Chinese stocks will take $600 billion from the US stock market, and that’s just the beginning.

The US market for Chinese stocks has always been a double-edged sword for investors, but now that years of accumulation have led to an inevitable end, Americans are faced with a terrible sword.

In 2021, the market collapsed in China-based stocks after hundreds of shady offers on US marketplaces for young Chinese companies that had the potential for development or total catastrophe.

“Valuations have fallen. There have been no IPOs in recent months. Harvard Law School professor Jesse Fried added, “There have been a number of private transactions.”

According to Matthew Kennedy, senior strategist at Renaissance Capital, an IPO research firm that also owns two IPO-focused ETFs.

After 30 deals raised $11.7 billion in 2020, excluding SPACs, Mr. Li claimed 34 Chinese companies raised $12.6 billion this year by going public in the United States (special acquisition companies).

There were mixed results for US investors who bought these stocks.

When it comes to IPOs in the United States, the average return for China-based companies in 2021 will be negative – 42 percent,” he says. According to him, only 12% of the stock market is currently in the dark.

Not only rookies are affected. According to the US-China Economic and Security Review Commission, 248 Chinese companies had a total market value of $2.1 trillion in May. $600 billion has been shaved off that valuation, which now stands at about $1.5 trillion.

More than a few US investors are holding on Chinese stocks expected to recover, or as potential losses to offset other taxable gains in 2021.

Even as new laws in the US and China force Chinese companies to release more information, the market for Chinese stocks in the US is now overflowing and could cause more pain, some analysts say.

“China doesn’t hold these securities, US investors do,” said Brendan Ahern, chief investment officer at Krane Funds Advisors, LLC, which has a China-focused ETF portfolio. There is a danger that we will lose that money.”

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Here’s a taste of what’s to come: Didi’s delisting

Didi Global Inc., the Chinese version of Uber, was the largest IPO of the year in the US, but fell apart just days after listing and is now delisting from the New York Stock Exchange and going to Hong Kong.

This is an example of what could be on the horizon for the dozens of Chinese companies still listed in US markets.

When Didi went public in June, it was already in conflict with the Chinese government. If Didi went public in the US, Chinese regulators warned it had too much data that posed a security risk, according to a Wall Street Journal investigation in July.

When Didi went public, the company had a market cap of approximately $80 billion after raising more than $4 billion from investors. Now valued at approximately $29 billion, it is the largest publicly traded company in the world.

The new legislation, the Holding Foreign Companies Accountable Act, or HFCAA, is expected to come into effect, and the delisting of Didi from the US is an example of what could happen to many other Chinese companies whose shares are held in the US. traded.

After the law was signed in December 2020, a provision in the HFCAA required that any foreign company trading in U.S. markets be subject to auditing their auditor’s workbooks.

If they don’t, they’ll be removed from the list after three consecutive years of non-compliance, with December being the first year since the law went into effect.

A rule requiring foreign companies to provide the PCAOB with the paperwork used in foreign financial audits was finalized last month by the Securities and Exchange Commission.

In addition, companies must demonstrate that they are not subject to the influence of their governments. There are many Chinese companies with board members associated with the Chinese Communist Party or the Chinese military.

In the words of Shaswat Das, a Washington-based lawyer and former chief negotiator for the PCAOB’s negotiations with Chinese authorities, “Everyone knew this was coming, so this was no surprise.”

According to the PCOAB, China and Hong Kong have already been declared non-cooperative jurisdictions by the SEC, so this appears to be moving forward.

In mid-December, it was reported that the China Securities Regulatory Commission (CSRC) was in talks with US regulators about cooperation in auditing US-listed Chinese companies, and progress was being made in those discussions.

According to Krane Funds, “the CSRC, the Chinese version of the SEC, has made some interesting comments.” To the best of my knowledge, the SEC and the PCAOB are still being contacted about this issue, and I have the impression that they want to resolve it. There may be further discussion or dialogue between the parties.”

Paul Zarowin, an accounting professor at the New York University Stern School of Business, described the situation as “a tug-of-war between US regulators and the Chinese.”

In other words: “The CCP and [President Xi Jinping] trying to get more control over everything.”

According to Harvard’s Fried, he remained unconvinced that China’s leaders will allow China-based accountants to be audited by the PCAOB, using Didi as an example.

“So if they’re concerned about sensitive information getting into the hands of Americans, it seems unlikely that China will allow the PCAOB to inspect audits,” Fried said.

As a result, even if China does not force these companies to return home, the ultimate goal of the HFCAA is to remove them from the list.

The biggest conceivable conclusion is moving to Hong Kong.

As a result, US investors are left in the dark, especially when it comes to well-known stocks such as Alibaba Group Holding Inc.

A senior portfolio manager at Synovus Trust Company, which owns about 30,000 shares of Alibaba at the beginning of November, says: “Right now we’re on a wait and see how it plays out.”

Investor investments have already been severely undervalued by a market that expects continued volatility and potential pull-outs.

On a year-over-year basis, Alibaba’s value is down nearly 50%, while Invesco Golden Dragon ETF has lost about 47% and KraneShares SCI China Internet ETF has lost about 51%.

However, Alibaba appears to have been planning to delist from the US market. A secondary listing of Alibaba shares on the Hong Kong Stock Exchange in November 2019 raised an additional $11 billion in cash for the company.

Five years after its IPO in the United States, the company went public in Hong Kong.

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Moving to the Hong Kong Stock Exchange is the easiest and best option for investors with large Chinese companies. IPOs such as Pinduodou, which has a market value of $68.6 billion, and electric car company Nio, which has a market value of $46.1 billion, fall into this category.

An investment strategist at Matthews Asia, the largest US company specializing only in Asian investments, said: “A large proportion of the US companies being delisted already have secondary listings in Chinese markets.”

Investors looking to participate in China’s expansion should partner with specialists as they can more easily convert American Depository Receipts (ADRs) to other exchanges, he said, citing the looming crisis.

For example, “If an institutional investor in the United States, to use Alibaba, for example, owns the ADRs in the United States, it’s just an administrative paperwork to convert those shares; it’s not a taxable transaction, you don’t have to. not making a market in it,” Rothman explained.

While China is an immense market that cannot be ignored, Rothman said it is a challenging market to understand.

“However, this is why Matthews was founded some 30 years ago….”

A lot of stock selection and thorough research is required because it is a difficult market to break into. Some scam incidents have been reported, but investors should not give up on the market as a result.”

According to Rothman, who added that he “sold his own book,” Matthews fund managers don’t just take numbers coming out of China. This is something we want to make sure we’re comfortable with before committing,” he said.

People who put money into it themselves can be overlooked

As noted in this column, if they are not prepared, the delisting process will have the greatest impact on retail and individual investors.

Going forward, the most dangerous companies to hold onto are those that have not set up dual listings and are not eligible to trade in Hong Kong.

Listing on the Hong Kong Stock Exchange is a complicated process. To qualify for listing under the HCFAA, a company must have a market capitalization of at least HK$2 billion and recent annual sales of at least HK$500 million, according to a recent study by Morgan Stanley.

In addition, they must have HK$100 million or more in positive operating cash flow during the last three years.

According to Rothman, the Hong Kong stock exchange is expected to revise its listing standards.

Rothman believes that the Hong Kong market will have to adapt to the higher quality companies that will have to leave the city.

In addition, “I expect Beijing and Hong Kong to reform the laws so that mainland investors can invest in ventures such as Internet companies.”

However, there are a few companies that do not meet the requirements. It is not uncommon for companies that do not meet these criteria to seek private equity buyers after their shares have been devastated by news or rumors that led to the delisting.

It would be a terrible consequence for American investors if they had to cash out instead of getting new shares to trade on the Hong Kong stock exchange, Harvard’s Fried said.

“Investors need to know what will happen to these companies. In larger organizations they are more secure, but in smaller organizations they are more vulnerable.”

As an example of smaller companies that have made a big fuss over the past two years, Qutoutiao Inc., which went public in September 2018, has fallen 98 percent on an all-time basis since its initial public offering (IPO).

It has a market value of approximately $81.6 million. IQiyi Inc., a video streaming startup, saw its shares fall 79 percent in the past year.

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A scathing analysis by short-seller Wolfpack Research, and most recently, regulatory uncertainties, have plagued China’s so-called Netflix since its public debut in March 2018. US company IQIYI has a market cap of $3.57 billion.

It’s a good idea for investors to take some losses now, rather than wait for the smaller companies to completely disappear from the US markets. US citizens who want to take advantage of China’s booming growth must deal with professionals who have no problem holding foreign stocks.