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US-China tensions intensify as Trump pursues financial decoupling

Washington threatens to expel Chinese companies from American stock markets

TOKYO -- Antagonism between the U.S. and China has moved beyond trade and technology and is now intensifying in the financial sector as well.

Global attention has been drawn to the Hong Kong Autonomy Act, signed into law by U.S. President Donald Trump. It imposes sanctions, including seizure of assets and exclusion from dollar-denominated account settlements, on officials and entities in the city and mainland China that are deemed to aid in the violation of the former British colony's guaranteed autonomy.

But Chinese companies listed in the U.S. are probably more worried about U.S. moves to toughen audits of them.

The Trump administration has also threatened to delist Chinese companies, indicating that the U.S. is determined to sever financial market links between the two countries.

On Aug. 6, the U.S. Treasury Department released a document with the somewhat startling title "Report on Protecting United States Investors from Significant Risks from Chinese Companies." It was compiled on July 24 by a working group on financial markets at Trump's direction on June 4.

A key phrase in the report is "non-cooperating jurisdiction" or NCJ. It means a country which has companies listed in the U.S. but which are uncooperative in disclosing information about their operations. With China in mind, the report calls for companies from such a country to have their auditing records checked by the Public Company Accounting Oversight Board, or PCAOB, if they wish to be newly listed or remain listed in the U.S. The report stipulates that if a company refuses, it will be delisted after a grace period lasting until Jan. 1, 2022.

The "Report on Protecting United States Investors from Significant Risks from Chinese Companies" was compiled on July 24 by Trump's working group on financial markets.

Some may see the report as the result of reading Trump's mind by his aides, but not in this case. The tough stance on Chinese authorities and companies shown in the report represents the aggregate opinion of U.S. financial regulators, as the working group includes such officials as Treasury Secretary Steven Mnuchin, Federal Reserve Chairman Jerome Powell, Jay Clayton, chairman of the Securities and Exchange Commission, and Heath Tarbert, chairman of the Commodity Futures Trading Commission.

China has rejected cooperation with the PCAOB since 2007, possibly because it does not want U.S. authorities to poke their noses into delicate information held by Chinese state-owned enterprises. But it is not just SOEs that have refused to cooperate; some major private-sector companies, including Baidu and Alibaba Group Holding, are also refusing to comply.

The PCAOB lists names of companies in NCJs that are audited by PCAOB-registered auditing companies, together with their auditors, on the board's website.

In the year and a half to March 31, the 17 PCAOB-registered auditing companies signed off on the financial reports of 195 companies from mainland China and Hong Kong, holding a combined market capitalization of as much as $1.7 trillion. The top 10 have market caps totaling $1.3 trillion.

According to the U.S.-China Economic and Security Review Commission, a bipartisan advisory body to the U.S. Congress, 156 Chinese companies were listed on the New York Stock Exchange, the NYSE American and the Nasdaq Stock Market as of Feb. 25, 2019. While they have market values totaling $1.2 trillion, 11 are state-run companies owned 30% or more by the Chinese government.

The 11 corporations include PetroChina, China Petroleum & Chemical, or Sinopec, and China Life Insurance. They have market caps of $123.6 billion, $104.6 billion and $76.1 billion, respectively. Shares offered for public trading in the U.S. by Sinopec total $3.5 billion while those by China Life stand at $3 billion.

The review commission feels a sense of crisis because Chinese companies, which pose threats to security of the U.S., raise funds there but operate opaquely.

Some companies cited by the commission overlap with those on the PCAOB's website. As examples of nontransparent management by Chinese companies, the report by the presidential working group pointed out that law enforcement officials with the SEC had resorted to dozens of indictments or administrative measures on suspicions of securities and exchange law violations involving Chinese bond issuers, registrants and companies over the past decade. The U.S. government is expected to make public a list of them if China continues its refusal to cooperate.

Chinese chain Luckin Coffee listed on the Nasdaq Stock Market in May 2019, but was delisted a little more than a year later. 

Chinese coffee chain Luckin Coffee, meanwhile, has been delisted from the Nasdaq for window-dressing sales data. Growing rapidly as the Chinese version of Starbucks Coffee, Luckin was listed in May 2019 and saw its market cap hit $5.6 billion on the first day of trading as investors in pursuit of promising companies like Alibaba and Tencent Holdings flocked to the market.

But a little more than a year later, Luckin ended up delisted. The catalyst was not its auditing company, the SEC, the PCAOB or Chinese authorities, but a report released by short seller Muddy Waters alleging instances of fraud committed by the chain.

When the 89-page report, titled "Fraud + Fundamentally Broken Business" was released in January, Luckin shares were hit by an avalanche of sell orders.

The report was compiled based on the dispatch of nearly 1,500 investigators to count sales and record traffic at 600 Luckin stores, according to Henny Sender, a Nikkei Asian Review columnist. Ultimately, they recorded more than 11,000 hours of video and collected nearly 26,000 customer receipts to check various possibilities including overstatement of sales, Sender said.

The scandal represents a case in which wrongdoing failed to be detected by auditors and was ignored or dismissed by Chinese authorities so that Wall Street brokerage houses were readily cheated due to their excessive eagerness to find promising stocks.

While the SEC and PCAOB are demanding better cooperation from Chinese authorities, China has one excuse of its own not to do so. The U.S. signed a memorandum in 2013 to effectively exempt Chinese auditors from U.S. inspections, according to the Aug. 12 edition of Nikkei.

The memorandum was concluded between the PCAOB and Chinese concerned parties including the Ministry of Finance. China interprets the deal as permitting it to reject U.S. requests for information in accordance with domestic law.

One of the U.S. officials who arranged the accord was then Vice President Joe Biden, now the Democratic nominee for president. Biden had sought an increase in investment in the U.S. from China through a series of economic dialogues from 2011 with then Vice President Xi Jinping, who is now China's president.

The report by the U.S. presidential working group is designed to amend the 2013 U.S.-China deal as the current consensus of American financial authorities.

Thus, if Biden beats Trump in November's election, China may call for the U.S. to not get too tough on the issue. But U.S. lawmakers and financial regulators have already shifted to a stance of alarm about China, meaning Biden will be unable to readily comply with any such Chinese plea.

Daniel Zhang, center, CEO of Alibaba Group, poses before the Chinese e-commerce giant's Hong Kong listing on Nov. 26, 2019. (Photo by Rie Ishii)

Opportunistic Chinese companies already recognize the risks of listing in the U.S. and are starting to "return" to Hong Kong.

The move was triggered by Alibaba, which listed on the Hong Kong stock exchange in November 2019, in addition to the NYSE. The Chinese e-commerce giant raised 101.2 billion Hong Kong dollars ($13.05 billion) through its initial public offering in Hong Kong. It took in $21.7 billion via the N.Y. IPO in 2014.

Portal site operator NetEase and leading e-commerce company JD. com, both traded on the Nasdaq, listed on the Hong Kong bourse in June.

As U.S. financial regulators toughen their stance on Chinese companies, more than 30 of them may be seeking concurrent listings in Hong Kong, the Japan External Trade Organization said in a July 20 report.

The U.S., through the Hong Kong Autonomy Act, is shaking the city's position as an international financial center. Further, the presidential working group in its report demanded that pension funds and other investors disclose the risk of investing in an NCJ, meaning China.

The U.S. has drastically shifted its policy toward decoupling from China, seeking such a break not only in the information and communications area but now also in the financial sector. It has therefore become more difficult for those in the finance and securities to "cherry-pick" businesses in the U.S. and China.

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