A new Securities and Exchange Commission rule that will require foreign companies to submit documentation about government affiliations and government influence is causing headaches for China investors. It's one of several snags that is popping up between U.S. and China investors.
China stocks have been in correction mode for several weeks, but the new rule is exacerbating the rout, particularly those with listings in the U.S.
U.S.-listed China stocks this week:
GSX down 57%
Tencent Music down 36%
Vipshop down 34%
Baidu down 22%
Bilibili down 12%
Trip.com down 11%
Alibaba down 6%
While the new SEC rules apply to all foreign-listed companies, they are specifically aimed at China, which has repeatedly run afoul of efforts by U.S. regulators to monitor the audits of Chinese companies.
This week, the SEC adopted interim final amendments to implement the Holding Foreign Companies Accountable Act. Under the new rules, companies will be required to submit documents to establish that they are not owned or controlled by a governmental entity in a foreign jurisdiction.
Chinese companies will also have to name each board member who is a Chinese Communist Party official.
If the companies fail to comply after three years, U.S. regulators could delist the companies.
Jay Clayton, who headed the SEC for the past four years and recently returned to private practice, said the SEC's move this week to begin implementation of the new law may have woken up the trading community.
"Congress has now decided that Chinese companies listed in the U.S. should not continue to have an effective exemption," Clayton wrote to me. "The audits from these companies must come into compliance" with U.S. law.
It's been a rough month for China investors.
China's CSI-300, the top 300 stocks in China, was one of the best-performing indexes in the world in the first six weeks of 2021, rising 15% and far outperforming the U.S., Europe, and almost all of Asia.
Since then, immediately following the Chinese New Year, it's been all downhill, as the index is now off 3% for the year.
Brendan Ahern, who runs the Kraneshares China Internet ETF (KWEB), a fund that holds primarily U.S.-listed China stocks, says that China's technology sector has been hit with many of the same valuation concerns that U.S. tech stocks have been hit with.
"Growth names in general have been suffering with the cyclical/value rotation, and that includes China's growth names," Ahern told me.
Ahern noted that there has been huge block trades going off recently in many China names, including Tencent Music, Vipshop, and Baidu. "There is some speculation that this is a forced liquidation by some fund," he said.
Other market observers also took note of the enormous trading. Tencent Music, for example, normally trades about 17 million shares a day, but was nearing 300 million at the close of trading today.
"The only logical explanation for this kind of size is there is some real fear of delisting or some of the political stuff going on between the U.S. and China," Steve Sosnick at Interactve Brokers told me. "Someone is puking, someone is saying, 'Get me out,' but it's not clear why."
Sosnick noted that Credit Suisse, Morgan Stanley, Baillie Gifford, and Nomura are among the largest shareholders of Tencent Music.
Ahern's Kraneshares Internet ETF has seen share trading north of 5 million shares a day for the past two days, twice normal trading volume, and is trading 10 million shares today.
Pressure is not just coming from U.S. regulators. In November, Chinese regulators stunned investors there by nixing Ant Group's IPO at the last minute.
Since then, Chinese officials have repeatedly expressed concerns about inflated stock prices and excessive leverage in the system.
Chinese regulators have recently fined some of the largest tech giants, including social media firm Tencent Holdings, search engine Baidu, and ride hailing company Didi Chuxing, among others, for violation of China's anti-monopoly laws, claiming it was protecting consumer interests.
Some traders also noted that the war of words between the U.S. and China this week had spilled over into apparel brands, and this may also be adding to the bad blood.
Adidas, Nike and H&M all dropped midweek as major players in China's social media called for a boycott of the companies over statements they had made months ago on forced labor in the Uyghur autonomous region.
"The Chinese government is prepared to say to corporations and to governments around the world, 'You desperately need access to our markets, and if you do not behave in ways that are unacceptable, we are going to punish you for that,'" Ian Bremmer, Eurasia Group President said on CNBC.
Put it all together, and it amounts to a very difficult moment for U.S. investors in Chinese companies.
Many China observers are hopeful that the latest move by the SEC to enforce the new U.S. law will ultimately be resolved.
"I am optimistic there will be an agreement because it is in both sides interest to solve this problem," Andy Rothman from Matthews Asia said on CNBC.
But getting to that point will not be easy. China regulators have resisted turning over data largely because of sensitivity around state-owned enterprises, mostly large banks, energy, materials and industrial companies.
"They do not want to open those books to U.S. government agencies, because you would know what subsidies these companies are getting from the Chinese government," Ahern said, noting that while most Chinese tech companies are privately owned, the extent of government involvement is also not entirely clear.