Political capital

IFR Awards 2019
15 min read
Thomas Blott

Trade tensions between Beijing and Washington are threatening to spill over into capital markets, with some policymakers even calling for a ban on Chinese listings in the US. Just how far can it go?

When it comes to China, Donald Trump is not shy about taking credit. The US president’s self-proclaimed list of achievements even includes convincing Chinese President Xi Jinping not to send troops into Hong Kong to deal with months of anti-government protests, according to a rambling interview he gave to Fox News in November.

As far-fetched as that may be, Hong Kong’s capital markets probably owe him some gratitude.

The Stock Exchange of Hong Kong leapfrogged the New York Stock Exchange and Nasdaq to become the largest venue for new listings in 2019 following Alibaba Group’s HK$101bn (US$12.9bn) November offering, according to Refinitiv data.

Trump cannot claim any direct influence on China’s biggest e-commerce group, but the timing of Alibaba’s float, against a backdrop of political unrest and volatile equity markets, points to rising concerns about the impact of the US-China trade dispute on global capital markets.

“A lot of Chinese companies listed in the US are having to think more carefully about the potential risk of being caught in the crossfire of the trade dispute,” said one senior investment banker. “Having a secondary listing either in mainland China or in Hong Kong is a natural hedge against the worst-case scenario.”

For Chinese companies, that worst-case scenario involves a loss of access to US capital markets. Three separate bills have been submitted to Congress that will force companies to delist from the US unless regulators agree to allow US oversight of their auditing process, a longstanding source of tension between Beijing and Washington.

In November, lawmakers also introduced a bill to prevent a government pension fund from investing in Chinese stocks, while the US Department of Commerce in October placed eight companies on a trade blacklist, including several IPO candidates.

“There’s a risk of the trade war spilling over into financial markets, although portfolio inflows from the US into China are still quite negligible and therefore the overall effect on its balance of payments would be low,” said Brad Setser, senior fellow for international economics at independent think-tank Council on Foreign Relations and former staff economist at the US Department of Treasury.

“So far most of the discussions around financial decoupling have been kept separate from the trade negotiations but if the negotiations were to turn sour, or if there was a breakdown in China-US relations over Hong Kong, for example, that could change matters.”


Trump has made a new trade deal with China a centrepiece of his administration and can legitimately claim to have had a lasting impact on relations between the two superpowers. Calls for a reset of the trade balance now cross the political divide, and Chinese companies expect US policymakers to be far less accommodating – regardless of the result of presidential impeachment proceedings and the 2020 presidential election.

So far, efforts to restrict China's access to US capital markets have come mostly from Congress, rather than Trump, with three bills submitted in the last two sessions (one of which has since expired) that would effectively ban Chinese companies from listing in the US and force those currently listed there to comply with tougher regulations or be delisted.

The most notable of the three bills, the Ensuring Quality Information and Transparency for Abroad-Based Listings on our Exchanges Act, or the Equitable Act, was introduced in Congress in June by a bipartisan group of lawmakers led by Republican senator and one-time presidential candidate Marco Rubio.

Ostensibly designed to improve transparency, the proposed law would block listings from foreign companies that fail to submit to US regulatory oversight of their auditing process. Companies already listed in the US would have three years to comply or face delisting.

Although the bill’s only reference to China is the requirement for listed companies to identify executives who are Communist Party officials, the bill appears to be aimed squarely at Beijing.

The Public Company Accounting Oversight Board, which oversees the audits of listed companies under the auspices of the Securities and Exchange Commission, said it is unable to inspect audits on 224 US-listed companies with a combined market capitalisation of US$1.8trn. Of those, 213 use auditors based in China or Hong Kong (the other 11 are Belgian).

Most market observers say that the bill is unlikely to be approved in its current form given the potential damage to the US stock market, although some have cautioned that the likelihood of it passing will increase if trade negotiations break down.

"I think its fate depends on the resolution of the trade war," said Paul Gillis, professor at Peking University’s Guanghua School of Management and former PwC partner. "Right now, Trump doesn't want anything to disrupt negotiations as he looks to secure a phase one deal; if they fail to do that then it becomes a lot more likely that you would see the executive throwing its support behind such measures."


An outright ban on US listings to restrict the flow of financing for Chinese companies will be fraught with difficulty, and several observers have pointed out it would be subject to legal challenge. Sean Darby, global equity strategist at Jefferies, said that it will contravene WTO rules allowing countries equal access to each other's markets.

Debt capital markets would be even more challenging as most Chinese issuers that issue US dollar debt do so in Reg S format, without marketing directly to US investors.

"I think if something quite draconian were introduced, it would probably be only the top end of the credit spectrum that would be affected as they're the ones that are doing SEC-registered deals. Although, they’re not reliant on a single funding source anyway," said one DCM banker. "It hasn't been an issue thus far and it's not something I envisage will be."

Rather than a blanket ban, some market participants expect the approach by the US to be more nuanced, for example enforcing existing securities regulations more strictly or curtailing the level of federal government investment in Chinese companies.

Several market observers told IFR that US regulators have started scrutinising cornerstone investments in IPOs, a common feature among Chinese issuers, as well as thinly traded stocks, again often a characteristic of smaller Chinese issuers.

There is also talk about banning US government pension funds from investing in Chinese companies. In November, Rubio tabled legislation that would force the Federal Retirement Thrift Investment Board, the administrator of US federal government employees' retirement savings, to reverse a decision to allow one of its funds to track an MSCI index that includes China-based stocks.

“I think the role of the SEC and PCAOB in the broader tensions between the US and China is somewhat limited," said Alan Seem, a US-based partner with law firm Jones Day. "As regulatory bodies, they just appear to be trying to hold Chinese companies and their auditors to the same rules and standards that other foreign private issuers follow. However, some of the laws currently being proposed in Congress are a different matter. It seems that everything, including the right to list shares in the US, is potentially a bargaining chip in the larger trade war."


While China's access to US capital markets may have taken a back seat thus far during the trade negotiations, Trump previously said he would be open to including negotiations around Huawei in any trade deal, suggesting that anything could be up for grabs. The Chinese telecom equipment maker was placed on a trade blacklist in May and its chief financial officer Meng Wanzhou is in Canada fighting extradition to the US.

The issue of trade sanctions is already having ramifications for primary capital markets. In October, the US Department of Commerce placed eight companies and 20 public security bureaus on an export blacklist over the alleged involvement of their surveillance technologies in the crackdown of Muslim Uighurs.

The list included Yitu Technology, a facial recognition company planning to list in China; Sensetime Group, which develops applications for facial recognition and video analysis and is working towards an international IPO; and artificial intelligence start-up Megvii Technology, which is looking to raise US$500m–$1bn in Hong Kong.

Goldman Sachs, which is joint sponsor on the Megvii IPO, previously said that it was evaluating its role on the deal following the Commerce Department's actions. Citigroup and JP Morgan, which are also sponsors, declined to comment. At the time of writing, the company had pushed back its IPO to next year after the Hong Kong bourse requested more information.

According to several lawyers, the export restrictions are not likely to prohibit US investors or underwriters from participating in any deals involving blacklisted companies, but such moves might make listings more challenging.

"The ban only extends to exporting components and to the extent that there is any legal risk involved, most of the large institutional investors and investment banks could probably get around it anyway by using a non-US legal entity," said one lawyer.

"The issue is more that it's a major red flag during an IPO. If they purchase equipment from US companies, where are they going to get their supplies from instead? For investment banks, it raises a lot of questions on the roadshow that are just going to distract from the core IPO story, while for investors it obviously becomes a lot riskier to invest in."


The growing hostility from the US comes as China is opening its financial markets, prompting concerns that Beijing may slam the door on foreign participants in retaliation.

So far, that hasn’t been the case. Following a liberalisation of foreign ownership rules, US-based S&P in January became the first of the big three ratings agencies to receive approval to begin rating bonds in China. Moody’s and Fitch have also applied and are awaiting sign-off. Moody’s has also been linked with a deal to increase its minority stake in its joint venture with China Chengxin Credit Ratings Group.

China has also finally eased restrictions on foreign investment in securities joint-ventures, following years of lobbying. In April last year, it allowed investment banks to apply for majority ownership of their JVs and increased the scope of licences available to them. UBS became the first foreign bank under the new rules to acquire a majority stake in its JV, UBS Securities, while JP Morgan and Nomura have received preliminary approval to set up JVs from scratch with majority ownership.

Market observers reckon the risk of China backsliding is low, although the likelihood of US financial institutions being pushed to the back of the queue has increased. In September, BNP Paribas and Deutsche Bank became the first foreign banks to receive approval to be lead underwriters on all non-financial corporate debt in the interbank bond market. Market observers speculated at the time whether Citigroup and JP Morgan, which have applied for the same licence, had been snubbed due to China-US friction.

“My personal opinion is that the trade tensions will not stop China opening up,” said Gaetano Bassolino, head of global banking for the Asia-Pacific at UBS. “If you look at a number of measures, whether it is Shanghai-London Connect or the Belt and Road initiatives, these pre-date the recent trade frictions. China has made a conscious decision that it wants to increase its connectivity with the rest of the world so I don’t see that changing because of any short-term, geopolitical headwinds.”

The increased participation of international investors in China’s capital markets is also seen as a reason for optimism, given that China has spent years lobbying for domestic stocks and bonds to be included in global indices. MSCI in November raised its weighting of Chinese A-shares in its widely followed emerging market index, while Bloomberg Barclays began adding onshore Chinese bonds to global debt benchmarks this year.

Against that background and as more US investors gain access to China, either directly or through Hong Kong, efforts to bar Chinese issuers from US capital markets will not dry up their sources of capital completely. And while such moves would certainly damage Chinese issuers by increasing their costs of capital, it wouldn’t be great news for US investors or US banks either.

“If Congress or the president were to attempt to impose a ban on Chinese companies from listing in the US, for example, those companies would most likely end up listing in Hong Kong instead, making it harder for some US investors to access their shares,” said Jones Day’s Seem. “Ultimately it would harm US investors by limiting their investment options, as well as US investment banks. But the one thing members of Congress can seem to agree upon is a wariness and suspicion of China, so it’s difficult to rule out such a ban entirely.”

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