Forbidden Cities – Deglobalisation Of The IPO Market

By 2020, Shanghai and Shenzhen exchanges had increased their combined market cap to $12trn on the back of strong domestic investor appetite, tech-friendly initiatives and a gradual opening up to foreign investment. A new exchange was even established in Beijing last November to manage the demand for new industries.

Despite this, fast-growth Chinese companies have generally favoured New York when turning public, raising $76bn of IPO capital there in the last 10 years. The attraction is the unparalleled liquidity, tolerance of pre-profitability and open-mindedness to untested business models. With a collective market cap of $1.4trn, there are now some 240 Chinese companies on NYSE and Nasdaq, of which 42 listed in New York in 2021 alone. However, only 4 of these 42 listed in the second half of the year because at the midpoint, the brakes went on.

Like many a dark drama, it began with a taxi journey gone wrong. Didi Global, the ride platform with a 90% market share in China, raised $4.4bn in its NYSE IPO in June 2021. It did so rather modestly, not mentioning the float on its Weibo channel and even declining the traditional invitation to ring the opening bell. The action nonetheless led to new subscriptions in China being blocked and an order to remove Didi from app stores, citing anti-trust laws and recently-passed cybersecurity legislation.

These laws were soon turned against other market-dominating enterprises accused of “disrupting the socialist market order”. The impact was primarily on the tech sector, whose stock values now fell by $1.5trn in the face of the public censure, changes to employment contracts and hefty fines.

Periodic reassertions of central authority can be expected in China, but the 2021 regulations surprised the business community in their contrast to the previous encouragement of limited inward investment and the tolerance of overseas listings. Chinese companies had routinely bypassed official foreign direct investment restrictions by floating in New York via offshore structures, known as the variable interest entity mechanism or VIE but this avenue appeared to be closed off.

Regulators were now given an effective right of veto on overseas listings by way of a compulsory “safety assessment”. As a consequence, 70 Hong Kong and Chinese firms were reported to have paused or shelved plans to go public in New York, most prominently LinkDoc Technology and ByteDance, the owner of TikTok.

The Cybersecurity Administration declared it was protecting Chinese data from being “maliciously exploited by foreign governments”. In the example of Didi, commentators in China were quick to point out that Didi was part-owned by Japan’s SoftBank and (in a deal to get it to leave China) America’s Uber, although Didi strenuously denied any data transfer to foreign authorities.

The US added to the perception of shutters closing on a fully globalised IPO market with its own mirroring manoeuvres. The Biden Administration adopted its predecessor’s Holding Foreign Companies Accountable Act, under which the SEC requires listed entities to have their audits examined by the Public Company Accounting Oversight Board (PCAOB).

Although the PCAOB’s own website states that it has been carrying out such inspections of non-US firms since 2005 (and specifically cites the 2002, post-Enron Sarbanes-Oxley Act as the basis for the regulation) the timing of its reinvigorated enforcement coincided with a worsening in relations between Washington and Beijing. Chinese companies were always most likely to be affected by the regulation and the consequent risk of de-listing because of Beijing’s longstanding opposition to this oversight, claiming national security concerns. Its Foreign Ministry complained that the rules were “clearly discriminatory against Chinese companies” and exemplified “wanton political suppression”. 

This sense of victimisation was heightened by the additional requirement for companies to prove that they have no links to a foreign government. Accordingly, China Mobile, together with China Telecom and China Unicom, was de-listed in the US, giving Shanghai, when the company returned “home”, the biggest IPO in a decade with a raise of $7.8bn.

Europe largely kept out of the tussle between Washington and Beijing, only to find itself up against Russia. As premier of the country with the continent’s leading exchange, Boris Johnson set the tone in promising the “largest ever” set of sanctions. These turned out to include “stopping Russian companies raising money on London markets” and the de-listing of the majority state-owned enterprises including VTB Capital, subsidiary of the second largest bank in the country. There was pressure on the FCA to de-list Russian companies altogether from the London Stock Exchange rather than suspend them, but the matter was deferred to the Foreign Office.

London has long been a second home for many international energy and mining companies. Since 2005, 39 Russian companies have raised $44bn on the London markets. As well as access to capital, listings here have conferred prestige and trustworthy pricing, not always available on the Moscow Exchange. 

The end of the commodities boom and the post-Crimea sanctions in 2014 saw Russian listings in London dwindle. However, 24 remaining companies had a market cap of $515bn and three of the country’s largest energy companies, Rosneft, Gazprom and Lukoil were still traded. Together they contributed over $40bn to Moscow’s treasury in 2020, demonstrating the reach of sanctions, fully realised when 98% of the value of the Russian depository receipts on the London market was wiped out.

The hosting of European IPOs before the Ukraine invasion was already becoming more widely dispersed post-Brexit. Covid then brought about the rediscovery of long-forgotten national frontiers. Amsterdam’s and Stockholm’s ascent, and the increasing ability of national exchanges to host stay-at-home flotations further encouraged a new diversity in capital markets.

The recent relaxation in regulations, however, may bolster London’s traditionally dominant position in Europe. As quoted by Bloomberg, Credit Suisse’s Equity Capital Markets head, Nick Koemtzopoulos, stated that, “listing changes to the London market, especially the provision for smaller floats, are positive…It’s likely to attract more tech, fintech and growth-oriented businesses.”

We know that capital and trade can quickly deglobalise by simply looking back. Nineteenth-century industrialists congratulated themselves on creating ever-strengthening trading lines, only to see the Great Depression of the 1870s bring to a halt the first golden period of globalisation. More recently, world trade increased 27-fold between 1980 and the crash of 2008, at which point worldwide foreign direct investment fell by 21% (5% in the US and 50% in the UK).

Aside from recessions, the World Trade Organisation notes that, “Geopolitics has a decisive impact – for good or ill – on underlying technological and structural trends.” During wars (as the response to Covid is often portrayed) or economic collapses, national governments tend to intervene in industry. There is then political pressure for this involvement to continue to be exercised to rebuild damaged national economies with protectionist measures that harm international commerce. An example of this is the record 25% import tariff imposed by the US after the Wall Street Crash, triggering a predictable response that caused world trade to fall by two thirds between 1929 and 1934.

With the present interconnectedness of trade and economies, however, it might be thought nearly impossible to unravel international supply lines and investments, whatever the political climate. After all, it famously takes the input of 43 countries to build an iPhone, and, being integral to so many companies’ manufacturing strategies, China could understandably feel less vulnerable to deglobalisation. Indeed, the record month for Sino-American trade traffic was in September 2021, China remained the top destination for new foreign direct investment last year and international holdings of Chinese company stocks having roughly to $600bn since 2019.

This would be to overlook the fact that shifts in global trading and investment patterns are not always immediately noticeable. Establishing new mines or semi-conductor plants can take four or five years, during which time there will be no discernible impact. China’s centrality in world trade appears unassailable, but there is a growing acceptance among manufacturers of the wisdom of the “China plus one” principle in order to hedge geopolitical risk. Other south-east Asian countries like Malaysia and Thailand are seeing trade upticks, while the aforementioned Apple and its suppliers are increasingly sourcing from India and Vietnam and away from China.

The liberal economic consensus has been that globalised trade and investment makes for a securer world. In the words of evolutionary psychologist Stephen Pinker, “It’s the theory of Capitalist peace… you don’t kill your customers or your lenders.”

Deglobalisation therefore has the potential for significant fall out. Excising Russia from the capital markets sends a strong signal, but necessarily weakens the deterrent effect of economic integration. Expelling Chinese companies from New York exchanges might prevent losses to investors from inferior auditing but certainly increases political tensions and has dismayed Wall St, which has earned $6.4bn in fees since 2014 from listing the likes of Alibaba and Tencent.

Similarly, stabling its unicorns back in China will give its exchanges a temporary boost but longer term constraints.  Secondary domestic listings have tended to be at a discount to the NYSE and Nasdaq and the daily trading of shares on HKSE even for headlining acts like JD.Com is around a quarter of New York.

The next generation of data-intensive, technological and fast-growth companies will therefore necessarily have to factor in prevailing trends in globalisation. If their trajectory is likely to be impacted by regulatory difficulties in accessing the most liquid capital markets from abroad then logically they would establish themselves in the higher liquidity geographies earlier or from the very beginning. This could lead to vicious and virtuous circles whereby restrictive economies see slower growth and techs which either defect or wither on the vine and an ever greater concentration of fast growth, new industries in the more open economies.  

Although history shows that deglobalisation has been followed by reglobalisation, there is little room for complacency. Since the last crash of 2008, the level of foreign direct investment, international equity, bond purchases and cross-border lending has still not recovered to anywhere near 2007’s $11.9trn, to the particular disadvantage of emerging markets. In the nineteenth and twentieth centuries, the repair of ruptured global trading links was led by Britain and the USA respectively. This time, there is no obvious and undisputed leader to drive the necessary initiatives.

There are encouraging signs that Beijing is loosening cross-border regulations which will are likely to diffuse the tensions. However, after a weak start to the year, 2022 will still be a pivotal year for IPOs and movement towards or away from globalisation will have a lasting impact on the major exchanges and the growth potential of the companies they serve.