Asset owners turn to onshore Chinese equities amid ADRs' muddy future
Long-term investors are not convinced that China’s recent posturing on improving the regulations for US-listed Chinese equities will reverse the delisting pressure they face from US regulators who show little signs of concession.
Instead, asset owners and fund managers are turning to the onshore Chinese equity market and reallocating from technology, media, and telecom (TMT) companies to consumer and healthcare-related sectors.
The China Securities Regulatory Commission (CSRC) had on April 2 proposed to relax auditing rules for overseas listing of Chinese companies and suggested “cross-border” cooperation with the US and provide them with some auditing access to sensitive information of Chinese companies.
Even before the CSRC proposal, Vice Premier Liu He has softened his position and indicated that China would cooperate with the US to support the overseas listing of Chinese companies.
China will adhere to the principle of “respecting international practices and complying with domestic laws and regulations", said CSRC chairman Yi Huimin in a public speech on April 9. He added that the Chinese regulator will expedite the revision of auditing rules.
“All the recent changes and announcements are indicating that the Chinese government is more and more willing to adjust their rules to facilitate those companies to continue to be listed in the US,” a chief investment officer (CIO) of a major life insurance company told AsianInvestor.
“And it is natural to link that to the need to stabilise China's financial system under an elevating Covid-19 situation,” said the North Asia-based CIO, who declined to be named for this article.
SHORT-LIVED POSITIVE REACTIONS
Any optimism investors might have felt has since turned to caution as details about the proposed changes remain scant.
“While this has triggered a short-term positive price reaction for Chinese American depositary receipts (ADRs), which mainly consist of companies in the technology and consumer services sectors, the enthusiasm quickly faded as investors realise the final agreement from the US is not a given and that further collaboration details remain unclear,” said Hyde Chen, head of investment strategy of asset management, Haitong International.
The Nasdaq Golden Dragon China Index, which tracks blue-chip Chinese stocks, jumped more than 7% soon after the CSRC policy statement on April 2, but is down 24% as of Tuesday (April 26).
There is a general sentiment within the US Securities and Exchange Commission (SEC) to see China and the US resolving their differences over the listing regulations, but it is unclear if the US is prepared to make any compromise, a partner of a global law firm with expertise in US IPOs told AsianInvestor.
“The latest is that the US won’t and China will need to amend its policies to comply with US Public Company Accounting Oversight Board standards,” he said.
Chinese companies will still run the risk of disclosing sensitive information if they comply fully with US listing requirements despite the recent statements by the Chinese authorities, said the CIO of the life insurance company.
There are over 250 Chinese companies listed in the US with a combined market capitalisation of over $1.4 trillion as of the end of March. They include big names such as Baidu, JD.com, and Alibaba.
“From the investors’ perspective, an elevated risk premium uplift is embedded in Chinese ADRs’ prevailing valuations. Besides the delisting risks, it also reflects a sustained profitability impairment on the back of ongoing potential regulation impacts,” said Haitong’s Chen.
“Fundamentally, as an investor, we would like to see a downward revision trend in consensus earnings to show signs of stabilisation before we can confidently call the market has turned the corner,” he told AsianInvestor.
SHIFTING FOCUS
Haitong maintains a small overweight position on onshore China A-shares as it is confident that China is determined to achieve its economic growth target. The firm believes there is limited room for further valuation de-rating after the sizeable corrections year to date.
“The onshore market is also more sensitive to the government’s policy stimulus, while less exposed to overseas market volatility and the ADR delisting risks,” Chen said.
Aside from the ADR delisting issue, investors in the Chinese capital market face risks from global geopolitical uncertainties, the impact of recent Covid outbreaks on the Chinese economy, ongoing regulatory crackdown, and fallouts from property credit risks.
Principal Global Equities – whose main focus is pension funds and long-term investors - has divested from the ADRs that face delisting risk and negative earnings growth.
“We’re moving to more consumer and healthcare-related companies in China as we see more potential for future investment and earnings positive or resilient companies,” its chief investment officer Mustafa Sagun told AsianInvestor.
The firm has underweighted China in its global strategy as it comes to grips with the slowdown in the growth of Chinese companies compared with their foreign counterparts.
“I truly believe these ADRs are investable, and the numbers and other listing requirements may be reconciled at some point,” said Sagun.
"Considering all the risks and the potential opportunities, we are not adjusting the allocation or exposure to China for now but switching stocks from H-share companies to A-shares companies," he said.