The United States has the most open capital markets in the world where firms come to raise capital. The one clear requirement is that firms follow the laws, rules, and regulations on U.S. securities and finance. Beijing is fighting to see if its firms raising capital in the United States can avoid this basic requirement.
For all the talk of the declining importance of the U.S. economy and the dollar, the United States remains the preeminent global financial market. The combination of unrivaled liquidity, depth of financial markets, and openness to foreign companies with a clear and transparent regulatory system for securities issuers have made the United States the dominant financial market in the world.
U.S. securities regulations are not even generally regarded as onerous. Probably burdensome with excessive box-checking, but not a feared regulator that quashes investment. At the risk of oversimplification, U.S. securities regulation works on a simple motivating idea: issuers need to tell the truth. Almost any company making any good or providing any service can raise money in U.S. capital markets, but they must tell the truth and follow the laws and rules.
Following U.S. securities laws is the hang-up for Chinese firms. In 2013, the Public Company Accounting Oversight Board (PCAOB) signed a memorandum of understanding with the Chinese Securities Regulatory Commission (CSRC) that effectively allows Chinese firms to raise capital in the United States but be exempt from the laws and rules and regulations of American jurisdiction.
Before the memorandum, the CSRC had been reluctant to share auditing or enforcement documents of Chinese firms when requested by the U.S. Securities and Exchange Commission (SEC). But after the agreement was signed, Beijing treated all information as a national security secret. This killed oversight or ability to enforce U.S. law on Chinese firms listed in the United States.
From this perspective, it is important to note that no other country or group of firms has an agreement with the United States or the SEC that they simply are not subject to U.S. jurisdiction or oversight if they have raised money on U.S. markets. Though some have argued this is part of a China scare, the United States does not impose regulations upon Chinese firms beyond what is required of all other market participants. The United States merely requests that Chinese firms raising capital in America be subject to the same oversight as all other firms raising capital.
Beginning under the Trump administration, the SEC started to push that Chinese firms face delisting from U.S. stock markets if they did not abide by the same rules and regulations. Under the Biden administration, the SEC has held firm to its demands that Chinese firms fully abide by U.S. law to avoid delisting.
The Chinese side has publicly hinted they were willing to negotiate to secure a deal to keep U.S. markets open to Chinese firms. Even after these public hints, the SEC declared there would be no backing down and expected Chinese compliance.
Beijing is currently signaling that Chinese firms will abide by SEC requirements. But how solid are their assurances?
Before the 2013 agreement, when U.S.-China relations were better and Beijing was anxious to appear like a good faith international actor, the CSRC had been dragging its feet on cooperation with U.S. regulators. In other words, even in what can be considered significantly better times prior to the agreement, China was refusing to allow Chinese firms to be subject to U.S. jurisdiction when raising capital. This raises the question of whether China’s assurances of complying should be met with a significant degree of skepticism.
So how should the SEC and the Biden administration handle their recalcitrant Chinese counterparts?
First, there should be absolutely no change from the position that Chinese firms must comply with all U.S. laws, rules, and regulations to list in the United States. The United States is not forcing Chinese firms to list on our markets, SEC regulation is not burdensome, and creating a class of firms not subject to U.S. regulation violates the very nature of equality before the law.
Second, if a deal is reached whereby China agrees to abide by U.S. regulations, negotiators must insist on a “snap back” provision. If an agreement is entered and China does not comply with the legal requirements, swift punishment should follow. This is intended to prevent further Chinese foot-dragging rather than full compliance.
Any firm, Chinese included, should be able to access U.S. capital markets, but they must comply with all laws, rules, and regulations that any other participant faces. China should face a “snap back” provision based upon a long history of non-compliance.
Though focusing on what appears to be a relatively small part of the U.S.-China relationship that accounts for a relatively minimal amount of money compared to the trade relationship, it underscores a fundamental problem.
Will the United States demand that Chinese firms abide by U.S. law in America? Will firms be required to post truthful accounting records in furtherance of a transparent financial system? Though it seems so simple, it is anything but.
