EPISODE 4

Leyla Gulen (00.00):

Hello and welcome. I'm Leyla Gulen. I'm the co-host of Quantitative Investment Insights presented by Greenwich Quantitative Research. Greenwich Quantitative Research is an Asia Pacific market neutral quant fund. In this episode, Gene Reilly, the Chief Investment Officer of Greenwich Quantitative Research is here with me to provide a timely update on DiDi, which was featured in Episode One of Quantitative Investment Insights. Well, DiDi is making headlines yet again. DiDi fell over 44% on Friday, March 11th on reports that it has stopped preparations for its listing in Hong Kong. As we discussed in episode one, DiDi became the subject of a regulatory investigation just days after its U.S. IPO last summer and announced its plans to de-list from the New York Stock Exchange in December. So what is driving DiDi's decision to halt its Hong Kong listing, Gene?

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Gene Reilly (00.56):

Leyla, thanks very much. Nice to speak to you today. And it's an important topic. Last year, the internet regulators required DiDi to overhaul the systems it uses to store user data. It's been reported that the regulators informed DiDi on Friday, March 11th, that their proposal to ensure data security and prevent data leaks were insufficient. We have no official reports from DiDi or from the Chinese regulators concerning the Hong Kong listing.

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Leyla Gulen (01.20):

Well apart from attempting to make its data storage systems compliant, what other actions did DiDi take to overcome regulatory concerns?

 

Gene Reilly (01.29):

As we mentioned in our Quantitative Investment Insight Episode One, DiDi announced plans to list in Hong Kong in 2021. It was believed that moving the listing closer to China would alleviate concerns about the leak of sensitive data overseas. In addition, DiDi considered redirecting user data collection to a third party Chinese firm and selling a stake to a state owned enterprise. We do not have clarity on the regulatory reaction and feedback to these additional considerations.

 

Leyla Gulen (01.59):

Well, are DiDi's apps still unavailable in domestic China app stores? I expect that DiDi's profits must be negatively impacted from the actions that it's been required to take since last summer.

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Gene Reilly (02.10):

DiDi was required to remove its main apps from local app stores last year, and they remain suspended. Existing DiDi users who were signed up before the apps were removed can continue to use DiDi. According to DiDi's third quarter earnings, DiDi extended its loss to 4.6 billion, 25% larger than the second quarter loss of 3.7 billion.

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Leyla Gulen (02.32):

Is DiDi one of the major ride sharing companies in China?

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Gene Reilly (02.35):

DiDi already had 90% share in China, at the time of its IPO there are two other major competitors, one is Meituan Dache and Alibaba's AutoNavi is the remaining competitor.

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Leyla Gulen (02.51):

Okay, well, what are the likely next steps for DiDi?

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Gene Reilly (02.54):

Chinese regulars haven't fully disclosed their regulatory agenda for the ride sharing space. The market reasonably assumes that the regulations will be formally applied to all the companies in the sector and therefore must be publicly communicated somehow. If DiDi is able to reach an understanding with the Chinese regulators, a Hong Kong listing is still probably the base case. According to reports, in addition to focusing on the internet regulation investigation, DiDi is continuing to work on its fourth quarter results, which are required for a listing perspective. Reports in the media have suggested that the investigation results may be announced in a few weeks. That would be the first step to establishing the tangible regulations that ride sharing companies need to adhere to.

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Leyla Gulen (03.38):

Well on Thursday, March 10th, one day before the DiDi news, the SEC named five Chinese companies that may be de-listed if they don't allow U.S. based accountants to audit their financials. China ADR indices were down approximately 30% days immediately following that announcement. Can you explain what's going on here?

 

Gene Reilly (03.58):

Leyla, that's a really important question and very much at the crux of issues around Chinese companies listed in the United States. This relates to the Holding Foreign Companies Accountable Act, which became law in December of 2020. The law requires the SEC to identify publicly traded foreign companies on U.S. exchanges that are not audited by U.S. auditors. The U.S. Public Company Accounting Oversight Board announced in March, 2021, that it lacked audits of more than 200 of the 250 Chinese companies listed in the United States. This is the first time the SEC identified specific companies since the law went into effect. The act also permits the SEC to ban foreign companies from trading and ultimately de-list them from U.S. exchanges if U.S. auditors are unable to audit requested reports for three consecutive years.

 

Leyla Gulen (04.49):

Why is this proving to be such a contentious issue in the markets right now?

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Gene Reilly (04.53):

That's the key issue. DiDi was the catalyst for investors to focus on the consequences of these regulatory issues. The HFCAA legislation refers to companies that use the ADR structure to raise money from U.S. investors and is focused on providing reliable financials to protect U.S. retail and institutional investors. The Chinese regulatory concern around DiDi's listing clarified that China had policy objections to U.S. auditors auditing certain Chinese companies, which were in strategic industries or had extensive data on Chinese individuals. This will continue to be a potential source of market volatility until an agreement can be reached to resolve the conflict between U.S. regulators and Chinese officials. U.S. regulators require foreign companies that raise money in the United States to be subject to U.S. audit. But China is concerned about having U.S. auditors inspect companies that are deemed to be strategically important in China.

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Leyla Gulen (05.52):

You've referenced a number of separate news stories concerning China that are weighing on investors' risk appetite. Can you provide some specific examples?

 

Gene Reilly (06.01):

Sure. There are a number of significant geopolitical tensions that our investors are well aware of. In addition, the zero COVID policy, China is experiencing the worst outbreak since the inception of COVID, with many cities, including Shenzhen being locked down, further lockdowns have occurred in Shanghai. COVID cases in Hong Kong are also at high levels. Finally, investors are concerned that regulatory tightening is resurfacing again. For example, there have been further delays in approval of some online games and online delivery platforms. Also the Chinese authorities are requiring state owned enterprises to report their exposure to the ANT Group.

 

Leyla Gulen (06.43):

When might we see Chinese companies that have been identified by the SEC actually getting de-listed?

 

Gene Reilly (06.49):

Our base case is that there'll be an agreement between the U.S. and Chinese regulators on this issue. If it's not resolved, it could force de-listings in the first half of 2024. Congress recently passed a bill to shorten the non-inspection period to two years and it's awaiting President Biden's signature. Consequently, the timeframe could advance to some time in 2023.

 

Leyla Gulen (07.10):

Are the discussions with the U.S. and China moving closer towards resolving the regulatory disconnections between the two sides?

 

Gene Reilly (07.17):

Yes, Vice Premier Liu He made official statements in mid-March aimed at reassuring markets, including comments that they were supportive of Chinese companies listing overseas. The statements were short on tangible details in terms of resolving the audit issue. He did make reference to progress on establishing a framework for resolving the audit issue. However, there really weren't any concrete details. It does seem that the Chinese would like to maintain access to U.S. capital markets for equity listings. So the expectation is that some reasonable compromise will be reached on this issue.

 

Leyla Gulen (07.54):

Yeah. How did Chinese stocks react to China's market reassurances?

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Gene Reilly (07.57):

In the U.S., the Chinese ADR indices essentially rebounded approximately 30% and almost recovered the entire loss from the three day sell off. Although there was no news on DiDi, DiDi also rebounded from a low of a $1.76 to a high of $4.16, right after the statements.

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Leyla Gulen (08.16):

Yeah. Does this shed any light on the potential solutions being discussed?

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Gene Reilly (08.21):

In context of user data, the discussion of moving sensitive user data out of the corporate entity that would be subject to U.S. audit to a third party company that would not be subject to U.S. audit could potentially solve the issue. We'll see in coming days.

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Leyla Gulen (08.38):

Yeah. Well, it has been really instructive to get a timely update on DiDi's story. Thank you so much, Gene. Well, that's all the time that we have for now. I'd like to thank you, our listeners and I look forward to covering more topics in the future. We will see you soon.

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