The US and China are trying to make their relationship work, and if they can’t agree, investors could be in for a messy split.

News last Friday shows the two are in discussions to keep Chinese stocks listed in the US — giving Chinese stocks even more momentum after falling hard the past two years.

Conflicting needs in a relationship

After the Enron scandal, the 2002 Sarbanes-Oxley required public companies to have their audits inspected. But two jurisdictions — China and Hong Kong — haven’t cooperated. For 20 years, Chinese companies were free to trade on US exchanges with little oversight.

In 2021, Chinese Luckin Coffee (OTC:LKNCY) filed bankruptcy for falsifying sales — with its NASDAQ-listed shares falling over 90% after the fraud was first discovered. This was the breaking point for the US:

• In 2021, the US finalized rules to ban foreign companies from US exchanges if they fail to meet auditing requirements by 2024.
• Last month, the US came out with an initial list of companies at risk of delisting — with 200+ companies expected to delist unless an agreement is reached.

For years, China kept a strong privacy stance, refusing audits on its companies’ books. But in March, China announced plans for favorable market policies, including supporting overseas stock listings, which sent Chinese stocks on their biggest two-day rally since 1998.

Chinese stocks are coming off a strong March

Chinese authorities are reportedly drafting a framework that’ll allow Chinese firms to stay listed on US exchanges, with regulators hoping to reach an agreement by summer.

• Not a done deal: The changes need approval from top Chinese regulators — and an agreement between the US and China
• Making progress: Both sides are “holding active talks on auditing cooperation, and progress has been smooth overall.” (BBG)

Still, certain companies holding sensitive data will be delisted, and the framework in progress is expected to highlight what is considered sensitive data.

Example: Alibaba processes large volumes of consumer transaction data. Will it be considered sensitive data?

Investors: Is China willing to compromise?

Positive news and a detailed framework could send stocks higher — but Gary Gensler, the SEC Commission Chair is feeling pessimistic — as it’s uncertain whether China will meet the US’ full demands.

For many investors, sticking with an ETF that gives broad exposure to Chinese stocks could save lots of headache.

• Broad exposure: The iShares MSCI China ETF (NASDAQ:MCHI) — which is down 41% from its 2021 peak — holds a basket of US-listed Chinese stocks in various industries.
• Internet-focused: The KraneShares CSI China Internet ETF (NYSE:KWEB) — which is down 68% from its 2021 peak — holds a basket of US-listed internet stocks.

To be continued tomorrow.