On Friday, Chinese ride-hailing champion Didi Chuxing announced it was delisting from the U.S. and refiling for an IPO on the Hong Kong stock exchange, completing a U-turn from June, when the taxi app snubbed Hong Kong in favor of debuting on the New York Stock Exchange.
The company’s return to Hong Kong was driven by Beijing. Shortly after Didi debuted in New York, Chinese regulators suspended the company’s app and accused Didi of violating data privacy laws, tanking the company’s share price. Didi shares now trade at less than half their IPO price.
More U.S.-listed Chinese companies might be making the same return journey in the years ahead. On Wednesday, Bloomberg reported Beijing plans to “close a loophole” that has allowed numerous tech and internet giants, including Didi, to list overseas without official government approval.
China’s regulator, the China Securities Regulatory Commission (CSRC), has denied the thrust of Bloomberg’s report. (It is the second time this year Bloomberg has reported such a change is coming.) But Didi’s return to Hong Kong signals one thing clearly: Hong Kong is a safe space for Beijing; the state feels more secure when its domestic tech giants list in the special administrative region (SAR) than when they do so in the U.S.
The VIE
Chinese tech giants including Alibaba, Baidu, and Didi have listed in the U.S. through so-called variable interest entity (VIE) structures which provide a work-around for Beijing’s strict prohibition on foreign investment in areas of the economy it deems sensitive to national security, like the internet.
In a VIE work-around, a shell company—not the Chinese company itself—lists on an overseas exchange. The shell company, often based in the Cayman Islands or the British Virgin Islands, owns a “wholly foreign-owned enterprise” or WFOE in China, which operates in a sector Beijing doesn’t deem sensitive. The WFOE then strikes a contractual arrangement with the parent of the Chinese company, onshore in China, whereby the parent company agrees to share revenue and profits with the WFOE. That parent company is the VIE.
Confusing? Yes, and the convoluted nature of the arrangement means Beijing’s regulatory options for restricting the use of VIEs as investment channels are limited. Beijing can’t prohibit a Cayman Islands shell company from listing in the U.S., but it could refuse to register the shell company’s wholly foreign-owned enterprise in China.
Some analysts doubt that Beijing—if it does implement new restrictions on listing overseas—would be targeting VIEs specifically. “I don’t think they’re trying to stop foreign listings, or even VIE listings,” says Fredrik Öqvist, founder of risk consultancy Blueflag.io, which specializes in advising on structural risk associated with VIEs. “This is about reasserting the party’s authority over who gets to list overseas.”
Most likely, Öqvist says, all Chinese companies will be required to seek Beijing’s approval before listing overseas, and those that operate in sectors Beijing deems sensitive will perhaps be directed toward Hong Kong.
“We’ll get a sense in the next few months of how this plays out, but there are companies [with VIEs] already listing or moving to Hong Kong,” Öqvist says. Cloud Village, the music streaming subsidiary of China’s NetEase, debuted in Hong Kong via a VIE structure on Thursday. Internet giant Weibo is planning a secondary listing to raise $385 million in Hong Kong through a VIE structure, too.
Hong Kong made easy
Chinese firms typically prefer to list in New York. Besides the prestige associated with floating in America and providing easy access to U.S. dollars, U.S. markets have lower barriers to entry for new firms. The Hong Kong exchange (HKEX) requires newcomers to have a higher market capitalization than bourses in the U.S. do, for example.
Until 2018, the HKEX also prohibited companies from listing in Hong Kong under a weighted voting rights structure, a setup most tech entrepreneurs favor. Under such a plan, companies issue two types of company shares, with one conferring more voting rights to the shareholder than the other. The process allows executives to sell shares without diluting their power.
Alibaba famously chose to debut in New York instead of Hong Kong in 2014 because of the latter’s prohibition on weighted voting rights. The Hong Kong bourse missed out on the world’s largest IPO when Alibaba went to New York and raised $21.8 billion. In 2019, the year after Hong Kong removed its ban, Alibaba launched a secondary listing on the HKEX, raising $11 billion in what the bourse operator trumpeted as a “homecoming” sale.
Starting in January next year, the HKEX is amending its rules even further to, in the words of law firm Mayer Brown, “enhance the attractiveness of the Hong Kong market, in particular to Greater China Issuers.”
“Most significantly, [the new rules] adjust both dual-primary-listing and secondary-listing requirements to facilitate listings on HKEX of a wider spectrum of issuers already listed on NYSE, Nasdaq, or the Main Market of the LSE…in particular those with center of gravity in Greater China,” the law firm said.
The rule changes make it easier for some companies to convert their secondary listing in Hong Kong to a primary listing, in the event that they delist from the U.S.—an event that looks increasingly likely.
Outbound capital
Last year, Washington passed legislation that would delist Chinese companies from U.S. exchanges if they fail to comply with the Securities and Exchange Commission’s rules on auditing within three years.
Historically, Beijing has blocked SEC regulators from properly auditing Chinese firms, citing national security laws. Until recently, the SEC went along with Beijing’s recalcitrance, but on Thursday the commission finalized a framework that will allow it to implement the so-called Holding Foreign Companies Accountable Act.
“I thought China and the U.S. would resolve this issue, and maybe they still will, but…there’s a big chance the Holding Foreign Companies Accountable Act will go into effect and there will be no Chinese-listed companies in the U.S. in five years,” says Paul Gillis, a professor at Peking University’s Guanghua School of Management.
“Instead, they will be in Hong Kong,” Gillis says.
According to Gillis, Hong Kong is better prepared to handle an influx of large-cap Chinese companies than it was 10 or 20 years ago when Chinese tech giants began listing overseas. The Hong Kong bourse has grown, providing a deeper capital pool for companies to draw from and greater liquidity for investors to trade on.
The exodus of Chinese companies from the U.S. will be a blow to American brokerages and bourse operators that generate fees off of trading the large-cap companies, but the “homecoming” won’t sever the two markets entirely: U.S. institutional investors are still able to trade stocks listed in Hong Kong, although American retail investors will likely miss out.
Not every Chinese company listed in the U.S. is able to list in Hong Kong, either, owing to the latter’s stricter capital requirements. Gillis says those small-size companies will “probably be delisted, go private and re-list in mainland China, or go dark.”
Subscribe to Fortune Daily to get essential business stories delivered straight to your inbox each morning.
