Will China’s compromise on foreign audits be enough to stop stock market deportations?

Nearly 100 Chinese companies are now threatened with delisting from US stock exchanges by the US Securities and Exchange Commission (SEC).

Earlier this month, the SEC added more than 80 Chinese companies to a record of US-listed companies facing eviction amid a long audit standoff between the US and China.

The latest batch, the regulator’s sixth, includes some of China’s largest and most successful companies, including JD.com, China Petroleum & Chemical, Bilibili, NetEase and JinkoSolar Holdings.

To date, 128 Chinese companies have been cited, including 105 on the provisional list and 23 on the final list. In the past year ending March 31, a total of 261 Chinese companies, with a total market capitalization of $1.4 trillion, were listed on US exchanges. But more Chinese companies, including the eight Chinese state-owned companies listed in New York, are at risk of delisting.

China is the only jurisdiction that has created a difficult situation for its listed companies. The country’s state secrecy laws prohibit its foreign-listed companies from handing over all of their financial and business records to foreign authorities and auditors. This conflicts with the US Holding Foreign Companies Accountable Act (HFCAA), a law passed by Congress in 2020 that seeks to remove foreign companies from US stock exchanges if they fail to comply with US auditing standards for three years. consecutive.

The Catch-22 created by the regulatory dispute has yet to be resolved. In March, the SEC announced that the first group of Chinese companies, which includes Yum China Holdings, the owner of fast food establishments KFC, Taco Bell and Pizza Hut in China, will be deregistered shortly for non-compliance with the HFCAA. .

Then last month, China extended a compromise by announcing new rules allowing foreign audit of the financial records of Chinese companies listed or intending to list in the United States. But lawyers say the new rules are unclear and the government has failed to demonstrate full commitment. to transparency, especially since the new provisions do not really change the application of its national laws on state secrecy.

The China Securities Regulatory Commission (CSRC) has said it will take a more hands-on approach to enforcing state secrets laws, but what will that look like? said Washington, D.C.-based Claudius Modesti, a partner at Akin Gump, who was formerly an SEC enforcement attorney, federal prosecutor and first director of the Public Company’s enforcement division. Accounting Oversight Board (PCAOB). On the US side, we do not know if the submitted working papers will contain the information needed for the audit. And that’s what we can’t really determine until this process takes place.

This process could take months or even years, which would do little for Chinese companies already identified by the SEC.

A lot of people are focused on what the Chinese government is offering, but that’s only a very preliminary step to the most important step, which is what the PCAOB will be able to see once they inspect the documents of work of these listed companies, Modesti explained. The two sides went through a back-and-forth process on how to potentially proceed, but they never passed an inspection. This is when the rubber will hit the road.

According to a Hong Kong-based partner at a Wall Street firm, the US is not too concerned about a compromise, the dispute has been brewing for a long time, and the SEC is fully prepared to release Chinese companies, especially since the regulator came under heavy pressure from lawmakers to force Chinese companies to improve disclosure standards, he said.

China’s disclosure standards have come under repeated scrutiny in the United States. Luckin Coffee, China’s version of Starbucks, is believed to be one of the culprits that has sparked closer scrutiny of Chinese companies listed in the United States. submitting fraudulent income figures. He was later delisted but has since enjoyed a remarkable comeback and is now said to have listing plans for Hong Kong.

DLA Piper’s Hong Kong partner George Wu says the threat of delisting in the United States and China’s new foreign audit rules won’t affect eligibility and considerations to registration in Hong Kong. Having an additional listing venue is a good addition for Chinese companies listed in the United States, regardless of whether the ongoing foreign audit talks are successful or not, he said.

Some US-listed companies have already taken steps to mitigate their risks. The Hong Kong market benefited from the quotes of several, including JD.com, Baidu, NetEase, Li Auto and Bilibili.

If Chinese companies such as NIO Inc. and JinkoSolar, which are not dual-listed, are indeed kicked out of the United States, the natural alternative is decidedly Hong Kong, the lawyers say.

But not everyone will be able to register. Under Hong Kong listing rules, companies must either generate an aggregate net profit of at least $6.45 million over the previous three years or have a minimum market capitalization of $255 million at the time of registration and revenues of at least $64 million.

Comparatively, the New York Stock Exchange requires companies to have a much smaller market capitalization base to list $200 million or $2 million adjusted pre-tax profit (rather than net profit), over the past two years.

For companies that do not currently meet the conditions for re-listing in Hong Kong, Wu said new foreign audit rules enacted by the Chinese government could help stabilize their investor confidence as well as stock market performance for a while. that they are looking for alternative solutions, including the possible new HK listing chapter that could come out in the coming years.

Unresolved issues surrounding US listings may be a headache for Chinese companies singled out by the SEC, but it’s good news for capital market participants in Hong Kong, especially UK companies. which have in recent months taken precedence over IPO work in Hong Kong. Over the past two years, US firms have topped the charts for advising more Hong Kong listings than UK firms, which have traditionally dominated the local IPO market.

A Wall Street partner said law firms are already aggressively embarking on privatization work to get a share of listing advice.