Chinese stocks are down sharply on Thursday. Here’s what could be behind the decline

Select Chinese stocks have declined sharply on Thursday.

China watchers believe this is likely because the Securities and Exchange Commission has identified five U.S.-listed American depositary receipts of Chinese companies (Yum China, BeiGene, Zai Lab, ACM Research and HUTCHMED) for failing to adhere to the Holding Foreign Companies Accountable Act (HFCAA).

ADRs are securities that represent shares of non-U.S. companies, and they are traded on U.S. exchanges.

The act, which was passed in 2020, permits the SEC to ban companies from trading and be delisted from U.S. exchanges if American regulators are not able to review company audits for three consecutive years. 

These are the first China ADRs to be identified as failing to adhere to the HFCAA. These five companies are on the list because they recently filed their annual reports with the SEC. 

“All the Chinese listed ADRs will likely end up on the list, because none of them will be able to comply with requests to have their audits reviewed,” said Brendan Ahern, chief investment officer at KraneShares, told me. This is “because Chinese law prohibits the auditor to provide their review to U.S. regulatory authorities,” he added.

Ahern noted that the SEC has not moved to delist any of these companies. He said SEC Chair Gary Gensler has said the clock had started last year, so the earliest a company could be delisted would be 2024 (after three years had elapsed).

The disputes with China are causing U.S.-listed Chinese companies to increasingly become dual-listed in Hong Kong. In the last year, Alibaba, JD.com, Baidu, Bilibili, Trip.com, Weibo, and Nio have taken that step.

The KraneShares CSI China Internet ETF, a basket of overseas-listed Chinese Internet companies, has also shifted its focus. A year ago, KWEB was 75% U.S.-listed, it is now only 34%, with the rest in Hong Kong.

However, even before the Holding Foreign Companies Accountable Act, Chinese companies were becoming leery of U.S. investors, Ahern told me.

“These companies have come to be used as proxies for China and the trade war,” he told me. “They don’t necessarily trade on the fundamentals.”