How might the US ban Chinese companies trading on US stock exchanges?
Impact of de-listing Chinese companies
For new listings, it would be fairly easy. The Securities and Exchange Commission (SEC) can find reasons during the filing process to disallow new Chinese companies from listing on U.S. exchanges. New securities regulation can be enacted, or existing regulation selectively enforced, that discriminates against Chinese companies. We have already seen how easy it has been to come up with the legal or regulatory justification for targeted actions in the case of Huawei.
For existing listings, the SEC could de-list companies that are non-compliant with prevailing (or newly enacted) securities laws and regulations. This would be similar to the de-listing of shady/fraudulent Chinese reverse-takeovers (RTOs) in the 2011–2012 time period and what Australian securities regulators have been doing in recent years.
The more reputable Chinese companies typically establish ADR programs that allow the stock to be traded indirectly through American financial institutions. There are different levels of ADR programs with successive levels featuring higher disclosure and other requirements. The easiest thing to do to execute a de facto ban on Chinese ADRs would be to work with financial institutions to cancel their ADR programs. Again, this is very easy to do because financial institutions operating in the United States are highly regulated.
The fates of de-listed Chinese companies ultimately depend on their underlying businesses. For example, the majority of Chinese RTOs did not have real underlying businesses — their underlying business was essentially to act as a mechanism for unscrupulous managers, egged on by unsavory bucket shop Tier III brokers, to prey on the mismatch in supply and demand for any sort of China exposure in early post-GFC period. If you were unlucky enough to have purchased any of these securities, chalk it up as a lesson in the dark underbelly of the stock market alongside penny stocks and other cons.
But for listed Chinese companies with real businesses, de-listing from U.S. stock exchanges should not lead to an existential crisis. The securities would still be able to traded on over-the-counter (“OTC”) markets, although spreads would certainly widen due to much lower liquidity and generally higher transaction fees. If the U.S. stock exchange was the primary listing, the Chinese company would most likely look for a new, more hospitable home.
Let’s take the case of Alibaba, a bellwether Chinese stock that I have written about before. Like many Chinese technology/Internet companies, it is listed as an ADR on a U.S. stock exchange (the New York Stock Exchange). It is not listed on a Chinese stock exchange — there are historical reasons for this, mainly around the structures that Chinese tech and VC investors used to get around specific Chinese regulation involving the ownership of technology companies. This involved offshore entities (typically Cayman Islands) involving a structure called a variable interest entity
If Alibaba were targeted by the SEC for whatever reason (e.g. the continued escalation in the trade war) and forced to de-list from NYSE, it would move its primary listing to China, most likely the Shanghai Stock Exchange and/or the Stock Exchange of Hong Kong. Current regulations make it difficult to list directly, but one easy way around it would be to list under the same depository receipt structure, but with Chinese institutions as the transfer agents (CDRs, or Chinese Depository Receipts). In the long run, if the trade battle continues to escalate, updating Chinese stock market regulation so that overseas-listed Chinese companies can “come home” would be very fairly easy for its policymakers to fast-track.
For American shareholders of Alibaba ADRs, they could continue to hold the depository receipts and trade them on an OTC basis or convert them into underlying shares through their broker. The biggest impact would likely be an inability to hold de-listed Chinese ADRs in retirement accounts like IRAs.
This was originally published on Quora in May 2019.