Daily Management Review

The China Audit Agreement Provides Relief, But There Are Few Reasons To Invest


The China Audit Agreement Provides Relief, But There Are Few Reasons To Invest
Investors applauded a breakthrough agreement that gives US regulators access to Chinese companies' accounting records, but they say markets will be required to see successful audits and economic recovery prior to expecting much more money to flow to China.
In principle, the agreement announced on Friday satisfies a long-held US demand for unrestricted access to Chinese audit papers, significantly reducing the risk of Chinese firms being delisted from US exchanges due to noncompliance. more info
However, US officials warned that the agreement was only a first step, and financial markets are similarly cautious. Investors are waiting to see actual cooperation and are concerned that, while the agreement is encouraging, it will not be enough to lift economic gloom or resolve broad Sino-US tensions.
On Monday, a new round of risk aversion prompted by rising global interest rate assumptions maxed share price profits made on rumors and speculation ahead of the audit agreement.
Shares of once-favorite Chinese internet companies, such as Alibaba and Baidu, are trading at less than half of their 2021 highs and not far above recent lows.
"There is optimism based on the fact China and the U.S. can see eye to eye and seek common ground," said Sam Lecornu, co-founder and chief investment officer at fund manager Stonehorn Global Partners in Hong Kong.
"But the audit issue is not the biggest driver of negative sentiment towards China," he said. The two countries still had "bigger deals to be done that would help lift that sentiment."
Investors are most concerned about a sharp slowdown in the Chinese economy, which has caused confidence and spending to fall and unemployment to rise, as reflected in the Chinese yuan's 2.5% drop this month.
Then there are steeply rising US interest rates, which encourage US investors to stay put, new strains in US-China relations over Taiwan, and ongoing concerns about regulatory tightening in China, particularly for internet firms.
"This announcement was a good outcome," said George Boubouras, head of research at K2 Asset Management in Melbourne.
"But (U.S.-China) divergence will continue to occur .... There are too many differences between the West and how China wants to dictate their narrative. The tension will remain."
While the deal's declaration on Friday provided significant relief to investors in Chinese companies listed in the United States, legal experts and China watchers warned that the two sides could still clash over the details.
According to HSBC, most global and even Asia-focused funds are underweight on China, and foreign institutional investor flows into the country this year have been cautious and only slightly positive.
In the short term, attention will shift to the first actual audit checks under the agreement, as well as an anticipated update to Chinese rules on how mainland companies can access global capital.
Due to COVID restrictions in mainland China, the US Public Company Accounting Oversight Board (PCAOB) stated that inspections would begin in Hong Kong. According to officials, selected companies have already been notified. 
"Much will depend on the outcome of the full and extensive audits and the prevailing geopolitics," said Daniel Tu, founder of Active Creation Capital in Hong Kong.
"U.S. investors, especially institutional investors, are staying on the sidelines for now."
Markets are also anticipating the China Securities Regulatory Commission's (CSRC) final regulations surrounding how mainland Chinese companies can list overseas.
Any floats will need to be vetted by CSRC officials, and overseas banks acting as sponsors or lead underwriters must also file annual paperwork, which bankers warn will further impede transactions.
Aside from that, analysts say investors must be confident that the transaction represents a positive shift in the Chinese government's attitude toward business and economic support before returning to a market that has underperformed for years.
"This is a potential sign that the Chinese leadership is returning to being pragmatic when looking at economic issues," said Andy Rothman, investment strategist at Matthews International Capital Management
"If this shows that we could (also) see a pragmatic approach to COVID mitigation and dealing with the Chinese property sector, then that could have a big impact on the Chinese economy, investment environment and sentiment towards Chinese stocks."