CAUGHT IN THE MIDDLE How Will Chinese Companies React to the HFCAA? XX June 2020

The United States’ relations with China have deteriorated under the Trump Author: administration. In 2018 Trump launched a trade war by imposing tariffs on Chinese Paul L Gillis imports. The global Covid-19 pandemic began in China in December 2019 and Guanghua School of rapidly spread around the world, causing U.S. government officials to effectively Management shut down the U.S. economy by April 2020. These events have strained the Peking University economic and financial ties between the United States and China. Ray Tang Hou On Wednesday, May 20, 2020, the United States Senate passed by unanimous School of Law consent Senate Bill 945, known as the Holding Foreign Companies Accountable Act University of Virginia (“HFCAA”). Louisiana Senator John Kennedy (R) introduced the HFCAA with four bipartisan co-sponsors. It now goes to the House of Representatives where Representative Brad Sherman (D-California) introduced the House version of the HFCAA. If the House bill passes, routine conference procedures will reconcile any differences between the House and Senate versions. After passage by both branches, it moves to President Donald Trump for signature into law. The White House signaled support for the legislation in its June 4, 2020, memorandum, stating that “[w]e must ensure that laws providing protections for investors in American financial markets are fully enforced for companies listed on United States stock exchanges.”

The argument for holding Chinese companies to the same standards as American companies when listed on U.S. stock exchanges has merit, but the legislation targets a minor issue – Public Company Accounting Oversight Board (“PCAOB”) inspections. While we think the PCAOB should inspect Chinese auditors if they audit U.S.-listed companies, we think such inspections will not likely alter the performance of such auditors nor eliminate the amount of fraud in Chinese companies. We believe that the culture of the Big Four accounting firms, which audit most of the U.S.-listed Chinese companies, has integrated PCAOB practices into its audit methodology and inspections in China will unlikely significantly change the way they audit. Moreover, the legislation does nothing to address other related issues, like the exclusion from Reg FD disclosure requirements, the absence of quarterly reporting, and the lack of inspection on audit work in China for multinational companies, such as the Chinese operations of IBM or Apple.

This paper examines the proposed legislation and its effect on U.S.-listed Chinese companies and their investors. We examine how the present situation developed out of Sarbanes Oxley (“SOX”) reforms almost 20 years ago, and how the proposed legislation deals with it. We speculate on the likely responses by U.S.-listed Chinese companies, including moving the listing to other markets like Hong Kong, taking the company private, or going dark. Finally, we suggest how Congress can strengthen HFCAA as it works its way through the legislative process.

GMT Research prohibits the redistribution, replication, retransmission, circulation or publication of this document (in whole or in part in any medium, print, electronic or otherwise, for any purpose) without its prior written permission Historical Background

China had robust stock markets prior to the establishment of the People’s Republic Shanghai and of China in 1949 and these markets reopened in the early 1980’s to serve the Shenzhen are amongst reforming Chinese economy. State-owned enterprises (“SOE”) initially dominated the largest stock the exchanges, using their public listings to introduce new shareholders and markets in the world corporate governance reforms. The listing rules initially did not allow privately- owned companies to list, but this changed over the years as the importance of private investment in the economy became clear. Today, most job growth and most IPOs on Chinese exchanges comes from private companies. The Chinese stock exchanges in Shanghai and Shenzhen have grown to join American and Hong Kong exchanges among the largest in the world.

Chinese SOEs incorporated in China began to list as so-called “H-shares” in Hong Started off listing Kong in the early 1990’s, usually in addition to their listing on the Shanghai Chinese companies in Exchange. Later, many Chinese SOEs began incorporating offshore companies and Hong Kong listing them in Hong Kong to obtain foreign currency or lower tax rates, and are known as “red chips”.

Some private companies, called “P-chips”, also incorporated offshore and listed in Private Chinese Hong Kong. This category includes companies such as Tencent and Xiaomi. companies preferred to However, most private companies chose to list in New York instead, for several list in New York reasons. First, the U.S. market has greater depth and experience with technology companies than the Hong Kong market. Second, U.S. markets allow the use of dual class shares and Variable Interest Entity (“VIE”) structures, which the mainland exchanges did not permit until recently, and then only on a limited basis. Chinese foreign investment laws require some evasive governance structures, such as VIE structures, to allow foreign investment in certain Chinese sectors, including the technology sector. Thirdly, U.S. exchanges permit unprofitable companies to list and defer to the law of the company’s incorporation on corporate governance matters, such as when to hold annual meetings. The mainland exchanges require companies to have profitable earnings records before allowing them to list, while Hong Kong often waives this requirement. Finally, we think that investment bankers encourage New York listings because they earn higher fees for such listings compared with listings on the Hong Kong or mainland exchanges.

Over the last few decades, the Hong Kong Stock Exchange (“HKSE”) undertook a Hong Kong modified its series of reforms that reduced the regulatory advantages of U.S. exchanges. Since rules to compete with 2005, the HKSE has allowed companies with VIE structures to list. After the HKSE New York lost the Alibaba listing to New York in 2014 over its unwillingness to allow dual class shares, it modified its rules in 2018 to allow large companies with dual class shares and no profitable earnings record to list.

Sarbanes Oxley Act

A series of corporate scandals headlined by Enron in the early 2000s led the U.S. The PCAOB was Congress to enact the Sarbanes Oxley Act (“SOX”) to reform corporate governance established to regulate in the U.S. SOX established the Public Company Accounting Oversight Board the accounting (“PCAOB”) to regulate the accounting profession that audits public companies. While profession that audits state boards of accountancy typically license and regulate accountants, the public companies profession had, since its inception, regulated itself with respect to the work related to audits of public companies. The PCAOB has three primary functions:

1. Set the standards for how auditors should perform audits of public companies. Previously, the American Institute of CPAs set these standards, which it still does for private companies.

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2. Register auditors that wish to audit public companies and inspect their work periodically. Any auditor anywhere in the world that intends to audit U.S.- listed public companies must register with the PCAOB and consent to inspections. Prior to the PCAOB, auditors inspected auditors through peer review, which many critics found toothless.

3. Investigate alleged violations of PCAOB standards and administer appropriate punishment. Prior to the PCAOB, investigations and enforcement belonged to state boards of accountancy and the Securities and Exchange Commission (“SEC”), neither of which frequently acted. The allegations arise from PCAOB inspections or from outside whistle blowers.

Following the enactment of SOX, over 50 Chinese CPA firms sought registration with Over 50 Chinese CPA the PCAOB. The PCAOB requires registration in two cases: if a CPA firm signs an firms sought audit report on a U.S.-listed company; or, if a CPA firm performs a significant role registration with the (over 20%) of the audit of a U.S.-listed company where another auditor signs the PCAOB even though report. Few Chinese CPA firms, other than the Chinese member firms of the Big these firms failed to Four, fell under these requirements, and many appear to have sought registration certify compliance for marketing purposes. The PCAOB requires registering firms to certify that they will comply with all PCAOB rules. Despite its own rules, the PCAOB has registered Chinese CPA firms even though these firms failed to certify compliance. For example, PwC China provided the PCAOB with a 25-page legal letter outlining the conflicts between Chinese and American rules and the PCOAB went ahead and registered PwC China. On October 7, 2010, the PCAOB announced it would no longer register accounting firms it could not inspect but took no action to de-register firms already registered.

PCAOB Inspections

SOX requires the PCAOB to inspect accounting firms periodically. The PCAOB The PCAOB inspects annually inspects firms which audit over 100 public companies. These large firms larger audit firms include the U.S. member firms of the Big Four, plus several smaller CPA firms. The annually and smaller PCAOB inspects smaller auditors that audit fewer than 100 public companies only ones every three years once every three years. All foreign CPA firms registered with the PCAOB audit fewer than 100 public companies per year, and fall into the latter category.

Note the organization and governance of the Big Four firms differ from Local partners of the multinationals because they do not have a common parent company. Instead, local Big Four firms are partners tend to own each country’s branch of the firm, which operates like a considered separate franchise operation. For example, the PCAOB appropriately considers the Chinese entities firm PricewaterhouseCoopers Zhong Tian CPAs LLP as an entity separate from the U.S. firm PricewaterhouseCoopers LLP.

Inspections comprise the most important part of PCAOB operations. The PCAOB fails PCAOB inspections are about half of the audits it inspects. During an inspection of a CPA firm, the PCAOB stringent and the most reviews a selection of the firm’s audits by looking at the audit working papers important part of the created by the auditor as a record of their audit work. The PCAOB also inspects the agency’s operations internal processes of the audit firm that affect audit quality, such as human resource practices and quality control processes. The PCAOB does not inspect every audit of a selected CPA firm, and a company whose audit the PCAOB inspects usually does not know of the inspection unless the PCAOB required the auditor to do remediation work on a previously completed audit. Some observers of the selection and inspection process note that it has become so routine and burdensome that audit firms prepare for the inspection at the cost of exercising judgment in performing audits. Audit compliance has replaced audit judgment they say.

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PCAOB International Inspections

SOX requires the PCAOB to inspect any non-U.S. auditor if the auditor audits a U.S.- The PCAOB must listed company or performs a significant role on an audit of a U.S. company signed inspect any non-U.S. off by another auditor. The PCAOB ran into considerable opposition to the auditor if the auditor extraterritorial nature of this requirement, with many countries resisting because of audits a U.S.-listed domestic data privacy laws. The PCAOB has succeeded in making inspection company or performs a agreements with regulators worldwide, with three exceptions, often agreeing to significant role on an conduct these inspections jointly with local regulators. At present, the three audit of a U.S. holdouts—France, Belgium, and China—each have a different status. France had a company signed off by cooperative agreement in place that expired in 2019; indications suggest renewal. another auditor Belgium—a long-term holdout—appears close to an agreement to allow inspections. China has, for over a decade, taken the position that it cannot allow a foreign regulator to enforce foreign laws on Chinese soil against Chinese people because to do so would compromise China’s sovereignty. Furthermore, China argues that audit working papers may contain state secrets that Chinese locals should not disclose to foreigners. Instead, China has argued that the PCAOB should apply “regulatory equivalency” and accept the work of Chinese regulators to inspect these firms. European Union regulators have accepted regulatory equivalency, but which the PCAOB has not. China has also blocked the PCAOB from inspecting Hong Kong CPA firms to the extent their clients have mainland operations, which nearly all do.

The PCAOB has attempted for over a decade to resolve the stalemate without No significant significant breakthroughs. The PCAOB has the authority to deregister accounting breakthroughs in the firms it cannot inspect, but has thought this option too draconian to exercise, as it stalemate would lead to serious push back from market participants. Worse, deregistering uninspected Chinese CPA firms could also impact multinational companies (“MNC”) that have operations in China. If the China portion of the audit exceeds 20% of the MNC worldwide audit, the auditor must have PCAOB registration. Deregistration would leave no registered Chinese auditors available to audit the Chinese operations of U.S.-based MNCs, which then could not produce financial statements. According to the PCAOB, there are eight large accelerated filers where Chinese auditors do more than 20% of the audit and 40 smaller companies.

Accounting Fraud in China

Many U.S.-listed Chinese companies have committed discovered frauds. Others Chinese companies likely remain undiscovered. Several possible explanations follow. Many Chinese have taken advantage companies have taken advantage of the relatively lax listing standards in the U.S. to of the relatively lax bring to market companies that likely could not list in other markets. These U.S. listing standards companies have taken advantage of the U.S. system by listing companies rejected in the U.S. from other markets due to multiple classes of stock, the absence of profits, use of variable interest entities, and the unavailability of reverse mergers. The U.S. exchanges shut down the reverse merger route in 2011, but several hundred reverse mergers had already come to market before the shutdown. Many companies listed by reverse merger went private or refused to communicate with shareholders and regulators—so-called “going dark.”

Activist short sellers have detected many of the discovered frauds in Chinese Short-seller activity companies. They identify problems with companies, short the stock, and publish peaked in the early reports alleging company wrongdoing, hoping to cover their short after share prices 2010s have declined. Short-seller activity peaked in the early 2010s but continues to find high profile targets like Luckin Coffee.

The prevalence of fraud put pressure on the SEC and PCAOB to act against U.S.- PCAOB has tried to listed Chinese companies and their auditors. The PCAOB has unsuccessfully tried persuade the Chinese since the mid-2000’s to persuade the Chinese to give it access to enable to give it access

Ó2020 GMT Research Limited Page 4 of 23 inspections. But without cooperation from China, both regulators failed completely. The SEC began terminating the public company status of companies that had gone dark.

The SEC demanded to see audit working papers related to fraud from each of the Big Four and BDO. The accounting firms refused, pointing out that Chinese law forbade them from doing so and that they now had to decide between breaking American law or Chinese law. The administrative trial judge who heard the case in 2014 observed that their bind resulted from their own decisions to audit U.S.-listed companies while knowing of their potential obligations to submit their work to regulatory inspection. The administrative trial judge banned the firms from auditing U.S.-listed companies, but the SEC later used its discretion to settle the case for fines of $500k to each firm.

In 2013, the PCAOB reached an enforcement agreement with China. The agreement The U.S. has provided for cooperation in obtaining evidence in an investigation. Investigations suggested that China under the agreement do not substitute for inspections, which remained banned. has not fully complied Investigations occur when whistle blowers allege wrongdoing, while inspections take with the agreement place on routine audits without allegations of wrongdoing. The U.S. has suggested that China has not fully complied with the agreement, which China denies.

Trade War President Trump campaigned by saying he would get tough with China, and in 2018 In 2018, Trump raised raised tariffs on Chinese goods, setting in motion a series of actions and retaliatory tariffs on Chinese actions by the United States and China. goods…

Following his election in 2016, Trump replaced the Chairman of the SEC with Jay ….and began to put his Clayton, who had served as Alibaba’s counsel on its IPO. The SEC then replaced the people in strategic entire board of the PCAOB and installed William Duhnke III, a Republican staffer, as positions… the chairman. Many senior staffers at the PCAOB departed. On December 7, 2018, the SEC and PCAOB jointly released an unexpected statement bemoaning the challenges in regulating Chinese companies.

Representative Mike Conaway (R-Texas) introduced the Holding Foreign Companies …leading to new Accountable Act (HFCAA) in the House on December 10, 2018. The legislation did legislation… not pass and expired when the new Congress arrived in January 2019, but legislators introduced four versions of the act during 2019.

Representative Mike Conaway and Senator Marco Rubio introduced the Equitable …and the passing of Act (Ensuring Quality Information and Transparency on Abroad-Based Listings Act of the Kennedy Bill 2019). Both the Equitable Act and the HFCAA have different versions in the House and Senate. The Senate passed the Kennedy (R-Louisiana) version of the HFCAA on May 20 by unanimous consent.

Before the HFCAA becomes law, it must pass the House, have differences between Different versions need House and Senate versions reconciled and receive the President’s signature. The to be reconciled House will likely send the bill to a committee, which may conduct hearings or amend the legislation before sending it to the full chamber for a vote. Representative Brad Sherman(D-California), sponsor of the House version, made public comments on the Senate passage:

“Some support for the bill is just about making a statement vis-à-vis China, and The most likely some people may not care to wait while I work on some of the technical language… outcome is that it So, there’s a slight possibility that it passes without improvement, there’s some passes in the next possibility that it doesn’t pass at all, and the most likely outcome is that it passes in three months with the next three months with some improvements.” some improvements

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The White House has signalled support for the legislation in its June 4, 2020, The White House has memorandum, highlighting the key issue addressed by the HFCAA: the inability of signalled support for the PCAOB to inspect registered audit firms. On that same day, Secretary of State the legislation Mike Pompeo praised NASDAQ’s proposed tightening of listing rules, stating that such action “should serve as a model for other exchanges in the United States, and around the world.”

What HFCAA will do

The HFCAA provides that companies certify to the SEC annually whether the PCAOB Companies must has inspected their auditor. If the company discloses that its auditor has gone certify to the SEC without inspection for three consecutive years, the company’s securities may not annually whether the trade on a U.S. exchange or over-the-counter (OTC) market. If the company PCAOB has inspected certifies that the PCAOB has inspected its auditor, the SEC can lift the ban. The their auditor company must make the disclosure, yet the company likely has no personal knowledge of the status of inspections of its auditor. Of course, the SEC and PCAOB know the inspection status of the auditor, so they can correct erroneous filings.

The HFCAA also establishes disclosure requirements. Where the SEC identifies a In the event of non- non-inspection, the SEC will require the identified issuer to submit documentation to inspection, the establish that the issuer is not owned or controlled by a governmental entity in the company must disclose foreign jurisdiction in which it is incorporated. Within 90 days after the HFCAA whether it is owned by becomes law, the SEC will issue rules to establish the manner and form for making a governmental entity the submission above.

The definition of a “covered issuer” defines which companies will be subject to the The bill does not cover trading prohibition and disclosure requirements. The Senate bill covers issuers who some companies which must file reports under section 13 or 15(d) of the Securities Exchange Act of 1934. trade OTC Those provisions provide the legal basis for the SEC’s rules on reporting requirements. Companies which do not report to the SEC fall outside the scope of the trading ban. For example, unlike exchange-listed securities, unsponsored American depositary receipts (“ADR”) do not trigger SEC reporting requirements and trade OTC. The trading ban does not affect them (see table below for OTC-traded Chinese and Hong Kong companies).

“Covered issuer” also considers the location of the auditor’s branches and offices. If a U.S. CPA firm U.S. based CPA firms inspected by the PCAOB sometimes audit U.S.-listed Chinese operates in China, the companies. Now, imagine a U.S. CPA firm operates in China without PCAOB PCAOB could disqualify inspection of its Chinese audit operations, violating PCAOB rules. Under the HFCAA, it the PCAOB may deem these operations an office or branch in China. Then, the PCAOB could disqualify the U.S. CPA firm from auditing any listed company, even one with no China operations. We suspect the legislators have not intended this result.

HFCAA defines a non-inspection year as one in which the PCAOB cannot inspect or Affects only China, investigate the issuer’s foreign auditor because of “a position taken by an authority Belgium and France in the foreign jurisdiction”—in essence, because of the opposition of local authorities. More specifically, the SEC certifies a non-inspection year only if it finds, for every report a covered issuer files, the associated audit report was issued by a firm that the PCAOB cannot inspect. At present, this applies only to China, Belgium and France, although we believe that Belgium and France will soon allow inspections, France renewing long-standing procedures and Belgium allowing them for the first time.

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Additional disclosure in Form 20-F and Form 10-K

The HFCAA also adds additional disclosure requirements for foreign issuers. A A foreign issuer in its foreign issuer, during its non-inspection year, will disclose in each Form 20-F and non-inspection year Form 10-K that covers a non-inspection year: must disclose a number of other items 1. that, during the period covered by the form, an accounting firm not subject to inspection by the PCAOB has prepared an audit report for the company;

2. the percentage of the shares of the issuer owned by governmental entities in the foreign jurisdiction in which the issuer is incorporated or otherwise organized;

3. whether the relevant governmental entities have a controlling financial interest with respect to the issuer;

4. the name of each official of the Chinese Communist Party who is a member of the board of directors of (A) the issuer; or (B) the operating entity with respect to the issuer; and

5. whether the articles of incorporation of the issuer (or equivalent organizing document) contains any charter of the Chinese Communist Party, including the text of any such charter.

HFCAA provides for no consequences for failing to give these disclosures. We expect Only large SOEs will that only the large SOE’s like PetroChina will disclose control by China, most will disclose control by disclose party members on the board, and none (with the possible exception of China large SOEs) will have modified their articles to include the party charter.

Interestingly, the disclosure rules apply only when the PCAOB cannot inspect a The disclosure rules company. Presumably, the drafters included these provisions to encourage the apply only when the Chinese government to allow inspections to avoid the disclosure requirements. PCAOB cannot inspect a company Potential delisting

The PCAOB has indicated that it cannot completely inspect the audit work on 207 PRC regulators forbid MNCs with operations in China. When the PCAOB inspects the audit firm that audits the PCAOB to inspect an MNC, it typically also looks at audit work done by other member firms that the work done by support the opinion of the signing firm and must do so if the other firm does more Chinese firms on the than 20% of the total work of the audit. The PRC regulators forbid the PCAOB to Chinese subsidiaries of inspect the work done by Chinese firms on the Chinese subsidiaries of U.S.-listed U.S.-listed multinational corporations. The PCAOB has indicated that eight large accelerated multinational filers used a Chinese audit firm for more than 20% of their audit, as well as 40 corporations smaller companies. The current version of HFCAA would not affect these companies since it does not deregister the auditors.

The current version of HFCAA differs from the existing rule under SOX by punishing the issuer, rather than the auditor. While SOX provides for a broad range of sanctions when auditors fail to disclose audit materials, its sanctions—including deregistration—currently punish only the audit firm. While deregistration of an audit firm could result in the delisting of a stock, it would do so at great cost. A deregistered audit firm could not materially participate in the issuance of any audit report submitted to the SEC or participate in such an audit in a significant role, forcing companies which retained the deregistered firm to find another auditor.

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How will companies respond?

The present bill would stop trading in U.S.-listed companies when the PCAOB cannot We can think of four inspect its auditor after a three-year transition period. That should provide ample possible outcomes time for investors and companies to react. We can think of four likely scenarios for companies to avoid the trading ban: The U.S. and China negotiate to allow inspections; companies relocate the listing from New York to Hong Kong; companies go private and possibly relist on a Chinese exchange; or companies go dark.

One possible outcome sees China negotiating a form of access to inspections that China could negotiate the PCAOB will accept. China’s bureaucracy has thwarted prior attempts to a form of inspections negotiate an inspection regime, with various industry regulators demanding that the PCAOB will exemptions for their industries. Any deal will likely require intervention at a high accept, although this level in the Chinese government. We’d bet against such a solution. seems unlikely

Removing Chinese companies from U.S. exchanges likely hurts the U.S. more than Removing Chinese China since it hurts the business of U.S. intermediaries like the exchanges, companies from US investment bankers, and lawyers. Moreover, U.S. investors have benefited from exchanges seems a investment in rapidly growing Chinese companies. From China’s perspective, it more likely outcome would no longer feel the scrutiny of U.S. regulators. On the other hand, China’s private sector has benefited from the ability to list on U.S. exchanges and obtain foreign capital. The costs and benefits here seem intermediate and suggest this is a likely outcome.

Who does HFCAA affect?

The SEC states that the PCAOB cannot inspect the auditors of 213 companies in Around 213 to 239 China and Hong Kong whose shares trade in the U.S. Using Bloomberg, we found companies are affected 239 unique companies domiciled in China but listed on NASDAQ or the NYSE. The with a combined difference between the two counts results partly from timing and partly because market capitalisation of some U.S.-listed Chinese companies have their audits done by U.S. based firms $1.5 trillion inspected by the PCAOB. Chinese law forbids taking audit working papers outside of China, and we cannot tell whether those audit firms comply with this Chinese law or whether the PCAOB winks at its own requirement to inspect audit work papers. The total market capitalization of U.S.-listed Chinese companies exceeds $1.5 trillion.

In addition to exchange-listed companies, we found 1,243 Chinese domiciled corporations that trade on the OTC market. Most of these trade as unsponsored ADRs, which means the company does not sponsor the ADR and need not file with the SEC. Thus, the HFCAA would not apply to these companies on the OTC market.

Relisting in Hong Kong

However, not all U.S.-listed Chinese companies will easily relist in Hong Kong. The Not all U.S.-listed HKSE’s listing requirements favor larger, established companies. The HKSE’s Main Chinese companies will Board listing requirements include three years of management continuity, one year easily relist in Hong of ownership continuity, semi-annual financial reporting, and the satisfaction of one Kong as the of three financial tests, based on aggregate profits, market capitalization, latest year requirements favor revenue, and overall cash flow. HKSE lists smaller companies on its Growth larger companies Enterprise Market (GEM), which has less demanding requirements. However, GEM requires quarterly financial reporting and does not allow for secondary listings.

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Chinese companies have listed on nearly every stock exchange in the world, yet China likely welcomes outside the mainland they have concentrated on Hong Kong and USA. Hong Kong, Chinese companies legally a part of China, will end its Special Administrative Region status by 2047. moving their listings China likely welcomes Chinese companies moving their listings from New York to from New York to Hong Kong because it begins the process of bringing them home. Hong Kong Hong Kong provides two paths to a listing – IPO or secondary listing.

Most U.S.-listed Chinese companies could not easily move their listing to a mainland Most U.S.-listed exchange. Most of the private companies would need to restructure before they Chinese companies could list on mainland exchanges, replacing their Cayman Islands incorporated could not easily move parent with a Chinese company, getting rid of dual-class shares, and possibly doing their listing to a away with the variable interest entities that enabled foreign investment in restricted mainland exchange sectors. China also requires new listings to have a profitable track record. And even if the company could accomplish all that, the Chinese stock markets likely do not have enough liquidity to handle many of the larger listings on U.S. exchanges.

Private companies have generally preferred to list in New York over Hong Kong with Private companies some significant exceptions. When private Chinese companies first started listing have generally around 2000 in the late stages of the dot.com boom, they preferred New York preferred to list in New because it provided greater liquidity and likely higher values than the small Hong York over Hong Kong Kong market. The HKSE has matured significantly over the last two decades, and now ranks among the world’s largest. Private companies have also taken advantage of relaxed corporate governance rules in the U.S., which allow dual-class shares that keep control in the hands of insiders, also allowing loss making companies to list. While HKSE has relaxed its rules related to a dual-class shares and profitable track records since 2018, they restrict these relaxed provisions to companies with valuations exceeding US$1 billion.

Some Chinese companies have obtained listings in Hong Kong in addition to their There is likely to be a U.S. listings in what may become a growing trend. In the wake of the Senate’s surge in secondary passage of the HFCAA, financial commentators have suggested that U.S.-listed market listings in Hong Chinese companies will move to Hong Kong. For example, Nelson Yan, the head of Kong offshore capital markets investment products at Credit Ease Wealth Management told Bloomberg that “Hong Kong will become the core market for Alibaba trading in the future.” Alibaba sold $13 billion of shares in a secondary offering in November 2019. NetEase raised $2.8 billion in a secondary offering in June 2020, citing the HFCAA as a reason for its move. JD.com says it will soon follow, and Reuters reports that Baidu might delist from NASDAQ, presumably to relist closer to home. These companies began preparing for secondary listings, however, before the HFCAA passed in the Senate.

Because China’s most successful companies list in the U.S., many Chinese investors A Hong Kong listing cannot easily buy shares in these companies. In order to purchase shares in a U.S.- may make the shares listed company, the investor must have foreign currency, and China restricts the available to Chinese ability of Chinese people to obtain foreign currency. A Hong Kong listing may make citizens the shares available on the Hong Kong–Shanghai Connect or the Hong Kong– Shenzhen Connect to Chinese citizens. These “Connects” provide conduits between exchanges to allow trading of designated shares on one exchange in the currency of the other. Thus, Chinese investors may purchase Hong Kong listed shares on the Connects using RMB and obtain RMB when they sell the shares, and foreign investors may buy Chinese shares using foreign currency.

Doing an IPO in Hong Kong Hong Kong provides a popular destination for Chinese companies wanting to raise Many of the U.S.-listed funds with IPOs, and finance professionals understand the procedures well. In sum, Chinese companies a company prepares a prospectus that includes historical financial statements and may have difficulty in sets up a structure that meets certain corporate governance standards. Many of the meeting the U.S.-listed Chinese companies may have difficulty in meeting the governance governance standards Ó2020 GMT Research Limited Page 9 of 23 standards, particularly those banning dual-class shares. Also, HKSE requires a profitable track record, which new companies often cannot show. While it often waives these standards for large companies, the HKSE may need broad waivers to accommodate some of the Chinese companies that wish to list.

The structure of an IPO must consider how to transfer shares traded on the U.S. Must consider how to exchanges into shares tradable on the HKSE. The considerable talent of the legal transfer shares traded and financial professions has yet to determine the best way to do this. One on the U.S. exchanges possibility has the company (Oldco) to establish a new Cayman Islands company into shares tradable on (Newco), list it in Hong Kong, and then offer to exchange shares in Newco for the the HKSE outstanding shares of Oldco. Presumably, a fairness opinion by a valuer or investment bank would need to bless the terms of the transaction. The SEC would need to evaluate completeness of disclosures before the issuing company can submit the transaction to a shareholder vote.

Can a secondary listing release a company from the grip of HFCAA?

Two of the largest U.S.-listed Chinese companies have already obtained secondary Will the secondary listing on the HKSE and others seek these listings. Will the secondary listings resolve listings resolve the the HFCAA issues or will they speed the process of moving primary listings to Hong HFCAA issues or will Kong? they speed the process of moving primary U.S.-listed Chinese companies can establish second listings in Hong Kong via two listings to Hong Kong? paths. The first option establishes a dual-primary listing in Hong Kong, which has most of the same requirements as when a company initially lists in Hong Kong. The second establishes a secondary listing, which has significantly lower fees. Both initial and annual fees for secondary listings cost only 25% the amount for primary listings.

Secondary listings can take place under two chapters of the listing rules. Chapter 19 Both Alibaba and provides general rules for secondary listings, while Chapter 19C provides a NetEase listed on concessionary route for companies listed in the U.S. or U.K. Companies with HKSE under Chapter secondary listings under Chapter 19C can take advantage of numerous waivers to 19C the listing rules designed to simplify regulatory compliance for overseas companies. These waivers eliminate the need to comply with rules regarding corporate governance, ongoing minimum public float, the purchase of a company’s own shares, notifiable transactions, and connected transactions. Furthermore, for Chinese companies listed on NYSE, NASDAQ, and LSE, a secondary listing under 19C also waives most of the dual-class shares requirements. Both Alibaba and NetEase listed on HKSE under Chapter 19C.

HKSE rules distinguish between Chinese companies and non-Chinese companies using a “centre-of-gravity” test. This test seeks to ascertain the degree of connection between a company and Greater China, examining factors such as the place of incorporation, company history, the locations of its business operations, and headquarters, and the nationality of the controlling shareholders. The listing rules do not specify the exact scope of “Greater China”, but the term presumably includes mainland China, Hong Kong, Macau, and, perhaps, Taiwan.

Chapter 19C secondary listings prove more difficult for Chinese companies. A non- Chapter 19C secondary Chinese company must have an expected market capitalization of HKD$10B listings prove more (USD$1.3B), while for Chinese companies, the company must also have HKD$1B difficult for Chinese (USD$130M) in latest year revenue, or else the market capitalization requirement companies increases to HKD$40B (USD$5.2B). This matches the requirement for companies to establish dual-class shares structures on HKSE more generally. Furthermore, the HKSE has stated that Greater China issuers who listed in the U.S. and U.K. after December 15th, 2017, must vary their articles of association, VIE structures, and dual-class share structures to satisfy the HKSE’s requirements, discouraging Ó2020 GMT Research Limited Page 10 of 23 companies from circumventing the primary listing requirements in Hong Kong by listing elsewhere first.

HKSE has opposed allowing Chinese companies to seek or maintain secondary HKSE may only allow listings in the past. The HKSE’s April 30, 2018, policy states that “[a]n application 19C secondary listings for secondary listing from an overseas company that has its ‘centre of gravity’ in the for Chinese companies Greater China region will not be approved.” But this prohibition seems directed at Chinese companies using Chapter 19 for secondary waivers generally, rather than the concessionary route under Chapter 19C, because Chapter 19C expressly contemplates secondary listings by Chinese companies. This suggests that the HKSE will exercise its discretion under the listing rules to disallow Chinese companies which do not meet the high Chapter 19C requirements from creating any secondary listing, even if they otherwise comply with the listing rules.. If true, U.S.-listed Chinese companies cannot acquire a Hong Kong listing unless they can satisfy the primary listing requirements.

The HKSE listing rules do not clearly indicate whether a company can maintain a What happens when a secondary listing if it loses its underlying primary listing. However, if the majority company loses its (over 55%) of trading in a U.S.-listed Chinese company’s shares permanently primary listing is migrates to HKSE, then the HKSE will regard the secondary listing in Hong Kong as unclear a dual-primary listing with the primary exchange. In that case, the waivers under Chapter 19C will no longer apply. HKSE listing rules indicate that when such a trading migration occurs, the company will have a one-year grace period to comply with the requirements for a dual-primary listing.

HKSE could respond to a U.S. delisting by viewing it as a migration of trading to the May potentially convert secondary listing in Hong Kong. If the HKSE chooses this approach, a Chinese a secondary HK listing company that has lost its listing from a U.S. exchange may potentially convert a into its primary listing secondary HK listing into its primary listing without a Hong Kong IPO, assuming it without a Hong Kong can satisfy the primary listing requirements on HKSE within the one-year grace IPO period.

If U.S.-listed Chinese companies wait too long to establish a secondary listing, or if This avenue is not they cannot list in Hong Kong before becoming subject to the trading ban, this open indefinitely avenue may close altogether. Because the HKSE requires two years of “good regulatory compliance” on the primary exchange to establish a secondary listing, a company caught by the trading ban may no longer satisfy this requirement and thus become ineligible for a secondary listing.

Listing procedure

While secondary listings and dual-primary listings largely share the same listing Listing by introduction procedures as a primary listing, they can more likely take advantage of so-called “listing by introduction.” This process requires no offering of securities in Hong Kong at the time of listing. Because the securities have not previously traded in Hong Kong and thus have no liquidity in the Hong Kong market, no mechanism for controlling the price of the securities exists in Hong Kong. The listing elsewhere establishes adequate market prices for the shares and guides subsequent pricing.

The Hong Kong listing process will also take time. Applicants must appoint a sponsor for the application two months before they can submit the application. The application must then clear two review boards before marketing the IPO and listing on the exchange. The HKSE also does not have a set timetable for its listing application process, stating that the length of an application depends on the applicant’s response time and the quality of their responses.

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HKSE Accepted Accounting Standards

To date, the HKSE has not allowed issuers who list only in Hong Kong to report The HKSE has not under U.S. GAAP. Under Rule 4.11, primary listings on the HKSE must normally use allowed issuers who IFRS, or Hong Kong Financial Reporting Standards (HKFRS), or, for PRC issuers, list only in Hong Kong Chinese Accounting Standards for Business Enterprises (CASBE). HKFRS is identical to report under U.S. to IFRS, apart from a few obsolete effective dates. In April 2018, the HKSE created GAAP provisions allowing companies with dual-primary listings or secondary listings on HKSE to use the accounting standard of their primary listing outside Hong Kong. This allowed U.S.-listed companies with secondary listings, whether under Chapter 19 or 19C to use U.S. GAAP without additional disclosure. Dual-primary listings may also use of U.S. GAAP, but in this case, companies must disclose and explain and quantify differences in accounting standards.

For both dual-primary and secondary listings, HKSE rules require the company to HKSE rules require the adopt IFRS, HKFRS, or CASBE if it delists from the primary listing in the foreign company to adopt jurisdiction. This means that even large U.S.-listed Chinese companies will have to IFRS, HKFRS, or present financial statements following IFRS or HKFRS instead of U.S. GAAP if they CASBE if it delists from delist from U.S. exchanges. Even the little difference between financial statements the primary listing in prepared under IFRS or HKFRS and U.S. GAAP will still take a few months for these the foreign jurisdiction statements’ preparation and audit.

We believe that most companies could reissue their U.S. GAAP financials under IFRS Numbers unlikely to and not see any numbers change since most, if not all, of the accounting policies change adopted by these firms under U.S. GAAP are also permitted under IFRS. The change from U.S. GAAP to IFRS allows a company to reconsider each of its accounting policies and select a method acceptable under IFRS that it may not have used before, and we expect companies to adopt IFRS principles that enable reporting higher earnings.

Small caps and micro caps

Many small Chinese companies came to market in the U.S. though a technique Reverse mergers were called a reverse merger. A reverse merger typically involves merging a Chinese effectively shut down company into an already listed shell company (a company with a corporate in the U.S. in 2011 structure but no operations, with the Chinese shareholders ending up in control. This popular method enabled a Chinese company to quickly list in the U.S. without going through the process of an IPO. The stock exchanges effectively shut down this technique in 2011 by denying them the opportunity to list until after they had made several periodic SEC filings. This took away the principal advantages of a reverse merger—speed and the ability to avoid regulatory scrutiny. The so-called “seasoning” rules effectively killed the reverse merger route to listing in the market.

Many Chinese companies which have listed in the U.S. using reverse mergers have Research has indicated abandoned the U.S. market using one of two techniques: going private and going that some companies dark. To go private a company offers to buy the outstanding shares and terminate sandbag their its listing. Minority shareholders often complain that the majority owners—the operating results to management—offer too little for their shares. But Cayman Islands law provides little drive down stock protection for minority shareholders. Research has indicated that some companies prices before a sandbag their operating results to drive down stock prices before a privatization. privatization Some companies that go private have relisted on Chinese exchanges after restructuring. Focus Media has taken this route successfully.

Going dark means a company stops communicating with shareholders and regulators and ceases filing regulatory reports. In this situation, shareholders lose all value with no recourse. Once a company has delinquent filings, the SEC typically moves to terminate the company’s public company status in the U.S.

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HFCAA will make shareholders of small and microcap companies particularly HFCAA will make vulnerable to losing their investments. Other markets, including Hong Kong, will shareholders of small have little interest in listing small, particularly loss-making companies. These and microcap companies may choose to either go private or go dark. Some may choose other companies particularly markets that will accept small Chinese companies. U.S. Secretary of State Mike vulnerable to losing Pompeo has suggested that other markets follow the recent example of NASDAQ their investments and reject small Chinese listings.

How Can Congress Improve the HFCAA?

Representative Sherman, the sponsor of the House version of the HFCAA, has said The bill will likely pass that he believes the bill will likely pass in a few months with some improvements. in a few months with How should Congress improve it? some improvements

Some criticize the three-year transition period as too long, given that all affected Some suggestions… parties have known the problem for nearly 20 years. The three-year transition appears to allow new auditors to enter the market. Because inspections would normally occur only every three years, a new auditor from China would likely have its first inspection in its third year, but this situation is unlikely to arise because the PCAOB no longer registers new auditors that it cannot inspect. A simpler and fairer approach focuses on the CPA firm instead of the listed company. The PCAOB should never have registered firms it could not inspect. While it fixed this problem prospectively in 2010, it left already registered about fifty firms. A better bill would require that the PCAOB terminate the registration of any CPA firm it cannot inspect and give firms a reasonable time—say one year—to decide whether to maintain registration, with inspection, or to resign their registration. This would provide time for companies to consider alternative audit firms, and for China to decide if it wants continued access to U.S. markets. The challenge with this approach occurs when the Chinese firm performs a material role in the audit of an MNC. The PCAOB has identified Deregistration of the Chinese auditor could leave the MNC unaudited. The draft HFCAA fails to address the uninspected audits of multinational corporations that have operations in China. We can think of no work around other than allowing PCAOB inspections or changing the rule.

Too short a transition causes unnecessary problems without attendant benefits. Unintended Companies need time to move their primary listing to another market or to go consequences when private. A short transition could result in untradable shares. Because many transition too short investment funds cannot hold illiquid securities, this could lead to serious selling pressure. This might create unintended opportunities for hedge funds not subject to the restriction against holding illiquid shares to buy and hold anticipating that values will increase once trading recommences on a new exchange.

We cannot discern the Congress’s purpose of seeking the expanded disclosure rules No purpose to related to government or Communist Party influence on the company. We can see disclosure of no consequences for government control nor party influence. Does Congress wish to government influence ban U.S. exchanges from listing SOEs or compamnies with Communists on the board? If not, what purpose does the disclosure serve? Most investors likely already understand which companies are state-controlled and have Communists on the board. We think U.S. investors already understand the role Communists play on the board in a Communist country.

The bill fails to address the fact that U.S.-listed Chinese companies need not comply The bill fails to address with provisions that apply to American companies. For example, a foreign company the fact that U.S.-listed need not file quarterly reports that an auditor has reviewed, need not make Form 8- Chinese companies K filings that report current events, and need comply not with Regulation FD, which need not comply with mandates fair disclosure to all interested parties. It appears these exemptions came provisions that apply about because the SEC and other regulators wanted to encourage foreign to American companies

Ó2020 GMT Research Limited Page 13 of 23 companies to make secondary listings in the U.S. and did not want to expand disclosure requirements beyond that required on their home exchange. We think Congress could improve HFCAA by tightening these requirements, particularly for companies that do not have a primary listing in their home and are not subject to potentially duplicative reporting requirements.

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China domiciled companies listed in U.S. exchanges Ticker Company Market Market Cap (US$) YI US Equity 111 INC NASDAQ GM 629,225,728 VNET US Equity 21VIANET-ADR NASDAQ GS 1,715,774,592 QFIN US Equity 360 FINANCE INC NASDAQ GM 1,446,564,480 KRKR US Equity 36KR HOLDINGS IN NASDAQ GM 254,961,520 WBAI US Equity 500.COM LTD-ADR New York 139,750,608 JOBS US Equity 51JOB INC-ADR NASDAQ GS 4,206,840,832 WUBA US Equity 58.COM-ADR New York 7,193,490,432 JFU US Equity 9F INC-ADR NASDAQ GM 1,147,782,656 ATV US Equity ACORN INTERN-ADR New York 36,598,028 AIH US Equity AESTHETIC ME-ADR NASDAQ GM 183,944,416 AGBA US Equity AGBA ACQUISITION NASDAQ CM 60,347,500 AGBAU US Equity AGBA ACQUISITION NASDAQ CM -- AGBAR US Equity AGBA ACQUIS-R NASDAQ CM 842,000 AGMH US Equity AGM GROUP HOLDIN NASDAQ CM 603,534,144 ANTE US Equity AIRNET TECHNOLOG NASDAQ CM 8,433,363 ALACR US Equity ALBERTON ACQ-RTS NASDAQ CM -- ALAC US Equity ALBERTON ACQUISI NASDAQ CM 155,711,344 ALACU US Equity ALBERTON ACQUISI NASDAQ CM 112,630,504 BABA US Equity ALIBABA GRP-ADR New York 539,710,226,432 ACH US Equity ALUMINUM COR-ADR New York 5,827,101,184 AMBO US Equity AMBOW EDUCAT-ADR NYSEAmerican 40,951,176 HKIB US Equity AMTD INTERNA-ADR New York 1,621,035,776 ANPC US Equity ANPAC BIO ME-ADR NASDAQ GM 85,130,336 APM US Equity APTORUM GROUP-A NASDAQ GM 95,717,368 AACG US Equity ATA CREATIVITY G NASDAQ GM 28,466,492 ATIF US Equity ATIF HOLDINGS LT NASDAQ CM 82,844,560 JG US Equity AURORA MOBIL-ADR NASDAQ GM 203,672,528 ATHM US Equity AUTOHOME INC-ADR New York 9,159,421,952 BIDU US Equity BAIDU INC-SP ADR NASDAQ GS 37,299,777,536 BZUN US Equity BAOZUN INC-ADR NASDAQ GS 1,720,640,896 BGNE US Equity BEIGENE LTD-ADR NASDAQ GS 12,460,599,296 BEST US Equity BEST INC - ADR New York 1,893,698,048 BILI US Equity BILIBILI INC-ADR NASDAQ GS 11,157,286,912 BITA US Equity BITAUTO HOLD-ADR New York 923,458,240 BHAT US Equity BLUE HAT INTERAC NASDAQ CM 33,454,340 BNSO US Equity BONSO ELEC INTL NASDAQ CM 11,067,786 BIMI US Equity BOQI INTERNATION NASDAQ CM 25,786,286 BRQS US Equity BORQS TECHNOLOGI NASDAQ CM 60,196,940 BEDU US Equity BRIGHT SCHOL-ADR New York 910,296,768 CAN US Equity CANAAN INC NASDAQ GM 474,444,448 CANG US Equity CANGO INC/KY-ADR New York 754,866,944 CBAT US Equity CBAK ENERGY TECH NASDAQ CM 25,534,620 CMCM US Equity CHEETAH MOBI-ADR New York 416,527,968 CAAS US Equity CHINA AUTOMOTIVE NASDAQ CM 60,165,908 CBPO US Equity CHINA BIOLOGIC P NASDAQ GS 4,160,520,192 CCCL US Equity CHINA CERAMICS C NASDAQ CM 5,379,640 CCRC US Equity CHINA CUSTOMER R NASDAQ CM 82,849,792 DL US Equity CHINA DISTAN-ADR New York 229,706,432 CEA US Equity CHINA EASTRN-ADS New York 8,338,086,912 JRJC US Equity CHINA FINANC-ADR NASDAQ GS 11,648,149 CGA US Equity CHINA GREEN AGRI New York 16,637,338 HGSH US Equity CHINA HGS REAL E NASDAQ CM 19,307,754 CIH US Equity CHINA INDEX-ADR NASDAQ GS 110,529,184 CJJD US Equity CHINA JO-JO DRUG NASDAQ CM 110,338,232 CLEU US Equity CHINA LIBERAL ED NASDAQ CM -- LFC US Equity CHINA LIFE-ADR New York 88,731,320,320 CHL US Equity CHINA MOBILE-ADR New York 142,222,704,640

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Ticker Company Market Market Cap (US$) CHNR US Equity CHINA NATURAL RE NASDAQ CM 20,175,350 COE US Equity CHINA ONLINE-ADR New York 525,430,784 SNP US Equity CHINA PETRO-ADR New York 67,478,302,720 CPHI US Equity CHINA PHARMA HOL NYSEAmerican 19,048,624 XRF US Equity CHINA RAPID-ADR New York 8,818,880 CREG US Equity CHINA RECYCLING NASDAQ CM 5,045,771 ZNH US Equity CHINA SOUTH-ADR New York 8,329,554,944 SXTC US Equity CHINA SXT PHARMA NASDAQ CM 11,673,522 CHA US Equity CHINA TELECO-ADR New York 26,246,367,232 CHU US Equity CHINA UNICOM-ADR New York 17,838,706,688 CXDC US Equity CHINA XD PLASTIC NASDAQ GM 61,947,764 PLIN US Equity CHINA XIANGTAI F NASDAQ CM 37,780,788 ZGYH US Equity CHINA YUNGHONG-A NASDAQ CM 70,029,152 CNET US Equity CHINANET ONLINE NASDAQ CM 22,125,764 CCAC/U US Equity CITIC CAPITAL New York 274,620,000 CCAC US Equity CITIC CAPITAL-A New York 266,340,000 CLPS US Equity CLPS INC NASDAQ GM 26,678,616 CNF US Equity CNFINANCE HOLDIN New York 254,439,824 CEO US Equity CNOOC LTD-ADR New York 51,130,265,600 CCNC US Equity CODE CHAIN NEW C NASDAQ CM 58,454,768 HHT US Equity COLOR STAR TECHN NASDAQ CM 8,703,374 CCM US Equity CONCORD MED-ADR New York 43,071,564 CTK US Equity COOTEK CAYMA-ADR New York 404,836,672 DQ US Equity DAQO NEW ENE-ADR New York 721,103,168 DTSS US Equity DATASEA INC NASDAQ CM 41,010,144 DOGZ US Equity DOGNESS INTERN-A NASDAQ GM 26,561,472 DOYU US Equity DOUYU INTERN-ADR NASDAQ GS 2,581,108,480 LYL US Equity DRAGON VICTORY I NASDAQ CM 10,850,323 DXF US Equity DUNXIN FINAN-ADR NYSEAmerican 9,375,178 MOHO US Equity ECMOHO LTD NASDAQ GM 121,266,368 EH US Equity EHANG HOLDINGS NASDAQ GM 642,513,984 CLWT US Equity EURO TECH HLDGS NASDAQ CM 7,051,730 EVK US Equity EVER-GLORY INTER NASDAQ GM 10,511,431 SFUN US Equity FANG HOLDING-ADR New York 99,611,016 DUO US Equity FANGDD NETWO-ADR NASDAQ GM 738,582,592 FANH US Equity FANHUA INC-ADR NASDAQ GS 956,837,568 FAMI US Equity FARMMI INC NASDAQ CM 7,229,625 FINV US Equity FINVOLUTION GROU New York 476,961,824 FEDU US Equity FOUR SEASONS EDU New York 63,085,564 FORK US Equity FULING GLOBAL IN NASDAQ CM 25,523,078 FUTU US Equity FUTU HOLDING-ADR NASDAQ GM 1,615,682,432 FTFT US Equity FUTURE FINTECH G NASDAQ CM 37,096,600 FFHL US Equity FUWEI FILMS HOLD NASDAQ CM 7,544,084 GDS US Equity GDS HLDGS - ADR NASDAQ GM 8,621,466,624 CO US Equity GLOBAL CORD BLOO New York 326,972,384 GSMG US Equity GLORY STAR NEW M NASDAQ CM 178,876,368 DNJR US Equity GOLDEN BULL LTD NASDAQ CM 14,745,723 GTEC US Equity GREENLAND TECHNO NASDAQ CM 20,192,602 GRNQ US Equity GREENPRO CAPITAL NASDAQ CM 141,187,632 GHG US Equity GREENTREE HO-ADR New York 1,228,190,976 GRNV US Equity GREENVISION ACQU NASDAQ CM 71,012,504 GRNVU US Equity GREENVISION ACQU NASDAQ CM 72,953,128 GRNVR US Equity GREENVISION AC-R NASDAQ CM -- GSUM US Equity GRIDSUM HOLD-ADR NASDAQ GS 27,435,308 GSX US Equity GSX TECHEDU-ADR New York 7,104,478,720 GSH US Equity GUANGSHEN RA-ADR New York 2,011,527,552 GURE US Equity GULF RESOURCES I NASDAQ GS 45,398,128 HLG US Equity HAILIANG EDU-ADR NASDAQ GM 1,185,394,944 HAPP US Equity HAPPINESS BIOTEC NASDAQ CM 67,000,000

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Ticker Company Market Market Cap (US$) HEBT US Equity HEBRON TECHNOL-A NASDAQ CM 296,431,680 HX US Equity HEXINDAI INC-ADR NASDAQ GM 23,367,104 HIHO US Equity HIGHWAY HOLDINGS NASDAQ CM 7,470,683 HOLI US Equity HOLLYSYS AUTOMAT NASDAQ GS 783,350,016 HMI US Equity HUAMI CORP-ADR New York 582,945,280 HNP US Equity HUANENG POWR-ADR New York 8,562,702,336 HTHT US Equity HUAZHU GROUP LTD NASDAQ GS 9,492,568,064 HUSN US Equity HUDSON CAPITAL I NASDAQ GM 9,064,606 HUIZ US Equity HUIZE HOLDIN-ADR NASDAQ GM 302,063,552 HCM US Equity HUTCHISON CH-ADR NASDAQ GS 2,754,012,160 HUYA US Equity HUYA INC-ADR New York 3,577,730,048 ICLK US Equity ICLICK INTER-ADR NASDAQ GM 390,188,736 IMAB US Equity I-MAB NASDAQ GM 1,402,352,640 IQ US Equity IQIYI INC-ADR NASDAQ GS 11,686,968,320 ITP US Equity IT TECH PACKAGIN NYSEAmerican 13,797,740 JD US Equity JD.COM INC-ADR NASDAQ GS 76,603,449,344 JT US Equity JIANPU TECHNOLOG New York 118,351,440 JFIN US Equity JIAYIN GRP-ADR NASDAQ GM 113,144,560 JKS US Equity JINKOSOLAR-ADR New York 701,056,704 YY US Equity JOYY INC NASDAQ GS 4,860,043,264 JP US Equity JUPAI HOLDINGS-A New York 37,760,036 KXIN US Equity KAIXIN AUTO HOLD NASDAQ CM 51,536,400 KNDI US Equity KANDI TECHNOLOGI NASDAQ GS 167,532,720 KBSF US Equity KBS FASHION GROU NASDAQ CM 4,111,051 KGJI US Equity KINGOLD JEWELRY NASDAQ CM 10,783,809 KC US Equity KINGSOFT CLO-ADR NASDAQ GS 3,895,918,848 LAIX US Equity LAIX INC - ADR New York 148,236,704 LEJU US Equity LEJU HOLDING-ADR New York 190,078,880 LX US Equity LEXINFINTECH-ADR NASDAQ GM 1,488,475,392 LLIT US Equity LIANLUO SMART LT NASDAQ CM 7,965,538 LITB US Equity LIGHTINTHEBO-ADR New York 90,504,680 LIZI US Equity LIZHI INC NASDAQ GM 194,365,488 LOAC US Equity LONGEVITY ACQUIS NASDAQ CM 55,598,500 LOACU US Equity LONGEVITY ACQUIS NASDAQ CM 54,808,000 LOACR US Equity LONGEVITY AC-RTS NASDAQ CM -- LK US Equity LUCKIN COFFE-ADR NASDAQ GS 652,153,856 LKCO US Equity LUOKUNG TECHNOLO NASDAQ CM 101,158,776 MDJH US Equity MDJM LTD NASDAQ CM 32,582,656 MLCO US Equity MELCO RESO-ADR NASDAQ GS 7,676,733,440 MFH US Equity MERCURITY FINTEC NASDAQ CM 12,909,992 METX US Equity METEN EDTECHX ED NASDAQ CM 544,280,448 MTC US Equity MMTEC INC NASDAQ CM 40,140,000 MOGU US Equity MOGU INC-ADR New York 132,121,456 MKD US Equity MOLECULAR DA-ADR NASDAQ CM 189,819,856 MOMO US Equity MOMO INC-ADR NASDAQ GS 4,407,874,560 MOXC US Equity MOXIAN INC NASDAQ CM 9,917,312 NTP US Equity NAM TAI PROPERTY New York 210,158,032 NTES US Equity NETEASE INC-ADR NASDAQ GS 48,699,166,720 NFH US Equity NEW FRONTIER HEA New York 1,062,677,952 EDU US Equity NEW ORIENTAL-ADR New York 18,277,963,776 NEWA US Equity NEWATER TECHNOLO NASDAQ CM 26,806,320 NBACR US Equity NEWBORN ACQ-RTS NASDAQ CM -- NBAC US Equity NEWBORN ACQUISIT NASDAQ CM 73,257,200 NBACU US Equity NEWBORN ACQUISIT NASDAQ CM 74,525,400 NIO US Equity NIO INC - ADR New York 4,638,950,912 NIU US Equity NIU TECHNOLO-ADR NASDAQ GM 783,343,552 NOAH US Equity NOAH HOLDING-ADS New York 1,659,485,568 OCFT US Equity ONECONNECT FIN New York 4,745,422,336 ONE US Equity ONESMART INT-ADR New York 657,357,248

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Ticker Company Market Market Cap (US$) SEED US Equity ORIGIN AGRITECH NASDAQ CM 18,743,848 OSN US Equity OSSEN INNOVA-ADR NASDAQ CM 13,128,104 PTR US Equity PETROCHINA -ADR New York 104,527,937,536 FENG US Equity PHOENIX NEW -ADR New York 96,083,512 DNK US Equity PHOENIX TREE HOL New York 1,415,526,912 PDD US Equity PINDUODUO INC NASDAQ GS 72,240,816,128 PME US Equity PINGTAN MARINE E NASDAQ CM 93,284,960 PT US Equity PINTEC TECHNOLOG NASDAQ GM 42,776,112 PLAG US Equity PLANET GREEN HOL NYSEAmerican 24,084,466 PBTS US Equity POWERBRIDGE TECH NASDAQ CM 25,237,226 PHCF US Equity PUHUI WEALTH INV NASDAQ CM 25,431,704 NEW US Equity PUXIN LTD-ADR New York 627,496,896 PUYI US Equity PUYI INC - ADR NASDAQ GM 379,982,464 QK US Equity Q&K INTERNAT-ADR NASDAQ GM 574,404,352 QD US Equity QUDIAN INC-SPON New York 403,413,280 QTT US Equity QUTOUTIAO -ADR NASDAQ GS 701,080,320 RCON US Equity RECON TECHNOLOGY NASDAQ CM 10,935,207 SOL US Equity RENESOLA LTD-ADR New York 45,672,988 RENN US Equity RENREN INC-ADR New York 94,504,616 RETO US Equity RETO ECO-SOLUTIO NASDAQ CM 22,002,000 REDU US Equity RISE EDUCAT-ADR NASDAQ GM 188,866,832 RUHN US Equity RUHNN HOLDING LT NASDAQ GS 223,329,232 RYB US Equity RYB EDUCATION-AD New York 75,034,864 SJ US Equity SCIENJOY HOLDING NASDAQ CM 151,593,808 SRL US Equity SCULLY ROYALTY L New York 95,416,488 SECO US Equity SECOO HOLDIN-ADR NASDAQ GM 119,581,664 AIHS US Equity SENMIAO TECHNOLO NASDAQ CM 10,670,727 SGOC US Equity SGOCO GROUP NASDAQ CM 79,202,376 TYHT US Equity SHINECO INC NASDAQ CM 11,480,860 SINA US Equity SINA CORP NASDAQ GS 2,068,100,992 SHI US Equity SINOPEC SHA-ADR New York 4,615,283,200 SVA US Equity SINOVAC BIOTECH NASDAQ GS -- SKYS US Equity SKY SOLAR HD-ADR NASDAQ CM 84,748,392 SOGO US Equity SOGOU INC-ADR New York 1,294,474,752 SOHU US Equity SOHU.COM LTD-ADR NASDAQ GS 270,215,904 SY US Equity SO-YOUNG INT-ADR NASDAQ GM 1,032,247,872 SPI US Equity SPI ENERGY NASDAQ GS 13,769,194 MSC US Equity STUDIO CITY-ADR New York 1,252,604,160 STG US Equity SUNLANDS TECHNOL New York 249,963,584 TKAT US Equity TAKUNG ART CO LT NYSEAmerican 14,913,046 TAL US Equity TAL EDUCATIO-ADR New York 33,125,484,544 TANH US Equity TANTECH HOLDINGS NASDAQ CM 28,853,242 TAOP US Equity TAOPING INC NASDAQ CM 15,129,041 TEDU US Equity TARENA INTER-ADR NASDAQ GS 143,101,424 GLG US Equity TD HOLDINGS INC NASDAQ CM 21,737,290 PETZ US Equity TDH HOLDINGS INC NASDAQ CM 47,225,496 TME US Equity TENCENT MUSI-ADR New York 20,516,229,120 NCTY US Equity THE9 LTD-ADR NASDAQ CM 21,811,768 TOTA US Equity TOTTENHAM ACQUIS NASDAQ CM 39,478,508 TOTAU US Equity TOTTENHAM ACQUIS NASDAQ CM -- TOTAR US Equity TOTTENHAM AC-RTS NASDAQ CM 682,496 TCOM US Equity TRIP.COM GRO-ADR NASDAQ GS 15,318,991,872 TC US Equity TUANCHE LTD-ADR NASDAQ CM 91,260,088 TOUR US Equity TUNIU CORP-ADR NASDAQ GM 105,800,096 TIGR US Equity UP FINTECH H-ADR NASDAQ GS 516,018,560 MYT US Equity URBAN TEA INC NASDAQ CM 13,194,878 UTSI US Equity UTSTARCOM HOLDIN NASDAQ GS 67,497,408 UXIN US Equity UXIN LTD - ADR NASDAQ GS 420,138,912 VIOT US Equity VIOMI TECHNO-ADR NASDAQ GS 384,917,600

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Ticker Company Market Market Cap (US$) VIPS US Equity VIPSHOP HOLDINGS New York 11,094,928,384 WAFU US Equity WAH FU EDUCATION NASDAQ CM 10,952,583 WSG US Equity WANDA SPORTS-ADR NASDAQ GS 348,983,040 WB US Equity WEIBO CORP-ADR NASDAQ GS 6,981,816,320 WEI US Equity WEIDAI LTD-ADR New York 119,735,152 WIMI US Equity WIMI HOLOGRAM-AD NASDAQ GM 222,639,488 WINS US Equity WINS FINANCE HOL NASDAQ CM 142,831,024 XYF US Equity X FINANCIAL-ADR New York 124,245,720 XIN US Equity XINYUAN REAL-ADR New York 133,162,920 XNET US Equity XUNLEI LTD-ADR NASDAQ GS 231,074,160 YIN US Equity YINTECH INVE-ADR NASDAQ GS 422,377,568 YRD US Equity YIREN DIGITAL LT New York 340,599,872 DAO US Equity YOUDAO INC New York 2,551,657,984 YUMC US Equity YUM CHINA HO New York 16,973,364,224 ZGYHU US Equity YUNHONG INTERNAT NASDAQ CM 70,390,128 ZGYHR US Equity YUNHONG INTERN-R NASDAQ CM -- YJ US Equity YUNJI INC-ADR NASDAQ GM 668,796,736 ZLAB US Equity ZAI LAB LTD-ADR NASDAQ GM 4,995,652,608 ZCMD US Equity ZHONGCHAO INC-A NASDAQ CM 44,598,096 ZKIN US Equity ZK INTERNATIONAL NASDAQ CM 18,876,162 ZTO US Equity ZTO EXPRESS -ADR New York 23,752,009,728 Source: Bloomberg

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China and Hong Kong companies traded on OTC markets with sponsored ADRs Ticker Company Market Market Cap (US$) SWRBY US Equity SWIRE PAC-ADR B OTC US 7,663,700,992 TCYMY US Equity TINGYI-SPON ADR OTC US 9,400,493,056 LASLY US Equity LENTUO INTER-ADR OTC US 3,257 ESPGY US Equity ESPRIT HLDGS-ADR OTC US 179,285,104 ZXAIY US Equity CHINA ZENIX -ADR OTC US 6,195,000 SHALY US Equity SHANGRI-LA -ADR OTC US 2,959,851,008 AIRYY US Equity AIR CHINA-SP-ADR OTC US 11,732,643,840 TSGTY US Equity TSINGTAO BR-ADR OTC US 10,185,803,776 BKEAY US Equity BANK EAST AS-ADR OTC US 5,421,497,344 LMPMY US Equity LEE & MAN-SP ADR OTC US 2,716,651,264 SMICY US Equity SEMICONDUCTOR-AD OTC US 12,100,783,104 ICABY US Equity I-CABLE COMM-ADR OTC US 53,509,676 TCYQY US Equity TINGYI-SP ADR OTC US -- CPCAY US Equity CATHAY PAC-ADR OTC US 4,004,653,824 HGKGY US Equity POWER ASSETS-ADR OTC US 11,460,984,832 CCIHY US Equity CHINACACHE-ADR OTC US 548,550 BHKLY US Equity BOC HONG KON-ADR OTC US 29,265,455,104 HNLGY US Equity HANG LUNG DE-ADR OTC US 2,753,192,192 WUXAY US Equity WUXI-UNSP ADR OTC US -- YYINZ US Equity YY INC-SPON ADR OTC US -- HKVTY US Equity HK ELECTRIC-ADR OTC US -- LSNVY US Equity LAI SUN DEV-ADR OTC US -- LGRTY US Equity LAI SUN-SP ADR OTC US -- LNGHY US Equity LAI FUNG HLD-ADR OTC US -- WHGLY US Equity WH GROUP LTD-ADR OTC US 12,047,933,440 SNLAY US Equity SINO LAND-ADR OTC US 7,890,577,920 CTPCY US Equity CITIC LTD - ADR OTC US 28,624,818,176 YGEHY US Equity YINGLI GREEN-ADR OTC US 2,362,929 PCCWY US Equity PCCW LTD-ADR OTC US 4,174,004,736 PNGAY US Equity PING AN INSU-ADR OTC US 179,583,533,056 FEPTY US Equity FAR EAST PHA-ADR OTC US -- NDVLY US Equity NEW WORLD DE-ADR OTC US 10,185,708,544 DIPGY US Equity DATANG INTL-ADR OTC US 4,453,018,112 HSNGY US Equity HANG SENG BK-ADR OTC US 29,461,495,808 JEXYY US Equity JIANGSU EXP-ADR OTC US 6,740,367,360 SGHIY US Equity SHANGHAI IND-ADR OTC US 1,914,579,584 HLPPY US Equity HANG LUNG PR-ADR OTC US 9,346,258,944 HOKCY US Equity HONG KG CHIN-ADR OTC US 27,215,484,928 JIXAY US Equity JIANGXI COPP-ADR OTC US 4,939,872,768 JGLMY US Equity JIANGLING-B ADR OTC US 1,084,989,568 AAGIY US Equity AIA GROUP LT-ADR OTC US 98,958,688,256 TVBCY US Equity TELEVISION B-ADR OTC US 560,640,000 TRUHY US Equity TRULY INTL-ADR OTC US 297,675,264 TTNDY US Equity TECHTRONIC I-ADR OTC US 16,059,189,248 SWRAY US Equity SWIRE PAC-ADR A OTC US 7,663,700,992 HDVTY US Equity HENDERSON IN-ADR OTC US 195,028,960 NWSGY US Equity NWS HOLDINGS-ADR OTC US 3,078,065,408 CRHKY US Equity CHINA RES BR-ADR OTC US 16,399,313,920 TSYHY US Equity TRAVELSKY-ADR H OTC US 5,458,112,512 SUHJY US Equity SUN HUNG KAI-ADR OTC US 33,961,984,000 YZCAY US Equity YANZHOU COAL-ADR OTC US 4,995,584,512 LNVGY US Equity LENOVO GROUP-ADR OTC US 6,548,061,184 BORNY US Equity CHINA NEW BO-ADR OTC US 3,344,250 HLDCY US Equity HENDERSON LA-ADR OTC US 17,235,337,216 VSTHY US Equity VST HOLDINGS-ADR OTC US -- CLPHY US Equity CLP HOLDINGS-ADR OTC US 24,809,744,384 Ó2020 GMT Research Limited Page 20 of 23

Ticker Company Market Market Cap (US$) HYSNY US Equity HYSAN DEV-SP ADR OTC US 2,888,670,208 CNTFY US Equity CHINA TECHFA-ADR OTC US 846,937 HKTVY US Equity HONG KONG TE-ADR OTC US 525,994,880 CPKPY US Equity CP POKPHAND-ADR OTC US 2,099,064,192 SIHBY US Equity SHENZHEN INV-ADR OTC US 1,078,591,616 FPAFY US Equity FIRST PACIFI-ADR OTC US 771,920,448 Bloomberg identifies 1,244 Chinese companies that trade in over-the-counter markets. Of the 1,244, Bloomberg identifies 61 companies, listed above, as being sponsored ADRs. Only sponsored ADRs are subject to HFCAA. It should be noted that Bloomberg did not identify the type of ADR for 940 companies. To determine whether HFCAA applies to a company, the best place to look is SEC’s Edgar database. Companies subject to HFCAA will have filed form 20F or 10K and are using a China based auditor. Source: Bloomberg

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THE ACCOUNTING PEOPLE

What we do GMT Research provides independent insight into markets, sectors and companies throughout Asia. Our unique method of mining a comprehensive collection of corporate financial statements for key data allows us to evaluate the financial health of a company, sectors and the market at large. We also investigate the application of accounting standards by companies and sectors, shedding light on the quality of reported profits. Armed with this information, we help investment professionals navigate the financial landscape.

Gillem Tulloch has been a financial analyst since 1994 and has been based in Asia since 1995, with spells in Singapore, Thailand, Korea and most recently Hong Kong. Over his career, Gillem has covered sectors ranging from telecoms to printing to electronics. He has achieved top industry rankings in regional polls like Asiamoney and Institutional Investor, and has appeared on Bloomberg and Business Week. Gillem has worked in research and strategy for several large sell-side institutions, including Cazenove, Nomura and CLSA, and founded the independent research company Forensic Asia before moving on to establish GMT Research.

Nigel Stevenson worked for eight years in investment banking at Dresdner Kleinwort Wasserstein in London, primarily advising on equity offerings and M&A transactions, both in the UK and internationally. He subsequently spent seven years as an equity research analyst at Veritas Asset Management, where he was a member of the global equities team, primarily focusing on the industrials sector. Nigel is a graduate of Cambridge University and a qualified barrister. He has a Masters in Finance from London Business School, awarded with distinction, and is a CFA charterholder.

Mark Webb is a research analyst and chartered accountant. He has been based in Asia for 21 years, writing research on transport, logistic and industrial conglomerate companies since 1997. Mark has worked for HSBC in equity research in Hong Kong and Singapore, and at PricewaterhouseCoopers in London and Hong Kong.

DISCLAIMER This document is published and distributed solely for information purposes only and does not serve as investment advice or recommendation of any security, strategy or investment product. It is not an advertisement for investment, trading or financial services, nor is it a solicitation to offer for the purchase or sale of investment, trading or financial instruments. GMT Research Limited (hereafter GMT Research) is not an affiliate or partner of an entity that sells or promotes, securities or other financial and/or investment instruments. GMT Research makes no warranty or guarantee, either express or implied, with respect to accuracy, timeliness, completeness or reliability of the information contained in this document. GMT Research, its directors, employees, agents and representatives disclaim any and all liability for losses, including but not limited to investment losses, errors or damages arising from use of the opinions, comments and information contained in GMT Research’s documents. Readers and subscribers of GMT Research’s documents must exercise their own due diligence and seek advice from financial or legal representatives in their relevant jurisdiction in making their own judgment. GMT Research is under no obligation to update news information or developments that are in its documents.

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