By now, everyone has heard of the Muddy Waters research alleging fraud at Sino-Forest that tripped up investor John Paulson.
Yet when this report arrived in my inbox last week, it was still an eye-opener, reading more like an Interpol indictment than a mosaic of analysis. It begins by asserting Sino-Forest is like Bernie Madoff, a rare fraud committed by an established institution, before estimating this Ponzi scheme overstates assets by $900 million.
Rather than being able to refute these allegations, it looks more like Sino-Forest (SNOFF - News) is just the tip of the iceberg, as more mainland Chinese companies listed in North America face questions over accounting irregularities. While Sino-Forest was listed in Toronto, numerous mainland companies listed on the Nasdaq and the NYSE have also been the subject of controversy.
Since March, at least five Chinese companies have been delisted and 15 suspended on the Nasdaq, and share prices have been hammered. Of the 52 mainland companies listed on the Nasdaq since 2010, only 8 have share-price gains this year, according to a recent Nomura report.
Why is it the once-prestigious U.S. stock exchanges appear to have listed so much mainland junk? It used to be only the best of China's companies got to list in the U.S.
While failures by regulators and bankers will need to be examined, there is a more fundamental explanation — the emergence of China's domestic stock markets as a major listing destination. Amid the recent clamor for China stocks, few appeared to notice that China was no longer sending its best companies to list overseas.
For a long time, the largest and better-quality mainland companies listed in Hong Kong, often with secondary overseas listings in New York or London.
That changed as Shanghai's stock market came of age in recent years. While Hong Kong continued to get chunky dual listings with Shanghai, London and New York were largely no longer needed.
Data from Ernst & Young show how, following the Lehman Bros. financial crisis, Shanghai led the rebound in global IPOs, overtaking the NYSE in 2009, which led the world in capital raised the previous year.
In 2010, the combined $58.1 billion raised by the Shanghai and Shenzhen exchanges dwarfed the $34.7 billion raised by New York.
The Nasdaq also witnessed a change in fortunes. While it listed the first generation of mainland Internet companies, such as Netease (NTES - News) and Sina -2.51% (SINA - News) , it is no longer the natural home for China tech stocks. Alibaba (ALBCF - News) , for example, listed in Hong Kong, while Shenzhen started its own GEM market in 2009 for tech and growth companies.
At the same time that China began listing more of its best companies at home, it also opened its doors to foreign exchanges. Back in 2007, the Singapore, New York, London and Tokyo exchanges were given permission to open offices in China to lure mainland companies to list.
A conflict always exists between winning new business and maintaining listing standards. Could it be this new scrum of competition between exchanges for listing fodder pushed this dynamic out of balance?
Investor fascination with the China-concept investment story and the easy-money policies of the Fed likely also created conditions that allowed some questionable companies to list.
The head of the Hong Kong Stock Exchange recently remarked that the problem in the U.S. with its mainland listings did not exist in Hong Kong. Tempting fate perhaps, but there are some reasons to believe him.
Companies in Hong Kong are certainly bigger.
According to figures referenced by Nomura, the 173 Chinese companies listed on the Nasdaq have an average market cap of $700 million, while the over 600 mainland Chinese companies listed on the HKEx have an average cap of $6.3 billion.
Hong Kong is attracting more established companies, which partly comes down to differences in regulation. Perhaps the key listing requirement of Hong Kong is its three-year profit rule, which means companies must have some discipline and wait before seeking a listing payday.
Hong Kong has had its own fraudulent listings in the past, but arguably regulators have grown more wise to them. Back-door listings or reverse takeovers, for instance, that have been the core of fraud in the U.S., have been discouraged here and are now rare.
The Securities and Futures Commission also continues to push to tighten listing procedures, most recently with an initiative to hold sponsors to account if they take shifty companies to market. Trying later to go after companies or executives on the mainland is a mugs game — something U.S .regulators will find.
Another factor is the analyst community is here on the ground, rather than trying to do research from another continent. Smaller companies can also struggle to get their fair share of analyst coverage and proper scrutiny.
While these revelations suggest the U.S. has a particular problem with listing dubious mainland Chinese companies, to be fair it is not alone. Singapore is also doing some soul searching with recent press reporting more than 1 in 10 Chinese companies, or "S-chips," having being delisted or suspended since 2008.
This often gets little publicity, as all exchanges have an interest to keep wrongdoings quiet in order to safeguard reputations. This might explain why aggressive firms like Muddy Waters have stepped into the void. Overall these developments should be positive for investors, however, as it forces mainland companies — wherever or not they are listed — to improve levels of disclosure.
这些飘洋过海的中股就是来斩洋葱头的。咱碰都不碰。