Chinese tech stocks dropped suddenly on Friday, with Chinese regulators considering tightening rules on overseas listings. Those changes, if they come, could also make life tougher for existing international listings or newly listed growth companies.
The STAR 50 Index of "next-gen" stocks in Shanghai plunged 3.5% on Friday, having opened higher. There are now 269 STAR-listed companies but double that, 557 in fact, looking to join.
U.S. regulators are also maintaining their pressure on Chinese listings after a string of accounting scandals on American markets. The administration of President Biden seems set to continue a process set in motion under the Trump administration, despite opposition on Wall Street.
Good. Too many Chinese company founders see a stock market listing as a way of cashing out and getting rich. They often then proceed to run "their" company as if it were still their own private enterprise, too frequently branching out into noncore or even totally different industries from the company's original purpose.
A sizeable minority also continue to treat the company's coffers as their own private piggy bank. "Loans" that are never repaid, suspect contracts awarded to friends and family, and even fraudulent accounting are all too common.
The China Securities Regulatory Commission, the stock watchdog, is mulling proposals that would force companies seeking listings outside China to submit listing documents to Chinese authorities as well, according to Bloomberg. That would force them to ensure they comply with Chinese securities law even if not listing at home.
The report says the new rules would also tighten up the sharing of sensitive information. That would include anything that could be considered of national security interest, Bloomberg says, citing unnamed "sources familiar with the matter," likely meaning market participants briefed on potential changes.
The new strictures on sharing information would put Chinese international listings in a difficult position that may force them to list at home instead. A new U.S. law, the Holding Foreign Companies Accountable Act, was signed into being in December. It requires foreign listings to file accounts that can be inspected by the Public Company Accounting Oversight Board, the SEC's accounting arm. China has not allowed Chinese accounting companies to share the accounts of Chinese companies with overseas accountants, claiming the risk is too great of sharing national secrets. Many Chinese companies are partly state-owned, and even private ones have a Communist Party cell within them.
A new Chinese rule saying you can't share official secrets would conflict with the U.S. law that accounting data must be shared. Foreign companies would face delisting in the United States if they don't allow PCAOB oversight for three straight years.
Many Chinese companies go public in the United States via entities registered in the Cayman Islands or the British Virgin Islands. Chinese tech companies in particular have also set up a structure known as a Variable Interest Entity, whereby international investors buy into an offshore entity that receives economic benefits from the Chinese onshore company.
As a result, foreign investors can buy into sectors that don't directly allow foreign ownership in China. The structure also allows Chinese founders or large shareholders to maintain control over the Chinese operating company to the detriment of voting control by international investors.
The Biden administration is also evaluating a trading ban put in place under Trump on Chinese stocks from companies that the Pentagon considers linked to the Chinese military. One week before Biden took office, that list was expanded to include 44 Chinese corporations, including Xiaomi (XIACF) , which sells 14% of the world's smartphones. China's three main phone companies - China Mobile (CHL) , China Telecom (CHA) and China Unicom (CHU) - are on that list as well, with a market cap of some US$150 billion. Investors have a year to sell out of those holdings, which will be de-listed in the United States, if the Trump-era orders go into effect.
Wall Street wants those strictures rolled back. It has wrought havoc with companies that issue China-focused or Asia-focused Exchange Traded Funds and other index trackers that might have small holdings in those companies. The index-fund operator would have to sell that portion, with even derivatives based off those stocks off limits, making it challenging to track the index correctly.
The Biden team delayed the deadline for enforcement of that ban from January 28 to May 27. But that's fast approaching. China's largest chipmaker, SMIC, and oil giant CNOOC (CEO) are also on that investment-ban list. There's bipartisan support for tougher action on Chinese companies that are accessing U.S. capital markets, so we have to watch if the delisting policy moves ahead this month.
The ChiNext Index, which tracks the performance of growth stocks listed in Shenzhen, also ended the day down 3.5% on Friday. Like the STAR 50, the ChiNext Index opened slightly higher.
Chinese shares also fell as a whole but not by nearly the same margin. The CSI 300 index of large caps in Shanghai and Shenzhen dropped 1.3% on Friday. Since peaking in early February as China controlled COVID-19, Chinese markets have buckled to regulatory pressure and lackluster consumer and investor sentiment, with the CSI 300 down 14.0% since then.
There has been particular pressure on Chinese tech stocks. President Xi Jinping appears personally invested in taking China's tech entrepreneurs down a notch, while regulators have grown concerned about the huge scope of fintech companies such as Alipay and WeChat Pay. They called in the 13 leading Chinese techs for showdown talks, as I explained last week.
Those will now have to be licensed as banks, and put up the capital for 30% of the loans they co-lend with banks, drastically cutting into their consumer-lending business. Chinese financial regulators called in the leading 13 tech companies for talks, telling them to rein in consumer credit and cut out monopolistic behavior. After fining Alibaba Group Holding (BABA) a record C¥18.2 billion (US$2.8 billion) for anticompetitive policies, regulators are set to levy similar fines on companies such as WeChat operator Tencent Holdings (TCTZF) and the delivery app operator Meituan (MPNGF) .
Chinese shares only resumed trading on Thursday after the Labor Day holidays, with the markets closed the first three days of the week. The ChiNext performed particularly poorly this week, down 5.8% in those two days. But Shenzhen tech stocks had previously shown surprising life, the ChiNext up 3.7% for the month and 38.1% in the last year. That's the best showing in China, whereas the broader market fell 2.1% in the last month.