China has been tightening its regulatory grip across a range of private sectors in recent months, leading investors to fear the changes may not be a “one-off”.
Regulators pulled the plug on Ant Group’s $37bn IPO last November and since then, a slew of fintech companies, including Alibaba, Meituan and Tencent, have been slapped with billion-dollar fines for antitrust violations, while others, including ride-hailing app Didi, have been grilled over data security concerns.
But over the weekend authorities turned their attention to China’s booming private tutoring industry, introducing sweeping rule changes that bar businesses from turning a profit, listing on stock exchanges worldwide and accepting foreign investment.
This sent investors into a tizzy, sparking a sharp, multi-day sell-off, in which China’s biggest education and internet companies lost billions of dollars. By Wednesday shares in Tencent were down 23% for the month, a $170bn reduction in its market cap.
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China’s industrial policy has become ‘more and more statist’
While shares have recouped some of their losses since then, the government crackdown has left investors feeling jittery and wondering which sectors could be impacted next.
Rathbone Investment Management co-CIO Edward Smith (pictured) thinks there are several reasons why the crackdowns in education, housing and tech “may not be one-offs”.
Under president Xi, China’s industrial policy has become “more and more statist,” Smith says.
“The latest Five Year Plan (FYP) was very clear that it wants to corral investment toward high tech manufacturing, which the leadership believes is how China can avoid falling prey to the ‘middle income trap’ and have a shot at challenging America’s place at the scientific frontier,” he says. “That means diverting investment away from property developers and service companies, even digital ones.”
China’s more aggressive intervention could also be viewed as an act of self-preservation, Smith says.
“China knows that Biden is gunning (economically-speaking) for them just as hard as Trump was. Therefore, the recent crackdowns, which have focused largely on offshore-listed companies, could be about planning for the worst – directing capital back towards domestic bourses and, again, to industries such as semiconductors in which China will need to increase competitiveness if it is to survive an economic cold war.”
“We don’t invest by second-guessing Beijing policymaking,” he continues. “But the fact that there are strategic reasons why China may have carried out some of the recent crackdowns as well as company-specific ones means that we should factor in a permanently higher risk premia when valuing these companies.”
Regulatory uncertainties could prompt US-listed Chinese companies to seek secondary listings
JP Morgan Asset Management global market strategist Chaoping Zhu doesn’t think the US-China relationship plays a direct role in the latest policy shift.
“That said US-listed Chinese companies remain subject to ongoing regulatory uncertainties from both the US and Chinese authorities,” he says. “This could prompt companies to seek secondary listings in Hong Kong or mainland China.”
Zhu believes the rule changes to China’s $100bn private tutoring industry are “unique” and do not foreshadow changes to come for other sectors.
“We do not see these actions setting a widespread precedent for other sectors, nor are they indicative of Chinese policymakers’ broader intentions towards the operations of private sector companies or the use of foreign capital,” Zhu says.
“Recent interventions by regulators aimed at China’s internet companies have been clearly focused on improving overall market competitiveness to enable more private companies to thrive over the long term.
“All of this suggests to us, on balance, that Chinese authorities continue to regard domestic and foreign capital as positive elements for the functioning of Chinese markets.”
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Offshore tech sector market cap has plunged 30% since regulatory scrutiny was stepped up
But the fact that most of the companies in the government’s crosshairs are majority owned by foreign investors has not gone unnoticed.
Alibaba, which was ordered to pay the largest antitrust fine on record of $2.8bn in April, is 25% owned by Japanese conglomerate Softbank, while Blackrock and T Rowe Price each own 2% of the business and Baillie Gifford owns 1%.
By contrast Huwaei, which is a privately held company owned by employees, has faced little resistance from the government.
Smith points out that the market capitalisation of China’s offshore tech sector has fallen by 30% since last September when regulatory scrutiny was stepped up. Meanwhile the market cap of its onshore tech sector has increased by around 30%. “This could be coincidence, or it could be by design,” he says.
Fidelity GEM fund trimming exposure to Tencent and Alibaba
Fidelity Global Emerging Markets portfolio manager Amit Goel has been trimming his positions in Alibaba and Tencent in recent months and has sold down exposure to smaller peers earlier in the year.
He thinks the downbeat market reaction to increased regulatory concerns, particularly in the internet sector, is “logical” given these issues “raise question marks on long-term regulation, profitability and capital allocation on these businesses”.
“We still don’t have deep insights into the data security framework which the Chinese government is trying to employ but it is very clear from the actions of last six to 12 months that the sector is going to be more regulated which is a negative for our long-term thesis on some names,” says Goel.
But he and co-manager Nick Price are maintaining “selective and measured exposure” to Chinese tech companies.
“Whilst we expect the regulatory scrutiny to continue in future, we should also be mindful of the fact that the sentiment is very negative around the sector and regulatory environment can be back and forth as we have seen in history.”
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