By Josh Woodard, CFA®
The COVID-19 pandemic will have a long-term impact not just on individuals and businesses, but on the political landscape as well. We’ve already begun to see some early signs of this in the form of a more tense relationship between the U.S. and China.
After a trade deal finally materialized late last year, relations have once again become frosty. In addition to ongoing trade discussions, Hong Kong protests have intensified as China moves to impose a new national security law, and the White House continues to tighten sanctions on telecom giant Huawei (China’s most important 5G company). And now, U.S. legislators are threatening to delist Chinese companies from U.S. exchanges.
These are all complex and interrelated issues which won’t be solved quickly and will likely only intensify in the short-term, but given that their consequences won’t just be political (they’ll likely have a significant economic impact as well), we’d briefly like to comment on the prospect for delisting of Chinese companies from U.S. exchanges.
On May 20, 2020, the Senate passed a bill that would compel companies to delist from U.S. stock exchanges if they do not comply with U.S. regulatory audits. Given what appears to be bi-partisan support, the bill stands a good chance of becoming law. There will, however, be a 3-year grace period before the law is implemented – affording foreign companies sufficient time to either comply or find a work-around.
With the passage of this bill, investors should benefit from greater protections from potential fraud. Currently, foreign companies listed on U.S. exchanges are not scrutinized to the same degree as domestic companies. As we saw with the recent Luckin Coffee (LK) scandal – where the company admitted to fabricating $300 million of its sales, resulting in a 90% plummet in the stock price – this can expose investors to considerable risk.
Obviously, weeding out and preventing firms that commit accounting fraud from being listed on U.S. exchanges is good for American investors. While large global firms like Alibaba (BABA) and Tencent (TCEHY) will likely be unaffected, we believe the potential for delisting is greatest for smaller companies that may not be able to meet these new audit requirements.
Although the growth stories of Alibaba, Tencent, and others have been compelling, investors must be willing to accept increasing headline risks and volatility associated with Chinese stocks. We expect China-related legislation to continue, especially as both parties seek to appear strong in an election year. The likely result of all of these disputes will be a reduction in business confidence and the potential for increased market volatility. We will continue to monitor trade tensions, the potential for delisting Chinese companies, and ongoing Huawei restrictions, as all of these topics (and others which have yet to emerge) will shape the future of U.S.-China political and economic relations.
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