Data as of July 29, 2021. Source: Bloomberg.
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What has happened?
Chinese policymakers have taken steps over the last eight months to step up regulation on several companies and industries, including consumer-facing technology platforms, private education, and property developers. Alibaba, a Chinese tech company analogous to Amazon specializing in e-commerce, retail, internet, and technology, as well as other major tech-related companies, found themselves in the crosshairs first as Chinese authorities halted the IPO of Ant Financial—Alibaba’s financial technology affiliate—and followed up a few months later with a $2.8 billion fine related to anti-competitive practices. The pace and scope of regulatory scrutiny appear to be accelerating, with the most alarming displays of reach occurring in July with the conversion of all Chinese private online tutoring companies to nonprofit companies and the forced cancellation of exclusive music contracts by Tencent Holdings Ltd. Regulations on property developers have increased and are expected to continue.
Why are Chinese policymakers doing this?
We have been in constant communication with our investment partners and emerging markets managers who either have an on-the-ground presence in China or intimate knowledge of Chinese politics and corporate culture. The reasons for the shift in regulatory enforcement are complicated, and the measures being taken are even more difficult to understand. The American corporate and legal system obviously operates very differently from that of China. A deep understanding of China’s long-term goals and current challenges has never been more critical for investors.
We identify four main priorities that have led to a structural change in regulation: 1) data security, 2) competition, 3) economic opportunity, and 4) population growth. So far, all regulatory action has been tied back to these four priorities in some way, all of which are part of China’s broader long-term economic and geopolitical strategy.
We expect that China will continue to take a hard line with technology companies when it comes to data security, particularly for companies looking to raise money outside of their domestic capital markets. That was the major issue with the Chinese policymakers’ response to Didi’s U.S. initial public offering (IPO). Didi is China’s version of Uber or Lyft, and the company filed for IPO on the New York Stock Exchange in June. However, just days after listing, the Cyberspace Administration of China launched an investigation into the company’s data privacy and risk as a threat to national security. The Didi app was ordered to be removed from all Chinese app stores. Competition and antitrust are also major concerns given the size and dominance of China’s major consumer-facing technology companies, like Alibaba and Tencent.
Economic opportunity and population growth are closely linked to the elevation of the middle class. China has reversed course in recent years, realizing the potential long-term damage to economic growth from their prior one-child policy, established in the 1970s (Figure 2). This policy was revised in 2016 to allow two children and, in May of this year, changed yet again to permit up to three children per family. However, the financial costs associated with raising three children are stifling population growth. The private education system in China, for example, is one in which extreme competition amongst students has led to sky-rocketing tutoring costs and an increasingly two-tiered system of upward mobility. The speculation in the property sector and the cost of homeownership is another inhibitor of population growth and of an industry facing regulatory scrutiny.
Figure 2: China aiming to reverse the population trend