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.

Calling U.S.-Listed Chinese Companies To Account

The U.S. Securities and Exchange Commission has sanctioned a California firm of auditors in connection with fraudulent accounts of China Energy Savings Technology, a Chinese technology company that has been entangled with the SEC since 2006. The auditing firm, Moore Stephens Wurth Frazer & Torbet LLC along with K. Dean Yamagata, a CPA, have settled the case, as is customary in such matters, without admitting or denying the SEC’s findings of improper professional conduct. The firm is barred temporarily from accepting new auditing assignments in China and will pay $129,500. (SEC announcement.)

Bloomberg’s report notes that this is one case in what it calls a broader probe by the American regulators into Chinese companies listing in the U.S., particularly the 150 or so that have done so via a reverse merger (the acquisition of a listed shell company that then merges with its acquirer; it is a way round the requirements of making an initial public offer). A number of such companies, many small and whose operations remain overwhelmingly in China regardless of their U.S. listing, have employed small California firms to audit their books for the purposes of U.S. regulatory reporting. The suggestion is that these firms have outsourced the audit to local firms in China, beyond the remit of U.S. accounting oversight, thus leaving U.S investors at best at the mercy of shoddy accounting and at worst at risk of being defrauded.

Gadflies pushing for an SEC investigation have suggested a third of Chinese companies listed in the U.S. are reporting fictitious profits. An investigation by theStreet.com reckons the losses to American investors could run to $34 billion. Sporadic incidents of fraudulent reporting by U.S. listed Chinese companies have emerged before. Rino, a manufacturer and another Frazer client, was delisted by Nasdaq after admitting that it had reported fictitious details about contracts; Fuqi International and Sky One Medical have also acknowledged being the subject of SEC investigations.

The SEC, as its practice, won’t tip its hand to how widespread its investigation runs, or to how much cooperation, if any, it is getting from regulators in China. Going after Chinese firms’ American auditors would suggest it feels it is best off playing this on home turf.  There is nothing uniquely Chinese about penny-stock scams in U.S. markets. The question now is whether the SEC will uncover a systematic attempt to bilk U.S. investors, or whether it is just the gap between the U.S. and Chinese regulatory systems giving scope for sharp practice, reform of which will become another item to add to the long list of Sino-American trade and investment issues.

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.