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Featured AIQ Podcast: The future of the internet
What does China’s wave of tech regulation mean for investors? Find out more in this episode.
Let me start with you Jack. I know you’ve been passionate about the need to fight climate change. I want to get a sense from you of why you think it’s so important.
If we do not care about this earth, if we do not care about the food, the water, the environment, I think nobody can survive, whether you’re big or small.
The Asia-Pacific Economic Cooperation summit in 2016, and US President Barack Obama is talking to Chinese tech mogul Jack Ma about how to address climate change. It’s a sign of Ma’s clout that Obama is the one asking the questions.
Ma was then on top of the world. He had turned Alibaba, his e-commerce firm, into a global powerhouse. Ant Group, another of Ma’s companies, was a pioneer in financial tech. As his business empire grew, Ma became a symbol of China’s entrepreneurial spirit. He zipped around the globe in a private jet to ink joint ventures, buy real estate and charm foreign dignitaries. Here he is at the World Economic Forum in Davos, talking about an unexpected inspiration on his path to success.
I was very depressed in the year 2002 or 2003, when I couldn’t find a way to make the internet work. Then I watched this movie at my friend’s house, and I thought, Forrest Gump, this is the guy we should learn from! Believe what you’re doing, love it. And I love the words: “Life is like a box of chocolates. You never know what you’re going to get.”
But as Ma became more powerful, he risked provoking the ire of the Chinese authorities. In October 2020, he finally overreached, making a fateful speech in which he complained about government-imposed barriers to the growth of his fintech business. He likened state-run banks to “pawnshops” and branded financial regulators “an old people’s club”.
[In Mandarin] We must change the pawnshop mentality of today’s finance and develop a credit-based system. Today’s banks still have a pawnshop mentality.
Beijing’s response was swift. The following week, the Shanghai Stock Exchange cancelled Ant Group’s planned $37 billion IPO, citing “changes in the financial regulatory environment”. In December 2020, the government’s antitrust body started investigating Alibaba over monopoly practices. Ma has rarely been seen in public since.
The downfall of the Alibaba chief points to a wider shift in Beijing’s attitude towards China’s tech giants and the tycoons who run them. Over recent months, a raft of new financial, antitrust and data-protection laws have been introduced, targeting not just Alibaba but the whole tech sector. Billions have been wiped off the value of major companies. The balance of power between state and private enterprise has undergone a decisive shift.
In this episode of the AIQ podcast, we’ll explore what China’s epic crackdown on tech means for investors.
Any foreign power that dares to challenge us will have their heads bashed bloodily against a great wall of steel. [Applause]
That was Chinese President Xi Jinping, speaking at an event to mark the centenary of the Chinese Communist Party. He warns foreign powers not to interfere in Chinese affairs.
Xi has been just as assertive in dealing with potential rivals at home. He has cemented control over Party and state since 2018, when he abolished term limits on the presidency. He wants to ensure no private business is able to challenge his political authority, and the country’s tech superstars are among his main targets.
Here’s Alistair Way, head of global equities at Aviva Investors.
The main reasons for extra tech regulation are firstly political, making sure no one is bigger than the state. Take the situation with Jack Ma and the farcical Ant Financial attempted IPO. That resonated quite strongly. There was a sense that these individuals and companies were getting too big for their boots and needed to be shown who is in charge. It felt a bit like a reaffirming of power.
For many years, the government was happy to let China’s fast-growing technology companies do as they wished. Tech firms provided apps and services to parts of the population the state couldn’t reach, boosting economic growth and prosperity.
I don’t think people appreciate how much the internet has changed people’s lives, and particularly companies like Alibaba and Tencent have been very instrumental in that process.
Duncan Clark, author of The House that Jack Built, a biography of Jack Ma, speaking to the US-China Institute.
Without the internet it’s hard to imagine how China would have evolved over the last 30 years. Yes, we’ve had opening up and reform, but policy has been slow, there has been backsliding more recently. It’s actually the internet and the revolution of the private sector, powered by the internet, that has really driven China forward.
One example of this revolution is online payments. Apps such as Alipay, run by Ant Group, turned China into a world leader in fintech. Millions of people now use their smartphones to pay bills not just online, but also in brick-and-mortar shops and restaurants.
Over time, the tech firms built on their digital expertise to explore more lucrative financial business lines. Ant created a wildly popular money-market fund that allowed 700 million monthly users to invest spare cash left over in their accounts. But this led to concerns over financial stability – another key reason behind the current crackdown.
The big selling point for investors in the lead-up to the ill-fated Ant IPO was its consumer lending business. The company’s lending to consumers ballooned to over 1.5 trillion RMB, or $250 billion, as of June 2020. This made it the country’s largest lender, surpassing traditional retail banks that faced stricter capital requirements. This made regulators anxious, says Way.
Clearly banking and lending are quite heavily regulated in China, and across most Asian financial markets in fact. So the financial system as a means for allocating capital is still viewed as something which should have significant state interest. If you have disruptive new entrants coming in, then, firstly, capital might be allocated in different ways, and maybe used less as a policy tool; secondly, there is much more potential for speculative bubbles and loss of control by the state, the potential for gearing and household finance to go up; and destabilisation of the old order of fairly traditional banks.
In their public statements, China’s regulators have said their new measures are not simply about politics or financial stability, but also about bringing tech companies into line with the country’s modernised competition and data protection laws.
As in the West, the government is concerned these firms are using the information they collect on users to manipulate their behaviour and outmuscle smaller business rivals, causing economic problems.
During the pandemic, for example, e-commerce firms began to operate so-called community buying schemes that enabled groups of people to buy groceries in bulk at sizeable discounts. But the government stepped in to control these schemes, due to concerns physical retailers were being put out of business.
On antitrust I feel it’s more about concern about the little guy […] A sense that some of the big companies have been abusing their wealth to effectively cross-subsidise and wipe out small and medium sized independent retailers. […] There’s a feeling that some of the regional and local e-commerce efforts that people are doing – particularly community group buying, where the likes of Pinduoduo and Meituan try to bypass the whole distribution network, appointing local group leaders, which could be a local kingpin or someone in a tower block, or sometimes actually a store themselves, and use them as a way of doing group buying. […] It’s quite an efficient way of doing it, but it does mean the local independent supermarkets get wiped out, and there’s a feeling that monopoly power and tech knowledge should be used to come up with new stuff rather than wipe out smaller competitors. There’s a strong antitrust push to avoid local disruption, bankrupting people, unemployment and so on.
The investigation into Alibaba drew attention to other anti-competitive practices, too. The company was found guilty of using its “market position, platform rules and data” to reward merchants that used its shopping sites exclusively, and to punish those that didn’t. In May, Alibaba was fined almost $3 billion over these activities.
Food-delivery giant Meituan stands accused of similar practices, including the use of algorithms to charge customers different prices for the same item based on their shopping history. And now regulators are moving onto new targets.
You can do almost anything you want now on this one single device. But in China, you can do anything you want on one single app. The company behind it all is Tencent. Not only is it China’s biggest social network but it’s the largest gaming company on the planet!
Like Alibaba, Tencent became famous around the world for its innovative platforms, such as the all-purpose app WeChat, and a formidable video games empire, including stakes in global hits like Fortnite.
But during this summer, regulators have put video games in the crosshairs. In August, state media published an article that likened gaming to opium addiction. Tencent swiftly announced plans to limit the amount of time young people could spend on its games platforms. But the threat of antitrust action still hangs over the company, and its music streaming arm, Tencent Music, has been ordered to give up its exclusive licensing rights.
Chinese authorities say they are concerned about how Tencent and other tech companies handle user data. And recent laws have indeed improved data security for Chinese internet users. But there are still fears that what the government really wants is to preserve its own exclusive access to user information – a big concern in a country where surveillance is already a fact of life.
Here’s Louise Piffaut, senior ESG analyst at Aviva Investors.
Chinese companies have improved their practices very much since that legislation, including for example when there is a data breach; they are getting better at informing the user as well as informing the authorities, which is not something that you see across the world at all. […] They are just constructing a firewall with the outside world, but the government is still inside. It is not going to improve their international perception at all.
In the West, we’ve seen tech companies like Facebook and Google fined on antitrust grounds. As in China, there are concerns over data privacy and security. So how is the Chinese situation different?
Legal scholar Angela Zhang of Hong Kong University, author of a new book on antitrust regulation in China, argues competition law in China is flexible, and so can be used by the government as a tool for its strategic objectives. This is one reason why enforcement has been much quicker and more radical there, as Zhang explained to the US-Asia Law Institute of New York University at a recent conference.
You will see the Chinese government appears to be much more aggressive and efficient – [it is moving at] lightning speed in reining in big tech and driving them in the direction they want. But at the same time this kind of very volatile, aggressive enforcement campaign could put off investors in Chinese tech and discourage investment in some areas, even though supposedly this regulatory intervention is meant to facilitate competition.
Investors in Chinese tech firms listing abroad have good reason to worry, given China now seems to be specifically targeting companies that seek US investment.
Consider the case of Didi, a ride-hailing app with almost 500 million users. In June it listed its shares in New York, raising $4.4 billion. But less than a week later, Didi’s service was removed from app stores in China after the government accused it of breaking rules on collecting user data. More to the point, it seems Didi had ignored warnings from the authorities not to list. The company’s share price fell by over 20 per cent on the day the app was banned.
After this development, there are reports regulators might look again at the use of “variable interest entities”, the special vehicles used to allow foreign investors to own stakes in Chinese tech firms. Meanwhile, the crackdown is widening even further, with the education tech industry another subsector targeted in recent months. No wonder some investors are spooked.
We are seeing some of the Chinese internet names down huge this morning. Alibaba, JD.com, Didi, they are down more than ten percent. Down even further are three stocks in the education sector, they’re seeing their value cut in half this morning. […] What do you think is happening between the government and the corporate sector?
It’s a Tiananmen Square moment of capitalism in China. The capitalists in China were sowing their oats, starting to act in what the Communist Party thought was a roguish kind of a way, and now you’re seeing a widespread crackdown, and I think it’s very damaging; it’s adding a risk premium to those stocks and it’s also sending a signal to the rest of the world that China’s turning inward, and it’s going to be more difficult for those companies to grow internationally.
Anthony Scaramucci there, founder of investment firm SkyBridge Capital and former director of communications in the Trump White House. Whether or not you agree with him that this is a “Tiananmen Square moment”, the crackdown is certainly bringing new risks.
There is even a chance the regulatory wave could hit non-Chinese companies, as Beijing seems to be using antitrust as a weapon against Western firms active in China. Here’s Professor Zhang again.
They can launch investigations into companies like Qualcomm, Cisco and Apple under the antitrust law. So as Sino-US tensions intensify, Chinese antitrust may well become a battleground for trade and national security issues.
So how can investors position themselves amid all this disruption? One important takeaway is that for companies in China to thrive, they need to make sure their operations do not clash with the government’s strategic objectives. Firms that act in ways that cause unemployment or otherwise destabilise society will face further headwinds. The biggest tech firms have all seen their market values fall in 2021 and share prices may take some time to recover.
But there could also be opportunities for those companies whose business models are more aligned with Beijing’s wishes. One example is Vip Shop, an online retailer that has won more customers since its larger rivals were forced to end their exclusivity agreements with top brands. Here’s Alistair Way.
The impact of antitrust is having an impact, particularly in e-commerce. In the past, Alibaba managed to abuse its monopoly power by insisting on exclusivity – so saying to a brand if you’re going to use us it has to be only us and you can’t supply JD at the same time. This being run back and made illegal is helping companies.
The crackdown on tech could also benefit other industries. Now that the fintech sector had had its wings clipped, traditional lenders will be shielded from disruption.
The government has ordered Ant Group to separate its payments and consumer loans businesses, providing banks with a competitive moat. Chinese financial institutions were already in a robust position, thanks to the economy’s strong rebound from the coronavirus slump. From an investment perspective, Chinese banks tend to offer higher dividend yields and lower price-to-earnings ratios than their counterparts in other emerging markets.
As regulators continue to target new industries, there is likely to be further uncertainty to come. In early August, the government announced a new five-year plan to strengthen its control of the economy, including fresh waves of tech regulation. The announcement contained very little specific information on these future measures – which suggests regulatory priorities could yet shift depending on political developments.
Since then, the crackdown has widened even further. The government says it wants to tackle extreme wealth and inequality, promoting “common prosperity”. To stay on the right side of the authorities, Alibaba, Tencent and other tech firms have pledged to donate billions of dollars to social projects.
As Jack Ma might put it, quoting his favourite American movie: Chinese regulation is like a box of chocolates; you never know what you’re going to get.
Thank you for listening to the AIQ podcast. Read the latest issue of AIQ magazine, a tech special, on our website at avivainvestors.com. Please look out for future episodes and feel free to subscribe through any of the major podcast channels.
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