China Signals End to $2 Trillion US Stock Listing Juggernaut

(Bloomberg) — For two decades, Chinese tech companies have flocked to the US stock market, attracted by a friendly regulatory environment and a huge pool of capital eager to invest in one of the world’s fastest-growing economies.

Now the juggernaut behind hundreds of companies worth $2 trillion seems to have stopped.

Beijing’s July 10 announcement that nearly all companies attempting to list in another country will need approval from a newly empowered cybersecurity regulator is tantamount to a death knell for Chinese IPOs in the US, according to longtime industry reporter. watchers.

“It’s unlikely that there will be Chinese companies listed in the US in five to 10 years, except maybe a few large ones with secondary listings,” said Paul Gillis, a professor at Peking University’s Guanghua School of Management in Beijing.

The curtailment caused by the decision of Didi Global Inc. to continue listing in New York despite objections from regulators is already causing shock waves through the markets. A gauge of US-traded Chinese stocks is down nearly 30% from its recent high. For investors in companies that have yet to be listed, there is growing uncertainty about when they will be able to get their money back. Wall Street firms are bracing for lucrative insurance costs to dry up, while Hong Kong will benefit as Chinese firms look to alternative — and politically safer — locations closer to home.

The importance of US markets to Chinese companies is hard to overestimate. The first wave began in 1999 with the sale of US certificates – surrogate securities that allow investors to hold foreign stocks. Since then, more than 400 Chinese companies have chosen US exchanges as their primary listings, raising more than $100 billion, including most of the country’s stock. technology industry. Their stocks later benefited from one of the longest bull markets in history.

Hong Kong-based website operator China.com Corp. The trend started when it went public on the Nasdaq in 1999 during the dotcom bubble. The stock, under the symbol CHINA, rose 236% on its debut, enriching founders and backers and showing Chinese internet companies a path to foreign capital — if only they could find a way to break the Communist Party’s strict regulatory controls. bypass.

Unlike companies in Hong Kong, whose laissez-faire approach to business meant few rules for raising corporate funds, private companies in the mainland faced much greater hurdles. Foreign ownership in many sectors, especially in the sensitive internet industry, was limited, while foreign listing required approval from the Chinese State Council or Cabinet.

To get around these hurdles, a compromise was found in the form of a floating rate entity – a complex corporate structure used by most ADRs, including Didi and Alibaba Group Holding Ltd. Under a VIE, which was developed by the now privately owned Sina Corp. in 2000, Chinese companies are converted into foreign companies with shares that foreign investors can buy. Legally shaky, difficult to understand, this solution nevertheless proved acceptable to US investors, Wall Street and the Communist Party.

Back in China, the government took steps to modernize its stock market, which only reopened in 1990, having closed forty years earlier following the communist revolution. In 2009, the country launched the Nasdaq-style ChiNext sign in Shenzhen. Under Xi Jinping, who became president in 2013, access to the outside world was significantly increased, including trade ties with Hong Kong, allowing foreign investors to buy stocks directly from the mainland. In 2018, China started a pilot program to compete with ADRs, but it failed to gain traction.

The most radical move came in 2019 when Shanghai opened a new exchange called Star board, which minimized red tape, allowed unprofitable companies to list onshore for the first time and abolished a cap on price movements on the first day. It also removed an unwritten valuation cap that forced companies to sell their shares at 23 times earnings or less. But mainland exchanges still don’t allow dual-class stocks, popular with tech companies because they give founders more voting rights. Hong Kong introduced the structure in 2018.

The goal was to create an environment that would allow Chinese tech companies to list successfully at home and be less dependent on US capital. This need became all the more pressing as tensions between Beijing and Washington mounted during the latter part of former President Donald Trump’s presidency. Trump introduced strict new rules that mean Chinese companies could be taken off the stock exchange in a few years if they refuse to hand over financial information to US regulators.

While secondary listings in Hong Kong picked up, Chinese companies still preferred New York, where it takes weeks rather than months to process an IPO application. China’s strict capital controls meant that domestic exchanges could not compete with New York in terms of liquidity and much higher valuations for technology companies. China Inc. has raised $13 billion this year alone through its first sale of shares in the US.

After Didi’s controversial IPO on June 30, it seems that the Communist Party decided enough was enough.

“The death of ADRs was inevitable,” said Fraser Howie, author of “Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise.” “Interesting is the mold and template with which that result is achieved. It comes from a mindset of controlling and suppressing things. That is quite different from building a reform and domestic market mindset.”

Beijing’s move to regulate foreign IPOs has coincided with tighter controls on Chinese technology companies, many of which have near-monopolies in their fields and massive amounts of user data. This campaign to rein in the tech industry has gained momentum in recent months as Xi tries to limit the influence of the billionaires who control these companies.

For Chinese companies already listed in the US, what happens next depends largely on what China does with VIEs. Banning them completely would be unlikely, as it would force companies to delist foreign exchanges, scale that structure and then re-list them — a costly process that would take years. The updated regulations are expected to be ready in a month or two, people familiar with the matter say.

Hong Kong is starting to look more and more like a viable alternative. First, China plans to exempt Hong Kong IPOs from the approval of the country’s cybersecurity regulator, Bloomberg reported last week. A forced delisting in the US will allow companies that have already sold shares in Hong Kong, such as Alibaba and JD.com, to migrate their primary listing to the city. The scrapped US notes, which can still be traded off-exchange, will not be worthless because they represent an economic interest in the company. Hong Kong’s open markets and dollar-pegged currencies should make conversion easier.

Holders can sell their ADRs before delisting or convert them into Hong Kong-listed common stock without much disruption. A company that chooses to end its ADR program completely can also pay out a dollar amount to investors.

Anyway, it seems that the two-decade era of China’s most successful and most powerful private companies in the US on the list is coming to an end. The message from Beijing is clear: the Communist Party will have the last word on pretty much everything, including IPOs.

“It’s really important to own companies that align with the Chinese government’s direction,” said Tom Masi, co-portfolio manager of GW&K Investment Management’s emerging wealth strategy fund, which has invested half of its money in Chinese stocks. “I wouldn’t fund companies that are going to get around something the Chinese government wants to achieve.”

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