China is revising the delisting rule. But investors may want to sell at the rally.

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Probability of mass delisting of Chinese stocks like

Alibaba Group Holding (GRANDMA),

NetEase (DETECT),

Baidu (BIDU) from US exchanges may have become lower. But the risk remains, adding to the effects of the Covid blockade in cities like Shanghai, and geopolitical challenges that could challenge Chinese stocks in the near future.

The

Invesco Golden Dragon
(PGJ) exchange-traded fund (PGJ), filled with US-listed stocks, rose 7% on Monday to $ 32.44, while

iShares MSCI China
The ETF (MCHI) rose nearly 3% to $ 56.36. But investors may not want to pounce on the latest rally and may even ease on online stocks that have been at the center of volatility.

Investors took the change in the rules proposed by Chinese regulators, which will allow non-Chinese government agencies to gain access to audit documents, as good news. Regulators previously did not allow the U.S. full access to audit working papers of Chinese companies. This is a problem at the heart of the Foreign Company Reporting Act, which has launched a process to remove Chinese companies from the list if they fail to comply with U.S. audit requirements for three consecutive years – until 2024.

Removing the key phrase that on-site inspections should be “dominated” by Chinese regulators was “China’s first concrete public step” to improve the chances of a resolution to keep Chinese companies in line, according to a customer note. from Bernstein analyst Robin Zhu.

It should be noted, according to him, the recognition by Chinese regulators that the documents and materials provided in the disclosure of the audit, “rarely contain state secrets and confidential information.” according to Zhu.

Also positive: the move was made not only by securities regulators, but also by China’s Ministry of Finance and the State Secrets Administration, says KraneShares Chief Investment Officer Brendan Ahern. “The likelihood of exclusion from the list is declining, but it is not being eliminated,” he says.

Zhu of Bernstein also noted that the risks remain, writing that much will remain in the details of the rule change.

Here’s one reason why changing the rules may not be enough: U.S. regulators stress they are looking for full compliance or no deal. The Public Oversight Accounting Board (PCAOB) said last week in a statement that it continues to work with the Chinese authorities, but its requirement for full access to relevant audit documentation, even from companies in sensitive areas, is out of the question.

And China’s change of rules does not meet this basic requirement of the United States. It continues to require Chinese companies to obtain approval from regulators before submitting any audit materials, and requires permission to transfer any documents that could “disclose state secrets or harm state and public interests,” writes Thomas Gatley, senior analyst. Gavekal. Dragonomics, in a note to customers. The most likely outcome, Gatley adds, would be that most Chinese companies would eventually be delisted from U.S. stock exchanges.

The United States has never seen the type of mass delisting that can happen if no agreement is reached, which is why some analysts think some work can still be achieved. This may include companies with confidential information, such as state-owned firms

PetroChina (PTR), or even some online companies, given China’s concerns about the security of data voluntary removal from the list. More Chinese companies are still likely to conduct secondary listings in Hong Kong, some similar

Lee Auto (LI) and

Xpeng (XPEV), which seeks to make Hong Kong their main list, which will allow them to attract investors from mainland China through the Stock Connect program.

And these shifts – no matter what happens to regulators – will bring changes as more and more investors choose local stocks. The MSCI China index, for example, has changed the ADR

Alibaba,

JD.com (JD) and

NetEase last year for these companies in Hong Kong.

Rebalancing MSCI in June could lead to more such swaps for companies that had secondary listings in Hong Kong for some time and met certain liquidity conditions, including

Baidu, and perhaps

Bilibili (BILI). “For big global U.S. asset managers, they’re just going to be conservative because the risk still exists,” Ahern says.

A bigger question for investors is whether to pounce on Chinese online stocks such as Alibaba, which are trading at two standard deviations below five-year historical estimates, especially after numerous assurances from Chinese officials earlier this month aimed at calming markets.

But the risk of exclusion from the listing is only part of the problem in the near future. China’s tough restrictions on Covid have pushed cities like Shanghai, a city of 25 million, into prolonged closure as it grapples with record cases, and a change in geopolitical landscape as China tries to remain neutral in Ukraine’s war adds another level of uncertainty. The Biden administration is still shaping its policy in China, and the Chinese bill is going through Congress – both of which could affect investor sentiment about Chinese stocks.

“We view these rebounds as good selling points, not as buying opportunities, because we believe the challenges for these stocks are cyclical and structural,” JA Sima told BCA China Strategist at a briefing last week. “The business cycle has not bottomed out, and will likely be a very shaky bottom with a resurgence of Covid cases and a citywide blockade.”

Hunters for deals may not be in a hurry, as volatility can persist for some time.

Email Reshma Kapadia to reshma.kapadia@barrons.com