China's start-up investors look to other markets as regulatory scrutiny on U.S. IPOs builds

BEIJING — While new Chinese regulation has hit pause on the Chinese IPO pipeline to the U.S. this summer, local start-up investors aren’t fazed.

They have other options for reaping returns on their investments and say the rules help clear up some uncertainty.

In the days since ride-hailing app Didi’s giant IPO on the New York Stock Exchange on June 30, Chinese regulators have announced, at a steady pace, new policies aimed at tightening control of data and the ability of companies to list overseas. Didi is down 14% from its offering price of $14 a share.

On Saturday, China’s cyberspace regulator proposed that any company with data on more than 1 million users must go through a cybersecurity review before listing abroad. The regulator, whose clout in China has grown rapidly, said public comment on the proposed rules would close July 25.

That followed an announcement last Tuesday from the top executive body and Chinese Communist Party’s central committee about cracking down on illegal securities activities, which included greater scrutiny on private equity and venture capital funds, as well as raising money overseas through stock.

“There is no impact at all on exits, investment direction and investment stage” for a firm like ours, Michael Xu, managing partner at China-based CEC Asset Management, said Thursday, referring to the increased securities regulation. That’s according to a CNBC translation of his Mandarin-language remarks.

The only aspect the firm would need to pay more attention to is whether investment projects had any shareholders without a clean record with the securities regulator, Xu said.

Large tech giants like Alibaba and Tencent, who have backed a significant number of companies listed in the U.S., have also fallen under heavy scrutiny in China’s crackdown on monopolistic practices in the last year.

Investor interest in China has climbed. Deal value from venture capital and private equity-backed buyouts reached $74.3 billion in the first quarter of this year, according to Preqin. That’s the most for any six-month period since the first half of 2018.

Getting returns on such investments are the priority, said Jeff Wu, a China-focused partner at Silicon Valley-based Pegasus Tech Ventures. In light of the latest market developments, he said he’s looking to exit investments via listings in Hong Kong or special purpose acquisition companies overseas.

However, mainland China has struggled with its own effort to keep tech IPOs at home. Authorities launched the Star board in Shanghai in July 2019, featuring a registration system for IPOs, rather than regulatory approval.

That registration-based IPO process has stalled. As of June 20, EY said more than 500 companies were on the Chinese securities regulator’s waiting list to go public on the Star board and a tech-focused stock board in Shenzhen called the ChiNext.

“Chinese investors are not sophisticated enough yet, and the legal environment is not mature enough to accommodate such a registration process,” said Zhu Ning, a professor of finance at Tsinghua University.

He noted that so far, Chinese securities law is “far less punitive” than it is in the U.S., and that recent securities regulation is “consistent with Chinese authorities’ continuous efforts to improve the requirements and standards of listing.”

“It’s important investors keep in their mind, China is still an emerging economy. No matter how fast-growing it is, the institutional background is still not the same,” he said.

Increased Chinese government scrutiny on local companies listing in the U.S. comes as tensions between the two countries are wearing away at economic and financial ties that have built up between over the last few decades.

Under the Trump administration, the White House began to call for less U.S. investment in Chinese assets. Since President Joe Biden took office in January, his administration has retained a tough stance on China.

Consulting firm Eurasia Group said in a note over the weekend that fallout over Didi’s listing will intensify U.S. political pressure for restrictions on Chinese stock offerings. “In short, the spigot of Chinese IPOs in the US will likely run dry,” the authors said, pointing out that several Chinese firms have already canceled plans for IPOs in the U.S.

Previously, Chinese companies had been going public in the U.S. at a record pace — accounting for 15% of the U.S. IPO market in the first half of the year, according to Renaissance Capital.

One strategy Chinese companies have pursued recently is listing in both the U.S. and Hong Kong — protecting against delisting risks while capturing a large pool of institutional investors.

This trend will likely continue, said Ming Liao, founder of Beijing-based Prospect Avenue Capital, which has had plans to list its invested companies in the U.S. He said the firm is “happy” with the latest regulatory developments because they specify the oversight of different agencies.

While investment funds look for other ways to exit their holdings, the Chinese government’s scrutiny on stock offerings isn’t going away.

Beijing stated in the national five-year development plan adopted in March that authorities aim to “fully implement” a registration for stock issuance and improve the “quality” of listed companies, while strengthening efforts to ensure national security and crack down on monopolistic behavior.

EY Asia-Pacific IPO Leader Ringo Choi said he expects overall uncertainty on IPOs to linger in the short term, as clarification on some policies could lead to other regulations. He noted that in China, one regulatory agency’s actions may compel another department to make similar moves.