China’s Regulatory Crackdown and Its Effect on the Market

Over the past decade, Alibaba, Tencent and other prominent tech companies in China have experienced blistering growth, which can be largely attributed to the growth at all costs mentality imposed by Xi Jinping and the Communist Party of China (CPC). Now the shift to more stable and sustainable growth has left these same tech companies in a cloud of uncertainty amidst regulatory concerns. On 17^th August, the State Administration for Market Regulation (SAMR) issued detailed rules tackling tech-monopolies and unfair competition. These included a ban on hijacking of traffic; fabricating deceiving information to harm competitor reputation and using cash incentives, called red envelopes, to entice positive ratings. Furthermore, companies will be barred from exploiting user data to influence customers away from competitors’ services. The decision from the CPC to impose the tech crackdown is one aspect of the ambitious objective to achieve “common prosperity”, something that is core to the party’s governing foundation. The aim is outlined to be “basically achieved” by 2050. Keeping the tech giants in line is key for Beijing to increase control over both the economy and society.

The sell-off for Chinese tech stocks, which has been brought about by Beijing’s regulatory crackdown has pushed the city’s main equites traded in Hong Kong into bear market territory. Concerns and pressures are escalating among investors, shares in three of China’s big tech companies; Baidu, Alibaba and Tencent have fallen between 18% and 30% over the last six months. Investor uncertainty is particularly evident in the gaming and FinTech sector. Within gaming, shares of Tencent and NetEase have plunged since the start of the month after Chinese state media reported that the two were among video game firms summoned to a meeting with regulators. Sentiment on the sector took a hit further when the South China Morning Post revealed that regulators were slowing the approvals process for new online games. Additionally, within FinTech, Chinese regulators continue to apply pressure, this time reportedly looking to split up Alibaba (BABA) founder Jack Ma’s Alipay. Similar market effects have been seen in the US markets for Chinese equities, currently the Invesco Golden Dragon China ETF is down 29.7% YTD. The reaction from the market possibly hints at increasing nervousness in the sector thus, with tech making up c. 39% of the MSCI China Index, it is likely we will see further weakness remaining in Chinese markets.

Without surprise, the recent developments from Chinese regulators surrounding the tech industry have clouded the outlook for Chinese tech stocks – forcing them to trade at discounts. China’s political dimension is likely to continue casting a shadow on Chinese equities, and specifically within tech. For this reason, investors should be cautious investing into Chinese tech, as it is possible it will take some time before confidence in the tech sector will rebound. With Chinese tech equity trading at a discount to its US peers, those looking for exposure in China should perhaps focus on other sectors such as consumer stocks. The common theme among Investors is the desire to have an understanding of when the playing field has been set by the Chinese regulators. The brute of the regulatory crackdown has evidently been absorbed by companies who engage in activities which destabilise society, create equity in education, sap the time of consumer internet users, and engage in predatory lending. Therefore, for as long as those sectors see sustained regulatory involvement, there will not necessarily be an endgame. On the other hand, sectors such as healthcare, core technology or enterprise, may be able to go on indefinitely with relatively less intervention. There is also the argument that we are only seeing the beginning stages of the crackdown as China goes back to a policy of total control. Through the eyes of a foreign investor, these developments in addressing wealth inequality may make it risky to hold Chinese stocks. It’s possible in the near term we will see continued weakness for tech players as investors look to shift money away from regulatory risks and towards value and quality stocks, especially companies who are exposed to the upside policy risk for climate change commitments – supported by a global trend as well as from the Chinese government.

For the short-term future, there is no shortage of additional risks for Chinese tech companies. Later this year anti-monopoly legislation will be reviewed by Beijing, prolonging the concerns regarding regulation. There is also the migration to state-run cloud systems by September 2022 for companies in Tianjin and away from private operators ran by Alibaba and Tencent to think about – this could be the start of a wider scale move across the country and take significant market share away from Alibaba Cloud despite plans of considerable investment ($28 billion over the next three years). Moreover, the crackdown on financial blogs and media could continue through Autumn, adding to the uncertainty with news coming to foreign investors. This has the potential to usher in an investing environment poisoned with miscalculation and misjudgement.

The aim to reduce wealth inequality is not limited to China’s borders and regulation of Big Tech could be well on its way to take action towards this goal in the US. Lina Khan, a 32-year-old Columbia Law School associate professor turned chair of the Federal Trade Commission, could be the pivotal appointment for the Biden administration in weakening the power of the tech behemoths. Her perspective revolves around preserving a competitive process and market structure, shifting away from the consumer welfare framework that has allowed companies such as Amazon to charge lower, anticompetitive prices to drive out smaller competitors. Similar to how China has taken action against tech companies to prevent them from utilising data to influence customers away from competitors, Khan argues that antitrust law needs to be adjusted to take into account how dominant firms acquire and exercise power and be able to identify whether or not the power shown by the current leaders in the tech industry is a threat to competition. Tech regulation is intertwined with government policy on tackling wealth inequality; China has been the first to take action and this is only the start of what could become a global trend.