A recent landmark agreement between China and the U.S. will allow U.S. regulators access to inspect the audits of Chinese companies listed on U.S. stock exchanges. The agreement is potentially a significant step towards resolving a long-running conflict that could have forced some of China’s largest companies to leave these exchanges, starting from 2024.

In the following Q&A, Siguo Chen discusses what this deal means, and shares her outlook on China over the mid to long term.

Do you feel that the recent announcement is a positive development?

While the news is clearly a step in the right direction, it comes amid broader concerns on the U.S.-China relationship as well as pressure on risk appetite from rising yields.

In our view, the Chinese regulators are conceding a lot more than previously expected. This is noticeable in some of their recent announcements and changes in the wording of some relevant rules. So, you could say that the ball is more in the U.S.’s court now.

The key point of concern, of course, is whether both sides can establish some common ground on both “definitions” (such as what is defined as “unlimited access”) and “processes” (such as how and where the inspections will be done).

What are the market implications of these announcements?

There is still a lot of uncertainty around the negotiations, not only because of the complexity of the matter but also because of broader tensions between the two powers.

If you look at the valuation levels of ADRs, it is obvious that at least some of the delisting scenario has been priced in by the market, although overall the sentiment is more optimistic versus six months ago.

Investors will likely want to see more specifics in terms of implementation, given the diverging announcements from both sides, before they are willing to invest back into ADRs.

A lot has been said and done about moving firms to non-U.S exchanges and the challenges this solution entails (i.e. liquidity bottleneck on the destination exchanges). There is really no market consensus on this right now, but for a corporation that’s listed in the U.S., we believe that the only wise thing to do would be to obtain a dual-listing status somewhere else, such as Hong Kong or Singapore.

Covid outbreaks have continued to restrict society and disrupt the economic recovery. How do you think this will play out in China over the rest of this year?

We are on the conservative end on this matter. We don’t expect any major changes this year in relation to the Covid-zero policy because firstly, the country is simply not quite ready. This will be the first winter after the Omicron surge and we are starting to see sporadic resurgences. A sudden opening up could pose a material risk to the country’s medical system, given that there is no previous mass infection on a country level thus no herd immunity against the virus.

Secondly – this is more observed evidence than a reason — if the Chinese government were to make a major shift in direction for a serious matter like this, we would have most likely seen a change in tone in public media and elsewhere, several months ahead of the event. The Chinese government has been telling the entire population of 1.4 billion how dangerous the virus is for three years now; a U-turn does not seem likely, nor would it be guaranteed to be effective.

On a more positive tone, we see a quick ramp-up in vaccination rate especially in the elderly (until July, the percentage of booster shots received for age 70-79 was 70% and for age 80-89 was 38%). A few more booster options (including China’s own mRNA vaccine) are due soon, which we see as potentially positive.

What’s your outlook on China for the rest of the year and beyond?

It has been a tough two years for the Chinese market, which has been caused by Covid lockdowns, the property market softening and to a certain extent, geopolitical tensions. At this juncture, we believe that Covid measures will be more relaxed by mid next year. We also expect stronger and more comprehensive policy support to be provided to the property sector and infrastructure to pick up speed post the 20th Party Congress.

Many companies we speak to believe that Q2 or Q3 will be the worst periods in terms of their operating metrics. Things are starting to improve as we speak, albeit very gradually. However, given the global macro environment, we will also need to closely monitor factors such as U.S. interest rates, the energy shortage and global export demand.

As long-term investors, we believe that market dynamics are moving in the right direction for China equity investing. With China’s economy growing and financial markets liberalizing, we expect the investment universe to provide investors with compelling long-term opportunities. With valuations not pricing in this long-term potential, we continue to believe that now is a good time for investors to benefit from the asset class.