Chinese ADRs: Boom or bust as the U.S. exodus continues?
Analysis by Aditya Raghunath
The U.S.-China financial war is heating up with five state-owned Chinese enterprises announcing the voluntary delisting of their Chinese ADRs from American stock exchanges.
The move out of U.S. markets comes amid rising geopolitical tensions.
Chinese securities listed in U.S. exchanges have a combined worth of $2.4 trillion, according to Bloomberg data and have been one of the simplest ways for U.S. residents to gain exposure to Chinese companies and the Chinese economy.
But a long anticipated exodus of Chinese ADRs is now underway.
The story so far for Chinese ADRs
The U.S. Congress passed the Holding Foreign Companies Accountable Act (HFCAA) in 2020. Finalized in 2021, the Securities Exchange Commission (SEC) can delist any foreign-based company listed on U.S. exchanges that do not comply with the auditing requirements under this law.
The audit reports are required to be submitted to the Public Company Accounting Oversight Board (PCAOB) annually. In addition, the SEC announced that Chinese companies trading on U.S. exchanges are required to disclose if they are controlled by a government body, along with evidence of the same.
Regarding this, SEC Chair Gary Gensler said, “We have a basic bargain in our securities regime, which came out of Congress on a bipartisan basis under the Sarbanes-Oxley Act of 2002. If you want to issue public securities in the U.S., the firms that audit your books have to be subject to inspection by the PCAOB.”
This comes as Chinese and Hong Kong-based firms failed to submit their audit reports for more than 15 years. While more than 50 countries have historically abided by the U.S. auditing requirements, Chinese and Hong Kong-based companies have failed to meet PCAOB guidelines, citing national security as the primary reason.
Currently, there are more than 270 Chinese and Hong Kong-based companies listed in the U.S. exchanges that do not comply with the auditing requirements and are at risk of being delisted. As per the new rule, companies that fail to meet the PCAOB guidelines for three years in a row will be delisted.
Earlier in March, Chinese regulators claimed they would cooperate with their U.S. counterparts to reach a mutually beneficial deal. In fact, China’s Vice Premier Liu He said in an interview that they had made progress, as both parties were committed to reaching a deal “soon.” As of May 2022, the bilateral talks were progressing smoothly as China’s Securities Regulatory Commission said in a statement, “We’ve always maintained that the audit inspection issue should be solved by cooperation on the basis of equality. Our attitude has always been positive and constructive.”
However, the SEC and PCAOB are required to have on-site inspections and investigations to determine whether it is possible to inspect Chinese and Hong Kong-based accounting firms. The U.S. regulators plan to complete these investigations by November this year so as to accelerate the deadline for Chinese companies from 2024 to early 2023.
Voluntary delistings of Chinese ADRs
While Alibaba Group Holding (NYSE: BABA) announced that it plans to cooperate with U.S. regulators to maintain its listing on the New York Stock Exchange (NYSE), five major Chinese state-owned companies are planning to delist from the U.S. capital markets.
Chinese Life Insurance Co., PetroChina Co., China Petroleum & Chemical Corp., Aluminum Corp. of China, and Sinopec Shanghai Petrochemical Co. are delisting their American Depository Shares (ADRs) this month.
These companies have a combined net market capitalization of nearly $320 billion. Moreover, Huaneng Power International, Inc., one of China’s largest listed power producers, announced the voluntary delisting of its ADRs on June 17.
The state-owned entities mentioned business concerns as the primary reason for delisting, as they operate in strategic sectors. Many analysts predicted this move, as China is expected to be hesitant regarding disclosing information regarding some of the largest state-owned Chinese companies to foreign regulators.
More Chinese state-owned enterprises are expected to follow suit as the U.S. regulators double down on strict auditing norms. Most of these stocks are thinly traded on the NYSE, and the delisting is expected to have a limited impact on the companies operations.
Nonetheless, this move could further escalate tensions between the two countries, as PCAOB might still demand their audit documents, despite their voluntary delisting plans. PCAOB Chair Erica Williams stated, “If a firm or issuer decides to delist this year, it really doesn’t matter to me because I need to know if you engaged in fraud last year.”
The recent audit battle seems like another phase of the years-long cold war between the U.S. and China. Initially started as a trade war during the Trump administration, the relations between the two countries never fully recovered even after Biden was sworn in as President.
In fact, U.S. House Speaker Nancy Pelosi’s recent visit to Taiwan rekindled tensions between two of the largest economies in the world. As China claims Taiwan as part of its territory, the U.S. representative’s visit came as “flagrantly provocative.” Lately, the U.S. has been engaging in trade talks with Taiwan in order to establish formal negotiations and trade relations.
China, which has critiqued any foreign negotiations with Taiwan, has announced earlier that it will take any and all necessary steps to maintain sovereignty and unite Taiwan with mainland China.
U.S.-China relations are currently at the lowest level in decades, given the increasing tensions on multiple fronts. The worsening relations might spill over to the capital markets as well, affecting investors holding Chinese ADRs.
The bottom line for Chinese ADRs
The majority of Chinese stocks listed in the U.S. exchanges are currently planning a dual-listing on the Hong Kong Stock Exchange to mitigate the delisting risk. Most Chinese ADRs gained momentum earlier this week thanks to better-than-expected trade data and decelerating inflation in the second-largest country.
However, the recent voluntary delisting news caused Chinese stocks in Hong Kong to rise while the U.S. witnessed a slump.
It is likely that a number of Chinese ADRs will see out the current tensions and remain listed in the U.S., however, many investors have been de-risking by moving their Chinese exposures from ADRs to the equivalent Hong Kong-listed stock or Chinese mainland A-shares, where possible.