The Details Debunk Fears of Chinese Stocks’ Delisting

If you are seeking a heartwarming display of holiday togetherness, we suspect Capitol Hill is not the first place you would look. But the season of goodwill does seem to have affected our hugely polarized congresspeople, as the House voted unanimously on Tuesday to pass a bill requiring foreign companies to submit their financial audits to US regulators within three years in order to retain their listings on US stock exchanges. With the Senate unanimously passing a near-identical bill earlier this year, it now goes to President Trump, who seems likely to sign it given he has championed the effort. Most companies domiciled outside the US already comply with this requirement, but there is one notable exception: China. Considering China presently bars mainland firms from complying with this requirement, investors fear delisting is a foregone conclusion—and deeply negative—for Chinese companies. We think that conclusion is too hasty. Even if these firms must delist eventually, it shouldn’t mean much for investors or these companies’ returns in practice.

The rule in this week’s legislation has technically been on the books for several years, but neither exchanges nor regulators have enforced it. US and Chinese regulators have also been haggling over access to audits for years. Chinese law doesn’t permit auditors to send their reports abroad, on the grounds that it could expose confidential information. However, in 2013, they reached an agreement to send certain companies’ records to the US’s Public Company Accounting Oversight Board (PCAOB). That seemed like a major breakthrough until they provided exactly … zero reports. The compromise still barred auditing firms from sending records directly to the US. Instead, the PCAOB had to request them from Chinese regulators, and those requests evidently went nowhere—yet companies continued listing on US exchanges, raising money from US investors and giving Americans access to mainland stocks. This was a win for investors seeking to diversify in China, but it came at the expense of transparency, and some argue it created an uneven playing field favoring Chinese firms. Hence, Congress’s moves to tighten the rules.

Nothing in this legislation means Chinese companies will be forced to de-list. The SEC has been working separately on a similar rule for months as well, and as part of this, it has reopened negotiations with China. They are reportedly nearing a compromise that would allow Chinese companies to remain on US exchanges—and keep the reports by their Chinese auditors confidential—if they agree to a secondary review by an international auditor that already reports to the PCAOB. If this happens, we would consider it a win for all involved. Companies would get to stay on US exchanges, and investors would get more disclosure and transparency. It may also force companies to up their accounting game if they don’t already follow international standards (which overlap heavily with Chinese standards), and it removes many questions about the veracity of Chinese audits.

That rosy outcome isn’t guaranteed, but even if this effort at compromise falters, three years is a long time. Regulators could come to a different, perhaps even more beneficial, agreement further down the line. But if not, again, three years is a long time—the near-term implications for investors are minimal. If you own a Chinese stock listed in the US, we think running out and selling it because of this news is an overreaction. Delisting a company doesn’t mean the company is forced out of existence with its stock price going to zero. It also doesn’t mean the shares in investors’ portfolios go poof with no compensation. It just means folks would have to trade it somewhere else, like Hong Kong, which is easily accessible to American financial institutions. Swapping American Depository Receipts (ADRs, the US-listed versions of non-US stocks) for Hong-Kong listed shares is a relatively simple procedure for major US custodians, wealth managers and institutional investors, all of which serve the vast majority of American individual investors. Many Chinese firms have already started preparing for the potential change by adopting secondary listings in Hong Kong. Investors greeted those listings enthusiastically, suggesting fundraising won’t be an issue for Chinese companies, if they are forced to delist in the US. Money tends to find a way to get where it wants to go, even if it has to pass a few speedbumps along the way.

Regulatory changes are always worth watching for their unintended consequences, and even minor shifts can create winners and losers. So in our view, the scrutiny on this bill is sensible. But overall, we don’t view it as a major risk for the companies or the US investors who own them. Whether it is a negotiating tactic or an administrative headache in 2023, it isn’t a call to action for investors or, in our view, likely to prove a huge influence on returns.