Chinese ADRs

Why Chinese ADRs will still keep one foot in New York

Amid the bellicose posturing of the US-China trade war, Hong Kong is emerging as a safe port for China’s corporate refugees – but there are powerful reasons for at least some of these ADRs to stay where they are

Among China’s biggest new economy names, Alibaba was touted as the secondary listing that would blow the doors off the Hong Kong bourse to allow China’s other tech giants – the Baidus, the JD.coms and the Neteases– to rush in.

Certainly its mega-listing in late 2019 went a long way to rectifying the IPO loss of five years earlier and restoring confidence in the Hong Kong exchange as the rightful home to China’s tech giants.

Particularly telling was the fact that a cash rich Alibaba did not need to raise additional funding for operational reasons. The secondary listing was seen by the market as something of a homecoming.

But while Alibaba was eligible to list in Hong Kong, it was ineligible for the Hang Seng Index (HSI) until the index compiler modified its rules in mid-May to permit companies with weighted voting rights (WVR).

Though the earliest inclusion will occur in August 2020, it holds little impact on the appetite of investors who have reflected their support for advanced technology and new economy stocks with heavy trading volumes and rich market valuations.

Along with Alibaba, notable tech stocks that qualify for the main benchmark include smartphone manufacturer Xiaomi and food delivery Meituan Dianping. The three stocks together are not only among the top traded stocks in Hong Kong but have a combined market capitalization which accounts for almost 60% of the HSI. 

Inclusion benefits not only attracts passive fund liquidity, but also helps eligibility for the China-Hong Kong stock connect. This would allow mainland investors to buy shares in emerging domestic leaders, particularly those with strong commercial branding and are well known in China.  

PUSH AND PULL 

The pull factors towards Hong Kong overlap push factors from the US, as bellicose rhetoric between the world’s two largest economies now spills over into capital markets.

Tensions are rising, with the Trump administration requesting the $600 billion Thrift Savings Plan - a retirement savings fund for federal employees and the military - to pause their investments into Chinese stocks.

The US Senate has also passed a bill that would force companies to delist from American exchanges if they did not comply with regulatory audits.

Politics coincides with Nasdaq efforts to implement tougher listing rules. The onus for more oversight is intensifying following a scandal at Luckin Coffee, which admitted to fabricating over $300 million in sales.

Following Alibaba’s script, pursuing a secondary offering should be relatively seamless, as many Chinese ADRs are already well known with extensive analyst coverage. Requiring roadshows or investor meetings would prove unnecessary for these ‘new’ stocks, especially when social distancing is still practiced, and virtual IPOs are effective alternatives. 

Within the immediate pipeline, NetEase is expected to raise between $2 billion to $3 billion when the secondary listing is launched in Hong Kong. JD.com is expected to raise more than $3 billion shortly thereafter. 

ADR RESPONSE 

While a path ‘home’ solidifies, Chinese ADRs, meanwhile, will unlikely exit out of New York immediately. Only Baidu, the $35 billion Chinese internet search engine, was reported to be considering a delisting should Nasdaq implement new oversight rules.  

For Chinese ADRs, delisting out of New York would be politically symbolic, particularly if they relist exclusively in Hong Kong.  But doing so forfeits several tangible benefits. Dual listings in the US and Asia essentially provide a 24-hour trading window, while exiting out of New York also removes direct access to US dollar funding.

The appeal of Hong Kong may also fade as its reputation as a global financial falters under recent political pressure. Amid the social unrest, the US Congress approved the HK Human Rights and Democracy Act of 2019, which reviews Hong Kong’s autonomy under “one country, two systems”.

The “nuclear option would be to remove the special status Hong Kong enjoys under the US … effectively reducing Hong Kong’s status to that of just another Chinese city,” according to a note by Christopher Wood, equity strategist at Jefferies. 

What exactly the loss of special status entails, and the extent of the damage, can vary depending on which end of Hong Kong’s economy you view, according to Aidan Yao, Senior Emerging Asia Economist at AXA investment managers.

At one end, removing special status could increase tariffs on HK export products, which accounts for a small percentage of the economy, or it could force a de-peg of the currency which could have a significant impact to financial markets, explained Yao. 

NOWHERE TO GO

To disincentivise listing on any American exchanges, Beijing has showcased other bourses as possible alternatives, including London via the Shanghai-London connect.

However, with few new economy or advanced technology names, activity is anaemic. Brexit uncertainty has also dampened its prospects.

Closer to home, the Shanghai Stock Exchange launched the STAR market last year, a domestic rival to Nasdaq that only features technology-related companies. But expensive valuations, market fluctuations, and buying restrictions have kept foreign institutional investors sidelined. 

Even if China fully opens its current account, few better alternatives exist beyond Hong Kong or New York.

According to a Morgan Stanley report, the bank expects limited impact on the overall Chinese ADR universe, with their analysis concluding that the largest 55 ADRs account for 97% of total market cap. The note also highlights that only 24 out of 500 ADRs meet Hong Kong’s secondary listing requirements, suggesting that the rest will likely stay in New York given their relatively limited options. 

Delisting smaller and less liquid Chinese ADRs would likely benefit those that remain, with the market viewing a New York listing as an indirect stamp of approval. This would go a long way towards fixing the reputational damage, as well as improving the performance for future Chinese ADRs.

According to data from Dealogic, shares in the 29 Chinese companies listed in New York since 2017 are averaging a market cap loss of 16% since IPO, compared to non-Chinese companies which are down less than 3%.

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