China is on the other side of the planet from the United States. It is so big and long-lived that it is little understood even by those of us who live here, and I've been in Hong Kong 20 years. So a lot of the barbs thrown its way by outgoing U.S. President Donald Trump and his administration have felt like China-bashing. A convenient, far-off foe. Blame it for anything.
However, Trump now has on his desk a merited piece of legislation that is widely seen as directed China's way. The nation isn't mentioned in the Holding Foreign Companies Accountable Act. It doesn't need to be.
The U.S. House of Representatives passed the bill by unanimous voice vote on Thursday. Coupled with the Senate's unanimous voice vote in May, it leaves the prospective law needing only the president's signature to go into effect. There's no doubt in my mind he will leave it as a legacy to the incoming administration of Joe Biden.
It is a necessary piece of legislation to protect U.S. investors. There have been frequent frauds involving Chinese (and other nations') companies listed on U.S. exchanges.
The act is, underneath it all, quite a reasonable one. It simply demands that foreign companies looking to take money from U.S. investors comply with U.S. accounting standards. Any securities of such companies will be kicked off American exchanges if they fail to comply with the audits of the Securities and Exchange Commission's (SEC) accounting arm, the U.S. Public Company Accounting Oversight Board (PCAOB), for three years in a row.
China will find it hard to respond. Because the new law would apply to companies of any nationality, China cannot say it is unfairly targeted unless it also admits that Chinese companies have a particular issue with accounting compliance.
But China also has a specific issue that makes it hard to comply. Chinese accounting firms have refused to allow outside companies, even from Hong Kong, to scrutinize their work. They have hidden behind the excuse that, because many Chinese companies are state-owned, allowing non-Chinese examiners to audit them could reveal "state secrets."
State secrets in China mean anything that the Communist Party does not want you to know. It can just as well cover competitive advantages that the CCP is keen to foster besides the military-sensitive technologies that it implies. Years of discussion over the auditing issue between Beijing and Washington have yielded no results.
The act also requires companies to reveal whether they are owned or controlled by a foreign government. This is also reasonable, and also a particular problem for Chinese companies. The Chinese state owns large swaths of the Chinese economy, which is not unusual in an authoritarian, command-driven system. But increasingly the Communist Party has sought to write itself into the charter of private companies and has created a system of shell companies in which one private company owns shares in another private company that in the end is controlled by a company owned by a Chinese city, provincial or national government.
It is not easy to tell where the Chinese state ends and the Chinese private sector begins. Now companies will need to make a call on that, and make it clear. The new law would not ban ownership by a foreign government. The authors of the bill just want those governments to come clean.
Bipartisan backing
The prospective law enjoys bipartisan support. It was sponsored by U.S. Sen. John Kennedy, R-Louisiana, and Democratic Senator Chris Van Hollen, D-Maryland. Van Hollen has stated that U.S. investors have been "cheated out of their money after investing in seemingly legitimate Chinese companies," while Kennedy said China has used U.S. exchanges to "exploit" Americans, a "toxic status quo" on Wall Street.
They are thinking of cases such as Luckin Coffee, the Chinese coffee chain that insisted all was well with its figures until attacked by a short seller. Eventually, it disclosed an internal investigation that it said had revealed fabricated sales figures. Shares in the company tumbled more than 80% and Nasdaq ultimately delisted the company from its exchange long after the latte was spilled.
President-elect Joe Biden, keen to continue diplomatic pressure on China, said in a phone call with the columnist Thomas Friedman that he intends to build greater international pressure on China by working with the nations that used to be U.S. allies before Trump antagonized them. Biden says he wants to combat China's abusive practices in terms of intellectual property theft, unreasonably cheap products, unfair state subsidies and forced technology transfer. The new law would still fit with that approach.
And China is finding it hard to respond. The Chinese embassy in Washington had no immediate comment on the passage of the House bill. Prior to that, Chinese foreign ministry spokeswoman Hua Chunying criticized it as a discriminatory policy that politically oppresses Chinese companies.
"Instead of setting up layers of barriers, we hope the U.S. can provide a fair and non-discriminatory environment for foreign firms to invest and operate in the U.S.," Hua said in a press conference.
It is hard to see how or why this is discriminatory. Foreign companies seeking to list in the United States will need to do so on the same terms as U.S. companies, which must already comply with the policies of the PCAOB. If anything, Chinese companies have been operating on unfairly freewheeling terms.
However, it is also less important that Chinese companies comply. Previously, it was the gold standard to be listed on the New York Stock Exchange even for a Shanghai- or Beijing-based executive team. That's no longer the case. A U.S. listing is nice and prestigious to have, the surest way of securing deep liquidity. But in a world of instant, digital and borderless securities trade, with Hong Kong, London, Tokyo and even perhaps Shanghai as alternate listing locations, it is no longer a necessity.
I don't envision compliance with the new rules being a problem for the biggest and best Chinese companies.
Alibaba Group Holding (BABA) commented on the bill in May when Chief Financial Officer Maggie Wu said the company would "endeavor to comply with any legislation whose aim is to protect and bring transparency to investors who buy securities on U.S. stock exchanges."
The thing the new law should prevent is the kind of back-door listings used by suspect Chinese entrepreneurs to cash out on their stocks, take the profits that are in fact investments in the company, but which they treat as money in their personal piggy bank, and run.
Even the top U.S.-listed Chinese companies have conducted secondary listings in Hong Kong, just in case. This brings them closer to their customer base and to investors willing to pay higher prices for their shares. It also provides the companies their own escape hatch should the situation on U.S. exchanges turn sour.
Alibaba, rival e-commerce platform JD.com (JD) , video game maker NetEase (NTES) and Yum China Holdings (YUMC) , the operator of Pizza Hut, Taco Bell and KFC restaurants in China, have all listed first in the United States and then in Hong Kong.
Mainland markets are emerging but still off limits to almost all non-Chinese investors. They are also unstable in terms of pricing and regulation. The Alibaba-affiliated fintech Ant Group had filed for an initial public offering in Hong Kong and Shanghai, set at US$37 billion and on track to be the largest IPO in world history, only for Shanghai stock exchange authorities to block it at the last minute.
Hong Kong is the top alternative to U.S. markets. It is not yet necessary. There are 210 Chinese companies listed on major U.S. exchanges as of October, with a combined market capitalization of about US$2.2 trillion, according to the U.S.-China Economic and Security Review Commission. If anything, the new law would improve the prospects for U.S. listings that account for their businesses, accurately, as they should have to do.
