What is driving the US-China talks over audits and delistings?


About 200 Chinese companies whose shares are traded in the United States, including JD.com Inc. and Baidu Inc., are at risk of delisting because US regulators are unable to verify their financial audits. As China and the United States continue to negotiate access to audits, there are signs that Chinese companies are preparing for the possibility of an expulsion from the New York Stock Exchange and the Nasdaq. Already, Alibaba Group Holding Ltd. said he would seek a primary listing in Hong Kong, a move that could be the precursor to his eventual departure.

1. Why does the United States want access to audits?

The Sarbanes-Oxley Act of 2002, enacted in the wake of the Enron Corp. accounting scandal, requires all publicly traded companies to make their audit working papers available for inspection by the U.S. Public Company Accounting Oversight Board, or PCAOB. According to the U.S. Securities and Exchange Commission, more than 50 jurisdictions are working with the board to enable the reviews. Only two do not: China and Hong Kong. The long-simmering issue escalated when Nasdaq-listed Chinese chain Luckin Coffee Inc. was found to have intentionally fabricated some of its 2019 revenue. The following year, in a rare bipartisan move , Congress passed the Foreign Company Accountability Act, or HFCAA, which says companies can’t trade on U.S. stock exchanges if their audits aren’t made available for inspection for three consecutive years.

2. Where is the application of this law?

In March, the SEC began publishing its “provisional list” of companies identified as non-compliant. By July, the list had grown to more than 100 companies, including JD.com, Pinduoduo Inc. and China Petroleum & Chemical Corp. In total, the PCAOB reports that in the 13-month period ending December 31, 2021, 15 audit firms it oversees signed audit reports for 192 companies based in China or Hong Kong, none of which cannot be reviewed by the regulator. The companies say China’s national security law prohibits them from handing over audit documents. SEC Chairman Gary Gensler said in July that it was unclear whether an agreement could be reached to avoid the delistings and that it would depend on the actions taken by Chinese authorities.

3. How did China react?

In April, the China Securities Regulatory Commission announced it would amend a 2009 rule that restricted the sharing of financial data by overseas-listed companies, potentially clearing the way for Chinese companies to comply with the US request. He also said he would provide assistance for cooperation with foreign regulators. Negotiations on the logistics of on-site inspections in China are said to be underway at the end of April. A month later, senior SEC official YJ Fischer spoke of “ongoing and productive discussions” but said “significant issues remain and time is running out quickly.” Access to audits is not the only problem. Ride-sharing giant Didi Global Inc. decided to delist from the NYSE in December under pressure from Chinese regulators who feared the company’s vast amounts of data could be exposed to foreign powers.

4. How soon could Chinese companies be removed from the list?

Nothing will happen this year or even in 2023, as a company would only be delisted after three consecutive years of non-compliance with audit inspections. A delisted company could come back by certifying that it had retained the services of an SEC-approved accounting firm.

5. What is behind the American pressure?

Critics say Chinese companies enjoy the trading privileges of a market economy – including access to US stock exchanges – while receiving government support and operating in an opaque system. In addition to inspecting audits, the HFCAA requires foreign companies to disclose whether they are controlled by a government. The SEC is also demanding that investors be given more information about the structure and risks associated with shell companies — known as variable interest entities, or VIEs — that Chinese companies use to list their shares on the New York. Since July 2021, the SEC has refused to green light new listings. Gensler said more than 250 companies already in operation will face similar requirements.

6. Are some Chinese companies really controlled by the government?

Large private companies like Alibaba could probably argue that they are not, although others with substantial public ownership may have a harder time. The U.S.-China Economic and Security Review Commission, which reports to Congress, said China considers eight companies listed on major U.S. stock exchanges to be “Chinese State-Owned Enterprises”. National level”. These are PetroChina Co., China Life Insurance Co., China Petroleum & Chemical, China Southern Airlines Co., Huaneng Power International Inc., Aluminum Corp. of China Ltd., China Eastern Airlines Corp. and SINOPEC Shanghai Petrochemical Co.

7. Why are Chinese companies listed in the United States?

They are attracted to the much larger and less volatile pool of capital, which can potentially be tapped much faster. China’s own markets, though huge, remain relatively underdeveloped. Fundraising for even quality businesses can take months in a financial system constrained by public lenders. Dozens of companies withdrew initial public offerings planned for 2021 after Chinese regulators tightened listing requirements to protect retail investors who dominate equity trading, as opposed to institutional investors and the fund base mutual funds active in the United States. And until recently, the Hong Kong stock exchange banned dual-class shares, which are often used by tech entrepreneurs to keep control of their startups after they go public in the United States. It was relaxed in 2018, prompting big listings from Alibaba, Meituan and Xiaomi Corp.

8. What is behind Alibaba’s decision?

Executives at China’s leading e-commerce company have publicly said a primary listing in Hong Kong – in addition to the one it has in New York – would broaden its investor base in Asia. The company pointed out that trading volumes in the Asian city have increased since its debut in 2019. The move is also a precursor to joining the so-called Stock Connect program, which allows millions of mainland Chinese investors to directly buy shares in Hong Kong. This would free up a large new pool of capital that could become particularly crucial if Alibaba delists in New York. A show of support for the Hong Kong stock exchange – and a main listing closer to Beijing – aligns with the Chinese government’s intention to revive the city’s reputation as an international financial hub, which has waned for a while. the harsh lockdown measures of the pandemic years. Such a change also offers a ready alternative for Chinese companies that risk being kicked out of the United States.

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