After a punishing 10 days for Chinese shares, regulators on both sides of the Pacific are trying to figure out how to handle the increasingly complex issue of Chinese companies that are listed outside China's borders. That counts China-focused companies here in Hong Kong, and some US$2 trillion worth of shares in the United States.
The steps outlined so far won't go far enough. The clash between Chinese Communism and Western capital markets will surely claim more victims.
Chinese shares were the worst performers in Asia last month, by some stretch. The CSI 300 is down 6.0% since July 1, reflecting the performance of the 300-largest companies in Shanghai and Shenzhen.
Offshore Chinese shares have, however, fared the worst. When you throw those into the mix, the S&P China 500 is down 9.0% in the last month. It represents the 500-largest listings of Chinese companies trading in Shanghai, Shenzhen and outside China. That's enough to produce significant losses in any Asia-focused emerging-market funds.
The Securities and Exchange Commission is working on new disclosure rules that would require Chinese companies to be clear about their interactions with the Chinese government over listing, as well as their corporate structure, normally a Variable Interest Entity.
SEC Chairman Gary Gensler has asked staff to "seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective," Gensler said in a public statement issued Friday.
Chinese companies looking to list in the United States would need to declare whether the issuer has received or been denied permission by the Chinese government to list on U.S. exchanges. They would also need to outline the risks surrounding any approval being denied or rescinded, and declare any change in status.
Prospective China-based U.S. listings would also need to give "detailed financial information, including quantitative metrics," demonstrating the relationship between the Chinese operating company and the offshore shell-company VIE. The shell company that overseas investors normally own strikes commercial contracts to get the business proceeds from the Chinese company - but does not own it. The Chinese company should stress international investors don't own it, Gensler insists.
Those are decent changes, but don't go far enough. Importantly, these proposed disclosure rules would only apply to companies seeking to go public, not ones that already are. It would make sense to seek greater disclosure from Chinese companies that already trade in the United States. I would suspect that the final wording would also apply to companies listed in all jurisdictions rather than just China, to avoid obvious discrimination, although the intent would be clear.
And to avoid meaningless boilerplate, it would be better to require Chinese companies to outline any "significant" interaction with Chinese regulators, whether that's in the runup to going public, or once they're up and running as public companies. We need a better accounting of business-critical backroom discussions.
In the case of the fiasco surrounding ride-hailing operator Didi Global (DIDI) , it appears the company felt it had satisfied the requirements from the stock-regulatory authorities. So they might have ticked the box that the SEC is creating. But Didi had not received clearance from the cybersecurity agency, something that had never previously been required when Chinese companies list. The cybersecurity agency, not the stock regulator, then barred it from signing up new customers. And it is the cybersecurity agency that will review applications from any company with data on more than one million customers in China, if they want to list overseas.
China's equivalent to the SEC, the China Securities Regulatory Commission, replied on Sunday to say it had "taken notice" of the prospective SEC action. Given the increasing interconnectedness of global markets, "strengthening regulatory cooperation is the inevitable path," the CSRC says in a brief statement, notably translated into English immediately for foreign consumption.
That's rich, some Western market participants say. The "cooperation" has been non-existent. There was no warning or interaction between Chinese regulators and their counterparts in other markets ahead of the decision to effectively outlaw for-profit tutoring, even though it directly destroyed the value of several U.S. listings. Chinese authorities don't give their own investors and companies a chance to provide review of or input over crucial decisions, let alone foreign investors.
Chinese shares have stabilized since a meeting on Wednesday evening between Chinese market regulators and major Western investors. Executives from the investment banks Credit Suisse (CS) , Goldman Sachs (GS) , J.P. Morgan (JPM) and UBS (UBS) were among those called to speak with CSRC vice chairman Fang Xinghai, according to Reuters.
"This is more to calm the market to isolate the education industry and not to over-interpret it," a source told the wire agency.
Of course, the market regulator wants calm and orderly markets. It wants to reassure investors into China that all is still well, and overseas listings aren't over. But I don't think the CSRC is really in charge.
The scrapping of the Alibaba Group Holding (BABA) spinoff Ant Group's world-record IPO had been approved by the regulators and the Shanghai Stock Exchange, until Chinese President Xi Jinping himself told them to scrap it. It seems the directives to take an increasing range of industries and executives down a notch come from the very top.
We can and should interpret a lot into how the Communist Party has treated the for-profit education industry. It's well-intentioned to ease the burden on parents who feel compelled to pay for after-class sessions to supplement what's taught in school. But there's an anti-commerce, anti-private-sector overture to the idea that it's wrong for the for-profit educational sector to make money.
After the shares of those companies plunged, "anyone who lost money in these recent drops has only themselves to blame," according to a column in the Global Times, often used as the foreign-policy mouthpiece for the Chinese government. There had been numerous complaints about schools and teachers; the industry had been poorly regulated; the burden on students was too great; the burden on parents incredible; "there were rumblings a long time ago that something needed to be done."
It is odd, when you think about it, that some 600 companies from a Communist country are listed on Wall Street, the capital of capitalism. Investors somehow reconciled themselves to this dichotomy as China continued to open up its economy and liberalize investment rules. The scales were somehow balanced.
The newly muscular approach to Communist governance under Xi has lately been heavy-handed when it comes to containing the power of rich entrepreneurs inside China, particularly Big Tech. Suddenly the scales have tipped toward the central government, and away from free markets. The Communist Party's uncomfortable marriage with a capitalist economy is on the verge of divorce.
It has been an uncomfortable union at the best of times. Whereas shareholder rights are viewed as something close to sacred in Western society, it was only 50 years ago that the Chinese Communist Party was looking to eliminate the bourgeoisie. The bourgeois members who had snuck into the Party "are a bunch of counter-revolutionary revisions," stated a Cultural Revolution notice prepared under Chairman Mao Zedong's personal supervision. "Once conditions are ripe, they will seize political power and turn the dictatorship of the proletariat into a dictatorship of the bourgeoisie."
Xi clearly sees himself as Mao's successor. Take his unusual choice to wear a grey Mao suit, instead of his normal black, at the July 1 celebrations in honor of the centennial of the Chinese Communist Party's founding. Xi waved to the crowd in similar stiff-armed salute to the thousands of Mao statues found around China, as the Nikkei Asia picked up in a column; just below him was a huge portrait of Mao in an identical grey suit. The visual similarity was striking.
The dictatorship of the Party, if not exactly the proletariat, is certainly in full grasp of political power. If bourgeois investors lose money betting on Chinese stocks - well, they have only themselves to blame.