China Comes Out in Support of Continued U.S. Listings – With Stronger Oversight

Country’s securities regulator issues draft document saying it will use a registration system to allow continued listings of Chinese firms overseas

Key Takeaways:

  • China’s securities regulator has announced its intent to continue allowing Chinese companies to list overseas, though with stricter oversight
  • Regulator will most likely limit such listings to large companies with global aspirations, possibly encouraging them to first list at home

By Doug Young

After a year of chaos and confusion for U.S.-listed Chinese stocks, some light at the end of the tunnel could finally be in sight for 2022.

That’s the message coming from Beijing these days, following the recent release of a few encouraging announcements that indicate China doesn’t want to close the door on U.S. listings for its companies. The latest – and most important – of those came last Friday, with the China Securities Regulatory Commission’s (CSRC) publication of draft new guidelines for such overseas listings.

The biggest takeaway was that China will continue to allow listings for its companies that use a controversial corporate structure known as a variable interest entity (VIE). The vast majority of Chinese firms listed in the U.S. and Hong Kong currently use such a structure, which allows them to skirt Chinese prohibitions on foreign investment in certain sectors of China’s economy.

We’ll look at the new guideline in more detail shortly, then spend the second half of this space exploring what the future landscape of U.S.-listed Chinese companies might look like.

But first we’ll take a deeper dive into the landmark Friday statement, which was detailed in a report in financial publication Caixin. Significantly, the statement said the new rules will only apply to companies seeking future overseas listings and won’t apply retroactively to companies already listed overseas like Alibaba (BABA.US), JD.com (JD.US) and Baidu (BIDU.US).

The new policy will create a registration system for companies seeking such listings to ensure they comply with a number of new requirements also detailed in the document. Those include a “negative” list that states, among other things, that companies listing overseas can’t: pose a national security risk through such listings; be involved in major disputes; or have top managers suspected of corruption. Companies with assets that could pose a national security risk could still be allowed to list overseas, but only after divesting certain assets to reduce such risk.

There’s quite a bit more detail about how things will work, and we would suggest anyone wanting to know more check out the Caixin report in English or the original document in Chinese. The bottom line is that U.S. listings will be allowed to continue, though the regulator is likely to play a stronger role of gatekeeper for who is allowed to list overseas.

Another equally important signal emerged earlier this month when the CSRC issued a briefer statement saying it was in talks with its U.S. counterpart, the Securities and Exchange Commission (SEC), on cooperation over sharing audit papers of U.S.-listed Chinese firms.

The SEC has complained for years that it lacks authority to order U.S.-listed Chinese companies’ auditors to hand over their audit papers when it suspects fraud. Beijing in the past prohibited the handing over of such papers, calling them “state secrets.” To force the issue, the U.S. passed a law at the start of this year giving China three years to devise a system for giving requested information to the SEC, or risk having its companies delisted from New York.

Thus, the CSRC’s mid-December statement was most significant for indicating the two sides were indeed in talks to reach an information-sharing arrangement, again showing that Beijing wants to keep allowing some Chinese companies to list in New York.

Window to the World

With China sending its clearest signals yet that it intends to let its companies keep pursuing listings in the U.S. and other global stock markets, we’ll take our own look at which companies exactly might be allowed to pursue such listings in the future.

To get a better idea on this point, it’s good to take a step back and understand what exactly a U.S. listing means for a non-U.S. company. In this regard, we can probably consider the two major U.S. stock exchanges, the NYSE and Nasdaq, as “windows on the world,” where foreign countries can showcase their most promising companies.

The reality is that many of the world’s best-known, non-U.S. companies are usually traded on stock exchanges in their home markets. But those exchanges are largely out-of-reach to all but the biggest global institutional investors. Thus, a second listing in New York makes those companies’ shares accessible to most global institutional investors – from the biggest to small fund managers – since nearly all such investors will have access to a brokerage account for New York-listed stocks.

In that context, China would rightly consider U.S. listings as suitable for its most-successful globally known companies. It might also encourage those companies to first list at home before making secondary U.S. listings, which is a common route for many big-name foreign companies listed in New York.

In October, six of the 10 most popular U.S.-listed foreign companies were big mainland Chinese names, including Alibaba, JD.com, Baidu and Pinduoduo (PDD.US), according to a list on the website thebalance.com, citing data from JPMorgan. The other four were all well-known global giants in their fields, including Taiwan chip maker TSMC (TSM.US), Finnish telecoms equipment maker Nokia (NOK.US), British drug maker AstraZeneca (AZN.US) and Dutch semiconductor chip equipment maker ASML (ASM.US).

So, it seems fair to say that China would probably welcome the continued listings of its own similar mainland-based national champions, who would benefit from access to global capital markets and are clearly of interest to international investors.

Then there’s the issue of which companies are likely to get cut off as the CSRC starts to exert more authority in its role as gatekeeper for who can and cannot list abroad. In this regard it’s probably fair to say that many of the nation’s smaller companies, typically with market values of less than $100 million, could well be blocked from such overseas listings in the future.

We’ve written about such companies on several occasions, most recently last week in a story on the latest developments for a company called Kaixin (KXIN.US), which recently changed its business model from car trader to electric vehicle manufacturer. Such companies are famously opaque and typically use their listings to raise money from unsuspecting investors to pay for financial shenanigans as they constantly change business models every few years.

At the end of the day, both China and the U.S. would be more than happy to get rid of this kind of company from New York. Accordingly, we can probably expect to see these smaller names eventually blocked from U.S. listings when the new rules and procedures are finalized, perhaps as soon as next year.

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