Last month the bipartisan U.S.-China Economic and Security Review Commission released a report of Chinese companies listed on NASDAQ and NYSE. It finds there are 217 Chinese companies with a total capitalization of $2.2 trillion—including 13 national-level state-owned enterprises (SOEs).
While many of these companies disclose that they are headquartered in China, others use offshore entities to obfuscate their nationality, locations and parent companies. That lack of transparency is problematic on several levels.
Lack of Accountability
The Public Company Accounting Oversight Board (PCAOB), a nonprofit watchdog created by Congress to audit the auditors of publicly-traded companies, is unable to inspect the work of companies based in the People’s Republic of China (PRC) and Hong Kong. The PCAOB explains, “Chinese cooperation has not been sufficient for the PCAOB to obtain timely access to relevant documents and testimony necessary to carry out our mission.”
That means U.S. investors can invest in these companies, but the regulatory framework (and protections it provides) is not being applied.
National Security Risks
U.S. investors in these companies may unknowingly be supporting development of technologies that can be used for cyber-espionage, disinformation and censorship, and military applications against the United States (and as tools to suppress human rights in China, like the government’s crackdown on democratic protestors in Hong Kong).
A national 2017 Chinese law requires “any organization or citizen [to] support, assist and cooperate with state intelligence work.” It also requires Chinese companies to “provide technical support and assistance to public security organs.”
Variable Interest Entities (VIE) Have No Legal Standing in China
Many of the Chinese companies listed on the US stock exchanges have chosen incorporation vehicles that are illegal in China—complex offshore corporations called Variable Interest Entities (VIEs). U.S. investors buy into these companies at their own risk.
Since the Economic and Security Review Commission’s last report, 16 Chinese companies have been delisted. But at least nine still trade over the counter, including China’s largest semiconductor maker, Semiconductor Manufacturing International Company (SMIC; $28 billion). The U.S. Department of Commerce recently restricted sales to SMIC as a designated military end user.