Alibaba Group in Hangzhou, China, on Feb. 21, 2022.
Qilai Shen/Bloomberg
Eyeing the sharp selloff in U.S.-listed Chinese stocks as a buying opportunity? Think twice. The Securities and Exchange Commission identified the first batch of Chinese companies at risk of delisting this week, sending stocks tumbling in the last two days. The headaches for investors in U.S.-listed Chinese stocks could just be starting.
Shares of the
Invesco Golden Dragon China
exchange-traded fund (ticker: PGJ), which is made up of American depositary receipts of Chinese companies, offered a glimpse at the damage, falling 15% since Wednesday. The SEC took another step to implement the Holding Foreign Companies Accountable Act passed in 2020 and identified five companies—
Yum China Holdings
(YUMC), biotechs
BeiGene
(BGNE),
Zai Lab
(ZLAB) and
Hutchmed
(HCM), and technology firm
ACM Research
(ACMR)—at risk of delisting if they don’t comply with U.S. auditing rules by 2024.
The clock for compliance started last year, but the process of actually identifying companies at risk this week served as another “nail in the coffin” for Chinese American depositary receipts, says Derek Scissors, senior fellow at the American Enterprise Institute. As companies file 2021 annual reports in coming weeks, more of the roughly 200-plus Chinese companies are expected to end up on the SEC’s list. And current Chinese law makes compliance unlikely.
As Barron’s has been reporting for more than a year, larger investors have been converting U.S.-listed shares, or American depositary receipts (ADRs), for Hong Kong listed shares of companies like
Alibaba Group Holding
(BABA),
NetEase
(NTES) and
JD.com
(JD) among others, and more Chinese companies have sought listings in Hong Kong—with
Nio
(NIO) the latest to debut.
“It’s YUM today but in one to two months it will be
Alibaba
.
It’s a wake-up that this is a real thing,” says Brendan Ahern, chief investment officer of KraneShares, which runs many China-oriented funds and has been swapping into local shares. For example,
KraneShares CSI China Internet
ETF (KWEB) now has two-thirds in Hong Kong stocks, compared with just a quarter a year ago. It’s a trend Ahern expects to continue.
The next step will be decisions by index providers to swap out of ADRs into local shares. The MSCI and FTSE, for example, have already done so when it comes to Alibaba, JD.com and NetEase, which have been among those with the longest dual listings. Further swaps will likely make U.S.-listed shares less liquid, even though delisting may not happen for a couple of years.
Questions continue about implementation, with no easy comparison to such a large number of companies facing delisting. But as of now, Beacon Partners Advisors’ Owen Tedford expects noncompliant companies to be delisted from U.S. exchanges. However, U.S. investors are unlikely to be barred from investing in these companies, unless they fall under other restrictions from the U.S. like blacklists related to national security threats that ensnared China Mobile in 2021 and left many individual investors scrambling after its delisting.
The move is more complicated for individual investors who may work with brokerages that don’t allow easy access to foreign markets and even wealth managers whose custodians don’t work as much in foreign markets.
“This isn’t good for many individual investors and elements of financial professionals,” says Ahern, who been pushing for regulators to find some sort of compromise and likens the move to a version of capital controls.
The SEC’s identification of companies doesn’t guarantee delisting in two years, but Scissors sees little scope for regulators in either nation to compromise, especially against a backdrop where U. S-China tensions continue to stay elevated and both are trying to reduce their reliance on the other. One possible avenue for compromise, Scissors says, could be if the delisting push is used as a bargaining chip in negotiations around other aggressive actions against China, like the push for increased scrutiny of outbound investment restrictions that some in Congress have advocated. But any such restrictions would rattle investors even further.
How China handles the war in Ukraine is also in focus as it walks a fine line between publicly supporting its friendship with Russia while trying to ensure it doesn’t get hit with devastating sanctions itself. The U.S.-China relationship could take a marked turn for the worse if China increases its support for Russia—or there could be a window for de-escalation if China’s leaders are willing to cooperate with the west, even behind closed doors, Scissors says.
“It isn’t like 3% odds but more like 30%,” says Scissors, noting pressure from some within China to cooperate and keep the country out of the war. “But if China doesn’t cooperate, it again strengthens the hand of those who say why do we even bother negotiating with them.”
For individual investors in U.S.-listed Chinese stocks, though, the outlook continues to be bad—and reinforces the advice that investors looking to tap into China lean toward funds better able to navigate the logistics of converting to local shares and volume-related issues still to come in ADRs.
Write to Reshma Kapadia at reshma.kapadia@barrons.com