China has embarked on an unprecedent regulatory crackdown on several companies across a range of sectors since the cancellation of the ANT group's IPO in November 2020. The objective behind the tougher regulatory regime is to achieve China's long-term goals of common prosperity, technology independence and the creation of a more sustainable economy. The timing of these changes is likely being driven by the upcoming 20th Party Congress in 2022, when President Xi Jingping expects to extend his leadership beyond the previous two term limit, which was abolished by the National People's Congress in 2018.
Some significant examples of regulatory and policy actions that comprise the crackdown:
Antitrust Crackdown on Big-Tech: The State Administration of Market Regulation (SAMR) launched an anti-trust probe into China's internet companies. Alibaba was the first to be subjected to the regulatory probe due to its actions that restricted merchants on its platform from doing business or running promotions on other platforms: the probe resulted in the company paying a record $2.8 billion fine. Subsequently, almost all big tech firms were required to rectify their antitrust practices. Almost all of these companies have now been fined by the SAMR for failing to disclose mergers, making vendors sign exclusivity contracts and engaging in false advertising, among other violations.
Further on August 17th, SAMR introduced draft regulation that banned unfair competition among internet companies that is expected to be implemented this year. The draft rules target anticompetitive practices, such as false advertising, fake reviews, unfair competition, data protection and consumer privacy. The state regulator has also said it is studying proposals to further ensure the rights of drivers who work for ride-hailing companies and to step up oversight of the online streaming industry. The unprecedent speed and degree of the regulatory changes has had an adverse impact on the stocks of these internet and eCommerce companies with index heavyweights such as Alibaba, Tencent, Meituan, JD.com and Baidu declining more than 20% year to date (through August 18th). Given that technology stocks dominate the MSCI China index, China has been among the worst-performing markets in EM this year.
Data Security: Data security has also become a major concern for the communist party. In recent policy documents, the government has designated “data” as a factor of production on par with land, labor, capital and technology. To oversee data security, the Cyberspace Administration of China (CAC) was formed in 2014. The agency oversees the country's censorship apparatus and also secures data of Chinese citizens that is collected by private companies. To that end, a cybersecurity law was implemented in 2017 that banned domestic data from being stored overseas and marks a shift in China's data strategy away from a narrow focus on security and towards a multi-pronged approach balancing security concerns and economic benefits. The ride-hailing app Didi was one of the biggest victims of the country's drive to enforce data security. The CAC suspended Didi's app on July 2nd, (just two days after the stock started trading on the NASDAQ), for violating security protocols. Subsequently, two other apps, Full Truck Alliance and Kanzhun, suffered the same fate.
China Regulatory Crackdown Punishes Chinese Equities
After School Tutoring (AST): In July, General Office of CPC Central Committee and General Office of the State Council jointly announced the "double-reduction" policy to reduce the burden of homework and after-school tutoring (AST) on students at the compulsory education stage (grades 1-9). A significant driver for the attack on the education sector has been demographics. China announced a three-child policy in May 2021 to address its aging and shrinking workforce. However, the cost of raising children has risen significantly, and one of the main drivers for this has been after-school tutoring, which saddles parents with exorbitant fees and discourages them from having more children. There was also a sense that after-school tutoring was contributing to inequality in Chinese society, as only the wealthy are able to afford tutoring. The government has also been concerned about the impact on children's health from all the additional work involved in attending after-school tutoring. Some of these tutoring institutes also held classes on weekends and summer/winter vacations further adding to the burden on children. Earlier this year Xí Jìnpíng held a conference on the health of children in the education sector and told committee members that the tutoring industry had become “a stubborn malady.” The regulations also address other issues, such as false advertising and aggressive expansion within the sector that was starting to hurt customers.
The regulations were harsher than expected with continuous monitoring by the government and the targets to effectively reduce the burden on students in one year and to achieve a meaningful outcome in three years. The new policy effectively banned academic AST for grades 1-9 for weekends, public holidays and summer/winter holidays, allows no new approvals of any academic AST agencies and requires existing agencies to re-register as non-profit organizations. Academic ASTs are also banned from IPOs or any fund raising, and existing listed AST companies are not allowed to raise money to invest in AST or merge with or acquire academic AST assets via share issuance or cash. This led to a sharp sell-off in stocks within the sector with Tal Education, the largest stock within the index, declining almost 70%.
In addition to the examples mentioned above there have also been several policy interventions addressing social matters, including climate change, property prices and healthcare.
The speed and breadth of the policy changes has created an environment of uncertainty for investors. Tencent Holdings has said the industry should brace for more regulation and uncertainty. This has resulted in Chinese stocks underperforming their global peers. Also, given that Chinese stocks have the largest weight (~40%) in the MSCI emerging market index, they have been the most significant contributor to EM's underperformance relative to developed market equities. If prior regulatory crackdowns by the Chinese government are any indicator, it is likely that the ongoing regulatory crackdown continues in the near future as the Chinese Communist Party forces its corporate behemoths to align behind its long-term strategic goals.