By Alvin Mak
What would happen to Chinese stocks if they are forced to delist from American stock markets?
Last month, the United States Senate signed a bill that would increase regulation on Chinese companies listed on American exchanges. Listed companies will be required to prove that “they are not owned or controlled by a foreign government,” in addition to being subjected to three consecutive years of audit inspection by American regulators.
How did we get here, and how is this bill gaining rare bipartisan traction? The answer lies in investigative investment firm Muddy Waters.
According to Muddy Waters’s website, it produces three types of research reports: “Business fraud, accounting fraud, and fundamental problems.” It is known for publishing research on Chinese companies believed to be fraudulent. Muddy Waters Founder Carson Block is a short-seller, but is better-known for documenting these fraudulent practices.
Muddy Waters’ most well-known research concerns Chinese coffee franchise Luckin Coffee. The company was once valued at $12.7 billion. With a reported 6,500 stores in China, Luckin Coffee seemed to have far surpassed American giant Starbucks’ domestic presence. In January of 2020, its stock was trading at a record high of $50 per share.
All of this was until Muddy Waters published a ground-breaking study on Luckin Coffee. The franchise was faced with allegations of fraud and earning inflation. This affected Luckin’s stock price, which plunged by 83% in a week, before its trading was suspended by Nasdaq. Following management shifts, its stock continues to struggle a month after it reopened for trading. It currently hovers around a humble $4 per share.
Muddy Waters more recently published research on Chinese online tutoring company GSX Techedu, accusing the company of fabricating online user traffic with bots. While GSX’s listing on the NYSE was not hit as hard, Muddy Waters’ due-diligence research sure gained its fair share of attention.
This prompted a protectionist reaction from Congress; legislators were motivated by a desire to defend American investors. It received almost nonexistent legislative opposition.
Californian Democratic Representative Brad Sherman noted in a press release, “Had this legislation already been signed into law, U.S. investors in Luckin Coffee likely would’ve avoided billions of dollars in losses.”
“We can’t let foreign threats to Americans’ retirement funds take root in our exchanges,” tweeted Louisiana Republican Senator John Kennedy.
If Chinese firms are indeed in danger of being delisted from American exchanges, some experts note potential backfiring on Wall Street.
Harvard Law Professor Jesse Fried predicts the transfer of these Chinese companies to exchanges in Hong Kong or the mainland as a response. He also expects a sharp fall in stock prices if Beijing disallows American inspections on Chinese-owned company audits–which could seriously hurt American investors just before these firms privatize.
Fried also notes China’s desire to build up its domestic exchanges. Abandoning American trading soil could open up an opportunity to further develop local stock markets, increasing the attractiveness of the region. He says that China is therefore not desperate to keep listings in the U.S.
In fact, Chinese tech company Baidu is already in talks with NASDAQ to delist, as it attempts to boost its valuation by moving back home. Baidu’s competition with ByteDance–the parent company of TikTok–has prompted this move, along with escalating tensions between the U.S. and China. Other Chinese firms have also already begun placing secondary listings in Asia.
The potential of Chinese companies exiting U.S. exchanges, and the corresponding fall in stock prices, has some investors wary of this bill. Experts are anticipating backlash from Wall Street, which is expected to lobby against the bill to protect American investors from further losses.
The world waits as the legislation moves towards the democrat-controlled House for passage. If the bill does become law, however, expect the migration of Chinese firms from U.S. listings back home. Only one thing is for sure: we are in the midst of a competition between two global superpowers, and the result could turn the tide firmly in Asia’s favor. At this point, it’s unclear who’s going to come out on top.