The Capital Markets Tug-of-War Between US and China

Alissa Kole is the Managing Director of GOVERN. This post is based on a GOVERN memorandum by Ms. Kole. Related research from the Program on Corporate Governance includes Alibaba: A Case Study of Synthetic Control, (discussed on the Forum here); and China and the Rise of Law-Proof Insiders (discussed on the Forum here), both by Jesse M. Fried and Ehud Kamar.

For the first time in modern history, Sino-American tensions are spilling in the capital market space, with the final announcement of de-listing of three Chinese telecoms from the New York Stock exchange earlier this month. This delisting, as well as the regulatory measures that underpin it, culminate a long debate on the future of foreign, notably Chinese issuers, on American exchanges. Much is at stake: over 700 Chinese companies are traded on US stock and bond markets, the vast majority in the less regulated over-the-counter market.

Whether Chinese issuers should be listed on American exchanges and how dozens of them were able to do so in direct and American Depository Receipts (ADRs) listings was explored at length in “China Hustle”, a 2017 documentary that highlighted the laissez-faire attitude of successive American administrations and the Securities and Exchange Commission (SEC) to Chinese issuers, which it has so far rarely investigated, much less enforced.

In fact, Chinese issuers are not the only ones that have received unwanted interest after they tapped into foreign capital markets where institutional investors deploy billions of dollars of savings. When Saudi Aramco, the Saudi national oil company, contemplated its listing two years ago, a number of institutional investors protested when the London Stock Exchange announced that it would relax its listing standards, to attract the mega IPO.

Yet, the tone has changed since—but only for Chinese issuers—while a number of other scandals this year have underscored problems in governance of foreign issuers more broadly. NMC, the largest Emirati healthcare provider listed on the London Stock Exchange, was forced to announce, after damning research reports were floated, $6 billion USD of previously undisclosed loans among other governance failings that led it to be de-listed last year.

Trump’s passage on November 12 of an order that led the Treasury to classify 35 Chinese companies as military-related, leading NYSE to hesitantly de-list them, was a minor dent compared to Congress approval, the following month of the “Holding Foreign Companies Accountable Act” (HFCAA). The Act aims to grant the US accounting regulator, the PCAOB, access to audit papers of all US-listed issuers within 3 years, also at the risk of delisting.

The measure is clearly aimed at China, since Chinese laws expressly forbid this, on the account of state secrets and national security. Both approaches are equally politically motivated. For now, the consequences of these measures are limited to three issuers that will continue trading on the Hong Kong Stock Exchange, now even more controlled by China, and where US investors will be able to keep their holdings.

However, the battle has just started. The consequences of the movement that has been unleashed by these two measures—unless unwound by the Biden administration, which does not look likely—will redefine the capital market landscape. Ironically, it will not have a net positive effect on shareholder rights.

This is because the heyday of US and UK markets—where foreign issuers have historically gravitated—may be slipping away. While the US has lost half of its issuers over the past decade, Chinese companies have been the most frequent users of IPOs during this period, with more than double transactions as in America, according to the OECD. Indeed, if all Chinese A shares were included in the MSCI Emerging Market index—a measure many investors would welcome—China would weigh 40% of it.

Deprived from access to the US markets, Chinese issuers will certainly not be short of options to list in London, Hong Kong or other less known financial centers where some smaller listings might awash as “regulatory refugees”. The net impact will be negative for American exchanges which have resisted them, accepting only when pressured by the Treasury. Perhaps more importantly, shareholder rights, will not be better protected if these companies list in less regulated markets.

A much more effective, and less politicized approach to improving the transparency of these companies would be for the SEC and exchanges to embed additional safeguards in the offering process and ongoing disclosure requirements. The audit issue, although a thorny one, could also be addressed from a more technical angle. A number of regulators, including in emerging markets such as India and Saudi Arabia, have previously banned auditors in case of grave breaches.

The SEC could adopt a similar approach towards Chinese-based subsidiaries of the Big Four as far as their audits of US listed companies are concerned. The catch 22 is that in doing so, it would, however, be sacrificing the interests of the US audit industry in China. Alternative approaches, including co-audits by PCAOB-approved firms have been proposed and such measures were previously adopted, for example in a similar disagreement between Japan and the US.

The Chinese are right in pointing out that the ultimate loser of the Act will be the American capital market, at a time when stakes are high in the economic warfare between the two countries. Biden’s administration would be wise to adopt other technical governance solutions, that would, inter alia, have a better effect on shareholders—whose interests were the purported objective of recent measures.

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One Comment

  1. Joshua Bentley
    Posted Sunday, February 28, 2021 at 10:06 am | Permalink

    Very interesting piece on a topic that deserves more mainstream attention and is being overshadowed by the retail frenzy which is unlikely to have long lasting political or structural impacts.

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