With all the fanfare going on in the news about Chinese stocks being delisted from U.S. exchanges, many investors are currently wondering what will happen to their shares… Don’t fret, a stock holding being delisted is not the end of the world, especially for small retail investors with little need for liquidity.
This article will discuss some of the implications of a stock being delisted, with particular notes concerning Trump’s executive order regarding certain Chinese companies, but is not investment or legal advice by any means.
Your Ownership Interest Still Exists in Delisted Stocks!
While the shares might no longer be traded on the largest exchanges, they are still an ownership interest in the underlying company and can be traded “over-the-counter” (OTC) outside of the major exchanges. This is still done electronically through your brokerage account. In the olden days, companies used to grant stock certificates to investors (and some still do so for a small fee as a fun gimmick!) and these shares could be taken to different markets or countries and traded in various venues.
The political risk surrounding outgoing president Donald Trump’s executive order is a whole other bag of worms though. As announced in the order on November 12, 2020, starting January 11, 2020, purchases by U.S. investors of the securities of certain Chinese companies (see list here) with military links will be prohibited. However, transactions made to divest ownership in the companies will be permitted until Nov. 11, 2021.
With Donald Trump not set to be in office come the November 11, 2021 deadline to divest ownership interests, it will be up to the incoming administration and other political bodies in power at that time to decide whether this executive order will be enforced or rescinded.
Whether the U.S. will really expropriate the assets of U.S. citizens is doubtful in my opinion. As a Canadian citizen however, I am less concerned about this political risk.
Implications of Being Delisted
The major implication of not being listed on a major stock exchange is liquidity, which is the ease at which investors can buy or sell shares without effecting the market price. Being able to have your shares listed on major exchanges offers the volume of many intermediaries and the technological advantages of the exchange itself.
However, even shares that are traded OTC can still offer small retail investors the liquidity they need, as their investment likely represents a small amount of the average shares that will be traded OTC on a daily basis.
For foreign companies (such as the Chinese firms included in Trump’s list) which have the majority of their shares traded on their home country’s stock exchange, the liquidity of new OTC shares will generally still be plentiful. This is because the price of delisted shares traded OTC will need to closely approximate the exchange-listed shares of the company back in its home country after adjusting for currency differences. If this close approximation is lost, an arbitrage opportunity will exist and market participants will step in to buy shares in one market and sell them in another. This no-arbitrage principle is a natural occurrence in an efficient market of large companies such as the Chinese firms listed.
However, most investment funds and ETFs have restrictions on not being able to invest in unlisted securities, which can lead to lots of selling pressure as securities get delisted. In the short-term, the negative connotations and selling pressure can definitely have a downward effect on prices, but in the long-term, the business’s fundamentals are what is important.
Why is the Delisting Happening?
Companies being delisted from major stock exchanges can happen for a number of reasons. Some of the most common reasons for delisting are not meeting reporting obligations under the U.S. Securities Exchange Act of 1934, companies purposefully seeking to lower their financial reporting costs, as well as the NASDAQ’s rule to delist shares which trade below $1 per share or $1.1 million total market capitalization for 30 consecutive trading days. I have seen a couple delistings happen in my personal portfolio and will discuss them both to give investors some real-world perspective.
The huge German conglomerate Siemens was the first company I owned which purposefully delisted their American Depository Receipts (ADRs) from the New York Stock Exchange (NYSE). The reason was that trading volume of Siemens shares in the U.S. was low, amounting to significantly less than 5% of its global trading volume in the year 2013. By not having an ADR listed on the NYSE, Siemens could lower its financial reporting costs and regulatory expenses by no longer have to meet reporting obligations under the U.S. Securities Exchange Act of 1934.
In my brokerage account, Siemen’s shares went from their fancy SIE ticker on the NYSE to their new SIEGY ticker traded OTC. The new OTC shares continue to trade with ample liquidity that more than meets my needs as a retail investor, and the stock price closely approximates the Deutsche Börse Xetra shares after adjusting for currency differences.
The second company I owned which was delisted in 2018 was Liberty Tax, a provider of tax preparation services to individuals and small businesses. The company was having some internal accounting issues and was unable to get a clean audit opinion and file their financial statements on time with the regulators as required. Following the delisting, Liberty Tax saw its NASDAQ listed ticker TAX change to a new OTC ticker TAXA and its already thin liquidity further dry up. The company went through a strategic transformation while trading OTC under a new name Franchise Group Inc. (FRGA) but has since been relisted on the NASDAQ under a new FRG ticker after satisfying regulatory requirements.
The Takeaway for Investors on Delistings
Stock delisting can happen for a number of reasons but investors should remember their ownership interest still exists while they keep an eye on the fundamentals of the business. While the liquidity of delisted shares can be a concern for major institution investors, smaller retail investors will probably find that stocks trading OTC will continue to meet their liquidity needs. The current political risk surrounding the delisting of Chinese firms with military links is a unique situation and investors (U.S. citizens especially) will need to weigh their risks and rewards carefully.