In recent years, with increasingly tough regulation and resulting continuous low IPO pass rates in the capital market in mainland China (A-share market), the Nasdaq, with shorter processes, better predictability and convenient subsequent financing options as the bonus of registration-based system, has become a preferred IPO destination for numerous Chinese companies. Alibaba, IQIYI, Bilibili, Sogou and some other big names are all listed on the Nasdaq, which proves its popularity.
However, the protracted China-US trade war waged since last year is leading people to believe that efforts from the US to curb the rise of China will become the norm. Thus, it is necessary to reassess the risks attached to a US IPO for Chinese companies.
The US Sarbanes-Oxley (SOX) Act, also known as the Public Company Accounting Reform and Investor Protection Act of 2002, mandated an overhaul of the Securities Act of 1933 and the Securities Exchange Act of 1934, introducing detailed rules on the governance of public companies, regulation of audit firms, and regulation of the securities market. The SOX Act imposes heavy compliance requirements on companies listed in the US.
Apart from the governance of the SOX Act, companies listed on the Nasdaq are subject to the Listing Qualifications Department, exclusive to the exchange, which is responsible for making sure that listed companies satisfy the listing requirements on a continual basis, and for issuing delisting notifications or public reprimand letters to companies non-compliant with the listing rules.
Under the SOX Act framework, Chinese companies have to factor in a variety of risks, including IT risks, if they seek to list in the US, and the subsequent internal costs incurred then increase notably.
Effect of US Foreign Corrupt Practices Act (FCPA)
According to the FCPA, Chinese companies listed in the US, subsidiaries and offices established in China by US companies, and their employees, as well as Chinese companies or individuals conducting corruption practices in the US – including even the practices of transferring money through American banks – might all be subject to the governance of the act. The act applies to “any company with a class of securities listed on a national securities exchange in the US”, and “a company thus need not be a US company”. In this light, Chinese companies listed in the US are expressly included.
We note that a US Department of Justice-issued (DOJ) “China Initiative” on 11 December 2018, in which 10 goals are set out, one of them being “identify FCPA cases involving Chinese companies that compete with American businesses”. This shows that there is a tendency that DOJ intends to use the FCPA as a tool to curb the development of Chinese companies, and to safeguard the economic interests of the US.
Judging from historical enforcements of the FCPA, China has indeed become the key objective area of FCPA enforcement. According to related statistics, from 2011 to date, 31% of the FCPA cases involving misconduct of companies relate to part or whole of the violations occurring in China.
In short, as the Belt and Road Initiative presses ahead, Chinese companies’ foreign business will continue to rise. With the extensive application scope of the FCPA, the probability of Chinese companies listed in the US triggering FCPA enforcement will markedly increase. Considering the explicit attitude of the DOJ, as manifest in its China Initiative, and the China-US trade war, Chinese companies may be subject to heavier scrutiny of US law enforcement based on the FCPA.
New considerations in selecting an IPO destination
Against the backdrop of the trade war, if the conflict surrounding the trade deficit is escalated to system or civilization-based rivalry, the conduct of Chinese companies may be magnified and overanalyzed. There is even risk of politicization of technology issues.
If this is the case, and given the current relationship between China and the US, and the regulatory framework of the US, the authors suggest that companies intending to seek an IPO in the US be very cautious about the high cost under the SOX Act and US attitudes towards the implementation of the FCPA.
Companies should be fully prepared in advance for any risks in relation to the Nasdaq. In this light, it is worth mentioning that there are other choices, for example, Hong Kong Exchanges and the exchanges in Europe such as Frankfurt Stock Exchange and London Stock Exchange. In particular, Hong Kong Exchanges has shown its determination to make changes and its commitment to connect to mainland capital markets in recent moves including changing the listing rules and allowing pre-profit biopharma companies and companies with weighted voting rights structure to have an IPO.
The convenient capital flow and refinancing resulting from its position as a global financial centre, plus its cultural and geographical advantages, make it a premium option worth consideration. Meanwhile, China-Europe relations will be reshaped as the China-US trade war extends. It is not a bad choice to select exchanges in Europe against this background.
In recent discussions with Chinese entrepreneurs on the option of foreign IPO destinations, the authors found that they have already begun to reassess the potential impact of a trade war on a US listing. Hopefully, this article serves as a reference for these entrepreneurs who are making relevant decisions.
Jason Cheng is a senior partner and Claire Wong is a paralegal at Dentons
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