Wild ride by US-listed China stocks: Reasons go beyond delisting concerns

THIS past week, China proposed revisions to its rules related to offshore listings that seem to address a longstanding impasse with the United States over the inspection of audits of Chinese companies listed on American exchanges.

Some market watchers are hopeful that the move will head off a potential mass delisting of Chinese companies in the US, and reduce the enormous volatility that has engulfed many once-high-flying Chinese stocks.

Last month, Chinese stocks gyrated wildly after the US Securities and Exchange Commission (SEC) named five companies - BeiGene, Yum China, Zai Lab, ACM Research and Hutchmed (China) - that could be delisted from American exchanges as a result of the US authorities being unable to inspect their audits as required under the Holding Foreign Companies Accountable Act.

Some of the best-known Chinese stocks were caught in the downdraft: Alibaba tumbled 23.9 per cent within 4 days while JD.com and Pinduoduo sank 41.1 per cent and 31.2 per cent within 3 days.

Amid the turmoil, the China Securities Regulatory Commission (CSRC) sought to calm investors by stating that it was engaging its US counterparts to resolve the matter.

"We believe the two sides will be able to jointly work out cooperation arrangements that comply with the legal and regulatory requirements of both countries in an expedited manner, to better protect global investors and promote the stability and robustness of the two capital markets," the CSRC said on March 11.

This seemed to trigger a snapback in many battered down Chinese stocks. By the end of March, however, the US SEC had named 6 more companies that potentially face delisting: Weibo Corporation, Futu Holdings, Nocera, iQIYI, Baidu and CASI Pharmaceuticals.

Then, on April 2, the CSRC announced draft revisions to its confidentiality rules relating to offshore listings. Among other things, the Chinese authorities have proposed scrapping the stipulation that "on-site inspections shall be dominated by domestic regulators or depend on the conclusions of inspections by domestic regulators".

Under the proposed revisions, overseas securities regulators may "inspect domestic companies that have been listed or offered securities in an overseas market, or securities companies and securities service providers that undertake securities business for such domestic companies".

The proposed revisions also stipulate "that such investigation and inspection shall be conducted under a cross-border regulatory cooperation mechanism, and that the CSRC and competent authorities of the Chinese government will provide necessary assistance pursuant to bilateral and multilateral cooperation mechanisms".

Anti-China sentiment

The Holding Foreign Companies Accountable Act, which was signed into law by former US President Donald Trump in December 2020, prohibits securities issued by foreign companies from being traded on US exchanges in the event their audits are not inspected for three consecutive years by the the US Public Company Accounting Oversight Board (PCAOB), a body created by the Sarbanes-Oxley Act of 2002.

Over the past decade, the PCAOB has periodically warned investors about its inability to properly inspect the audits of China-based companies, and griped about the lack of cooperation on the part of the authorities in China to enable it to obtain relevant documents and testimony to conduct its inspections.

Yet, investors hoping that China's revised position on this matter will mark a turning point for Chinese stocks should keep in mind that facilitating audit inspections was not the only purpose of the Holding Foreign Companies Accountable Act.

The Act also requires foreign issuers of securities to submit documentation to prove they are not owned or controlled by a government entity in the foreign jurisdiction. And, it sailed through the US legislature unopposed amid loudly expressed anti-China sentiment.

My own non-expert observation of US-China relations is that suspicions on both sides have only grown over the past year, no thanks to China's decision to ally itself to Russia even as Russia wages war in Ukraine.

Even if China has now decided that it is time to cooperate in order to stem the rout in US-listed Chinese stocks, they may find that attitudes of US regulators and lawmakers have hardened - indeed, the Holding Foreign Companies Accountable Act is a manifestation of this.

Strong headwinds

In any case, I would be cautious about attributing the recent turmoil in Chinese stocks entirely to the US SEC identifying candidates for delisting.

The risk of Chinese stocks being booted off American exchanges has been widely discussed in the market over the past couple of years, and the consensus seemed to be that a Hong Kong listing was just as good as a US listing.

Moreover, the significantly heightened volatility in US-listed Chinese stocks did not come out of the blue. The Nasdaq Golden Dragon China Index - whose components include the ADRs of Alibaba, Baidu, Pinduoduo, JD.com, Netease and Trip.com Group - tumbled 42.7 per cent last year. This was partly the result of very strong performance in 2020, and the seemingly capricious crackdown by China last year on its private education sector and technology companies.

More recently, accelerating inflation and rising interest rates have created strong headwinds for stocks in general and technology stocks in particular. Since the beginning of this year, the Nasdaq Golden Dragon China index has fallen 20.8 per cent. The S&P 500 index and Nasdaq 100 index, which were both up strongly in 2021, have declined 5.8 per cent and 12.2 per cent, respectively, this year.

It is also worth pointing out that the financial performance of some major Chinese stocks has been less than inspiring recently.

Alibaba reported year-on-year revenue growth of just 10 per cent to 242.6 billion yuan (S$52 billion) for the quarter to Dec 31, while its income from operations sank 86 per cent to 7.1 billion yuan. Even after backing out a goodwill impairment charge of 25.1 billion yuan, income from operations would still have declined 34 per cent to 32.2 billion yuan.

For the same quarter, JD.com reported a 23 per cent year-on-year rise in revenue to 275.9 billion yuan but a 392 million yuan loss from operations versus income from operations of 595 million yuan in the corresponding quarter the previous year.

So, what does all this mean for investors? While the big sell-off in US-listed Chinese stocks might seem to be a tempting buying opportunity, there is probably no hurry to jump in.