Talking Point

Trading places

Could tense Sino-US relations be a blessing in disguise for the HKEx?

Alibaba-Listing-w

More like this to come? Alibaba bosses got a warm welcome from the Hong Kong bourse last year

“You will only begin to earn their respect after you strike the opening bell of the New York Stock Exchange.” This is one of the quotes from American Dreams in China, a film based loosely on the story of New Oriental, an education firm founded to coach Chinese students trying to get into American universities. Business began in the early 1990s, feeding from the growing number of Chinese sitting the SAT and TOEFL exams. New Oriental prospered, going public in New York in 2006 (see WiC83).

In the 2013 movie, three deadbeat students aspire to make it big in America. After various setbacks they find success when they set up a school to help others pursue the same dream of an American education – a common aspiration for Chinese of that generation. In the plot an American examination agency sues the school for plagiarising its materials. The movie doesn’t dwell on the outcome (in reality, New Oriental was sued for copyright infringement in 2004) but the three partners plough ahead towards an IPO in New York (see WiC167).

The film classes the ringing of the NYSE’s opening bell as a defining moment for China’s entrepreneurs. That’s less the case today, however. Indeed, as the trade and tech rows worsen between Beijing and Washington, many Chinese firms are delisting from US bourses. With a new threat from Congress that more could be forcibly sent home, more firms look set to head back to stock markets in Hong Kong and mainland China.

Which companies could be coming home?

Alibaba went public in New York in September 2014. But it has already shifted some of its investor base closer to home. The e-commerce firm raised nearly HK$100 billion ($13 billion) in a secondary listing in Hong Kong last November (see WiC476) and other internet heavyweights are said to be following the same path. Bloomberg reported last week that NetEase, which went public on the NYSE as early as 2000, is planning to list its shares on the Hong Kong Stock Exchange (HKEx) on June 11. JD.com, the second largest e-commerce platform behind Alibaba, could debut a week later on June 18. The two secondary listings could raise a combined $5 billion, Reuters reports.

Internet search firm Baidu is also considering delisting from the Nasdaq and moving to Hong Kong or a mainland exchange. “For a good company, there are many choices of destinations for listing, not limited to the US,” its chairman and CEO Robin Li told reporters last week at the Two Sessions, China’s annual parliamentary gathering.

Baidu’s market cap has more than halved over the past 24 months, falling to about $37 billion as of this week, which means it has been overtaken by both JD.com ($65 billion) and NetEase ($49 billion). In a sign of its decline, it is now worth about a fifteenth of Alibaba. Yet as one of the BAT trio (the acronym for the original tech triumvirate of Baidu, Alibaba and Tencent), any departure from the US bourse would still command a lot of attention.

What are the factors driving the exodus?

One of the newest is the regulatory environment, which is now less friendly for Chinese firms listed in the US (which are known locally as ‘China-concept stocks’). Last week the US Senate passed a bill that prevents foreign companies from going public in New York should they fail inspections by the Public Company Accounting Oversight Board (PCAOB), an agency set up to oversee the audits of public companies, for three consecutive years. Firms already trading on US bourses face forced delistings if they fail the same test and the legislation requires all companies trading on US markets to disclose whether they are owned or controlled by a foreign government.

According to the PCAOB, audit firms in China and Hong Kong issued audit reports for 188 public companies in 2019 that were listed on foreign exchanges (primarily in the US) and had a combined global market capitalisation of approximately $1.9 trillion.

The new rules, if passed by the House of Representatives and signed off by Donald Trump, will put Chinese executives in a difficult position. For a start, complying with US accounting standards will require a huge amount of work, as well as the adoption of a new set of auditing procedures. Probably more significantly from their perspective, they could also be breaking Chinese law by turning over accounting documents to foreign regulators like the PCAOB. “Companies failing to comply with the new rules would risk sanctions from the SEC. Those who do comply, however, would find themselves infringing Chinese regulatory requirements,” noted 36Kr.com, a Chinese news portal which went public itself on Nasdaq last year.

“More embarrassingly, it would deem the entire Chinese auditing profession untrustworthy,” 36Kr.com added.

This explains the immediate rebuttal of the new legislation from the China Securities Regulatory Commission (CSRC), which has been working with the PCAOB since 2017 on a cross-border scheme for closer inspection of China’s accounting firms. In a statement published this week, the regulator suggested that the new proposal was motivated less by professional considerations and more by “the politicisation of securities administration”.

“We believe that global investors will make their own wise choices, according to what benefits them the most,” it noted, warning that the bill would erode investor confidence in the American financial markets.

Short-sellers are lurking too…

Besides regulatory concerns, Chinese firms have also found themselves in the crosshairs of short-selling outfits such as Muddy Waters.

Short-sellers have actively targeted Chinese firms for a decade. The likes of Sino-Forest and Focus Media – two investor darlings before they became the subject of intense interest from the shorts – have been forced to depart US exchanges (see WiC111). New Oriental – the inspiration for the film mentioned earlier – was also accused of accounting fraud. The allegation led to a slump in its share price and an investigation by the SEC (see WiC160) and plenty of other “China-concept stocks” have experienced collateral damage from short-seller raids.

And now Luckin Coffee…

The latest case of a Chinese concept stock running into trouble is Luckin Coffee. It went public last May (see WiC451) in what looked like a classic case of a Chinese unicorn coming to Wall Street – a listing locale where investors have been willing to afford more generous valuations to fast-growing start-ups from China. The three year-old firm’s market value had surged to more than $12 billion in January but the stock then crashed when the coffee chain revealed that its revenues were inflated by at least $300 million (see WiC490).

Luckin said last week it had been notified by Nasdaq that it will be delisted from the bourse on “public interest concerns”.

The debacle has revived distrust in Chinese firms in general. “This is the best opportunity to short-sell,” a hedge fund manager told 36Kr. “[Luckin] has tarnished the reputation gradually rebuilt by China-concept stocks over the last few years.”

More established companies such as GSX Tech Education, an online tutoring service provider; GDS Holdings, a data centre operator; and even iQiyi, a popular video platform backed by Baidu, have all been accused by short-selling research firms of accounting frauds.

Chinese firms in Hong Kong have been short-selling targets too (see WiC370), although market regulators there have tried to curb some of the activities of the short-sellers (the head of Citron Research was found guilty of publishing “false and misleading” information about Chinese property developer Evergrande in 2012 and barred from trading Hong Kong stocks for five years; see WiC158) .

Not that the shorts have been discouraged. Tianneng Power, a battery maker, saw its stock fall nearly 10% on Wednesday, following a damaging report by CloudyThunder, which identifies itself as “a group of activist investors”. It claims that Tianneng’s shares are actually “worth close to zero” based on its research.

Where will the departing firms choose to go next?

Should more Chinese companies opt to return home, the next question is where they might choose to go public again. One option is China’s A-share market, but it hasn’t seemed particularly receptive to these kinds of returnee. Over the last 10 years, the majority of the China-concept stocks taken private from US bourses were only able to refloat in Shanghai or Shenzhen via backdoor listings. These include the likes of Giant Interactive (see WiC400) and computer security provider Qihoo 360 (see WiC388).

That trend suggests a reluctance on the part of the CSRC to give IPO approvals for the returnees, most of which have relied on ‘variable interest entity’ structures to bring foreign investors onto their shareholding registers (see WiC197 for one of our reports on the VIEs).

There has been talk that the newly established tech bourse in Shanghai (the STAR market) might introduce looser regulations to lure more tech returnees, including the companies that have relied on offshore ownership in the past. An exception has already been made for the imminent IPO of SMIC, a semiconductor foundry that has been receiving state support to help it compete with Taiwan’s TSMC (see WiC495).

Hong Kong is already being more flexible in its bid to woo more listings from China’s biggest firms. The HKEx initially lost out on Alibaba’s huge IPO in 2014 because of a rule disallowing dual shareholding rights (see WiC237), leading the Hangzhou company to choose New York instead. But HKEx has changed tack and it now permits the listing of these so-called ‘W-shares’, or companies with weighted voting rights, such as Alibaba, Xiaomi and Meituan-Dianping (see WiC445).

“The A-share market remains off limits to companies with VIE or weighted dual-shareholding structures, so more and more Chinese firms will opt for a Hong Kong listing,” 36Kr.com predicts.

Politics spoiling profits?

A company’s choice of bourse typically reflects the confidence of its major shareholders or financial backers in a particular market. Another way to put this: will China’s tycoons feel more secure parking their primary assets in New York, Hong Kong or mainland China?

Tech bosses are already being forced to address this question as the rivalry between China and the US flares further, and the politics of the row would seem likely to drive more of the decision on where they should be issuing their companies’ shares.

For instance, the Commerce Department added another 33 Chinese firms to its trade blacklist last Friday. Among those denied the supply of US components is Qihoo 360, a software firm that made headlines recently for claiming that it has evidence that the CIA has been hacking Chinese firms for years. Qihoo 360 was taken private from the NYSE in 2015.

Yet the lesson of its blacklisting won’t be lost on other tech contenders from China such as DJI, the world’s biggest drone maker, or AI unicorn Sensetime, which have been mentioned as candidates to go public in the US as well. Why consider that as an option when the mood is already looking hostile?

In the near term it seems that Hong Kong will benefit most as an alternative hub for fundraising, as indicated by the new high-profile arrivals on its bourse over the next few weeks. Another attraction is that the city’s stock connect schemes with the Shanghai and Shenzhen exchanges allows mainland Chinese investors to buy into the same shares.

That said, the city experienced some new uncertainties of its own this week, following the passing of a new national security law at the National People’s Congress (NPC) in Beijing. Responding to the legislation – which will be imposed on the city by the central government in Beijing – the Trump administration said that it would no longer consider Hong Kong as politically “autonomous” from China.

The move could have direct consequences for the former British colony’s investment and trading status, warned senior figures from Washington, including Mike Pompeo, the Secretary of State. The US move could also damage Hong Kong’s status as an international financial centre – depending on what types of American measures arise from the city’s changed status.

Hong Kong’s government refuted the claims from Washington, insisting that the city’s rights and freedoms would remain unchanged, underpinning its attractiveness as a financial hub.

But how have investors reacted? Last Friday – the first trading day after the legislation was announced – Hong Kong’s Hang Seng Index slumped by more than 5%. However, yesterday – when the NPC passed the new law – it closed down a more modest 0.7%.


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