U.S.-China Audit Deal Won't Slow Hong Kong Dual Listing Train, Analysts Say

Key Takeaways:

• Despite a landmark U.S.-China information-sharing agreement, some predict dual listings in New York and Hong Kong will remain the preferred choice for Chinese stocks
• UBS estimates Hong Kong Stock Exchange trading volume could rise up to 25% if all U.S.-traded Chinese stocks delist from New York and move to Hong Kong

By Ken Lo

The new information-sharing agreement between U.S. and China stock regulators was a welcome relief for the more than 200 Chinese companies listed in New York, pulling them back from a cliff that could still see them forcibly delisted. But many unknowns remain over whether the deal can be successfully implemented, which requires giving the U.S. near-complete access to the internal accounting records of U.S.-listed Chinese companies without obstacles.

That risk alone is likely to keep the gates open for an ongoing migration that has seen dozens of China’s biggest U.S.-listed stocks come to Hong Kong to make second IPOs as a  hedge against the potential for future New York withdrawals. What’s more, such dual primary listings in the U.S. and Hong Kong may still become the preference over the longer term to protect against future tensions. Such listings also bring certain other advantages, such as near round-the-clock trading and making the stocks more accessible to mainland Chinese investors.

It’s been more than 20 years since Chinese companies embarked on their trans-Pacific journey to New York, with plenty of bumps along the way. As early as 2011, dozens of those companies were accused of accounting irregularities after notorious short-seller Muddy Waters published reports targeting the group and their fast-and-easy account practices. Fraud was later confirmed at many of those targeted companies, resulting in plummeting share prices and even some delistings.

Not surprisingly, the bad reputation earned by Chinese stocks triggered alarms at the Public Company Accounting Oversight Board (PCAOB), the auditing arm of the U.S. Securities and Exchange Commission (SEC), resulting in tighter regulation of the group.

But it wasn’t until late 2020, with the U.S. passage of the Holding Foreign Companies Accountable Act (HFCAA) by then-President Donald Trump, that the issue came to a head as the U.S. said it would delist any foreign company from U.S. exchanges as early as 2024 if it failed to meet U.S. accounting requirements for three consecutive years. The law was widely seen as targeting Chinese companies, since 90% of companies affected were Chinese stocks.

Last Friday, the China Securities Regulatory Commission (CSRC) and the Ministry of Finance finally reached anaudit agreement with PCAOB, taking an important step towards easing the delisting crisis. Now the SEC will conduct several trial cases over the next three months, with e-commerce giants Alibaba BABA and JD.com JD, as well as Yum China YUMC, operator of KFC and Pizza Hut restaurants in China, as the first guinea pigs, according to a Reuters report this week.

Hard to meet in the middle

Despite the breakthrough, concerns remain that actual implementation of the agreement won’t be smooth. Versions of different announcements on the deal issued by the Chinese and U.S. regulators afterwards show there could be significant differences in the two sides’ understanding of the agreement, as we reported on Monday. Such difficulties could work to Hong Kong’s advantage as long as the U.S. delisting threat remains.

According to the CSRC, companies are obliged to comply with Chinese laws including China’s recently implemented Data Security Law, Personal Information Protection Law and other information security-related laws and regulations. That means it’s unclear whether Chinese companies can give the PCAOB unlimited access to their corporate audit information without violating Chinese law. Meantime, the U.S. has said it won’t accept any restrictions from China on its review of audit papers. Given the potential for different interpretations, the market has every right to remain concerned over whether the deal will succeed.

Kenny Wen, head of investment strategy at KGI Asia, is among the suspicious. He said the U.S. requires that all working papers must be available for PCAOB regulators to review during inspections, which are supposed to take place in Hong Kong. But is that possible? After all, such working papers are loaded with what seems to fit mainland regulators’ definition of sensitive information. Wen was also concerned over how the U.S. would react once one of its requests was denied.

Wen also believes the agreement’s positive impact on Hong Kong stocks was reflected in trading last week, and that investors don’t have too high expectations. Instead, the financial performance of Chinese companies, U.S. interest rate hikes and China’s economic performance will be more important focal points for the Hong Kong stock market.

As frictions are likely to continue between the U.S. and China for now, the agreement does not really provide a greater sense of security for Chinese stocks. Wen estimated that dual-primary listings in both New York and Hong Kong will remain the trend among Chinese stocks that want to reduce their risk of being delisted and expand their investor base. Alibaba, which looks set to become one of the first companies reviewed by the PCAOB, exemplifies the trend. After becoming the first U.S. listed company to get a second listing in Hong Kong in 2019, its more recent application to upgrade its Hong Kong listing to primary status is expected to be complete by the end of this year. Many other U.S.-listed companies are making similar moves, both by listing in Hong Kong and upgrading existing secondary listings to primary status.

In addition to Alibaba, the Hong Kong Stock Exchange has confirmed receiving dual primary listing applications from BeiGene BGNE, XPeng XPEV, Li Auto LI and Bilibili BILI. According to a report published by UBS, if all Chinese stocks were delisted in New York and transferred to Hong Kong, the estimated average daily turnover of the Hong Kong stock market could increase by 20% to 25%, and Hong Kong as an offshore listing center for Chinese companies would be further consolidated.

Francis Lun, CEO of GEO Securities, also believes that the U.S. is likely to hold a tough position on what it wants from the deal, meaning the implementation process could be far from smooth. But in the end, he believes China will give in and cooperate. Of the more than 200 Chinese stocks listed in the U.S., he estimates it would be easier for both regulators to meet in the middle on large technology companies like Alibaba, which are boosters of economic development and huge job creators in China, and darlings of large U.S. funds.