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CHINA is the only one of the world’s three larg- est economies in which a significant number of its most important companies are listed on share markets outside direct regulatory control of their home country’s main fi nancial administration. Almost all major U.S. companies are listed in the U.S. The same applies in Japan. But many Chinese companies are listed in Hong Kong， part of China but with separate regulation and capital markets from China’s mainland economy. Furthermore a signifi cant number of Chinese companies are listed in London and the U.S.
This was highlighted by Alibaba’s IPO on the New York Stock Exchange. Alibaba became the history’s largest IPO. But this success was only the latest upswing of a roller coaster record of U.S. listings by China’s companies. The wild oscillations raise two questions：
Immediately， what can be done to minimize risks for U.S. listed Chinese companies？
Over the long run can these risks be controlled – is it strategically sensible for China， and for China’s companies， to list in the U.S.？
Analyzing short-term risk， recent IPOs are not the fi rst time Chinese companies have rushed to U.S. listings. In 2008-2011 over 60 Chinese companies listed on U.S. exchanges – 38 in 2010 alone. But by 2012 this had collapsed to two new listings. This precipitate fall accompanied accounting and other scandals.
Most notorious， affecting sentiment towards U.S. listed Chinese companies， was Sino-Forest – although it was listed in Canada. In 2011 Muddy Waters Research， the short selling fi rm， accused Sino-Forest of fraud. SinoForest’s shares fell and eventually the company fi led for bankruptcy. Other U.S. listed Chinese companies were hit by auditor resignations， stock delistings， and investigations by the U.S. Securities and Exchange Commission（SEC）.
Particularly severely hit were Chinese companies practicing reverse mergers – buying listed U.S. companies， thereby avoiding regulatory procedures associated with IPOs. Amid scandals 82 companies in the Bloomberg Chinese Reverse Mergers Index lost 52 percent of their market value in June and July 2011. This was followed by severe falls in the overall value of U.S. listed Chinese companies. The China Development Bank then supplied funds for Chinese companies to buy back shares and leave U.S. markets.
This led to a regulatory clash between China and the U.S. The SEC wanted audit documents from China which international auditors could not give as that violated Chinese law. In this context Alibaba’s original intention was not a U.S. listing. The company originally investigated listing in Hong Kong， but abandoned this as Hong Kong’s exchange prohibits guaranteed company control by a preferred shareholder group which Alibaba wanted – in line with Facebook and Google.
In the short term China’s companies have learned to avoid the risks which led to the 2010-2011 debacle. Reverse takeovers have been abandoned as a strategy， it is understood major accounting irregularities will be discovered， Muddy Waters type short seller risks are well known. Against a backdrop of strong rises in U.S. stock markets， shares from Chinese companies began to outperform again – a new upswing of the roller coaster after precipitate descent. By the end of 2013， as Dhara Ranasinghe of CNBC noted：
“Shares of Qunar Cayman Islands more than doubled in their U.S. debut… valuing the Chinese travel website controlled by Internet giant Baidu at US $1.05 billion. Shares of 58.com， a classifieds website… soared more than 45 percent when they started trading.”
By the beginning of 2014 the Financial Times found the eight Chinese companies going public in the U.S. in the previous year usually delivered gains of over 10 percent on their debuts. The 55 biggest Chinese stocks listed in the U.S. climbed 18 percent over the previous two years. Alibaba’s successful IPO therefore came on the crest of short-term spectacular gains by U.S. listed Chinese companies.
But warning signs are beginning. In December， less than three months after Alibaba’s IPO， an advertising campaign was launched against it by U.S. retailers. As the Financial Times noted： “Bricks-and-mortar retailers…have now turned their fi re on Alibaba…”
“A campaign group whose members include Target， Best Buy， Home Depot and JC Penney have aimed their ad at U.S. lawmakers， claiming that Alibaba will ‘decimate’local retailers unless a new law can be passed to prevent online shoppers avoiding sales tax…We believe it’s just a matter of time before Alibaba exploits this loophole.”
This attack was a political manoeuvre. Alibaba’s U.S. retail presence is insignifi cant compared to Amazon， but politically U.S. retailers found it more convenient to at-tack a Chinese company. The effect of politically inspired campaigns， if backed by the U.S. government， is shown in such successful Chinese companies as Huawei and ZTE being effectively shut out of the U.S. market.
In parallel Alibaba began to lose its premium compared to the performance of U.S. shares. Between its September IPO and the fi rst weeks in November Alibaba shares had risen by 27 percent compared to a one percent rise for the S&P 500 – a 26 percentage point Alibaba premium. But by the beginning of December Alibaba had fallen to only 12 percent above its first day price compared to a three percent S&P 500 rise in the same period– only a nine percent premium， with a clear downward direction. Future pressure that can be put on Alibaba by U.S. authorities is evident – including potentially by regulatory probes. If Alibaba does not go along with U.S. government demands actions can be taken limiting its U.S. expansion. Such threats can make Alibaba an instrument of pressure on China as the company tries to prevent such measures.
In the author’s judgement， regarding the immediate situation， Hong Kong made a serious mistake in not accepting Alibaba’s proposed share structure. As the company was not asking for a state subsidy， and nothing relevant was hidden， private shareholders should have been left to decide if they wanted to invest given its proposed share structure.
More fundamentally the risks of having a country’s major companies listed on share markets outside its own directly regulated territory are insurmountable –the good reason why the largest economies have their companies listed in their own jurisdictions. A country’s largest companies are important national assets. Ability to regulate these companies is a key feature of national policy. The bases for signifi cant clashes if companies are listed outside a major country’s jurisdiction are inevitable given differing structures of different countries and can become conscious policy matters.
Objective structural issues were illustrated in the China-U.S. auditing dispute. In January 2014 an SEC judge ruled the Chinese branches of main Western auditing firms should be suspended for six months. Even if this immediate issue is solved， the clash of regulatory regimes is inevitable. The Financial Times drew attention to the risk： “Because of restrictions on foreign investment in the Chinese Internet sector， China’s tech companies have listed in the U.S. as ‘variable interest entities.’ U.S. shareholders are tied to these companies through contractual obligations… rather than as their actual owners. This has been a clever structure for working around China’s rules. Yet it is also one that can crumble apart under pressure， whether because a Chinese company chooses to ignore the agreement or because the Chinese regulator decides it has had enough of the ruse.”
In addition to inevitable regulatory issues the possibility for direct political pressure exists – as seen with Huawei and ZTE， and as has begun with Alibaba. This occurred when relations between the U.S. and China were not extremely tense. But if there were major tension between the two countries， the temptation of U.S. authorities to put pressure on Chinese companies listed in the U.S. would almost certainly be irresistible.
The conclusion is evident. It does not matter if second- or third-rank Chinese companies list in the U.S.， they must simply comply with U.S. regulation whether or not they agree with it. But for the same reasons that almost all fi rst-tier U.S. companies are listed in the U.S.， the most important Chinese companies should be listed in China. The wild up-and-down roller coaster seen in the last period， plus the structural features， shows that while short-term measures can be taken the risks of having fi rst-rank Chinese companies listed in the U.S. cannot in fact be controlled in the long run.
This was highlighted by Alibaba’s IPO on the New York Stock Exchange. Alibaba became the history’s largest IPO. But this success was only the latest upswing of a roller coaster record of U.S. listings by China’s companies. The wild oscillations raise two questions：
Immediately， what can be done to minimize risks for U.S. listed Chinese companies？
Over the long run can these risks be controlled – is it strategically sensible for China， and for China’s companies， to list in the U.S.？
Analyzing short-term risk， recent IPOs are not the fi rst time Chinese companies have rushed to U.S. listings. In 2008-2011 over 60 Chinese companies listed on U.S. exchanges – 38 in 2010 alone. But by 2012 this had collapsed to two new listings. This precipitate fall accompanied accounting and other scandals.
Most notorious， affecting sentiment towards U.S. listed Chinese companies， was Sino-Forest – although it was listed in Canada. In 2011 Muddy Waters Research， the short selling fi rm， accused Sino-Forest of fraud. SinoForest’s shares fell and eventually the company fi led for bankruptcy. Other U.S. listed Chinese companies were hit by auditor resignations， stock delistings， and investigations by the U.S. Securities and Exchange Commission（SEC）.
Particularly severely hit were Chinese companies practicing reverse mergers – buying listed U.S. companies， thereby avoiding regulatory procedures associated with IPOs. Amid scandals 82 companies in the Bloomberg Chinese Reverse Mergers Index lost 52 percent of their market value in June and July 2011. This was followed by severe falls in the overall value of U.S. listed Chinese companies. The China Development Bank then supplied funds for Chinese companies to buy back shares and leave U.S. markets.
This led to a regulatory clash between China and the U.S. The SEC wanted audit documents from China which international auditors could not give as that violated Chinese law. In this context Alibaba’s original intention was not a U.S. listing. The company originally investigated listing in Hong Kong， but abandoned this as Hong Kong’s exchange prohibits guaranteed company control by a preferred shareholder group which Alibaba wanted – in line with Facebook and Google.
In the short term China’s companies have learned to avoid the risks which led to the 2010-2011 debacle. Reverse takeovers have been abandoned as a strategy， it is understood major accounting irregularities will be discovered， Muddy Waters type short seller risks are well known. Against a backdrop of strong rises in U.S. stock markets， shares from Chinese companies began to outperform again – a new upswing of the roller coaster after precipitate descent. By the end of 2013， as Dhara Ranasinghe of CNBC noted：
“Shares of Qunar Cayman Islands more than doubled in their U.S. debut… valuing the Chinese travel website controlled by Internet giant Baidu at US $1.05 billion. Shares of 58.com， a classifieds website… soared more than 45 percent when they started trading.”
By the beginning of 2014 the Financial Times found the eight Chinese companies going public in the U.S. in the previous year usually delivered gains of over 10 percent on their debuts. The 55 biggest Chinese stocks listed in the U.S. climbed 18 percent over the previous two years. Alibaba’s successful IPO therefore came on the crest of short-term spectacular gains by U.S. listed Chinese companies.
But warning signs are beginning. In December， less than three months after Alibaba’s IPO， an advertising campaign was launched against it by U.S. retailers. As the Financial Times noted： “Bricks-and-mortar retailers…have now turned their fi re on Alibaba…”
“A campaign group whose members include Target， Best Buy， Home Depot and JC Penney have aimed their ad at U.S. lawmakers， claiming that Alibaba will ‘decimate’local retailers unless a new law can be passed to prevent online shoppers avoiding sales tax…We believe it’s just a matter of time before Alibaba exploits this loophole.”
This attack was a political manoeuvre. Alibaba’s U.S. retail presence is insignifi cant compared to Amazon， but politically U.S. retailers found it more convenient to at-tack a Chinese company. The effect of politically inspired campaigns， if backed by the U.S. government， is shown in such successful Chinese companies as Huawei and ZTE being effectively shut out of the U.S. market.
In parallel Alibaba began to lose its premium compared to the performance of U.S. shares. Between its September IPO and the fi rst weeks in November Alibaba shares had risen by 27 percent compared to a one percent rise for the S&P 500 – a 26 percentage point Alibaba premium. But by the beginning of December Alibaba had fallen to only 12 percent above its first day price compared to a three percent S&P 500 rise in the same period– only a nine percent premium， with a clear downward direction. Future pressure that can be put on Alibaba by U.S. authorities is evident – including potentially by regulatory probes. If Alibaba does not go along with U.S. government demands actions can be taken limiting its U.S. expansion. Such threats can make Alibaba an instrument of pressure on China as the company tries to prevent such measures.
In the author’s judgement， regarding the immediate situation， Hong Kong made a serious mistake in not accepting Alibaba’s proposed share structure. As the company was not asking for a state subsidy， and nothing relevant was hidden， private shareholders should have been left to decide if they wanted to invest given its proposed share structure.
More fundamentally the risks of having a country’s major companies listed on share markets outside its own directly regulated territory are insurmountable –the good reason why the largest economies have their companies listed in their own jurisdictions. A country’s largest companies are important national assets. Ability to regulate these companies is a key feature of national policy. The bases for signifi cant clashes if companies are listed outside a major country’s jurisdiction are inevitable given differing structures of different countries and can become conscious policy matters.
Objective structural issues were illustrated in the China-U.S. auditing dispute. In January 2014 an SEC judge ruled the Chinese branches of main Western auditing firms should be suspended for six months. Even if this immediate issue is solved， the clash of regulatory regimes is inevitable. The Financial Times drew attention to the risk： “Because of restrictions on foreign investment in the Chinese Internet sector， China’s tech companies have listed in the U.S. as ‘variable interest entities.’ U.S. shareholders are tied to these companies through contractual obligations… rather than as their actual owners. This has been a clever structure for working around China’s rules. Yet it is also one that can crumble apart under pressure， whether because a Chinese company chooses to ignore the agreement or because the Chinese regulator decides it has had enough of the ruse.”
In addition to inevitable regulatory issues the possibility for direct political pressure exists – as seen with Huawei and ZTE， and as has begun with Alibaba. This occurred when relations between the U.S. and China were not extremely tense. But if there were major tension between the two countries， the temptation of U.S. authorities to put pressure on Chinese companies listed in the U.S. would almost certainly be irresistible.
The conclusion is evident. It does not matter if second- or third-rank Chinese companies list in the U.S.， they must simply comply with U.S. regulation whether or not they agree with it. But for the same reasons that almost all fi rst-tier U.S. companies are listed in the U.S.， the most important Chinese companies should be listed in China. The wild up-and-down roller coaster seen in the last period， plus the structural features， shows that while short-term measures can be taken the risks of having fi rst-rank Chinese companies listed in the U.S. cannot in fact be controlled in the long run.