With a population of more than 1.4 billion, China is the world’s largest consumer market in purchasing power parity terms (taking into account the price differences among countries). It’s no wonder why international companies try to get a piece of the pie.

But doing business in China means playing by the rules of the Chinese Communist Party (CCP). High-profile businesses accused of bending the knee to the CCP include the NBA and Hollywood.

Some investors eschew Chinese stocks for environmental, social, and governance (ESG) reasons, or they just don’t want to invest in anything in a country ruled by the CCP. For the other investors who don’t mind investing in Chinese equities, there are special risks beyond the normal risks associated with investing in companies.

Some Hurdles to Overcome

For one, fairly or unfairly, Chinese stocks have been under suspicion of the F word: fraud. A number of Chinese companies previously trading in the U.S. have been shown to have lied in their accounting. However, those tended to be relatively smaller companies, not the mega-cap companies on most American investors’ radar.

Secondly, it’s no secret that the U.S. and China are geopolitical rivals and China is arguably the most serious threat to U.S. hegemony ever, especially when its economic might is considered. Washington will continue to seek ways to counterbalance Beijing.

A major strategic line of attack for the U.S. has been to target China’s semiconductor industry, to prevent advanced chip technology from falling into Chinese hands and to try to stymie its internal development of the semiconductor industry.

Washington has also taken a harder stance to make Chinese companies whose stocks trade on U.S. exchanges abide by U.S. rules.

About two years ago, the U.S. passed the Holding Foreign Companies Accountable Act of 2020 (HFCAA), which requires U.S.-listed Chinese companies to open up their audits for inspection. Failure to comply for three straight years would result in delisting. The obstacle to inspection is that the Chinese government forbade its companies from complying, citing national security concerns. This meant that the cloud of potential delisting has overhung Chinese stocks.

Pressure from Their Own Government

Making matters even worse for Chinese stocks, they came under pressure from the Chinese government. The CCP decided that homegrown giant tech conglomerates had become too powerful and cracked down on them. One main casualty was Alibaba (NYSE: BABA), whose share price went from over $300 at its peak 2020 to around $60 in under two years.

Notice you don’t see or hear much of Jack Ma (formerly high-profile Alibaba co-founder) in public anymore? This is because he ruffled feathers in the CCP with his outspokenness and now he’s wisely keeping a very low profile to stay out of trouble.

To show Ma who’s boss, Beijing blocked the highly anticipated Ant Group initial public offering (IPO) at the last minute. Since Alibaba owns about a third of Ant, this was another strike against the stock. The CCP even forced Jack Ma to give up most of his voting rights, which effectively relinquished his control of Ant. Indeed, in China if you get in the CCP’s doghouse, life will be very difficult.

Besides the government more stringent regulation, Covid also caused Beijing to impose draconian lockdowns, which slowed the economy and further hurt the Chinese market. Indeed, the last two years have not been kind to Chinese stocks.

2023 Looking Better

But things are looking better lately. In response to protests, Beijing rolled back its zero-Covid policy and reopened its economy, even loosening control over international travel for the first time since the pandemic outbreak. Furthermore, to stimulate the economy, the top Chinese financial regulator has stated that the central bank will support private companies to drive economic recovery. He even suggested that crackdown on homegrown tech companies will ease.

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Further good developments: China has relented and agreed to allow foreign regulators to examine its companies’ audits. The Public Company Accounting Oversight Board recently announced that it was able to conduct full audits on eight Chinese U.S.-listed companies and expects to conduct more examinations going forward. Compliance with the HFCAA greatly reduces delisting risk.

All these positive trends have led to a strong rally in Chinese stocks in recent weeks, and suggests they may have their first positive year since 2020.

There are still risks, however. For example, the economic reopening may not go smoothly if COVID hits the population especially hard. Also, while Beijing appears to be easing its crackdown, Washington could still find ways to target Chinese companies and their stocks.

If you wish to invest in Chinese stocks, it’s worthwhile to check with your broker to see the cost and availability of the Hong Kong-listed shares. If the cost is too prohibitive, then the U.S. shares are acceptable.

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