Chinese companies seeking to launch IPOs in the US are facing unprecedented pressure from both Chinese and US regulators.
According to an exclusive report by Reuters on 30 July, Chinese companies that seek to list on US stock exchanges would need to fully explain their legal structures and disclose the potential risk of Beijing interfering in their businesses.
At the same time, Chinese technology stocks are experiencing a massive sell-off on US stock markets, as investors fear Beijing’s widening crackdown on Chinese tech companies.
The panic has spread to other types of Chinese companies listed in the US. According to the Nasdaq Golden Dragon China index, which tracks the performance of Chinese companies, Chinese stocks have dropped by 22% in July, the biggest monthly tumble since 2008. Is it a turning point for Chinese stocks on Wall Street?
China's regulatory risk
In early July, Beijing said it planned to strengthen supervision of all Chinese firms listed offshore and enhance scrutiny over cross-border data flows.
In addition, the Ministry of Industry and Information Technology (MIIT), which is responsible for regulating the tech industry, has launched a six-month campaign to step up its oversight of the operations of Internet platforms and tech companies, including those that disturb the market order, infringe users’ rights, and threaten data security.
The crackdown came after ride-hailing leader Didi's listing on the New York Stock Exchange on 30 June. Didi ignored the suggestion of delaying its IPO and reviewing its network security given by the government and debuted on Wall Street, raising US$4.4 billion in its IPO.
Just a few days later, Beijing announced a cyber security investigation of the company. Didi was ordered to remove its apps from Chinese app stores and stop the signing up of new users.
In addition, Beijing is considering a slew of punishments against Didi, according to Bloomberg News. This does not look good for Didi, as its shares have dropped by about 25% since its debut on 30 Jun.
It is not the first time Chinese authorities have cracked down on a wide range of Internet and technology companies. In early 2020, the government started to take a series of actions to rein in monopolistic Chinese tech companies.
Besides announcing the record fine on Alibaba, regulators summoned another 34 tech companies to conduct a “comprehensive self-inspection”. Furthermore, the government had earlier suspended Ant Group’s public listing at the end of 2020, and asked Ant Group to carry out “rectifications”.
Recently, China has introduced new operation restrictions to the nation’s education-technology companies. These companies are not allowed to make profits or seek public listings. The news made the share prices of Chinese education-technology firms in New York fall by two thirds, incurring huge losses for many US investors.
Although China’s securities regulator explained to international bankers in a meeting that they would only target private education companies, investors are still worried about changes in regulatory rules. They have become cautious about all young Chinese listed firms, which were once viewed as reliable investments.
This is an important reason why the US Securities Exchange Commission has imposed new disclosure rules for Chinese companies that seek an IPO.
Henceforth, the route for Chinese firms to raise money abroad will be beset with difficulties.
Many investment analysts have warned that holding Chinese stocks has become very risky for investors. Delisting Chinese listed companies on Wall Street is not unlikely based on the current market situation. But the uncertain changes in policy may lead to a storm that washes away investors’ funds.
Chinese stocks on Wall Street
Traditionally, Chinese firms seek to be listed overseas using the so-called Variable Interest Entity (VIE) structure as China restricts foreign investment in some particular industries such as telecommunications and media.
The structure allows a Chinese company to raise funds overseas while sidestepping Beijing’s scrutiny and the corresponding vetting process. In this structure, a Chinese company, which operates in China, can set up an offshore company in the Cayman Islands and British Virgin Islands, and then finance its own company with great flexibility via offshore listings.
The VIE structure, which makes the firms fall into a legal grey area, has been widely adopted by many Chinese firms over the past two decades. It also provides a channel for foreign investors to profit from the speedy growth of the Chinese firms. By the end of May 2021, the market value of Chinese stocks has reached US$2 trillion.
In order to close the loopholes, the China Securities Regulatory Commission (CSRC) is planning to strengthen the supervision of all Chinese firms listed offshore. It means that a company which seeks an IPO overseas would have to go through a much stricter process and get approval from Chinese government agencies first.
Many investment analysts have warned that holding Chinese stocks has become very risky for investors. Delisting Chinese listed companies on Wall Street is not unlikely based on the current market situation. But the uncertain changes in policy may lead to a storm that washes away investors’ funds.
US-China relations
The fortunes of Chinese firms listed in New York are also dependent on US-China relations. With escalating tensions between the two countries, Chinese listed firms in the US are in an awkward predicament.
Not only are they being enforced stricter rules at home, they are also required to be audited by the US watchdog, according to a new law this year.
This comes after the long-term complaint of US lawmakers that Chinese firms have raised capital in the US, but have never complied with US rules.
The new law requires companies that fail to submit certain documents for auditing to stop trading in the stock market. But China does not allow their own firms to be audited by US regulators due to national security concerns. This is like an unsolvable problem.
Some other US-listed firms are considering a secondary listing in Hong Kong. It seems that the Hong Kong Stock Exchange is the biggest winner in the battle.
Some Chinese firms have already prepared for a “homecoming” listing. According to the news from Asia Financial, car-selling platform Autohome and search engine giant Baidu have listed shares in Hong Kong, and video-streaming site Bilibili has done the same.
Some other US-listed firms are considering a secondary listing in Hong Kong. It seems that the Hong Kong Stock Exchange is the biggest winner in the battle. In addition, it will be convenient for the Chinese government to monitor the listed companies if they raise funds in Hong Kong.
Related: If not the US, can the Chinese government provide better IPO choices for internet companies? | Ride-hailing giant Didi slapped with Chinese cybersecurity review days after IPO | Why is Beijing punishing Didi? | Alibaba probe: China's challenges in dealing with monopolies start with the state-owned enterprises | China to impose strict measures on tuition centres to allay anxiety over education
