China intends to toughen its regulation of Chinese companies that list overseas. The step suggests that the enforcement action against ride-hailing app Didi Chuxing (DIDI) and two other companies newly listed in the United States is linked to concerns about a new U.S. securities law.
China's State Council issued a policy statement on Tuesday that stresses the importance of "strictly cracking down on illegal securities activities." It says the State Council, equivalent to the Chinese cabinet, and the Central Committee of the Chinese Communist Party "recently" issued a notice requiring government departments to implement various new securities policies, and the council is now providing details.
There's not a lot of detail, to be honest, more like broad brush strokes, mainly about criminal behavior. But there are a couple of sections that apply to overseas listings.
The notice says the Chinese government will "improve relevant laws and regulations on data security, cross-border data flow and the management of confidential information."
"Efforts will be made to revise the regulations on strengthening the confidentiality and file management related to the issuance and listing of securities overseas, and to consolidate the responsibility of data security for overseas-listed companies," it adds.
The Communist Party wants to see cross-border data sharing "standardized," and deepen cooperation on cross-border audit supervision.
Another clause (No. 21, for anyone looking for it) says that China will seek to "establish and improve" a system of "extraterritorial application of capital-markets laws." That makes explicit an earlier report that China will attempt to extend its own securities law to govern Chinese companies overseas.
It is unclear whether any of the information was already shared outside government circles, or with private companies such as Didi, which went public last Wednesday only to be slapped two days later with a ban on signing up new customers in China. China's cybersecurity agency then on Sunday ordered its app to be removed from app stores.
I'm sure class-action lawyers are chasing the ambulances on this one, and looking to line up lawsuits. Didi denies it knew anything about the regulatory activity. I can't believe Didi management or their bankers knew for sure about the imminent new-customer ban. They're not that dumb.
And it's not just Didi that is affected. Two other initial public offerings, the online-recruitment company Zhipin.com and its owner Kanzhun (BZ) as well as the freight-consolidator app Full Truck Alliance (YMM) , have been similarly caught out on Monday after going public in June. So this appears to be the shaping-on-the-fly of new government policy on overseas-listed apps.
However, both investors and management have been well warned already that such action was likely. I wrote in May that China's stock watchdog was considering exactly this kind of new regulation. The China Securities Regulatory Commission is looking at a proposal to force Chinese companies that list overseas to also file listing documents with the Chinese authorities, meaning they would have to comply with Chinese securities law. In May, we also knew the CSRC was also looking at tightening up the sharing of sensitive information, including anything considered of national-security interest.
The State Council is therefore confirming those proposals will happen, although it hasn't said how. China also has an extremely broad view of what consists of "national security" information. It's never defined, that way it can be whatever the Chinese Communist Party says you should not have shared.
At the heart of this all is a new U.S. law, the Holding Foreign Companies Accountable Act, passed in December that will force overseas companies listed in the United States to file accounts that can be inspected by the Securities and Exchange Commission's accounting arm. Overseas companies could be delisted if they fail to do so for three years.
China has been treating the accounts of listed companies like national-security secrets. Many Chinese companies have some kind of tie to the Communist Party. A hefty chunk of industry is state-owned, while around one-third of companies have a Chinese Communist Party cell operating within the company. Others have written into their charter that the Communist Party is the ultimate power governing the company, above shareholders and the board.
The Chinese authorities have also expressed concern about Chinese tech companies sharing or selling computer algorithms to overseas partners. They also insist that all data for Chinese customers is stored within China, ostensibly for data safety but also so the party can inspect it at any time.
An app operator that lists overseas ticks all these boxes. So who knows what kind of remedial steps Didi Chuxing, Zhipin.com and Full Truck Alliance are going to have to take? They are the unwitting kids playing in a "secret sandbox," and must now ask their Communist Party "parents" what they can and can't do.
It is par for the course for Chinese regulators to make overnight decisions that have broad ramifications, without any warning. Sometimes regulators work the other way around, too, allowing companies to act unofficially in a certain way where the regulation is not clear or established, another sort of secret sandbox. If all goes well, fine, and others can follow suit. If it goes badly, well you shouldn't have been doing that anyway!
Regulators on May 1, May 10 and June 11 said that, after running a series of tests, they found problems at a total of 246 apps in various fields, including the online shop app of Nike (NKE) . The general charge for them all was that they were excessively gathering and illegally using information on their customers. The first batch were given 10 days to rectify the situation, a grace period extended to 15 days for the second and third tranche of apps. Even that change suggests the regulatory decisions are being made on the fly, after the first batch struggled to meet the deadline.
Didi Global shares closed on a 19.5% loss on Tuesday in New York, having opened 24.2% down. After their initial public offering last Wednesday, the shares rose as much as 17.9% above their US$14 offer price, but stand at US$12.49 now. The moves from Chinese regulators suggest there may be further yet to fall. Other Chinese tech stocks will surely be affected, too.
Chinese companies have so far raised US12.5 billion this year on U.S. markets, in 34 deals, according to Refinitiv data. That's a record, and it may stand for a long time if deal flow stops. Reuters reported in May that Beijing was pressuring China's largest online-audio platform, Ximalaya, to drop U.S. listing plans and go public in Hong Kong instead.
Chinese authorities have already demonstrated that they can make damaging decisions at the last minute to the detriment of the mainland capital markets. When Alibaba (BABA) affiliate Ant Group's initial public offering was pulled two days before it was set to set a world record in terms of size, the meddling reached epic scope. There's no decision that's too last minute or too broad-reaching. Chinese President Xi Jinping apparently stepped in at the last minute to scrap the Ant offering after founder Jack Ma angered Communist Party officials.
That's the reason the equity markets in Shanghai and Shenzhen lack credibility. There are no investor protections over government interference. It is also the reason that Chinese companies looking to establish themselves with investors chose to list internationally, outside the scope of Chinese regulatory tinkering.
By extending Chinese securities regulation to Chinese companies listed overseas, China will be exporting that sort of regulatory insecurity. It remains to be seen what would happen if U.S. politicians took countermeasures to prevent Chinese law from applying.
Marco Rubio, the Florida senator who is a frequent China critic, told the Financial Times in a statement that it was "reckless and irresponsible" for Didi to be allowed to list on the New York Stock Exchange since it is an "unaccountable Chinese company."
Rubio raised the issue of the Chinese Communist Party blocking U.S. regulators from reviewing the books of Chinese companies. "That puts the investment of American retirees at risk and funnels desperately needed U.S. dollars to Beijing," he said, implying he will push further revision of U.S. securities law.
Chinese companies can't win if they are subject both to U.S. and Chinese law, which conflict on the sharing of accounts. It appears Beijing is intent on forcing all Chinese companies listed overseas to "come home," if not by listing in Shanghai or Shenzhen then by listing in the freer market in Hong Kong. The action against three Chinese listings so soon after they went public in the United States indicates that, whether a purposeful strategy or not, a retreat from New York is the likely ultimate effect.