What happened

Chinese stocks sold off significantly on Friday morning. As of 11:50 a.m. ET:

  • E-commerce giant Alibaba Group (NYSE:BABA) was down by about 8%;
  • Internet streamer iQIYI (NASDAQ:IQ) had lost 13.2%;
  • Video game streamer HUYA (NYSE:HUYA) had shed 14.4%;
  • Alibaba's archrival in e-tail, JD.com (NASDAQ:JD), was down 9.3%;
  • And for-profit education company New Oriental Education & Technology (NYSE:EDU), already hard-hit by intensifying Chinese regulation of its industry that began earlier this year, had slipped another 8%.
Chinese flag superimposed on a stock market chart

Image source: Getty Images.

So what

So what's going on in China today? Actually, this is more a story of what is happening to Chinese companies that are listed on U.S. stock markets.

Simply put: They may not remain listed here much longer.

Ever since the Trump administration, U.S. regulators have been weighing the possibility of using the threat of delisting Chinese stocks from U.S. markets as a way to require greater transparency from Chinese companies about their finances, and to discourage such behaviors as censorship, internet piracy, intellectual property theft, and human rights violations both by those companies and the Chinese government. This threat was repeated early in the Biden administration, and now it seems the risk of delisting is greater than ever.

As Securities and Exchange Commission Chair Gary Gensler explained in a statement Thursday regarding amended rules for companies under the Holding Foreign Companies Accountable Act: "We have a basic bargain in our securities regime ... If you want to issue public securities in the U.S., the firms that audit your books have to be subject to inspection by the PCAOB [Public Company Accounting Oversight Board]."

As the regulator's press release explains, under these rules, any foreign company trading on a U.S. stock exchange will be required "to submit documentation to the SEC establishing that, if true, it is not owned or controlled by a governmental entity in the public accounting firm's foreign jurisdiction," along with "certain additional disclosures." Companies that fail to provide acceptable documentation face the risk that the SEC will sanction them by prohibiting their securities from being traded on U.S. markets.  

Now what

Granted, as a CNBC journalist noted in a televised segment on the new regulations Friday, the Chinese government has explicitly been forbidding its companies from complying with U.S. disclosure rules. But regardless of where one places the blame, the potential consequences for those companies failing to provide the information the SEC demands will be the same: delisting. 

So what happens now? Despite the drastic reaction on Wall Street Friday, delisting won't be immediate. The SEC's announcement was more in the nature of a shot across the bow -- the U.S. government warning China that it's really serious about this. Still, the new rules do move the SEC and China a step closer to a confrontation, and raise the risk that Chinese companies -- even great hulking big ones like Alibaba -- will be booted from U.S. exchanges if they fail to comply.

Investors Friday are selling before that can happen.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.