It has been an unprecedented few days for Chinese technology stocks.
It began at the end of last week, when the US Securities and Exchange Commission named five Chinese companies listed in New York for a possible delisting over audit-related concerns.
The result? Shares of Mainland technology majors tumbled in Hong Kong and the US, as many of the firms are dual listed on both markets.
The meltdown has only continued this week. Hong Kong’s Hang Seng Index lost 5.72% on Tuesday alone, putting its losses over the past five trading days at nearly 12%. The Hang Seng Tech Index tumbled about 11% on Monday, and followed up with another 8% fall on Tuesday.
In the US, the Nasdaq Golden Dragon China Index — which tracks the stock of firms listed in New York but doing the majority of their business in Mainland China — closed 11.73% down on Monday, and has fallen by a whopping 24% in the past five-day trading period.
These are extraordinary numbers — but the trigger for the meltdown is equally extraordinary. The SEC said that five firms — BeiGene, HutchMed (China), Zai Lab, Yum China Holdings and ACM Research — risked being kicked out of Wall Street if they didn't hand over audit documents with their financial statements to the US authorities.
But the audit pressure on US-listed Chinese companies is nothing new.
China and the US are engaged in a long stand-off over the power of US authorities to inspect the books of Hong Kong or Mainland-based companies trading in New York.
In December 2020, the US passed the Holding Foreign Companies Accountable Act, which gives it the power to review audit documents of international companies listed in New York. The Chinese authorities, on the other hand, ban foreign inspection of working papers from local accounting firms. Companies only risk a delisting after another two years if they fail to meet the US requirements.
This regulatory overhang is something that investors have had to contend with for more than a year.
It hasn’t helped, of course, that Beijing itself has been cracking down on its technology sector, including by fining major names like Alibaba Group Holding and Tencent Holdings, and all but cutting off possible US listings from Chinese companies that collect user data.
Again, this is nothing new, as the tightening of the sector began well over a year ago.
So, while one explanation for the relentless sell-off over the past few days is the sudden threat of possible delistings and reports that Russia had asked China for military support for its war in Ukraine, another explanation is that investors have been vastly under-estimating the risks from the sector despite the many well-flagged headwinds, and that a correction was overdue.
That is a problem. If there is one thing investors should have learnt from China’s growing oversight of the tech sector in the past year, it is that the noose will only tighten around the industry — and that it could tighten unexpectedly and without much by way of explanation. There are numerous examples of this, after all: from the eleventh-hour cancellation of Ant Group’s jumbo IPO to the onslaught on Didi Global days after the ride-hailing firm went public in the US.
The implications of the tech sell-off are many. The already thinning pipeline of China-into-US IPOs will likely slim down even further. With geopolitical risks still looming large and investors around the globe taking a risk-off stance, any new issuer will need to time its deal well, given sentiment has taken a further hit amid the regulatory uncertainty.
The rout is also bad news for the Chinese government, which is battling numerous issues: a spike in Covid-19 cases resulting in city-wide lockdowns, a property industry in significant distress, and a global community watching its every move.
What China — and investors — need now is clear and decisive communication from Beijing.
This is something market observers have long been demanding: clarity on whether further tech crackdowns are coming, and more transparency on what the authorities are doing to tackle the growing debt crisis in the real estate sector.
Now more than ever, China needs to pull out all the stops to instill some confidence among investors. Being vocal about its plans for the tech industry would go a long way towards providing some certainty to both companies and panicky investors. Even if the conclusion is that the crackdown is nowhere near over, the clarity can certainly help.
Unless China acts soon, the country’s issuers, the government and regulators risk losing all credibility in international financial markets. It’s not a risk worth taking.