Two lawyers are cautiously optimistic for red-chip companies seeking a US listing following news that the Public Company Accounting Oversight Board (PCAOB) can inspect China-based accounting firms for the first time in history.
The news led to a positive response from capital markets in both countries and a rise in legal advice.
The PCAOB’s final statement last month on completing inspections strongly indicated that the alarm over some 200 Chinese companies being kicked off the US stock exchange has been allayed.
The China Securities Regulatory Commission subsequently issued a positive statement, saying it welcomed the PCAOB’s decision to vacate its previous decisions and looked forward to carrying out audit oversight co-operation with the US in the years ahead, establishing a long-term and sustainable arrangement.
More than two years ago, former president Donald Trump signed the Holding Foreign Companies Accountable Act (HFCAA), which demanded foreign companies withdraw from the US stock exchange if they failed to file audit reports with the PCAOB for three years.
Shihui Partners’ Shanghai-based partner Darren Liang said that, according to recent client enquiries, Chinese companies were rekindling their interest in listing in the US, and investors were beginning to re-evaluate the feasibility of investing in companies planning to delist from the American stock market.
Companies that are required to be delisted due to their inability to meet the HFCAA’s audit inspection requirements would be valued less, which deterred investors.
“In terms of existing clients, they have started to rethink their capital market development strategies and some red-chip corporate clients have recently suspended their original plans to dismantle such structures or privatisation,” Liang said.
Vivian Yiu, Morrison & Foerster’s partner in Hong Kong, said the firm has adjusted its advisory strategy. “Whereas we would have previously discouraged all Chinese companies from attempting to list in the US, we are now cautiously optimistic that companies that do not operate in sensitive sectors or hold sensitive data should be able to complete US IPOs,” she said.
She also added that she had observed a notable rise in US IPO requests for proposals from Chinese brokerage firms.
However, PCAOB Chair Erica Williams said that the “announcement should not be misconstrued in any way as a clean bill of health for firms in mainland China and Hong Kong”. The board planned to continue its inspections this year.
Liang agreed that in the long run, the conflict between the US and China has not been completely resolved.
He advised red-chip companies interested in listing in the US to keep open the possibility of offering shares in other regions when designing their company structures, in case “the proposed change of listing location will lead to high costs associated with red-chip restructuring”.
A red chip is a Chinese company incorporated outside of mainland China that transfers its domestic assets to the offshore shell firm for the purpose of listing overseas. A variable interest entity (VIE) is a typical type of red-chip structure.
Although the listed entity is separated from the operating entity in terms of equity, listed companies are still exposed to domestic policy risks, such as ride-hailing app DiDi.
Marcia Ellis, global co-chair of private equity practice at Morrison & Foerster, said companies operating in grey areas may face obstacles on their way to a US listing.
“The SEC will continue to be cautious about allowing companies using VIE structures to list in the US and will very likely subject China-headquartered listing candidates to many more rounds of questions than those addressed to listing candidates from other jurisdictions,” she said.
Besides the audit hurdle, another major overhang for the Chinese company is the cybersecurity review, Ellis said.
China issued the Measures for Data Export Security Assessment in September last year, providing a framework for regulating outbound data transfers.
“If a company holds any sensitive data, it may be difficult for that company to pass cybersecurity clearance and complete an IPO. Such companies will have to list in Hong Kong or on the mainland,” she said.
