China-US clash over stock market rules casts doubt over $1tn of listings

Linda J. Dodson

HONG KONG — Escalating tensions between the world’s two largest economies have taken on a new edge with a proposed audit rule for U.S.-listed Chinese companies, which threatens to restrict their access to American capital markets.

U.S. senators last month approved a bill that could push companies off American stock markets if they fail to comply with the country’s regulatory audits for three consecutive years. Chinese officials have said that the bill would harm the interests of both Washington and Beijing and that political forces in the U.S. are pushing the two powers into a new Cold War.

Shares in U.S.-listed Chinese tech companies, such as Alibaba Group Holding and, have yet to recover from the steep losses they suffered after details of the bill were revealed on May 20.

“The most important relationship in the world is being decimated,” said Hao Hong, head of research at BOCOM International in Hong Kong, referring to U.S.-China ties. “Most investors are now anticipating the bill being passed into law and I expect Chinese companies to make a beeline to list in Hong Kong.”

Here are five things to know about what it all means.

What is at stake and why now?

By one measure at least $1 trillion is at stake in what are known as American depositary receipts (ADRs). These are instruments that allow shares of a foreign company to be traded in the US without a full stock market listing. Goldman Sachs estimates there are 233 Chinese ADRs with an aggregate market value of $1.03 trillion. That represents 3.3% of total U.S. equity market valuation, the highest level in a decade. It also represents 8% of China’s total market capitalization.

Companies with listings on the line include the biggest tech names in China. In addition to e-commerce leader Alibaba and, listings of Pinduoduo, search giant Baidu and gaming company NetEase are also at risk.

Even Yum China, China’s largest restaurant chain operator and previously a unit of U.S.-based Yum Brands, may not be spared. While the operator of the KFC, Pizza Hut and Taco Bell brands in China is registered in the U.S., its audit documentation is in the mainland.

If the bill, formally known as the Holding Foreign Companies Accountable Act, were to become law, all these names would either have to meet the regulations or delist from U.S. stock exchanges. Meeting the regulations is not currently possible for Chinese companies. China Securities Regulatory Commission rules require audit papers for overseas-listed Chinese companies to be held in mainland China. These documents cannot be examined by foreign regulators, as it would be in conflict with Chinese laws governing the protection of state secrets and national security.

While U.S. regulators have long raised noncompliance concerns as a matter of investor protection, the focus has intensified with recent cases of alleged accounting irregularities, such as at Luckin Coffee. The cafe chain, which listed on the Nasdaq market last year, said in April that senior managers had inflated revenue by $310 million, sending its shares crashing.

How has China responded?

China’s securities regulator has opposed the bill and accused the U.S. of “politicizing securities regulation.”

“While impeding foreign issuers from listing in the U.S., [the bill] would also undermine global investors’ confidence in the U.S. capital markets and weaken the U.S. markets’ international standing,” the commission said in a statement last month.

The proposed law “completely ignores the continuous efforts made by Chinese and U.S. regulators to enhance audit oversight cooperation,” the regulator added, while expressing hope that both sides will work together to protect investors’ interests.

The U.S. Public Company Accounting Oversight Board has long complained of a lack of access to the audit work papers of board-registered firms in China. Since the 2013 signing of a memorandum of understanding, Chinese cooperation “has not been sufficient for the PCAOB to obtain timely access to relevant documents and testimony,” the board said recently.

What is next, and how soon will things unfold?

If the bill is passed by the House of Representatives and signed by President Donald Trump, it would become law.

The U.S. Securities and Exchange Commission would then issue specific rules for regulatory oversight and implementation. It is still unclear how long the legislative process may take, but if the Act is passed, there could be a three-year “non-inspection” transition period for companies to come into compliance with the regulations. This may leave room for potential negotiation among related parties given the high stakes, according to analysts.

Analysts at Goldman Sachs, Citigroup and other market watchers expect moves toward Hong Kong listings to accelerate. Goldman Sachs estimates 29 companies with a market value of $370 billion as eligible to list in Hong Kong.

The biggest companies are already hedging their bets. Alibaba undertook a secondary listing in Hong Kong last November and raised $13 billion. Nasdaq-listed NetEase on Monday began selling shares in the Asian financial center to raise as much as $3 billion.

Online retailer, which is also listed on Nasdaq, is set to open its Hong Kong offering next week. Baidu is considering a similar move, with Chairman Robin Li telling China Daily the company was discussing options internally.

Alibaba Chief Financial Officer Maggie Wu said last month the company was “closely monitoring the developments of this bill.” The company “will endeavor to comply with any legislation whose aim is to protect and bring transparency to investors who buy securities on U.S. stock exchanges,” she said.

If the bill becomes a law, it “could cause investor uncertainty for affected issuers, including us, the market price of our [American depositary shares] could be adversely affected, and we could be delisted from Nasdaq,” NetEase said in a filing.

Will there be any liquidity impact?

Goldman Sachs estimates that U.S.-based investors currently own $350 billion worth of Chinese ADRs, or about one-third the entire universe. Analysts reckon U.S. investors trade $8.1 billion of such instruments daily, representing 6% of daily stock market turnover in the U.S. By that measure, it would hypothetically take more than 200 days for U.S. investors to fully liquidate their ADRs.

While that looks like a daunting task with investors expected to take a hit, analysts say the potential three-year transition period suggests the impact on liquidity would not be immediate.

Shares of companies that haven’t planned their move and are pushed into a delisting will come under severe pressure, affecting both the company and investors, analysts said.

Where can companies go?

The size of the companies means they need to be listed in public markets.

Chinese corporations have preferred for years to list in U.S. capital markets for their deep investor base and their dollars, amid capital controls at home. For now, there is no market as liquid or deep as the U.S. Analysts from banks including Morgan Stanley and Jefferies say Hong Kong, the largest listing destination globally last year — and in seven of the past 11 years — is a natural choice.

Other options include mainland exchanges — Shanghai, Shenzhen and the STAR Market — and London, with the possibility to piggyback on the London-Shanghai stock connect scheme. The scheme, which began operating last year, aims to help Chinese companies expand their investor base and give mainland investors access to U.K.-listed companies. China is urging domestic companies to look at listing in London, Reuters reported last month before the U.S. bill was passed by the Senate, citing several sources.

While companies might get a higher valuation on the mainland exchanges, that would not solve the problem of gaining access to a deep market, analysts said. Given not all companies are eligible to list in Hong Kong, those with only a primary listing in the U.S. may well be forced to look at these options. But for those eligible to trade in Hong Kong, the city’s stock exchange with its comparatively easier listing requirements sits in the pole position, analysts from Morgan Stanley to JPMorgan Chase said.

Analysts single out one particular clause in the Hong Kong listing framework, which makes delisting from American stock exchanges easier. Hong Kong stock exchange rules say the primary listing of greater China companies will move to the city permanently if 55% or more of total worldwide trading volume, by dollar value, takes place in Hong Kong in a financial year.

“Listing emigration” could add $557 billion to the Hong Kong bourse’s total market valuation, an increase of 12%, and lead to $28 billion of capital raising if companies sell 5% stakes, analysts at Jefferies said.

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