A long-running dispute between the United States and China over auditing and compliance standards is escalating and could see some Chinese companies delisted from U.S. stock exchanges.
The Securities and Exchange Commission on Thursday warned of the potential delisting of five companies that are in the middle of the dispute: operator of fast-food chain Yum China (YUMC)wafer processing solution provider ACM Research (ACMR)and BeiGene biopharmaceutical companies (BGN)Zai Laboratory (ZLAB) and HutchMed (HCM)which is a biopharmaceutical manufacturing branch under CK Hutchison of Hong Kong (CKHUF).
The question is whether Chinese companies are able to provide sufficient disclosure and access to US-certified auditors.
The US Senate passed a bill in June 2021 that would allow the SEC to suspend the business activities of companies if they do not submit their working papers to the Public Company Accounting Oversight Board for three consecutive years (2021, 2022 and 2023) . The rule also requires companies to declare whether they are owned or controlled by a foreign government.
The five companies cited by the SEC have had until the end of March to prove to authorities that they have complied with audit requirements, failing which they will have to withdraw from the New York Stock Exchange by 2024. of those five companies fell on Thursday’s news.
Will more Chinese companies have to drop from the list?
The escalation of the dispute between China and the United States comes as the Russian attack on Ukraine has heightened the sensitivity of more investors to geopolitical risks following the measures taken last summer by Chinese regulators to clamp down on some of the country’s biggest internet companies. This action, combined with the accounting dispute, caused the prices of many Chinese stocks listed on US exchanges to plummet.
The SEC’s latest decision may be just the first round of threatened delistings.
“These five companies were the first to be included in the provisional list as they were the first to publish annual reports for 2021,” said Ivan Su, senior equity analyst at Morningstar. “The SEC identifies companies eligible for delisting from the time the company files its annual report. Therefore, we expect more Chinese ADRs to be included in the provisional list in the coming weeks.
For the delisting schedule, under current HFCAA provisions, forced delisting of Chinese ADRs can begin in 2024, according to Su. “That said, the timeline could potentially increase by a year if the Accelerated Expungement Bill is signed into law. This bill passed the Senate in June 2021 but has yet to be approved at the House If this bill is passed, delisting can take place as early as next year.
The PCAOB asserts that the preparation of reliable and independent audit reports is fundamental to protecting the interests of investors and the public. The board expressed a lack of access in China, and it became more vocal after Luckin Coffee LKNCY, China’s largest coffee chain, fabricated its sales records. This was a wake-up call for regulators to step up oversight of non-compliant companies.
National security breaches?
From the Chinese authorities’ perspective, the request for information may have crossed the line, triggering national security concerns. Chinese laws have long prohibited companies from handing over audit working papers to foreign regulators on the grounds that they constitute “state secrets”.
However, given the impending timeline for compliance and potential delisting explanations, Su sees “a slim chance” that Chinese companies will be delisted from US stock exchanges, as both countries are actively working to resolve this ongoing challenge.
“We have started to see signs of collaboration between the United States and China to resolve audit issues,” he said, citing the discussion between regulators from the two countries in December. “Progress is being made, as evidenced by the CSRC Vice Chairman’s comment on January 29, 2022, which stated that “China and the United States are making progress in coordinating regulations governing Chinese companies listed in New York , and there could be a “positive effect”. surprise’ by June or earlier.’
Su also noted, “Most of the Chinese ADRs covered by Morningstar equity research have a fungible dual listing in Hong Kong. This means that investors can convert their US stocks into stocks listed on the Hong Kong stock exchange.
However, risks can also arise from the volume of transactions and the resulting liquidity problems. Su continues, “The majority of trading of these Chinese ADRs currently takes place in the United States. For example, more than 90% of Yum China’s trading volume comes from US exchanges, so investors with large positions may have concerns about future liquidity. .”
An ongoing battle over disclosure
The audit impasse has been discussed in recent years as the US-listed Luckin Coffee accounting scandal unfolded. Last year, Chinese authorities launched an investigation into Didi Global and data security. Subsequently, the carpooling platform was voluntarily removed from the US board of directors.
“The data collected by these companies isn’t even directly associated with national secrecy and also appears unrelated to politics,” according to Chelsey Tam, Morningstar’s senior equity analyst covering China’s tech sector. She says, for example, that the online recruitment company Boss Zhipin (BZ) and the Full Truck Alliance Mobile Truck Call App (MMD) were also being investigated for alleged violations of national security and cybersecurity laws. Both companies have sought an initial public offering in New York in 2021.