How the US is getting closer to delisting Chinese companies

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1. Why does the United States want access to audits?

The Sarbanes-Oxley Act of 2002, enacted in the wake of the Enron Corp. accounting scandal, required all public companies to have their audits inspected by the US Public Company Accounting Oversight Board. During the two decades of negotiations that followed, China refused to grant access. The long-simmering accounting problem has turned into a political one as tensions between Washington and Beijing have escalated under the Trump administration. Nasdaq-listed Chinese chain Luckin Coffee Inc. was discovered to have intentionally fabricated part of its 2019 revenue. The following year, in a rare bipartisan move, Congress decided to force listed companies in the United States based in China and Hong Kong to finally allow inspections.

As required by the law, known as the Holding Foreign Companies Accountable Act or HFCAA, the SEC has begun publishing its “provisional list” of companies identified as non-compliant. While the decision had long been telegraphed, the first release in early March fueled a sharp decline in U.S. stocks of companies based in China and Hong Kong, dashing hopes of some sort of compromise. China’s securities regulator issued a statement saying “positive progress” had been made in the talks while reaffirming its opposition to what it called “the politicization of securities regulation”. The PCAOB called speculation about a deal “premature.” The SEC is obligated by law to move forward, and its chairman, Gary Gensler, has pledged to enforce the three-year deadline for Chinese companies to authorize inspections. “The way is clear,” Gensler told Bloomberg News in an August 2021 interview. “The clock is ticking.”

3. What is the larger problem?

Critics say Chinese companies enjoy the trading privileges of a market economy – including access to US stock exchanges – while receiving government support and operating in an opaque system. In addition to inspecting audits, the HFCAA also requires foreign companies to disclose whether they are controlled by a government. Meanwhile, the SEC is also demanding that investors receive more information about the structure and risks associated with shell companies, known as variable interest entities or VIEs, which Chinese companies use to list stocks for New York. Since July 2021, the SEC has refused to green light new listings. Gensler also said more than 250 companies already in operation will face similar requirements.

4. Why don’t Chinese companies share their audits with the PCAOB?

They say China’s national security law prohibits them from handing over audit documents to US regulators. According to the SEC, more than 50 jurisdictions work with the PCAOB to enable the required inspections, two have not historically done so: China and Hong Kong. (On March 17, China’s Securities Regulatory Commission was considering allowing U.S. officials to inspect documents about companies that don’t have sensitive data, such as restaurateur Yum! China Holdings Inc. or travel platform Trip.com Group Ltd. The news came a day after President Xi Jinping’s government promised a series of measures to support the country’s financial markets and ease concerns among global investors.)

5. How soon could Chinese companies be removed from the list?

Nothing will happen this year or even in 2023, which is why markets initially seized on this possibility. Under the HFCAA, a company would only be delisted after three consecutive years of non-compliance with audit inspections. He could come back by certifying that he had retained the services of an SEC-certified accounting firm. However, when the SEC did start publishing company names, the market reacted strongly. For example, the Nasdaq Golden Dragon China index plunged 18% in the week ended March 11 after the agency released the top five names.

This is an ongoing process and a function of when companies report their annual financial statements and an audit firm that the PCAOB has identified as non-compliant. For example, Yum! China reported on February 8 in New York, and it was added on March 8. The Weibo Corp. social media platform. was added on March 23.

7. Ultimately, how many will be affected?

There is not much discretion. If a company from China or Hong Kong does business in the United States and files an annual report, it will soon appear on this list because they have been identified as non-compliant jurisdictions. In total, the PCAOB said it was barred from reviewing the audits of more than 200 companies based in China or Hong Kong, including Alibaba, PetroChina, Baidu and JD.com. All should appear on this list in the coming months. Chinese companies listed in the United States have a combined market capitalization of hundreds of billions of dollars.

8. Are any of them really controlled by the Chinese government?

Large private companies like Alibaba could probably argue that they are not, although others with substantial public ownership may have a harder time. As of May 2021, the US-China Economic and Security Review Commission, which reports to Congress, had eight “national-level Chinese state-owned enterprises” listed on major US stock exchanges. .

9. Why are Chinese companies listed in the United States?

They are attracted by the liquidity and large investor base of US capital markets. They provide access to a much larger and less volatile pool of capital, in a potentially faster time frame. China’s own markets, though huge, remain relatively underdeveloped. Fundraising for even quality businesses can take months in a financial system constrained by public lenders. Dozens of companies canceled planned IPOs last year after Chinese regulators tightened listing requirements to protect retail investors who dominate stock trading, as opposed to institutional and grassroots investors. of active mutual funds in the United States. And until recently, the Hong Kong stock exchange had a ban on dual-class shares, which are often used by tech entrepreneurs to maintain control of their startups after they go public in the United States. It was relaxed in 2018, prompting big quotes from Alibaba, Meituan and Xiaomi.

10. How did China react?

In December, China unveiled new rules that require all companies seeking IPOs or additional overseas stock sales to register with China’s securities regulator. The requirements apply only to new shares and will not affect foreign ownership of companies already listed overseas such as Alibaba or Baidu. However, Chinese companies in industries prohibited from foreign investment will have to apply for a waiver before proceeding with the sale of shares, and foreign investors in these companies will be prohibited from participating in management and limited in their ownership.

(Updates Section 2 with PCAOB comment; Weibo’s inclusion on the list in Section 6. An earlier version of this story has been corrected to remove reference to Alibaba’s February 24 report, which concerned the fourth trimester.)

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