Q&A on the regulatory risks hanging over Chinese tech stocks

Chinese stocks are facing headwinds from both sides of the Pacific. The United States have been pushing regulation that directly targets Chinese firms listed in the US and may lead to their delisting, while China is actively enforcing tough new regulation on the technology sector. The consequence has been a ~30% drop in the price of Chinese ADRs (mostly US-listed Chinese tech firms) since February 2021.

Q1: What is the size of the US-listed Chinese equities market?

There are currently about 250 Chinese firms listed in the US with a total market capitalisation of USD 1.7 trn. American Depositary Receipts (ADRs) account for the overwhelming majority of these listings.

Q2: What is the Holding Foreign Companies Accountable Act (HFCAA) and why does it matter for Chinese firms?

HFCAA prohibits the securities of a company from being listed on US exchanges if the company has failed to comply with the Public Company Accounting Oversight Board’s audits for three years in a row. In effect, HFCAA could result in the delisting of Chinese companies’ stocks listed in the US.

Q3: What is Executive Order #13959?

Executive Order #13959 essentially bars US persons from investing in any security of companies deemed to be related to Chinese military activities. There are currently 59 entities identified as such.

Q4: How serious is the delisting risk and what can Chinese firms do about it?

The risk of delisting from US exchanges is real, especially for firms closely tied to the Chinese military or government. Also, HFCAA could lead to a delisting of most US-listed Chinese stocks. Those with an alternate listing in Hong Kong are best protected.

Q5: What happens to an ADR in case of delisting?

A delisting usually leads to a termination of the ADR programme, whereby holders typically receive the corresponding local shares (or cash in some cases). However, investors stand a liquidity risk in case the programme is not terminated, of if the corresponding local shares are not exchange traded.

Q6: Why is the Chinese government cracking down on tech firms?

The Chinese authorities have recently intensified their scrutiny of the tech industry in order to curb monopolistic behaviour, adapt regulation to the digital economy, and ensure proper collection and use of personal data, especially when cross-border flows are involved.

Q7: Why do Variable Interest Entities (VIEs) matter?

This ubiquitous legal structure has historically allowed Chinese firms, particularly tech firms, to circumvent domestic restrictions on foreign investment in certain industries. Chinese authorities are increasingly clamping down on this regulatory loophole.

Q8: Are US listings over for Chinese tech companies?

US listings for Chinese firms have been dealt a severe blow, though not a mortal one. US issuance is set to be muted for the rest of this year, probably to the benefit of Hong Kong.

Q9: Are Chinese tech stocks still investable?

We remain positive on Chinese tech over the long term but acknowledge that patience is needed as Chinese companies adapt to the new regulations. While the regulatory overhang is likely to persist until the end of this year, resumption of strong earnings growth should lead to an eventual re-rating.