China Internet

KWEB China Internet Market Volatility FAQ

How might KWEB be affected by the US delisting legislation? Can you convert US-listed shares to Hong Kong shares for companies with dual listings?

Congress passed the Holding Foreign Companies Accountable Act (HFCAA) in December of 2020. The new law requires all US-listed foreign companies to allow the Public Company Accounting Oversight Board (PCAOB) to inspect their audit books, disclose government ownership, if any, or face delisting. On March 8th, 2022, the Securities and Exchange Commission (SEC) began to determine which companies are not in compliance with the HFCAA. The SEC has so far named 12 ADRs, reinforcing investors’ concerns about delisting and triggering market volatility in offshore Chinese equities. The China Securities Regulatory Commission (CSRC) has been in talks with the SEC and Public Company Accounting Oversight Board (PCAOB) on resolving this issue, but the two sides have yet to arrive at a solution.

Since the law was passed, we have received questions regarding the US-listed Chinese companies held within KWEB. We believe there are several vital points to consider regarding the potential for delisting.

  1. KraneShares can convert US-listed KWEB holdings to their Hong Kong-listed equivalents. About 71% of KWEB’s holdings by weight are comprised of Hong Kong-listed Chinese companies as of March 11th, 2022.1 The Hong Kong Stock Exchange (HKSE) has a new listing rule that went into effect on January 1st, 2022, allowing almost all US-listed Chinese companies to re-list in Hong Kong. We anticipate that more companies will list in Hong Kong and that the liquidity of Hong Kong shares is expanding as more institutional investors convert ADRs to Hong Kong shares. We expect KWEB to be close to 100% Hong Kong by the end of 2022 from 71% Hong Kong today.
  2. There is a long runway before this becomes an immediate concern. Under the current law, these companies have a three-year window to become compliant. Companies will have the opportunity to comply in their annual reports for fiscal years 2022, 2023, or 2024. The House passed a version of the “America COMPETES Act” that includes a provision to reduce the compliance window to just two years. However, the version passed in the Senate does not include such a provision, so we will have to wait and see whether the provision remains in the final bill following negotiations between the House and Senate. There is a significant window for the companies to come into compliance by 2023 or 2024, but doing so will require a resolution by regulators.
  3. On March 11th, the CSRC published a press release on their website saying that they are engaging with the PCAOB and have made positive progress. They believe the two sides will be able to jointly work out cooperation arrangements that comply with both countries’ legal and regulatory requirements in an expedited manner. China’s Vice Premier Liu He also said during the State Council meeting on March 16 that “the Chinese and the US regulatory bodies have maintained good communication and made positive progress. The two sides are working on a concrete cooperation plan.”2 On March 22, Reuters reported that the CSRC told Alibaba, JD.com, and other private companies that they should prepare their audit disclosures for PCAOB inspections. This would indicate that segmentation between private companies and state-owned enterprises (SOEs) is the path towards a resolution. Allowing the private companies to comply would also provide them time to address the more complicated situation for SOEs.3 However, on March 24, Bloomberg quoted the PCAOB as saying that confidence in a resolution was premature. Nonetheless, the article did confirm that the two sides are engaged in active dialogue.

What is KWEB’s current ADR exposure, and what percentage of the portfolio still needs to be converted?

KWEB has converted most of its US holdings to Hong Kong shares. We expect the portfolio to be fully converted out of ADRs by the end of the year.

20% of KWEB’s remaining ADR holdings are likely to be converted to Hong Kong shares by Q3 2022 or sooner.

Could China be vulnerable to similar geopolitical risks as Russia?

No. China and Russia are very different from one another economically, culturally, and geographically.

China is an integral part of the global economy, accounting for a far larger share of global GDP, US imports/exports, and US foreign direct investment. China accounted for over 18% of global GDP in 2020 while Russia only accounted for 3%. The US imported $450 billion worth of goods and services from China in 2020 and only $18 billion from Russia, mostly oil and gas.

As the world’s largest trading partner, ensuring that global trade is stable and healthy is a top priority for China. Freezing trade with China could potentially cause a global depression, not just a bout of market volatility.

Both the US and China have entirely too much to lose to fully decouple from one another. As such, we believe the risk that similar economic sanctions are applied to China is low. On March 25th, US Treasury Secretary Janet Yellen told CNBC that she does not believe that sanctions on China are “necessary or appropriate.”4

Despite its neutral official stance, China has expressed its disapproval of the invasion through various soft power measures. China state-backed banks, including the mammoth Asian Infrastructure Investment Bank (AIIB), have suspended Russian activity. Meanwhile, China has urged “constraint” from all parties through multilateral channels.

What are some potential near-term catalysts for KWEB?

  • China is currently easing monetary conditions while most of the developed world is tightening. While the cost of capital for US internet firms is rising, the cost of capital for KWEB companies is falling.
  • China’s government seeks to achieve an ambitious 2022 GDP Growth target of 5.5% and create 11 million new urban jobs.5 China’s internet giants will play an integral role in achieving these goals.
  • KWEB’s long-term growth story remains intact. China’s internet population continues to grow and China’s internet companies continue to grow their revenues.
  • As the market is currently pricing in a high degree of uncertainty, any increase in clarity on HFCAA, Ukraine, internet regulations, or the pace of Fed rate hikes could lead to a significant boost in the share prices of KWEB companies.

What about KWEB’s fundamentals?

  • The 3 & 5-year average revenue growth rates for China internet companies are similar to those of many U.S. internet companies. However, KWEB’s holdings are currently trading at less than one-half of the multiples of their US equivalents.
  • Periods of low forward P/Es tend to be associated with higher 12-month returns in the future.
  • 13 companies in KWEB now have a price to book (P/B) ratio lower than 1, meaning that they are valued at less than the sum of their assets and cash on hand.
  • Of those 13, five have a market value that is less than their cash on hand.

Citations:

  1. Data from Bloomberg as of 3/11/2022.
  2. Xinhua. “China Focus: State Council committee stresses economic, financial stability,” Xinhua News. March 16, 2022
  3. Reuters. “EXCLUSIVE: Chinese regulators ask some U.S.-listed firms to prepare for audit disclosures,” Reuters News. March 22, 2022
  4. Franck, Thomas. “Treasury Secretary Yellen sees no need for China sanctions as US tries to deter aid to Russia,” CNBC. March 25, 2022.
  5. People’s Republic of China. Government Work Report. March 7, 2022.

r-ks-sei