(Bloomberg) – For two decades, Chinese tech companies have flocked to the US stock market, attracted by a friendly regulatory environment and a large pool of capital eager to invest in one of the world’s fastest growing economies .
Now the heavyweight behind hundreds of companies worth $ 2 trillion seems to have stopped in its tracks.
Beijing’s July 10 announcement that nearly all companies trying to go public in another country will need approval from a newly empowered cybersecurity regulator amounts to a death knell for China’s initial public offerings in the United States , according to longtime industry observers.
“It is unlikely that there will be any Chinese companies listed in the United States in five to ten years, other than maybe a few large ones with secondary listings,” said Paul Gillis, professor at the Guanghua School of Management of Peking University in Beijing.
The crackdown, sparked by Didi Global Inc.’s decision to go ahead with a New York listing over objections from regulators, is already sending shockwaves through the markets. A gauge of Chinese stocks traded in the United States has fallen nearly 30% from its recent high. For investors in companies that have not yet been listed, there is growing uncertainty about when they might get their money back. Wall Street companies are bracing for lucrative underwriting fees to dry up, while Hong Kong is expected to benefit as Chinese companies seek alternative – and politically safer – locations closer to home.
It’s hard to overstate the importance of the US markets for Chinese companies. The first wave began selling US certificates of deposit – surrogate securities that allow investors to hold stocks overseas – in 1999. Since then, more than 400 Chinese companies have chosen US exchanges for their primary listings. , raising more than $ 100 billion, including most of the tech industry. Their stocks went on to profit from one of the longest bull markets in history.
Hong Kong-based website operator China.com Corp. started the trend when it went public on Nasdaq in 1999 during the dot-com bubble. The stock, under the symbol CHINA, jumped 236% in its early days, enriching founders and backers, and showing Chinese internet companies a path to foreign capital – if only they could find a way around them. strict regulatory controls of the Communist Party.
Unlike Hong Kong companies, whose laissez-faire approach to business meant there were few rules on corporate fundraising, mainland-based private companies faced much greater hurdles. Foreign ownership in many industries, especially the sensitive internet industry, was restricted, while overseas registration required approval from the Chinese State Council, or cabinet.
To get around these hurdles, a compromise was found in the form of a variable interest entity – a complex corporate structure used by most ADRs, including Didi and Alibaba Group Holding Ltd. in 2000, Chinese companies are transformed into foreign companies with shares that foreign investors can buy. Legally flawed, difficult to understand, this solution has nevertheless proved acceptable to American investors, Wall Street and the Communist Party.
Back in China, the government was taking steps to modernize its stock exchange, which only reopened in 1990, after having been closed 40 years earlier following the communist revolution. In 2009, the country launched the Nasdaq-style ChiNext board in Shenzhen. Under Xi Jinping, who became president in 2013, access to the outside world was significantly increased, including trade ties with Hong Kong that allowed foreign investors to buy mainland stocks directly. In 2018, China launched a test program to compete with ADRs, but it failed to gain traction.
The most radical step came in 2019 when Shanghai opened a new stock exchange site called Star board, which minimized bureaucracy, allowed unprofitable companies to register ashore for the first time, and removed a cap on price movements on the first day. It also removed an unwritten valuation cap that required companies to sell their shares at 23 times earnings or less. But mainland stock exchanges still don’t allow dual-class stocks, popular with tech companies because they give founders more voting power. Hong Kong introduced the structure in 2018.
The goal was to create an environment that would allow Chinese technology companies to successfully register in their country and be less dependent on American capital. This need has become all the more pressing as tensions between Beijing and Washington increased during the latter part of former President Donald Trump’s presidency. Trump has introduced tough new rules that mean Chinese companies can be banned from stock exchanges in a few years if they refuse to provide financial information to US regulators.
While secondary listings in Hong Kong have picked up, Chinese companies have always preferred New York, where it takes weeks rather than months to process an IPO application. China’s tight capital controls meant that national stock exchanges could not compete with New York on liquidity and the much higher valuations of tech companies. China Inc. has raised $ 13 billion from the first sales of shares in the United States this year alone.
After Didi’s controversial IPO on June 30, it looks like the Communist Party has decided it has had enough.
“The death of ADR was inevitable,” said Fraser Howie, author of “Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise”. “What is interesting is the mold and the template that make it possible to achieve this result. It comes from a mindset of control and repression of business. It is very different from a state of mind of reform and building markets at the national level.
Beijing’s move to regulate overseas IPOs coincides with tighter controls on Chinese tech companies, many of which have near-monopolies in their fields and vast pools of user data. This campaign to curb the tech industry has gained momentum in recent months as Xi seeks to limit the influence of the billionaires who control these companies.
For Chinese companies already listed in the United States, what happens next largely depends on what China does with VIEs. Banning them outright would be unlikely, as it would force companies to withdraw from foreign exchanges, undo that structure and then re-register – a costly process that would take years. The updated regulations should be ready in a month or two, people familiar with the matter said.
Hong Kong is increasingly emerging as a viable alternative. On the one hand, China plans to exempt Hong Kong’s IPOs from first seeking approval from the country’s cybersecurity regulator, Bloomberg reported last week. During a forced delisting from the United States, companies that have previously sold shares in Hong Kong – like Alibaba and JD.com – can migrate their main listing to the city. Written off U.S. receipts, which can still be exchanged over the counter, will not be worthless because they represent an economic interest in the business. Hong Kong’s open markets and the currency pegged to the greenback should facilitate the conversion.
Holders can sell their ADRs before they are delisted or convert them into Hong Kong listed ordinary shares without much disruption. A company that chooses to end its ADR program entirely can also pay a dollar amount to investors.
Either way, it looks like the two-decade era that saw China’s listing of China’s most successful and powerful private companies in the United States is coming to an end. Beijing’s message is clear: The Communist Party will have the final say on just about everything, including IPOs.
“It is really important to own companies aligned with the guidelines of the Chinese government,” said Tom Masi, co-portfolio manager of GW&K Investment Management’s emerging wealth strategy fund, half of its money of which is invested in stocks. Chinese. “I would not fund companies that will bypass whatever the Chinese government wants to accomplish.”
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