Tag Archives: decoupling

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.

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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.

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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.

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Chastened Didi Chuxing Will Head To Hong Kong

Didi Chuxing logo

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.

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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.

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NYSE Delisting Move Reflects Hardening US Line Against China

THE NEW YORK STOCK EXCHANGE’S decision to suspend trading in the shares of China Mobile, China Telecom and China Unicom HK in preparation for delisting is mostly a symbolic move. The three state-owned companies’ businesses are domestic, and their shares are little traded in New York. Their primary stock exchange listing is in Hong Kong.

However, it is also symbolic of how the hardening of opinion against China in the United States is more widespread than just China hawks in the Trump administration.

All three telcos stand accused of having links with the People’s Liberation Army. Since November, US investors have been banned by US presidential executive order from buying and selling shares in Chinese companies designated by the US Department of Defence as being ‘Communist Chinese military company’. Both China Mobile and China Telecom were on such a list that the Pentagon published in June. China Unicom was added in an update published in October.

The NYSE says its move to delist the three telecoms companies is to be compliant with the executive order.

The list and executive order are part of the Trump administration’s attempts to slow both the PLA’s modernisation and the drive to develop indigenous technologies by denying Chinese firms access to US capital. Three of the world’s leading index providers, MSCI, FTSE Russell and S&P Dow Jones, have also dropped the proscribed Chinese companies from their indexes, depressing their stocks’ attractiveness to global investors.

More than 200 Chinese companies are listed on US stock markets with a total market capitalisation of $2.2 trillion. Prominent names like Alibaba and JD.com have pre-emptively taken secondary listings in Hong Kong.

The US House of Representatives has recently followed the US Senate in passing a bill requiring non-US listed companies (for which read Chinese firms) to comply with US stock exchanges’ auditing rules and disclose whether they are owned or controlled by a foreign government. Firms have three years to comply or face delisting.

The Trump administration has been ramping up its actions against China in its final weeks, intending to lock-in as much of its China policy as it can before it leaves office on January 20.

On December 18, it the Bureau of Industry and Security (BIS) in the U.S. Department of Commerce added more than 70 entities, including the high-profile chipmaker Semiconductor Manufacturing International Corp. (SMIC) of China, to the Entity List.

Listing effectively prevents a company doing business with any US firm as it requires the granting of a special export licence under the Export Administration Regulations (EAR) for any export, reexport or transfer to them of goods, software or technology. That licence is presumed to be denied for firms on the Entity List.

BIS followed that by announcing on December 21 that it was adding a new category, Military End User, to the EAR. Of the initial 103 entities so designated, 58 are Chinese.

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US Edges Closer To Pushing Chinese Companies Off Its Exchanges

Screeenshot of Senate bill S.945

ATTEMPTS TO EXCLUDE Chinese companies from US capital markets have advanced with the US House of Representatives approving a bill on December 2 that would ban foreign companies (for which read Chinese) trading on US exchanges if the US Public Company Accounting Oversight Board is prevented from reviewing a company’s financial audits for three consecutive years.

Existing firms that fail to meet the requirement would have to delist. The bill also requires a company listed on a US exchange to declare whether a foreign government controls it, and whether any of its directors is, specifically, an official of the Chinese Communist Party.

The US Senate passed the legislation in May. US President Donald Trump will undoubtedly sign it into law before he leaves office on January 20.

More than 50 foreign jurisdictions permit such reviews, but for more than a decade, China has refused to allow them, claiming strict confidentiality laws, but in effect because Chinese law prevents firms from sharing audit papers with foreign regulators on national security grounds. Regardless, more than 150 Chinese companies, with a combined value of $1.2 trillion, trade on US exchanges, including such well-known names as Alibaba and JD.com.

The business has been too lucrative for US exchanges not to turn a blind eye to the auditing review requirement. Trump, however, has become increasingly determined to cut off Chinese firms access to US capital markets, believing it supports China’s push for technological self-reliance and modernisation of the People’s Liberation Army.

Beijing’s response will turn on how it balances the need to ensure that Chinese firms have adequate access to international capital markets with its desire to develop its own in Shanghai, Shenzhen and Hong Kong.

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China Mirrors US List Of Unreliable Entities As US Bans TikTok and WeChat

Screenshot of China Ministry of Commerce announcement of the provisions of the Unreliable Entity List, captured September 19, 2020

IN THE MIDDLE of last year, Beijing announced that it was creating an ‘unreliable entity list’. This mirrored the US administration’s use of its cold-war-era entity list of companies, organisations and individuals Washington held to be involved in ‘activities contrary to the national security or foreign policy interests of the United States’.

Beijing today published the regulations of how its version will work — although not the identities of those companies or other entities that are on it. The list will catalogue any entity that poses a threat or potential threat to China’s sovereignty, national security, development and business interests; and those that discriminate against or harm Chinese businesses, organisations or individuals. Those on the list face sanctions from bans on investment to restrictions on work and residence permits and fines. Those come into effect immediately, although listees may be granted a grace period to set right their alleged transgressions.

The new rules were published the day after the US administration banned downloads and transactions related to two Chinese apps, WeChat and TikTok. The restrictions on downloads of the two apps from the Apple and Google app stores take effect from tomorrow (September 20) as does a prohibition on third-party companies providing services within the United States to WeChat such as internet hosting, content delivery networks or peering services.

The third-party services restriction on TikTok is due to take effect on November 12. The stay is to give time for the administration to review a proposed deal whereby the US enterprise-tech giant, Oracle, will take a minority stake in the US and some other international assets of TikTok to satisfy US national security concerns about the video-sharing app’s use of the data it holds on US citizens.

There was a rush to download the apps from the Apple and Google app stores before the bans took effect. It is unclear what penalties US users of the apps will face if they contravene the bans, although the US Treasury is indicating that neither criminal nor civil prosecutions are likely.

The prohibition on using WeChat and its parent Tencent for messaging and for financial transfers and payments aims further the Trump administration’s desire to decouple the two economies. The app is widely used by US businesses and Chinese expats to conduct business with contacts colleagues and customers in China. It has a reported 19 million active daily users in the United States. The Reuters news agency reports that Tencent has quietly developed an enterprise version of WeChat, rebranded as WeCom to avoid the ban, but which it is keeping under-ther-radar in the United States.

As an aside, Beijing recently granted TikTok’s parent, ByteDance a rare new licence to conduct online payments, enabling its Chinese service to move into e-commerce in competition with Alibaba and Tencent, a revenue stream that is out of the question for its US operation, however the ownership of that ends up.

Tencent has said that it will pursue further discussions with the US government while TikTok took the more assertive line that it will continue to challenge what it calls an unjust executive order. The Ministry of Commerce condemned the bans on both apps, promising ‘necessary measures’ to protect the legal interests of Chinese firms, without saying what those might be. Banning US apps in retaliation is not an option as they are already mostly excluded from China.

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Decoupling Cuts Both Ways

Screenshot of SMIC web site

THE THREAT TO blacklist China’s largest contract chip-maker Semiconductor Manufacturing International Corp. (SMIC) fits squarely with the US administration’s efforts to hobble China’s technology development by denying it access to the US technologies that it will need until it can develop indigenous industries.

According to the Reuters news agency, the US Defence Department has proposed adding state-owned SMIC to the entity list, part of the US export-control regime that would prevent any US company doing business with it without a special licence from Washington.

The nub of the threat that poses to SMIC’s business is that one-half of the company’s chip-making equipment is US-made. A blacklisting would deny it the servicing and maintenance that the equipment will inevitably need, even if production is kept going in the short-term.

More significantly, it would make it impossible for SMIC to buy the equipment that is required to make the more advanced chips that it does not yet manufacture but which Chinese tech firms such as Huawei and HikVision will need as Washington chokes off their US sourcing. SMIC was already vulnerable to US sanctions.

The recent extra-territorial expansion of US export controls against Huawei barred any company from selling it chips without a US licence if those chips were designed using US software or manufactured using US equipment. SMIC is a Huawei supplier.

Like Huawei, SMIC is also accused of endangering US national security and of having links to the People’s Liberation Army. Although SMIC denies this, it is more than likely that its chips do get used in hardware that gets sold to the military, however indirectly. A US defence contractor claims that researchers at PLA-affiliated universities use SMIC chips and processes and that there are business links between SMIC and China Electronics Technology Group (CETC), a state-owned defence electronics research contractor.

Thus the race is on to develop an indigenous chip-making industry before the US administration destroys Chinese tech firms’ supply chains.

Meanwhile, US President Donald Trump gave a further airing to his musings on decoupling the US and Chinese economies over the long holiday weekend in the United States. He spoke of making the United States a manufacturing powerhouse that was not dependent on China.

Driving out SMIC and other customers for US products would create the mirror image of that.

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A US Ban On WeChat Would Hold Deeper Decoupling Threat

OUR MAN IN Washington passes on this observation: the Trump administration is now escalating its attacks on China’s ability to access US technology and its drive to decouple the Chinese and US technology sectors regardless of domestic costs. Concern about the damage to US business interests has held the administration’s China policy in check up to a point. If that constraint is no longer in place, it would indicate a new adversarial phase in the relationship.

Our man proffers two pieces of evidence.

The first is the cautionary statement issued by the Semiconductor Industry Association, the US chip industry’s trade association, about the much tougher Foreign Direct Product Rule within the US export control regime. This is aimed at preventing Huawei Technologies from not only buying US-made chips but any made by non-US firms that have been developed or produced with US technology, including software. The new rule, the association says, “will bring significant disruption to the US semiconductor industry”.

Part of that disruption will be caused by significantly increased business and compliance costs for technology suppliers who will now have to monitor the entire value chain of their products and services from development to end-user sale. They may find that doing some business is not longer viable, and thus they will surrender those customers to competitors.

The second is the executive order prospectively banning US individuals and entities from using WeChat, the instant messaging app that is central to Tencent’s social media platform.

WeChat is so ubiquitous within China that a ban could make it all but impossible for US businesses to operate in China. The main channel US multinationals use to communicate with their customers, colleagues, business partners and suppliers in China would be cut off.

The order gives the US Secretary of State the authority to identify which transactions are subject to the ban, but does not require him to provide advance notice of his decisions.

How extensive the impact would be will depend on how strictly the order is applied. It is written with a degree of ambiguity that would make a Chinese legal drafter proud, allowing broad administrative interpretation in its implementation whose very uncertainty provides a chilling effect on any who might be affected.

As now written, under the terms of the executive order, the US Secretary of State, currently Mike Pompeo, one of the most bellicose of the China hawks in the administration, could, in theory, decide that, say, Apple installing WeChat on its iPhones in China would violate the order.

Removing the app from the handsets Apple sells in China would kill the company’s sales there. It might also lead Beijing to enact its new regulations that allow for sanctions on foreign companies that limit technology exports to China for political reasons. Sanctions could take the form of retaliatory measures against Apple’s supply chain. That would not be easy to reconfigure in short order for the reasons that we have recently discussed.

This is an extreme but still conceivable example. There is no evidence that the administration is seeking what would be Pyrrhic victories in destroying the Chinese markets of US multinationals. Indeed, there is no indication at all of how the WeChat order would be implemented. Our man’s broader point is that the decision would be political. Should Apple or any other US tech company show open defiance of the administration’s drive to decouple the two countries’ tech sectors, the conceivable examples could suddenly become more plausible.

This, in turn, suggests the determination to decouple is more robust within the White House than is perceived outside it, and that the China hawks now in the ascendency within the administration will grasp every opportunity to push it further.

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