The U.S. market for Chinese stocks has always been a double-edged sword for investors, but now that years of accumulation have led to an inevitable end, Americans face a terrible blade.
In 2021, the market in China-based equities collapsed after hundreds of shady offerings on US marketplaces for fledgling Chinese enterprises that had the potential for either development or utter catastrophe.
“Valuations have plummeted. No IPOs have occurred in the past few months. Jesse Fried, a Harvard Law School professor, added, “There have been a number of going-private transactions.”
There were 30 China-based IPOs on US markets in the first half of 2021, and just four in the second half, before the window closed, according to Matthew Kennedy, a senior strategist at Renaissance Capital, an IPO research business that also has two IPO-focused ETFs.
After 30 deals in 2020 raised $11.7 billion, excluding SPACs, Mr. Li claimed that 34 Chinese firms raised $12.6 billion this year by going public in the United States (special-purpose acquisition corporations).
There have been mixed results for U.S. investors who purchased these equities.
When it comes to IPOs in the United States, the average return for Chinese-based companies in 2021 is negative-42 percent,” he says. According to him, only 12% of the stock market is currently in the black.
Not only rookies have been affected. According to the U.S.-China Economic and Security Review Commission, 248 Chinese enterprises had a total market value of $2.1 trillion in May. $600 billion has been shaved off that valuation, which now stands at around $1.5 trillion.
More than a few American investors are holding on to Chinese stocks in the expectation that they will rebound, or as possible losses to balance other taxable profits in 2021.
Even if new laws in the US and China are forcing Chinese companies to disclose more information, the market for Chinese equities in the US is now overflowing, and more pain may be on its way, according to some analysts.
“China doesn’t hold these securities, U.S. investors do,” said Brendan Ahern, chief investment officer at Krane Funds Advisors, LLC, which has a China-focused ETF portfolio. There is a danger of losing that money.”
Here’s a preview of what’s to come: Didi’s delisting
Didi Global Inc., China’s version of Uber, was the largest initial public offering of the year in the U.S., but fell apart just days after listing, and is now delisting from the New York Stock Exchange and heading to Hong Kong.
This is an example of what could be on the horizon for the dozens of Chinese companies still listed on US markets.
When Didi went public in June, it was already in conflict with the Chinese government. If Didi were to go public in the U.S., Chinese regulators cautioned that it had too much data that was a security risk, according to a Wall Street Journal investigation in July.
When Didi went public, the company had a market capitalization of around $80 billion after raising more than $4 billion from investors. Now valued at roughly $29 billion, it is the largest publicly traded company in the world.
The new legislation, the Holding Foreign Companies Accountable Act, or HFCAA, is scheduled to take effect, and the delisting of Didi in the US is an example of what could happen to many other Chinese companies whose shares trade in the US.
After signing into law in December 2020, a provision in the HFCAA mandated that any foreign firm that trades on US markets must be subject to the scrutiny of their auditor’s workbooks.
If they don’t, they will be delisted after three consecutive years of non-compliance, with this December being the first year since the law was established.
A rule requiring foreign businesses to provide the PCAOB with the papers used in overseas financial audits was finalized last month by the Securities and Exchange Commission.
In addition, firms must demonstrate that they are not subject to the influence of their governments. There are many Chinese corporations that have board members who have ties to the Chinese Communist Party or the Chinese military.
In the words of Shaswat Das, a Washington-based lawyer and former lead negotiator for the PCAOB’s negotiations with Chinese authorities, “Everyone knew this was coming so this wasn’t a surprise.”
According to the PCOAB, China and Hong Kong have already been declared non-cooperative jurisdictions by the SEC, so this appears to be moving forward.
It was reported in mid-December that the China Securities Regulatory Commission (CSRC) was in talks with US regulators regarding collaboration over the auditing of US-listed Chinese companies, and that progress was being made in those discussions.
According to Krane Funds, “The CSRC, China’s version of the SEC, put out some interesting comments.” As far as I know, the SEC and the PCAOB are still being contacted about this issue, and my impression is that they want to resolve it. It’s possible that there will be more discussion or dialogue between the parties.”
New York University Stern School of Business accounting professor Paul Zarowin described the situation as “like a tug of war between U.S. regulators and the Chinese.”
To put it another way, “The CCP and [President Xi Jinping] are seeking to gain more control over everything.”
According to Harvard’s Fried, he remained unconvinced that China’s leaders will allow China-based auditors to be audited by the PCAOB, using Didi as an example.
‘If they are thus worried about sensitive information coming into the hands of Americans, it seems unlikely China will allow the PCAOB to inspect audits,’ Fried said.
As a result, even if China does not compel these companies to return home, the HFCAA’s ultimate goal is to delist them.
The greatest conceivable conclusion is to relocate to Hong Kong.
As a result, American investors are left in limbo, especially when it comes to well-known stocks like Alibaba Group Holding Inc.
A senior portfolio manager at Synovus Trust Company, which owns roughly 30,000 shares in Alibaba as of early November, says, “At this time we are in a wait-and-see mode, to see how it works out.”
Investors’ investments have already been severely undervalued by a market that expects continued volatility and possible delistings.
On a year-to-date basis, Alibaba’s value has fallen by nearly 50%, while Invesco Golden Dragon ETF has lost about 47% and KraneShares SCI China Internet ETF has lost around 51%.
However, Alibaba appears to have been planning for the possibility of its delisting from the US market. A secondary listing of Alibaba shares on Hong Kong’s stock exchange in November 2019 raised an additional $11 billion in money for the company.
Five years after its initial public offering in the United States, the company went public in Hong Kong.
Moving to the Hong Kong stock exchange is the easiest and best option for investors with large Chinese companies. IPOs like Pinduodou, which has a market value of $68.6 billion, and electric car firm Nio, which has a market value of $46.1 billion, are included in this category.
An investment strategist at Matthews Asia, the largest U.S. firm specializing only in Asian investments, said: “A large share of U.S. businesses exposed to delisting already has secondary listings in Chinese markets.”
Investors who want to participate in China’s expansion should work with specialists because they have an easier time converting American Depository Receipts (ADRs) to other exchanges, he said, citing the imminent crisis.
For example, “If an institutional investor in the United States, say using Alibaba as an example, owns the ADRs in the United States, it is merely an administrative paperwork procedure to convert those shares; it’s not a taxable transaction, you don’t have to make a market in it,” Rothman stated.
While China is an immense market that cannot be ignored, Rothman said it is a challenging market to comprehend.
“However, this is why Matthews was founded some 30 years ago….”
A lot of stock selection and due investigation is required because it is a difficult market to break into. A few scam incidents have been reported, but investors shouldn’t give up on the market because of that.”
According to Rothman, who added that he was “selling his own book,” the Matthews fund managers don’t take any of the figures coming out of China at face value. This is something we want to make sure we are comfortable with before we commit,” he said.
People that put money into it on their own could be overlooked
As this column has already stated, the delisting process will have the greatest impact on retail and individual investors if they are unprepared.
Going forward, the most perilous companies to hold are those that haven’t set up a dual listing and aren’t eligible to trade in Hong Kong.
Listing on the Hong Kong stock exchange is a complicated process. For a firm to be eligible for listing under the HCFAA, it must have a market capitalization of at least HK$2 billion and recent annual revenue of at least HK$500 million, according to a recent Morgan Stanley study.
In addition, they must have HK$100 million or more in positive operating cash flow during the last three years.
The Hong Kong stock exchange is expected to make revisions to its listing standards, according to Rothman.
Rothman believes that Hong Kong’s market will have to adjust to suit the better-quality enterprises that will have to leave the city.
In addition, “I expect Beijing and Hong Kong to reform the laws to allow mainland investors to invest in enterprises like Internet companies.”
There are, however, a few companies that don’t meet the requirements. It’s not uncommon for companies that don’t meet these conditions to hunt for private equity purchasers after their stock has been savaged by news or rumors leading up to the delisting.
It would be a terrible consequence for American investors if they were forced to cash out instead of receiving fresh shares that could be traded on the Hong Kong stock exchange, Harvard’s Fried said.
“Investors need to know what is going to happen to these companies. With larger organizations, they’re more secure, but with smaller ones, they’re more vulnerable.”
As an example of smaller companies that went public in the previous two years with a lot of hooplas, Qutoutiao Inc., which went public in September 2018, has fallen 98 percent on an all-time basis since its initial public offering (IPO).
It has a market value of approximately $81.6 million. IQiyi Inc., a video streaming startup, has seen its stock fall 79 percent over the last year.
A scathing analysis by short-seller Wolfpack Research, and most recently, regulatory uncertainties, have plagued the so-called Netflix of China since its public debut in March 2018. U.S. company IQIYI has a $3.57 billion market value
It’s a good idea for investors to take some losses now, rather than wait until the smaller companies fully disappear from US markets. U.S. citizens looking to take advantage of China’s massive growth should deal with professionals who have no problem holding foreign shares.