Are Chinese stocks worth owning in 2020?
The intensification of the Sino-American conflict and the consequences for the stock market landscape
In the ongoing US presidential election campaign, there is a particular focus on Sino-US relations, in particular the trade conflict and how to deal with the corona pandemic. A question that has been discussed for a long time is increasingly coming to the fore, namely whether Chinese companies pose risks for investors and financial markets by evading the audits and regulatory requirements that apply to US companies. Corresponding legislative and regulatory developments, including a possible restriction on trading in Chinese securities, could have consequences for investors.
Will Chinese stocks be banned from US stock exchanges?
Both Congress and US regulators are currently stepping up their efforts to prevent emerging market companies, and especially China, from raising capital on US stock exchanges without subjecting themselves to the same supervision as US and other companies Industrialized countries. An estimated 224 US publicly traded companies with a market capitalization of approximately $ 1.8 trillion could be affected by the new legal and regulatory requirements.1
Congress is considering legislation aimed at removing US-listed Chinese companies from listing on the stock exchange if they refuse to regularly publicly audit and oversee their accounting. The Nasdaq also wants to introduce new rules that would allow it to impose stricter eligibility criteria for companies from "restrictive countries" if there are concerns about the auditor, disclosure and transparency in certain emerging countries and if they have greater accountability and a better one Deems access to information necessary.
The regulatory concerns are not new. This is because Chinese companies have long been raising billions in capital by listing them on the US stock exchanges, but at the same time they evade the strict auditing of accounts to which other stock corporations have to submit. The Public Company Accounting Oversight Board (PCAOB), which is responsible for monitoring auditing companies, has for years been referring to "problems with accessing Chinese companies" that make it difficult or impossible to access the documents required for controls "without restriction and in a timely manner" and conduct investigations.
At the same time, the US Senate passed a bill aimed at stricter regulations, and the House of Representatives is also considering similar measures. According to a Senate draft of the Holding Foreign Companies Accountability Act, companies should be required to disclose whether they are "owned or controlled by a foreign government". In addition, certain companies listed in the USA are to be excluded from securities trading on the American stock exchanges if the responsible auditing company cannot be controlled by the PCAOB.
This is to ensure that the PCAOB can examine Chinese audit firms in the same way as it does for domestic or other foreign audit firms. According to the new regulations, the PCAOB could carry out an audit at least every three years. Companies that do not guarantee this are threatened with exclusion from the US stock exchanges.
"Even if it is still unclear whether this measure will actually be implemented, leading members of the US Congress are apparently determined to tighten the regulation of Chinese companies," said Katie Deal, an analyst in Washington for US stocks. However, delisting would not be possible until 2025 at the earliest, so that the companies concerned would have time to switch exchanges or ensure compliance with the regulations.
However, some Chinese tech companies that are listed on the US stock exchange could easily switch to the Hong Kong stock exchange. T. Rowe Price's portfolios in China are primarily invested through American Depository Receipts (ADRs), which are also listed on the Hong Kong Stock Exchange and can be converted into corresponding positions with very little effort. However, operational procedures would need to be in place with certain customers to enable trade outside of the United States. In addition, it may be necessary to build relationships with the custodians on a global platform.
Eric Veiel, Co-Head Global Equity, emphasizes: “The risks of our positions, including regulatory risks, are continuously monitored at T. Rowe Price. Forecasts regarding regulatory developments are always particularly difficult, which is why a corresponding risk assessment could trigger significant price fluctuations in the short term. Our team of analysts and portfolio managers bases its assessment on close industry contacts as well as our own experience and analyzes. We will continue to keep a close eye on the situation and its effects on the individual companies. "
Restricting Investments in Chinese Securities
Tighter regulation of Chinese companies could also affect retirement plans for federal and state employees. The U.S. The Federal Retirement Thrift Investment Board (FRTIB), which manages US pension funds for the US government, recently put plans on hold to raise capital from the Thrift Savings Plan I &; fund of $ 593.7 billion to switch from the MSCI EAFE index of developed countries to the MSCI ACWI ex USA Investable Market Index, which contains securities from China and other emerging countries.
The authority referred to the possible effects of the corona pandemic on the emerging countries, "because they are coming under pressure and we are not sure what condition they will be in two or three years," said FRTIB director Michael D. Kennedy. The board was under considerable pressure from the Trump administration to revise the investment project. On May 4, the US President nominated three candidates for the five-member governing body, which, if confirmed by the Senate, could form a new majority. The Board had also received a letter from members of the government referring to "national security and humanitarian concerns for the United States."
Government pension plans could also face similar pressures. For example, Florida Governor Ron DeSantis received a letter from Senator Marco Rubio and Congressman Michael Waltz to withdraw capital from the state pension funds from Chinese companies, whereupon DeSantis announced that he might press for appropriate measures in 2021.
"The US government's measures are a symbolic step that does not lead to any significant direct impact on China," believes Chris Kushlis, Fixed Income Sovereign Analyst, Asian Markets. “However, the pressure is likely to increase if other state and local public pension funds in the US were also forced to foreclose Chinese securities. It is important to monitor this development closely. "
1 Source: Fortune Magazines.
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