Didi’s Wall Street dreams falling by the wayside and the ride hailing company’s decision to list in Hong Kong shows decoupling between China and the US gathering pace. Meanwhile, other sectors of the Chinese economy like healthcare are next in line for the government’s regulatory crackdown as investor, bank and corporate risk spikes.

Chinese ride hailing app Didi Chuxing’s announcement at the end of last year that it will delist from the New York Stock Exchange and relist in Hong Kong has repercussions well beyond the fortunes of those who bought into the US$4.4bn IPO five months ago. “After a careful study, the company will start delisting on the New York Stock Exchange immediately, and start preparations for listing in Hong Kong,” wrote Didi on its verified account on Weibo, a popular Twitter-like platform in the country.

The decision is a consequence of relentless regulatory scrutiny from Chinese authorities, including a wide-ranging government investigation into Didi’s cyber-security practices. The Chinese government wants to regulate new, online tech companies that have escaped traditional regulatory frameworks around business rules and consumer protection, argues Fraser Howie, author of Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise in an interview from Singapore. The clampdown was first witnessed in the halt to Ant Group’s dual listing on the Shanghai and Hong Kong stock exchanges in November 2020.

Nor does the Chinese government want foreign investors to have the granular knowledge of Chinese companies’ customer base – Didi’s mapping data, for example – that is granted by modern technology. And the pressure on Chinese firms to delist isn’t just coming from Beijing. The US Securities and Exchange Commission has drawn up rules that would allow it to delist Chinese firms that refuse to open their books over three straight years to US regulators – China has long rejected US audits of its firms, citing national security concerns.

Today’s backdrop has put the wind up Chinese NYSE IPO hopefuls, all shelving their plans to follow in the footsteps of companies like Alibaba, Baidu, JD.com and NetEase and list on the most sought-after global stage. And although none of these big Chinese names have yet to mirror Didi’s decision and pull out of New York, everyone is watching the next move and manifestation of China’s gradual decoupling from US capital markets. “The West got it wrong; China is closing down once again,” predicts Howie.

Long wait

At the very least Chinese companies hoping to float in the US are in for a long wait for further clarification of the rules. Companies still wanting to list will then face rigorous scrutiny and regulatory clearance from different government agencies and authorities. “The State Council’s special regulations on overseas equity fundraising and listing will be amended; the responsibilities of domestic industry supervisors will be clarified, and cross-departmental supervisory coordination will be strengthened,” lists Bruce Pang, Head of Research at investment bank China Renaissance, who predicts a much more difficult climate for Chinese companies hoping to raise funds overseas ahead. Looking to the future he says the NYSE listing door may open slightly, but only to small and mid-cap companies in less controversial industries and low-profile sectors holding less sensitive data.

Positively, he hopes that investors and companies’ concerns will be allayed by clearer communication. He expects Chinese authorities to better manage the pace and intensity of the regulatory campaign; communicating with the market about the motives behind the regulatory push and telegraphing future regulatory hotspots. Besides, the Chinese government is still keen for local companies to tap alternative sources of finance. China’s state-controlled local banking system needs to be freed up to service SOEs and the “commanding heights of the economy,” says Howie.

Homecoming in Hong Kong

Didi had decided to swap New York for Hong Kong, but the Hong Kong Stock Exchange my not provide the growth capital or platform for expansion Chinese companies seek. Initial public offerings in Hong Kong raised less than US$26bn in 2021, down 10% compared with 2020, according to data from Dealogic. By comparison, global IPO fundraising jumped 75% in 2021 compared to 2020, with deals in New York alone rising to about US$300bn.

Hong Kong will appeal to companies wanting to raise foreign currency capital and the region has deepened its capital market reforms: valuations, analyst coverage and liquidity have all improved. The Hong Kong Exchange recently announced consultation results regarding further facilitating dual primary and secondary listing in Hong Kong. “We expect the listing requirements to become more flexible and convenient, spurring a recovery in sentiment with a strong potential pipeline of Hong Kong listings ahead,” says Pang.

But Hong Kong may struggle to draw the deep pools of foreign capital Chinese companies seek. Foreign investors remain wary of Hong Kong’s different rules and weak disclosure. For example, demand for listed stocks could be dampened by rules or conditions that make critical research difficult. “Hong Kong could become a dumping ground,” says Howie who observes that Hong Kong’s Zero Covid policy and strict quarantine rules will continue to hinder investors’ ability to travel to the region and conduct due diligence on Chinese companies listing on the exchange. “It’s difficult to build a financial centre if you can’t get in or out,” he says. “It’s a lazy idea to think that Hong Kong will become the replacement for listing in NYSE.”

Limits to listing in Hong Kong, and unable to expand their capital base, brand and reach through the US, Chinese companies will have to rely on domestic investors on Shanghai and Shenzhen stock exchanges. Most of China’s biggest tech companies still derive the bulk of their revenues from customers in China, and these businesses will continue to thrive, says Howie. Listing on the mainland has also grown more appealing because of recent reforms in China’s A shares, adds Pang, “A-share market reform is helping to facilitate listings with streamlined processes and more flexible options for companies with key technologies and market recognition.”

However, Chinese tech companies’ ability to expand geographically and compete internationally has been crimped. Going forward this means their valuations will be more aligned to a utility than the explosive growth profiles they could have had. “Chinese firms will need to rely primarily on organic business growth or domestic markets to fund their expansion. A decade ago, listing on a foreign exchange would have been the goal of many IPO-bound mainland firms, but this has certainly been de-prioritised by regulators,” says Zennon Kapron, Director of Kapronasia, a financial technology research and consulting firm. “Longer-term, it may actually inhibit growth and kill the golden goose that has been such a big part of China’s international story.”

Not just tech

The government’s crackdown on the country’s US$100bn-a-year tutoring industry shows its regulatory sweep goes beyond thwarting overseas listings, the tech sector and business models around customer data. Chinese companies across all sectors face a new perilous regulatory landscape. “In our view, regulators look likely to crackdown on anything relating to anti-trust, abuse of dominance, monopolisation, M&A, controversial industries and juvenile protection,” lists Pang, adding that financial holding companies and variable interest entity (VIE) structures are also in regulators’ sights. A VIE involves creating an overseas holding company that allows investors to own a stake in a Chinese company that would otherwise be difficult because of restrictions in the mainland. Companies like Didi, Alibaba, Pinduoduo and JD.com have all benefited from the system.

Healthcare groups targeting the middle class with prescription drugs and services is the next sector most likely to see the government come in over the top. President Xi wants to support moderate wealth for all under the banner of “common prosperity,” yet the health-care industry is one of the country’s so-called “three big mountains” (alongside education and real estate) where spiralling prices are posing obstacles to affordable living. “As well as house prices and education, China is struggling to regulate healthcare fees,” says Pang. “My guess is healthcare will be next to reduce inequality and maintain social stability because China’s medical bills are rising steeply, outpacing government insurance provision.” It holds damaging repercussion for healthcare groups, flags Howie. “Will they allow healthcare companies to set prices, or force them to act as a utility just delivering a service?”

Banks

Banks that have tapped into lucrative IPO business will also start to feel the pinch. “As the majority of Chinese IPOs aimed for US exchanges are either suspended or diverted to other venues, some banks’ underwriting fees have been axed,” says Pang, adding that company valuations (and potential fees) are now vastly different. “Chinese firms are tempering their expectations for valuations amid regulatory overhang.” Meanwhile foreign banks get very little business from China’s onshore IPO pipeline where deals are dominated by mainland lenders like Citic, the state-owned financial services group that oversaw 17% of a record US$65bn in fundraising this year from new listings in Shanghai and Shenzhen, according to Dealogic data.

Banks, investors and corporates are only just beginning to feel the effects of decoupling in a sweeping reminder of the power of China’s communist party, concludes Howie.