Chinese companies look set to retain their Wall Street listings after years of uncertainty as the U.S. Securities and Exchange Commission clears a path for them to remain.
The SEC's accounting arm, the Public Companies Accounting Oversight Board, has issued a statement that it's happy with the access it secured for its inspectors to examine the audits of U.S.-listed Chinese companies. More than 30 inspectors arrived in Hong Kong in September and spent nine weeks reviewing the books of those companies on site.
The SEC unit said it is confident it secured "complete access" to inspect and investigate those companies. As a result, the PCAOB has voted to vacate its determination made on Dec. 16, 2021, that China was actively preventing the inspection of Chinese company audits.
However, the PCAOB also said it has identified "numerous potential deficiencies" at the Chinese companies. It expects to release those findings "as soon as possible in the new year."
The SEC had previously complained that China and Hong Kong were the only accounting regimes worldwide preventing such audit inspections, unlike the other 50 jurisdictions where the SEC is able to arrange audit access.
U.S. Congress passed the Holding Foreign Companies Accountable Act, which went into effect at the end of 2020, requiring the delisting of any overseas-based company if the SEC said it is unable to review three years of company accounts. That means the first delistings for Chinese companies could come in 2024.
The PCAOB says this "historic and unprecedented access" to U.S.-listed Chinese companies was only possible thanks to the leverage created by Congress and the new law.
"Congress sent a clear message with that legislation that access to U.S. capital markets is a privilege and not a right, and China received that message loud and clear," PCAOB Chair Erica Williams said.
Hong Kong shares are bucking the downtrend in Asia today as a result. Nearly all Asian markets are in the red on Friday, following through on heavy selling on Wall Street overnight. The degree of the selloff is more restrained in Asia, though, with the broad-market Topix closing down 1.2% on Friday after the S&P 500 lost 2.5% on Thursday.
In Hong Kong, the Hang Seng Index finished Friday up 0.4%, with the Hang Seng China Enterprises Index of mainland-based companies up 0.7%. I'll explain the major movers in a moment.
The PCAOB's Williams said she wants to reinforce that "this is the beginning of our work to inspect and investigate firms in China, not the end." Inspectors will return to review the books of Chinese companies in early 2023 and beyond, she notes.
But the SEC unit for now sees no advantage in retaining the designation of China as uncooperative on allowing access to audits. It said it reserves the right to reinstate that determination if Chinese authorities "obstruct or otherwise fail to facilitate" SEC access to Chinese books.
'Troubling' deficiencies found
Williams said while the SEC is happy with the access it is receiving, this week's statement does not mean all Chinese companies are in the clear. She said what the SEC unit found during its inspections of the books "is a separate question that we will address through our typical inspection and enforcement process."
"Today's announcement should not be misconstrued in any way as a clean bill of health for firms in mainland China and Hong Kong," she said.
The SEC unit's preliminary findings are that there are numerous "troubling" deficiencies that it believes it has detected at the Chinese companies and the auditors working with them. The inspectors selected two accounting firms to examine: KPMG Huazhen in mainland China and the Hong Kong arm of PricewaterhouseCoopers. The inspectors then looked at the books of eight companies audited by those firms. None of the companies or firms was given advance notice.
The deficiencies, while worrying, are not out of the ordinary when the PCAOB staff carries out inspections in a jurisdiction for the first time, Williams said. The potential issues are "consistent" with problems it has uncovered elsewhere in the world, she says.
Despite those cautionary words, the SEC's statement is a surprisingly wholehearted endorsement of the access provided to date by the Chinese authorities to the inspection team. You can read it as a reward thrown the way of the Chinese officials for finally opening access.
I had been expecting there to be quibbles about the extent of cooperation from Chinese officials, who had demanded the ability to sit in on any interviews the SEC audit team conducted with executives at the companies they are examining. The presence of Chinese officials, coupled with the Chinese side going to great pains to say that any requests for information must be routed through them, suggested that members of the Chinese Communist Party and the Beijing administration might attempt to screen information and prevent executives from speaking freely.
And I wasn't alone. SEC Chairman Gary Gensler told the Senate Banking Committee in September, as the inspectors were en route to Hong Kong, that he wasn't sure the Chinese side would comply with the deal they had agreed.
Those misgivings were off the mark, according to the SEC's account. The announcement, the PCAOB said, is in answer to one and only one question: Is the PCAOB able to inspect and investigate firms in mainland China and Hong Kong completely at this time?
"The answer, following thorough and systematic testing, is yes," the SEC accounting arm concludes.
Reprieve for Chinese stocksIt was in August that the SEC agreed a deal with its Chinese counterpart, the China Securities Regulatory Commission, as well as the Chinese Ministry of Finance on access to Chinese company books, as I explained at the time. The SEC demanded three things: sole discretion in picking what companies to examine without input from the Chinese side; the ability to review complete audit work papers and retain information as necessary; and direct access to take testimony from auditors as well as company executives.
The PCAOB said it now is satisfied with the access on all three points. The Chinese officials didn't influence or direct the inspections, Williams said, and didn't have warning of which companies would be inspected. The SEC unit said it got full access to complete audit papers "with no redactions," has been able to retain whatever paperwork it requires, and had direct access to all personnel it requested.
"I have been clear from day one, there would be no loopholes and no exceptions to our demand for complete access, and there were none," Williams concluded.
The ringing endorsement of the system that has been set up, requiring PCAOB inspectors to fly to Hong Kong to examine the company books, should be highly encouraging to holders of the U.S. shares of Chinese companies. At the peak of U.S.-China tensions over the issue, it looked as if all Chinese companies might be forced to delist from U.S. exchanges. They can now breathe easy.
Until now, China has refused to allow any accounting firm to share Chinese audits overseas. Even the Chinese arm of the Big Four accounting firms could not share audit papers with their Hong Kong office. The heart of the concern appears to be that many Chinese companies have a component of state ownership, and Chinese Communist Party officials were terrified that sharing their finances would let slip "state secrets." Almost anything can be considered a "state secret" in China, particularly how well the economy is functioning.
And indeed, several major Chinese state-owned enterprises have voluntarily delisted from New York rather than participate in the audit access. Gone from the New York Stock Exchange are the oil multinationals PetroChina HK:0857 and Sinopec HK:0386 and the oil subsidiary Sinopec Shanghai Petrochemical HK:0338, alongside the Aluminum Corporation of China (better known as Chalco) HK:2600 as well as the insurance giant China Life Insurance HK:2628.
But there are plenty of Chinese companies that desperately want to remain listed abroad. A Wall Street listing gives them access to a vastly deeper well of capital markets than is available in mainland China, where access to stocks is also tightly controlled. Chinese companies with global ambitions list in the United States to get easy access to major investors as well as a steadier base of institutional investors than they find at home. The Chinse markets are notoriously volatile and driven by retail and momentum traders.
Buyers step in
On Friday, shipping company Orient Overseas (International) (HK:0316 and (OROVY) ), which operates the Orient Overseas Container Line, is the Hang Seng's top gainer, up 8.7% on the day.
CG Services (HK:6098), the property management arm of China's largest developer, is the next-best performer, closing on a gain of 6.9%. Its parent Country Garden (HK:2007 and (CTRYY) ) finished with a 5.9% advance.
Upscale rival property developers also moved higher with China Resources Land (HK:1109) 3.9% ahead and China Overseas Land (HK:0688 and (CAOVY) ) advancing 2.4%.
Chinese electric vehicle makers with Wall Street listings also got a share price boost. Nio Inc. (HK:9866 and (NIO) ) was up 2.1%, Li Auto (HK:2015 and (LI) ) was up 1.7% and Xpeng (HK:9868 and (XPEV) ) rose 1.6% in Hong Kong trading, a strong showing considering that U.S. tech stocks had sold off the day before.
Geely Automobile Holdings (HK:0175 and (GELYY) ) was the top auto gainer, up 3.0%. The company said this week that its high-end electric car brand Zeekr has filed for a U.S. initial public offering, which would make it the first major new U.S. listing for a Chinese company in nearly two years. Reuters reports Zeekr will aim to raise US$1 billion on a valuation of US$10 billion or more.
Any initial public offering will be a significant test case. Besides state-owned enterprises, the Chinese authorities are also concerned about tech companies sharing user data and algorithms with international investors. Zeekr will have a sufficient tech element and customer base to give Chinese regulators pause for thought;we'll see if they do sign off on a Wall Street IPO.
Chinese tech companies, some of the favored "China story" plays among U.S. investors, also gained on the back of the news.
E-commerce platform JD.com (HK:9618 and (JD) ) gained 1.5%, while rival Alibaba Group Holding (HK:9988 and (BABA) ) edged ahead 0.6%. The online travel agency Trip.com (HK:9961 and (TCOM) ) was the top tech, rising, 4.0%, with the company set to gain as China removes its Covid-19 restrictions and frees up the rules on domestic travel.