, Alibaba is not part of the link through which mainland Chinese investors can invest in Hong Kong but, as more secondary listings make their way from the US, Beijing is expected to relax the rules and allow mainland investors to buy fast-growing Chinese internet shares. Mainland investors currently own just 2.9% of the stocks eligible for cross-border trading. As such, there is plenty of room for mainlanders to own a bigger piece of the pie in Hong Kong. “The Shanghai and Shenzhen-Hong Kong southbound stock connect will eventually be a big driver of Chinese tech stocks,” says Brendan Ahern, chief investment officer of Krane Funds Advisors, the world’s largest provider of China-focused exchange-traded funds, or Krane Funds Advisors in New York.
Greater Bay Area
Eventually, Ahern argues, large US-listed Chinese firms such as Alibaba, Baidu and JD.com, which were never part of any of the major US indices, will be included in Hong Kong’s main stocks barometer such as the Hang Seng Index (HSI) and other indices. The Hong Kong Exchange is considering whether it should allow corporate entities to hold weighted voting rights to lure more portfolio companies backed by internet giants such as Alibaba and Tencent Holdings to list as well.
Ultimately, the combination of secondary listings and innovative-growth companies with weighted voting rights will change the composition of the HSI, which currently looks like an old economy barometer full of banks and local property developers, says Jefferies & Co strategist Sean Darby in a recent report. He expects the HSI to be eventually broadened to become a Guangdong-Hong Kong-Macau Greater Bay Area Index that is more reflective of the territory’s vastly transformed economy and its close integration with Macau and the Pearl River Delta region in southern China.
“US delistings are a blessing in disguise for Hong Kong,” veteran Hong Kong analyst Francis Lun told me recently. Lun also cited the Hong Kong Exchange snatching a major index-licensing deal from Singapore and trading China stock futures, which will strengthen its role as a global equity derivatives trading hub.
On July 9, the US SEC will hold a virtual roundtable meeting to hear the views of investors, other market participants, regulators and industry experts on the risks of investing in emerging markets, including China, to help fine-tune policies around China delistings. “In many emerging markets, including China, there is substantially greater risk that disclosures will be incomplete or misleading and, in the event of investor harm, substantially less access to recourse, in comparison to US domestic companies,” SEC chairman Clayton said in April.
While there is decoupling of capital markets, “nobody really wants all Chinese companies to completely disappear from Nasdaq or NYSE”, says Ahern. The threat of delisting, US regulators hope, will force Chinese companies to be more transparent and improve their corporate governance. China and the US need each other to thrive and prosper. The US may have a deep pool of capital but, without China’s growth and dynamism, it will struggle to deliver good long-term returns.
Assif Shameen is a technology writer based in North America
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