If you have followed my column over the years, you have probably read a lot about “Splinternet”, which is the decoupling of the Chinese Internet from the US-dominated global Internet, as well as the broader US-China tech war and the ongoing financial cold war between Beijing and Washington.
In the simplest terms, the real battle is all about the decoupling of the US and China whose economies, markets and technology have long been closely intertwined. Over the past two decades, China grew faster than any other in history to become a serious rival of the world’s sole superpower. As the factory to the world, China is also now a key cog in the sprawling global supply chain. Since the 2018 Global Financial Crisis, China and the US have been slowly moving away from each other even though America remains by far China’s biggest market and its reliance on Chinese components, intermediate goods as well as finished products, has grown.
What started as a tit-for-tat over tariffs between the world’s largest economy and the second-largest in 2018 when President Donald Trump was in the White House escalated into a protracted trade war and is now morphing into a cold war of sorts. There is also a tech war brewing between Washington and Beijing and a simmering financial cold war with the delisting of Chinese companies in the US. There are also efforts by the US and its Western allies to stop China from acquiring sophisticated military technology that can be used in an attack on Taiwan or to help strengthen China’s defence forces.
Late last month, there was a truce of sorts on the financial front when the US Securities and Exchange Commission (SEC); US Public Company Accounting Oversight Board (PCAOB); China Securities Regulatory Commission, the main corporate regulator; and the Chinese Ministry of Finance signed an agreement on cross-border audit investigation arrangements. US regulators had threatened to delist all Chinese companies whose American Depositary Receipts (ADRs) are listed on the New York Stock Exchange or Nasdaq under the Holding Foreign Companies Accountable Act within three years unless Beijing allowed auditors to scrutinise their accounts the way US companies are audited. By late August, almost 20 months had passed and the clock was ticking for Chinese ADR delistings in America.
At the last minute, after repeatedly saying Chinese companies will not share financial information and data with US-based auditors or regulators, Beijing agreed that companies with ADRs listed in the US will fully comply with PCAOB’s audit requirements. As a compromise, however, instead of US auditors and regulators auditing the books of Chinese companies in America, the two sides agreed that they will do so in Hong Kong.
Beijing also agreed to three other conditions that it had previously rejected. PCAOB now has the sole discretion to pick the firm, and audit engagements and cases for inspection, without any influence from China. The two sides also agreed that PCAOB investigators must be able to view complete audit work papers that they need to see for their investigation and that PCAOB will be allowed to directly interview relevant people and take testimony from all personnel related to their audits and investigations.
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To be sure, there is a lot at stake on the financial front. China wants to protect its state-owned enterprises (SOEs), which are listed in the US. It does not want sensitive information about its large oil, financial services or telecommunications firm to be handed over to US regulators on a silver platter. Private Chinese companies like its tech giants, however, are another matter. Beijing understands that Chinese private companies need access to foreign capital because state banks which are tools for policy-lending just cannot afford to fund them. For their part, politicians in Washington do not want to give Chinese companies a free ride and easy access to US capital unless they are willing to subject themselves to the same rigorous audits that American companies as well as other foreign companies listed in the US do.
American investors own a huge chunk of Chinese companies. At the end of 2020, the market capitalisation of Chinese ADRs in the US was just over US$2.1 trillion. Among them were top Chinese banks, Chinese telcos and most of the largest Chinese Internet companies including e-commerce giant Alibaba Group Holdings with their primary listings in New York. Since then the market value of Chinese ADRs in the US has fallen by over 50%. Part of that is the dramatic fall of Chinese stocks on US bourses. (Alibaba shares are down 73% from their peak in late October 2020 when its fintech affiliate Ant Group’s Hong Kong listing was abruptly pulled.) Another reason is that some of the largest Chinese firms have delisted or begun a process of delisting from the US and relisting in Hong Kong.
Beijing recently undertook a “screening” process to decide which Chinese companies it does not want to be subject to PCAOB audits. There are 248 Chinese companies with a market value of around US$1.05 trillion ($1.48 trillion) that are still listed in New York. Earlier this year, the CSRC modified its overseas listing regulations, which now require firms currently listed overseas or planning a foreign listing to inform local regulators what information they would need to provide to foreign regulators. If a company is unsure whether certain information would be considered sensitive, it should ask the government.
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Last month, five SOEs with US ADRs, oil giant Sinopec and China Life Insurance, Aluminium Corporation of China (Chalco), PetroChina and Sinopec Shanghai Petrochemical Co, a subsidiary of the oil giant, said they would voluntary delist from the US while maintaining their Hong Kong and mainland China listings. That announcement was seen as a prelude to a deal being struck as those five companies do have sensitive information that could be seen in an audit review by US auditors or regulators.
Holding Foreign Companies Accountable Act or HFCAA has been a big sword hanging over the heads of Chinese firms listed in the US. Although firms like Alibaba, search behemoth Baidu and others have their accounts audited by one of the Big Four global auditors — PwC, KPMG, Ernst & Young and Deloitte — the real grunt work is actually done by their local joint venture partners in China. So, mainland Chinese audit teams from those accounting affiliates would now travel to Hong Kong to answer questions from PCAOB investigators and auditors.
But just because Chinese regulators have been dragging their feet over PCAOB audits does not mean all Chinese firms with ADRs listed in New York were unwilling to undergo scrutiny. Maggie Wu, chief financial officer of Alibaba, in an earnings call in May 2020 said that her firm’s “financial statements are prepared in accordance with US GAAP, and since inception in 1999, have been audited by PwC Hong Kong, the local affiliate of the worldwide firm, and its auditing standards are overseen by the PwC national office in the United States”. Alibaba, she noted, has filed with the SEC since 2014 and holds itself to the high standards of transparency like any other company listed on the New York Stock Exchange, local or foreign.
The other front where US and China are battling it out is technology. I wrote about the US-China Chip War some weeks ago including the US ban on the sale of sophisticated equipment used to make high-end chips to China. Washington also recently took a page from Beijing’s playbook and began helping US semiconductors firms like Intel, GlobalFoundries and Micron to invest in manufacturing facilities in America to reduce help reduce reliance on foreign-made chips. Last week, the Biden White House approved the ban on the sale of advanced graphic chips made by Nvidia and Advanced Micro Devices or AMD to China. Graphic chips are used in artificial intelligence (AI) and robotics. Nvidia chipset that was banned last week can also be used for autonomous driving. The chipsets are essentially advanced processors that can be used with sophisticated algorithms developed by deep learning and have military applications.
Washington wants to rein in China’s ability to advance in AI and prevent Beijing from accessing advanced US technology and American capital that can help its main adversary advance in technology that can be used to strengthen its military capabilities. Aside from high-end graphic chips from Nvidia and AMD that it has banned, the US reportedly wants to deny China access to Electronic Design Automation (EDA), a category of sophisticated software tools for designing integrated circuits and printed circuit boards; as well as Single Pair Ethernet (SPE), a network implementation that uses a unique physical layer transceiver over a single pair of wires; and facial recognition technology.
Over the past year, Washington has identified 68 Chinese firms that it says are part of the Chinese military-industrial complex which helps Beijing advance its military ambitions. Among them are SenseTime, which was listed in Hong Kong last late December and develops facial recognition and image recognition software, and Shenzen-listed DJI Technology Co, the world’s largest maker of drones. In the aftermath of US House Speaker Nancy Pelosi’s visit to Taipei last month, China deployed DJI drones over Taiwanese airspace.
On Sept 6, President Xi Jinping in a speech at the 27th meeting of the Central Commission for Comprehensively Deepening Reform called on the country to redouble efforts to localise the production of key technologies — particularly advanced semiconductors as well as chip equipment — two areas where China lags Western nations and has a lot of catching up to do. Replacing Nvidia’s highend graphic chips will not be easy. Nvidia is a chip design house. Even if China could design graphics chips that are as good as Nvidia’s, it will not be able to manufacture them because Taiwan Semiconductor Manufacturing (TSMC) is the only foundry or customised chip maker that has the capability of making them. A Chinese foundry trying to replicate TSMC would need extreme ultraviolet lithography equipment from a company like ASML of the Netherlands.
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Why are simmering financial and tech wars suddenly on the front burner? For one thing, the US is a democracy and in eight weeks Americans will vote in one of the most crucial mid-term elections in history. If the Republicans win control of the House of Representatives, which they are currently poised to, and the control of the Senate where the race with the Democrats is still very tight is passed on as well, former President Trump is likely to have the upper hand in the next Presidential election in 2024 against the incumbent President Joe Biden who narrowly defeated him two years ago.
Whatever happens in November mid-terms, American and Chinese leaders urgently need to de-escalate tensions to prevent the tech and financial cold war from blowing into something more serious or a point from where it would be difficult to turn back.
Assif Shameen is a technology and business writer based in North America
