S&P Dow Jones Indices is complying with an executive order issued by the Trump administration back in November that bars investments in private Chinese firms with ties to China’s military. On Thursday, December 10, the company announced that 10 Chinese firms would be removed from its equities indices by December 21, and another 18 would be removed from fixed-income indices by January 1.
The move by S&P Dow Jones follows in the footsteps of FTSE Russell who announced on Monday the removal of eight Chinese companies from its indices effective December 21.
Chinese firms affected
The Chinese firms in question are private companies linked to China’s military, intelligence, and security organizations. American investors’ funds find their way to these companies through mutual funds, pensions, and other investment vehicles listed on domestic as well as international exchanges. According to the U.S.–China Economic and Security Review Commission, the market capitalization of Chinese firms listed on U.S. exchanges totaled $2.2 trillion as of October 2 of this year.
The executive order was issued in November to safeguard America’s interests after both the Department of Defense and Department of Commerce found that certain private Chinese companies use the funds raised from American investors for modernizing and developing technology for China’s People’s Liberation Army (PLA). The Department of Defense and Department of Commerce had both added Chinese companies to their entities list earlier in the year.
Notable companies removed from the indices include Hikvision, Huawei, and Semiconductor Manufacturing International Corp. (SMIC). All three companies have been implicated with intellectual property theft in the past.
Hikvision, the maker of security and surveillance equipment, has been recently accused of supplying labor and concentration camps in the Xinjiang and Tibetan region of China with their equipment.
New audit bill
A new bill passed by the U.S. House of Representatives prohibits Chinese firms from being listed on US exchanges if they do not comply with US auditing standards. The law was passed as the bill was already approved by the Senate back in May and is expected to be signed into law by President Trump.
If the foreign companies do not comply with U.S. audits for three years in a row, they will be delisted on American exchanges. The risks of not complying with standard audits can be significant as seen earlier this year when Lukin Coffee disclosed $310 million of its 2019 revenue was fabricated. The amount represents 40 percent of total revenue reported for the company last year.
Certain Chinese companies had been exempt from U.S. auditing standards in the past under the SEC Exchange Act Rule 10A-3, which allows exemptions of foreign entities from U.S. audit reporting. The SEC issued a public statement earlier in the month over the challenges faced with conducting financial audits of Chinese companies that are listed on US exchanges. “In particular, Chinese laws governing the protection of state secrets and national security have been invoked to limit foreign access to China-based business books and records and audit work papers. As a result, for certain China-based companies listed on U.S. stock exchanges, the SEC and PCAOB have not had access to the books and records and audit work papers to an extent consistent with other jurisdictions both in scope and timing,” the SEC stated.