China’s VC investors look elsewhere as regulation on U.S. IPOs builds

A Chinese day trader is playing cards with others at a local brokerage house in Beijing on August 27, 2015, the summer of a dramatic sell-off in Chinese stocks.

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On Saturday, China’s cyberspace regulation proposed that any company with data from more than 1 million users must go through a cybersecurity review before being listed overseas. The regulator, which has been rapidly gaining influence in China, said public commentary on the proposed rules would be closed on July 25.

This was followed on Tuesday by an announcement by the top executive and the Central Committee of the Communist Party of China to crack down on illegal securities activities, including increased scrutiny of private equity and venture capital funds and raising funds overseas through stocks.

“There is absolutely no impact on exits, investment direction and investment phase,” said Michael Xu, Managing Partner at CEC Asset Management based in China, for a company like ours on Thursday with regard to the tightened securities regulation. That comes from a CNBC translation of his notes in Mandarin.

The only thing the company needs to pay more attention to is whether investment projects have had shareholders without a clean record with the securities regulator, Xu said.

Big tech giants like Alibaba and Tencent, which have backed significant numbers of US-listed companies, also underwent rigorous scrutiny in China’s crackdown on monopoly practices last year.

Looking for other IPO markets

Investor interest in China has increased. The transaction value from venture capital and private equity-backed buyouts reached $ 74.3 billion in the first quarter of this year, according to Preqin. This is the highest value for a period of six months since the first half of 2018.

Realizing returns on such investments is a priority, said Jeff Wu, a China-focused partner at Pegasus Tech Ventures based in Silicon Valley. Given recent market developments, he said he wanted to get out of investments through Hong Kong listings or special acquisition companies overseas.

Mainland China, however, is grappling with its own efforts to keep tech IPOs at home. The authorities launched the Star Board in Shanghai in July 2019, which provides for a registration system for IPOs instead of official approval.

This registry-based IPO has stalled. On June 20, EY said more than 500 companies were on the Chinese Securities Commission waiting list to go public on the Star Board and a technology-driven equity board in Shenzhen called ChiNext.

“Chinese investors are not mature enough and the legal environment is not mature enough to allow such a registration process,” said Zhu Ning, professor of finance at Tsinghua University.

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He noted that Chinese securities law has been “far less criminal” than in the US and that recent securities regulation is “in line with the ongoing efforts of the Chinese authorities to improve listing requirements and standards.”

“It’s important for investors to keep in mind that China is still an emerging market. No matter how fast it grows, the institutional background is still not the same, ”he said.

The Chinese government’s increased scrutiny of the listing of local companies in the United States comes as tensions between the two countries erode the economic and financial ties that have developed over the past few decades.

Under the Trump administration, the White House began calling for less U.S. investment in Chinese assets. Since President Joe Biden took office in January, his administration has maintained a tough stance on China.

Consultancy Eurasia Group said in a statement over the weekend that the aftermath of Didi’s listing will add to US political pressure to restrict Chinese stock offering. “In short, the spigot of Chinese IPOs in the US is likely to dry up,” the authors said, pointing out that several Chinese firms have already canceled plans to launch an IPO in the US

Previously, Chinese companies had gone public in the US at record speed – according to Renaissance Capital, they accounted for 15% of the US IPO market in the first half of the year.

One strategy that Chinese companies have recently pursued is listing in both the US and Hong Kong – they protect against delisting risks while attracting a large pool of institutional investors.

That trend is likely to continue, said Ming Liao, founder of Beijing-based Prospect Avenue Capital, which had plans to list its invested businesses in the US using various agencies.

Regulatory uncertainty remains

As mutual funds seek other ways to dispose of their holdings, the Chinese government’s scrutiny of stock offerings persists.

Beijing said in the national five-year development plan approved in March that the authorities intend to “fully implement” registration for the stock issue and improve the “quality” of listed companies, while stepping up efforts to ensure national security and combat monopoly behavior .

EY’s Asia Pacific IPO chief Ringo Choi said he anticipates the general uncertainty surrounding IPOs will persist in the short term as clarification of some policies could lead to different regulations. He noted that in China, action by one regulator could force another department to take similar steps.

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