China-US trade: Suboptimal outcomes

The face-off between China and the US has already escalated from trade to technology, with suggestions that restrictions placed on Huawei Technologies will help trigger a decoupling process whereby Beijing eases its reliance on US intellectual property in favor of homegrown solutions. If tensions enter the financial realm, Marco Rubio might be regarded as the one who started it.

The senator from Florida is behind legislation – the so-called Equitable Act – that may prevent Chinese companies from trading on US stock exchanges. There are 156 of these businesses listed in the three largest US bourses. They have proved a reliable and lucrative exit route for private markets players, with Chinese entrepreneurs regularly appearing at bell-ringing ceremonies on the balcony overlooking the New York Stock Exchange and at tickertape celebrations on the floor of NASDAQ.

Since Sina pioneered the variable interest entity (VIE) structure in 2000, laying a path for IPOs by Chinese tech start-ups, nearly 180 PE and VC-backed offerings on the two major bourses have raised a combined $57 billion. Alibaba Group alone accounted for $25 billion of that when in 2014 it chose New York over Hong Kong due to a dispute over multiple class share offerings. 

Rubio is proposing that Chinese companies be forced to vacate US exchanges unless they permit inspections by the US Public Company Accounting Oversight Board (PCAOB) within three years. This is a gray area of long standing. Beijing insists that US regulators have no business enforcing their rules on Chinese soil and that compliance risks disclosure of state secrets. Meanwhile, the lack of transparency around Chinese companies has led to numerous blow-ups, notably a spate of accounting frauds in 2011-2013.

Five years ago, the Securities & Exchange Commission (SEC) tried to the force the issue by recommending that Chinese affiliates of the Big Four accounting firms be temporarily barred from auditing US-listed Chinese companies after they refused to turn over documents for fraud investigations. This good cop, bad cop routine – with the PCAOB playing the good cop, signing countless, largely toothless enforcement agreements – came to nothing. 

It is unclear how the latest iteration in this battle of wills will be resolved, but what Chinese companies have now that they didn’t five years ago is a viable alternative closer to home. Hong Kong is already positioning itself as a rival to the US bourses for listings of a certain size following the alterations in listing rules to accommodate Alibaba-style weighted voting rights. Indeed, Alibaba itself is planning a secondary listing in the territory. The bar has been set even lower for biotech companies.

Beyond that, Shanghai’s new technology board could be an option for some companies, although it remains to be seen how the relatively young initiative develops. Several VC investors told AVCJ they are now prioritizing Hong Kong over the US for listings due to the overall climate of uncertainty around China-US business. This is a matter of prudence rather than choice: the same VCs freely admit that some companies are better suited to a more sophisticated US investor base.

Much like the workaround solutions companies must employ in response to trade tariffs, it is a messy business that undermines capital efficiency. And that’s just for new listings. If the Rubio legislation means all companies that currently trade on US exchanges must find a new home, bourses like Hong Kong need to revise processes and standards in order to accommodate them. A costly and excruciating transition would result, with the capacity of regulators and institutional investors put to the test.

The realities of decoupling on any level are painful, especially if it involves unwinding the financial threads spun by globalization.

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• Topics
• Greater China
• North America
• Regulation
• GPs
• China
• USA
• Technology
• IPO