US-China audit deal is reached
· China and US regulators announced last Friday that they signed a Statement of Protocol that would allow US regulators to inspect the audit papers of US-listed Chinese companies.
· The US regulators can now conduct on-site inspection which is likely to start in mid-September and conclude by December. While there is still uncertainty regarding the details of inspection such as the different interpretations from both sides’ regulators as well as the final inspection results, the audit agreement is at least a major step forward to alleviate the China ADR delisting risk.
· Global asset allocators have been underweight China equities amid the overhang of the audit dispute. For example, global institutional investors’ holdings of the Top 30 China ADRs is the lowest in 3 years. The deal provides a long-awaited catalyst for investors to increase China exposure (or cover their short positions), especially on the ADRs and Hong Kong-listed tech names, which are at very depressed valuation levels.
· With the reduction of the tail risk of delisting, coupled with the recently announced rate cuts and RMB 1 trillion (USD 145bn) stimulus, we could see relative outperformance of China shares in the short term when the US market is adjusting to a hawkish Jackson Hole speech from Fed Chair Powell.
· Further upside potential of China market still hinges on the volatility of the global market and the Mainland’s growth outlook which for now remains sluggish. We believe (1) further post-covid re-opening, (2) increasing easing support, (3) signs of stabilization in the property market, and (4) positive progress of the audit inspection are the key factors for a more sustained outperformance of China equities.