Negotiations between American and Chinese securities regulators, usually dry affairs, took observers on a surprisingly wild ride this winter. The US, specifically its congressionally appointed Public Company Accounting Oversight Board (PCAOB), has been seeking direct access to the financial documents of Chinese companies listed in New York.
In 2011, a series of scandals spelled out big losses for American investors and brought the earnings reports of Chinese companies into question. The Chinese government has thus far refused to let auditors share documents with the PCAOB, which oversees the auditors of companies listed on US exchanges, saying the documents could contain state secrets. Both sides appear deadly serious about getting their way.
Late last year, Lewis Ferguson, a PCAOB board member, told China Economic Review that the board would “not rule out sanctions, including revocation,” should Chinese firms not adhere to US law. China hasn’t flinched at the possibility of delisting Chinese companies that have issued shares in the US, which have a combined market capitalization of about US$100 billion in the US.
What insiders had called a deadline for reaching a deal passed on December 31, but discussions are ongoing. No one yet knows what will happen next.
The surprise on world capital markets last month wasn’t delisting Armageddon. It was the Shanghai Stock Exchange that caught investors off guard by climbing 16% after a nearly four-year low. The bourse has been one of the world’s worst performing for more than two years but was uplifted in early December when the government promised to boost urban development and continue reforming inefficient state-run enterprises.
Reports that China will abolish rules requiring Renminbi Qualified Foreign Institutional Investors (RQFII) to hold their funds in bonds also sent a shock wave of interest through Shanghai, as the change would allow foreign investors to invest more in mainland stocks. This came after a November 14 announcement that RQFII would expand its quota from RMB70 billion to RMB270 billion.
This is good news not just for companies and shareholders on the Shanghai exchange but for any Chinese company facing delisting in New York. If Chinese firms are indeed struck from US trading boards, the Chinese government would like to see them re-list at home. Insiders have scoffed at this possibility, pointing to a queue of more than 850 companies waiting for permission to list on the mainland.
However, the government is making sincere efforts to quickly clean up the market. On December, the China Securities Regulatory Commission ruled that Chinese firms no longer need approval from provincial authorities to list abroad, a move that will likely shorten the line of issuers-in-waiting on the mainland. The rule, which took effect January 1, also abolished the requirements that said companies listing abroad must have net assets of US$64.3 million and annual profits of US$9.6 million.
If Chinese companies listed in the US were delisted tomorrow, they would still have more than a year to prepare for an exit. Paul Gillis, a professor of practice at Peking University’s Guanghua School of Management and an expert on accounting in China, notes that the delisting process would be intentionally long and “minimally interruptive.” The timeframe offers an opportunity for leaders to push through with market reform in the hopes that the Shanghai exchange could become an easier place to re-list Chinese firms that might be forced out of the US.
Shanghai’s December rally was a refreshing start, but it could quickly become a memory if new Chinese leaders don’t follow through with pledged reforms. Paying homage to Deng Xiaoping, as new Communist Party Secretary Xi Jinping did last month in Shenzhen, will not be enough to maintain new interest in the market.
The head of the Shanghai government’s investment arm said as much in a recent interview with Bloomberg. Pang Yang, chief executive at Shanghai Alliance Investment, said the government must break down state monopolies, as well as provide better support for smaller business, if it is to encourage investor interest in the Shanghai market. Pang said he believed in the government’s commitment to unleashing value from private companies that have been crowded out by state enterprise.
Pang has grounds for this optimism. If officials can maintain a quick pace for reform, which has included four significant steps to open China’s capital accounts since the beginning of the 18th Party Congress in November, this could help remedy some of the poor investor sentiment that has become characteristic of the market. It could also pave the way for possible listings at home for companies that leave the US.