In mid-March, it was reported that U.S. and Chinese regulators were getting closer to a cooperation plan regarding Chinese companies listed on U.S. stock exchanges. The New York Stock Exchange and Nasdaq had threatened Chinese companies with delisting if the Chinese government didn’t make changes to their audit access rules, reports Biospace.
Examining U.S.-listed Chinese companies
Now there is mixed news on this front. Reportedly, the China Securities Regulatory Commission (CSRC) issued draft guidance that would allow U.S auditors to examine U.S.-listed Chinese companies. These rules require the overseas-listed companies and relevant securities service providers to disclose previously confidential documents in overseas offerings and listings.
However, the U.S. Securities and Exchange Commission (SEC) added 12 China companies to their delisting watchlist this week. These include Microvast, China Automotive Systems, Daqo New Energy Corp., Connect Biopharma, OneConnect Financial Technology Co., Green Vision Biotechnology Corp., Legend Biotech, Soahu.com Limited, Studio City International Holdings Limited, Melco Resorts & Entertainment Limited, Logiq and Noah Holdings. The SEC indicates the companies will need to release evidence by May 3 to remain listed.
Pre-delisting list
This is the fourth group of China Concepts Stock companies to be included on the “pre-delisting list” since the beginning of March. If they don’t prove eligibility, they will be moved to the “determined delisting list,” which requires them to submit the correct documents to the SEC within three years. If that doesn’t happen, they will be immediately delisted after the disclosure of their 2023 annual reports in early 2024.
In March, five companies, BeiGene, Yum China, Zai Lab, ACM Research (Shanghai) and Hutchmed, were placed on the “pre-delisting list.” On March 29, all had been moved to the “determined delisting list”
Change in auditors
However, it was announced on April 11 that BeiGene had changed auditors for its New York listing from a Chinese firm to a U.S.-based one in order to comply with U.S. law. This will likely decrease the likelihood of it being delisted from Nasdaq.
Seeking Alpha wrote, “The company looks like quite a safe long-term investment due to its strong drug lineup, as well as its international team and global focus. It may have listings in Hong Kong and Shanghai, but cancer drug maker BeiGene Ltd. is making it clear it wants to keep its original listing in the U.S. which is currently under threat due to U.S.-China tensions.”
Zai Lab is also reported to be making a similar move. According to a Caixin report, BeiGene has cautioned that this move “may not be adequate” to meet SEC requirements.
The U.S. enacted the 2002 Sarbanes-Oxley Act after the Enron Corp. accounting scandal. Sarbanes-Oxley requires all public companies to have their audits inspected by the U.S. Public Company Accounting Oversight Board. Since then, China has refused access. The Trump Administration made this a particularly notable point in its numerous economic and political conflicts with China. The Biden administration has continued with the policies.
Provisional list
Based on the Holding Foreign Companies Accountable Act (HFCAA), the SEC began publishing its “provisional list” of companies that were not complying. China’s new draft guidelines are a signal the country is taking the problem seriously, and a top official from the China Securities Regulatory Commission (CSRC) called for fast implementation of the new rule.
In addition to audit access, the HFCAA requires foreign companies to disclose if they are government-controlled. The SEC also requires investors to be provided more information about shell companies, so-called “variable interest entities” (VIEs) that Chinese companies create to list stock in New York. Since July 2021, the SEC has refused new stock listings from China.
Stock market
As COVID lockdowns in China continue and the Securities and Exchange Commission adds names to the list of U.S.-traded Chinese companies asked to submit to audits, investors may wish to shift their focus to mainland stocks, or A-Shares — companies listed in Shanghai and Shenzhen.
These two stock markets trade approximately 7,000 individual firms with the most quoted index being the CSI300. This index represents the 300 largest companies on these two exchanges as measured by the free floating market capitalization. Many of the companies in this index are not household names, but they are massive companies in almost every respect, from revenues and earnings to assets and employees.
From the top down, companies listed in Shanghai represent 61% of the index and Shenzhen the remaining 39%. The sector allocation creates good diversification and breaks down as follows:
Financial: 23.44%
Industrials: 19.88%
Consumer staples: 14.08%
Information technology: 9.85%
Healthcare: 9.39%
Materials: 7.48%
Consumer discretionary: 7.3%
Utilities: 2.92%
Real estate, communication services and energy represent less than 6%
Four companies represent more than 15% of the total index:
Kweichow Moutai (600519), the maker of China’s most famous liquor (baijiu)
Market cap: 2,238.54 billion yuan ($351.35 billion)
Annual revenue 109.46 billion yuan ($ 17.18 billion)
Annual profit: 52.46 billion ($8.23 billion)
Employees: 29,000
CATL (300750), the world’s biggest manufacturer of batteries for electric cars
Market cap: 1,100.16 billion yuan ($ 172.68 billion)
Annual revenue 92.16 billion yuan (TTM, $ 14.47 billion)
Annual profit: 11.57 billion yuan (TTM, $1.82 billion)
Employees: 33,000
China Merchants Bank (600036), China’s leading commercial bank
Market cap: 1,152.55 billion yuan ($180.9 billion)
Annual revenue 327.06 billion yuan ($ 51.33 billion)
Annual profit: 119.92 billion yuan ($ 18.82 billion)
Employees: 90,000
Ping An Insurance (601318), state-based financial giant
Market cap: 886.04 billion yuan ($ 139.07 billion)
Annual revenue 36.336 billion yuan ($5.7 billion)
Annual profit: 119.92 billion yuan ($ 18.82 billion)
Employees: 362,000
Rounding out the top ten are:
Wuliangye (000858), another baijiu company
ICBC (601166), the largest bank in the world measured by assets
Longi Green Energy (601012 ), the largest provider of solar infrastructure
Midea (000333), the largest appliance manufacturer in the world
China Yangtze Power (600800), parent of the Three Gorges Hydro Power Project
East Money (300059), a financial information powerhouse
Policy first
The numbers and the potential returns are huge. But China is a policy first, top down market, and prudence dictates objectively evaluating what Beijing is implementing now, ranging from crackdowns on internet and tutoring companies to COVID lockdowns that will certainly slow growth rates. On the other hand, stimulus is already happening with China’s central bank, the People’s Bank of China, injecting 10 billion yuan ($1.57 billion) in reverse repos this week.
There was also discussion at the State Council, China’s main administrative authority, about cutting reserve ratio requirements for banks. Beijing-style stimulus frequently benefits the large financial, materials, and industrial enterprises which is exactly the profile of the CSI300 index.
In addition, none of the companies mentioned above are at risk of getting caught in between China and the U.S., as they are all largely China-first businesses. This week another 12 Chinese companies listed in the U.S. were notified under the Holding Foreign Companies Accountable Act (HFCCA) that their corporate audit documents do not meet SEC requirements. A-Shares do not run this risk.
Investors need to watch central government policy carefully, and re-allocate accordingly. Currently large mainland based institutions close to the government look to be in the sweet spot. For U.S. investors, that looks like the ETF known as ASHR which tracks the CSI300 index.
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