Removing Chinese companies from the list could be detrimental to investors. But it’s the right thing to do

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Individual investors who own Chinese stocks listed in the US could see the biggest disruption to recent legislation paving the way to delisting Chinese companies in three years, a possible unintended consequence of a targeted boost. to protect investors.

It is not yet clear how the Securities and Exchange Commission can implement the Foreign Companies Liability Act, which was passed with the support of both parties and is expected to be signed by President Donald Trump. If regulators in the US and China fail to compromise on long-standing audit and disclosure issues, US-listed Chinese companies may be able to do so.

Most of the larger investors, including fund managers who own US-listed Chinese stocks, should be able to maneuver through the various ways delisting could occur. But smaller retail investors who own individual stocks could have a harder time.

The SEC requires that all publicly traded companies be registered with the Public Companies Accounting Oversight Board, which must verify the accuracy of company audits. But the Chinese government does not allow foreign oversight of audit documentation without its permission, and Chinese companies listed in the United States have not adhered to this standard. That hasn’t stopped investors from buying these companies, which represent $ 2 trillion in market value.

Alibaba Group Holding

(ticker: BABA) makes up the bulk, but there are more than 200 companies on US exchanges.

Many policy watchers and fund managers hope the two nations will reach some kind of compromise, perhaps with joint audits. Meanwhile, widely owned Chinese companies, such as Alibaba,

JD.com

(JD) and

NetEase

(NTES) have already looked for side ads closer to home. Others like

JD Health International

(6618.HongKong), the health care unit of JD.com, will remain local for its public debuts. That trend will accelerate, especially if it is more likely to be delisted. Over time, the multiples of these companies could even benefit if they returned home while turning to domestic investors more familiar with their businesses.

Currently, more than 100 Chinese companies are listed in the US, including

Baidu

(BIDU) and

Pinduoduo

(PDD) and Chinese EV stocks such as

Child

(NIO) and

Xpeng

(XPEV): you don’t have a sublist. If regulators cannot agree on audit oversight, fund managers expect China to ease the requirements so that a large majority of these companies can be listed on the Hong Kong or Shanghai stock exchanges.

The bill comes at a time when investors are grappling with a strained relationship between the United States and China, even as strategists and larger institutional investors advocate greater exposure to China. The appeal of investing in China has grown steadily, especially this year, as the nation recovers faster from the pandemic and its stocks outperform their American counterparts. the

MSCI

China’s index is up about 25% this year.

In an opinion piece last week, former Treasury Secretary Hank Paulson wrote that “efforts to delist legitimate Chinese companies” carry serious risks. He warned that China is becoming a major challenge for the United States in financial markets and the dangers of making it difficult for American investors to own Chinese stocks while global investors benefit from doing just that.

For institutional investors, the cost of switching between a listing in the US and Hong Kong is small, and many have already exchanged their holdings. Others are monitoring the situation. If the three-year clock for delisting starts ticking, the KraneShares CSI China Internet ETF (KWEB), for example, would likely convert its holdings and ask its index provider to do the same, says Brendan Ahern, investment director of China focused Krane Fund Advisors.

That’s not a breakthrough for the New York Stock Exchange (

ICE

) or Nasdaq (NDAQ), although it helps

Hong Kong exchanges and clearing

(388. Hong Kong), whose shares are up 52% ​​this year.

Retail investors who own individual Chinese stocks have fewer options. While some brokerages, such as Fidelity and Interactive Brokers, allow clients to invest in currencies with relative ease, Schwab requires a global account, and Vanguard and Robinhood do not allow currency trading at all. Investors can always transfer their shares to a company that does, but that comes with costs. Possession of foreign securities also comes with its own additional paperwork at tax time.

Other risks arise if the situation is not resolved in an orderly manner, if some smaller companies are unable to list elsewhere, or if there is a commitment that does not include Chinese SOEs. Some of these companies could go private, which could hurt shareholders based on the price offered. Others could be excluded from the list and homeless.

Typically, companies are delisted due to fraud, financial problems, or developments that conflict with listing requirements. These companies can often continue to trade over the counter, albeit with less liquidity.

But this bill also applies to Chinese companies that trade without a prescription. The three-year window makes liquidity unlikely to run out overnight, and larger investors will help smooth out any delisting process, says Roger Silvers, a former senior SEC economist who He is now an assistant professor of accounting at the University of Utah and consults with foreign regulators. Earlier this month, The Wall Street Journal reported that the SEC was considering a proposal that would allow Chinese companies to comply by using an accounting firm based somewhere that would allow auditors to open their books to the PCAOB. And companies would have to accept responsibility.

Retail investors are often the hardest hit by changes like these, one of the reasons why experts recommend that individual investors use funds or ETFs rather than buying individual stocks, says Barbara Roper, the Federation’s director of investor protection. Consumers of America. “I sympathize with those who are hurt by loss of liquidity or falling valuations, but the policy is still correct,” he says. “Investors benefit best by investing in companies that comply with basic laws designed to ensure that their financial disclosures are reliable.”

Given the potential scenarios, it might be easier for retail investors to rethink how they get exposure to China. Leaving the logistical challenges created by the bill and the task of discovering the best opportunities amid the disruption for asset managers may be the least demanding option.

Write to Reshma Kapadia at [email protected]