Shares in Chinese drugmaker Kangmei Pharmaceutical plunged by their daily limit on Tuesday after the company said it overstated its cash holdings by more than $4bn, highlighting risks for global investors who are piling into China stocks via passive vehicles. Kangmei, a manufacturer of traditional Chinese medicines, blamed an accounting error for overstating its cash balances for 2017 by Rmb30bn ($4.5bn). Kangmei, which had disclosed late last year that it was being probed by the securities regulator over suspected disclosure violations, is one of more than 200 Chinese companies included in MSCI’s flagship emerging markets index, a benchmark tracked by many global fund managers.
Critics have argued that MSCI’s recent decision to increase the weighting for Chinese stocks in its EM index will lead to continued upsets for investors — sometimes with bizarre explanations attached. In 2015, for example, Hong Kong-listed China Animal Healthcare told the market that five years of accounting records had been lost when a truck carrying them was stolen.
Kangmei, based in China’s southern Guangdong province, also revised down its operating revenue for 2017 on Tuesday, by Rmb8.9bn. The company’s Shanghai-listed shares fell 10 per cent and were then halted, after reaching the daily maximum for rising or falling. By the end of this year MSCI’s China weighting will rise to 3.3 per cent of its EM index, up from less than 1 per cent at the start of the year — and none before Chinese shares were included for the first time in the first half of 2018. The reshuffle of the benchmark, which is tracked by about $1.9tn in funds around the world, is expected to lead to an inflow of more than $100bn as investors are obliged to allocate more to China. Kangmei, which has a market capitalisation of more than Rmb47bn, narrowly averted a default on bonds earlier this year. Local media reported that the company received assistance from the local government in the city of Guangzhou to avoid a missed payment on debt.
Other Chinese companies tracked by indices have hit trouble too. In March, Hong Kong’s securities regulator froze the shares of China Ding Yi Feng after they rocketed more than 5,000 per cent, gaining them entry to MSCI’s EM index in 2018. The inclusion led to BlackRock holding 2.29 per cent of the Shenzhen-based company, which was later accused by the regulator of market manipulation. BlackRock held more than 1m shares in Kangmei as of last August, according to the annual report from iShares, the firm’s family of exchange traded funds.