China is reportedly prepping a three-tier system that it hopes will allow some Chinese companies to remain listed on markets in the United States. But the system appears unlikely to appease U.S. regulators, who are insisting on access to the audits of all U.S.-listed foreign companies.
The Chinese system would categorize companies into three classifications: those with non-sensitive data; those with sensitive data; and those with "secretive" data.
The "secretive" category of companies would have to delist, according to the Financial Times, which cited four sources "with knowledge of the situation" in first reporting the plans.
The companies with non-sensitive data should have no trouble remaining listed in the United States. The middle tier, potentially covering a large proportion of companies, would be the proving ground.
The Beijing authorities are discussing whether companies with sensitive but not secretive data should be allowed to restructure their operations to become compliant with U.S. rules, one source told the FT, perhaps by outsourcing information to a third party.
Chinese tech stocks already surged in April when China brought in new disclosure rules on data sharing that would allow overseas regulators to review the accounts of Chinese companies, as I outlined at the time. China's stock watchdog, the China Securities Regulatory Commission (CSRC), proposed rules on sharing data to allow "overseas securities regulators and competent authorities" to investigate and inspect Chinese companies that are listed overseas.
China's top trade negotiator, Liu He, also prompted a tech-stock bounce in March, as I noted, when he told a State Council committee meeting that Chinese and U.S. regulators have made "positive progress" on allowing Chinese companies to remain on Wall Street, and that both sides are "working on forming a specific plan for cooperation."
The enthusiasm for these efforts, however, has all come from the Chinese side. U.S. regulators say their stance is very clear: that all foreign-listed companies must allow access for the U.S. Securities and Exchange Commission to examine their audits.
At last count, there are 261 Chinese companies listed on U.S. markets, worth a combined US$1.3 trillion in market value. They would be forced to delist starting in 2024, according to the stipulations of the Holding Foreign Companies Accountable Act, which went into effect at the end of 2020.
The SEC has already identified 155 companies that fall afoul of the requirements in the new law. Those cited include heavy hitters such as the e-commerce platform JD.com (JD) (HK:9618), the videogame maker NetEase (NTES) (HK:9999), and the operator of restaurant chains such as Pizza Hut, KFC and Taco Bell in China, Yum China Holdings (YUMC) (HK:9987). But the SEC is essentially adding all Chinese companies to its list after they file non-compliant annual accounts.
Restaurant chains like Yum as well as retailers would likely fall into the lowest category of concern, with non-sensitive data. But the SEC list includes thornier companies such as the Twitter-like platform Weibo (WB) (HK:9898), browser operator Baidu (BIDU) (HK:9888), Chinese air carrier China Eastern Airlines (CEA) (HK:0670), and the oil drilling giant Sinopec (SNP) (HK:0386).
It's unclear how "low-risk" or "secret" China would consider details of flight routes, oil-drilling exploration or online searches. The U.S. Securities and Exchange Commission is insisting on full access to Chinese audits for its accounting arm, the Public Company Accounting Oversight Board (PCAOB).
The PCAOB issued a statement that it "must have complete access to audit work papers of any firm it chooses to inspect or investigate - no loopholes and no exceptions." The demand is reasonable enough since U.S. companies that are listed already provide that access. The PCAOB is demanding the same access for all overseas-based companies, whatever country they call home.
The three U.S.-listed makers of electric cars are also on the U.S. watch list: Li Auto (LI) (HK:2015), NIO (NIO) and Xpeng (XPEV) (HK:9868). We have seen Chinese authorities grow concerned about the amount of data Tesla (TSLA) is able to generate from its vehicles, with the Chinese military banning Tesla vehicles from its compounds for fear its cameras could be overridden to provide secret access.
All the planning on the Chinese side is "under discussion and subject to change," according to the FT. The CSRC says it "has not studied this three-tier" system as of yet.
But the flow of data has become a major concern of the Chinese Communist Party, which seemed to wake up over the last 18 months to the power Big Tech can wield by virtue of the information it generates.
We have already seen that Chinese regulators have scant regard for overseas investors when it comes to data-security concerns, after the cyberspace watchdog targeted ride-hailing market leader Didi Global immediately following its June 2021 stock listing on Wall Street. Poor data handling was cited as the justification for compelling Didi to stop signing new customers, with app stores ordered to remove 25 of its apps from stores.
Didi delisted in June from the New York Stock Exchange per the demands of the Cyberspace Administration of China. It was last week fined US$1.2 billion by China to bring its "network-security review" to an end. It is now awaiting word on when and how it may be allowed to reinstate its apps and take on new customers. Meantime, its U.S. shares left Wall Street down 82.4% from their listing price.
U.S. regulators are acting after a string of scandals involving accounting fraud at Chinese companies culminated in the disastrous listing of Luckin Coffee. Luckin went public at a US$2.9 billion valuation in May 2019 but was forced to admit less than a year later that its chief operating officer, Jian Liu, and other employees had been making up its sales numbers.
Luckin Coffee would almost certainly have fallen in the "low-risk" category of companies with non-sensitive data. An oil company or tech stock with Artificial Intelligence capability would almost certainly class as "secretive." But the vast majority of companies would likely fall in the middle.
The Chinese Communist Party has an extremely broad definition of "state secrets," having defined even the birth date of an Army general as a secret because knowing it would suggest when he might retire. Many companies, even those listed abroad, have a large component of state ownership, or are directed by state officials. Some Chinese companies have been forced to rewrite their corporate charters to state that the Chinese Communist Party is the ultimate authority, able to override management or board decisions.
The new U.S. law requires not only access to audits but also forces companies to declare whether they are owned by a foreign government or national body. It also requires Chinese companies to identify any board members who are also members of the Chinese Communist Party, and to provide any language written into their company charters that refers to the CCP.