Strong Dollar Sends Yuan To New Lows, And No One Is Bothered

THE YUAN HAS fallen to a record low against the US dollar since it became internationally convertible in 2011 when Beijing allowed some overseas fund-management and securities firms to invest their yuan onshore.

This point has been coming. The People’s Bank of China has been letting the currency fall, managing only the speed of the descent with its trading band mechanism.

With inflation relatively low by world standards at 2.5% in August, China has the headroom to take the inflationary hit from a depreciating currency that makes imports more expensive. The intention is that the boost the falling yuan will give to exporters will revitalise an economy whose growth has slowed.

However, exports now account for only around 20% of the economy. A cheaper yuan will go only some of the way to offsetting the effects of zero-Covid lockdowns and a deeply troubled property market that is looking more and more like a structural, not cyclical, problem.

Raising interest rates to defend the currency would only worsen the property sector’s malaise. To the contrary, cutting them has been part of Beijing’s stimulus toolkit.

The yuan is far from the only currency to be battered by the US dollar’s strength. The euro, yen and British pound are all reeling from the US Federal Reserve’s aggressive raising of interest rates to bring down US inflation that has proved more persistent than expected.

The Federal Reserve will not abandon that policy soon. So far, US exporters have not been squealing about how the strong dollar is hurting them, as happened in the run-up to the Plaza accord in 1985. That international agreement to the US dollar led to the endaka shock to the economy of Japan, then playing the role China has recently taken as exporter to the world.

We are not at the point of a re-run of that yet. Neither China nor the United States have a short-term incentive to alter their currency’s trajectory. That point will come, but the question is whether it arrives before or after the Fed thinks it has tamed inflation.

However, just recall, a decade ago Beijing was being accused of being a currency manipulator for keeping the yuan low.

China-US Audit Deal Has Room For Many A Slip

BEIJING AND WASHINGTON have reached a preliminary deal to allow US inspectors to review audit documents of Chinese businesses that trade on US exchanges, a first step toward avoiding the delisting of about 200 Chinese firms from New York exchanges.

This is the latest attempt to resolve a more-than-a-decade-long standoff over mutually incompatible auditing regulations. As the two headlines from the official announcements (above) indicate, it is progress towards a resolution, not the resolution itself.

So that regulators can ‘audit the auditors’ of companies listed on US exchanges, US securities rules require Chinese firms listed in the United States to allow access to documents that Chinese restrictions prevent them from disclosing.

China and Hong Kong are the sole foreign jurisdictions that have not allowed inspections by the Public Company Accounting Oversight Board (PCAOB), the US agency that audits the auditors. All companies listed in the United States must submit to PCAOB inspections under the Sarbanes-Oxley Act of 2002. Beijing cited national security and confidentiality concerns as its grounds for refusing.

Since the US Congress passed the Holding Foreign Companies Accountable (HFCA) Act in 2020, putting a three-year time limit on uncompliant companies coming into compliance, some 200 Chinese firms with a market value of more than USD1tn have been potentially at risk of mandatory delisting if they do not do so.

Under the new agreement, the PCAOB will start inspections in Hong Kong in mid-September. Its inspectors are not travelling to the mainland for health safety reasons, but the agreement stipulates that all the documents they request will be made available to them in Hong Kong.

Towards the end of the year, the PCAOB will determine if they have had the access they require to affirm whether Chinese firms listed in the United States are in compliance with US rules. If not, the US Securities and Exchange Commission (SEC) will determine if the delistings process will go ahead under the HFCA.

The deadline is tight. PCAOB inspections can take months, and the agency will need an army of inspectors to conduct a sufficient sample of audits in parallel.

This is the most detailed and prescriptive agreement on this issue that the two sides have reached, but it is not the first. China’s record of making commitments in principle but then stalling on honouring them in practice advises caution. The success of this deal will be determined by its implementation. There is many a slip between cup and lip, as the old saw has it.

The public announcements of the agreement on both sides underscore the need for caution, with the China Securities Regulatory Commission calling it a ‘cooperation framework’ and the PCAOB, ‘a first step’.

The recently announced intent of several prominent Chinese firms to delist voluntarily from the New York exchanges also suggests that Beijing may be comfortable with a managed withdrawal from US capital markets in favour of primary listings in Hong Kong.

NYSE Delistings Will Nudge Forward China-US Decoupling

DID THEY JUMP, or were they pushed? Whichever, the coordinated announcements by five large Chinese state-owned companies that they are to delist voluntarily from the New York Stock Exchange pre-empt US authorities doing it mandatorily.

The five companies are the oil giants PetroChina and China Petroleum and Chemical (Sinopec), Sinopec’s refining subsidiary, Sinopec Shanghai Petrochemical, Aluminum Corp. of China (Chalco) and China Life Insurance, one of the largest state-owned insurers. All have primary listings in Hong Kong. 

All are also in sectors that Beijing would consider strategic and thus is sensitive to information about them being made available to foreign regulators.

The US Securities and Exchange Commission (SEC) and the China Securities Regulatory Commission have been battling for two decades over incompatible auditing regulations. 

The SEC wants US-listed Chinese mainland-based companies to provide the top US audit watchdog, the Public Company Accounting Oversight Board, with the same access to their financial records that is required of all companies to protect investors from accounting frauds and other financial wrongdoing. 

China refuses to let its companies open their books to foreign regulators for national security reasons.

Last year, there were indications of a compromise being struck, but discussions seemingly have stalled. However, it is possible that voluntary delistings that take the most sensitive Chinese companies out of the equation could be paving the way for an agreement. 

The fundamental problem remains that US rules require listed firms to allow access to information that China bars them from disclosing. 

Under the Holding Foreign Companies Accountable Act passed in 2020, the US Congress has imposed a deadline of 2024 for the NYSE to expel companies that do not comply with US audit requirements. 

Upwards of 200 Chinese firms, Alibaba among them, with an aggregate market capitalisation of more than $1 trillion, are potentially at risk of delisting. The departure of each one would mark another step in the slow walk of economic decoupling between the two countries.

China Continues To Welcome Foreign Capital But On Beijing’s Terms

THE DETAILS OF China’s well-signalled coming restrictions on overseas listings by its start-ups are slowly becoming clearer.

A consultation paper issued on December 24 by the China Securities and Regulatory Commission lays out a regime that would require any company wanting to sell shares abroad to register with it. The commission would review the listing plans and coordinate with other relevant agencies.

Authorities would have the power to block any overseas listing they considered a threat to national security, which would encompass compliance with the country’s new data protection regime.

The new rules fall short of a blanket ban on overseas initial public offerings (IPOs), which some had feared. However, they would give authorities blanket veto power over any proposed IPO or secondary listing considered undesirable. Chinese firms will be free to continue to take foreign capital where it is supportive of, or at the least, does not conflict with China’s national goals.

More surprisingly, perhaps, the new regime would not kill off variable interest entities (VIEs), the governance structure often adopted by Chinese companies to get around strict restrictions on Chinese companies taking foreign investment. While VIEs have long existed in legal limbo, they will be allowed to register with the securities regulator providing they are legally compliant.

The legal compliance could well refer to not falling afoul of a blacklist that comes into effect on January 1 of sensitive sectors that would be off-limits to foreign investors.

The regulatory uncertainty has already had a chilling effect on overseas listings, especially since ride-hailing app company Didi Chuxing incurred the wrath of regulators when it pushed ahead with its $4.4 billion IPO in New York in June.

Authorities were cracking down on the tech sector, and Didi’s blanking of their advice to pull the listing led to a series of retaliatory measures and, earlier this month, an announcement that it would delist from New York and switch to a Hong Kong share listing.

VIEs’ Grey Zone Darkens

VARIABLE INTEREST ENTITIES (VIEs) have always existed in a grey area between legal and illegal.

It has been a happy ambiguity for Chinese companies wanting to skirt the restrictions on foreign ownership and for authorities when they wanted Chinese companies to acquire foreign capital and access to foreign, particularly US technology.

Now priorities have changed. Decoupling from foreign capital markets is the order of the day and the sensitivity that foreign ownership could result in the disclosure or compromise of mass Chinese user data has become acute, perhaps on it-takes-one-to-know one grounds. Thus new rules are being prepared to control tightly which companies can use the VIE governance structure to list on overseas markets and thus end up with foreign shareholders.

While that has been known for some months, the new information emerging is that the mechanism will be a blacklist, which can be played administratively like a concertina. As we noted earlier, the restrictions are likely to vary in intensity by sector. VIEs will be out of reach for any startup that collects data, which means all of them. A national security provision will provide a catch-all for regulators.

Given the political and economic incentives available to force domestic technology firms to list within Beijing’s jurisdiction (including Hong Kong), if there is any surprise, it is that authorities feel the need to take coercive powers. The slights and rebuffs they received earlier touched a nerve.

Existing VIEs will likely be left untouched, if not alone. Tech giants like Alibaba and Tencent that used them but are being reined in by other means.

Nor will VIEs move out of their grey zone status by being banned. They will remain an option for Chinese companies wanting to raise foreign capital where and when that is deemed in China’s national interests.

Chastened Didi Chuxing Will Head To Hong Kong

RIDE-HAILING APP Didi Chuxing incurred the wrath of regulators when it pushed ahead with its $4.4 billion initial public offering (IPO) in New York in June in the face of their advice not to, even as others fell into line as China prepared to crack down on its tech companies.

A series of retaliatory measures rapidly followed, including online app stores being ordered not to offer Didi’s app because it violated regulations on collecting user data and the company being banned from signing up new users. The Cyberspace Administration of China (CAC) launched an investigation of the firm on the grounds of national security and public interest.

Now the company has announced, abruptly, that it will delist its Didi Global American Depositary Receipts (ADRs) from the New York Stock Exchange and switch to a Hong Kong share listing. Existing shareholders will be able to convert their ADRs into freely tradeable shares on the new bourse. This implies the Hong Kong listing will come before the New York delisting is finalised, probably sometime between spring and summer next year.

Japan’s SoftBank is Didi’s largest shareholder with a stake of some 20%. Tencent and US venture capitalists Sequoia also have significant holdings. All will be covered by the six-month lock-up following the IPO, which will end at the end of December. Big shareholders may well consider the financial hit they will take on their holdings to be worth it if delisting draws a line under Didi’s punishment by authorities.

The lock-up will also cover company executives who face significant losses on their holdings. Didi’s shares have fallen 40% since their listing as the measures taken against them, which also included new protections for the millions of ride-hailing drivers, took their financial toll. The company also abandoned plans to expand in the EU and the United Kingdom.

The Didi IPO was the biggest by a Chinese company since Alibaba in 2014, but there has been growing pressure from the United States to deny Chinese firms access to US capital markets.

On Thursday, the US Securities and Exchange Commission said it had finalised rules under legislation the US Congress passed last year that put US-listed foreign companies at risk of delisting if their auditors do not comply with requests for information from US regulators.

Driving capital market decoupling from the other end, Chinese regulators need to approve any plans by a Chinese company to list overseas and are making the approval process more stringent. Particular scrutiny is being applied to any company that holds data that Beijing deems sensitive.

Regulators also intend to close the loophole through which Chinese tech companies can go public on foreign stock markets via variable interest entities (VIEs). That was the governance structure that Didi Global used. VIEs are unlikely to be banned outright, but will get sector-specific new rules for when and how they can be used.

Even without those new rules, Didi’s complete climbdown will have a chilling effect on any other Chinese tech company still harbouring thoughts of a New York listing — if there is one.

Evergrande Worries The US Fed After All

THE US FEDERAL RESERVE’S latest semi-annual financial stability report comes with an uncommon warning about China’s financial stresses, not the sort of thing it typically comments on.

Its concern is that the stresses in China’s real estate sector could strain the Chinese financial system, with possible spillovers to the United States:

In China, business and local government debt remain large; the financial sector’s leverage is high, especially at small and medium-sized banks; and real estate valuations are stretched. In this environment, the ongoing regulatory focus on leveraged institutions has the potential to stress some highly indebted corporations, especially in the real estate sector, as exemplified by the recent concerns around China Evergrande Group. Stresses could, in turn, propagate to the Chinese financial system through spillovers to financial firms, a sudden correction of real estate prices, or a reduction in investor risk appetite. Given the size of China’s economy and financial system as well as its extensive trade linkages with the rest of the world, financial stresses in China could strain global financial markets through a deterioration of risk sentiment, pose risks to global economic growth, and affect the United States.

Was it just two months ago that Fed Chair Jerome Powell said that the risks from Evergrande’s troubles seemed very particular to China?

Evergrande’s Two Aspirin Help For Now

FOR A COMPANY whose $300 billion of debt sent shivers through investors around the world, sketchy news that it has resolved a $36 million interest payment that was due on Monday seems more a palliative than the curative medicine investors are taking it to be.

Even though it is the equivalent of a doctor telling a patient to take two aspirins for a broken leg and see how they feel in the morning, the announcement by Hengda Real Estate, the main property unit of the world’s most indebted if no long largest real estate developer, Evergrande, that it reached an unspecified agreement with holders of one of its onshore bonds appears to have eased the pain in the financial markets.

International investors have now returned to worrying about something they at least think they understand how to worry about, inflation and stimulus unwinding. Evergrande’s financial accounting is more opaque than even central bank monetary policy.

However, the announcement said nothing about the little matter of an offshore bond on which an $84 million coupon payment falls due on Thursday, although it has a 30-day grace period.

On Monday, Evergrande reportedly missed interest payments to at least two of its biggest lenders. Authorities remain concerned about the systemic financial risk that Evergrande’s sprawling debt obligations pose if there is a disorderly collapse of the group.

They also worry about the potential spillover into the real economy, which risks social instability and thus is a political matter. The group owes $147 billion to unsecured trade creditors such as suppliers, while some 1.5 million disgruntled buyers of Evergrande homes off plan who now face losing their deposits will, at the very least, vent to let off steam, even if more serious protest will be contained.

One reason that the amount owed to trade creditors is so eye-popping is that Evergrande systematically deferred payments to its suppliers so it could cut its interest-bearing liabilities, which it succeeded in doing, reducing them by some 145 billion yuan ($22.4 billion) to 571.7 billion yuan as of end-2020..

For now, the ‘d’ word has been avoided — and authorities have the administrative tools to ensure it stays that way. That will dull the pain and provide temporary relief, if not a cure.

Update: Regulators have reportedly instructed Evergrande to focus on completing unfinished properties or repaying deposits while avoiding a near-term default on its dollar-denominated bonds. Beijing is also said to have told local officials and state-owned enterprises to step in with bail-outs only as a last resort in the even of a disorderly collapse of the property developer.

Beijing Reportedly Tightening Up On Tech Company Foreign IPOs

CHINA’S SECURITIES REGULATORS indicated last month that stricter supervision of all firms listed offshore was coming. Reports now say this sweeping intent is being narrowed to a ban on foreign listings by platform technology companies whose data poses potential security risks. Any proposed foreign listing would have to pass Cybersecurity Administration of China review.

In recent months, Beijing has tightened its grip on the platform companies. Particular attention is being paid to unfair competition and the companies’ handling of the enormous troves of consumer data they collect. Foreign initial public offerings have been part of that, but have become more politically sensitive after Didi Global, parent of ride-hailing app Didi Chuxing, ignored the authorities’ request to pull its share offering in New York.

The new rules to limit foreign listings are also reported to include a tightening up on variable interest entities (VIEs), a legally ambiguous corporate governance structure used by technology companies to raise capital overseas as it gets around Beijing’s restrictions on foreign investment in sensitive industries such as media and telecommunications. The changes could include greater shareholding disclosure and bringing VIEs, generally incorporated in tax havens, under direct legal jurisdiction.

One intent behind the change may be to drive tech companies back to domestic markets on the mainland or Hong Kong for their listings. After the halting of Ant Group‘s $37 billion share flotation last year and subsequent regulatory tightening over domestic new listings, scores of tech companies seeking outside capital dropped plans to list on Shanghai’s STAR Market and Shenzhen’s ChiNext market and rushed to list overseas, particularly in New York.

More broadly, the new rules, if they come to pass as advertised, will be in line with Beijing’s national security concerns, imagined or not, that foreign ownership could result in the disclosure or compromise of mass Chinese user data.

They will also align with the leadership’s growing intent to ensure that business supports China’s national interests as the Party defines them. Keeping the wealth created by the country’s burgeoning technology sector at home to fund more indigenous development in the sector is one of them.

ByteDance IPO Reportedly Moves Ahead

BYTEDANCE, OWNER OF short video sharing app TikTok, looks set to be rewarded for toeing the Party line amidst the crackdown on tech.

The Financial Times reports that the company is likely to be allowed to go ahead with an initial public offering (IPO) of its shares in Hong Kong later this year or early next.

ByteDance had planned to go public in New York earlier this year but put those plans on hold when told by Chinese regulators to address data security concerns.

It has since been going through the review process and has submitted filings to authorities, the Financial Times reports. ByteDance is hoping that it will get clearance to proceed next month.

It has also denied that the Financial Times report, but with the sort of non-denial denial that suggests that it would not be politically expedient to do anything else.

Last month, Beijing indicated it would require a cybersecurity review of nearly all companies looking to list their share abroad.

Overseas listings have been frozen in effect to safeguard data security in the wake of ride-hailing app Didi Global’s controversial $4.4 billion IPO in New York that the company pushed forward in the face of official objections.