China is cracking down on stocks that trade on U.S. exchanges. Here’s what it means

China’s most powerful companies – including Didi, Alibaba and Tencent – are suddenly under intense scrutiny as the country vows to crackdown on domestic companies listed on US stock exchanges. This move could turn a $ 2 trillion market on its head that is loved by some of America’s largest investors.

Beijing is stepping up its oversight of the spate of Chinese US stock market listings, most of which are tech companies. The State Council said in a statement on Tuesday that the rules of the “overseas listing system for domestic companies” will be updated while tightening restrictions on cross-border data flow and security.

The crackdown on technology is not a new trend. But because the nation has the ability to move quickly, any action in key areas of Wall Street could be devastating. Market analysts say this could not only threaten the upcoming IPOs, but also put pressure on the popular Chinese ADR market.

Chinese President Xi Jinping is taking part in the virtual WEF event of the World Economic Forum of the Davos Agenda and will give a special address via video link in Beijing, the capital of China, on January 25, 2021.

Li Xueren | Xinhua News Agency | Getty Images

Weigh the risks of owning ADRs

According to the U.S. China Economic and Security Review Commission, at least 248 Chinese companies were listed on three major U.S. stock exchanges with total market capitalizations of $ 2.1 trillion. In the USA, eight Chinese state-owned companies are listed at the national level

The Invesco Golden Dragon China ETF (PGJ), which tracks US-listed Chinese stocks consisting of ADRs from companies based in mainland China, has lost a third of its value since its high in February due to increased regulatory pressure . ADR stands for American Depositary Receipt and is practically a way for US investors to buy shares in foreign companies.

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“US investors must weigh the risks of owning ADRs at a time when tensions between Beijing and Washington continue to rise, while all global investors must weigh the appeal of China’s vast addressable market with the possibility of officials looking at the corporate outlook could reshape a stroke of a pen by imposing regulatory restrictions, “Peter Berezin, chief strategist of BCA Research, said in a note on Wednesday.

The ride-hailing app Didi became the latest victim of crackdown by the Chinese authorities. The stock plunged nearly 20% on Tuesday after Beijing announced a cybersecurity investigation that suspended new user registrations.

Republican Senator Marco Rubio told the Financial Times in a statement Wednesday that it was “ruthless and irresponsible” to allow Didi, an “unaccountable Chinese company”, to sell shares on the New York Stock Exchange.

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Meanwhile, the Nasdaq-listed Weibo is now planning to go private after its operator Tencent reportedly received regulatory scrutiny, particularly in its fintech business. Beijing has tried to contain Chinese billionaire Jack Ma’s Alibaba by opening a series of investigations since last year.

“You need to be able to understand the political and national security dynamics that go into an investment, a deal, your exposure to a Chinese company, your investment in the Chinese company, your interest in doing business across borders,” said Longview Global Managing Director and Senior Policy Analyst Dewardric McNeal said. “It’s not neat and tidy and just the numbers.”

Some of these big Chinese companies are Wall Street favorites. According to Goldman Sachs, Alibaba has been one of the top five stocks held by hedge funds alongside Facebook, Microsoft, Amazon and Alphabet for years.

Billionaire investor Leon Cooperman recently said Baidu and Alibaba were some of his biggest holdings when he touted stock picking as the path to success for the second half of the year.

IPOs in danger

Chinese regulators are envisaging a rule change that would allow them to block a domestic company from listing in the U.S. even if the entity that sells shares is based outside of China, Bloomberg News reported, citing the matter familiar people.

The move could be a severe blow to Chinese companies that have been looking loudly for New York in recent years. In 2020, 30 China-based US public offerings raised the most capital since 2014, data from Renaissance Capital shows.

In the US, there could be fewer and slower new listings due to government crackdown, said Donald Straszheim, senior managing director of China Research at Evercore ISI Group.

“Beijing [is] don’t try to stop all US offers. Even so, the US-China business relationship is better than not, ”Straszheim said in a note [Is] trying to add a layer of protection against corporate foreign compliance. “

At the end of April, according to the New York Stock Exchange, around 60 Chinese companies were planning to go public in the US this year.

– CNBC’s Hannah Miao, Evelyn Cheng and Michael Bloom contributed to the coverage.

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