The number of Chinese companies seeking to list in the United States is climbing, despite rising tensions between the U.S. and China and increased scrutiny of Chinese companies by U.S. regulatory authorities, amid the huge lure of U.S. capital markets.
Drip, China’s leading online car platform, went public in U.S. trading on Wednesday (June 30), raising about $4.4 billion in an initial public offering (IPO) that valued the company at a peak of $73 billion, making it the highest-funded Chinese company in the U.S. since Alibaba Group went public in 2014.
While the drop was welcomed by Wall Street investors, the prospect of a large number of Chinese companies facing forced delisting could emerge in the future as listed Chinese companies that lack financial transparency are coming under stricter scrutiny from U.S. officials, driven by tensions between the U.S. and China.
A total of 29 Chinese companies went public in the United States in the first six months of this year, raising a total of $7.6 billion, the highest level ever for the same period, according to financial data provider Lufthansa.
Drew Bernstein, co-chairman of Marcum BP, an audit and advisory firm focused on Asia, said the U.S. offers unbeatable financing conditions for companies around the world that want to go public.
The U.S. market offers the most diverse source of capital, allowing for additional rounds of financing and elevating companies to the global stage,” he told the Voice of America. Despite political pressure, there is clear interest from both U.S. and Asian investors to close the deal.”
In addition to being able to attract more capital, listing in the U.S. helps Chinese companies escape the capital flow restrictions imposed by Chinese authorities. Dropshipping’s major investors include SoftBank, Uber and Tencent.
Jay Ritter, a finance professor at the University of Florida, told Voice of America, “Drip has some foreign shareholders, and if Drip goes public in China, those shareholders could face problems in selling their shares out of China because of government currency controls.”
Despite the current hot U.S. IPO market in general, enthusiasm for newly listed Chinese companies is trending downward.
According to a report in The Wall Street Journal, citing knowledgeable sources, Drip decided to price the IPO cautiously, with a lower valuation than initially expected, mainly because of the poor performance of some recent Chinese companies that have IPO’d in the U.S. and the current glut of IPO deals listed in the U.S.
Last week, Chinese fresh food e-commerce company Daily Fresh broke on its first day of trading in the U.S., closing down more than 25 percent, and its shares have been underperforming ever since. Another e-commerce company, Dingdong Buy, voluntarily reduced its fundraising to a quarter of its original size on the eve of its IPO, and its shares still experienced a roller coaster ride after the IPO.
Three-year delisting risk
Even though they are allowed to list in the U.S., these Chinese companies are facing increasing regulatory pressure to risk delisting in the U.S. if their audits don’t meet standards.
The Biden administration is pushing for increased scrutiny of securities trading that the previous administration called for. Last December, then-President Trump signed the Foreign Company Accountability Act (HFCAA), which aims to delist Chinese companies from U.S. exchanges if they fail to meet U.S. auditing standards for three consecutive years.
Jesse Fried, a professor at Harvard Law School, told Voice of America: “DDT faces the same delisting risk as other Chinese companies, and its stock must be suspended if its audits are not inspected for three consecutive years.”
He went on to say, “Chinese companies can’t fix their own accounting problems. The only solution is for China to agree to some form of audit inspection by the U.S. Public Company Accounting and Oversight Board (PCAOB), or for the U.S. not to fully enforce the HFCA.”
Unlike other countries listed in the U.S., China has never allowed U.S. regulators to do an inspection of the audit records of Chinese companies listed in the U.S. to rate the company’s financials. the PCAOB and the SEC have made numerous attempts to negotiate with China about access to audit records, with no effective resolution to date.
China considers the sharing of audit transcripts to be an infringement of its sovereignty and a risk of revealing state secrets. Beijing has also declared that it is illegal for Chinese companies to comply with foreign securities regulations without government permission.
Many Chinese companies listed in the U.S. are fully or partially controlled by the Chinese government, which is even less likely to share information about leading domestic industry companies amid increased geopolitical and economic competition between the U.S. and China.
You have to read the Chinese government’s reluctance as a political measure,” George Calhoun, director of the quantitative finance program at Stevens Institute of Technology, told Voice of America. I don’t think the companies are opposed to it, it’s the Chinese government regulators who are opposed to it, and it’s part of the current standoff between China and the United States.”
Indeed, Chinese regulators are adopting stricter regulations on large Chinese technology companies, requiring them to properly collect, store and handle critical data. Some reports say China is considering joint ventures with domestic tech giants to oversee the data they collect from hundreds of millions of consumers.
Just two days after DDT’s IPO, China’s Internet Information Office declared Friday that it was launching a new investigation into DDT to protect national security and the public interest. During the investigation, new users will not be able to register for the Drip hailing service.
From a U.S. perspective, the new securities regulation policy, which has bipartisan support in Congress, will not only not make concessions to audit conditions for Chinese listed companies, but could tighten them further.
Late last month, the U.S. Senate passed a bill that would reduce the three-year grace period for audits of Chinese public companies to two years. And according to a bill introduced in May by Republican Senator Macro Rubio (R-Fla.), it calls for an outright ban on any Chinese company that fails to meet U.S. auditing standards.
What happens after delisting?
The prospect of delisting does not appear to have dampened enthusiasm for Chinese companies to go public in the U.S., as they often have already raised their profile and reaped the financial benefits through the U.S. market.
According to the U.S. China Economic and Security Review Commission (USCC), a U.S. congressional body, 248 Chinese companies with a total market capitalization of $2.1 trillion were listed on U.S. exchanges as of May of this year.
The risk of delisting has done little to slow the number of Chinese companies seeking to list in the U.S.,” said Jennifer Schulp, director of financial management research at the Cato Institute, a think tank. The U.S. IPO market is particularly hot right now, increasing its attractiveness to companies with short-term capital needs, even as regulatory risk may be on the rise.”
A number of Chinese listed companies have previously been delisted for fraud, and others have voluntarily chosen to do so, due to the lack of access to U.S. scrutiny of Chinese listed companies. They often choose to go private after delisting, become unlisted companies, or head to China or a third country to relist.
China’s RuiXing Coffee was delisted from the U.S. Nasdaq market last year for financial fraud. RuiXing Coffee agreed to pay $180 million in fines to exonerate the company from charges of financial fraud, which will be used in part to compensate victims, but will hardly satisfy all of them, and some investors are still launching lawsuits against the company.
By comparison, RuiXing Coffee raised nearly $700 million through its U.S. IPO and reached a market capitalization of $12 billion at its peak.
In another example, in 2005, China’s Focus Media went public in the U.S., raising nearly $120 million, a record for a Chinese IPO on Nasdaq at the time; in 2013, Focus Media was taken private from Nasdaq for $3.7 billion and re-listed in Shenzhen two years later, where the company now has a market capitalization of nearly $20 billion.