U.S.-Listed Chinese Companies Worth $1.1 Trillion Face Risk Of Delisting

The window for regulators in China and the U.S. to resolve their auditing dispute is closing–threatening nearly $1.1 trillion worth of U.S.-listed Chinese stocks after the Securities and Exchange Commission signaled its intention to delist five such firms for failing to comply with accounting rules.

The SEC announced on Thursday that fast-food chain Yum China, technology firm ACM Research as well as biotechnology companies BeiGene, HutchMed and Zai Lab are now facing the prospect of delisting under the Holding Foreign Companies Accountable Act, which became law in December 2020. The SEC identified the companies as the first batch to be put on its provisional list for potential future delisting for failing to submit detailed audit documents that support their financial statements.

Many companies have already issued stock exchange filings that say they are working to comply with the requirements. They have until March 29 to dispute the decision, and only failure to provide the Public Company Accounting Oversight Board (PCAOB) access to required accounting documents for three consecutive years will result in a forced delisting.

Still, the SEC’s move sparked a broad sell-off in U.S.-listed Chinese stocks, with the Nasdaq Golden Dragon China Index registering its biggest slide since 2008 by plunging 10% on Thursday. Traders in Hong Kong were also alarmed by the news, and the Hang Seng Tech Index dropped 4.3% on Friday.

“The SEC identifies what companies are subject to delisting as early as the firm files its annual report and on a rolling basis,” Morningstar senior equity analyst Ivan Su writes in an e-mailed note. “Therefore, we expect more Chinese ADRs to be included in the Provisional List over the next few weeks.”

Analysts say more than 200 Chinese companies listed in the U.S. are at risk of getting delisted eventually, and the the room for future negotiation appears to be rather limited.

Although the China Securities Regulatory Commission said in an online statement that it “opposes the politicization of securities regulation,” but it is willing to continue to communicate with U.S. regulators to resolve the dispute.

The crux of the matter is that Beijing has long viewed auditing papers as state secrets, and handing books over to U.S.-based regulators could endanger national security because they may contain sensitive economic data or information related to state-linked projects.

SEC Chairman Gary Gensler had earlier pointed out if companies are going to issue public securities in the U.S., then their books have to be subject to inspection. He said more than 50 foreign jurisdictions have worked with the PCAOB to allow such inspections, only two historically have not: China and Hong Kong.

The worsening relationship between the two countries also doesn’t help, with tensions ratcheting up most recently over China’s refusal to condemn Russia’s invasion of Ukraine. Relations between the world’s two largest economies have deteriorated in recent years over issues including the Covid-19 pandemic, Taiwan, Hong Kong and Xinjiang.

The U.S. now views China as a “strategic competitor” and seeks to counter what it describes as “Beijing’s aggressive and coercive actions” while defending its own economic interests.

“They are competitors,” says Joseph Fan, an emeritus professor at the business school of the Chinese University of Hong Kong. “Neither government can be neutral enough to solve economic issues.”

Feng Chucheng, a partner at Beijing-based research firm Plenum, says the talks between regulators in the two countries over the auditing issue has so far made little progress. Chances for change could still arrive as there is a three-year time span, but for now, delisting for all U.S.-listed Chinese companies remains a “higher probability” scenario.

“The U.S. is considering whether to give China access to its capital markets, and allowing trade of China-based companies by U.S. persons may pose threats to U.S. national security,” he says. “Under a context of U.S.-China strategic competition, everything related to China has been elevated to a national security level.”

Losing access to U.S.-based financing channels could prove to be a heavy blow. Although Chinese companies from e-commerce giant Alibaba to games developer NetEase have in recent years completed secondary listings in Hong Kong, relatively small turnover in the Asian financial hub suggests lower liquidity and investor interest to trade the shares. Yum China, for example, sees more than 90% of its turnover volume taking place in the U.S., despite being dual-listed in New York and Hong Kong, according to Morningstar’s Su.