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Overseas-listed Chinese stocks have plunged amid tightened supervision both at home and abroad, yet investors ignore the overall robust Chinese economy when judging policies

By Luo Zhiheng , Fang Kun Updated Nov.1

The headquarters of New Oriental Education, Haidian District, Beijing. US-listed China education stocks including New Oriental Education, TAL Education and Gaotu Techedu experienced some of the sharpest declines

Share prices in US-traded Chinese companies have been sliding since July, far below the benchmark index. The S&P/BNY Mellon China Select ADR Index that reflects Chinese stocks trends saw an accumulative decline of 17.9 percent in July, while the S&P 500 and NASDAQ rose by 2.3 percent and 1.2 percent. Domestic adjustments to policies toward the internet, education and gaming sectors are pushing down stock market values of companies in these industries. In particular, after Chinese authorities in late July released strict regulations on education institutions in terms of training, profit and raising capital, the S&P/ BNY Mellon China Select ADR Index slumped by 15.8 percent between July 21- 27. Shares in education giants New Oriental Education & Technology Group and TAL Education Group plunged over 70 percent, while in the gaming industry, NetEase and Bilibili both slid over 20 percent.  

The falls in value are mainly caused by tightened supervision both at home and abroad and overseas investors are adjusting their understanding of the logic behind China’s development. On one hand, US-listed Chinese stocks are under pressure from tightened regulation in both countries, and on the other, overseas investors may have false expectations about China’s policies and thus lowered their risk appetite, failing to take in the overall picture of the Chinese economy that is progressing steadily.  

Behind the Fall 
Fluctuations in US-listed Chinese stocks grew more obvious in recent years against the backdrop of anti-globalization and global trade frictions. During the Trump-era, the US put pressure on US-traded Chinese companies in terms of complying with local accounting standards, which led to declines in share prices. In late summer, shares in Chinese companies plunged again and saw largescale selloffs, mainly because overseas investors have lowered their risk appetite.  

On the surface, the fluctuations are a result of tightening industry supervision policies and rocky Sino-US relations. The new education policies not only subverted the traditional operation and profit modes of extracurricular education in China, but also put it at risk of losing the ability to raise capital by going public. Before that, China’s cybersecurity review of ride-hailing firm Didi two days after it raised $4.4 billion in its New York IPO at the end of June shows the country is stepping up supervision over data security of internet companies. The worries of overseas investors about possible expansion of tightened supervision in the country have implications for Chinese stocks in other industries.  

Quarrels between China and the US have spilled over from trade to other fields including finance and technology, which leads to more frequent disturbances to Chinese stocks. For example, during the two highlevel China-US diplomatic talks held in Anchorage, Alaska and Tianjin in March and July, US-listed Chinese stocks were the first to be affected and plunged across the board, falling victim to the uncertainties.  

But the deeper reason is that overseas investors are reassessing the logic behind the country’s economic development. China’s development pattern is obviously changing – the goal is turning from efficiency to fairness, from speed to safety, and from letting some people get rich first to realizing common prosperity – while achieving common prosperity based on building a well-off society is becoming the dominant logic. But as Yuan Jiajun, Party secretary of Zhejiang Province, now a pilot area for achieving common prosperity in the country, said, “Common prosperity means a narrowing gap between regions and people rather than an equal level of prosperity at the same time or bulldozing the gap between the rich and the poor by robbing the rich.”  

The purpose of regulating the education sector, for example, is not to crackdown on certain companies but to boost efficient allocation of education resources and ensure people’s livelihoods, so it will not expand casually. Foreign investors require time to adjust their expectations about the policy. But it is easy for overseas investors to misread the policy before reaching a consensus and consequently lower their risk appetite overnight. Panic can spread fast and cause plunges in the stock market. Overreaction in the market has exaggerated the short-term effects of the policy but neglected that China’s economy is moving steadily forward overall and the foundation of its capital market remains sturdy.  

Changed Environment 
Chinese companies started to list overseas in 1993 when the domestic capital market just got going and the threshold for issuers was rather high, including restrictions on foreign investment. In June 1993, Qingdao Beer went public in Hong Kong, the first company from the Chinese mainland to list beyond the border. In 1994, Huaneng Power International was the first Chinese company to go public in the US.  

Overseas listing helps companies expand fundraising sources and use international capital to engage in global cooperation. Meanwhile, it helps improve the quality of listed companies at home. The domestic market learns from advanced systems abroad and pushes domestic-listed companies to do better in terms of disclosure, accounting and corporate governance.  

When there was no base for fostering technology start-ups in the early stages of the domestic capital market in the 1990s, the multi-tier capital market abroad had built a mutual-promotion virtuous cycle with the real economy and technology development. Going public abroad provided the foundation for a large number of Chinese internet tech companies to grow. Consumer-internet and information technology firms account for two-thirds of Chinese stocks traded abroad (in market value) and the top three are internet firms boasting market values in the hundreds of billions of US dollars.  

Now Chinese stocks play an important part in pushing two-way opening-up of the capital market. Chinese stocks have become a prime choice for global investors in allocating Chinese assets. The majority are traded in the US. According to Wind Financial Terminal, a Shanghai-based financial information provider, the market value of 285 US-listed Chinese stocks totaled US$1.8 trillion by the end of July, accounting for more than 3 percent of the overall stock market in the US. This year, the number of companies seeking listing in the US has rebounded after the blows from Sino-US friction and the coronavirus pandemic in 2020. Between January and July, 38 companies listed in the US, exceeding the total in 2020.  

But the environment for Chinese stocks has changed a lot. The Trump administration’s anti-globalization crusade has led to trade friction, the curbing of China in terms of technology and finance, and also measures that attempted to prevent US investment from flowing to China. In September 2019, reports that the White House was considering limits on US investment in China resulted in slumps in Chinese stocks. In November 2020, former US president Donald Trump banned Americans from investing in Chinese companies they claimed had military links. The S&P Dow Jones Indices thus removed some Chinese companies from its index products. A month later, Trump signed the HFCA (Holding Foreign Companies Accountable) Act into law, which is aimed at removing Chinese companies that fail to comply with US auditing standards from US exchanges.  

The Biden administration continued the toughness. It barred US investors from investing in even more Chinese companies in June. Several global index publishers said they would remove a number of Chinese companies from equity indexes. On July 30, the US Securities and Exchange Commission (SEC) said in a statement it will demand additional information disclosure from Chinese companies that seek to list in the US, including stating possible risks from oversight of the Chinese government. Chinese stocks listed in the US might face more regulatory pressure in the future.  

At home, China is tightening supervision of overseas-listed Chinese companies, but with a different purpose from the US government that increasingly uses financial regulation as a political tool. China is more pragmatic and deals with concrete issues in pushing cooperation in supervision, realizing that the differences in laws and phases of the capital market in the two countries are standing in the way of regulating listed companies. As China is pushing liberalization of capital flows in and out of the country, the two countries’ capital markets will be more tightly linked and more and more companies, investors and financial institutions will participate in each other’s markets, so enhancing cooperation in supervision is inevitable.  

At present, Chinese H-shares that are directly issued in the Hong Kong Stock Exchange by companies registered in the mainland are within regulatory scope. But companies that use a contract control or VIE (variable interest entities) structure, a common method among Chinese companies to get listed abroad that involves using an overseas registered shell company to control a company that actually operates within China’s borders, are not subject to substantive domestic regulation. China’s new securities law that came into effect in March 2020 stipulates that China-based companies that issue securities overseas or trade securities overseas should comply with provisions of the State Council, though which department will supervise overseas-listed Chinese stocks is yet to be clarified.  

China aims to prevent risks and promote safety and development by strengthening supervision of overseas listings. In July, Chinese authorities released a document about tightening the crackdown on illegal activities in the securities market. The document said China will adopt solid measures to cope with risks and emergencies involving Chinese companies listed abroad and promote the building of a supervision system. It also mentioned improving laws and regulations on cross-border data security and classified information management.  

On July 30, the Central Political Bureau of the Communist Party of China (CPC) called, for the first time, to improve the regulatory system for companies listed abroad. For China, the move is a response to internal and external changes. On the one hand, overseas-listed internet platforms need to be better regulated in China’s efforts to fight against monopolies, promote fair competition and prevent unregulated expansion of capital. On the other, frictions with the US in economic and financial areas are placing overseas-listed Chinese stocks in an increasingly rigorous regulatory situation, which makes it necessary to plan ahead to prevent financial risks that might be caused by forced delisting of Chinese companies.  

Striking a Balance 
Improving the capital market system needs to balance enterprise development and economic security. At the primary stage of the capital market in China, many companies had to go abroad to list and the regulatory system left some room for this, which provided conditions for emerging industries to grow. While helping with financing, however, practices like using the VIE structure caused a supervision vacuum.  

Today, the threshold for going public has substantively reduced in China and regulators have increased efforts to crack down on illegal activities. While making up the weak spots in oversight of overseas listing, it is more important to build a system that allows a smooth return of overseas-listed companies to promote financial openness and security, hold the bottom-line of preventing financial risks and improve the quality and efficiency of using finance to serve the real economy.  

In the future, Chinese stocks may seek second offerings in other countries and regions to mitigate risk. The US was seen as the first choice to list overseas for its advantages for investment and financing, possessing the largest financial market capacity and the biggest scale of institutional investors. But in recent years, other overseas markets such as the UK, Singapore and Hong Kong have improved their financial infrastructure and systems, making them options for secondary offerings.  

Besides, firms can go back and trade shares at home. In June 2018, the China Securities Regulatory Commission (CSRC) released a document allowing Chinese companies that go public overseas via a VIE structure to trade in the A-share market (yuan-dominated equity shares of China-based companies) at home by issuing CDRs (Chinese Depositary Receipt). Following a pilot of a registration system in the country’s sci-tech innovation board (STAR market) and ChiNext, its Nasdaqstyle board of growth enterprises, in 2019 and 2020, now returned eligible Chinese stocks can directly go public in the A-share market.  

In April 2020, the CSRC announced a lowering of the previously rigorous listing requirements in market value for overseas-listed Chinese companies with competitiveness in scientific and technological innovation, which offers more possibilities for similar companies to get listed at home. In the future, overseas-listed Chinese companies in traditional industries may choose to go back to the Main Board, while tech companies may go public in the STAR market or ChiNext.