CHINA — REGULATING FOR CHANGE
Recent Chinese regulatory initiatives across high-profile industries have spooked global investors. Foord Singapore portfolio manager JC XUE discusses the changes and what they mean for the China investment thesis.
The Chinese authorities have tightened the regulatory environment significantly over the last year, rolling out new measures to improve governance oversight. Prominent examples are the new anti-monopoly rules for technology companies—which resulted in fines for dominant players like Alibaba—and rules to take the ‘profit’ out of the ‘for-profit’ tutoring industry. Cryptocurrencies have also come under the spotlight.
The markets certainly seem to be pricing in fears for the investability of the Chinese market given the rising regulatory risks. But let’s take a step back to dissect what the Chinese leaders are communicating through these regulations: they want to correct actual or perceived market failures from having unintended social consequences that are detrimental to the nation’s long-term development. Regulation has become an instrument of social engineering.
As we all know, Western economies have more than their fair share of regulation—but the regulatory processes work slowly and regulators usually signal regulatory trends years in advance. China has lagged the Western economies in most areas of regulation and is slowly catching up for the benefit of Chinese consumers. However, we tend to forget that China operates a command economy. The Chinese authorities can therefore act quickly to improve regulation in areas of previously weak or immature regulation.
The Chinese antitrust regulations targeting technology platforms were established to eradicate monopolistic behaviours such as exclusivity contracts and predatory pricing. These anti-monopoly rules are aimed at reducing the rent-seeking behaviour of the dominant tech platforms. The purpose is not to shut down the leading tech platforms, but to regulate them. Having seen the tremendous success of the first platforms, the authorities now want to promote fair competition. Antitrust regulations will allow the next generation of innovators to emerge and to not be gated by the monopolistic behaviours of existing market leaders.
On the other hand, Chinese regulations banning companies that teach the school curriculum from making profits, raising capital or going public have noteworthy social goals. Aside from extreme pressures on students, the financial burden on parents was rising rapidly as the tutoring industry raised prices due to soaring demand. The increased costs of having a child were starting to impact already-low birth rates, adding to China’s demographic headwinds. The government needed to tackle this issue resolutely to ensure China’s long-term competitiveness.
The government unequivocally wants to build a stronger middle class, to advance innovation and to get stronger as a nation. The policy changes thus have worthy objectives, but their abrupt implementation has undoubtedly increased investment uncertainty in the short term. In the long term, the regulatory results should drive healthier economic development, helping China towards its goal of reducing income and wealth inequalities.
China is not rejecting a market driven economy with these initiatives. In fact, the government continues to view vibrant private enterprise to be the most effective way to drive innovation and wealth creation, thereby fulfilling its ‘common prosperity’ goals. However, private enterprise needs rules and regulations to keep playing fields level and to weed out bad actors from the market.
Foord has held a positive view on the rising Chinese middle class and the corresponding consumption growth. This investment thesis is aligned to the Chinese government’s goal of redistribution and a ‘stronger middle’. In fact, core fund holdings like JD.com and Tencent have always created positive value across their ecosystems.
JD.com has used economies of scale to provide everyday low prices for consumers. Tencent has been criticised for under-monetising its assets and continues to give more value than it takes—most recently through WeChat mini-programs. In our view, companies like these, building their businesses by treating customers fairly and innovating through healthy competition over monopolistic practices, should experience robust long-term earnings growth in an environment of healthier competition.
Still, each has seen its share price impacted by regulatory actions. In the Foord Global Equity Fund, we opportunistically added to our existing holdings and initiated positions in some others that fell to attractive valuations.
Finally, we are still optimistic for China’s long-term growth trajectory. This round of regulation serves as a healthy reminder to tech platforms to compete on value creation instead of monopolistic behaviour. It facilitates a more conducive environment for new business innovations to flourish and we are excited to discover the next JD.com, Alibaba and Tencent.