South China Morning Post
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A trader works during the IPO for Didi Global Inc on the New York Stock Exchange floor in New York City on June 30. China’s cyberspace agency said it had launched an investigation into the Chinese ride-hailing giant to protect national security and the public interest, two days after it began trading on the NYSE. Photo: Reuters
Opinion
Macroscope
by Neal Kimberley
Macroscope
by Neal Kimberley

Why investors must get the message in China’s regulatory crackdown

  • Recent events might lead investors in China’s tech sector to seek out firms in sectors the government has designated as strategically important
  • Greed will still conquer fear in markets, but investing in China will require more thought than just buying the dip
Neal Kimberley
Neal Kimberley
Why you can trust SCMP
Greed usually conquers fear when it comes to investing. Investors might well perceive that the sell-off in Chinese equities, caused by Beijing’s recent regulatory crackdown on certain economic sectors, offers a great buying opportunity.

“Buy the dip” is a popular mantra with many investors. To do so when the investment landscape has shifted is a dangerous game, though, and the investment landscape has definitely shifted.

Beijing might have made reassuring noises last week to calm frayed market nerves after the equities sell-off, but it will not backtrack on its crackdown. Additionally, it is increasingly clear that China-US rivalry is going to affect cross-border listings of Chinese firms on US equity markets.
In China itself, ideological issues now have real-time consequences for investments. The Communist Party is implementing the central tenets of “Xi Jinping Thought on Socialism with Chinese Characteristics for a New Era”, including the first of 14 fundamental principles, which asserts the need to ensure the party’s “leadership over all work”.
Exercising greater supervision over the activities of certain technology companies fits with attempts to assert party leadership over all work. This is especially so given the strategic importance Beijing attaches to the vast quantities of personal data the targeted firms hold.

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Why China is tightening control over cybersecurity

Why China is tightening control over cybersecurity
In the future, investors might have to take a more selective approach towards China’s technology sector. Recent events might lead those who want exposure to this area to search out investments in firms whose business lies in areas that Beijing has already earmarked in China’s Vision 2035 development strategy as strategically important and thus worthy of support.
Investors need also to consider that Beijing is intent on tackling China’s demographic challenges and on pursuing a goal of “common prosperity”. Bearing in mind those dual policy goals, Beijing’s decision to crack down on the after-school tutoring sector becomes more explicable. The move offers the chance to address social inequalities while potentially also reducing child-rearing costs at the same time.

Investors who were caught out by China’s change of attitude towards this part of the education sector have every reason to feel aggrieved. Markets need to compute that there are ideological and practical explanations that have driven Beijing’s approach, however, and investors should respond accordingly.

That means that, going forward, the challenge for investors will be to identify investment opportunities that offer good potential returns as well as ones that will not easily fall foul of Beijing’s longer-term policy objectives.

Regulation of tech sector could be a tipping point for China’s economy

Then there is the separate but thorny issue of Chinese companies listed on US exchanges.

Beijing has long resisted allowing Chinese companies with such listings to provide audited accounts to American regulators, much to the chagrin of US authorities. Following the enactment of the Holding Foreign Companies Accountable Act in December 2020, pressure has been building on the US Securities and Exchange Commission (SEC) to delineate regulations that would permit the delisting of Chinese companies that fail to fully comply with US auditing rules.

Even though CNBC reported last week that China Securities Regulatory Commission vice-chairman Fang Xinghai had told brokerages that Beijing would still allow Chinese companies to go public in the United States so long as they meet listing requirements, it is perfectly conceivable that Chinese firms listed on US exchanges could end up being caught between the competing regulatory demands of the two countries. That would not play out well for investors.

Neither should anyone assume Washington will merely play along with future Chinese company listing proposals. Chinese firms seeking a US listing have employed a Cayman Island-linked “variable interest entity” (VIE) structure to sidestep limitations on companies from China raising capital overseas.

In effect, buyers of those shares hold stock in a shell company that has a contractual relationship with the Chinese firm but not stock in the Chinese company itself.

US authorities no longer seem wholly comfortable with this arrangement. “In light of the recent developments in China and the overall risks, I have asked staff to seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective,” SEC chairman Gary Gensler said on Friday.

Such disclosures might be forthcoming, but Beijing has already said it was planning rule changes to permit Chinese regulators to block companies from listing overseas even if the entity selling the shares is based outside China. If China comes down hard against these VIE structures, many investors could lose large sums of money very quickly.

The investing landscape has changed. Greed will still conquer fear in markets, but investing will require more thought than just buying the dip.

Neal Kimberley is a commentator on macroeconomics and financial markets

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