Is China Targeting Foreign Investors Amid the Tech Crackdown?
No. While the ongoing regulatory crackdown on technology companies in China is unsettling markets, it is not specifically targeting foreign investors. The Chinese government is addressing what it sees as increasing risks and abuses by technology companies in China. What started last year as financial stability concerns related to the lending practices of Ant Financial and the anti-competitive behavior of major e-commerce companies (Alibaba, JD . com, Meituan, etc.) has now morphed into data collection and national security concerns posed by US-listed Chinese companies and social concerns over excessive spending on online education and tutoring.
On July 23, share prices of Chinese education companies crashed amid rumors (subsequently confirmed over the weekend) that the government was seeking to heavily regulate the sector. Measures included banning for-profit K-to-12 tutoring in core curriculum subjects in an attempt to reduce the amount of time and money spent on after school tutoring, which the government sees as placing an undue burden on children and household finances, and, ultimately, the birth rate in China. The new regulations also banned foreign investment in the sector, as well as unlicensed foreign tutors.
This follows the launch of an investigation into ride-hailing company Didi two days after its multi-billion-dollar IPO in New York in mid-July. Reportedly, the authorities suggested Didi delay the IPO until a data security review could be completed, although this is contested by the company. Regardless, China has passed new regulations stating that any company with data for more than 1 million active users must now seek pre-approval and complete a data security review before listing in the United States. After years of allowing Chinese companies to list in the United States, the supposed tipping point for Chinese authorities was 2020’s passage of the US Holding Foreign Companies Accountable Act (HFCAA). The HFCAA allows the United States to de-list foreign companies that do not submit their audit papers to the Public Companies Accounting Oversight Board for three consecutive years, something current Chinese law does not allow Chinese companies to do. Last month, a bill passed the Senate (but not yet the House) that would potentially shorten this grace period to two years. Some in Congress want an even shorter period, which has further raised alarms in Beijing.
The concern is that by listing in the United States, these tech companies fall under the jurisdiction of US regulators and may be forced to share data with US authorities. While the current three-year grace period gives Chinese companies enough time to secure a secondary listing in Hong Kong (and therefore reduce the impact of a US de-listing on the company and investors), a shorter period increases the leverage a potential de-listing may have on a company.
Furthermore, given the firm stance the Biden administration is taking with China in regards to Hong Kong, Xinjiang, and Taiwan, and the broad bipartisan support for being tough on China, the Chinese government is concerned that US-listed Chinese companies pose a national security risk that needs to be assessed. This is similar to how the United States views Chinese companies acquiring US companies, and has increased the oversight and usage of the Committee on Foreign Investment in the US (CFIUS) to delay or block deals.
It is also true that part of the tech crackdown stems from the government’s distrust of having so much economic power concentrated in a few private firms and thus a desire to assert some control over a sector that until now has been lightly regulated. However, the regulatory crackdown is not driven by a desire to attack foreign investors. While the new tutoring regulations place bans on foreign investor involvement in primary and secondary education, it is to starve the for-profit education sector of capital, as raising domestic capital is also banned. In contrast, the government has made its uneasiness clear with the broader tech sector listing in the United States, but it has left the door open for Hong Kong listings. It is also likely that further reforms to China’s domestic IPO rules will be forthcoming to support Chinese tech companies in raising capital. The Shanghai STAR Board (China’s answer to the NASDAQ) is an example of this, which has attracted both domestic and foreign investors.
Indeed, there is a disconnect between rising China tensions and investment flows into China. Equity inflows into the onshore A-share market via the Stock Connect program remain strong, reaching $35 billion through June 30 compared to $31 billion for all of 2020. Foreign buying of onshore bonds is even stronger at $82 billion year-to-date. Foreign direct investment into China is also at all-time highs, with $94 billion of investment year-to-date, led by service sector investments.
It remains to be seen whether the expanding regulatory crackdown and recent actions against Didi and online education companies reverses this flow of capital, since China remains a large and growing part of the global economy. Also, despite the current pressure being placed on China tech firms, the government correctly acknowledges the broader sector as a source of innovation and economic growth, especially as China seeks to reduce its dependency on overseas technology in critical areas such as semiconductors. Investors, both foreign and domestic, are justified in feeling nervous over the expanding regulation of the tech sector in China and the uncertainty it is generating. But so far, this tech crackdown is geared more toward punishing bad corporate behavior at home and reducing national security risk than an outright attack on foreign investors.