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Why US-listed China tech shares are taking a beating
China’s technology giants have seen more than $800 billion combined wiped from their market value since February thanks to Beijing’s expanding crackdown on the sector.
The recent crackdown by China’s authorities on ride hailing firm Didi Global and other US-listed Chinese tech stocks has sent Chinese American Depository Receipts, or ADRs for short, tumbling and has investors puzzled about what to expect next.
Many of the largest Chinese technology companies, like Alibaba, Tencent and JD.com, use a complicated structure to allow overseas investors to invest in them.
Often registered in the Cayman Islands, they use a variable interest entity, or VIE structure, allowing them to get around Chinese restrictions on foreign ownership and capital and currency controls.
Didi’s US-listed ADRs have lost more than 30% since the start of July, erasing about $25 billion from its market value.
The VIE structure has long raised questions but has been largely ignored by investors. After four years of headwinds from the trade war between former US president Donald Trump’s administration and Beijing, the Chinese Communist Party now appears to be upping the ante, posing a significant threat to US-listed Chinese stocks and fuelling investor concern that the sell-off is far from over.
Under the ADR/VIE structure, Chinese companies can pledge to pass cash flows and earnings through the offshore vehicle, but if anything goes wrong, investors have little ability to enforce better governance in these companies since decisions are made on the mainland, absent of investor participation.
Bank of America analyst Michael Li said a new statement by the China Securities Regulatory Commission indicates that China will soon be revising rules on overseas listings of Chinese companies.
The changes could have implications for both new Chinese listings and current Chinese stocks that trade on major US exchanges, such as online retail platform Alibaba, AI company Baidu and Pinduoduo, the groceries delivery platform.
‘Today there are more than 100 publicly-traded Chinese firms in the US with VIE structures, according to one Asia-focused broker,’ said Henry Taylor or Mirabaud Securities. ‘About 42% of those across a variety of industries employ this structure, according to research by the Peking University’s Guanghua School of Management,’ Taylor adds.
Chinese authorities are struggling to balance their desire to maintain absolute power over Chinese corporations with a need for outside investment to fuel economic growth.
The Didi crackdown immediately following its US listing on 30 June 2021 and the wider sabre rattling over US-listed Chinese firms looks like a slap in the face to investors, including those in the UK. The risk is that Chinese companies using US-listed ADRs could become toxic.