Is China Out to Get Foreign Investors and Move Listings Back Home?
Sep 15, 2021
By Aleksey Mironenko

China's objectives are a question that's top of mind for many of our clients in recent months. While anything is possible, we don't think punishing foreign investors or moving all listings back to China are the goals. Though some listings may move to Hong Kong, Shanghai, or Shenzhen, that process is not straightforward. It will only occur if the US and China cannot resolve their regulatory disclosure differences. But before we get to that, let's take a broader look at why the regulatory crackdown in China is happening and what the Chinese government is trying to accomplish.

The regulatory regime change has caught many investors by surprise, but if we look closely, we'll find that many of the issues are not dissimilar to challenges voiced in the US and Europe. The difference is that China is obviously a less transparent environment and acts decisively without public debate. It's hard to know what's being discussed and when decisions are to be expected, with the latest bout of evidence of this fact creating a crisis of confidence by the world's investors.

We believe China's regulatory objectives break down into three distinct components: domestic industrial and social policies, company-specific regulation, and geopolitical/security regulation.

Domestic industrial and social policies

 

Technology giant loopholes

  • Anti-competitive behavior – Tencent, Alibaba, and others have required "them or us" commitments from retailers for many years. If you're on Alibaba's platform, you can't be on Tencent's. The new rules stop these policies and require all "platform" businesses to be open (i.e., compete on their merits rather than lock-ups).
  • Data security concerns - Tesla cars driven in China were rumored to be sending camera data to US servers and Didi (the Chinese equivalent of Uber) had careless cybersecurity policies regarding traveler data. New regulations require this data to be stored locally in China, protected, and managed.
  • Offshore listings – None of the China stocks listed in NY ever received approval from Chinese authorities. While the SEC reviewed all of the IPOs, there has always been a law on the books in China that prohibited foreign listings. Yet, it was never enforced as the structure used by most Chinese companies listing overseas was an indirect listing rather than a primary listing. New regulations give Chinese authorities to review even indirect listings going forward.

Social challenges

  • The exploitation of working-class - Meituan (UberEats equivalent) delivery or Alibaba/JD logistics (Amazon) personnel were not treated as employees, had unrealistic targets, and many were paid less than minimum wage as a result. Even the high-tech programming industry circumvented rules due to their 996 policy – working 9 to 9, 6 days a week. Recently the courts ruled that such practices were against China's labor laws, and companies must review how they treat employees.
  • Personal wealth and income inequality - China now has more billionaires than any other country in the world but also 600 million people making less than US$140 a month. We will likely see additional taxes on high earners and requests to donate to support those who are less fortunate. In the US, it's called taxes and philanthropy – in China, it's common prosperity.
  • The exploitation of parents/children - Tencent aggressively marketed video games to minors, and various education firms preyed on single-child family fears about education and getting into the "right" university. Virtual goods spending and child exhaustion, not to mention child-rearing costs overall, were becoming unbearable.

All these issues exist in the US and Europe and are debated daily. But, with China's distinct and non-transparent approach, they have decided to act now rather than discuss. We would not be surprised if, after a robust democratic debate, a similar "reigning in of tech giants" comes to the western hemisphere in a few years.

Company-specific regulation

 

  • Ant Financial – while the actions of the last year may look draconian, we must ask: "What would happen in the US if a company started writing insurance, providing bank accounts, investment advice, and lending services, as well as processing payments, all without a bank, insurance or asset management license?" That's precisely what Ant Financial did, and it's not far-fetched to argue that it could have become a systemic risk to the country overall. This is a case of regulations catching up with the industry. There were 34 other companies reprimanded afterward for similar issues.
  • Didi – Chinese regulators, suggested that Didi delay listing due to cyber security concerns and user privacy concerns. Yet Didi disregarded the request. In China, a suggestion from a regulator equals an order, and at least two other companies received similar "suggestions" and didn't list, thus avoiding any further scrutiny.

These are random, not predictable, and will continue to happen. But issues like this are to be expected in a country trying to wean itself from a wild east mentality. Similar investigations occur in other countries, and nowhere do investors cry foul. The punishments also need to be put in perspective. Alibaba was fined US$3 billion for monopolistic behavior (with cash on hand at the time of ~US$70 billion), and Ant Financial was ordered to convert to a financial holding company with separate businesses and relevant licenses (and permitted to continue operations). Even Didi remains listed and continues to operate.

Geopolitical/security regulation

 

  • US decoupling – as conflict and disagreements grow, it is not realistic to ask China to continue to depend on the US for capital much longer. Senior leaders on both sides are in favor of separating and improving the regulations around capital activity.
  • Hard technology – US sanctions on Huawei made Chinese leaders realize that though they dominate and low-cost labor assembly, and maybe even consumer technology, they are materially behind the US, Germany, Netherlands, Korea, Taiwan, and Japan in advanced manufacturing and key technology sectors. It is no wonder that China is prioritizing those sectors and reorienting the economy to ensure that China remains the world's (and its own) factory floor.

The geopolitical aspects of the regulatory regime change are likely to unfold over the coming decade, not the next few months. With wage growth comes the risk that Chinese manufacturers become less competitive than their counterparts in Southeast Asia and Latin America. With a focus on consumer technology, dependency on essential hardware components becomes critical. We can expect to see policy shifts to promote key technology areas - factory automation, 5G and AI technologies, semiconductor manufacturing, environmental technologies, etc. This pivot has to be funded and encouraged but cannot be done with additional credit as before. It will come at the expense of mature and "non-critical" industries that China does not consider fundamental to continuing its rise.

What does it all mean for investors?

 

These challenges should sound familiar to US and European investors. Replace Alibaba with Amazon, Didi with Uber, Tencent with Facebook. Remember Intel's market share loss to Taiwan/Korea? And the resulting concern from US politicians? It does not sound too different at all. The key to finding opportunities in change is understanding these challenges and the transition China is trying to undertake.

Every three to five years, China suffers a crisis of investability confidence by foreign investors. Aggressive bull markets occurred in 2000, 2006, 2009, 2015, 2020 and were followed by flat or bear-market behavior in-between. But the overall trend has been up and benefited investors willing to diversify globally.

Onshore Chinese stocks (measured by the CSI 300 index) have delivered 13.2% per year in USD since 2004, compared with 10.4% for the S&P 500. Without a doubt, that higher return came with more volatility. Much like China policy, which has fewer checks and balances than the US, the market tends to overreact often because so many retail investors are involved. After the aggressive bull markets end, Chinese stocks often become quite cheap, and institutional/patient investors can take advantage of new opportunities in generating significant returns.

Below are a few charts showing China's valuations today, making clear the potential opportunity for investors. Long-term, stocks follow GDP growth, and though China is slowing, it is still growing quicker than most major economies. Though Chinese stocks can be volatile, that volatility has trended to the upside in terms of returns, rewarding long-term investors.

So what about taking listings back home?

 

While dual-listings are likely, complete US de-listings and China re-listings are not straightforward and won't happen overnight. Alibaba is a prime example. Instead of delisting in the US, they simply became dual-listed and added a Hong Kong listing. Why? Foreign investors own approximately half the market cap, which means someone would need to pay US$200 billion or more to buy out the US listing. A dual-listing and maybe an eventual conversion from US shares to Hong Kong shares make more sense. The US and other global investors can own Hong Kong, and China would be happier with a listing there than in New York. This dual-listing process is likely to repeat in the coming years, especially if the US and China cannot resolve their differences over financial regulations and disclosures. Ultimately, however, US-sourced capital is not a huge portion of Chinese funding, and moving it all to Hong Kong or mainland China won't be a huge hit.
 

Chinese equities IPO 

Conclusion

 

The last few months have not been pleasant, but we do not believe China is out to get foreign investors, nor do they want their market to be uninvestable. However, they do want to address many of the same problems that the rest of the world is experiencing and prioritize domestic rather than international investor needs. 

So, the easy trade may be obvious - close China positions and ignore that market from now on. Alternatively, the more challenging but potentially more long-term rewarding trade is positioning portfolios for a "dual spheres of influence" world. The US / China relationship will define the 21st century, but it is not a zero-sum game. The US will continue to dominate in many areas and China will start to dominate in some as well; making it important to allocate to both markets and ensure that portfolios don not have zero exposure to a 1.5 billion person nation. However, the key for us as investors is not to blindly own "China" but to understand the exposures we are taking and how they align with national objectives and priorities.


Aleksey Mironenko is Global Head of Investment Solutions at Leo Wealth, an independent global wealth advisor. Based in Hong Kong, Aleksey is responsible for constructing client portfolios and overseeing the firm’s investment function. He is a strong believer in cost-efficient portfolio construction and asset allocation as the primary drivers of investor returns and thrives on achieving meaningful results and providing considered counsel to clients.


The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to the accuracy, completeness or reliability of this information. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth or the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.


Disclosures: This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results.

Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.

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