• Equities
  • Emerging Market Equity

EM equities: Will Chinese regulators tear down the house that Jack built?

In late 2020, Chinese authorities announced an antitrust investigation into e-commerce giant Alibaba and halted the IPO of its financial services affiliate, Ant Group. Alistair Way looks at the implications for investors in Chinese tech.

EM equities: Will Chinese regulators tear down the house that Jack built?

When Jack Ma started his e-commerce company in 1999, he decided to call it Alibaba, after the famous character from the One Thousand and One Nights. In the story, Ali Baba opens the door to a cave of treasures using a magic phrase: “Open sesame.” Ma pledged that his company, like its namesake, would “open a doorway to fortune”.1

Over the following two decades, Ma delivered on his promise: Alibaba became the dominant Chinese e-commerce firm and expanded into other areas, including artificial intelligence, cloud software and filmmaking. An affiliate firm, Ant Group, controls Alipay, the world’s leading mobile payments platform.

As his business empire flourished, Ma became a global celebrity. At the G20 Summit in Hangzhou in 2016, visiting dignitaries divided their time between conferences with Xi Jinping and audiences with Ma at Alibaba’s headquarters.2

Alibaba is being investigated over alleged monopolistic practices

But in late 2020, Ma overreached. On October 24, he delivered a speech at a high-level business forum, likening state-run banks to pawnshops and branding financial regulators “an old people’s club”.3 The following week, the Shanghai Stock Exchange cancelled Ant Group’s $37 billion initial public offering (IPO) – which would have been the world’s biggest – citing “changes in the financial regulatory environment”.4 In December, the State Administration for Market Regulation (SAMR), an antitrust body, started investigating Alibaba over alleged monopolistic practices.

Ma disappeared from public view, prompting rumours he had been detained by the authorities. After a three-month absence, he posted an online video on January 20, pledging that he and his colleagues would devote themselves to “education and public welfare”.5

So, are the doors of opportunity finally slamming shut for Alibaba? And what does Beijing’s new trustbusting stance mean for the wider technology sector? In this Q&A, Alistair Way, head of emerging market equities, discusses the implications for investors.

What does the crackdown on Alibaba and Ant tell us about the regulatory environment for Big Tech in China?

Regulation of technology companies is tightening everywhere – it’s a global trend. In practice, though, Chinese tech firms were already under much more state influence than their counterparts in the US or Europe. What we are seeing is more of a shift in emphasis from the authorities. Beijing is trying to balance the interests of China’s national tech champions with its own policy objectives.

This is not the first time regulators have put pressure on the company

Although the timing was dramatic, the intervention to thwart Ant Group’s IPO shouldn’t have come as a surprise. This is not the first time regulators have put pressure on the company; in 2016 the government imposed restrictions on Ant’s popular money-market fund, Yu’e Bao, because of potential liquidity risk. It looked as though Ant was trying to aggressively push through its IPO on a wave of publicity from investment banks and hysteria among retail investors, before regulators could properly assess the implications for financial stability.

The investigation into Alibaba is more interesting, because it suggests e-commerce is now under closer regulatory scrutiny. Previously, authorities had focused on social media and gaming because of the potential for political dissent to spread online.

Why has e-commerce drawn the attention of regulators now?

Jack Ma’s inflammatory speech might have been the catalyst for regulators to take a closer look at his companies, but there are underlying economic issues the government is trying to tackle. Take the “community-buying initiatives” that became popular during the pandemic, whereby groups of people would club together to purchase heavily discounted groceries via e-commerce platforms. These schemes have sparked concerns over employment, because smaller food retailers are being squeezed out.

There are underlying economic issues the government is trying to tackle

This is one of many e-commerce practices the government is targeting, drawing on new antitrust guidelines unveiled last year. In December, the state-run China Daily ran a strongly worded editorial warning that monopoly behaviour “hinders fair competition, distorts resource allocation, harms the interests of market players and consumers, and stifles technological progress”.6

Policymakers may be concerned about a possible backlash if tech firms persist with unpopular tactics, such as using AI algorithms to offer consumers different prices for the same product based on their ability or willingness to pay. A government-backed consumer-rights association recently accused tech firms of “bullying” their users with such methods.7

What penalties does Alibaba face if it is found to have broken the rules?

The maximum fine for breaching the antimonopoly rules is ten per cent of the previous year’s revenues, which would be insignificant in the context of Alibaba’s gargantuan balance sheet. It is conceivable regulators would go further, and force Alibaba to spin off some of its non-core units or curtail further empire building in areas such as cloud computing. But the company’s central e-commerce business is so vast it would be more-or-less impossible to break up, and it wouldn’t be in the government’s interests to try.

Valuations of Ant have been slashed

Ant Group looks more vulnerable. Valuations of Ant have been slashed over reports the firm will be forced to reorganise under a new holding company, so it can be regulated more like a traditional bank. Officials at the central bank have also ordered Ant to rein in its successful consumer lending and securitisation businesses.8

It is very unlikely the company will be able to return to the market with a public offering anywhere near the $37 billion originally planned. Having been reminded that internet finance in China is subject to huge regulatory risk, investors would demand a much higher risk premium next time around.

Has the Alibaba situation affected investor sentiment towards China’s other tech firms?

Alibaba’s shares have lagged those of other large Chinese tech firms since its regulatory troubles began. Investors in emerging market equities appear to have decided this is an Alibaba-specific issue, and that rival Chinese e-commerce firms such as JD.com, Meituan and Pinduoduo will be able to take the opportunity to gain market share.

Antimonopoly regulators are unlikely to stop with Alibaba

I’m not so sure. It is true Alibaba was already battling on numerous fronts with its rivals before the antitrust probe was announced: JD.com has the superior logistics operation and better-quality goods; Pinduoduo is catching consumers’ interest with its distinctive, entertaining platform; and Meituan is using its strong local distribution operation to snatch customers from Alibaba’s food-delivery subsidiary. But investors need to look at which way the wind is blowing on regulation. Alibaba is not the only company that offers subsidies for community-buying schemes; Meituan and Pinduoduo are involved as well. Antimonopoly regulators are unlikely to stop with Alibaba.

If the outcome of this antitrust action is a more balanced and diversified competitive environment, that would probably benefit the market as a whole. At its peak on October 27, Alibaba accounted for as much as 8.9 per cent of the MSCI Emerging Markets Index, bringing concentration risk. Its shares fell after the regulatory clampdown on Ant and suffered a further sharp dip in December, after the investigation into Alibaba itself was announced. By the end of the year its index weighting had fallen to below six per cent (see Figure 1).

Figure 1: Alibaba weighting in MSCI EM Index, 2020
Alibaba weighting in MSCI EM Index, 2020
Source: Bloomberg, January 2021

Will any smaller tech firms gain an advantage, if regulators continue to put pressure on the giants?

There are some smaller companies whose business models look more aligned with the government’s current objectives of promoting employment and balanced growth. One is called Dada Nexus, a firm that works like eBay for local supermarkets: its platform allows smaller retailers to connect with customers online to sell their stock.

The government wants traditional food retailers to survive – they have cold-chain facilities, good inventories, fresh-food distribution routes – and a company that helps these firms gain a digital presence is more likely to stay on the right side of regulators than one that aggressively seeks to put them out of business.

How will the Ant regulation affect the financial landscape?

Regulatory pressure on Ant should favour the large incumbent banks, now that their leading digital challenger has had its wings clipped.

Regulatory pressure on Ant should favour the large incumbent banks

Chinese financial institutions were already in a robust position, given the strong GDP growth numbers posted in January. 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. The regulatory moat against digital insurgents gives them a further competitive boost.

Does Jack Ma’s downfall tell us anything new about the risks of investing in China?

It serves as a reminder of something investors in China should have known already: you always need to be aware of subtle shifts in the tone of statements emanating from official bodies. No company – not even a goliath like Alibaba – is big enough to defy the state.

Want more content like this?

Sign up to receive our AIQ thought leadership content.

Please enable javascript in your browser in order to see this content.

I acknowledge that I qualify as a professional client or institutional/qualified investor. By submitting these details, I confirm that I would like to receive thought leadership email updates from Aviva Investors, in addition to any other email subscription I may have with Aviva Investors. You can unsubscribe or tailor your email preferences at any time.

For more information, please visit our privacy notice.

Related views

Important information

THIS IS A MARKETING COMMUNICATION

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.

In Europe, this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK, this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: St Helens, 1 Undershaft, London EC3P 3DQ. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1 Raffles Quay, #27-13 South Tower, Singapore 048583.

In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business address: Level 27, 101 Collins Street, Melbourne, VIC 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.

Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission as a commodity trading manager, exempt market dealer, portfolio manager and investment fund manager. AIC is also registered as an exempt market dealer and portfolio manager in each province of Canada and may also be registered as an investment fund manager in certain other applicable provinces.

Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.