Regulator causes prices of Chinese platforms to crash

First the good news: The Original Platform Fund was only slightly invested in Chinese stocks from the beginning due to regulatory uncertainty and we zeroed out our position weeks ago. This is because the incalculable Chinese regulatory actions of first canceling Ant Group's IPO, then launching investigations into Didi Chuxing just two days after the IPO, and now - to top it all off - declaring the major education platforms non-profit enterprises (not for profit) have put massive pressure on the share prices of all Chinese platforms.

Background to regulation in China

The policy initiatives "Made in China 2025 Master Plan", "Internet Plus" and "China Standards 2035" have transformed China into one of the leading countries for digital products, services and platforms. Platforms in the areas of commerce, payments and insurance have contributed to this development. Alibaba, Tencent and Ant Group are among the top three platform companies in China.

However, the rapid growth of platforms has raised concerns in the Chinese government about the negative impact (monopolies, unfair competition, or infringement) on the market, competition, and currently, socio-political power relations.

In 2020, the Chinese government announced that it would regulate the digital market and exercise greater control over platform companies. In this context, China's SAMR (State Administration for Market Regulation) has published the draft guidelines on combating monopolies in the platform economy to prevent monopolies in the platform economy, guide operators to operate in accordance with laws and regulations, and promote sustainable and healthy development of the digital economy.

The key points of the guidelines refer to the Anti-Monopoly Law ("AML"), which is currently being revised, and set out the rules for regulating the digital economy. It mainly addresses the following issues: Avoidance of monopoly agreements, hub-and-spoke agreements, creation of leniency, avoidance of abuse of dominant position and abuse of dominant position in the platform economy.

The new legal framework will have a direct impact on the behavior of platform companies and the platform economy in China:

• Closely investigating or restricting corporate acquisitions or mergers that may eliminate or restrict competition (e.g., gaining control of other companies by acquiring their shares or assets, or gaining influence by acquiring contracts). 
• Closer scrutiny or restriction on the disposal of tangible assets and the disposal of intangible assets such as intellectual property, technology, data or related rights and interests.
• More difficult mergers with variable interest entity (VIE) participation also fall within the scope of antitrust scrutiny. The reason for this scrutiny is that VIE structures (also referred to as "contract-based control") in China can be used by foreign investors to gain control of a Chinese platform company subject to restrictions under Chinese law and thus circumvent Chinese regulations.
• Avoiding Abuse of Administrative Power to Eliminate and Restrict Competition: Under both the Guidelines and the AML, administrative departments and other organizations authorized by law or regulation to perform the function of managing public affairs may not abuse their administrative power to eliminate or restrict competition. 

Regulatory impact

The regulations will impact the largest companies such as Taobao, Tmall and JD.com, as well as payment services such as Ant Group's Alipay and Tencent Holding's WeChat Pay. There will be no more IPOs of relevant Chinese companies in the US for the time being. Since February 2021 through July 7, Chinese stocks have already lost about $831 billion. Further intervention must be expected, because the impact on stock prices is not a criterion, as Bloomberg writes: China doesn't care how much money investors lose.

TikTok parent Bytedance, currently valued at $140 billion, has already canceled its planned IPO in the US. If Chinese companies still dare to go public, then only in Hong Kong or Shanghai. At least representatives of Ant Group have just indicated that the postponed IPO could be made up for soon. The U.S. banks, which have so far earned handsomely from the IPOs of Chinese companies, are also exploring the possibilities of a detour to Hong Kong.

The current expansion of Chinese regulatory intervention may be a sign of a lack of transparency regarding the market power of the platform giants and a resulting lack of balance in the general economic and socio-political power relations in China. Possible domestic and foreign economic disadvantages of these actions may be accepted. This is because the confidence of international investors in Chinese values is currently lacking and will - at best - recover only slowly.

Although many Asian platforms have a high level of development and would therefore be natural candidates for the fund, we remain in observation mode in view of the uncertain situation.

The author and/or related persons or companies may own the shares mentioned herein or are already invested in these shares, e.g. via an investment vehicle. This article is for general information purposes only and constitutes a free expression of opinion and not investment advice. Please also note the detailed legal information.

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