Author: Michael B. Greenwald
In the post-9/11 era, Washington has waged innovative campaigns against terrorism finance, sanctions evasion, and money laundering. Leveraging America’s heavyweight status in the international financial system, the United States Treasury has isolated and bankrupted rogue regimes, global terrorists, and their enablers. As financial technology transforms global business, the traditional financial system faces new competition across a suite of offerings, ranging from brokerage services to peer to peer lending. In no area is this clearer than in mobile payments, where a global hegemon lies ready to exercise its weight, and it is not the United States.
Chinese Fintech Landscape
That hegemon is China, which has seen its tech giants, Alibaba and Tencent, transform the mobile payments landscape in China. With a lack of a sophisticated credit card market and an undeveloped consumer banking system, both firms’ platforms have experienced explosive growth, far outpacing their peers in OECD countries. Today, Alibaba’s financial subsidiary, Ant Financial, commands a higher valuation than Goldman Sachs: the image of American financial hegemony, while managing the world’s largest money market fund, Yu’e Bao.
Mirroring this trend, Tencent’s money market fund, Licaitong, has seen its assets triple in the past three years. This growth has been powered by its messaging app, WeChat, which enables consumers to perform activities, ranging from ordering groceries to scheduling dental appointments, in addition to normal social media functions. Earlier this year, its mobile payments subsidiary, TenPay, exceeded Alipay’s in terms of monthly active users, powered by the growing market for electronic wallets.
Chinese Equity Listings in the United States
With the emergence of these new players on the global arena, the United States’ economic statecraft has to grapple with the inevitable prospect of competition. How can the US effectively ensure that a Tencent or Alibaba is preventing terrorists listed under US sanctions from accessing their payments? In essence, how can the US pressure platforms that exist outside of US jurisdiction?
Despite being publicly traded firms, neither Alibaba nor Tencent have mainland listings on either the Shanghai or Shenzhen stock exchanges. Alibaba’s stock is listed in New York, with its 2014 IPO ranked as the largest in the NYSE’s history, while Tencent is listed in Hong Kong, with a planned listing of its subsidiary, Tencent Music, slated for later this week. Other Chinese tech giants, like Baidu and JD.Com, as well as dynamic startups, like Qutoutiao and Nio, have listings in New York as well.
The underdeveloped characteristics of China’s mainland equity markets have been frequently highlighted. The dominance of these markets by retail investors, rather than by institutions, has contributed to significant bouts of volatility. IPO backlogs on these markets are massive, attributable to the government’s strict regulation, ostensibly to protect the interests of investors. Trading halts are frequently overused and abused by firms, reducing market efficiency and concerning global investors, like MSCI and FTSE Russell, about allowing Chinese stocks into major benchmark indices.
Even New York’s closest rival, Hong Kong, lags behind in a number of key characteristics, despite its status as a hub for doing business in Asia. Reeling from its defeat for the Alibaba IPO, the exchange recently adjusted its rules to permit dual class shares, which are popular in public tech firms. Though Hong Kong attracted large names in 2018, like Xiaomi and Meituan, its strict vetting procedures have placed it at a disadvantage to its peers. Hong Kong’s investors also have a noted preference for firms operating with stable cash flows, in contrast to the many loss-generating startups operating in the New Economy.
Despite lower name recognition in New York, its market offer outstanding liquidity and high valuations for Chinese firms seeking to list abroad. In addition, many Chinese exchanges feature strict rules regarding profitability, mandating a firm be profitable prior to its listing, while New York has been much more accommodative, with Amazon being a prime example of this. With so many comparable tech giants already listed in New York, many Chinese firms have come to view it as a better listing location for this reason alone. Though worthy of attention, Hong Kong’s regulatory changes are simply too little, too late, to alter the calculus of many Chinese firms.
Simply put, American markets, in contrast to their peers in mainland China or Hong Kong, enjoy the marriage of mature financial infrastructure with sufficient liquidity. With Hong Kong having captured Meituan and Xiaomi this year, New York has been able to capitalize on a number of smaller listings, like that of Tencent Music. Moving forward, the observed affinity for American listings among Chinese tech firms creates a powerful asymmetric opportunity for policymakers seeking to address matters of sanctions enforcement.
USD Exposures
In the aftermath of the Russian annexation of Crimea, the United States targeted a number of key Russian firms with a combination of debt and equity restrictions. Realizing that a number of Russian firms relied on steady refinancing from the American and European debt markets, all debt with a maturity above 90 days became barred to Western investors. With these new Chinese tech platforms, it could be the case that major deals are transiting global waters, conducted completely over these messaging channels, and nobody is out there to listen.
To win their compliance in future sanctions regimes, these listings offer prime leverage for American policymakers. The threat of a delisting, typically only used in law enforcement against criminally-charged companies, could be an effective psychological tool to encourage Chinese CEOs to adopt American risk management and compliance standards. At the same time, should these hard conversations not be effective, Washington should be ready to up the ante by targeting the personal assets of Chinese entrepreneurs, including their stock portfolios and American assets, in a bid to force the hand of senior management. Should this move be either ineffective or ignored, the United States could then explore the possibility of a debt/equity restriction, or even a full delisting, if the threat is great enough to warrant such extreme action. These measures would have a significant impact on Chinese firms, who would likely comply long before negotiations reached that stage.
It should be noted that Beijing has not ignored this asymmetric advantage in the hands of Washington. Earlier this year, the country’s regulators established the landmark China Denominated Receipt (CDR) program, which would enable Chinese firms listed abroad to establish listings on the mainland. However, this initiative has had a lackluster performance since initial enthusiasm in the Spring.
These relate to a number of key issues within the initiative, the first being convertibility. A denominated receipt would be redeemable for shares of the stock, but not trade the underlying shares themselves. Should a Chinese investor seek to redeem dollar-denominated shares of Alibaba or Baidu, it is a much more contentious debate of whether they will receive those shares than if they were receiving them in New York or in London. Should China’s securities regulatory agency, the CSRC, not allow for convertibility, large and volatile valuation gaps between CDRs and their foreign-listed shares could emerge, damaging market efficiency. More broadly, a CDR would also be more challenging in the long run, as secondary share offerings are much harder to execute in mainland markets than in New York. Beijing requires regulatory approval for all new share offerings, whereas a secondary share offering in other markets is typically more lax, requiring solely a mandate from investors at an annual meeting.
Xiaomi presents an effective case study in analyzing the potential downsides of the CDR market. Originally having targeted a $10 billion fundraise between its Hong Kong IPO and a mainland CDR listing, Xiaomi suddenly placed its CDR plans on hold. This was likely due to a combination of bearish market sentiment, strict vetting criteria in mainland markets, and the lack of finalized rules on convertibility. As it stands right now, HSBC may, in fact, be the first firm to tap the CDR market, allowing it to access mainland investors through the Shanghai-London Stock Connect.
With this episode aside, it is likely that the Chinese will try to challenge American financial supremacy by leveraging the combination of their sizable capital markets and advanced financial technology. However, by effectively utilizing the USD’s role as a global reserve currency, the attractive liquidity of American markets, and the broader economic links between New York and Shanghai, Washington can build effective sanctions regimes in the future that account for these new trends.
Michael B. Greenwald is a Fellow at Harvard Kennedy School Belfer Center. He is Deputy Executive Director at The Trilateral Commission, the Senior Advisor to the Atlantic Council CEO and Adjunct Professor at Boston University. From 2015-2017, he served as the US Treasury Attaché to Qatar and Kuwait. He previously held counterterrorism and intelligence roles for the US government.
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