Explanation of US-China audit deal: China still needs Wall Street. The agreement with the United States is proof of this.

Last Friday, regulators on both sides announced an agreement that would allow U.S. officials to review the audit documents of these firms, satisfying long-standing demand in the U.S. and bringing relief to businesses and investors in each country.

The breakthrough means that there are currently more than 160 Chinese companies could evade imminent threat of expulsion from the world’s largest stock market.

But officials warn that the deal is only the first step forward in an issue that remains delicate, suggesting that these Chinese companies will not move out of the woods until access is secured and a broader agreement is reached. Experts also say it is unlikely to quickly resolve other hot spots in US-China business relations.

What is happening?

The agreement allows US regulators to review and investigate registered accounting firms in mainland China and Hong Kong that review the books of Chinese companies.

The agreement is the most comprehensive of its kind ever between the United States and China. US Public Company Accounting Oversight Board. US inspectors are expected to travel to China and Hong Kong to begin on-site inspections, likely “by mid-September,” according to Gary Gensler, chairman of the US Securities and Exchange Commission (SEC).

“Reaching agreement on these pilot reviews was a key test of whether both sides could complete a broader deal that would avoid the possible delisting of Chinese firms on U.S. exchanges,” Lauren Gludeman, director of China at Eurasia Group, told CNN Business.

Drew Bernstein, co-chairman of Marcum Asia CPAs, an accounting firm, auditor and consultant for Asian companies looking to enter the US markets, also believes the first big hurdle has been overcome.

“China has made it clear that they believe it is in China’s interests to allow some of its companies access to US capital markets, and regulators have made some significant concessions to secure the deal,” he said.

Who got hurt?

The long list of companies at risk includes some of China’s top tech giants, Alibaba (WOMAN), Baidu (BIDU)as well as JD.com (JD).
US rules stipulate that firms that do not comply with requests to fully open their books will be banned from trading in the United States in early 2024. However, this deadline is subject to change.
And the pressure has increased significantly in recent months: this year, the SEC added more Chinese companies to its list of entities that could face delisting, while US legislators have increase in the number of calls give these enterprises an ultimatum.
Five state-owned Chinese companies to be delisted from the New York Stock Exchange
China earlier hesitated allow foreign regulators to inspect their accounting firms, citing security concerns. Tensions have already seen some Chinese companies pull out of US markets.
Only this month five state companies decided to leave the New York Stock Exchange, citing low turnover and high costs. Voluntary delisting was made by China Life Insurance, PetroChina, Sinopec, Aluminum Corporation of China and Sinopec Shanghai Petrochemical.

Others are trying to keep their options open.

Alibaba – perhaps the best-known Chinese company among Western investors – in July outlined plans to upgrade its Hong Kong listing status to mainstream, which is expected to happen by the end of this year.
Alibaba shares in Hong Kong fall after US delisting threat

The company, which has been listed on the New York Stock Exchange since 2014, hopes to have a dual primary listing once the changes are complete.

Hong Kong has become a popular destination for companies seeking to allay fears of being fired from Wall Street.

“Because cooperation takes time [on the new deal] To materialize, the risk of a delisting of U.S.-listed Chinese stocks cannot be fully mitigated in the short term,” said analysts at Bocom International, the investment banking division of Bank of Communications.

Dual primary or secondary listings in Hong Kong are likely to remain “an attractive choice” for now, they wrote in a report on Monday.

Why is it important?

The situation not only forced the companies to reconsider their plans, but also contributed to the slowdown in the issuance of shares.

According to data provider Dealogic, initial public offerings of Chinese companies in the US have declined significantly, with eight initial listings this year compared to 37 in the same period last year.

The cost of these transactions has also been significantly reduced. In 2022, companies raised just $332 million through IPOs in US markets, compared to nearly $13 billion a year ago, according to Dealogic.

Other factors are contributing to the slowdown, including a market downturn that has created an overall dismal IPO market affecting companies of all kinds.

Some Chinese players are also concerned about regulatory action.

You can wait a bit for the next hot IPO
Over the past year, Didi, China’s largest taxi company, has become a cautionary tale. The company went public in New York last year before being delisted. after falling into runaway at home.

But there could be a rebound in Chinese stock issuance if the US Congress sees evidence that China is sticking to the audit deal.

“In our experience, Chinese management teams are still very interested and interested in a US listing given the relatively simplified listing process,” Bernstein said.

“So if the IPO market recovers next year, we expect a surge in new listings in China in 2023.”

Will the deal work?

Analysts remain wary that the new audit deal will clean up companies.

Analysts at Goldman Sachs believe that there is still about a 50% chance that Chinese stocks will be delisted.

Last week, the head of the SEC also warned that companies still face expulsion if US authorities cannot access their securities.

“The proof will be in the pudding,” he said in statement.
Pedestrians walk past the New York Stock Exchange on August 26.  Earlier this month, five state-owned Chinese companies delisted from the exchange.

Confirmation of upcoming inspections “with a high probability – with a 90% probability – that both sides will complete a wide-ranging agreement on inspections by the end of the year or soon thereafter,” Eurasia experts write in the report.

“The leading US regulator will not go [to] trouble traveling to Hong Kong if he lacks confidence in China’s commitment to the deal.”

Xiaomeng Lu, director of geotechnology for Eurasia, said Beijing could still order more state-owned enterprises to be preemptively delisted “because these firms manage information that is considered sensitive to national security.”

China may choose to go this route, “instead of being subject to annual checks,” her team writes in the report.

Will this help the United States and China get along better?

Despite the progress made, the world’s two largest superpowers are expected to continue to disagree on other issues.

“While the agreement is generally a constructive signal, it does not have much connection to the broader bilateral relationship,” said Gludeman, director of Eurasia China.

US and Taiwan agree to start talks on trade and investment pact

“It’s hard to see a reset on the horizon with geopolitical hotspots intensifying, such as disagreements over Taiwanese politics and China’s relationship with Russia. The upcoming election cycles in Taiwan and the United States risk further deterioration of bilateral relations.”

Bernstein, the chief accountant, said the deal pointed to the limits of the separation, even as ties are torn.

“The relationship between the US and China reminds me of a conflict relationship where in the end they realize they cannot afford a divorce,” he said.

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