Article / 04 December 2012 at 10:18 GMT

China shares may dive in today's US trading on delisting fears

Founder / ChinaRAI
China

Executive summary

  • The US SEC is charging the Big 4 US accounting companies and BDO for not following regulations. The Federal PCAOB is widely expected to follow this hard-line approach
  • If this happens, all US-listed Chinese companies could be unable to file audited financial statements in the US, leading to them all being delisted
  • Look for Chinese concept stocks to fall across the board today, or this week if no assurances are made. Lots of possible short plays

With all the talk about the US fiscal cliff approaching, a perhaps bigger risk is now rearing its head at investors. I’m going to call it the Chinese Accounting Apocalypse. The grand sum of what could happen here is that all US-listed Chinese companies might be delisted from the US exchanges, and many multinational corporations could have to deconsolidate their Chinese operations.

The basics of this issue are relatively simple:

  • US agencies are not allowed to inspect auditors on Chinese soil, and the Chinese will not allow the auditors to release their working papers to foreign agencies.This has been the case for some time now and there have been many negotiations held to try to find a solution, but so far they have failed to yield concrete results.
  • This situation violates the rules of the SEC and the US federal Public Company Accounting Board (PCAOB). The SEC can sue and otherwise punish the auditors for rules violations, but the PCAOB has the right to not grant them approval to audit US-listed firms.
  • If the PCAOB were to revoke the approval for the Chinese accountants to sign audits, no Chinese company could file an audited financial statement in the US, thus leading to a mass delisting of all these companies.

Furthermore, any multinational corporation listed in the US with significant operations in China would have to deconsolidate these from their financial statements, as they would also have to be audited in China. So this issue has wider implications than just pure Chinese stocks, although there are possible solutions for the MNCs that are unlikely to work for Chinese companies.

The real panic was set off by a statement from the SEC about charging the big 4 accounting firms plus BDO for not releasing their working papers, something which they are banned from doing by Chinese law. Professor Paul Gillis from Guanghua School of Management at Peking University has this to say on the matter:

I believe that this marks the beginning of the process to deregister Chinese accounting firms from the PCAOB and to ban them from practice before the SEC.  Unless resolved, this will likely lead to the delisting of U.S. listed Chinese companies. Multinational companies in China may also face issues since PCAOB rules require an auditor playing a substantial role in the audit of an MNC be registered with the PCAOB.  There are situations where the China Big Four are playing a substantial role in the audit of U.S. MNCs that have substantial operations in China. They may need to resolve this by dividing the work among several firms so that no single firm plays a substantial role. 

If there was one thing the recent climb for Chinese stocks did not need it was this level of uncertainty, and any increases will naturally be stopped dead in their tracks.

This issue is so serious and widespread that there is unlikely to be a single Chinese stock that does not take a beating when the US market opens Tuesday, unless the market simply doesn’t believe there will be any actions to go with these words. So it would seem the prudent course of action here is to short Chinese concept stocks across the board.

The risk element of shorting is always large and should be used carefully in my opinion, but with such a big even to swing the prices it's a gamble that should be worth taking.

Your best bet for short positions is likely to be the bigger Chinese companies, as the smaller ones are already trading at prices that are much too low. Also make sure they are not dual listed as this would offer a convenient solution should the worst happen. Baidu (NASDAQ: BIDU), Sina (NASDAQ: SINA), or indeed the newly IPOd YY Inc (NASDAQ: YY) which could be more susceptible to price swings at precent, all offer decent opportunities and plenty of shares to short. But there are likely to be many other targets out there as well.

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Fredrik Oqvist writes regularly about Chinese equities, mainly those listed on foreign exchanges. If you'd like to comment on this story or be notified by email whenever a new China Finance story is published, become a member - it's free, and you can use your Twitter, Facebook, Google or LinkedIn login - and "follow" the China Finance blog during the signup process. You can also bookmark the China Finance blog page.

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