Hong Kong - Moody’s warnings on accounting and governance risks at dozens of small Chinese companies sparked a sell-off in their shares and bonds on Tuesday, as investors already unnerved by accounting scandals at overseas-listed Chinese firms stampeded for the exits.
The rating agency’s report comes as US and Chinese officials are holding a two-day meeting in Beijing to discuss joint supervision of China-based audit firms that review US-listed mainland companies.
“The Moody’s report is another excuse for people to sell off these stocks,” said Patrick Shum, president of BMI Funds Management in Hong Kong.
“Some of the Chinese companies have operational practices that are questionable, but it may not be just concentrated in certain sectors that we’ve seen. So far, we haven’t seen gambling stocks or retail stocks being targeted, but it’s hard to say who will be next,” he said.
Accounting scandals at US-listed companies based in China have been the subject of regulatory probes and dozens of investor lawsuits in America. A number of companies were highlighted in research reports by short-sellers.
Moody’s said it screened 49 junk-rated companies and a few investment-grade firms in China against 20 yardsticks it called "red flags", grouped into five categories: weak corporate governance, risky business models, fast-growth strategies, poor earnings quality and audit concerns.
The companies are mostly small and mainly listed in Hong Kong, but include stocks listed in North America and elsewhere in Asia.
Shares and bonds issued by the firms on the rating agency’s list bore the brunt of selling on Tuesday. Some of the stocks tumbled more than 20% at one point, contributing to a 3.7% drop in the Hang Seng Chinese Enterprises Index which tracks major Hong Kong-listed Chinese shares.
The blue chip Hang Seng Index also suffered its worst one-day drop in 14 months, dropping 3.1% as the eurozone debt crisis worsened.
Bonds of several Chinese companies mentioned in the list tumbled even as analysts and investors maintained such issues are well known and do not bring to light any new credit concerns.
“On a longer term horizon, valuations are attractive but in the coming weeks, it will be relatively volatile since it will take some time until there is clarity about the quality of results reported by companies which have recently been accused of earnings manipulation by short-sellers,” said Joep Huntjens, fund manager with ING Investment Management which manages about $400m in Asian credits.
Red flags Representatives from the US Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB) met with officials from China’s ministry of finance and the China Securities Regulatory Commission (CSRC) on Monday and again on Tuesday.
US regulators have faced criticism about lax oversight of American shell companies acquired by Chinese firms through so-called reverse mergers to gain access to US capital markets without having to go through an initial public offering.
The PCAOB has been trying to inspect China-based auditors of US-listed companies since 2007 but has encountered reluctance from China. However, the recent run of scandals has upped the pressure on regulators from both jurisdictions to improve cooperation.
PCAOB chairperson James Doty told Reuters last week that he expects a deal to be in place by early next year.
Most of the Chinese companies on Moody’s list are non-state firms involved in resources or property sector - which was among the most active overseas high-yield issuers this year as China took steps to cool its real estate market and tighten credit controls. Their stocks nosedived on Tuesday to multi-month lows.
Moody’s said that the most common corporate governance weaknesses involved family ownership, which led to decision-making processes that favoured the interests of some shareholders at the expense of bondholders and other creditors.
Of the 49 companies mentioned in the Moody’s report, more than half were property firms.
Longfor Properties, which is on the Moody’s list, fell as much as 16% to HK$11.54. West China Cement, which received 12 red flags from Moody’s, plunged 26.5% at one point.
China Forestry Holdings received the same number of red flags. Its shares have been suspended from trading since January after Hong Kong’s securities regulator said it had started court proceedings against the chief executive of the company, which is backed by Carlyle Group.
Also on the Moody’s list are several Chinese mining and chemical companies, including coking coal miner Hidili Industry International Development, Winsway Coking Coal Holdings and China Lumena New Materials.
Citic Pacific is the only Beijing-backed major company on the Moody’s list. The conglomerate, whose shares lost more than 4% on Tuesday, suffered huge losses in 2008 due to its wrong-way bets on the Australian dollar.
It is not time for bargain-hunting yet, some equities analysts say.
“The issues raised in the report are not particularly surprising, but at the moment who wants to catch a falling knife? Real money and long-only investors are cutting positions and (it) looks like they want to sit on cash at this point,” said Tom Kaan, a director at Louis Capital.