To paraphrase Patek Philippe, in America you never actually own a Chinese ADR. You merely look after it for its Hong Kong-listed parent company.
Almost 300 Chinese companies have listings on US exchanges, and most of these are in the form of ‘American depositary receipts’. In essence, these give US investors a claim over the underlying shares of an overseas company. Prominent ADR issuers include the likes of Alibaba, PDD and JD, and the aggregate market cap is over $1tn, so this is not a niche thing.
Dual-listed ADRs can technically be exchanged for the equivalent shares in the primary listing — for example, in Hong Kong — which gives rise to a transpacific arbitrage trade that has kept the market efficient (ish) over the years.
However, Chinese ADR investors are now understandably freaking out that they could become collateral damage in the escalating Sino-American trade war. And those ADRs without a listing elsewhere — like Temu-owner PDD — are in an even more complex situation.
As Goldman Sachs said in a recent note (with Alphaville’s emphasis below):
. . . Equity investors are very focused on the renewed risk of Chinese ADR de-listing as flagged in President Trump’s America First Investment Policy 2 months ago, which highlighted the risks regarding the potential for expanded scope of restriction (industry and investor types) for US outbound investment into China, the accounting and reporting standards for Chinese ADRs (VIEs), and investability of Chinese companies that have been added to the Chinese Military Companies List (CMC List).
When asked in a recent TV interview about the potential response against Chinese companies after China imposed retaliatory tariffs on US goods, Treasury Secretary Bessent said “Everything is on the table”. In an extreme scenario, US investors may have to liquidate US$800bn worth of holdings in Chinese stocks if they are banned from investing in Chinese securities, and Chinese investors might need to unload their US financial assets, which could amount to US$1.7tn (around US$370bn in equities and US$1.3tn in bonds) in aggregate per our estimates.
For now, investors more broadly are understandably more worried about the prospect of China dumping Treasuries and US agency bonds than they are ADR shenanigans. But the ADR issue could become the proverbial thin edge of the wedge, so Alphaville thought we’d take a closer look.
The issue of Chinese companies listed in the US is not a new flash point. It last came to a head in 2022, when an audit disclosure act introduced by the original Trump administration clashed with a Beijing edict that this kind of company information doesn’t leave China. The two parties eventually settled after China allowed the US Securities and Exchange Commission access to ADR audits in Hong Kong.
However, all Chinese state-owned enterprises promptly delisted their US ADRs by 2023 amid speculation this was in order to avoid handing over information that Beijing may deem sensitive.
Despite long-simmering tensions, many Chinese companies — especially in the consumer and tech segments — have still been selling equity in the US. After all, a NYSE listing still has intangible prestige benefits and, more tangibly, often leads to higher valuations. Shanghai-based tea vendor Chagee is the latest to dip its toe in the water.
But as relations between the US and China have headed back into the dumps, investors are once again seriously considering the potential impact of the end of the Chinese ADR regime.
Goldman Sachs analysts estimate that the market is now pricing a 66 per cent delisting probability for Chinese ADRs, using their “ADR Delisting Barometer” that compares the performance of Chinese ADRs with Hong Kong listings to those without.
It’s not a perfect metric, as Goldman admits, given there are sectoral and market cap differences between the two sets of companies. But these are imperfect times.
Here are the mechanics, according to GS:
Chinese ADRs de-listing can be broadly grouped into two categories: voluntary and involuntary. Voluntary de-listing is usually a lengthier process although the transactions have typically been supportive to share prices before the de-listing date. Deregistration and privatization are the major options for voluntary de-listing, depending on whether the subject companies are also listed outside of the US.
Forced/involuntary de-listing, once announced, would proceed (relatively) faster and share prices tend to be under pressure. We observe that forced de-listing of Chinese ADRs could be triggered by four main reasons and mechanisms per existing rules and frameworks: 1) accounting fraud; 2) non-compliance to HFCAA; 3) US sanction, such as outright trading ban on Chinese military-linked securities stipulated by the Executive Orders from President Trump and President Biden; and 4) violation of Chinese regulations. Under all these scenarios, the US stock exchanges would move to de-list a company under the Exchange Act and in compliance with relevant rules.
In the event of an involuntary delisting, what is the damage? Jason Lui of BNP Paribas emphasises that “if ADR delistings happen on a regulatory or accounting rationale versus a national security rationale the market implication can be quite different”.
Companies like taxi-hailing app DiDi or coffee chain Luckin still trade ‘over-the-counter’ in the US despite not being listed on US exchanges. But if the US government were to invoke a national security rationale, as the Trump administration threatened in February, that could further restrict companies’ options.
Here’s the key line from Trump’s February missive:
The PRC exploits United States investors to finance and advance the development and modernization of its military.
Investors in Chinese ADRs with a primary or dual listing in Hong Kong could transfer their shares there by ordering the cancellation of their ADR and the withdrawal of their equivalent HK shares from a depositary bank into a local brokerage account. This process does NOT create new shares, as ADRs are backed by a pre-existing pool of shares.
There is a time lag and a fee for this process, but the bigger issue is that many US investors will not have the ability to own local Hong Kong shares, essentially cutting them out of the Chinese investment universe.
The GS analysts estimate that 7 per cent of the total ADR market cap — $1.1tn in March of this year — is held by US institutions that may not be able to trade in HK.
And for those companies that do not currently have a primary or dual listing in a friendly jurisdiction like Hong Kong the options are scarce. Here’s what Goldman says on that:
Our latest estimates suggest that 27 ADRs, with an aggregate market cap of US$191bn, would satisfy the criteria for either dual primary or secondary listing in HK. This would also imply that the other ~170 Chinese ADRs are currently ineligible for HK listing and therefore might consider privatization or other means to return capital to shareholders in the case of forced de-listing on US bourses.
Now Hong Kong has been making positive noises about helping Chinese companies in the US, like Temu’s PDD, to move their listings to the city. Paul Chan, the territory’s financial secretary, wrote the following in his official blog on April 13:
In light of recent global developments, I have instructed the Securities and Futures Commission and the Hong Kong Exchanges and Clearing Limited (HKEX) to be fully prepared for the potential return of Chinese Concept Stocks listed abroad.
Alphaville notes that the HKEX yesterday posted a job advert on LinkedIn for another “Vice President of IPO Vetting”. Could that be a sign they are getting ready for the deluge?
Companies that meet the HKEX requirements on market cap, revenues, voting structure and compliance can apply for a dual-primary or secondary listing in the territory.
Goldman said that 24 companies have since 2015 used Hong Kong’s “listing by introduction” regime that allows companies to transfer their equity from elsewhere, without selling or issuing new shares. Carmaker Nio did this in 2022. As Goldman notes:
Comparing to other listing options, this process is usually less time-consuming as only sponsoring is needed as opposed to underwriting . . . Listings by introduction are still subject to the secondary or dual-primary listing regimes, and dual-listed companies will also be eligible for Southbound inclusion consideration after trading in HK for 6 months and 20 days.
The minority of companies that are able to quickly move to a primary listing in Hong Kong would encounter the challenge of lower trading volumes than in New York. But they would benefit from an increased “southbound” flow of capital from mainland investors via the Hong Kong-Shanghai-Shenzhen stock connect, which has sent some $76bn year to date into eligible Hong Kong stocks this year according to Goldman.
We asked Alicia Garcia Herrero, chief Asia-Pacific economist at Natixis, what she made of all this, and she reckons that Hong Kong ultimately could come out of this financial tussle as a winner, recertifying its credential as China’s offshore financial hub:
Chinese companies are more exposed to Hong Kong than to US stock markets (over 1.400 companies vs over 300) but those in the US are clearly bigger on average (PDD, Alibaba, NetEase, JD, Baidu, Nio, Tencent). Chinese companies have raised 4 times more capital from HK than from US (USD$4.5tn vs 1.1tn).
This seems to offer HK as [an] obvious solution for Chinese companies if Trump pushes delisting again but the reality is that the HK stock market is changing in nature.
US asset managers (certainly also Canadian and European) are less keen to offer Chinese names to clients so that the investor universe is increasingly different (HK is increasingly Asia/Gulf based).
In other words, if Trump were to push Chinese companies out of the index, their financing needs would be covered mostly by Asian/Gulf investors and not so much Western investors as a consequence. [The] bifurcation of financial assets [is] potentially growing.
However, there are some caveats here. This post doesn’t even take into account the wider risk of a full scale investment ban for US investors on all Chinese or Chinese-linked assets.
As we noted at the top, Goldman analysts estimate that US investors own $960bn of Chinese and Hong Kong companies, including A-shares, H-shares and ADRs. In the event of reciprocation Chinese investors own about $370bn of US equities and $1.3tn of bonds.
Liquidating all this would be a real China shock, and it’s hard to see how Hong Kong (or anyone else) would win from that.
