The Didi debacle: A watershed of financial decoupling vis-à-vis resilience epitome of global data governance

1. Introduction

Technology and data have a critical role in driving innovation and stimulating all aspects of the global economy. Particularly noteworthy is the emerging battle for data sovereignty and security as tensions between the USA and China escalate. This escalating confrontation is increasingly spilling into the capital markets, transcending institutional and ideological differences. Both the USA and China are striving to fortify their economies against geopolitical threats.¹ Amidst legal uncertainties, Variable Interest Entities (VIEs), business structures that allow investors to control a company without majority voting rights, are under renewed scrutiny as China tightens oversight of US-listed Chinese companies (ULCCs). Despite Chinese laws restricting foreign investment in sensitive sectors, the VIE’s legal workaround enables tech firms to list on American stock exchanges. China views big data as a crucial asset in global competition and tightens its grip, imposing restrictions on cross-border data transfer. Through strategic investments in the digital economy, China has prioritized regulating the internet industry. Transitioning from a laissez-faire approach, it now asserts greater control over private companies with extensive data. China has cracked down on domestic tech giants, such as Didi, listed on US stock exchanges. Additionally, it faces challenges with the Public Company Accounting Oversight Board (PCAOB) regarding access to ULCCs’ audit files. In response, the USA introduced the Holding Foreign Companies Accountable Act (HFCAA) as part of a broader strategy to adopt a more assertive stance on maintaining auditing standards. The Act grants VIE-based ULCCs 3 years to allow PCAOB inspection of their audits or face delisting.²

These dynamics ultimately boil down to a strategic interplay, epitomized by the plausible hypothesis of decoupling. The resolution of this challenge holds far-reaching implications for the global financial system. In response to these pressures, high-tech ULCCs will face heightened scrutiny and must navigate a landscape of increasing risk and regulatory oversight in the digital economy. This study unfolds in five sections. Section 2 examines how Chinese firms exploit regulatory and jurisdictional arbitrage, discussing cross-listing premiums from a theoretical perspective and China’s efforts to advance its national interests. Section 3 conducts a case study of Didi, serving as a focal point in the regulatory tussle between the US and Chinese authorities. Didi’s regulatory ordeal marks a turning point, showcasing China’s tightened oversight in what was once a loosely regulated sector. This section also explores the potential impact of the Didi incident on the geo-financial landscape. Section 4 evaluates whether the HFCAA could be a game-changer in addressing the long-standing challenge of PCAOB’s inability to inspect ULCCs’ audit papers. It argues that the HFCAA could prompt the delisting of ULCCs if they persistently flout US auditing standards. Section 5 examines China’s multifaceted efforts to rein in technology firms, focusing on heightened scrutiny of the Variable Interest Entity (VIE) structure through which Chinese firms seek overseas equity capital. Section 6 delves into lifting the veil on the strategic manoeuvring between the world’s two largest economic powers, exploring avenues to break the deadlock beyond mere leverage. The study concludes with a summary of findings.

2. Jurisdictional arbitrage: take advantage of grey regulations of the USA and China

American stock exchanges have long been the preferred destination for cross-listings due to their prestige, deep liquidity and high valuations. The VIE structure provides Chinese tech firms with more flexibility to raise capital while bypassing the scrutiny and lengthy IPO vetting process involved in domestic listings in China. Seeking to address the longstanding legal loophole, China has not banned offshore listings but has tightened procedural rules for approvals. Despite the tightening of rules from both the USA and China, tech firms’ integration into global financial markets continues apace.

The bonding theory: cross-listing premium

A stronger legal and regulatory environment has a positive effect on capital costs.³ Offshore IPOs provide an alternative source of capital for Chinese firms that receive higher valuations compared to companies that do not cross-list.⁴ Many variables underscore the attractiveness, with a key driver being the reduced cost of financing available to cross-listed firms in the USA.

That Chinese firms are keen to list in the USA is not just due to higher valuations but also access to a large global institutional investor base. A valuation premium up to nearly 40 per cent can be associated with cross-listing on USA stock exchanges.⁵ This premium is partly created by the direct increase in the number of investors able to more easily access these companies in the New York markets.⁶

More significantly, greater political freedom lowers the cost of capital.⁷ Chinese stock exchanges suffer from higher costs given their less reliable legal and political environment. China’s economic growth would not necessarily and eventually bring about political liberalization, but rather more control over a less effective capital market, which inevitably raises the cost of capital.⁸ A higher degree of intervention minimizes liquidity and increases the volatility of its shares. Non-transparent processes feature a certain political element in decision-making, which increases political and regulatory risk. ⁹ The USA has a liberal regime allowing firms to go public with lighter regulation, making it a magnet for Chinese IPOs, despite rising political, trade and regulatory tensions between the two powers.¹⁰

Notably, investors have largely ignored the Securities and Exchange Commission’s (SEC) threats to delist ULCCs that fail to meet stricter audit standards.¹¹ They held $1.1 trillion in equities issued by Chinese companies at the end of 2020,¹² and their investments reached record levels in 2021.¹³ This increase has coincided with China’s tightened control over cross-border data transfer and the SEC’s escalated surveillance of Chinese IPOs. There is no well-justified evidence to support that a decoupling of global capital markets is taking place.¹⁴ However, the clampdown on Didi seems to have reshaped the ecosystem.¹⁵ It remains to be seen whether the risks posed by geopolitical and regulatory uncertainty will deter Chinese firms from cross-listing in the US capital markets.¹⁶

Jurisdictional and regulatory arbitrage

Internet firms have enjoyed laissez-faire policies regarding cross-border data flow during their rapid growth stage. The VIE structure allows firms to list abroad without undergoing the lengthy and rigorous vetting process in China’s domestic markets. A sweeping regulatory shift is set to fill this legal loophole. The move requires VIE-based companies to seek China’s approval before an offshore listing.

Pros and cons of an approach of laissez-faire?

Chinese tech giants are considered key to driving the country’s economic and geopolitical goals. The country had followed a laissez-faire approach, instead of reining in the digital platforms, because they needed foreign capital to grow.¹⁷ Over 80 per cent of all ULCCs use VIEs that are material to their operations.¹⁸ Regulators, like the China Securities Regulatory Commission (CSRC), had taken a softer attitude towards the VIE-structured firms. China had little legal recourse and no effective regulatory framework to regulate cross-listing of VIE-structured companies. For instance, the Didi IPO went ahead despite requests for a delay from the State Administration for Market Regulation (SAMR). Most Chinese tech giants fall outside China’s jurisdiction, since they are listed in the USA in the form of VIEs but generally domiciled in tax havens. Chinese VIEs in the Cayman Islands had a market capitalization of $1.7 trillion in 2017.¹⁹ The VIE workaround essentially makes a mockery of China’s foreign investment restrictions, as the complicated structures render it hard for Chinese regulators to control.²⁰ The laissez-faire approach would hamper China’s geopolitical aspirations to play a greater role in global capital markets.

Regulatory and jurisdictional arbitrage

Regulatory requirements for IPOs in China are more stringent than those imposed by American regulators. China has much tougher listing requirements, such as requisite profits and a long and uncertain waiting period for regulatory approval. Firms face capital controls that limit their access to US dollars. Chinese regulators require companies to have solid cash flow and earnings for listing on the domestic market, known as the A shares market.²¹ Seeking access to foreign capital to expand, firms have to navigate Chinese restrictions on foreign ownership and capital controls.²² Designed to achieve this goal, the VIE structure allows Chinese firms to access foreign capital that would otherwise be unavailable due to Chinese laws on foreign ownership of sensitive areas.²³ VIEs entail a set of contractual relationships that mirror the rights a shareholder would have in a traditional equity stake.²⁴ In theory, VIEs allow US shareholders to benefit economically from a Chinese company while limiting their operational control of the business.²⁵ The precarious legal structure underpins many of the biggest US listings.²⁶ Nearly all major data platforms have dual-class shareholdings and VIE structures.²⁷ Didi and other Chinese blue-chip firms, such as Baidu, Alibaba and Tencent (BAT), have long used the VIE structure to list on US markets. They operate in a regulatory grey zone, where an investor does not have a controlling stake but retains a controlling interest.²⁸ The controversial structure has come under greater scrutiny from Chinese authorities.

Reassess the viability of the VIE structure

Seeking to rein in high-tech firms after years of a more laissez-faire approach, China has taken unprecedented steps to tighten scrutiny on overseas listings. By checking sources of funding for securities investment and controlling leverage ratios, the Chinese government is reasserting state control over VIE-driven firms taking advantage of regulatory arbitrage.²⁹ As a nuclear option, revoking VIEs would cut off China from Western capital markets, causing Chinese tech giants to be delisted.³⁰ On the other hand, Chinese regulators had not outright endorsed the VIE framework before, upon which hundreds of billions of dollars of foreign investments rely.³¹ Without an explicit ban on VIEs, internet behemoths operating in a legal grey zone can still evade the Foreign Investment Law restricting foreign equity ownership.³² Furthermore, the Antitrust Guidelines for the Platform Economy came into effect after the abrupt suspension of Ant Group’s IPO on 7 February 2021.³³ The SAMR was empowered to oversee mergers and acquisitions (M&As) conducted by VIEs.³⁴ This change has subtly conferred upon VIEs a measure of legitimacy.

The CSRC has been seeking to close a loophole that has allowed internet firms to circumvent limits on foreign investment. The CSRC’s Draft Regulation requires that firms seeking to list abroad must undergo relevant security screening procedures to ensure they comply with Chinese laws.³⁵ In this regard, ULCCs do not actually have to move for regulatory arbitrage to occur; just the threat of leaving can be sufficient to effect policy changes.³⁶ With economic impact factored into decision-makers’ calculus, firms are still allowed to use VIEs for offshore listings, provided they seek prior approval from the CSRC. They are mandated to register with the CSRC within three working days after the first filing for an overseas IPO.³⁷ The Draft Regulation aims to provide a predictable framework for overseas listings. It clarifies proceedings in a market rocked by the state’s crackdown on overseas listings.³⁸ The changes take aim at the very mechanism of VIEs, closing a gap that has long been used by tech behemoths to list offshore. Positively, the additional oversight could bestow a level of legitimacy on the structure, mitigating foreign investors’ concerns about the VIE’s shaky legal ground.³⁹ However, the move represents a huge blow to Chinese firms struggling to get listed in the USA. Once amended, the CSRC Regulation would require VIE-based firms to seek explicit approval before going public abroad. If so, the VIE structure will be in the crosshairs of China’s regulators. The crackdown on Didi illustrates that the Chinese authorities are seeking to fill such a long-standing gap in regulating the VIE structure.

3. Watershed: Didi’s delisting from New York stock exchange (NYSE)

China has launched an unprecedented clampdown on data security violations. Actions against ULCCs signal a significant move in a sweeping crackdown on its booming and once laissez-faire online platform economy. Meanwhile, the USA has been seeking to delist ULCCs from its exchanges for failing to comply with auditing requirements. China launched a clampdown on Didi during its campaign to strengthen oversight of overseas listings. The Didi delisting marks a major change in the politics of global investment, which came amidst pressure from China over concerns about the security of data when exposed to US audit norms.⁴⁰

The Didi debacle

China has shown no sign of reining in its crackdown on some large tech behemoths. After actions aimed at Alibaba, Tencent and Bytedance, the SAMR has intensified a probe into Didi founded in 2012. Acquiring the Chinese business of Uber in 2016, Didi has dominated China’s on-demand transport sector. The firm handles sensitive information such as mapping data, which can be considered state secrets.⁴¹ The Cyberspace Administration of China (CAC) accused Didi of violating national security, cybersecurity and personal data laws. Despite the CAC’s concerns, Didi pushed forward with one of the NYSE’s largest IPOs, raising $4.4 billion on 1 July 2021.⁴² The CAC saw Didi’s IPO decision as a challenge to the central government’s authority. It initiated China’s first cybersecurity review of a private internet firm and banned Didi’s ride-hailing platform from app stores on 4 July 2021. The penalty has greatly curtailed the firm’s prospects as it cannot sign up any new users, adversely threatening its market share and heavily affecting Didi’s expansion plans. The CAC’s move represents an escalation in the crackdown on tech behemoths. The Didi debacle marks an unprecedented data and security review under China’s sweeping changes to data governance.⁴³ It symbolizes that China is tightening restrictions on cross-border data flows and security. Meanwhile, the crackdown sends a message that China has attempted to implement a crackdown on overseas listing. It also sends a stark message to Chinese firms about the government’s authority over them, even if they operate globally and their stock trades overseas. Underscoring the uncertainty, the CAC’s enforcement discourages listings of Chinese firms in the USA. It is likely to impact multibillion-dollar technology listings planned for New York in the years to come.⁴⁴

Between a rock and a hard place

In an era of global uncertainty surrounding the regulation of big data, ULCCs are caught between a rock and a hard place. Political and national security dynamics are involved in an investment in ULCCs. They face regulatory challenges from both China and the USA, where the former seeks to rein in its tech giants, while the latter threatens to enhance disclosure requirements. ULCCs are prohibited from making disclosures under state secrecy provisions.⁴⁵ China’s heightened regulatory scrutiny is echoed in the HFCAA, which requires the PCAOB’s access to their financial audits. As a sensitive trigger, ULCCs may face delisting if they refuse to hand over their audits to the PCAOB. They are increasingly having to navigate a complicated set of conflicting rules. Caught in an auditing deadlock between China and the USA, ULCCs would be forced to hand over financial data to the PCAOB or face the prospect of being delisted within 3 years.⁴⁶ They must either continue to take advantage of US markets by abiding by the HFCAA or lose access to the US capital markets. The second scenario would deny ULCCs access to large segments of the global financial system. Audit firms are also caught in the middle of two warring jurisdictions.⁴⁷ As a result of the conflict between the CSRC and the SEC, auditors face the threat of enforcement actions in both China and the USA. The Chinese operations of the Big Four could be deregistered by the PCAOB, barring them from auditing ULCCs.⁴⁸ This could have damaging ramifications for the audits of US-headquartered multinational corporations (MNCs) with large operations in China. In the crosshairs of the US–China cold war in capital markets, the DiDi’s plight will likely prompt other Chinese internet firms to wind down their US listings.⁴⁹

Dual-listings in the HKEX: a touchstone of the regulatory race theory

Didi’s delisting will have a far-reaching impact on various stakeholders, including Chinese firms’ incentives for overseas listings, IPO location decisions and China’s strategic development of its own capital markets. Seeking to rely less on US capital markets, the country is developing its own stock market. China has been heavily bolstering its exchanges in Beijing, Shenzhen and Shanghai as viable option for raising capital. The primary beneficiary of a US delisting policy would appear to be the Stock Exchange of Hong Kong Limited (HKEX). The US’ tougher inspection of ULCC’s audits and China’s regulatory clampdown boost Hong Kong’ allure as the only IPO centre for Chinese firms to raise foreign capital. As the decoupling of the equity markets accelerates, Didi’s withdrawal from the NYSE and relisting in the HKEX could serve as a catalyst for a revival of its business prospects. This strategy would inspire ULCCs to pursue secondary listings as a hedge against the delisting risk. Amidst these uncertainties, many ULCCs have undertaken secondary listings to facilitate a smooth withdrawal from the US capital markets. Chinese tech behemoths, like Alibaba, JD.com and NetEase, have begun hedging their bets with secondary listings in the HKEX.⁵⁰ Carruthers and Lamoreaux argued that a regulatory race requires:

• an initial difference in regulatory rules across jurisdictions;

• the credible threat that firms’ locational decisions will be affected by that difference; and

• a move by jurisdictions with more burdensome rules to change their regulations in response to the threat.⁵¹

With the USA initiating a statutory shift to maintain its auditing standards, ULCCs’ response through migration will be viable only when Hong Kong reacts by changing its listing policies. The HKEX’s shift in allowing dual-class IPOs well epitomizes the regulatory race theory.⁵² In 2018, the HKEX changed its rules to allow firms with dual-class shares to list, which also instituted landmark revisions to the Hang Seng Index.⁵³ The HKEX Listing Rules offers a new concessionary route allowing firms already primarily listed on a Qualifying Exchange, including the NYSE, NASDAQ and the Main Market of the London Stock Exchange (LSE), to apply for a secondary listing in Hong Kong.⁵⁴ The reform has paved the way for ULCCs to list on the HKEX. In November 2019, Alibaba’s secondary listing on the HKEX helped it secure nearly US$13 billion in capital.⁵⁵ Alibaba’s success has mainstreamed a growing trend of secondary listings by Chinese tech giants. JD.com Inc. and NetEase Inc. were secondarily listed on the HKEX in April and June 2020, raising US$4 billion and US$2.8 billion, respectively.⁵⁶

With more and more ULCCs setting up secondary listings to mitigate the fallout, Hong Kong seemingly emerges as a leading capital-raising hub for Chinese tech firms. Nevertheless, Hong Kong’s institutions face gradual decay and it drifts away from being a globalized financial centre, given that the liberty premium is fragile.⁵⁷ Erosion of the rule of law could lessen future foreign capital inflows, ultimately impacting Hong Kong’s status as an international financial centre.⁵⁸ This is especially true in terms of the delisting and relisting strategy exploited by many Cayman-incorporated companies.⁵⁹ After all, whether a regulatory race ensues depends on how China responds and whether it alters its own policies to prevent movements of capital.⁶⁰

Far-reaching impact: a de facto precedent in a civil law jurisdiction

Didi’s delisting portends a windfall for China’s ‘safe space’ market, ie, the HKEX.⁶¹ The Didi debacle has become a test case for a broader Chinese government effort to curb the power of private internet titans. It sets a precedent, which could allow the CSRC and CAC to control those tech firms planning overseas listings. Companies will be subject to review if their operations are deemed important to critical national infrastructure, including critical information infrastructure (CII). Any breaches would entail higher compliance costs and risk large penalties or the suspension of business operations over their handling of data. The penalties imposed on Didi mean that other firms attempting listing in the USA must gain approval beforehand.

China’s sweeping regulatory shift seems to have triggered a sell-off in US-listed Chinese stocks.⁶² Most ULCCs would seek to eventual delisting by converting US shares to an HKEX listing. The HKEX allows US investors to exchange American depositary shares (ADSs) for HKEX shares.⁶³ In principle, Didi should be able to ensure that its NYSE stock would be convertible into freely tradable shares on the HKEX, allowing investors to swap between the two stock exchanges.⁶⁴ Investors could likely shift more of their China exposure from New York to Hong Kong as a result. Otherwise, it would pose the greatest risk to investors if companies do not plan to list elsewhere after being delisted from the NYSE. Furthermore, Didi did not disclose the CAC’s accusation of its failure to comply with Chinese laws and regulations. US federal securities laws allow for rescission if buyers of shares did not know about a misstatement or omission at the time of purchase.⁶⁵ Section 10b of the Securities Exchange Act and Rule 10b-5 are widely applied by investors suing for fraud.⁶⁶ Given that VIEs per se are inherently risky and unenforceable, American investors seeking redress for losses have limited options because they have little insight into the firms’ financial status.⁶⁷

4. Would the HFCAA be a game changer to level the playing field?

The HFCAA aims to level the playing field for all issuers and to address the longstanding issue for the benefit of investors in the US markets. It is worth examining whether the SEC’s finalized framework would enable the US regulators to bring ULCCs into compliance with auditing standards.

SEC’s remedial actions: more stringent disclosure obligations

Chinese markets are opaquer and subject to political control than those in the West, making demands for Western-style transparency far more complicated.⁶⁸ Amidst the uncertainty surrounding VIEs and China’s wider regulatory clampdown, the SEC has suspended new listings of Chinese companies.⁶⁹ The regulator will not allow a Chinese firm to be listed in the USA unless they fully clarify their legal structures and disclose the risk of Chinese government intervention.⁷⁰ New stringent reporting requirements are imposed on Chinese firms, requiring them to disclose significant risks related to the regulatory environment. These risks include potential Chinese government interference and enforcement of compliance with the PCAOB’s audit requirements. Disclosures also include their structures and state ties, such as the percentage of shares owned by governmental entities.⁷¹ The HFCAA Disclosure requires issuers to distinguish between shell companies and operating companies in China, including the enforceability of certain contractual arrangements.⁷² This ensures that investors fully understand the financial relationship between the VIE and the issuer. Firms should also disclose whether Chinese law allows them to list in the USA via an offshore shell company. For instance, Didi did mention some regulatory risks to its operations but gave no indication that the CAC would start investigating the firm and ban its apps. It is vital for ULCCs to have sufficient disclosure about serious potential investment risks associated with China’s centrally controlled economy. These regular reporting obligations will ensure that investors can better assess material risks that may influence the value of their investment. Notably, the recent clampdown on China’s tech firms resulted in erasing as much as $1.5 trillion in shareholder value.⁷³ Such disclosures are crucial not only to inform investment decision-making but also at the heart of the SEC’s mandate to protect investors in US capital markets.⁷⁴

Would the HFCAA be viable to level the playing field?

The HFCAA aims to purge all non-compliant companies from the USA if they have failed to comply with the PCAOB’s audits for three consecutive years.⁷⁵ The Act seeks to ensure that ULCCs are subject to the same independent audit requirements that apply to US companies. As an elephant in the room, China has long barred the PCAOB from discharging its auditing review process in the same way that the watchdog does with US companies. Neither ULCCs nor subsidiaries of the Big Four firms in China are allowed to share their audit papers with the PCAOB.⁷⁶ The watchdog’s failure to obtain the underlying audits has impacted the integrity of US capital markets. As such, some egregious accounting frauds have not been detected, exposing investors to material risks and resulting in losses. These frauds have also damaged ULCCs’ international image and adversely affected their overseas financing. The effect of PCAOB noncompliance suggests a 5–7 per cent valuation haircut for Chinese firms associated with negative publicity.⁷⁷ The delisting of Luckin Coffee represents a tipping point in the US–China dispute over auditing regulations. The New York-listed firm admitted to fabricating over $310 million of its sales.⁷⁸ The Luckin scandal catalyses the US’ enhancement of auditing standards. The HFCAA empowers the SEC to delist ULCCs that flout auditing rules. The Act requires the SEC to delist ULCCs that are not overseen by the PCAOB.⁷⁹ On 2 December 2021, the regulator finalized rules allowing the SEC to force ULCCs to delist from American exchanges if they do not comply with US auditing requirements.⁸⁰ ULCCs are statutorily required to be inspected by the PCAOB under the Sarbanes-Oxley Act of 2002⁸¹ if they seek to list in the USA. The HFCAA came amidst simmering tensions between China and the USA, stemming ultimately from Chinese laws prohibiting foreign oversight of ULCCs’ auditors.⁸² The implementation of the HFCAA determines how much transparency investors can expect from ULCCs. Continuing to deny the PCAOB’s access to the audits would handicap the firms in global competition. The HFCAA provisions potentially accelerate the decoupling of US and Chinese capital markets. It remains to be seen whether this is the nail in the coffin for decoupling in equity markets between the USA and China.⁸³

5. China’s multipronged approaches to rein in technology firms

China has been scrutinizing major internet firms that intend to list their shares abroad. It has also pursued a multipronged approach to rein in ULCCs. Chinese comprehensive laws prohibit firms from complying with US audit requests, as the audits are considered state secrets. The landmark enforcement action by the CAC against Didi highlights how China is enforcing data-related laws. China’s moves add a new layer of uncertainty for firms already struggling to navigate the escalating tensions between China and the USA over data governance.

Chinese laws and regulations on data protection and security

China is tightening its grip on the internet sector by pushing forward new legislation to address data security concerns. Sweeping laws have been passed to govern data gathering and harvesting. The objective to tighten regulation around data protection includes an additional layer of national security.⁸⁴

China Cybersecurity Law (CSL 2017)

The country has moved aggressively with legislation designed to safeguard cybersecurity. The China Cybersecurity Law (CSL 2017) requires foreign firms, like Apple and Amazon, to store Chinese data within the country and mandates them to secure a local partner to manage that hoard of information via local data centres.⁸⁵ This is the only path to a world where companies have to localize their data and are audited by local regulators.⁸⁶ Cybersecurity review with a heavy emphasis on data security will become the new norm, especially for those deemed as critical information infrastructure (CII) operators. On 17 August 2021, China’s State Council released the Critical Information Infrastructure Security Protection Regulations (CII Regulation) to fully implement the CSL 2017.⁸⁷ The Regulation provides the protection of CII against cybersecurity risks and threats at home and abroad.⁸⁸ The law prevents data from flowing freely and disproportionately prohibits cross-border transfers of information that are routine in the ordinary course of business.

Data Security Law (DSL 2021)

China has passed a data security law that forbids companies from handing over any data to foreign officials without government approval. Designed to end the free harvesting of data and curtail invasive data collection, the DSL 2021 places systematic control over cross-border data transfer.⁸⁹ The law targets potential issues related to cross-border data security and restricts the collection of data that may harm national security.⁹⁰ The DSL 2021 prohibits enterprises from transferring ‘core state data’ overseas without the approval of Chinese regulators.⁹¹ This means Chinese firms need government authorization before providing any China-based data to foreign judicial or law enforcement agencies. The PCAOB is thus prevented from examining the ULCCs’ audit papers. The DSL 2021 provides a further legal basis for the Chinese authorities to enforce data security requirements. It promises additional oversight of data sharing and hefty punishments for those who breach cross-border data transfer rules. Violators will be subject to a fine of up to ¥RMB10 million ($1.6 million) and have their operating licenses revoked.⁹² The DSL 2021 sets up a framework for companies to classify data based on its relevance to China’s national security.

The Personal Data Protection Law (PDPL 2021)

Chinese consumers have grown increasingly privacy conscious in recent years, and the authorities have taken particular interest in safeguarding platforms like Didi. China has articulated a modern national data policy with implications for the development of technologies. The PDPL 2021 lays the groundwork for implementing concepts like user consent and other requirements for collecting, processing and sharing personal data. China’s first data protection regime strictly governs consumer data. Its strict guidelines make it one of the toughest laws protecting personal data in the world.⁹³ China has become increasingly concerned about the potential national security risks associated with personal data leaving its territory.⁹⁴ Under the PDPL 2021, data collectors must establish a specialized agency in China or appoint a representative to be responsible for data flows across borders.⁹⁵ Storing data overseas does not exempt a firm from compliance with the PDPL 2021 given the statutory duties of privacy mitigation and security assessment on data transfer.⁹⁶ The law requires companies to notify consumers when they are collecting and storing their data and gives consumers greater control over that data, including the right to have it deleted.⁹⁷

Many countries seek to facilitate data sovereign in the name of personal data protection. For instance, data protection has become a momentum with the introduction of the EU’s General Data Protection Regulation (GDPR) in 2018.⁹⁸ The PDPL 2021 draws on the GDPR and seems similar to the argument underpinning its adoption. However, the implementation will differ in the EU and China because the balance between state power and individual rights differs substantially between the two.

Paradoxical thoughts behind the legislative approaches

The DSL 2021 and PDPL 2021 are used to restrict data transfer to foreign countries. The laws require any cross-border data transfers to be submitted first to the CAC. These laws give the Chinese government more direct control over data. They show China’s strengthened monitoring and regulations of cross-border data transfer, especially when national security is involved. With extraterritorial reach, the laws aim to consolidate China’s efforts to set up regulation in the country’s tech sector. However, they neglect the limits on the information the government can access. In particular, the cross-border data transfer rules seek to address threats to data security and national security in the era of big data.

Pursuing a politically motivated strategy for assertive control, the comprehensive legal framework has broad extraterritorial effects. The extent to which large internet firms will be affected by the new laws on data and algorithms remains unclear. It is becoming increasingly challenging for them to navigate the emerging data governance landscape. Tech giants will have to adapt their operational models and the degree of their autonomy to comply with the laws. In theory, stringent restrictions on data collection and processing would inevitably compromise the development of AI. It is essential for China to strike a balance between materially limiting Chinese tech giants’ ability to process data and proportionately controlling data flows across borders.

Reining in data security and cross-border data flow: state interventionism

Chinese private firms overwhelmingly dominate the supply of data that comprise China’s expansive surveillance apparatus, which presents challenges to social stability and national security. Some CII operators are at the centre of scrutiny and subject to stricter oversight than before. In particular, China has been tightening the rules for companies seeking to list overseas and closing loophole by targeting offshore IPOs.⁹⁹

A political-economic theory

Sustainable economic efficiency and political omnipotence do not go hand in hand.¹⁰⁰ A contradiction inevitably persists between economic dynamism and increased authoritarian control.¹⁰¹ Under the Beijing Model, firms’ data sovereignty is crucial for attracting investor capital.¹⁰² The reinforcement of the state’s intervention into data in the name of national security is proceeding at full speed. China relies on its private internet giants, like BAT, to aid in intelligence and geopolitical competition.¹⁰³ The Chinese government is concerned that they are too big to regulate and seeks to use data governance laws to reassert control. One of its regulatory strategies is to centralize government power by tightening control over private internet sectors. A main purpose of the crackdown is to establish an ecosystem that keeps Chinese data in China, and further to maintain digital sovereignty and control through protectionist data localization mandates.¹⁰⁴ In a macro-context, it is more an epitome of a broader pattern of government efforts to curtail private firms. Behind China’s waves of regulatory action is essentially a battle for control over data between the government and private tech behemoths.¹⁰⁵

Structural adjustments to mitigate security risks

A possible approach is to introduce state shareholders to ULCCs’ governance structures in response to China’s national security and data security concerns. It is proposed that governmental investment in a company would provide effective control. ULCCs would be required to hand over their data to third-party platforms. The titans of China’s digital economy have reportedly been pushed to grant the government 1 per cent special management shares, which seeks to convert the tech behemoths into ‘public-private partnerships (PPPs)’.¹⁰⁶ The introduction of a ‘golden share’ would enable closer state control in the future.¹⁰⁷ A strategy of tightening ownership would curb the growing influence of China’s internet behemoths. Bringing in a third party to manage and monitor firms’ data could effectively limit the transfer of onshore data. It is, however, worth noting that stringent data security controls risk disrupting global supply chains (GSCs) and balkanizing international capital markets.

Scrutinize and limiting overseas IPOs: ex ante approval vis-à-vis ex post oversight

China seeks to control the vast reams of data held by tech giants. The CAC expands its national security review, proposing broad new rules to limit overseas listings. All Chinese companies seeking IPOs and additional share sales abroad would have to register with the CSRC. As part of China’s strategy to reduce reliance on the US capital markets, ULCCs with a VIE structure may need the CAC’s approval for future equity issues. These constitute an overhaul of how Chinese firms list on US stock markets. The effects on some of the world’s most innovative companies may be crippling, especially in conjunction with increased scrutiny of ULCCs.¹⁰⁸

Ex ante jurisdictional control

Chinese data-rich firms are the subject of heightened scrutiny. China tries to reassert control through a variety of regulatory hurdles. The CAC is taking a lead role in tightening regulations over ULCCs, particularly regarding cross-border transfers of sensitive information. It has mandated a data security review for firms seeking overseas listings with more than one million users, requiring clearance for potential ramifications of data transfer.¹⁰⁹ The new measures are set to significantly delay the listing process and add uncertainties. They may impose long waiting periods on any companies hoping to list abroad, which will hit investor sentiment, depress IPO valuations and make it more challenging to raise funds overseas.¹¹⁰ In the worst-scenario, the CSRC could prevent any internet firms with large amounts of user data from filing for overseas IPOs.¹¹¹ The challenges have made it difficult for Chinese firms to raise capital under stringent restrictions on overseas IPOs. Despite the lucrative source of funding, the risk of additional scrutiny could potentially thwart firms contemplating listing abroad. Amidst the ongoing turmoil, many tech firms have reportedly shelved their overseas IPO plans. For instance, ByteDance has decided to delay its IPO efforts over concerns stemming from data security risks.

Ex post mandatory requirements

China is stepping up its regulatory oversight of ULCCs as well. VIEs, like Alibaba, that have already gone public, may need approval if they seek a secondary offering. The framework would strengthen supervision of all Chinese firms listed offshore and tighten rules for cross-border data flows. The requirement marks a further tightening of government control, holding ULCCs accountable for keeping their data secure. It erects another unpredictable regulatory hurdle deterring most foreign investors.¹¹² The new rules will have huge implications in China, one of the most data-restrictive country in the world.¹¹³ The overhaul represents a major step to tighten scrutiny on overseas listings. The rules would create extraterritorial laws to govern Chinese firms with foreign listings, subjecting them to severe sanctions for non-compliance. A side effect of the increased scrutiny could be fewer Chinese IPOs on US exchanges and an acceleration of large ULCCs’ secondary or even primary listings in mainland China or Hong Kong. The stricter oversight of overseas listing may improve the regulatory framework for companies listing shares overseas. Apart from improving regulation of cross-border data flows and security, China also seeks to crack down on illegal activity in the securities market and punish fraudulent securities issuance and market manipulation.

6. More than a ‘tit-for-tat’ strategy: A game theoretical leverage

The capital sector witnesses intensified rivalries between the USA and China.¹¹⁴ Hstate and tech behemoths, and geopolitics have led to a speedy crackdown on tech giants, which is more than a ‘killing two birds with one stone’.¹¹⁵ Didi could serve as a touchstone case for China’s campaign to rein in its internet industry and wrest back control of data. The crackdown would dilute the threats imposed by the HFCAA, helping to accomplish China’s goal of decreasing its reliance on US stock markets while building up a homegrown rival.¹¹⁶

Theory of espionage

Data security issues are at the centre of China’s crackdown, based on a concern that a foreign listing could leak data if ULCCs disclose information in accordance with HFCAA for stock market debuts. A key aspect of tech nationalism is the protection of data. These concerns have escalated as relations between China and the USA have deteriorated in recent years. Ideologically, there is a deep-seated perception that the PCAOB’s auditing would lead to US espionage against China’s economic and national security. It is perceived that the leakage of sensitive data would result from the PCAOB’s access to ULCCs’ audits.¹¹⁷ The Didi debacle exemplifies the presumption that reams of Didi’s data would risk falling into foreign hands, given its sensitivity about the usage of onshore mapping data. China assumes that hostile foreign states may use such data to subvert the Chinese government, launch cyber-attacks and endanger national security. Further concerns include risks of supply chain interruption and the malicious use of data by foreign governments. As such, the Chinese government has long forbidden the PCAOB from inspecting ULCCs’ audit firms. It seems that China is willing to suffer significant decoupling costs in order to exert political control.¹¹⁸

Decoupling: a hypothetical theory vis-à-vis a strategic maximum pressure

Moves from both US and Chinese regulators seem to catalyse the decoupling of the two economies. The security probe into Didi illustrates a risk of the decoupling dichotomy between the two powers running through global capital markets. The extent to which China will crack down on its high-tech companies’ overseas listing indicates how much the Chinese government is willing to pay to ensure its dominance under state capitalism. To protect and maintain its data sovereignty, China has introduced protectionist measures and a strategic move toward a ‘dual circulation’ economy.¹¹⁹

Game of decoupling in capital markets

Rising geopolitical tensions show few signs of easing, and the threat of Chinese firms being delisted from US exchanges remains. The world is increasingly dividing into distinct, if not purely ideological, camps.¹²⁰ Differing values and political ideologies often result in policy fragmentation between the two largest economies. The tightened oversight adds to concerns of decoupling in sensitive areas like internet finance. The SEC’s threat to delist ULCCs if they fail to comply with US auditing rules underscores this hypothesis. This incremental build-up in decoupling frameworks on both sides has flung many firms into a dilemma, where the contradiction between politics and narrower financial interests becomes starker.¹²¹ The Chinese crackdown on Didi makes financial decoupling increasingly likely,¹²² while Didi’s delisting reinforces the perception and accelerates China’s decoupling from US capital markets.¹²³

One sign of financial decoupling between the USA and China is the sharp decline in Chinese direct investment in the USA.¹²⁴ This drop reflects increased surveillance of inbound Chinese investment by the Committee on Foreign Investment in the United States (CFIUS) and, more importantly, a sharp increase in the control of outbound capital by Chinese authorities. Denying Chinese companies access to US equity markets would be another sign of decoupling. US regulators have long sought to force ULCCs to submit auditing documents to the PCAOB. In response, Chinese authorities have refused to permit ULCCs to make such disclosures due to concerns about the leakage of sensitive data. China seems intent on decoupling its companies from US capital markets.¹²⁵ Predictably, the trends of protectionism and deglobalization are set to continue for years to come. China could risk losing access to the US’ deep capital markets that facilitate its pursuit of tech superiority, while US firms could be cut off from investing in China, the second largest economy. The decoupling is likely to reshape how China’s fledgling tech firms will be financed and portend changes in how foreign investors will access Chinese shares in the future.

Would either side afford the decoupling?

Economic growth has long been key to the Chinese Communist Party’s (CCP) legitimacy.¹²⁶ Behind China’s strategy of dual circulation is the goal of achieving technological and economic parity with the West. The regulatory challenges would undercut China’s economic dynamism, which has already pummelled the value of some ULCCs.¹²⁷ Without the world’s deepest capital markets, China could lose roughly $45 trillion in new capital flows into and out of China by 2030.¹²⁸ The delisting of ULCCs en masse could slow down China’s once-buoyant tech sector and potentially generate financial instability. Important as data security is, China cannot afford to kill the golden goose of tech until it has alternative growth drivers in place.¹²⁹ The Chinese authorities may, therefore, find it prudent to eliminate this vulnerability.¹³⁰ It remains debatable whether China has enough capital to sustain its own capital markets.

China’s tightened restrictions on ULCCs could threaten more than $2 trillion worth of shares on Wall Street, which may not significantly impact the US economy and financial system.¹³¹ Regarding American economic dynamism, foreign firms had only a tiny slice, namely, less than 2 per cent of banking assets and less than 6 per cent of the insurance market.¹³² The delisting will, however, hit a lucrative trade for US investment banks. This is a bargaining chip. China’s crackdown can be seen as a calculated step towards open confrontation with US capital markets and its regulators.¹³³ While some ULCCs may experience a devaluation in their IPOs, this would not pose a major challenge to the Chinese financial ecosystem. It seems that neither the US nor Chinese regulators are keen on ULCCs retaining their US listings.

A game theoretical leverage: retreat to advance vis-à-vis kill two birds with one stone

The utmost priority of the CCP is to reassert control over data security and maintain social stability. The growing clout of tech behemoths is considered a threat to the Chinese political system. China may consider its clampdown on the technology industry as a refinement of its state capitalism policy—a blueprint for combining prosperity and control to keep China stable and the CCP in power.¹³⁴ The confrontation escalated when US regulators threatened to delist ULCCS that did not open up their auditing process to PCAOB scrutiny. A tipping point of US maximum pressure has manifested in the HFCAA, prompting China to launch a strategic campaign of ‘internal pacification first, resistance to foreign aggression later’.

Contrary to a conventional geopolitical rhetoric?

China’s integration into the global economy continues to deepen.¹³⁵ Its recent efforts in financial liberalization may mitigate its reliance on US capital markets. As a vital part of global financial markets, Chinese stocks account for around 4 per cent of global stock indexes, and Chinese bonds make up about 7 per cent of some global bond indexes.¹³⁶ As a high-savings country and a net exporter of capital, China does not need US listings of its companies to import more capital. Instead, it highlights that stronger capital-market regulation should be combined with broader efforts to uphold national security and social stability.¹³⁷ How the friction plays out could have implications for Wall Street, as China has opened its financial markets more fully to some financial giants such as Goldman Sachs Group Inc.

With a shift towards Chinese markets, cross-border capital flows into China have been increasing. Foreign investors have been snapping up stocks and bonds at record pace despite China’s geopolitical belligerence.¹³⁸ In 2019, foreign ownership of Chinese bonds and stocks topped ¥RMB4 trillion.¹³⁹ Global holdings of Chinese stocks and bonds surged about 40 per cent to more than $800 billion in 2020 as investors bought assets at a record pace despite souring relations between China and the West.¹⁴⁰ Bond inflows in 2021 have taken total foreign holdings to about ¥RMB3.7 trillion ($578 billion), bringing overseas investors’ holdings of Chinese equities and bonds to about $806 billion, up from about $570 billion in 2020.¹⁴¹ Inflows into China rose from $141 billion to $149 billion, partly reflecting perceptions of China’s swift rebound from the Covid-19 pandemic.¹⁴² Another driving force is the Financial Times Stock Exchange’s (FTSE) potential inclusion of RMB in its influential global stock and bond indices tracked by trillions of dollars’ worth of assets.¹⁴³ These figures show a steady increase in foreign ownership of Chinese stocks and bonds, reflecting China’s commitment to gradual liberalization of the financial system, which foreign financial institutions have taken advantage of.¹⁴⁴ It raises the question of whether global investment is contrary to geopolitical rhetoric, given that offshore investors have been surging into China’s onshore stocks. Even so, it remains unclear about the extent of the impact on China’s strategic leverage compared to the impact of regulatory challenges to US listing imposed by both China and the USA.

Break the deadlock for a more equitable governance landscape?

China’s crackdown echoes similar concerns that motivate Western regulators, which may objectively help China reshape China financial governance landscape. The enforcement gives Chinese regulators more sway over unruly digital markets. The Didi debacle marks a new era for the modernization of China’s capital market governance. It has taken a key step in closing its securities regulatory loopholes in the face of financial decoupling from the USA. Didi’s delisting could serve as a touchstone in a transition to a tougher data security oversight regime that could reshape the landscape where Chinese tech giants develop their business in the future.¹⁴⁵ It could also make Chinese digital platform companies more competitive and stimulate innovation. To reduce US leverage, the threat of annihilation could be a strategy to prevent a bark from turning into a bite.¹⁴⁶ The crackdown on Didi will create a de facto challenge to the legitimacy of the HFCAA since China can, at least ostensibly, show its tough restrictions on breaches of cybersecurity and data protection. It seems that it is not the HFCAA that would stymie the capital flows, but Chinese regulators themselves who plug the spigot.¹⁴⁷

The paramount problem still exists that the SEC has unsuccessfully attempted to obtain Chinese cooperation with the PCAOB. The ongoing blending of tech companies globally will only get stickier amidst escalating tensions and make it increasingly difficult to cooperate when necessary.¹⁴⁸ The confrontation indicates that either side, the USA or China, would withstand the effect of the plausible delisting.

China seeks to strengthen cross-border regulatory cooperation and amend laws on data security and cross-border data flow, although the law, ideologies and technical constraints work together to map and remap power.¹⁴⁹ After all, China needs to avoid further decoupling from the global financial system. Under a theory of non-zero-sum game, China would have to keep collaborating with overseas peers on cross-border securities regulations, including strengthening information-sharing and audit-inspections cooperation. How this tension gets resolved will determine whether or not Chinese firms have open access to the deepest and most liquid source of investment capital in the US stock markets.¹⁵⁰ More specifically, it is essential for watchdogs like the CSRC to improve cross-border cooperation over audits and update rules on cross-border data flow.¹⁵¹ The effects of delisting could be manageable for both authorities. Wisdom is greatly needed to chart a middle path between outright decoupling and unconditional engagement.¹⁵² It remains to be seen whether the decoupling game could entail a more equitable governance landscape. Nor is it clear whether the USA would actually end up delisting companies, although the tension continues to escalate the decoupling.

7. Conclusion

China’s stepped-up scrutiny of overseas listings and its clampdown on Didi have darkened the outlook for listings in the USA. The Didi debacle reflects a significant move in a sweeping clampdown on China’s massive and once-freewheeling platform economy, aimed at safeguarding its data security. Due to geopolitical tensions and the two countries’ battle for tech supremacy, this case marks China’s discouragement of the listings of Chinese tech companies in the USA amidst its sea changes in data governance. The crackdown implies China’s determination to improve the regulatory framework for ULCCs and its intention to strengthen oversight of overseas listings. Meanwhile, the HFCAA portends the delisting of Chinese companies from US stock exchanges unless they meet US auditing standards. In this squeeze play, ULCCs are caught in a tug-of-war between US capital markets, which requires financial transparency, and China’s prohibition of disclosure. However, China has not launched an outright ban on VIEs, thereby eliminating the legal workaround for the sake of its strategic national interest. It remains uncertain whether the Didi debacle is China’s starkest effort to disconnect its firms from US capital markets. It is too early to say that Didi’s delisting reflects the death knell for Chinese IPOs in the USA, nor that the delisting signals an official end to US markets for Chinese tech firms. In terms of their global operations, tech firms will need to adapt to an evolving legal landscape to sustain their success and realize their international ambitions.

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Footnotes