Add stock IPOs to the growing list of hot button issues between the United States and China, and now, Nasdaq's new rules are aiming at Chinese companies.
Understandably, making it harder for a Chinese company to do their initial public offering on the Nasdaq exchange doesn’t rank nearly as high on the importance scale as the already simmering trade war or disagreeing about China’s public response to the COVID-19 outbreak.
But the new restrictions do put further strain on an already uneasy financial relationship between the two countries.
Nasdaq’s move does not specifically mention Chinese companies nor does it outright forbid them from listing on the exchange. However, it’s very clear who the new regulations are aimed at it. For more than a decade, the Securities and Exchange Commission (SEC) has been locked in a battle with the Chinese government. They're fighting over the SEC’s inability to access audits of U.S.-listed Chinese companies.
Start of Investigations
The issue came to a head last month after Luckin Coffee, a Chinese coffee chain founded in Beijing and had an IPO on the Nasdaq exchange in early 2019, announced an internal investigation. This happens after news surfaced that its chief operating officer and other employees fabricated sales deals to inflate the company’s stock price.
The heart of the issue with Chinese companies listed on US exchanges is a perceived lack of accounting transparency. It also closely-held shares often with large blocks in the hands of company insiders. This increases the risk of price manipulation.
The accounting concerns go back to the passage of the Sarbanes-Oxley Act in 2002. In that year, the SEC set up an accounting oversight division, called the Public Company Accounting Oversight Board (PCAOB).
The PCAOB has the task of policing the accounting firms that sign off on the books of the nation’s listed companies. But since at least 2011, the PCAOB has been unable to get any audit information on the US-list Chinese companies. A handful of Chinese companies received accusations of accounting irregularities during that time.
The new rules will require that companies from specific countries – including China – raise at least $25 million in their initial public offering. Alternatively, it requires them to raise at least one-quarter of their post-listing market capitalization. So a company that is valued at $20 million after its initial offering must have raised at least $5 million of that value in the IPO. It’s the first time that the Nasdaq has placed a minimum IPO size.
Research firm Refinitiv looked at Chinese IPOs going back to 2000. About 155 Chinese companies were listed on Nasdaq since 2000. However, 40 would have fallen short of the new threshold of $25 million.
Listing on a US exchange is appealing for smaller Chinese companies. It does so since it allows the company founders and investors to cash out of their investment in US dollars and skirt Chinese currency controls. The companies often use their US listings to convince banks to lend them money as well as apply for Chinese subsidies.
Last week, President Trump told Fox Business that he was looking “very strongly” at requiring Chinese companies that list here in the US to follow our accounting standards. However, he expressed some concern that increased scrutiny could cause the companies to list in London or Hong Kong instead.
That appears to be the case. Yesterday, China began urging domestic companies to list in London under a Stock Connect scheme.
The Shanghai-London Stock Connect scheme, which started last year, aims to strengthen the relationship between Britain and China. It also aims to help Chinese companies expand their investor base. Additionally, it also intends to give mainland Chinese investors access to UK-listed companies.