Investors feel the pinch of China’s crackdown on US listings

Markets summary

China’s regulatory authorities have sent shockwaves through financial markets last week with plans to tighten restrictions on Chinese companies listed in the US, which are overwhelmingly technology companies.  This so called Chinese American Depositary Receipts (ADRs) market consists roughly of 248 Chinese companies with a combined market valuation of $1.7 trillion.  The value of this market, which incorporates China’s most powerful companies such as Alibaba, Tencent and Meituan is trading at its lowest level in over a year at a time when major US tech giants continue to hit record highs.

Regulatory fears over China’s technology companies resurfaced in recent weeks after Chinese authorities announced that ride-hailing giant Didi Chuxing (a proxy of Uber) was under investigation for allegedly collecting users’ personal information illegally.  As a result, the app was removed from China’s app stores and will not be available for new downloads while the company was under review. 

The announcement came just days after Didi’s initial public offering in the US.  Previous action was mostly focused on anti-monopoly and financial technology regulation, which led to the suspension of Ant Group’s $34.5 billon listing in November of last year and Alibaba’s $2.8 billion antitrust fine — major developments that shook the confidence of investors.

The new rules would impact both firms already listed abroad and those still seeking listing.  Besides regulating what corporate data can and cannot be shared with foreigners, the new rules would target illegal securities activities and create extraterritorial laws to govern Chinese firms with foreign listings.  Chinese regulators also want to restrict the use of offshore legal structures that help Chinese companies skirt local limits on foreign ownership.

Nearly all Chinese tech giants listed in America, use what is called a “variable-interest entity” structure or a VIE.  A VIE permits a company to be domiciled in a tax haven country like the Cayman Islands for example, and accepts foreigners as investors.  It then sets up a subsidiary in China, which receives a share of the profits of the Chinese firm using the structure. 

China’s government has long implicitly supported this questionable structure arrangement but it now wants Chinese firms to seek explicit approval for the structure.  The assumption going forward is that Beijing would be hesitant to grant it while existing VIEs may also come under greater scrutiny.

The events of the past few weeks highlight the very peculiar risks associated with an investment in Chinese companies, and indeed in other emerging markets where governments continue to play a major role in the operations of the market.  It is important that in these circumstances, investors do not only focus on the fundamental aspects of the company but also fully understand the political and national security dynamics that go into an investment of this sort.  Failure to recognize such risks, would expose investors to excessive risks beyond what is normally associated with similar companies in more developed nations.


Disclaimer: This article was written by Stephen Borg, Head of Private Clients at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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