Will China Inc shun Uncle Sam?

Will the stringent Sarbox rules persuade Chinese companies to list elsewhere? Alexandra Harney reports from Hong Kong

Will tighter compliance rules under Sarbanes-Oxley keep more Chinese companies from listing on US stock exchanges?

This question has become a hot topic of debate among the investment bankers, lawyers and accountants in Hong Kong who bring mainland Chinese companies to the international capital markets.

Last December, Air China, the country’s flagship airline, chose to list on the London Stock Exchange in a move thought to be partly motivated by its concerns about the regulatory scrutiny of New York under Sarbanes-Oxley. The following month, it emerged that China Construction Bank, one of the country’s big four state-owned lenders, is considering listing its shares in Hong Kong, bypassing New York entirely because of the tougher compliance regulation and higher costs there.

The moves came amid a wave of complaints from US and European executives about the high costs of complying with the law, which the Congress passed in 2002. Sarbox, which was intended to prevent the kind of creative accounting and fraud that led to the Enron and WorldCom scandals, requires US-listed companies to introduce new, stringent corporate governance routines.

Sarbox reportedly cost General Electric about US$30m in additional auditor payments in 2003. Smaller US companies say the costs of complying with the law are devouring their profits. The requirement that senior executives personally sign off the company’s financial records and become legally liable for their accuracy is keeping some US executives awake at night.

Chinese companies, many of which have little or no experience with international accounting standards, much less corporate governance regulations, are similarly concerned, say people involved in their listings.

In particular, Sarbox’s requirement that senior executives be personally liable for the accounts is ‘something that Chinese companies are not used to,’ says Rob Ashworth, partner and head of the corporate group at Freshfields Bruckhaus Deringer in Hong Kong. ‘Remember where they’re coming from; they’re coming from the warm arms of the state, and they’re going on their own into the big new world’ a lot of people are saying that’s just one step too far.’

Increased credibility

While Hong Kong has long been the first port of call for mainland Chinese companies seeking an overseas listing, a New York offering confers additional credibility. In the past, a New York listing allowed Chinese companies to tap a wider range of international investors than a Hong Kong offering might have. Many of these investors, such as hedge or pension funds, have in recent years set up shop in Asia.

But a public offering is still ‘a branding event in the history of the company,’ says Neil Torpey, a partner at Paul, Hastings, Janofsky & Walker in Hong Kong. ‘It forever after associates the company with the stock exchange on which its shares are listed and traded. There are a lot of people in the world, and in China in particular, who want to be listed in the United States.’

Therein lies the dilemma for many Chinese groups. Linktone, a Shanghai based company providing services for mobile phones, listed on NASDAQ in March 2004. Complying with Sarbox has cost it time and money. Linktone hired PwC to help with its audits at a cost of between US$200,000-US$300,000, according to Bian Lin, internal audit manager. ‘I don’t think it was tough or difficult to comply,’ she says. ‘It just took up a lot of our time.’

Beyond Sarbox, there are other factors which appear to be affecting Chinese companies’ decisions about where to go public. Lawyers and stock exchange officials say executives are also concerned about litigation risk. China Life, the country’s largest life insurance underwriter, was sued in the US for failing to tell investors about accounting irregularities at its parent company before it debuted in the year’s largest initial public offering on the New York Stock Exchange in December 2003.

‘I think that scared a lot of people,’ says Torpey, echoing the views of other observers. ‘A lot of Chinese companies that were planning to go to the US to list were put off quite a bit by that occurrence.’

Enter the London Stock Exchange, which opened a regional office in Hong Kong in October 2004. The LSE is trying to position itself as a welcoming, international alternative to New York for mainland Chinese companies, without giving anyone the impression that its allure is based on looser regulation.

‘London’s corporate governance has very high standards, but the only difference is approach,’ says Jane Zhu, head of the exchange’s Asia Pacific operations. ‘Our corporate governance is more principle-based, whereas the US one is rule-based.’

Zhu ticks off the benefits of an LSE listing: London accepts international accounting standards, while companies must comply with US accounting standards to list there. Hong Kong and London have the same listing rules, making it easier for mainland Chinese companies to list in both places. The time difference between China and the UK means that London opens for trading during China’s business day; New York does not open until the evening.

Nonetheless, so far the LSE can only claim to have lured six mainland Chinese companies, including Air China. By comparison, there are 17 mainland Chinese companies listed on the NYSE alone and a similar number on NASDAQ.

People advising China Inc on international fundraising say that despite the extra cost and fear of litigation risk, Chinese groups are not all planning to shun a New York listing as a result of Sarbox. Instead, these people say, companies are weighing their options more thoroughly than they might have in the past. ‘I don’t think you will see a lot of companies automatically saying yes, we will go to New York,’ says Ashworth. ‘And I think that will result in fewer companies going to New York.’

But he, like others involved in the listing process, says that for Chinese companies that are intent on building an international presence a careful audit will not be an insurmountable obstacle. ‘If you’re serious about being a global company, then you are going to have to do that anyway,’ says Mr Ashworth.

‘These companies tend to be very large and an extra couple million dollars of costs associated with regulatory compliance is obviously not particularly welcome,’ says Torpey. ‘But I don’t think in a lot of cases it’s going to change the decision of top management of where the company goes public.’

At the same time, there are signs that US regulators are listening to foreign issuers’ concerns. In a 25 January speech, William Donaldson, chairman of the Securities and Exchange Commission, said he might allow non-US companies more time to comply with Sarbox’s requirement that executives must verify the efficacy and adequacy of internal controls in their filings at the end of the year, and this has now happened.

Analysts are forecasting another strong crop of listings by mainland Chinese companies this year, which should send a flow of business to both the LSE and NYSE. ‘We think China is one of the largest potential markets,’ says Zhu of the LSE. ‘Not only the big state-owned enterprises, but also the mid-cap, non-state owned... We are very bullish about it.’

Alexandra Harney is the Financial Times’ South China Correspondent.