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What’s Driving the US-China Spat Over Audits and Delisting

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About 200 Chinese companies whose shares trade in the US, including JD.com Inc. and Baidu Inc., face delisting because American regulators aren’t able to verify their financial audits. While China and the US continue to negotiate access to audits, there are signs that Chinese companies are preparing for the eventuality of expulsion from the New York Stock Exchange and the Nasdaq. Already, Alibaba Group Holding Ltd. said it will seek a primary listing in Hong Kong, a move that could be the precursor to its eventual departure.

1. Why does the US want access to audits?

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

2. Where does enforcement of that law stand?

In March, the SEC started publishing its “provisional list” of companies identified as running afoul of the requirements. By the end of July the list had grown to more than 100 companies, including Alibaba, JD.com, Pinduoduo Inc. and China Petroleum & Chemical Corp. In all, the PCAOB says that in the 13-month period ending Dec. 31, 2021, 15 audit firms it oversees signed audit reports for 192 businesses based in China or Hong Kong -- none of which can be reviewed by the regulator. The companies say Chinese national security law prohibits them from turning over audit papers.

3. How has China responded?

In April, the China Securities Regulatory Commission said it would modify a 2009 rule that restricted the sharing of financial data by offshore-listed firms, potentially opening an avenue for Chinese companies to comply with the US demand. It also said it would provide assistance for cooperation with foreign regulators. Negotiations on the logistics for on-site inspections in China were said to be underway. SEC Chair Gary Gensler said in late July that an agreement was needed “very soon” to avoid delistings. Access to audit papers isn’t the only issue prompting delistings. Ride-hailing giant Didi Global Inc. decided to delist from the NYSE in December under pressure from Chinese regulators who feared the company’s vast troves of data would be exposed to foreign powers. 

4. How soon could Chinese companies be delisted?

Nothing is going to happen this year or even in 2023, since a company would be delisted only after three consecutive years of non-compliance with audit inspections. A delisted company could return by certifying that it had retained a registered public accounting firm approved by the SEC. 

5. What’s behind the US 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 if they’re controlled by a government. The SEC is also demanding that investors receive more information about the structure and risks associated with shell companies -- known as variable interest entities, or VIEs -- that Chinese companies use to list shares in New York. Since July 2021, the SEC has refused to green-light new listings. Gensler has said more than 250 companies already trading will face similar requirements. 

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

Major private firms like Alibaba could probably argue that they are not, although others with substantial state ownership may have a harder time. The US-China Economic and Security Review Commission, which reports to Congress, says China considers eight companies listed on major US exchanges to be “national-level Chinese state-owned enterprises.” They 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 do Chinese companies list in the US?

They are attracted by the much bigger and less volatile pool of capital, which can potentially be tapped much faster. China’s own markets, while giant, remain relatively underdeveloped. Fundraising for even quality companies can take months in a financial system that is constrained by state-owned lenders. Dozens of firms pulled planned initial public offerings in 2021 after Chinese regulators tightened listing requirements to protect the retail investors who dominate stock trading, as opposed to the institutional investors and mutual-fund base active in the US. And until recently, the Hong Kong exchange had a ban on dual-class shares, which are often used by tech entrepreneurs to keep control of their startups after going public in the US. It was relaxed in 2018, prompting big listings from Alibaba, Meituan and Xiaomi Corp. 

8. What’s behind Alibaba’s move?

Executives of China’s leading e-commerce company said publicly a primary listing in Hong Kong -- in addition to the one it has in New York -- will broaden its investor base in Asia. The company pointed out that trading volumes in the Asian city had surged 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 stocks in Hong Kong. That would free up a large new pool of capital that may become especially crucial if Alibaba delists in New York. A show of support for Hong Kong’s stock exchange -- and a main listing closer to Beijing -- aligns with the Chinese government’s intention of reviving the city’s reputation of an international finance hub, which waned during the harsh lockdown measures of the pandemic years. Such a switch also provides a ready alternative for Chinese companies that face expulsion from the US.

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