You may be thinking of investing in China because the country is one of the top destinations for international investments. You may also be interested because of the Chinese new year. In any case, let’s just say that it may not be a bad investment idea. The country does not only report double-digit GDP growth. It is also one of the largest economies in the world. With this in mind, many investors buy shares of Chinese companies in stock exchanges in New York, London, or Frankfurt.
With that, if you are willing to become a trader of Chinese stocks, you need to be aware of the risks. Experienced investors in China are usually fully aware of the changing regulatory environment and the unique characteristics of Chinese Stocks. In this article, I offer some fundamental risks that you need to learn.
1. New Economic Policies of the People’s Republic of China Government May Damage Your Stock Returns
It is not a secret that the Chinese government has significant power over laws and regulations that may affect the economic environment in the country. It does not matter the industry that you choose. Any slight change in the regulation may adversely affect the results of your company. As a result, the stock price will most likely decline.
2. The Company May Be Controlled By The CEO, Who May Take Care Of Her/His Interests, Not Yours
Many companies based in China are controlled by the CEO or any other large investment group. It means that the controlling shareholder controls the Board of Directors and may elect non-independent directors. In this case scenario, directors may decide to raise their salaries to insane levels. Besides, if the company does not perform, removing the management may be very difficult. Take into account that any takeover attempt may be blocked by the controlling shareholders. In this case scenario, traders may lose tons of money in the medium term.
3. If The Company Is Incorporated In An Offshore Jurisdiction, Traders May Not Be Protected
There are many Chinese companies that are incorporated in The Cayman Islands, The British Virgin Islands because they offer tax benefits and fewer regulations. With that, you need to proceed with caution. Take into account that securities law in offshore jurisdictions is not developed. Traders are less protected than in Delaware, London, or Paris. Directors may not have the obligation to act in the best interest of traders and shareholders. Besides, it may be difficult for foreign investors to start actions against the Board of Directors because some of the members live in China.
Many traders may not invest in companies incorporated in an offshore jurisdiction. It means that the demand for the company’s stock may be minimal. As a result, traders may encounter significant issues as the stock exhibits significant trading volatility. If you are not an expert in volatility plays, you may simply lose money.
4. Related Party Transactions May Be Detrimental For The Financial Results
With many entities being controlled, Chinese companies report more related-party transactions than companies in the United States, Germany, or Japan. There are many types of related party transactions that may damage the company’s bottom line.
The company may be using a property owned by the CEO. In this case, the CEO would be receiving some money for the rent. Management may also decide to hire consulting companies owned by directors or linked to the CEO. Controlling shareholders could also force the company to sign collaboration agreements to share intellectual property with related parties. In all these case scenarios, traders may lose money. Keep in mind that the company may pay less money if management works with a non-related party.
5. If The Assets Are Located In China, Foreign Traders May Have Little Information About The Company’s Operations.
Even if you speak Chinese, if you live in the United States or Europe, you may have little visibility over the company’s assets or operations in China. Traders investing in China will find information on the company’s website, which may not be enough. Take into account that you may be investing in a brand that you hardly know because it is not present in your country.
That’s not all. If the company does not have operations outside China, the brand may be unknown. In this case scenario, a few foreign traders would invest in the stock, and the demand for the stock would be limited. As a result, management may have issues while trying to find equity financing. In sum, the financial risk may be significant, and traders could lose money.
