April 5, 2021
U.S. Capital Markets and China: Issues for Congress
Financial ties between the United States and China have
certificates. Most listings of China’s large state-owned
expanded significantly over the past few years. The
firms (SOEs) are ADRs. These ADRs include a small
government of the People’s Republic of China (PRC or
number of the shares that SOEs list in China, and the
China) has created limited openings in China’s debt and
China-listed shares represent only a small portion of the
equity markets, while China’s firms have sought access to
overall firm, potentially shielding the parent and its assets
U.S. capital, debt, and private equity markets. The Rhodium
from the exercise of shareholder rights and financial or
Group estimates that, as of December 2020, U.S. investors
litigation risk. The U.S. legal entity for Chinese SOEs is
held $100 billion of Chinese debt and $1.1 trillion in
often a shell company with few assets of its own. Even
Chinese equities, while Chinese investors held $1.4 trillion
when a U.S. entity is directed and controlled by an SOE
in U.S. debt and $720 billion in U.S. equities. Many U.S.
parent, it has proven difficult (but not impossible) to legally
investors see growth opportunities in Chinese stocks and
establish connectivity. In U.S. litigation since 2014, the
other financial investments.
Aviation Industry Corporation of China (AVIC) has tried to
deny direct ties to its U.S. affiliates and twice tried to assert
Some Members in Congress have raised concerns, however,
immunity under the Foreign Sovereign Immunities Act
that U.S. investments may fund certain Chinese firms and
(P.L. 94-583) to thwart commercial litigation despite
activities that are tied to the state and efforts to advance
China’s World Trade Organization accession commitment
China’s industrial, military and other goals. Congress
that its state firms would operate on a commercial basis.
passed the Holding Foreign Companies Accountable Act
AVIC’s actions put the evidence burden on the U.S. party
(P.L. 116-222) to address its concerns about the lack of
to show how the China parent is tied to its U.S. affiliates
compliance by PRC firms with the U.S. Security and
and why PRC state firms should not have immunity in
Exchange Commission’s (SEC) statutory audit
commercial deals. The opacity of China’s system can make
requirements. Chinese firms appear to use complex
it hard to secure evidence, prolong litigation, and impose
structures that may obscure risks, state ties, and other
significant costs on U.S. investors asserting their rights.
corporate details, complicating the effectiveness of U.S.
government oversight and U.S. investors’ legal recourse.
Figure 1. Outline of the VIE Structure
China’s Presence on U.S. Exchanges
U.S. exchanges offer China’s firms access to deep capital
markets and paths to earn hard currency, build brand
recognition, and expand overseas. There were 217 Chinese
companies listed on the three major U.S. stock exchanges
as of November 2020, up from 200 in December 2019.
Some Chinese firms have delisted since 2019, but initial
public offerings (IPOs) have been popular for Chinese firms
in emerging industries, such as electric vehicles. China’s
chipmaker Semiconductor Manufacturing International
Corporation (SMIC) delisted from the New York Stock
Exchange (NYSE) in 2019, but continued to trade on U.S.
over-the-counter markets until February 2021, when trading
Source: CRS with information from multiple sources.
stopped in response to former President Trump’s Executive
Order 13959 (see below). PRC firms raised an estimated
CRS estimates that two-thirds of all Chinese firms listed in
$12 to $19 billion on U.S. exchanges in 2020. As of
the United States—including Alibaba, Baidu, and
October 2020, Chinese firms listed on U.S. stock exchanges
Tencent—use a variable interest entity (VIE) structure,
accounted for a total market capitalization of $2.2 trillion,
often to address China’s investment restrictions. A VIE
according to the U.S.-China Economic and Security Review
structure involves the owners of a Chinese firm creating an
Commission.
offshore holding company to which foreign investors can
purchase an equity claim. The holding company is tied to
In many instances, the stocks and core assets of parent
the “parent” through a series of contracts and revenue
Chinese firms are not listed on U.S. exchanges. Many firms
sharing agreements that mimic ownership arrangements but
use American Depositary Receipts (ADRs), a structure that
do not provide the same rights typically afforded to
allows a U.S. financial institution to sponsor a secondary
investors in U.S.-listed firms. The contracts underpinning
U.S. exchange listing of a foreign company. The overseas
the VIE allow the Chinese owner(s) to move funds across
parent firm’s stocks are listed in the United States through a
the business while creating a firewall between the listed
contractual arrangement that bundles the company’s stock
entity and the core assets and licenses held by the Chinese
https://crsreports.congress.gov
U.S. Capital Markets and China: Issues for Congress
owner. VIE arrangements appear to have no definitive legal
fund to an index that includes Chinese firms in response to
standing in China, which may leave U.S. investors without
pressure from Congress and the Trump Administration.
recourse. SEC 20-F disclosures by some firms acknowledge
the risks of VIEs because they are incorporated offshore,
Military-Tied Firms
conduct most operations in China, and have executives who
In November 2020, the Trump Administration issued
reside outside the United States. Some Chinese VIEs have
Executive Order 13959 to prohibit U.S. persons (including
reduced U.S. shareholder value, including for large
financial services firms) from investing in Chinese firms
corporate investors, by shifting business licenses and
with military ties. Several funds initially removed certain
issuing off-the-books bonds. In 2010, for example, Alibaba
Chinese firms from their indices, and the NYSE moved to
cut out Yahoo (a 43% stake investor) in its spinoff of the
de-list three PRC state telecom firms. Since January 2021,
online payment firm Alipay to a separate VIE, controlled by
the U.S. financial sector has challenged the scope of the
its chairman Jack Ma. In February 2021, global investors
order, including corporate nomenclature and whether listed
reportedly also had no alternative exit strategy or legal
firms are tied to their China parent; Morgan Stanley said it
rights for an estimated $10 billion invested in an offshore
would launch parallel indices to retain stocks in question,
shell company after the Chinese government suspended Ant
Also in January, the Biden Administration announced a
Financial’ s $34.5 billion IPO in Shanghai and Hong Kong.
three-month stay to review the order. Since June 2020, the
Disclosure and Auditing Requirements
U.S. Department of Defense (DOD) has identified 44 PRC
While most Chinese firms are required to file an SEC 20-F
military firms operating in the United States under reporting
annual report for foreign issuers, there are exemptions on
requirements established in the FY1999 National Defense
specific disclosure requirements, particularly for ADRs.
Authorization Act (NDAA) (P.L. 105-261). DOD’s list is
The SEC relies on China’s reporting and disclosure rules,
not exhaustive, and is viewed by some experts as a first step
which are less extensive than U.S. requirements. Disclosure
in addressing U.S. commercial ties to PRC firms of
of shareholders and operations may present a conflict of
concern. In the FY2021 NDAA, Congress reauthorized and
interest for Chinese firms with government ties. The
bolstered requirements for DOD to identify and report on
Chinese government prohibits the Public Company
Chinese military firms.
Accounting Oversight Board (PCAOB)—a nonprofit entity
Issues for Congress
created by Congress that oversees audits of U.S.-listed
companies—from inspecting the work of auditors based in
To address its concerns, Congress might consider the
China and Hong Kong. The inability of the PCAOB to
potential costs and benefits of whether to:
confirm the financial health of U.S.-listed Chinese firms
exposes U.S. investors in these firms to substantial risk. In
Expand U.S. government review and reporting on
June 2020, NASDAQ delisted Luckin Coffee after it was
Chinese firms with state and military ties and related
found to have fabricated sales. The Holding Foreign
U.S. investment restrictions.
Companies Accountable Act (P.L. 116-222) requires firms
to disclose state and military ties and a delisting from U.S.
Examine China’s role in other areas—such as private
exchanges if the PCAOB cannot inspect a firm’s auditors
equity and debt financing—to assess the costs and
for three consecutive years.
benefits of U.S. exposure and strategic implications.
Figure 2. Select U.S. Funds’ China Stock Holdings
Consider additional due diligence and liability
(June 2020)
requirements for U.S. actors that represent Chinese
firms; potentially seek for the SEC to further investigate
and verify the accuracy and completeness of the
information provided and to issue regular alerts on
China investments.
Strengthen disclosure requirements—including for
investment risk and beneficial ownership—to account
for state ties, opacity in China’s system, complex
corporate structures, and limited legal recourse. Such
measures might include requiring that all firms,
Sources: CRS with data reported in Caixin, Citic Securities, and
including ADRs, file a 10K equivalent with complete
Bloomberg.
details about ownership, shareholding, and corporate
ties; b) issue quarterly reports and timely updates on
Mutual Funds and Indices that Include PRC Firms
major changes; and c) provide separate unconsolidated
Five major index fund providers include PRC bonds and A-
financial statements for VIE contracts and controllers.
shares of firms listed on China’s exchanges. U.S. pension
funds have China exposure through these indices and direct
Require Chinese firms to establish a U.S. legal presence
holdings in Chinese firms. U.S. funds seek China exposure
directly tied to its China parent; b) hold ultimate
with an eye to potential higher returns but some in Congress
beneficiaries in China legally accountable for listed
and the U.S. government are concerned about potential
firms; and c) require Chinese firms to place a significant
risks. (Figure 2). In July 2020, the SEC issued an alert
deposit with U.S. regulators in the event of litigation.
about U.S. exposure to China’s financial markets. In May
2020, the U.S. government’s Thrift Savings Plan board
deferred implementing a decision to tie its international
https://crsreports.congress.gov
U.S. Capital Markets and China: Issues for Congress
Karen M. Sutter, Specialist in Asian Trade and Finance
IF11803
Michael D. Sutherland, Analyst in International Trade and
Finance
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https://crsreports.congress.gov | IF11803 · VERSION 1 · NEW