By Mark Hulbert
The Securities and Exchange Commission is making things rougher for Chinese companies — and their U.S. shareholders. I’m referring to the agency’s recent threat to delist Chinese stocks that trade in the U.S. if they do not make their accounting books and auditing records available for inspection by the U.S. Public Company Accounting Oversight Board (PCAOB).
The reason the SEC’s threat could be counterproductive: Chinese companies may not need the U.S. financial markets. Given China’s goal of making its stock exchanges the center of global financial markets, the SEC’s threat in fact could be playing into China’s hands. Beijing might like nothing more than to deprive U.S. exchanges of the listings of premier global brands such as Tencent Holdings /zigman2/quotes/207908563/delayed TCEHY -5.14% and Alibaba Group Holding /zigman2/quotes/201948298/composite BABA -2.26% .
DiDi Global /zigman2/quotes/227703899/composite DIDI +2.36% , the Chinese ride-hailing company, appears to be a good illustration of this possibility. The company has been under pressure from the Chinese government to delist its shares from the New York Stock Exchange, and last week it announced it would do so. The resulting headline in The New York Times read: “ With Its Exit, DiDi Sends a Signal: China No Longer Needs Wall Street .”
DiDi’s delisting announcement came on Dec. 2. At one point in pre-open trading the following morning, the stock was up more than 10%. Though the stock subsequently closed down in Dec. 3 trading, it’s noteworthy that the stock’s immediate reaction to the delisting announcement was to rally.
DiDi Global is just one example. But consider the 10-largest U.S.-listed Chinese companies with American Depositary Receipts (ADRs). The table below lists their returns on Dec. 2, the day the SEC announced its new rules. As you can see, four of the 10 rose that day, and the average among all 10 was a loss of just 0.7%. These data hardly tell a story of investors particularly worried about the implications of the SEC’s latest move.
|Company||Ticker||Performance Dec. 2|
|Alibaba Group Holding||BABA||-0.4%|
|China Construction Bank||CICHY||+2.5%|
|Ping An Insurance Company of China||PNGAY||+2.5%|
To be sure, the smallest Chinese companies with ADRs performed more poorly than the largest ones. That makes sense, Andrew Karolyi, told me in an interview. Karolyi is a finance professor at Cornell University and Dean of Cornell’s SC Johnson College of Business. His reasoning: The smallest Chinese companies presumably will have a harder time than the biggest firms in accessing markets outside the U.S., at least for now.
Consistent with this hypothesis is the poorer performance on Dec. 2 of Chinese electric-vehicle companies. Though their market values are sizeable, they aren’t as big as the 10-largest that appear in the table above. As you can see below, their average return that day was a loss of 3.1%.
|Company||Ticker||Performance Dec. 2|
|NIO Inc. Sponsored ADR Class A||NIO||-5.5%|
|XPeng, Inc. ADR Sponsored Class A||XPEV||-5.6%|
|BYD Co. Limited Unsponsored ADR Class H||BYDDY||-0.1%|
|Li Auto, Inc. Sponsored ADR Class A||LI||-3.4%|
|Niu Technologies Sponsored ADR Class A||NIU||-1.1%|
The price of politics
The politics of subjecting these companies to PCOAB oversight are separate from the merits of the SEC’s demand. It’s hard to argue with SEC chairman Gary Gensler’s assertion, in an SEC press release last week, that “If you want to issue public securities in the U.S., the firms that audit your books have to be subject to inspection by the Public Company Accounting Oversight Board (PCAOB)… The auditors of foreign companies accessing U.S. financial markets [must] play by our rules.”
The SEC’s frustration is understandable. The PCOAB was created in 2002 with the passage of the Sarbanes-Oxley Act, so efforts to convince China to allow inspections have been in motion for almost 20 years now. If China never wanted to reach an agreement in the first place, the SEC has been negotiating in vain for two decades. Who wouldn’t be frustrated?
Nevertheless, Karolyi told me that he believes an agreement with China over the inspections is more likely to be achieved through “quiet and agile diplomacy” between the two countries’ securities regulators. He lamented that the situation has devolved into public threats, since investors will end up paying the price.
That price will be paid in at least two ways. First, it will be harder for U.S.-based investors to gain exposure to individual Chinese stocks. Without an ADR, you will be able to invest in a Chinese company only by buying ordinary shares on a Chinese exchange. That entails the additional transaction costs of exchanging dollars into Chinese currency.
You could characterize this as a mere inconvenience. The bigger price, according to Karolyi, is the greater uncertainty surrounding a company’s governance and its financials that buyers on local exchanges face. In contrast, when a firm is listed on a U.S. exchange, Karolyi said, it’s sending “an important signal that it’s able to withstand scrutiny.”