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Investors in Chinese stocks listed on US exchanges have been living with more uncertainty than usual for the past year and a half. March was a particularly exciting month. The NASDAQ Golden Dragon China Index tracks these companies. From 10,571 at the start of 2020, the index rose by 94% in February 2021. Since then, it has fallen by 65%. This month alone, it crashed by a third before partially recovering as companies spent tens of billions of dollars buying back shares. What causes such fluctuations?
Much of the volatility stems from renewed concerns about the impact of the pandemic and China’s zero covid mitigation measures (eg lockdowns, travel restrictions) on the country’s economy. Another factor is the potential economic fallout from the war in Ukraine. The United States threatened to punish China if it helped Russia evade sanctions.
Corn another looming concern for these Chinese companies and their investors is the possibility of some or all of the companies being “delisted” from US stock exchanges.. In November 2020, then-President Donald Trump issued an executive order ordering the debarment of companies associated with the Chinese military. The three Chinese telecommunications giants and one of its main oil companies have been delisted. Previously, the US Department of Defense listed a number of companies believed to be linked to the Chinese military. Last June, President Joe Biden ordered US entities not to invest in dozens of companies suspected of having ties to China’s military or surveillance programs. As a result, many companies on these lists have been removed from well-known indices run by MSCI, S&P Dow Jones and FTSE Russell and the funds that track them.
The White House and the Pentagon said they acted for security and human rights reasons. But in December 2020, Congress passed the Holding Foreign Companies Accountable Act as a way to protect U.S. investors and restrict Chinese companies’ access to U.S. capital markets. A year later, the Securities and Exchange Commission (SEC) finalized the rules for applying the law. This month, the SEC opened investigations into several listed companies, including Yum China, the parent company of KFC in China, and biotech giant BeiGene, as a first step in ordering the companies debarred.
These pressures stem from the Chinese government’s refusal to allow the SEC and the Public Company Accounting Oversight Board (PCAOB) to review audits conducted by firms of Chinese companies listed in the United States. This means that these companies are not held to the same standards that other listed companies must meet. The Chinese government maintains that it cannot allow the US government to investigate the work of Chinese citizens on Chinese soil. He further argues that some audits involve sensitive information and that allowing the US to access it could compromise Chinese security. The United States responds that their obligation relates to market integrity and that they must do what they can to ensure the validity of the audits. These tensions have existed for a long time. Paul Gillis, professor of accounting at Peking University, told us about it in 2013 (web | YouTube). He noted that most investors valued the increased risk in Chinese company stocks.
The charts below relate to the over $1 trillion invested in over 250 companies listed on US stock exchanges. The first Chinese company to list on the New York Stock Exchange was Shandong Huaneng Power. In 1994, it raised $333 million with its initial public offering (IPO) on the New York Stock Exchange. Twenty years later, Alibaba smashed Facebook’s IPO record by bringing in more than $22 billion. Why are Chinese companies listed in the United States? Three reasons are often given. 1) Capital is cheaper due to the large pool of potential investors. 2) Listing in the United States is prestigious because companies must meet certain minimum standards for size and liability. 3) US stock exchanges allow different classes of shares, allowing founders, for example, to retain control of a company even if others “own” more. The Hong Kong exchange only started allowing it in 2018.
Chinese companies could lose this option. The Chinese government has tightened data security laws, making it illegal to share information with foreign investigators. Beijing regulators have the companies’ attention on this rule and others. In 2020, they blocked Alibaba from moving forward with a planned $34 billion IPO (in Hong Kong and Shanghai) for its financial group Ant. In 2021, ride-sharing company DiDi went public in the United States, raising over $4 billion. Regulators have launched an investigation into the company’s data security and blocked further downloads of the app. In December, DiDi announced that it would withdraw from the New York Stock Exchange.
What about Americans who own or want to own shares of a company that may be delisted from US stock exchanges? Those who own the biggest companies will likely be able to exchange (for a fee) the American Depository Receipts they currently hold for Hong Kong-listed shares. However, not all companies are equally listed in Hong Kong. Pinduoduo’s US shares have a market value of $52 billion. The e-commerce company is not listed in Hong Kong. Foreign institutions have increased their investment in Chinese-listed stocks in recent months. But not all Chinese companies can register in China. Regulators of these markets expect listed companies to be profitable (it took Amazon seven years to turn a profit) and do not allow special classes of shares that favor some owners over others. (as operated by the founders of companies such as Alphabet and Meta). Investors can also trade stocks through the over-the-counter markets, although reduced liquidity generally leads to lower prices. Luckin Coffee was delisted for accounting fraud in 2019. Its shares fell to less than a dollar in the over-the-counter markets, but as of today are trading at $9 a share. That’s still a far cry from the $39 per share before the fraud was exposed.
Please note that the charts below show the value of stocks listed in the United States. That’s $1 trillion less than a year ago. Alibaba is clearly the largest listed in the United States, although it is behind Hong Kong-listed Tencent among Chinese companies in terms of total market capitalization. For some companies, their total market capitalization is higher because they are also listed elsewhere. State-owned (and Shanghai-listed) oil giant PetroChina, for example, has a market capitalization of $152 billion, of which $11 billion is in ADR.