To better understand the crackdown on Chinese tech companies from a Chinese perspective we need to take a look at what is being said inside China. In this second article in a series (read part 1 here), we’ll look at ‘disorderly expansion of capital’ and an opinion piece by Ren Yi, a.k.a. Chairman Rabbit.
Disorderly expansion of capital
In December 2020, Xi Jinping presided over a meeting of the Political Bureau of the CPC Central Committee. Among many other things, the meeting called for strengthened antitrust efforts and the prevention of ‘disorderly expansion of capital‘. Preventing ‘irrational’ or ‘disorderly’ expansion of capital has been a magic phrase ever since.
“Why ‘disorderly’?”, you might ask. Well, here’s a few examples. Monopolies in the private sector have made it a bit too easy to get consumer loans to buy stuff on their affiliated e-commerce platforms while adding risks for smaller local banks that provide the actual loans (Ant Group and Alibaba Group). e-Commerce companies have forced merchants to sell exclusively on their platforms, thereby making competition between platforms more difficult and possibly driving up prices for consumers (Alibaba, Meituan). Community Group Buying platforms were selling below cost-price in their attempts to attract price-sensitive consumers, while pushing out small merchants and pop-and-mom shops from the market (Alibaba, Meituan, Didi and others). Internet companies have abused customers’ data to implement discriminatory pricing and have circumvented labour laws by having their staff ‘voluntarily’ work 72 hours or more per week (many). Gig economy companies have had algorithms manage their workers, have paid them badly and haven’t provided social securities (Meituan, Ele.me, Didi). These are all results of the ‘disorderly capital expansion’. Give any one industry too much rope …
The world according to Chairman Rabbit
Ren Yi (aka Chairman Rabbit) is a graduate of Harvard University’s John F. Kennedy School of Government, former assistant to the late renowned sinologist Ezra Vogel and an influential Chinese blogger who has more than 1 million followers on Weibo. In an opinion piece in Caixin, Ren explains how 7 categories of companies are now being targeted by the government.
- Companies that are ‘too big to fail’ and ignore or even defy regulations. Characteristics:
- They cause risk to local economies or other companies in sub-sectors and related industries.
- They have deep connections with the financial system.
- They operate massive ecosystems connected to workers, consumers or end-users.
- They have the potential to establish a monopoly through technology (e.g., internet).
- Companies involved in (national) security issues. Risk: disclosure of information to foreign regulators when listing abroad. Being used as ‘bargaining chips’ in international tensions.
- Companies in industries closely related to people’s livelihood that are subject to China’s overall strategic direction. Examples: education, finance, real estate. Risks: inefficient allocation of resources, profit-seeking.
- Companies that hurt small and midsize businesses or consumers through abuse of market power and monopolies.
- Companies in labour-intensive industries that don’t protect basic rights of workers (wages, social security, safety).
- Companies that produce or deal with content related to culture and ideology.
- Companies that violate traditional morality or values.
Ren explains that the government is bothered by financial and capital drivers behind the companies that fall in these categories. The disorderly expansion of capital that has been mentioned since the end of 2020, combined with the size of the companies, their listings overseas and ignoring of government regulations has resulted in the hard crackdown.
All the companies and sectors that have been hit by new regulations and fines fit neatly into one or more of Ren’s 7 categories: Alibaba (1, 4), Ant Group (1, 3), Didi (2, 4, 5) and Meituan (4, 5). Some of the categories also match the five focus areas for legislation I described in a series of Dutch articles earlier this year: anti-monopoly, financial markets, privacy and data security and content. More recently education and labour rights seem to have been added to the government’s list of grievances.
Ren continues his opinion piece by explaining the characteristics of China’s regulators and incorrect views of foreign investors that now worry about investing in Chinese companies. I’m less convinced by some of his reasoning, but the advice he closes off with seems to be a reasonable one: investors should ‘discount’ the valuation of a Chinese company to reflect regulatory pressure and a different logic of governance. Ren also writes:” China doesn’t need to bow down to overseas investors when it comes to supervising the sensitive industries and companies and cannot be influenced by them.”
Regarding foreign IPOs, some people are wondering: “Does the Chinese government want to prevent companies from listing abroad?” While the CCP might have a preference for Chinese companies listing in Hong Kong or Shanghai’s STAR market, listing abroad is not forbidden. New legislation that was implemented after the Didi IPO will however require companies with one million users or more – I can’t imagine a Chinese B2C internet company with less users even considering listing – to go through a national security auditing process first. In this process it will be determined if there is a risk of national security through data sharing. That doesn’t seem unreasonable to me. Didi ignoring requests to have its cybersecurity in order before listing has made such a law necessary in the government’s eyes. Depending on the type of company and the data it holds, listing abroad might indeed be forbidden. But not by default.
Besides, there are cases in which listings in Hong Kong or Shanghai are difficult because requirements on leadership structure, compliance and profitability might be stricter than abroad. Didi could not list in Hong Kong because it didn’t have its licences for drivers and cars in order. Foreign listings will therefore remain attractive and not forbidden, but the government will determine on a case-by-case basis if it would be too risky to be allowed.
Noticing the worries in the markets, the China Securities Regulatory Commission held a video conference with executives of major investment banks on the 28th of July to inform them that the regulations in the education sector (more on this next time) were targeted and not meant to hurt companies in other industries. Recent crackdowns were meant to fix industry-specific problems and China had no intention of decoupling from global markets, they told participants. According to the South China Morning Post the official Xinhua news agency published a commentary saying that recent regulatory acts were aimed at “fostering healthy growth” and overseas share listings could continue in the future. This reassurance was highly necessary since investors had started to ask themselves if Chinese companies were getting too risky to invest in. I doubt if the investment banks are relieved though.
Some investors are now complaining about the lack of disclosure of risks that accompany IPOs of Chinese companies. But anyone that has ever browsed through a prospectus of a Chinese internet company knows that they are filled with assessments of the real risk of changing government regulations. Take the prospectus of Ant Group, which contained 56 pages of risk assessment, including many pages on potential new regulations of the financial market by the government.
Likewise, Didi’s prospectus contains 60 pages of risk assessment, many of which are related to the government, among which on page 53: “Changes in China’s economic, political or social conditions or government policies could have a material adverse effect on our business, financial conditions and results of operations.” Having said that, many are questioning why Didi failed to mention the CAC’s request to withhold an IPO until they had their data security in order.
The tech crackdown has investors worried about the risks of investing in Chinese companies, while they should have considered risks of investing in Chinese companies all along.