What Happens When Stocks Delist? What to Know if You Own Didi.

Didi’s delisting decision comes amid brewing regulatory pressures in both Washington and Beijing. The Securities and Exchange Commission finalized rules last week that would force foreign companies to open their books to U.S. auditors or be delisted from U.S. markets if they don’t comply for three years. Reports from China, beginning last week and continuing this week, indicate that the country’s market regulator is scrutinizing the corporate structure used by companies that list overseas.

Analysts are split on what will happen next for Alibaba, JD.com, and other U.S.-listed Chinese stocks. “The risk of eventual delisting is real,” Robin Zhu, a Bernstein analyst, told Barron’s. Needham analyst Vincent Yu doesn’t agree: “On the Chinese regulator’s side, there’s no intention to delist them.”

Mass delistings would be a chaotic and dramatic move. And as Barron’s has previously reported, experts think regulators could reach a compromise within the three-year window provided by the SEC’s rule that would prevent delisting. But concerns and regulatory pressure are unlikely to disappear soon.

Here’s what investors should consider if they own these stocks. 

What Are ADRs and How Do They Work?

Investors in U.S.-listed foreign companies own shares of an American depositary receipt, or ADR. Here’s how they work.

U.S. banks bundle shares of foreign-listed companies into ADRs, which are issued as stock that can be traded on U.S. exchanges in dollars. Foreign companies, in turn, gain access to U.S. capital.

But in the case of a U.S.-listed Chinese stock, investors own shares in an offshore holding company. These shell companies are called variable interest entities, or VIEs, and are a corporate structure used by Chinese companies to circumvent Beijing’s rules about foreign investment while still tapping U.S. capital. The offshore company has a contractual relationship with the operating company, which means investors don’t have a direct stake.

VIEs are under scrutiny in both the U.S. and China. SEC Chair Gary Gensler said earlier this year he worried investors didn’t realize how these companies work and pushed for more oversight and transparency. Based on recent reports from China, regulators in Beijing are also looking to crack down on VIEs, especially technology or data-heavy companies.

What Happens to Your Shares When a Company Delists?

If a U.S.-listed Chinese company like Didi delists, there are essentially three possible outcomes for investors: a share buyback, share transfer, or share limbo.

In a buyback scenario, the Chinese company could purchase its shares back from investors at a price agreed upon by shareholders—effectively going private. If the company wishes to go public again, it would do so in a separate listing in the likes of Hong Kong.

In a share transfer scenario, investors would swap their ADR for the Chinese company’s foreign stock. In the case of Didi, which doesn’t have a secondary listing, would need to first launch a listing—in Hong Kong or Shanghai, for instance— to establish both a home for its foreign stock and mechanism for the transfer of ADRs.

If Didi doesn’t buy back shares, but rather delists and doesn’t launch another listing, the ability to trade its shares would be in limbo. Investors would still own equity in the company, but they’d be unable to trade their stock on regulated exchanges. They could sell their shares in over-the-counter markets—with limited liquidity—or hold on to them until a suitable listing was launched.

China Mobile
,
which was blacklisted by the Trump administration because of its ties to China’s military, remains a cautionary tale. The widely held stock was forced to delist from the New York Stock Exchange, leaving many individual investors unable to execute trades or transfers at their U.S. broker.

What Choices Do Investors Have?

Concerned investors have a few options if they believe that they own stock that could be delisted and want to get ahead of the risk.

The first is to sell their stake in U.S.-listed Chinese companies. If investors still want to own shares of Chinese companies, they can try to buy a stake on a foreign exchange through a brokerage. That option isn’t available on every brokerage, though.

There are other options too, including converting an ADR into a stake. Explore those options at the links below:

• How to Buy Chinese Stocks Now That U.S.-Listed Shares Have Become Risky

• How Funds Can Help Investors Navigate China

Write to Jack Denton at jack.denton@dowjones.com