There are signs that there may soon be a regulatory breakthrough on overseas IPOs of Chinese companies.
The Singapore Exchange (SGX) and the China Securities Regulatory Commission (CSRC) reached a deal to allow Chinese companies to list directly in Singapore, that is, without using an offshore holding company. While there are hundreds of Chinese companies that have listed overseas, only large SOEs tended to get the necessary permission to list directly. The rest used offshore structures, typically with a Cayman Island holding company, to get around Chinese regulations. The offshore structures contributed to the regulatory mess that ensued, where Chinese regulators did not regulate the companies because they were not Chinese, and foreign regulators could not regulate them because China would not let them have access to the people and records in China.
Now Chinese companies can directly list in Singapore after their applications are approved by both CSRC and SGX. The agreement, however, does not deal with the troublesome variable interest entity (VIE) structure that is used to circumvent Chinese rules restricting foreign investment in certain sectors.
Most private Chinese companies prefer to list in the United States to Singapore and Hong Kong. There are some clues that suggest that the standoff between U.S. and Chinese regulators may be ending.
Duoyuan Printing, Inc. (Duoyuan Printing) was delisted from the NYSE in 2011 after the company crumbled under fraud allegations. Duoyuan Printing went dark – ceasing to file required reports with the SEC. The SEC began the process of deregistering the company but was unable to serve a complaint. On November 15, the SEC asked an administrative trial judge for a delay while they attempted to serve Duoyuan Printing. The SEC’s Office of International Affairs indicated it might take up to a year to do so. Based on filings in the Big Four cases, it appeared that the SEC had given up on cooperation with China. But perhaps things are back on track again.
The SEC filed charges in 2012 against the Big Four and BDO in China over their refusal to provide audit working papers to the SEC as required by U.S. law. A hearing took place in July 2013 and the parties have been slow walking the case. That is because just before the hearing the CSRC coughed up the working papers on Longtop Financial Technologies. On November 21, 2013 the firms asked to be able to supplement the hearing record with evidence that more working papers had been turned over in the past few months. Deloitte, with the support of the other firms, filed for summary disposition on the basis that the SEC now had the requested working papers. If it didn’t get its way, Deloitte asked that the case be postponed.
The judge refused to dismiss the case or postpone his decision. I expect that the judge will find the firms guilty of not turning over the work papers when they were supposed to, but I also do not believe the firms will get the death penalty for that. So the firms will get a slap on the wrist that they will probably continue to fight for the foreseeable future, but the risk to the capital markets will be gone.
Although the PCAOB reached a deal to share working papers in connection with investigations, it remains banned from inspections, which are its most important function. PCAOB Chairman James Doty has indicated that the PCAOB cannot wait forever for a deal on inspections. There are signs of a breakthrough. The Wall Street Journal reports that Chinese regulators are in Washington this week for discussions on inspections and other audit-oversight issues.
Hopefully the next thing in line is a process for CSRC approval of direct listings of Chinese companies in the U.S. There is no barrier in the U.S. to direct listing of Chinese companies, but requiring CSRC approval will bring these companies under Chinese regulation, which is a good thing for investors since the CSRC has the power to punish companies that defraud investors.
Direct listing, however, does not solve the VIE problem. I have heard rumors of a paper circulating that would require the CSRC to vet VIE structures before they list abroad. CSRC approval might suggest that CEOs think twice before walking away from the agreements. I hope the CSRC goes another way, and eliminates the need for VIEs. There is enough room in the Third Plenum reforms to allow direct foreign ownership in companies in the internet and education sectors. Direct listings of Chinese internet companies in the US with CSRC oversight would go a long way towards protecting U.S. investors.
And direct listings of Chinese companies in the U.S. also paves the way for secondary listings of these companies on China’s stock exchanges. To date, Chinese citizens have been blocked from owning shares in many of China’s most successful companies.