COMMENTARY: Banning Chinese Listings on U.S. Stock Exchanges May Be Next Element in Trade War

Bipartisan bill in Senate targets China’s refusal to allow audits of company books, and a little flexibility in Beijing would go a long way to stave it off.

Mark Melnicoe
    Jun 22, 2019 5:05 AM  PT
COMMENTARY: Banning Chinese Listings on U.S. Stock Exchanges May Be Next Element in Trade War
author: Mark Melnicoe   

The trade war, which has already morphed into a technology war, may now be on the verge of extending into the realm of financial markets as the economic decoupling of the U.S. and China continues.

A bill introduced in Congress earlier this month would banish foreign companies from listing on U.S. stock exchanges if they do not allow American officials to inspect their financial audits. Only two countries – China and Belgium – refuse such access from U.S. regulators, and the bill is aimed squarely at China.

"Beijing should no longer be allowed to shield U.S.-listed Chinese companies from complying with American laws and regulations for financial transparency and accountability," said Florida Sen. Marco Rubio, a co-sponsor of the Senate bill. "If China-based companies want to list on stock exchanges or access capital markets in the U.S., we should make them comply with American laws."

The bill would provide a three-year window for the companies to either comply or delist from American exchanges. Most U.S.-listed Chinese companies – 92 in all - are on the Nasdaq. China's position is that handing over the audits would violate its sovereignty.

Impacted would be some of the biggest tech companies in the world, including Alibaba (NYSE: BABA), Baidu Inc. (Nasdaq: BIDU), and Ltd. (Nasdaq: JD).

Steve Bannon, the ultranationalist former adviser to President Trump, told the South China Morning Post that the U.S. needs to shut Chinese companies completely out of U.S. stock markets.

"The next move we make is to cut off all the IPOs, unwind all the pension funds and insurance companies in the U.S. that provide capital to the Chinese Communist Party," he said in a recent interview with the Hong Kong-based paper.

In truth, even getting access to the audits may be of limited value. Numerous scandals have embroiled Chinese companies that have provided phony numbers in order to cheat shareholders and boost local governments' desire to report strong GDP figures.

China's main statistical bureau last year reported that nearly 1,200 companies and 2,775 investment projects falsified their books by overstating their earnings and hiding losses. The report covered January to April of 2018 and found that, in total, 80 percent of the observed records were fraudulent - quantifying the extent of cheating by Chinese companies despite the law.

Local statistics agencies were also found with incorrect numbers in their audits – the documents that Rubio and others are seeking.

The stakes are quite high. As of February 25, the total valuation of then 156 Chinese companies listed on American exchanges exceeded $1.2 trillion, according to the U.S.-China Economic and Security Review Commission.

The Nasdaq, in particular, is not eager to lose these listings. Bob McCooey, senior vice president of the New York-based Nasdaq, dismissed Bannon's suggestion in a message last month on the WeChat Chinese messaging system.

"Like many of you, I have seen the comments by President Trump's FORMER and discredited adviser Steve Bannon. I do not believe these words to have any truth," McCooey wrote. "With 22 IPOs from China in 2018 and 15 already this year, we look forward to welcoming many Chinese companies to Nasdaq and supporting them as members of our family of global leaders."

Indeed, based on the number of initial public offerings, Chinese companies aren't exactly leaving the U.S. markets. Luckin (LK: Nasdaq), the Chinese coffee house chain that is challenging Starbucks, raised more than half a billion dollars in an IPO this month.

Yet there are some unsettling moves. Alibaba Group Holding Ltd., the world-beating e-commerce giant that held the biggest IPO in Wall Street history five years ago, reportedly has applied for a second listing in Hong Kong. Some worry that a wave of companies may start looking at options outside the U.S.

Paul Gillis, a Peking University professor and an expert on accounting in China, said in an online post that he expected the bill "has a good chance of passing," according to the Nikkei Asian Review. "That will start the three-year countdown for negotiations, or for the companies to find another listing home. I expect most of them will move their listings to Hong Kong." 

That would be a shame because this whole issue could be easily solved if Chinese authorities would loosen their stance. There is nothing unreasonable about putting foreign companies listing in the U.S. under the same requirements faced by domestic firms. It is U.S. law, after all.

A continuing refusal by China to open the audits only plays into the hands of hardliners like Rubio and Bannon. The harshness of the trade and technology war is bound to rub off in other areas, especially with authoritarian, inflexible leaders such as Trump and Xi Jinping.

The two leaders are set to talk next week at the G20 summit in Japan, with a relaunch of trade talks in the wings. But it wouldn't be a good idea to expect much from it. The issues separating the U.S. and China on trade seem insurmountable, as both sides dig in with no face-saving way out. Trump is likely to impose 25% tariffs on the remainder of Chinese imports before long – a move that will shake markets and increase consumer prices on products ranging from toys to smartphones.

And unless there's an unlikely thaw in relations, the next stage of economic separation may be in the financial markets. Even before the bill was introduced, analysts at Bank of America Merrill Lynch said there was a "moderate risk" that some Chinese companies will choose to delist.

Maybe this is Beijing's chance to make a game-changing concession.