January 28, 2023


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How the U.S. Is Moving Closer to Delisting Chinese Firms

1. Why does the U.S. want access to audits?

The 2002 Sarbanes-Oxley Act, enacted in the wake of the Enron Corp. accounting scandal, required that all public companies have their audits inspected by the U.S. Public Company Accounting Oversight Board. In the ensuing two decades of negotiations, China has refused to grant access. The long-simmering accounting issue morphed into a political one as tensions between Washington and Beijing ratcheted up during the Trump administration. The Chinese chain Luckin Coffee Inc., which was listed on Nasdaq, was found to have intentionally fabricated a chunk of its 2019 revenue. The following year, in a rare bipartisan move, Congress moved to force U.S.-listed companies based in China and Hong Kong to finally allow inspections. 

As required by the law, known as the Holding Foreign Companies Accountable Act or HFCAA, the SEC has started publishing its “provisional list” of companies identified as running afoul of the requirements. While the move had long been telegraphed, the first release in early March fueled a sharp decline in U.S. shares from companies based in China and Hong Kong as it dashed hopes for some kind of compromise. China’s securities regulator issued a statement saying “positive progress” had been made in talks while reaffirming its opposition to what it called “politicizing securities regulation.” The PCAOB called speculation about a deal “premature.” The SEC is compelled by law to press ahead, and its chair, Gary Gensler, has pledged to enforce the three-year deadline for Chinese firms to permit the inspections. “The path is clear,” Gensler told Bloomberg News in an August 2021 interview. “The clock is ticking.”

3. What’s the broader issue?

Critics say Chinese companies enjoy the trading privileges of a market economy — including access to U.S. stock exchanges — while receiving government support and operating in an opaque system. In addition to inspecting audits, the HFCAA also requires foreign companies to disclose if they’re controlled by a government. Meanwhile, the SEC is also demanding that investors receive more information about the structure and risks associated with the shell companies, which are known as variable interest entity or VIEs, that Chinese companies use to list stocks in New York. Since July 2021, the SEC has refused to greenlight new listings. Gensler has also said more than 250 companies already trading will face similar requirements.

4. Why don’t Chinese firms share their audits with the PCAOB?

They say Chinese national security law prohibits them from turning over audit papers to U.S. regulators. According to the SEC, more than 50 jurisdictions work with the PCAOB to allow the required inspections, two historically have not: China and Hong Kong. (The China Securities Regulatory Commission was said on March 17 to be considering allowing U.S. officials to inspect documents on firms that don’t possess sensitive data, such as restaurant operator Yum! China Holdings Inc. or travel platform Trip.com Group Ltd. That news came a day after President Xi Jinping’s government promised a range of steps to support the country’s financial markets and ease the concerns of global investors.) 

5. How soon could Chinese companies be delisted?

Nothing is going to happen this year or even in 2023 — which explains why markets initially took the possibility in stride. Under the HFCAA, a company would be delisted only after three consecutive years of non-compliance with audit inspections. It could return by certifying that it had retained a registered public accounting firm approved by the SEC. However, when the SEC actually started publishing firms’ names, the market reacted sharply. For example, the Nasdaq Golden Dragon China Index plunged 18% during the week ended March 11, after the agency released the first five names.

It’s a rolling process and a function of when companies report their annual financials and an auditing firm that the PCAOB has identified as being non-compliant. For example, Yum! China reported on Feb. 8 in New York, and it was added on March 8. The social media platform Weibo Corp. was added on March 23.

7. Ultimately, how many will be affected?

There’s not much discretion. If a company from China or Hong Kong trades in the U.S. and files an annual report, it will be on this list soon because these have been identified as non-compliant jurisdictions. In all, the PCAOB has said it’s blocked from reviewing the audits of more than 200 companies based in China or Hong Kong, including Alibaba, PetroChina, Baidu and JD.com. All of them are expected to be on that list in the next few months. Chinese companies traded in the U.S. have a combined market capitalization of hundreds of billions of dollars.

8. Are some of them really controlled by China’s government?

Major private firms like Alibaba could probably argue that they are not, although others with substantial state ownership may have a harder time. As of May 2021, the U.S.-China Economic and Security Review Commission, which reports to Congress, counted eight “national-level Chinese state-owned enterprises” listed on major U.S. exchanges. 

9. Why do Chinese companies list in the U.S.?

They are attracted by the liquidity and deep investor base of U.S. capital markets. They offer access to a much bigger and less volatile pool of capital, in a potentially speedier time frame. China’s own markets, while giant-sized, remain relatively underdeveloped. Fund-raising for even quality companies can take months in a financial system that is constrained by state-owned lenders. Dozens of firms pulled planned IPOs last year after Chinese regulators tightened listing requirements to protect the retail investors who dominate stock trading, as opposed to the institutional investors and mutual-fund base active in the U.S. And until recently, the Hong Kong exchange had a ban on dual-class shares, which are often used by tech entrepreneurs to keep control of their startups after going public in the U.S. It was relaxed in 2018, prompting big listings from Alibaba, Meituan and Xiaomi.

10. How has China responded?

In December, China unveiled new rules that require all companies seeking IPOs or additional share sales abroad to register with China’s securities regulator. The requirements apply to new shares only and won’t affect the foreign ownership of companies already listed overseas such as Alibaba or Baidu. However, Chinese firms in industries banned from foreign investment will need to seek a waiver before proceeding for share sales and overseas investors in such companies would be forbidden from participating in management and limited in their ownership. 

(Updates section 2 with PCAOB comment; Weibo’s inclusion on list in section 6. An earlier version of this story was corrected to delete reference to Alibaba’s Feb. 24 report, which was for fourth quarter.)