KATHY DAVEY: The Chinese-US stocks standoff

In assessing the risk of Chinese companies being forced to delist from US exchanges, it’s best to take a step back and consider why the Securities & Exchange Commission (SEC) has taken what is seemingly a heavy-handed approach.

Tension between US and Chinese regulators began in 2002 when the Public Company Accounting Oversight Board (PCAOB) was created by the US congress as part of the Sarbanes-Oxley Act. This act requires that auditors of foreign companies listed in the US allow the board to inspect their audits of these operations. Most foreign jurisdictions have complied with this requirement, but Hong Kong and China have not.

There have been compromises, with Chinese regulators offering some access to US-listed Chinese companies’ auditors. However the PCAOB believes it has not been given the access required to satisfy oversight requirements.

China’s stance is that greater access would compromise state security and therefore it has been unwilling to co-operate fully.

In April 2020, the issue reached breaking point. It was revealed that Nasdaq-listed Chinese company Luckin Coffee had inflated its revenue in 2019 by $310m, roughly 70% higher than what the company actually achieved.

By December 2020 the US House of Representatives had approved the Holding Foreign Companies Accountable Act, which requires the SEC to prohibit the securities of foreign companies from being listed or traded on the US markets if the company retains a foreign accounting firm that cannot be inspected by the PCAOB for three consecutive years.

Now, the nearly 250 Chinese companies listed on US exchanges have until April 2024 to comply or be delisted. This has inevitably weighed on their share prices. And with little prospect of resolution in sight, conversations have shifted from "if these companies are delisted" to "when these companies are delisted".

Why have so many Chinese companies chosen to list in the US rather than closer to home on the Hong Kong Stock Exchange (HKEx)? Clearly, access to sizeable and sophisticated US investors is appealing for companies wanting to raise money — but another reason is that Hong Kong has more stringent listing requirements than the US.

The HKEx had been e-commerce giant Alibaba’s first choice for its IPO in 2014. But this was not possible due to the company’s weighted voting rights (WVR) structure, whereby certain shares had greater voting power than others, a structure often used when the founders of a company want to maintain control.

This share structure was not allowed on the HKEx at the time and Hong Kong missed out on what was then the largest IPO in the world.

This was most likely the catalyst for the exchange to change its rules in 2018 to allow the secondary listings of WVR companies (with certain requirements), paving the way for Alibaba’s listing on the HKEx in 2019.

Since then, a string of US-listed Chinese companies have obtained dual listings on the HKEx, including JD.com, Yum China and Baidu. These secondary listings are fully fungible with the US listing and allow international investors the opportunity to simply move their holdings from the US to the HKEx at little cost.

The worry is in holding the stock of a Chinese company that is listed only on a US exchange. It’s likely these companies are scrambling to find a plan B, and the HKEx has made this a lot easier with further reforms implemented as of January 1 2022.

The other issue is that there will be investors who own shares in the US but cannot invest in Hong Kong. These investors will be forced to sell their holdings.

It’s not all bad news, however. There is another source of capital that Chinese companies listed on the HKEx can tap into: the Southbound Stock Connect programme.

This links mainland-China stock exchanges to the HKEx, allowing mainland-China investors to buy shares in Hong Kong.

The programme excludes companies with dual listings, which means dual-listed Chinese stocks would need to delist from the US and move to a primary listing on the HKEx to participate.

With little co-operation between the US and China it may be prudent for Chinese companies that are eligible for a primary listing in Hong Kong to delist from US exchanges before they are forced to.

But for investors keen to stick with Chinese stocks, the safest option right now is to hold shares in companies that are already dual listed.

*Davey is an investment manager at Ashburton Investments