Weblog with daily updates of the news on a frugal, fair and beautiful China, from the perspective of internet entrepreneur, new media advisor and president of the China Speakers Bureau Fons Tuinstra
China’s tech firms have faced US listing limitations on both US and China regulations. China lawyer Mark Schaub look at the new issues tech firm face on data, privacy, VIE’s, and other regulations for listing in the US at the vlog of his law firm KWM.
Until a few weeks ago, listing at US stock markets was a favorite way to raise capital for fast-growing Chinese companies. That venue is closed now, and VC veteran William Bao Bean sees still bears on the road for on-shore listing’s at China’s stock markets, he tells the South China Morning Post.
The South China Morning Post:
“For years, the biggest exit path for venture-back companies has been the US,” said William Bao Bean, general partner of New Jersey-based venture capital firm SOSV. “But now that has been closed off.”
Compared to going public overseas, Bean said listing in mainland China poses many more challenges for investors because of the country’s strict regulations in both the tech and capital markets.
“When it comes to an onshore listing, the timing is always uncertain [because] it’s hard to see when one can exit. In terms of both liquidity and the experience required, it is not as easy an exit as if it were in the US,” he added.
I do not believe the ban will ever come into effect. China made an offer on April 3, 2020 that the PCAOB rejected but which I believe is a reasonable offer. I fear their response was political and a case of putting the perfect ahead of the good. China has since sent another proposal to the PCAOB in August and has indicated that it is willing to deal.
I expect the issue will be settled by China agreeing to inspections. Biden has indicated he is not going to repeal Trump’s phase one trade deal immediately, but rather begin a multilateral discussion with former allies. I expect PCAOB inspections will be one of China’s concessions in reaching a new deal. There is no real urgency given the long transition period.
Inspections are not going to change much. I believe that the Big Four firms in China (which audit substantially every company of any meaningful size) are currently doing the audits under PCAOB standards. They have internal reviews of these audits by teams from outside of China (although I expect these reviews have been suspended under Covid-19).
PCAOB inspections have been tough, with a substantial share of audits found defective. Companies generally learn of problems with their audit when auditors show up to do remediation work, and shareholders rarely learn of problems. PCAOB inspections often result in financial sanctions against audit partners by the firm (the PCOAB itself only sanctions partners for serious offences such as altering working papers). I believe the rules should be amended to require disclosure of any sanctions against the partner (by the firm or regulators).
The fear of financial sanctions may change the behavior of audit partners, who may become more skittish and conservative. While sometimes that may be appropriate, it does undermine the independent judgment of partners.
Financial authorities in Beijing are playing with the idea to give tech firms a faster-track IPO in China, says accounting professor Paul Gillisat his weblog. Taking away some of the cumbersome restrictions for IPO's in China might lead to the expected abolishment of variable interest entity or VIE's, a side-track allowing Chinese firms to list in the US, he suggests.
Paul Gillis:
Chinese tech companies often also faced restrictions against foreign ownership. That should have blocked foreign venture capital investments and foreign IPOs, but a workaround was developed. The workaround was the variable interest entity (VIE), which enabled the listing of companies controlled through contracts instead of ownership. VIEs have been a source of pain for many investors, since the contracts proved difficult to enforce and control through contracts proved to be vastly inferior to control through actual ownership.
A few formerly US listed companies have succeeded in relisting in China. Before doing so they needed to restructure to get rid of the VIE structures and offshore structures (and control features) that had been put in place for the US listings.
The Reuter’s article points to three companies that may be the initial beneficiaries of the queue-jumping initiative - Ant Financial, the world's most valuable financial technology company, Zhong An Online Property and Casualty Insurance, and security software maker Qihoo 360 Technology Co. Ant and Zhong An would be doing IPOs, while Qihoo went private in 2016 and would be relisting in China.
It is not known whether China plans to change its rules to facilitate control structures. Ant is owned by Jack Ma and his associates. Jack Ma insisted on a control structure for Alibaba. It would also appear that it will be difficult for foreign investors to participate in these transactions, since foreigners can only purchase shares on the Chinese exchanges through the Qualified Foreign Institutional Investor (QFII) programs or the Hong Kong Connects.
I have been hearing rumors that China soon plans to announce that the VIE structure will no longer be tolerated for foreign investment, while at the same time grandfathering existing VIE structures. China had earlier proposed to change the foreign investment rules to exclude companies that were controlled by Chinese from restrictions, effectively encouraging the control structures, but these rules were not adopted when the foreign investment rules were modified last year.
If VIEs are banned (and the rules are actually enforced), it would likely mean the end of new US listings of Chinese tech (and other restricted sectors such as education and finance) companies. The queue-jumping program might foreshadow that announcement. The big losers would appear to be US venture capital firms and US investment banks.
