Latest developments regarding Chinese ADRs

1)  What is the latest development of the Chinese ADRs issue?

• There are positive developments in removing the overhang on US-listed Chinese companies.
  
• Over the weekend, the China Securities Regulatory Commission (CSRC) has initiated a revision on “Provisions on Strengthening Confidentiality and Archives Administration of Overseas Securities Offering and Listing by Domestic Companies". We believe this is an important step for China to help resolve the US ADR issue given this has been going on for a long time. Previously, US authorities found it challenging to conduct a comprehensive review for Chinese companies under the Foreign Company Accountability Act.
  
• The revised provisions deleted “Onsite inspection should be conducted by Chinese regulatory body or rely on their inspection result”. The revision indicates China’s willingness to assist companies listed offshore to collaborate with the US audit requirement.
  
• It also indicates that Chinese authorities are supportive of business developments in the global financial market.
  
• Following this development, we believe the likelihood of de-listing has decreased, potentially removing a significant overhang for Chinese companies.
• We will continue to monitor the response from US regulators and more details on the full access on audit reports of foreign-listed companies.
  
• We believe this positive development could trigger a short-term rebound on the stock prices of ADR.
  
  

2)  What happened to Chinese companies listed in the US prior to the latest development?

• The Foreign Company Accountability Act by US Securities and Exchange Commission (SEC) aims to enhance the audit quality of companies in foreign jurisdictions in general and is not specific to Chinese companies.
  
• The issue is that the US Public Company Accounting Oversight Board (PCAOB) found it challenging to conduct a comprehensive review given the Chinese jurisdiction.
  
• It is not that Chinese companies are not willing or unable to provide such information.
  
• While this matter has been going on for a long time, this has recently received further investors' attention as US SEC announced the first batch of five non-inspection Chinese companies last month.
  
• These five Chinese companies are named by SEC because they are the first to file annual reports with the regulator, and we may see more companies added to the list.
  
• It is worth noting that most of the large US-listed Chinese companies already have a secondary listing in Hong Kong.
  
  

3)  What are the key implications should Chinese companies are to be de-listed in the US?

Investors have two critical questions: i) whether the Hong Kong equity market can absorb all the fundraising due to Chinese equities' homecoming and ii) whether international money will follow.

i) Will the Hong Kong market be under liquidity pressure?
It is of our view that liquidity pressure on the Hong Kong equity market should be minimal, given the following:

• The share conversion procedures for company listing in Hong Kong do not involve buying and selling. It is a mere re-registering of shares to the Hong Kong Central Clearing and Automated Settlement System (CCASS) system.  
  
• Although some companies may decide to issue new shares while doing the secondary listing, historically, most large companies only issue a small portion (~3% to 5%) of their market cap as new shares. 
  
• Dual-primary listed stocks may be added to Southbound Connect, attracting further inflows from China's onshore investors.  
  
• The 30 largest Chinese companies’ US ADRs with turnover over US$10mn, have a total market cap of USD284bn.¹  Together they account for 5.2% of the Hong Kong exchange's currently listed market cap or 5.4% of the current turnover. Many large ADRs are already dual-listed in Hong Kong, so the impact should be minimal.

ii) Will all international capital flow follow?

• We believe not all international capital flows will follow should the Chinese companies are listed only in Hong Kong. 
• The turnover velocity of the Hong Kong exchange on a relative basis was lower than the US and Mainland China. For companies currently dual-listed in the US and Hong Kong, a large portion of the trades are conducted in the US. The turnover is likely to be lower after the migration.
  
  

4) What is the outlook for the ADR issue?

• The US set a 2024 deadline for kicking non-compliant companies, i.e. the first de-listing (if it happens) will not occur until 2024.
  
• There is still time for the regulator on both sides to work out a resolution. The matter is usually resolved closer to the deadline.
  
• The key is that authorities are willing to work towards a resolution. The recent announcement by the Chinese regulators has demonstrated China's willingness to work on the issues.
  
• Therefore, we are hopeful to see positive outcomes come along in removing the de-listing risks.
  
  

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

When investing in less developed countries, you should be prepared to accept significantly large fluctuations in value.

Investment in certain securities listed in China can involve significant regulatory constraints that may affect liquidity and/or investment performance.

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