Traders work during the IPO for Chinese ride-hailing company Didi Global Inc on the New York Stock Exchange (NYSE) floor in New York City, U.S., June 30, 2021.

Brendan McDermid | Reuters

BEIJING — Investors may have to think twice about whether to bet on Chinese tech start-ups as new regulations are imposed on mainland companies looking to go public in the U.S.

If listing in Hong Kong becomes the only viable option, fund managers will likely need to rethink their investment strategies, as there are practical differences with how New York stock exchanges handle initial public offerings.

Since the summer, both China and the U.S. have raised the bar for Chinese companies wanting to trade in New York.

Not only investors are affected. Chinese companies looking to raise capital face greater uncertainty about their path to listing on public stock markets, and possibly lower valuations too, analysts said.

Beijing’s actions have more imminent consequences. From Feb. 15, the increasingly powerful Cyberspace Administration of China will officially require data security reviews for certain companies before they are allowed to list abroad.

Putting aside the technical complexities of why and how Chinese companies have worked with foreign institutional investors to list in the U.S., the new regulations could mean that similar IPOs in the future will likely need to go to Hong Kong.

For tech companies, that could mean lower valuations than if they listed in New York, said Richard Chen, managing director with Alvarez & Marsal’s Transaction Advisory Group in Asia.

He said a market familiar with Silicon Valley could put a higher price on a tech company’s growth potential, versus Hong Kong’s greater focus on profitability and familiarity with business models for companies operating physical stores or working in fields such as semiconductors and precision engineering.

With new Chinese regulations, Chen said his clients — mostly traditional private equity firms — are looking more at traditional industrial companies and businesses that sell to other businesses, or sell to consumers without relying much on technology.

“That’s what our clients are taking a think about: ‘Does it make sense to look at those sectors if ultimately it will be a challenge to list in the U.S. given the regulatory concerns?'” Chen said. He added that clients are also rethinking their investment strategies with consideration for whether their minimum goals for a return might be harder to achieve because a Hong Kong listing resulted in a lower valuation.

What it means for investors

Faced with the potential of lower returns — or inability to exit investments within a predictable timeframe — many investors in China are holding off on new bets. That is, if they can raise money for their funds to begin with.

Data from Preqin Pro shows a sharp drop-off in fundraising by U.S. dollar-denominated and yuan-denominated China-focused venture capital and private equity funds in the third and fourth quarters of 2021.

For U.S. dollar funds focused on early-stage Chinese start-ups, annual fundraising since the pandemic started in 2020 has fallen below $1 billion a year — that’s down from $2.43 billion in 2019 and $5.13 billion in 2018, according to Preqin.

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While start-ups may be looking for support, U.S. dollar-denominated funds focused on China have been sitting on capital. A measure of undeployed funds, known as dry powder, reached $45 billion in June 2021 — the highest level for at least 10 years, according to the latest Preqin data.

“Due to uncertainty over exiting, we slowed our pace of investment in the second half of last year,” Ming Liao, founding partner of Beijing-based Prospect Avenue Capital, said in Mandarin, according to a CNBC translation. The firm managed $500 million as of the summer and had previously expected to list some of its invested companies in the U.S. last year.

“Practically speaking, the U.S. is the best path of exit for Chinese internet and technology companies,” Liao said. “There’s high acceptance of new models and high tolerance for unprofitability, while liquidity is very good.”

Last year’s average daily turnover for stocks in Hong Kong, a measure of liquidity, was about 5.4% that of the Nasdaq and New York Stock Exchange in the U.S., according to a China Renaissance report earlier this month.

Even for large Chinese companies like Alibaba and, the average daily turnover of their Hong Kong-traded shares has been between 20% and 30% of those traded in New York, the report said. The analysts added that U.S.-listed Chinese companies typically price their secondary listing in Hong Kong at a discount.

Chinese IPOs in the U.S. were headed for a record year in 2021, until Chinese ride-hailing company Didi‘s listing in late June on the New York Stock Exchange drew Beijing’s attention. Within days, China’s cybersecurity regulator ordered Didi to suspend new user registrations and remove its app from app stores.

The move revealed the enormity of Chinese companies’ compliance risk within the country, and marked the beginning of an overhaul of the overseas IPO process.

Among several measures, the China Securities Regulatory Commission announced new draft rules in December that laid out specific requirements for filing for a listing abroad, and said the commission would respond to such requests within 20 working days of receiving all materials. The commission ended the public comment period on Jan. 23, without revealing an implementation date.

We expect this uncertainty to dampen investor sentiment, potentially depress valuations for Chinese IPOs in the US and make it more difficult for Chinese companies to raise funds overseas.

In remarks to reporters last week, Li Yang, chairman of the government-backed think tank National Institution for Finance and Development, described the new draft rules on Chinese IPOs overseas as bringing the country further in line with international standards on institutional investing.

Meanwhile, the U.S. Securities and Exchange Commission in December asked Chinese companies to disclose more details about their regulatory risks and ties to government backers. White House sanctions on certain Chinese companies like SenseTime briefly disrupted IPO plans.

Foreign financial institutions involved with Chinese IPOs face rising “commercial risks” of the invested company “becoming sanctioned because of its reputation with the U.S. government,” Nick Turner, a Hong Kong-based of counsel with law firm Steptoe & Johnson. “This is now one of the key areas of focus in the due diligence process before any IPO.”

What it means for start-ups looking to list

The path to an IPO in Greater China or elsewhere remains uncertain, even if prices are favorable.

“For (Chinese) companies applying for an overseas listing, they likely must wait for further clarification from regulators of both sides, and may expect stricter scrutiny, regulatory clearance, and pre-approval from different agencies and authorities,” the analysts said.

“The new rules may impose long waiting periods for companies hoping to list abroad,” the analysts said. “We expect this uncertainty to dampen investor sentiment, potentially depress valuations for Chinese IPOs in the US and make it more difficult for Chinese companies to raise funds overseas.”

After the high-profile suspension of Alibaba-affiliate Ant’s planned IPO in Hong Kong and Shanghai in late 2020, authorities also delayed the public listing of computer manufacturer Lenovo and Swiss seed company Syngenta on the mainland last year.

More than 140 companies have active filings for Hong Kong IPOs, according to the Hong Kong exchange website. An EY report showed the backlog of companies wanting to go public in the mainland or Hong Kong remained above 960 as of the end of 2021, little changed from June, before the latest regulatory scrutiny.

On the pre-IPO end, 12 Chinese companies joined the list of new unicorns — private companies valued at $1 billion or more — in the second half of last year, according to CB Insights. In contrast, India added 26 unicorns and the U.S. gained 148 unicorns during that time.

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