Inspection Rights / Regulatory Risk Discussion Thread
This thread's a response to one of @casey's posts; in its wisdom, Yahoo won't let me include a LINK to it, but it essentially discussed casey's near term outlook on the SEC/PRC discussions on Inspection Rights.
Casey, you outlined two potential tracks for the next six months: either the Chinese SEC gets its act together and behaves like a grown up or else the SEC delists many China stocks, and they split and re-list back home.
1. The China Grows Up Option.
On the first option, by getting their act together, do you mean that the CSRC will reach a compromise with the SEC on Inspection Rights, or do you mean more specifically that it will internally improve its own regulatory standards to a level approximately equal to that of the SEC's? If the latter, don't the winds in Beijing seem to be blowing the other way? I view the recent decision banning investor (or potential investor) access to SAIC filings without express company permission as a step backward in transparency; do you have a different take on that?
On the other hand, if you mean the grown up behavior we can hope for is that the CSRC might "allow" the SEC to "intrude" into Chinese affairs enough to have real Inspection Rights over US listed China stocks, then, like you, I've got my fingers crossed hoping for the best, but expecting the worst.
My go-to guy for all things Chinese accounting is Professor Paul Gillis (if you Google it, I suspect you'll find his blog informative), but, unfortunately, he's recently lowered his estimate of a happy outcome for the current SEC/PRC Inspection Rights negotiations to a crummy 10%. Hopefully, at worst, we'll get an extension of time, what he calls the "Kicking the Can Down the Road" solution, but those two aren't the only two possible outcomes:
2. The China Stock Delisting Option.
Let's hope it never comes to this, at least not an involuntary version of it, but if XIN did ever opt to pull out of the US capital markets, why would you expect the market to price in a lower fraud risk once it relisted in HK or Shanghai than it does now? Wouldn't the market be more likely to view fraud as easier to get away with if it's just XIN vs the CSRC, rather than XIN vs the SEC? I don't mean to sound jingoistic here, but I personally have some doubts about the CSRC's effectiveness -- possibly even its WILLINGNESS -- to be vigilant about fighting fraud in Chinese companies' reporting.
I fear that Chinese regulation might only be "regulation." Don't you?
3. A Couple Quick Words on XIN Pricing Model.
If you've got time, I'd love to hear your take on the pricing model that TT and I put together a few months ago. I can't post a LINK, but I bumped forward a thread that does have a LINK in it. Click into the first post of a thread called "Reconstructed Pricing Model Thread #3"
I looked at the model. Thank you, good work. I think your 62 % is a tad high. The beta is 1.4 for the company and 1.52 for the industry. The TTM P/E is 1.36 company and 36.58 industry. That would make the price $ 75.87. The price/book is .31 company 3.35 The price is 30.47, That is a discount of 40.2 %. I am not sure what else would be in the discount from market to book?
Dr. Gillis is great. Who I am to disagree with a professor at the prestigious Peking University and former partner at PWC?
As Dr. Gillis would agree, we are both just laowai. We do not know and are just looking at tealeaves. He looks at the tealeaves and says there is a 10 % chance the Chinese agree to PCAOB oversight of the auditing firms in China. I look at the tealeaves and say there is over a 50 % chance. He thinks that the Chinese will do what the Chinese love to do when not everything is perfectly in their favor, wait for another day. I think the SEC and the Big 4 will not let it go that far. Those are some powerful players and they will be losing money in China until this issue is resolved. They will bring in the politicians to get the job done. Dr. Gillis pedigree exceeds mine both in accounting and Chinese business. I have a self-interest, as I have money in play, while we do not know Dr. Gillis’s proclivities.
CRSC, the Shenzhen, and Shanghai exchanges are far away from being able to handle even one of the NYSE listed Chinese companies. For example, one day of trading China Mobile would shut down the Chinese financial markets for months. The Chinese being grown up enough to bear the yoke of a modern financial market is impossible. It is just not a regulatory issue. It is also an infrastructure issue. It just does not exist in China and cannot be purchased. It has to be homegrown or imported there are no other options. Imported would be repugnant to the Chinese people. Homegrown is a multi-generational project.
A couple huge steps would have to be completed before that China could consider a modern financial market. The RMB would have to become a reserve currency. An actively traded yuan is one of the few things that scare Chinese. The banks would have to be privatized. This is more a political than an economic question. The politics are complicated. I believe that a generation will have to pass in China for it to occur. I believe once the Chinese work through all those issues, they will concluded what everyone else has concluded it is much better to stick with the establish markets. However, this will be done on China’s timeline, perhaps 50 years.
I believe that the Chinese will allow US regulators sufficient oversight of audit firms and listed companies before the end of the year.
If the SEC cannot perform it mandated duty, regulating the United States financial markets, then it has no choice. It has to deregister all the Mainland CPA firms. The political fallout of a Chinese listed company melting down next audit season would be too much to bear. No listed companies can obtain an audit and delisting will follow quickly. The companies will not wait to be delisted the ex-Big 4 Mainland firms will help them list in Hong Kong.
Hong Kong is China, granted, a weird hybrid of China but China. They have designated officials within every China’s government agency with marching order from Beijing to make it work. They also have public promises from the Premier on the business independence of Hong Kong. Most importantly, they have a population that is willingly to actively protest intrusions by Beijing in Hong Kong’s economic activity. There a couple places WWIII could start. Hong Kong is one. There is nothing more intimidating than a Chinese, who is determined to stand his ground. Hong Kong has the will and the expertise to force the Chinese companies to comply. The market will value risk differently in Hong Kong.
There is two cases to watch on how this plays out, Longtop and Standard Water. As I feel it will get resolved by the end of the year, I think the Longtop case is more important of the two. The Standard Water case has a longer history, they delisted in Hong Kong in 2010, than Longtop, trading suspended in 2011, but the SEC has moved quicker. The SFC has only escalated Standard Water to an up or down decision in the last couple of weeks. The SEC has some specific deadlines tied to the end of the year and the MOF May 2012 regulations have to be dealt with before December. The resolution of Longtop will tell the tail. If the SEC is not satisfied, then how Standard Water resolves is the bell weather case for Hong Kong.
The difference between Dr. Gillis’ and my assessment might be location. He is in northern China far removed from the influences of Shanghai and Hong Kong. I am in southern China where the activities of Shanghai and Hong Kong are immediately felt. If the Chinese acknowledge this difference, high noses should also.