Disclosure: All posts on Giro’s Newsletter are for informational purposes only. This post is NOT a recommendation to buy or sell securities discussed. So please, do your work before investing/gambling your money.
(Reading time 8 minutes)
Considering that I’m holding a position in a Chinese ADR (~0,2%/0,3% exposure), it might be of your interest to know more about this.
Delisting risks for Chinese ADRs
Last week, the SEC announced that 5 Chinese stocks had been identified as CII (Commission Identified Issuer), triggering a ~30% drawdown of Chinese ADRs since Mar 10 — roughly a 5-sigma move in each of the past three trading days.
So I spent my weekend reading the Consultation Conclusion for the listing regime for overseas issuers for the HKEx.
A little context here…
On Dec 1, Chinese authorities reportedly discussed plans to ban companies from going public abroad through the VIE structure due to data security concerns.
Existing VIEs may have to provide more transparency, according to the report. However, later on, the same day, the CSRC denied such an intention, and on Dec 3, China Daily reported that regulations are expected soon for “orderly overseas listings.”
On Dec 2, the SEC in the US adopted amendments to finalize rules relating to the Holding Foreign Companies Accountable Act (HFCAA). The HFCAA was passed by Congress and signed into law by then-President Trump in Dec 2020.
It permits the SEC to ban (foreign) companies from trading and delist them from US exchanges if the US Public Company Accounting Oversight Board (PCAOB) cannot audit requested reports for three consecutive years.
On Dec 2, Didi, a Chinese ride-hailing company that floated its shares on the NYSE on June 30, 2021, announced that it will file for delisting its American Depositary Shares (ADS) from the exchange and start work on a Hong Kong share sale. 🤡🤡🤡
— So, what’s up?
According to the Chinese Securities Law, audit papers of Chinese companies are considered state property and are not accessible by foreign regulators. 🙄
While the CSRC (Chinese SEC) stated it has “made some progress” with its US counterpart over the regulatory disconnections, the PCAOB said in a recent report that it was “unable to inspect or investigate completely” 15 accounting firms in mainland China and Hong Kong that signed audit reports for 191 public companies.
“The PCAOB spent significant time and resources negotiating a Memorandum of Understanding (MOU) with the Chinese authorities for enforcement cooperation. Unfortunately, since signing the MOU in 2013, Chinese cooperation has not been sufficient for the PCAOB to obtain timely access to relevant documents and testimony necessary to carry out our mission consistent with the core principles identified above, nor have consultations undertaken through the MOU resulted in improvements.”
— Ow, what is the timing?
The Commission will identify CIIs for fiscal years beginning after Dec 18, 2020, suggesting that the first batch of CII will be added to the provisional list by the SEC as early as in 1H22 (20-F Form will be due).
On Mar 8, 2022, the SEC added 5 Chinese companies to the provisional CII list. If no agreements are reached, the timing for delisting would be from 1H23 to 1H24.
Technically, the best case would be 1H24, when their annual 20-F forms for the 3rd non-inspection year come due. Nevertheless, the US Congress recently passed a bill to shorten the non-inspection time window to two years, and President Biden may sign it into law any time.
— What, then?
Investors will have ten days to sell the stock (before the last ADR trading day) after filing Form 25 with the SEC.
Investors could continue trading the shares on the OTC market under a sponsored level I ADS program, such as Luckin Coffee and Guangshen Railway.
They could return their ADS to the custodian and withdraw the equivalent deposited security (in the HKEx).
Investors could wait to receive the net proceeds upon the termination of the ADR program.
However, if you wish to hold the stock and it’s not listed in the HKEx, things could get messy…
According to the Consultation Conclusions published by HKEx in Nov 2021, a secondary listed issuer would be regarded as a primary listed issuer in the event of:
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The majority of trading in an Overseas Issuer’s listed shares is considered to have migrated to the Exchange’s markets on a permanent basis if 55% or more of the total worldwide trading volume, by dollar value, of those shares (including the volume of trading in depositary receipts issued on those shares) over the Overseas Issuer’s most recent financial year…
A dual-primary listed issuer should continue to enjoy the Automatic Waivers and other special waivers granted to them upon a voluntary conversion from a secondary listing until the Trading Migration Requirement is triggered.
For involuntary delisting from the overseas exchange, transitional arrangements apply for continuing transactions entered into before the issuer’s notification of the expected involuntary delisting to the Exchange;
An automatic 12-month grace period provided to allow for the preparation of financial statements in accordance with HKFRS/ IFRS in the event of a delisting from the primary listing market (so that the issuer may switch to HKFRS/IFRS, at the latest, by the time it publishes its first financial statements (which may be annual or interim statements (or quarterly for GEM issuers only) after the first anniversary of its delisting).
For involuntary delisting from the overseas exchange, transitional arrangements apply for continuing transactions entered into before the issuer’s notification of the expected involuntary delisting to the Exchange so that the transactions are exempt from applicable Listing Rules (e.g. annual review, monetary caps) for 3 years from the date of the delisting notification.
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Finally, I'll be doing nothing until I have greater visibility of how the process would work.
Of course, valuations look like a screaming buy, but I'm in no hurry for exposing myself to unnecessary risk.