Beijing offered a rare concession on Friday, agreeing to allow US accounting regulators to examine the audits of Chinese companies listed on US exchanges.
Big Chinese companies such as Alibaba and Baidu may be rewarded in return as investors “see a revaluing” of some of the biggest tech names, according to KraneShares chief investment officer Brendan Ahern, who manages the KraneShares CSI China Internet ETF (KWEB).
“The deal is an important catalyst — it’s an important first step,” Ahern said on Yahoo Finance Live (video above). “The titles we hold at KWEB are halved [price to earnings ratio], half the engagement ratio of US internet companies. We should see a bit of an upgrade there.”
The agreement between the Corporate Accounting Oversight Board (PCAOB) and the China Securities Regulatory Commission (CSRC) establishes a framework for PCAOB inspectors to travel to mainland China and Hong Kong to investigate China-based audits of companies listed on the USA. SEC Chairman Gary Gensler said he expects inspectors to be on the ground by mid-September to begin their investigation.
“The proof will be in the pudding. While important, this framework is just one step in the process,” Gensler said. “This agreement will only make sense if the PCAOB can actually fully inspect and investigate audit firms in China.”
The landmark deal momentarily removes an overhang that has clouded the prospects of Chinese companies trading in the U.S. for years. The Securities and Exchange Commission requires foreign companies to comply with PCAOB inspections and investigations of its controls. While “more than 50 jurisdictions have complied,” according to the SEC, China and Hong Kong remained the outliers.
Chinese regulators have long harbored concerns about state secrets being shared in the process, but that has only increased pressure for US compliance.
Since Congress passed the Holding Foreign Companies Accountable Act (HFCAA) last year, the SEC has identified about 200 US-listed Chinese companies that have yet to comply with the PCAOB’s accounting standards, including Alibaba ( BABA ), Baidu (BIDU) and JD. com (JD). Companies now face the risk of delisting if they fail to comply within three years.
“The vast majority of the 200 plus names listed, particularly the large-cap, mid-cap companies are controlled by the Chinese arms of the big four US accounting firms. So the quality of the audit is not the point,” Ahern said. “Being able to meet this global standard, the great work of the PCAOB should be no big deal.”
Many Chinese companies have already started pulling out of the US stock markets.
Earlier this month, five of the largest state-owned enterprises, long considered among the most sensitive when it comes to audit documents, all revealed their intentions to delist on the same day. This has led to speculation that a deal is imminent between regulators in both countries.
Meanwhile, major tech companies including JD.com and NetEase ( NTES ) have sought secondary listings in Hong Kong amid concerns about US regulatory pressure. This month, Alibaba’s Hong Kong-listed shares soared after news that the Hong Kong Stock Exchange had approved the e-commerce giant’s application to seek a primary listing there.
Ahern said the listings allowed the companies to tap Stock Connect with South, which allows Chinese investors to buy shares listed in Hong Kong.
The deal announced on Friday is likely to give an added boost to major Chinese internet stocks that are trading at what Ahern described as a “significant valuation discount” due to the delisting threat.
He added that active emerging market funds are $2 underweight against China, mainly because investors were hesitant to buy with the regulatory cloud hanging over them.
“Ultimately the Hong Kong listing along with the US listing allows companies to raise their capitalization,” Ahern said. “It allows them to have their cake and eat it too. I think it’s more positive that companies can participate in the US, the largest capital market in the world, but also bring in their own backyard.”
Akiko Fujita is an anchor and reporter for Yahoo Finance. Follow her on Twitter @AkikoFujita
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