How the U.S. Is Moving Closer to Delisting Chinese Firms

1. Why does the U.S. want access to audits?

The 2002 Sarbanes-Oxley Act, enacted in the wake of the Enron Corp. accounting scandal, required that all public companies have their audits inspected by the U.S. Public Company Accounting Oversight Board. According to the SEC, more than 50 jurisdictions work with the board to allow the required inspections, while two historically have not: China and Hong Kong. The long-simmering accounting issue morphed into a political one as tensions between Washington and Beijing ratcheted up during the administration of President Donald Trump. The Chinese chain Luckin Coffee Inc., which was listed on Nasdaq, was found to have intentionally fabricated a chunk of its 2019 revenue. The following year, in a rare bipartisan move, Congress moved to force action.

As required by the law, known as the Holding Foreign Companies Accountable Act or HFCAA, the SEC in March started publishing its “provisional list” of companies identified as running afoul of the requirements. While the move had long been telegraphed, the first batch of names fueled a sharp decline in U.S. shares from companies based in China and Hong Kong as it dashed hopes for some kind of compromise. In all, the PCAOB has said it’s blocked from reviewing the audits of more than 200 companies based in China or Hong Kong. Those companies say Chinese national security law prohibits them from turning over audit papers to U.S. regulators. SEC Chair Gary Gensler in late March said that the Chinese authorities faced “a hard set of choices.” Days later, China said it would modify a 2009 rule that restricted the sharing of financial data by offshore-listed firms, potentially clearing one obstacle.

3. What is China changing? 

The China Securities Regulatory Commission said the requirement that on-site inspections should be mainly conducted by Chinese regulatory agencies or rely on their inspection results would be removed. It said it would provide assistance for cooperation with foreign regulators. The CSRC said it’s rare in practice that companies need to provide documents containing confidential and sensitive information. However, if required during the auditing process, they must obtain approvals in accordance with related laws and regulations. The April 2 announcement came weeks after China’s top financial regulator said it supported overseas listings, and Chinese authorities promised greater policy stability following a series of regulatory crackdowns that have rattled markets.

4. What’s the broader issue?

Critics say Chinese companies enjoy the trading privileges of a market economy — including access to U.S. stock exchanges — while receiving government support and operating in an opaque system. In addition to inspecting audits, the HFCAA also requires foreign companies to disclose if they’re controlled by a government. Meanwhile, the SEC is also demanding that investors receive more information about the structure and risks associated with the shell companies, which are known as variable interest entity or VIEs, that Chinese companies use to list stocks in New York. Since July 2021, the SEC has refused to greenlight new listings. Gensler has also said more than 250 companies already trading will face similar requirements.

5. How soon could Chinese companies be delisted?

Nothing is going to happen this year or even in 2023 — which explains why markets initially took the possibility in stride. Under the HFCAA, a company would be delisted only after three consecutive years of non-compliance with audit inspections. It could return by certifying that it had retained a registered public accounting firm approved by the SEC. However, when the SEC actually started publishing firms’ names, the market reacted sharply. For example, the Nasdaq Golden Dragon China Index plunged 18% during the week ended March 11, after the agency released the first five names.

It’s a rolling process and a function of when companies report their annual financials and an auditing firm that the PCAOB has identified as being non-compliant. For example, Yum! China Holdings Inc. reported on Feb. 8 in New York, and it was added on March 8. The social media platform Weibo Corp. was added on March 23 and Baidu on March 30. 

7. Ultimately, how many will be affected?

There’s not much discretion. If a company from China or Hong Kong trades in the U.S. and files an annual report, it will be on this list soon because these have been identified as non-compliant jurisdictions. In the March interview Gensler also pointed out that the American law focuses on non-compliant countries rather than specific companies. So if one request is blocked, it means the requirement isn’t being satisfied.

8. Are some of them really controlled by China’s government?

Major private firms like Alibaba could probably argue that they are not, although others with substantial state ownership may have a harder time. As of May 2021, the U.S.-China Economic and Security Review Commission, which reports to Congress, counted eight “national-level Chinese state-owned enterprises” listed on major U.S. exchanges. 

9. Why do Chinese companies list in the U.S.?

They are attracted by the liquidity and deep investor base of U.S. capital markets, which offer access to a much bigger and less volatile pool of capital, in a potentially speedier time frame. China’s own markets, while giant, remain relatively underdeveloped. Fundraising for even quality companies can take months in a financial system that is constrained by state-owned lenders. Dozens of firms pulled planned IPOs last year after Chinese regulators tightened listing requirements to protect the retail investors who dominate stock trading, as opposed to the institutional investors and mutual-fund base active in the U.S. And until recently, the Hong Kong exchange had a ban on dual-class shares, which are often used by tech entrepreneurs to keep control of their startups after going public in the U.S. It was relaxed in 2018, prompting big listings from Alibaba, Meituan and Xiaomi.

10. How else has China responded?

In December, China unveiled new rules that require all companies seeking IPOs or additional share sales abroad to register with China’s securities regulator. The requirements apply to new shares only and won’t affect the foreign ownership of companies already listed overseas such as Alibaba or Baidu. However, Chinese firms in industries banned from foreign investment will need to seek a waiver before proceeding with share sales and overseas investors in such companies would be forbidden from participating in management and limited in their ownership. 

(Updates with CSRC rule change in section 3. An earlier version of this story was corrected to delete reference to Alibaba’s Feb. 24 report.)