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what it means for investors, start-ups

Traders works during the listing of the Chinese travel company Didi Global Inc on the New York Stock Exchange (NYSE) floor in New York City, USA, June 30, 2021.

Brendan McDermid | Reuters

BEIJING – Investors may have to think twice about investing in Chinese technology start-ups as new regulations are imposed on mainland companies wishing to go public in the US

If listing in Hong Kong becomes the only viable option, fund managers will probably have to reconsider their investment strategies, as there are practical differences in how New York Stock Exchanges handle IPOs.

Since the summer, both China and the United States have raised the list for Chinese companies wishing to trade in New York.

Not only investors are affected. Chinese companies wishing to raise capital are facing greater uncertainty about the way to listing on public stock markets, and possibly lower valuations as well, analysts said.

Beijing̵[ads1]7;s actions have more imminent consequences. From 15 February, the increasingly powerful cyberspace administration in China will officially require data security reviews for some companies before they are allowed to register abroad.

Apart from the technical complexity of why and how Chinese companies have worked with foreign institutional investors to list in the US, the new regulations may mean that similar listings in the future will probably have to go to Hong Kong.

For technology companies, this could mean lower valuations than if they were listed on the New York Stock Exchange, said Richard Chen, CEO of Alvarez & Marsal’s Transaction Advisory Group in Asia.

He said a market familiar with Silicon Valley could put a higher price on a technology company’s growth potential, as opposed to Hong Kong’s greater focus on profitability and knowledge of business models for companies that run physical stores or work in fields such as semiconductors and precision engineering.

With new Chinese regulations, Chen said his customers – mainly traditional private equity firms – look more at traditional industrial companies and businesses that sell to other businesses, or sell to consumers without relying much on technology.

“That’s what our clients think of: ‘Does it make sense to look at these sectors if it’s ultimately a challenge to list in the US given regulatory concerns?'” Chen said, adding that clients also reconsider their investment strategies in to whether their minimum return target may be more difficult to achieve because a listing in Hong Kong resulted in a lower valuation.

What it means for investors

Faced with the potential for lower returns – or the inability to quit investing within a predictable time frame – many investors in China are keeping up with new games. That is, if they can raise money for their funds to begin with.

Data from Preqin Pro shows a sharp drop in fundraising from US dollar-denominated and yuan-denominated China-focused venture capital and private equity funds in the third and fourth quarters of 2021.

For US dollar funds focused on early-stage Chinese startups, annual fundraising since the pandemic began in 2020 has fallen below $ 1 billion a year – down from $ 2.43 billion in 2019 and $ 5.13 billion in 2018, according to Preqin .

Read more about China from CNBC Pro

While start-ups may be looking for support, funds denominated in US dollars have focused on China sitting on capital. A target of unused funds, known as dry powder, reached $ 45 billion in June 2021 – the highest level in at least 10 years, according to the latest Preqin data.

“Due to uncertainty about the exit, we slowed the investment rate in the second half of last year,” said Ming Liao, founder of Beijing-based Prospect Avenue Capital, in Mandarin, according to a CNBC translation. The company managed $ 500 million from the summer and had previously expected to list some of its invested companies in the United States last year.

“Practically, the United States is the best starting point for Chinese Internet and technology companies,” Liao said. “There is high acceptance of new models and a high tolerance for unprofitability, while liquidity is very good.”

Last year’s average daily turnover for shares in Hong Kong, a measure of liquidity, was about 5.4% of the Nasdaq and New York Stock Exchange in the US, according to a China Renaissance report earlier this month.

Even for large Chinese companies such as Alibaba and, the average daily turnover of their shares traded in Hong Kong has been between 20% and 30% of those traded in New York, the report says. Analysts added that US listed Chinese companies usually price their secondary listing in Hong Kong at a discount.

Chinese listings in the US went towards a record year in 2021, until the Chinese company Didi’s listing on the New York Stock Exchange in late June caught Beijing’s attention. Within days, China’s cyber security regulator Didi ordered the suspension of new user registrations and removal of the app from app stores.

The move revealed the enormity of Chinese companies’ compliance risk in the country, and marked the beginning of an overhaul of the foreign IPO process.

Among other measures, the China Securities Regulatory Commission announced new draft rules in December setting out specific requirements for filing a listing abroad, saying the commission would respond to such requests within 20 business days of receiving all material. The Commission closed the public comment period on 23 January, without revealing an implementation date.

We expect that this uncertainty will dampen investor sentiment, potentially lower valuations for Chinese IPOs in the US and make it more difficult for Chinese companies to raise funds abroad.

In comments to journalists last week, Li Yang, chair of the government-sponsored think tank National Institution for Finance and Development, described the new draft rules for Chinese stock exchanges abroad as bringing the country forward in line with international institutional investment standards.

Meanwhile, in December, the US Securities and Exchange Commission asked Chinese companies to reveal more details about their regulatory risks and ties to government supporters. White House sanctions against certain Chinese companies such as SenseTime briefly disrupted IPO plans.

Foreign financial institutions involved in Chinese listings face increasing “commercial risk” that the invested company “will be sanctioned because of its reputation with the US government,” Nick Turner, a Hong Kong-based lawyer with the law firm Steptoe & Johnson. “This is now one of the most important focus areas in the due diligence process before any IPO.”

What it means for start-ups that want to list

The road to an IPO in Greater China or elsewhere is still uncertain, although prices are favorable.

“For (Chinese) companies applying for a foreign listing, they will probably have to wait for further clarification from regulators on both sides, and can expect stricter scrutiny, regulatory approval and pre-approval from various agencies and authorities,” the analysts said.

“The new rules could impose long waiting times for companies hoping to be listed abroad,” said analysts. “We expect this uncertainty to dampen investor sentiment, potentially lower valuations for Chinese IPOs in the US and make it more difficult for Chinese companies to raise funds abroad.”

Following the high-profile suspension of Alibaba’s affiliated Ant’s planned IPO in Hong Kong and Shanghai in late 2020, authorities also delayed the public IPO of computer maker Lenovo and Swiss seed company Syngenta on the mainland last year.

More than 140 companies have active registrations for Hong Kong IPOs, according to the Hong Kong Exchange website. An EY report showed that the lag of companies wishing to go public on the mainland or Hong Kong remained above 960 by the end of 2021, little changed from June, before the last regulatory investigation.

At the end of the pre-IPO, 12 Chinese companies joined the list of new unicorns – private companies valued at $ 1 billion or more – in the second half of last year, according to CB Insights. In contrast, India added 26 unicorns and the United States got 148 unicorns during that time.

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