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US-China tensions

Didi IPO fallout reminds Wall Street of China policy risk

Investors start to feel the burn of 'capitalism with Chinese characteristics'

Chinese and American flags fly over signs of Alibaba Group Holding on the facade of the New York Stock Exchange before the company's record-breaking initial public offering in September 2014.   © Reuters

NEW YORK -- One cloudy September morning in 2014, the New York Stock Exchange building was draped in orange and white as the Chinese and American flags flew side by side, with then-Alibaba Group Holding Executive Chairman Jack Ma inside on the day of the largest initial public offering ever on a U.S. stock market.

Nearly seven years later, the halcyon days of capital pouring into Chinese companies on American exchanges ended after the Cyberspace Administration of China launched an investigation into Didi Global -- a ride-sharing app provider that just had the second-largest IPO by a Chinese company on the NYSE, after Alibaba's -- sending its share price tumbling.

Alibaba-backed LinkDoc suspended its IPO in the wake of the news. And this past weekend, Chinese authorities announced new regulations requiring companies to undergo cybersecurity reviews ahead of their foreign IPOs. An index of U.S.-traded stocks of Chinese companies fell to its lowest point in more than a year.

Investors have filed class-action lawsuits against Didi as well as lead underwriters Goldman Sachs Group, Morgan Stanley and JPMorgan Chase, which purchased a combined 82% of Didi shares under the IPO.

It appears that the risks of capitalism with Chinese characteristics are starting to rear their head on Wall Street.

"China policy risk is real," said Leland Miller, CEO of China Beige Book, an economic and data firm that advises institutional investors on China.

"And until we understand that better, we may need to run out of the whole space," he said.

Daniel Alpert, founding managing partner at Westwood Capital, said: "You have to ask yourself, why are we bothering at this point?"

Exchanges like the NYSE are not lacking in liquidity or a global presence, and Didi's plummeting shares may cause lead underwriters Goldman, Morgan Stanley and JPMorgan Chase to think twice about the next massive Chinese IPO.

For the Chinese side, a law signed last December by then-U.S. President Donald Trump threatens to delist foreign companies from American bourses if they do not share information for the Public Company Accounting Oversight Board's audits for three years.

The companies themselves may want to seek foreign capital, but this is not something the Chinese government is particularly concerned with, according to Alpert.

"They're looking at this, and they're saying, what's in the best interest of China?" he said. "And it's not necessarily what's in the best interest of the Chinese private sector."

Even as bilateral tensions rose in recent years, Chinese companies continued to list on American exchanges, giving them access to greater liquidity and range of investors than available in Shanghai.

Thirty-four Chinese companies have raised a record $12.5 billion in listings so far this year, and Chinese companies on American exchanges have an overall market cap north of $2 trillion. But the Cyberspace Administration's investigations into Chinese companies including Didi have thrown cold water on U.S. investors who have ignored the risks to have a slice of the pie of Chinese companies listing on American exchanges.

The risks of investing in Chinese companies are alluded to in Didi's prospectus filed with the Securities and Exchange Commission, such as the possibilities of investigation or rising tensions between the U.S. and China.

But investors do not have access to the same detailed information for Chinese companies that they have for American counterparts. Chinese companies that list on New York exchanges do not face the same regulatory and disclosure requirements as American ones.

"Why do I want to make it easier for a Chinese issuer to take American investor dollars, in terms of less transparency, in terms of less strong governance, than I do for a U.S. company?" former SEC Commissioner Robert Jackson told Nikkei Asia.

"I must tell you, I can't think of a good answer to that question," he said.

Miller says this should be the easiest question to answer in all of U.S.-China relations.

"There is this idea that we can't possibly enforce our rules because there's too much hell to be paid if we do, and that's never been the case," he said.

In theory, the U.S. holds significant leverage in its ability to enforce oversight of Chinese companies listed on American exchanges. But this leverage has never been fully deployed. Even under Trump, with his bombastic anti-China rhetoric, it took until 2020 for legislation to pass for increased accountability of Chinese firms traded in the U.S.: the law signed that December, which also requires publicly traded companies to declare that they are not owned or controlled by foreign governments.

Republican Sen. Marco Rubio -- who called the Didi listing "reckless and irresponsible" -- introduced in 2019 a bill requiring the SEC to delist foreign companies that do not comply with oversight and auditing rules. But it went nowhere.

Going forward, investors will have to rethink how to treat Chinese IPOs after treating them like a gold mine for so long. And such self-reflection can be difficult for massive institutions like investment banks.

Miller does not think there will be a true U.S.-China decoupling in the financial space but that there will be aggressive moves in both countries that could lead to a new scenario where a company cannot comply with both countries' laws.

"We don't know how anyone's going to handle it," he said. "But it's going to be one of the big issues to deal with."

"If companies in particular don't have an idea of how they're going to approach this, bad things are going to happen," Miller said.

Reporting by Jack Stone Truitt in New York.

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