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Posts Tagged ‘China stocks’

The big talking point last week was undoubtedly the New York Times article that laid out the personal wealth of Wen Jiabao’s family in great detail. It was a piece of reporting very reminiscent of the earlier Bloomberg piece regarding the wealth of Xi Jinping’s immediate family, and the result of both articles has been the same: immediate blocking of the entire site inside China. But there are other potential repercussions because of this as well, and they have the potential to harm investors and Chinese stocks listed overseas.

Both stories used Chinese records to build and confirm the bulk of the data they presented, this is also commonly done when conducting due diligence on Chinese companies. These are the SAIC filings where you can find a lot of data about a company to help guide your due diligence process. It used to be that you could get all manner of economic data from the SAIC files, but access rights were severely restricted earlier this year, which forced due diligence professionals to adapt their processes.

It was widely speculated that the restricting of access to the SAIC files was a response to them often being used as a first stop when the now infamous short sellers were putting together reports on Chinese companies. The theory then went that because these reports were having a negative effect on Chinese stocks overall, as the perceived fraud risk increased, the political class stepped in to try to limit the short reports and decrease the downward pressure on Chinese stocks. It may even have been the case that the reason for the political class to move on the issue was that they were themselves losing too much money because of the stock decline.

The risk we face, now that these reports have been put together, at least to some extent, based on the SAIC filings is that access will be restricted even further. This would cause a multitude of problems for conducting due diligence in China, and it would add uncertainty to the market for China concept stocks as it would become even harder to confirm holdings, or even simple things like ownership.

This is especially problematic for people who trade Chinese stocks on the IFRS exchanges, as disclosures from companies on these exchanges tend to be much less detailed. The classic example for me in this is the fact that you can still report a VIE as a subsidiary under IFRS. The classic check on this would be to pull the SAIC filings to find out who were the actual registered equity owners of the entity in question, if you remove this option then investors truly are flying blind.

What’s more, this will probably also increase the costs of performing due diligence in China, which would harm smaller investors more that institutional players who have enough money involved to warrant the outlay. With the easy option of checking SAIC filings for suspicious discrepancies gone investors will need to find other ways of red flagging potential investments, it will also increase the value of having a good network set up for conducting due diligence.

Further, In my opinion it’s quite the opposite of what the overseas listed Chinese companies, especially the small- and mid-cap companies, need right now. many of them appear to be legitimately undervalued and would benefit greatly from increased transparency to help soothe investors concerns regarding them.

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In a move that is likely to have many investors in China concept stock scratching their heads the Chinese government has further restricted access to SAIC filings, often used as the start of any due diligence on a Chinese investment. The new rules make it virtually impossible to get detailed financials, as filed to the Chinese government, without the expressed consent of the company involved.

While there are limits to what you can tell by comparing SAIC filings to those made by the company overseas it is nonetheless the preferred starting point of most DD professionals and can act as a good road map for where to look in more detail. So restricting, or in effect banning, access to these files will cause some very real problems for investors looking to confirm the validity of a company’s financial statements.

Some are speculating that the reason behind the new restrictions is the use of SAIC filings in short reports written by muddy waters et al. While this may well be true, the effects of the policy will likely be much more widespread as the filings are also used to confirm financial information by investors looking to take long positions in Chinese companies. Perhaps most interestingly, checking SAIC filings was always a relatively cheap way to get some level of confirmation about a company’s financials. The alternatives that we are left with are likely considerably more time consuming and expensive, so these restrictions are potentially putting a higher value on reliable China DD.

The timing of the change in policy could also have been better, coming on the back of delistings,  companies unable to file financials on time, and changes in ownership of the big 4 in China this adds more uncertainty that foreign listed Chinese companies certainly don’t need right now. Something that may prompt companies to act on their own to provide some level of transparency for their investors.

In such an uncertain climate, one way to assuage investor concerns might be to grant any holder of a company’s ADS the right to review its SAIC filings. Whether this will happen or not investors are unlikely to act in a positive manner to restrictions in their ability to double check companies in a sector historically prone to misstatements and frauds.

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This post will be a quick comment on some new developments in China, an analysis will follow later in the week.

The CSRC has come up with some basic rules for RTOs in China, and reverse listings. The rules are still out for comment by industry professionals and we’re likely to see some minor changes in them still, but the overall road they wish to take is clear: RTOs and reverse listings will be subject to a similar legal framework as regular listings. This means demands on profitability and stable balance sheets.

What this will mean in reality is that listing overseas will become even more attractive to Chinese companies. Although it also provides an opportunity for the SEC to have a long talk with the CSRC about regulations on reverse listings in the US.

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