Chinese Securities to be Delisted? Will Alibaba, JD.com, and Nio Crash?
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What is the Holding Foreign Companies Accountable Act?
The Holding Foreign Companies Accountable Act is a bill which seeks to protect investors by requiring any company traded on a US exchange to place their company audits under the purview of the Public Company Accounting Oversight Board (PCAOB).
This requirement runs against guidelines the Chinese government has in place to prevent companies from taking any action which risk exposing national secrets. The Chinese government has expressed a belief that these mandates apply to information exposed within these audits.
Is This a Recent Issue?
While the exact act is new, the heart of what it seeks to accomplish and the conflicts that presents between the US and China have existed for over a decade. Chinese companies first gained access to US capital markets back in 2009 with the listing of China Green Agriculture Inc. In 2013, the PCAOB granted leeway to Chinese companies allowing them market access while not holding them completely to the established standards of financial reporting and transparency.
What Happens to My Stock if a Company Gets Delisted?
While the underlying business of a delisted company may not change, it could still impact you financially. Losing access to a capital market (at least partially as delisted securities could still be part of exchange traded funds or mutual funds) impacts awareness, liquidity, and ultimately valuation. Upon removal from an exchange, a company could see their market cap shrink overnight even though they still generate massive annual sales.
It is important to understand that simply because a company no longer trades on one of the primary markets does not nullify your holding. As a rule, even if your broker does not allow trading of over the counter stocks they may allow you to sell your shares of a delisted holding. Situations vary and you should always verify your options with your particular broker.
Why a Mass Delisting Might Not Happen
Mutual interest– With over two hundred companies listed representing trillions of dollars of invested capital Chinese companies are a strong part of the New York Stock Exchange. The US benefits from the
ability to meet an obvious demand while China benefits from the visibility, accessibility, and increased valuation access to the world’s largest stock exchange brings. In the same vein, fraud runs against the interest of both countries. It harms investor confidence, is a drain on market resources, and looks bad for the companies which are a source of nationalistic pride.
A Long Enough Timeline for Cooler Heads to Prevail: With a guidance for delisting “within three years” there is time for both countries to act in their best interest and reach a compromise to avoid such action.
Recent comments from officials in both countries points to ongoing discussions and hope that the current issues are not insurmountable. With much of the interest of both countries aligned, an agreement allowing companies such as Alibaba and Nio to continue to trade, currently appears inevitable.
Not as Far Apart as Initially Feared– Many of the larger companies in China are routinely audited by well-respected firms and have been for years. Alibaba is audited by the Hong Kong branch of the well known
auditing firm Price Water House Cooper.
The Elephant in the Room- Luckin Coffee, the Starbucks of China
In 2019, the Nasdaq did take the action of delisting a security. Luckin Coffee, a seeming fast growing coffee shop which was gaining a reputation as “the Starbucks of China” reported inflated sales numbers far beyond what they had earned. These inflated sales numbers made it appear that they were growing at a much more rapid pace than their sales supported and promoted hope for a faster and greater expansion based on demand which may not have existed.
Here, a company inflated their number and their actions directly harmed investors. This presented exactly the situation the government is attempting to protect investors from by enforcing tighter standards, including PCAOB overview. Where this gets interesting is if we look at the auditor of record for Luckin Coffee, at that time, and note that they appear to have been a branch of Ernst and Young one of the most established and reputable auditing companies in the world. So what happened? It appears that E&Y had audited Luckin Coffee in recent years, but the fraud in 2019 came to light prior to that year’s audit.
The goals of greater transparency and understanding of the numbers for the company you are investing in is always a noble thing. Audits are not perfect, they are not real time, and they depend on the good faith and openness of the employees the audit firm must work with.
Do Chinese Stocks Have a Role to Play in a Responsible Portfolio?
On balance, I feel certain Chinese securities can play a moderate role in one’s portfolio. The size of the Chinese Economy is too large to simply cut yourself off from. Companies such as Alibaba are audited by respected firms and I believe the chance of a full delisting to be low. The companies I currently consider holding are limited, but I will not throw out Alibaba with the likes of Luckin Coffee.
Questions for the Community
What actions are you taking?
Do you feel the current market action has created an opportunity or do you feel there is too currently too much risk?
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