U.S. public company regulators and accounting watchdogs have recently introduced new rules that will penalize Chinese companies for delisting once U.S. regulators fail to effectively supervise them for three consecutive years, according to the regulations, which are believed to be aimed primarily at Chinese companies. Observers say the future will not be easy for Chinese companies in the U.S. amid continued tensions between the U.S. and China.
New Proposal Aims to Strengthen Regulation
The Public Company Accounting Oversight Board (PCAOB) on May 13 proposed a new rule for comment to implement the Foreign Company Accountability Act (FCAA), which President Trump signed into law on Dec. 18 last year. “(HFCAA), which was signed into law by President Trump on December 18 of last year. The deadline for public comment is July 12, 2021.
The PCAOB’s announcement says it is proposing a framework rule on how to determine “failure to exercise effective accounting supervision” under the authority of the HFCAA to address the PCAOB’s inability to verify and investigate accounting firms registered in foreign jurisdictions. The draft rule states that the PCAOB has made a determination of “failure to exercise effective regulatory oversight” because it is unable to verify and investigate accounting firms registered in foreign jurisdictions.
The draft states that the PCAOB’s primary factors in making a determination include foreign government interference in the PCAOB’s verification process, the PCAOB’s inability to obtain necessary information and materials, and the firm’s inability to implement the PCAOB’s own investigative approach. If a listed company violates one of these factors, it will be penalized and delisted. Commentators believe that the PCAOB’s new rules address the problem of overseas authorities denying the PCAOB the authority it needs to conduct its mandated regulatory activities.
Delisting if not “compliant” for three years
On the other hand, the U.S. Securities and Exchange Commission (SEC) announced on March 24 that in order to fulfill the requirements of the Foreign Company Accountability Act mandated by the U.S. Congress regarding the filing and disclosure of information, they adopted an interim final amendment requiring U.S.-listed foreign issuers are required to file documents with the SEC certifying that the company is not owned or controlled by a government entity in a foreign jurisdiction and to disclose their annual reports, including audit arrangements and government influence. The announcement also stated that if a foreign issuer fails to meet the PCAOB’s requirements for an examination by an accounting firm for three consecutive years, its securities will be delisted. This new requirement has taken effect after Announcement 30.
“The “Foreign Company Accountability Act” is an amendment to the Sarbanes-Oxley Act of 2002, the largest U.S. energy company. “On December 2, 2001, Enron, the largest energy company in the United States, suddenly filed for bankruptcy, followed by a scandal involving the joint financial fraud of Enron and Arthur Andersen. As a result, the U.S. Congress enacted this public company accounting reform and investor protection bill and established the independent Public Company Accounting Oversight Board (PCAOB).
Although the “Foreign Company Accountability Act” targets all foreign companies listed in the U.S., it is widely believed that the Act targets Chinese companies in particular, especially after the outbreak of the Ruixing Coffee financial fraud scandal in 2020, the PCAOB introduced new regulations to eliminate or eliminate companies with financial fraud under the “Foreign Company Accountability Act “, to eliminate or eliminate the jurisdiction of overseas governments on the grounds of so-called national security, refused to PCAOB verification and investigation of the relevant audit institutions.
Information shows that there are currently 1,727 accounting firms registered with the U.S. Public Company Accounting Oversight Board, 853 of which are in 90 jurisdictions outside the U.S. The PCAOB inspects more than 200 overseas audit firms in more than 40 jurisdictions every three years. However, this is not possible in China and Hong Kong. 241 accounting firms listed by the PCAOB in 2019 refused to be inspected by the PCAOB on the grounds of cross-border oversight authority, 95% of which are from mainland China and Hong Kong.
Fang Xinghai, vice chairman of the China Securities Regulatory Commission, said at the Boao Forum for Asia in April that the claims of the U.S. Public Company Accounting Oversight Board are entirely reasonable . However, the PCAOB inspects Chinese accounting firms to comply with China’s rules and to abide by China’s national security and information security requirements. He said the China Securities Regulatory Commission advocates a joint inspection approach, but the regulatory measures proposed by the PCAOB, including delisting Chinese stocks if they are not allowed to be independently inspected by the PCAOB, or having to disclose information on the percentage of government ownership of Chinese stocks and whether there are any Communist Party members on the board of directors, is not a cooperative attitude.
How to choose after increased regulatory pressure
Guo Yafu, president of New York-based Tianjiao Fund Management, told Voice of America that Chinese companies listed in the U.S. are under increasing challenge and pressure in the face of increasingly stringent laws and regulations from U.S. regulators. If they are unable to meet the “compliance” requirements, they face three options for the future.
One way is to go private and become an unlisted company,” he said. The second is to go to a third country to be listed. For example, Singapore has been pulling good technology companies listed in the U.S. to list in Singapore, and provide some subsidies to high-tech companies, and support in listing fees, or dual-listed in Hong Kong. The third is that the worst and most inferior of those companies, after delisting in the U.S., can still return to China to list on the A-share. In short, good companies that have no problem raising money at all.”
Good Chinese technology companies, whether they list in the U.S. or in Hong Kong, are able to raise money, Guo Yafu said. Of course, they must consider the risks they may face in the future when they go public in the U.S.
Chinese companies listed in the U.S. that fail to have their accounting firm’s annual reports independently reviewed by the PCAOB in the future could be punished by delisting. Seventeen Chinese companies, including SMIC, CNOOC, China Mobile and China Unicom, have already been delisted from the U.S. stock market because of their perceived links to the Chinese Communist Party authorities and military, which could pose a risk to U.S. national security. China Mobile is now ready to go public on the Shanghai Stock Exchange with 960 million shares of stock.
Chen Zhaohui, a professor at the University of Virginia School of Business, believes the changes in U.S. regulations and policies are a reaction to the deterioration of U.S.-China relations, not because of increased problems with fraud or financial opacity by Chinese companies. However, he said, in the past, SMIC, China Unicom could still get exemptions from U.S. regulators in terms of scrutiny on the grounds that their financial audit reports were related to national security, and they will be forced to delist in the future if they still comply with Chinese laws and regulations and cannot disclose state secrets, I’m afraid.
It’s hard to say if there will be in the future,” he said. It all depends on the development of Sino-US relations. Now it seems that the development of Sino-US relations is going in the direction of deterioration, so the risk still exists, especially for technology companies, dual-use, and companies with military industry ties, which may be affected a little more. However, the more general, not involved in sensitive areas of the company, will not be greatly affected, at least not in the short term.”
U.S.-listed Chinese stocks increase rather than decrease
While scrutiny of Chinese companies listed in the U.S. has intensified, the U.S.-China Economic and Security Review Commission, a congressional advisory body, released a report on May 13 on “Chinese Companies Listed on Major U.S. Stock Exchanges,” saying the number of Chinese companies listed on the U.S. stock market has increased by 14 percent in the past seven months, from 217 in October last year to 217 in May this year. The number of Chinese companies listed on the U.S. stock market increased by 14 percent over the past seven months, from 217 in October last year to 248 in May this year, an increase of 31, with IPOs raising a total of $17.5 billion, more than four times the $4.1 billion raised during the same period last year. However, the report warns investors that investing in U.S.-listed Chinese companies can involve a variety of risks related to the legal, regulatory and financial environment in mainland China, including lack of transparency, the legal status of variable interest entities in China, and national security.
According to Guo Yafu, there are two main reasons why the number of Chinese companies listed in the U.S. is increasing rather than decreasing against the backdrop of increased U.S. regulation of Chinese companies. It is difficult to list in China, but with the development of the Chinese economy, many Chinese companies are eligible to list in the U.S.,” he said. The other reason is that the pandemic has not affected China’s economy much.”
The U.S. is the world’s largest capital market, making it a magnet for listed companies and investors, Guo Yafu said. Low interest rates in the U.S. have depressed the cost of financing for public companies. In addition, about 40 percent of the world’s unicorns (valued at at least $1 billion) are Chinese companies, and their desire to list in the U.S. is relatively strong. Moreover, the U.S.-China economic and trade exchanges over the past decades have created a large and efficient team that specializes in Chinese companies, listed companies.
Professor Chen Zhaohui said that after the U.S. stock market hit the bottom in mid-March last year, the three major indices rebounded all the way in the second half of the year and kept climbing higher, so it is a good time for companies to list on the NYSE and NASDAQ, not only Chinese companies, but even U.S. companies listed are increasing. When the stock market is good, financing will be easy and stocks will sell at high prices, he said. As long as the company is good, it can be listed in the U.S. soon. On the other hand, it is still more difficult for Chinese companies to go public in China, as they have to wait in line for approval and are more tightly regulated by the Chinese Communist authorities.
Times may be tougher in the future
During the Trump administration, especially in the later stages, a series of issues derived from the U.S.-China trade war and other issues have led to more tension between the two sides. Four months after Biden took office, will he inherit some of the policies from the Trump era in terms of China policy, especially the review and regulation of Chinese companies, or will he somehow moderate his previous tough policies? Will Chinese companies listed in the U.S. have a tougher time in the future? In response to this question, President Guo Yafu said that looking ahead, Chinese companies listed in the U.S. will not have a better time.
Guo Yafu said the performance of Chinese companies’ stocks is terrible. So far, KWEB, the Chinese Internet index, has fallen 36 percent from its peak, a worse decline than during last year’s epidemic. The continued weak slide in Chinese stocks is mainly due to the Biden administration following the lead of the Trump administration, which continues to pressure Chinese companies on audits, transparency and other aspects. In addition, the Chinese government has taken anti-monopoly initiatives, imposing sky-high fines on leading companies such as Alibaba. Therefore, with two major global economies striking one after another, it will certainly be a tough time for Chinese listed companies. Guo Yafu expects that whether Biden’s China policy will continue to follow the blueprint laid out by Trump may not be clear until after the U.S. midterm elections next year.
Professor Chen Zhaohui expects the U.S. to impose stricter regulations on U.S.-listed Chinese companies in the future, with more rules on sensitive areas and mergers and acquisitions of companies: “It will definitely not be an easy time for Chinese companies listed in the U.S. As long as the relationship between the U.S. and China continues to deteriorate, times will get tougher and tougher. Especially for those big companies that are linked to the Chinese government, be prepared to delist.”
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