China’s national security restrictions have threatened to come between Chinese firms and their overseas listings, but recently some of the rules were loosened. Chinese rules that have forbidden Chinese firms from being audited by foreign regulators in their listed countries, as well as rules that restrict overseas-listed Chinese firms from violating data privacy laws, have reined in enthusiasm over foreign listings by Chinese firms.
One of the rules was recently relaxed. On April 4, the China Securities Regulatory Commission and three other state departments revealed draft rules to provide better cooperation with foreign regulators in order to protect global investors. The draft rules remove the requirement for on-site inspections to be conducted only by Chinese regulators. Foreign regulators may now be provided with financial information, as long as what is provided does not disclose state secrets. The new law will loosen restrictions for Chinese firms that have faced difficulties in maintaining overseas listings, both from the Chinese and American sides.
However, there is no guarantee that all Chinese firms will measure up to U.S. audit standards. Some U.S.-listed Chinese firms continue to face potential delisting due to their noncompliance with audit rules. While some Chinese firms are gearing up to face additional audit measures, others may not survive. Internet portal Sohu announced on April 14 that it would exit the Nasdaq due to expected inability to meet U.S. audit requirements. Twenty-three companies are currently at risk of delisting, but no U.S.-listed Chinese firm is in compliance with U.S. audit rules. Therefore, many will have to submit to U.S. auditing, as is now permitted under Chinese law, or be forced off their U.S. stock exchanges.
U.S.-listed Chinese firms have also faced regulatory critique from Chinese authorities. A recent spate of regulations starting in 2020 resulted in the delisting of Didi on the New York Stock Exchange after one month. Chinese regulators stated that Didi was not in compliance with data security laws. Companies such as Alibaba and Baidu were asked to conduct internal inspections to strengthen their own compliance.
This came at a time of increasing scrutiny over privacy and cross-border information flows as well as rumors that China’s Variable Interest Entity structure, in which Chinese firms used offshore entities to list in the United States, might be eliminated. This latter concern was dampened when regulators indicated that the VIE structure would not be banned. Rules put forward by the China Securities Regulatory Commission has permitted the VIE structure under a mechanism for filing offshore.
The threat of delisting from both U.S. and Chinese regulators has been reflected in the share prices of U.S.-listed Chinese firms. Alibaba experienced declines in 2021 and 2022 for those reasons, as well as for a decline in earnings due to slowing economic growth in China. Baidu faced declines due to the regulatory threat but was able to avert a slowdown in sales due to its expanding artificial intelligence and cloud computing business. While JD faced mild declines due to the regulatory threat, it has been more resilient than other stocks, particularly with Walmart as the largest corporate shareholder and with ongoing overseas expansion. Netease has seemed to escape the brunt of the regulatory threat due to strong fundamentals.
Stock prices rebounded after China put forward the draft rule removing the auditing restriction on overseas-listed Chinese firms. After these firms pass U.S. auditing requirements, the threat of delisting due to audit noncompliance will be removed. In addition, the Chinese regulatory threat that was responsible for delisting Didi has appeared to die down. As Chinese firms emerge from the risk of regulatory crackdown, their share prices are likely to better reflect broader market and firm-specific forces.
U.S.-listed Chinese firms have experienced strong regulatory pressures in recent months, but the loosening of one such requirement may improve the outlook for these firms. Companies must still pass through the U.S. audit, but after that, their performance will likely be more contingent on their own fundamentals.