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.

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.

China’s Securities Regulators Say Sky Is Not Falling, Honest

AUTHORITIES MAY HAVE had specific reasons for their unexpected assault on the e-tutoring industry a week ago. Still, they were not necessarily distinct enough to the eyes of investors to prevent a broad sell-off in Chinese tech stocks and, on international exchanges, Chinese companies listed in general.

It looked like another front in the expanding crackdown on the technology sector to ensure its entrepreneurs were aligned with the Party’s development agenda. In addition, the reasoning went, if authorities could ban private companies from making profits and going public in one industry, they could potentially do the same in any industry.

Regulators and other financial officials have now undertaken a damage limitation exercise, suggesting that the estimated $800 billion of market value wiped out in recent days was an unintended consequence or at least a more severe and broad reaction than had been expected.

China Securities Regulatory Commission (CSRC) Vice Chairman Fang Xinghai has held a hastily convened call with leading investment banks, including foreign ones, to ease market fears. The message was that last week’s actions were particular to e-tutoring companies and narrow, to protect online data security and social welfare, not to close them down unilaterally.

Meanwhile, state media is suggesting the stock market sell-off has been overdone. In addition, they are highlighting comments by CSRC Chairman Yi Huiman, albeit made at the Lujiazui Forum seven weeks ago, that the regulator is generally supportive of companies that seek foreign listings. State media is also trying to allay fears that variable interest entity structures will be banned and that Chinese companies will not be allowed to list in the United States.

How reassuring to investors this charm offensive — and some suspected buying up of shares by state-linked investment funds to prop up prices — will prove is an open question.

The Fifth Plenum, the Central Economic Work Conference and the Ninth Meeting of the Central Finance and Economics Committee emphasised the necessity of strengthening anti-monopoly measures and preventing the disorderly expansion of capital. That policy direction is set from on high, as is the intent to reform the governance of the platform tech companies to make them internationally competitive as part of Beijing’s development priorities.

That implies that, regardless of whether you call it a crackdown or the strengthening of regulation and supervision to ensure the development of the platform economy is on a sound and orderly track, the technology sector will continue to be in authorities’ crosshairs.

Investors should be under no illusions about the Party’s commitment to its overall political, social and economic agenda and to redirecting the tech sector to serve China’s national interest as it sees it.

China-US Decoupling Changes Its Terms Of Engagement

KEEP, CHINA’S MOST popular fitness app, and medical data group LinkDoc Technology pulled plans for initial public offerings (IPO) on the New York Stock Exchange in advance of last weekend’s crackdown on four other sector-leading app platforms, it has now emerged.

Didi Chuxing (ride-hailing), Huochebang and Yunmanman (commercial vehicles), and Zhipin (recruitment) were all put under investigation by the Cyberspace Administration of China, shortly after launching IPOs in New York, for failing to protect the data privacy of Chinese citizens, as foreign investors would have access to it through their share ownership, thus creating a national security risk.

Didi Chuxing reportedly ignored a warning from authorities to ‘delay’ its $4.4 billion IPO. As Jack Ma’s Ant Group can attest, there are some tigers it is rarely wise to poke in the eye.

In the meantime, authorities are preparing to end the governance structure that allows them to do so, variable interest entities (VIEs). VIEs were created to get around the restriction on foreign ownership of Chinese tech companies that hamper Chinese companies from raising foreign capital but exist in that peculiarly Chinese governance grey area between allowed and forbidden.

The China Securities Regulatory Commission’s (CSRC) is setting up a team that will review any proposed overseas IPO, which will now also require the approval of the relevant ministry. It will be paying particular attention to any Chinese company using a VIE structure.

This will lead to fewer and probably no listings of Chinese companies in New York and more in Hong Kong, where Beijing’s view of sovereignty-based digital governance is more easily enforced.

It appears we have reached a point of asymmetric decoupling of equity markets. In the United States, the Trump administration launched a policy of denying Chinese firms access to US stock exchanges to prevent Chinese access to US technology and capital, leading to the unedifying flip-flop by the New York Stock Exchange over delisting the three leading Chinese telcos. China is now responding by denying US investors access to Chinese data and forcing US capital that wants to invest in Chinese companies to move offshore to Hong Kong.

This would provide the decoupling the previous US administration wanted, and which the current one has shown no signs of reversing, but on China’s terms, which would not have been the original intention.

Time For A Poacher Turned Gamekeeper At The Exchanges?

LIU SHIYU, who has replaced the ill-starred Xiao Gang as China’s top securities regulator, is a former chairman of the Agricultural Bank of China. Liu is the China Securities Regulatory Commission’s eighth head, a job he will combine, like Xiao, with being the Party chief in the Commission. Six of Liu’s seven predecessors also worked in state banks.

And therein lies a clue to the innate contradiction in China’s attempts to control the animal spirits of financial markets by old-school administrative measures, which, like Xiao’s ‘circuit breakers’ can end up embarrassingly making matters not better but worse.

State bankers whose careers have been spent within the confines of a highly protected banking system where administrative guidance has long made the need for risk management a redundant skill are unlikely to have that gut feel for how markets work and what reinforces or undermines investor sentiment. Even Liu’s spell at the People’s Bank of China was mostly concerned with the bailout of the state banks in the early 2000s.

While having someone from the securities industry regulating the markets would no doubt come with its own mixed bag of connections and conflicts, it might be time for Beijing to consider appointing a poacher turned gamekeeper to oversee the exchanges.

China’s Financial Regulators’ 2014 Priorities

CHINA’S FOUR MAIN financial regulators have outlined their legislative priorities for the year: No great surprises. The introductions of catastrophe and food liability insurance, probably the least discussed reform proposals to date, are in line with the Party’s overall top priorities for the year, food security and improving the rural environment. In summary:

People’s Bank of China: Expand cross-border use of the yuan; maintain steady credit growth; improve the multi-tier capital market; and engage further in international financial regulation policy-making.

China Banking Regulatory Commission: Pilot three to five private banks, opening up the banking sector to domestic and foreign private capital; gradually reduce the threshold for foreign banks to enter the banking sector and ease their RMB operation requirements; keep a close eye on big housing developers, and reduce the risk of default through weak links in the construction industry’s money chain; restructure overcapacity industries, liquidating their assets and reducing the risk of default.

China Securities Regulatory Commission: switch IPOs from the current approval system to one based on registration; let the timing of IPOs and how shares are issued be determined by the market, as long as issuers disclose all relevant information as required; abolish approval requirements on 21 items over the next three years starting from 2014.

China Insurance Regulatory Commission: work with the finance and other ministries to implement catastrophe insurance; set up food liability insurance, given the importance of food safety in China.

At Least The Stock Fund Freeze Is Thawing

Such are the vagaries of administering markets. Five months ago, China’s securities regulators banned new stock funds in an effort to take some air out of
Shanghai’s stock bubble. Now they are allowing them again in a effort to break the fall in stock prices.

Two new closed-end funds will raise 14 billion yuan between them and will launch after lunar New Year, Shanghai Securities News reports, here via AFX. In all, Chinese funds have 3.2 trillion yuan ($445 billion) under management, more than double their assets in 2006, according to Xinhua.

The benchmark Shanghai Composite Index had doubled in the year before the China Securities Regulatory Commission imposed the fund freeze. It has fallen 30% since.

Stock Sheriff Swaggers

China’s securities regulators say they are closing some of the loopholes in the regulations released in Dec. 2006 intended to rid the country’s Wild West stock market of insider trading and other illegal stock transactions.

A statement, jointly issued by the Supreme People’s Court, the Supreme People’s Procuratorate, the Ministry of Public Security and the China Securities Regulatory Commission, focuses on illegal share issues, and tightens the wording of the original regulations whose ambiguities, the commission says, have let 90% of transactions it believes to be illegal, escape prosecution. Details via China Daily here.

One rampant area of abuse that needs tackling is the widespread front running by managers of state-run investment funds, in which individuals buy for their own account ahead of a much larger and marketmoving buy by the fund they manage.

The new announcement promises that some exemplary cases will be brought before the courts. We’ll see. Just as we’ll see how the regulators will tackle the task of cleaning up the market without pulling the rug from under prices.