Since the end of July, news has been dominated by a clash between the Chinese tech sector and regulators, rattling Chinese financial markets and placing doubt over the future of the sector that has been driving the Republic’s economy during the last 20 years.
China’s unprecedented “tech crackdown” began last November, with the suspension of Ant Group’s much-anticipated IPO, that was only the beginning as their regulations became more aggressive. Companies like Alibaba, Tencent, Meituan, and Pinduoduo were hit directly. The clampdown also was harsh on online private education and tutoring companies, as well as cryptos.
We will go over what exactly is happening in China and what are the reasons behind putting the brakes in the globally leading industries.
What is the Deal?
There are a few major points that we will go over to display what is happening, mainly the Antitrust probe, an overhaul of data security, and a check on irregular capital expansion.
1. Crackdown on Antitrust:
- This was initiated by China’s watchdog on financial markets; the State Administration of Market Regulation (SAMR).
- The law was first authorized back in 2008, but only enforced in November.
- A week after the IPO of Ant Group was suspended, the SAMR laid out its new regulations for internet platforms.
- China’s Politburo, the junction of all political power in China, declared its support in December for the initiative, and this unleashed the SAMR on China’s tech sector.
- The impact of the scrutiny has been felt across most sectors and over 35 internet companies.
- On the surface, this may seem like it would have a negative impact, but if China managed to properly put antitrust laws and regulate the behemoths of tech, then it would have achieved what the US has now failed to even start doing.
2. Chinese Data Security:
- This is handled by the Cyberspace Administration of China (CAC), an agency founded by Xi Jinping in 2014.
- This controls China’s censorship framework while making sure data on China’s citizens does not go outside the country.
- This started back in 2013 when China began pushing for data security in the wake of the US National Security Agency surveillance scandals.
- Two years after the foundation of CAC, they passed a broad cybersecurity law that banned most data collected by private companies to leave China. Not only domestic companies like Tencent and Didi were abiding by this law, but also foreign giants like Apple.
- Tesla was among the first companies the CAC applied its laws on, banning its cars from China’s military. Tesla then had to meet the new regulations and announced it would store local data in order to operate in China.
- On 2 July 2021, two days after Didi launched its IPO in the US, the CAC suspended its ride-hailing app for breaching security protocols.
- Shortly after, freight logistics application Full Truck Alliance and recruitment app Kanzhun were suspended.
- In the same month, they passed the Data Security Law (DSL), which would terminate companies for “mishandling core data”. That term is still unclear yet, so the tech sector is still jittery about its ramifications.
- The government is attempting to revise what is called the VIE Structure, which is the way Chinese companies raise equity, mainly by doing IPOs in the US.
- Since the law does not allow foreign ownership of Chinese companies, the VIE structure allows high-risk tech startups to gather funding.
- The looming change to that structure could hamper the substantial growth these high-growth companies could have.
3. Irregular Capital Expansion:
- In December 2020, China’s Politburo made a vow to stop “the disorderly expansion of capital”. This is one of the notable recent affairs.
- The Ant Group’s IPO was suspended on this basis, together with the crackdown on fintech, media, gaming companies, and the private tutor.
- This one issue can be justified by Politburo’s message behind “disorderly expansion of capital,” in the context of that growth being at the expense of public interest.
- Ant Group’s business model looks similar to the predatory lending that caused the global financial crisis in 2008.
- The most recent example was the ban on for-profit tutoring last month.
- Shares of companies like New Oriental Education, Goatu Techedu, and Tal Education Group took a huge slump then. Prices slumped as much as 70% in a single session for some.
- This came after a public outcry over the tedious education system and the inordinate education costs, as well as following the issuance of gaming curfews for minors and stopping approvals for new gaming companies after a public outcry on gaming addiction in 2018.
- It is not certain if regulators anticipated the impact on financial markets or the future of its economic plan as this is damaging the main consumer-centric industries in China.
- Alibaba’s share price has been in a year-long downtrend, even with consistent acceleration in growth.
What is the Reasoning?
So far, the reasoning is not yet clear. We can try to make sense of the reasons and think of a few goals behind the massive regulatory actions.
1. Shifting to a German-like economy
This means that China is trying to direct its efforts away from the highly profitable “consumer internet” and towards more strategic technologies such as industrial technologies, biotechnologies, and hard technologies (e.g. batteries and semiconductors).
2. Appeasing the public
The “tough-on-business” regulations could be China’s solution to translate the public disappointment in the status quo.
Public backlash over workers’ rights and housing and education costs are starting to trigger a regulatory reaction from the Chines government that is actually pouring in favor of its people rather than investors.
The perception that the government is favoring the well-being of its people is needed and will prove to be popular. One could say that this works more in the East than the West, but the west could use some of that tough pro-consumer regulations.
Who Will it Reach Next?
- This industry has been one of the biggest areas of disenchantment and the government has publicly hinted that it will try to control prices.
- The aspect of social inequity, one of the main reasons for the crackdown on education, is the focal point for this industry.
- China President Xi Jinping previously said, “Housing is for the living and not for speculation,” which was echoed by Vice Premier Han Zheng that the property sector should not be used as a short-term tool to stimulate the economy.
- This is the industry that is believed to be most in need of reform.
- Healthcare companies with high medical expenses, and accompanied by cosmetic costs, are expected to be on the watchdogs’ anti-monopoly radar.
- Some healthcare sectors are expected to be safe. Sectors with more strategic importance like biotech and novel drug makers should be less vulnerable to regulations.
- In China, the gaming sector is controlled entirely by only two companies, NetEase and Tencent.
- The government has already placed multiple regulations in the past few years, but more is expected to come. The industry has no discernable value to the objectives of the state, and there is still public outcry over its expansion and addictive nature.
Advertising and the Cloud Space
- Since the government is big on protecting the citizens’ data, we might see some new laws that change the way data is handled on the cloud space, especially for foreign companies.
- Regulations on what type of content is used for marketing have already been put in place in apps that feature advertisements, but there could be more coming for marketing providers for use of misleading content.
- Nearly USD 400 billion have been shed from the value of US-listed companies, however, this type of risk has always existed in both eastern and western markets, as have the opportunities that come with it.
- The drop in some of these companies should not be seen as a complete reversal.
- Shifting the weight of your investment towards companies that align more with the new strategic goals of China seems like a good idea.
- Industries like 5G, biotechnology, AI, green energy, and semiconductors, not only align with China’s strategic goals, but also the rest of the world.