DiDi (Chinese name: 滴滴), a Chinese equivalent of Uber or Southeast Asia's Grab, went public on the New York Stock Exchange on June 30th, 2021, as the largest IPO of a Chinese company to go public on an American exchange since the IPO of Alibaba Group. However, two days later, the Cyberspace Administration of China announced that it will investigate DiDi regarding cyber safety concerns and suspended new user registration for the DiDi platform. In the following week, the Cyberspace Administration of China ordered all application stores to remove the main DiDi application and 25 other applications by DiDi due to "illegal collection and usage of personal information".
In this article, we summarize the key events following DiDi's IPO, as well as go through the underlying legal and political backdrop that explain how the DiDi incident actually pertains to a national security conflict between China and the US, rather than just a mere regulatory concern over privacy or cyber security.
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Background and Context
Formally speaking, DiDi's applications have been removed from application stores and DiDi is currently under investigation over privacy and cyber security concerns. However, we believe that the underlying issue is far more intricate than this, as it pertains to conflicting political and national security interests between China and the US.
Public Company Accounting Oversight Board (PCAOB) Requirements
Registered accounting firms that issue audit reports for publicly listed companies in the US are required to be inspected by the Public Company Accounting Oversight Board (PCAOB), a non-profit corporation established by the US Congress in 2002. The frequency of inspection varies depending on the number of companies that each accounting firm issues audit reports for, with an annual frequency for auditors that issue reports for more than 100 companies and a requirement of at least once every three years for auditors that issue reports for fewer than 100 companies.
According to Chinese law, however, foreign entities are prohibited from examining the raw data submitted for audit by Chinese firms due to national security concerns. Consequently, the PCAOB claims that it does not have "timely access to relevant documents and testimony necessary to carry out [its] mission" (see here) with regards to inspecting registered firms in China and Hong Kong (to the extent that an audit involves a company's operations in China).
Holding Foreign Companies Accountable Act (HFCAA)
In December 2020, the US signed into law the Holding Foreign Companies Accountable Act (HFCAA), whereby companies that are publicly listed in the US are required to declare that they are not owned or controlled by any foreign government if the PCAOB is unable to audit specified reports due to the company using a foreign public accounting firm that is not subject to inspection by the PCAOB.
Additionally, foreign companies that use such an accounting firm must also disclose (to the US Securities and Exchange Commission), for each non-inspection year:
(1) the percentage of shares owned by government entities where the issuer is incorporated
(2) whether these governmental entities have a controlling financial interest
(3) information related to any board members who are officials of the Chinese Communisty Party
(4) whether the articles of incorporation of the issuer contain any charter of the Chinese Communist Party
If the PCAOB is unable to inspect a company's public accounting firm for three consecutive years, the company's securities would be banned from trading.
The detailed framework for implementing the HFCAA was proposed by the PCAOB in May 2021 (details here).
During the 13-month period ended June 30th 2021, the PCAOB identified 15 auditor firms in mainland China and Hong Kong that have registered with the PCAOB. The 15 auditor firms issued audit reports for 194 public companies constituting a combined global (i.e. including US and non-US exchanges) market capitalization of US$2.4 trillion, where the ten largest companies alone have a combined market capitalization of US$1.6 trillion. (Source: PCAOB)
Essentially, the HFCAA implies that Chinese companies listed in the US would either have to comply with the new rules (and provide the US regulators with their raw data), or alternatively, delist from the US. On the surface, this may seem like a regulatory conflict between the two countries, however we think that the Chinese government is concerned that China's national security could be compromised if Chinese companies were to provide their raw data to the US.
Timeline
Below, we outline the key events that took place following DiDi's IPO.
June 30th
DiDi went public on the New York Stock Exchange at $14 per share, raising US$4.4 billion in total. DiDi's IPO was the largest IPO for a Chinese company listed on an American exchange since Alibaba went public in 2014.
July 2nd
The Cyberspace Administration of China announced that it will conduct an audit on DiDi due to cyber safety concerns and suspended new user registration for the DiDi platform.
July 4th
The Cyberspace Administration of China ordered all application stores to remove the main DiDi application due to "illegal collection and usage of personal information".
July 9th
The Cyberspace Administration of China ordered all application stores to remove 25 additional applications by DiDi (e.g. DiDi Driver, DiDi Goods Delivery), citing the same reasons as above.
July 10th
The Cyberspace Administration of China announced that all companies with more than one million users' worth of data must apply for cyber security auditing before going public in a foreign country.
(Note: Hong Kong SAR is included as Chinese territory and does not count as a foreign country under this policy)
July 16th
Seven regulatory bodies in China, including the Ministry of Public Security and the Ministry of State Security, announced a joint investigation into DiDi's cyber security issues.
Why DiDi? Could Things Have Gone Differently?
Since early June, rumours surfaced that the Chinese regulators had reached out to and requested DiDi to postpone its US IPO in order to give the regulators some time to plan and finalise how they intend to handle the HFCAA framework proposed by the PCAOB. Nevertheless, DiDi chose to continue with its plan to go public, with the company debuting on the New York Stock Exchange on June 30th 2021, one day before the Chinese Communist Party (CCP)'s 100-year founding anniversary. On the day of the listing, DiDi's CEO requested all employees to refrain from celebrating the IPO in order to avoid garnering too much public attention, including refraining from featuring the IPO on social media
The CCP tends to adopt an approach called “先礼后兵”, which translates to “negotiating politely first before fighting”. Consequently, we think that DiDi could have negotiated with the regulators first and complied by postponing the IPO in order to prevent any ramifications, rather than blatantly ignoring the regulators’ requests. The course of action which DiDi had chosen led the company to become a prime example for the CCP to use in order to warn other companies what the consequences of disobeying regulatory requests might be.
After the DiDi incident, most Chinese companies that have filed for an IPO in the US cancelled their IPO plans.
What Next?
Unless there are further regulatory changes, we think that it is definitely plausible for there to be a trend of Chinese companies delisting in the US (and perhaps re-listing in mainland China on the STAR Board or in Hong Kong), or alternatively, having dual listings in both Hong Kong and the US as companies such as Alibaba, JD, and Baidu have done. Typically, dual-listed stocks are fungible, meaning that the shares on one exchange can be converted to and/or sold as shares on the other exchange without significant price divergence. Fungibility provides dual-listed Chinese companies with a simpler contingency plan in case the company has to delist from the US in the future, in comparison to Chinese companies that only have a single listing in the US.
In general, we anticipate that Chinese companies looking to raise funding abroad would probably choose to list on the Hong Kong Stock Exchange, as going public in mainland China involves more stringent requirements (refer here for a brief discussion). Companies that operate under a variable-interest entity (VIE) structure and/or that have significant foreign funding and require listing in a place with free movement of capital may also prefer to list in Hong Kong.
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