Commentary on Political Economy

Tuesday 24 November 2020


Under pressure: SEC move threatens Chinese companies' access to US capital

With the Trump administration rushing to lock in policies that will bind or embarrass its successor, the US Securities and Exchange Commission is pushing ahead with a plan that could eventually result in Chinese companies valued at about $US2 trillion ($2.7 trillion) being thrown off US stock exchanges.

The push by the SEC, part of a long-running dispute over audits of the Chinese companies that dates back nearly 20 years, has sufficiently alarmed the Chinese that China's main securities regulator is calling for more negotiations as soon as possible to work out a compromise.

It should be said that the US position is a valid one and the policy it is pursuing isn’t confined to China but applies to all foreign listings on US exchanges. China, however, is the one major jurisdiction that refuses to comply.

China’s companies have flocked to Wall Street in recent years because it provides access to a much deeper pool of capital than is available in their home market.

China’s companies have flocked to Wall Street in recent years because it provides access to a much deeper pool of capital than is available in their home market.CREDIT:AP

In the wake of the accounting scandals revealed in the collapses of Enron and WorldCom at the start of this century, the US Sarbanes Oxley Act created a new body in 2002, the Public Company Accounting Oversight Board (PCAOB), to essentially audit the auditors of public companies.

Chinese companies have been listing in the US since the early 1990s, but in 2009 its authorities issued a directive restricting the ability of overseas regulators to supervise auditors based in China. Any foreign regulator wanting to inspect the accounts of a Chinese company has to obtain the approval of the Chinese authorities. The reason given for the directive was "national security".

There has been a lot of to-ing and fro-ing between the US and China over the issue since then, but two developments breathed new life and urgency into the US position.

One was the increasingly hostile attitude and actions of the Trump administration towards China, with its trade war and financial sanctions, but the other was the collapse of China’s home-version of Starbucks, the Nasdaq-listed Luckin Coffee, earlier this year amid massive accounting frauds that were exposed by short-seller Muddy Waters. Luckin admitted the fraud in April.

In May, the US Senate passed legislation banning companies from listing on US exchanges if the PCAOB wasn’t able to inspect the working papers of their auditor for three years in a row. The legislation had bi-partisan support.

In August, the US "President’s Working Group on Financial Markets", which includes SEC chairman Jay Clayton and Treasury Secretary Steve Mnuchin, is reported to have urged the SEC to take action. A few days ago it did.

Last week’s SEC proposal, if implemented, would force the New York Stock Exchange and Nasdaq to require compliance with audit inspections. Failure to do so would see the non-compliant companies’ shares delisted. Companies would have until 2022 to follow the directive.

Bipartisan agreement

China, while seeking more talks and promoting a "co-audit" approach where there would be joint inspections by Chinese authorities and PCAOB-approved firms, nevertheless wants to protect its national security and the commercial confidentiality and strategic information of its companies, some of which are state-owned or controlled. The US wants unlimited and unfettered access to audits, while China wants to limit it.

The SEC proposals won’t be in place, assuming they are adopted after public exposure, before the Biden administration takes office in January. In the meantime Clayton, a Trump appointee, has announced he will relinquish his role at the end of the year.

A Biden appointee to the SEC chair will decide the ultimate fate of the proposal, but that shouldn’t be comforting for the Chinese – the Democrats might approach China differently to the Trump administration but they are just as invested in the tussle for geopolitical supremacy between the world’s two largest economies and most powerful nations as the Republicans.

On the audit issue, there has been bipartisan agreement. In most major economies, access to financial markets and the capital they provide does come with local regulatory and disclosure requirements.

China’s companies, particularly its technology companies, have flocked to the US market in recent years because it provides access to a much deeper pool of capital, on more attractive terms and within far shorter time frames, than is available in China.

Money vs national security

Very recently, some changes to Hong Kong’s listing rules have made that market another viable option – that’s where the world’s largest initial public offering, the $US34 billion ($46 billion) raising by Jack Ma’s Ant Group that would have valued it at more than $US300 billion was supposed to take place before the Chinese authorities pulled the rug from under it.

Nevertheless, the US market remains compelling for foreign companies seeking to raise capital, particularly the tech companies which benefit from the halo effect of the big US tech groups, and the Chinese firms listed in the US have had considerable success.

Nasdaq’s Golden Dragon China Index tracks those Chinese companies listed in the US. This year it is up almost 40 per cent against Nasdaq’s 32 per cent and the S&P 500’s 12.5 per cent.

The problem for China in agreeing to the SEC’s proposal is that, apart from its tech companies and their potentially valuable commercial secrets, a number of the Chinese companies on the US lists are state-owned or controlled and are central to its longer-range national strategic plans and interests.

While Alibaba, with a market cap of about $US730 billion ($992 billion) is the largest Chinese company with a US listing, among the others are state-owned China Life ($202 billion), China Mobile ($171 billion) and PetroChina ($153 billion).

There are many others that are either controlled by China or where the state has a major shareholding but, in any event, China reserves the right to direct even privately-owned companies on national security grounds.

The recent spate of corporate bond defaults, including some deemed AAA-rated by domestic Chinese credit ratings agencies, will only encourage US regulators and legislators to take a hard line on the audit issue to protect US investors.

It would also follow other actions that have impacted Chinese companies.

Apart from the high-profile efforts to force the sale of Tik Tok’s US business, the Trump administration has banned US investment in Chinese companies with links to the military and imposed sanctions on individuals and companies for their roles in the treatment of the Uighurs and China’s actions in Hong Kong.

It also pressured the pension fund for US federal government employees against investing in an international index that included shares in Chinese companies.

The SEC action isn’t the only iron in the fire when it comes to US actions against Chinese companies. But it is consistent with the Trump administration’s efforts to remove economic links it believes are beneficial to China – cutting off trade and investment flows and revoking visas for Chinese students and researchers among them – in order to weaken its challenges to US economic and geopolitical supremacy.

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