Hong Kong: Brace for incoming!

Hong Kong moved up a geopolitical level this week. It is no longer only the front line of an ideological war between China and the West; it is also where the two sides are set to fight their fiercest battles in the Great Financial Decoupling to come.

It might be said that conflict between the Treasuries of the two superpowers has been under way for some time. Sanctions imposed last year by the United States against some of Hong Kong’s and China’s top officials shook the city’s financial institutions. And who can forget former U.S. president Donald Trump’s saber rattling throughout four fraught years, which led to speculation the Hong Kong dollar might be cut off from the global financial system. Yet what makes the likelihood of real, protracted financial conflict more likely now is the Chinese government’s action against the country’s dominant ride-hailing app, Didi Chuxing; what that action means for Chinese listings on stock exchanges in New York and Hong Kong; and the likely U.S. reaction.

The Didi saga might appear similar to what happened to Ant Financial, only this time, the IPO of a colossal tech company was knee-capped days after the fact, rather than days before. Didi will recover, of course, as will Ant (which will likely list later this year), but the confidence of foreign investors in China’s tech sector will surely take longer to bounce back. This is especially as the central government is apparently considering whether to vet (read: block) all further IPOs by Chinese companies on overseas exchanges — at least, by those using the so-called Variable Interest Entity structure. (Which are the only ones worth buying.) Yet what makes Didi different from Ant, besides that the drama is playing out in New York, is that it appears to be part of a broader effort by Beijing to end not only a litany of monopolistic abuses by its tech giants, but also the access that foreigners might have to their data. And even that, it could be said, is part of a broader effort by China’s paramount leader, as enunciated in his Mao suit atop the Tiananmen Gate last week, to force the U.S. to accept that it has an equal in the world.

This is about more than face. The rug pulling from under Didi appears to have set in motion — or come amid, depending on one’s view — a chain of events that will likely make it impossible for Chinese companies to stay on U.S. exchanges for much longer. Next week, the Public Company Accounting Oversight Board (PCAOB) will issue a ruling on all Chinese companies listed in the U.S. that have not yet submitted to its auditing oversight. This is likely to result in a stampede from New York to Hong Kong of Chinese companies. Any that might previously have had a moment’s pause to ponder the rock or the hard place will undoubtedly have been given clarity by President Xí Jìnpíng’s 习近平 July 1 speech.

The more important question is whether their departure is going to be acceptable to Uncle Sam, or whether the SEC and the Treasury Department will be hard on their heels. This ruling has been eagerly anticipated by both sides of Congress for six months, since the Holding Foreign Companies Accountable Act was passed on December 18 last year. A tough line might be enough to pacify the laziest representative or senator, but there are probably going to be voices among them who bay for further reckoning if, as expected, the targets of their ire flee to Hong Kong.

It might also be said that this conflict has been brewing for a while. The Chinese side could rightly claim that the U.S. has been threatening to kick its companies off the New York stock exchanges since before President Joe Biden took office; the U.S. could retort that these companies have been in breach of their commitment to PCAOB audit oversight since President Xi took office in 2013. The trigger for the latest conflict is an important escalation, however. The idea that it’s all about protecting sensitive data, such as how many rides the Ministry of Public Security booked via the Didi app, is laughable. (The NSA has far more sophisticated monitoring tools, people.) Rather, this is part of an ideological struggle about asserting China’s right to manage what its companies do around the world in the same way that the U.S. does. It took Xi’s CCP 100th anniversary speech to make this a no-going-back moment. What happens next in New York and Washington is far more important to the Party, and to its leader seeking a Mao-like third term in October next year. This is fundamentally different from the Ant case, which was a domestic kerfuffle. It is about putting Xi’s July 1 gauntlet throwdown into effect.

The harder question is what might come next. Will the U.S., as the (self-appointed) manager of the global financial system, accept that companies in which American teachers’ pension funds are invested can skip across the pond to Hong Kong rather than having to cough up their financial audits as required by the PCAOB? Will American regulators continue to accept that the HKSE is run like a Chinese stock exchange, full of companies that do not meet global auditing standards, yet sucking in Ray Dalio and others nevertheless? Or will they seek to assert Washington’s primacy over the choke point for those flows of global capital, via the local currency’s link to the U.S. dollar?

How this crisis point was reached so quickly is the easy part. To understand the Chinese perspective, read Xinhua and Global Times analyses of the state of U.S.-China relations. The American perspective can be read in the Washington Post or New York Times. For hard evidence of the two sides’ incompatibility, look back to the trade deal inked at the start of China’s sixth millennium — its accession to the WTO in 2001 — and count the number of years it took before the reform pain forced onto 60 million SOE workers began to show up in social unrest statistics. By 2006, it was obviously enough to affect the next-generation leadership transition, as a relatively bland outsider, a compromise candidate between Bó Xīlái 薄熙来 and Wāng Yáng 汪洋, who were running contrasting governance models in Chongqing and Guangzhou, respectively, was pushed forward for a position on the Standing Committee of the Politburo. Xi Jinping took the VP seat in 2007, but the five years until his ascension to the top job in 2012 were the closest China has come to civil war since the party’s 1949 triumph.  

This is not a personality story: Once the backlash against WTO-related SOE reforms reached fever pitch, the Party clearly realized it could not achieve its founding mission while continuing to play by the rules of globalization as set by the G7. It should have surprised no one, therefore, that when Xi took office, he almost immediately decided Chinese companies no longer needed to cooperate with the PCAOB. That it took the SEC and White House so long to respond is testament to how distracted the entire U.S. leadership was by Iraq and Afghanistan, followed by the GFC. But they are fully focused now, as “Asia Czar” Kurt Campbell has let it be known.

There is, theoretically, plenty of middle ground for the two sides to reach an understanding on. It should be easy to accept that Chinese bureaucrats are right to get their tech firms to reform their monopolistic ways. China is doing what the U.S. should have been doing a decade ago with its own tech titans. However, bureaucrats are not making the bigger decisions. Just as it wasn’t a bureaucrat who yanked the Ant IPO, it surely won’t be one who decides to end the VIE loophole. Similarly, declaring Chinese companies in violation of their U.S. listing status might be the SEC’s call, but it hasn’t made that call since 2013 for a reason. Ideologues are hands on now, on both sides.

Can they find restraint? Will their people allow them to? The smart money must start to accept that the more likely answer is no.

Some investors will disagree and buy the dip, believing that what is happening here is nothing more than bureaucrats whittling the Chinese tech giants into manageable shape, and that China is still a growth story worth investing in. Others will say that the two sides will surely come to their senses because both have too much to lose. Yet others will point to the power of financial lobbyists in Washington, who will see to it that regulators maintain the status quo.

To hold such assurances would require looking past what China’s history suggests is more likely to happen. When the CCP was founded a century ago, its headquarters in Shanghai was surrounded by the kings of global finance, much like those who are working from home in Hong Kong today. Thirty years later, they were all gone. Since then, the CCP has only once made a decision against its own interests to lure them back, which led to regime-threatening instability. It is unlikely to do so again. From here on out, the global financial community is likely going to have to accept investing in Chinese companies on China’s terms, or not at all.  

It is hard to be sanguine about the U.S. side, too. Xinjiang has become like Jerusalem was to the Crusaders in 1099. The Biden administration added more Chinese names to the Entity List today. Could defiance on Chinese NYSE listings be allowed to go unpunished much longer? And once engaged, which U.S. president could survive at the polls if Fox News decided to take up the cause of U.S. pensioners being exposed to the CCP’s clutches on the HKSE?

Not to sound overly melodramatic, but the Great Financial Decoupling is on its way. It’s time for Hong Kong to brace for impact.