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What's Behind the Growing Chinese Crackdown on Tech Firms?

Jul 31, 2021 5:28 PM 5 min read

China's Napoleonic crusade against its domestic tech giants has caught the world with glaring interest, to say the least. 

It comes, sees and conquers. 

And it is leading to an outflow amounting to billions of dollars worth of investments away from its own shores and impacting foreign markets while at it. 

Starting with the cancellation of Ant Financial's IPO and Jack Ma's alleged incarceration last year, the Chinese government has intensified its crackdown on internet giants like Alibaba and Tencent, the ride-hailing app Didi, food delivery apps, online-tutoring firms and of course, cryptocurrencies. 

The impacts (apart from the threat of an ongoing bureaucratic diktat) internationally have been sharp sell-offs in Chinese stocks and erosion in the market values of these tech firms outside the country. A considerable amount of foreign capital is tied to Chinese startups whose values are now effectively frozen, thanks to the risk of arbitrary rule changes by the regulators. 

The Financial Times has branded these crackdowns as "techlashes", indicating the growing intent of China to reign in the unyielding operation of its tech companies

But whether it is motivated by the control reflexes of the Communist Party or is being done to avoid market disruptions which may or are already hurting the pockets and safety of the Chinese public - few expect an end to this crackdown anytime soon.

Let's try and see what it's been all about.

Cash Out and Burn 

After disrupting (and penalising) what could have been one of the world's biggest IPOs (Ant), Beijing rained on the parade of another IPO (Didi) by stopping it from accepting new users and removing its products from the app stores. The IPO phobia in China is so high that even a massively successful enterprise like ByteDance (TikTok's parent) put its listing plans on hold being wary of any potential regulatory setback. 

But the most recent and savage crackdown by China has taken effect on its private education sector. The $120bn industry is staring in the face of crisis after regulators banned online tutoring firms (offering core school subjects) from operating on a for-profit basis or raising funds in the stock markets.

While the government says it was done to release financial pressures on Chinese families, it translated quickly into financial pressures on the markets. Shares of Chinese tutoring firms like the US-listed TAL Education and Gaotu Techedu braced for major declines (70.7% and 63.2% on NYSE) on July 23rd, hours after the announcement. 

The Chinese education industry sub-index also dived as much as 8% on Monday. The founders of Edtech firms like Gaotu and New Oriental who had built their fortunes by capitalising on the country's highly-competitive education sector, lost their billionaire statuses overnight. Analysts from firms including Goldman Sachs have described the sector as "virtually un-investable" now. 

The sell-off effect eventually trickled down to other tech-related sectors. The top three tech titans of China - Tencent, Meituan and Alibaba - combinedly lost more than $237bn in under 48 hours. The tech-heavy Hang Seng Index (Nasdaq's so-called Chinese twin) plunged by 8% on Tuesday. In fact, Nasdaq's very own Golden Dragon China Index, which tracks 98 of China's biggest companies listed in the US, took a 6.8% beat down on Monday (biggest two-day drop since 2008). 

The losses in Chinese tech and education stocks now amount to more than $1trn since February. 


Foreign Buyers Beware

Regulatory crackdown is not a novelty in China. But hardly ever have the effects of such crackdown spilled so vigorously that investors had to cope with rule changes that decimate entire industries and business models.

China's homegrown tech giants often relied on foreign backers in their early stages. This is a reason why those investors now require US-listing or VIEs (Variable Interest Entities) to collect a return on their investments. But with the rising clampdowns, perhaps we are headed on a path where Chinese startups will have to pay foreign investors a higher premium to compensate for domestic regulatory uncertainties.

From the looks of things, that path seems to have been charted already. SEC Chairman Gary Gensler announced earlier today that the agency will increase disclosure norms for Chinese companies who wish to sell shares in the US. These norms will particularly target the VIEs which are essentially shell companies that allow Chinese firms to raise offshore capital despite government restrictions on foreign ownership and overseas listing. 

However, for those who are already listed (like Didi), it's a classic foot-in-both-camps predicament. The US has threatened to delist Chinese companies if they don't disclose full audit papers to regulators, which includes data the Chinese government doesn't wish to share, partly for cyber security (and allegedly for surveillance) reasons. 

Didi is now grasping at existential straws by considering going private to appease China and compensate its investors. 

In any case, the ongoing global blending of tech companies is expected to get only stickier under these events, especially for US-based investors. It is one thing to tolerate regulatory volatility in exchange for higher returns but another to invest against the interests of the Chinese government whose motivations behind these curbs are not entirely clear yet.


Curbs on the Chinese Proletariat

Today, China has more billionaires than the USA. An offshoot of the roaring economic progress in the country over the last fifty years was the rising power of the business class which has now triggered fears of huge inequalities within China. Some say the recent crackdown is an attempt to quell this fear and send the right socio-political message. 

Then there is the theory that it is simply antitrust governance mirroring those in the US and EU currently. But unlike in the US and EU where the moves have been largely limited to counteracting Big Tech monopolies, in China it hasn't seen such limitations.

The government's actions against Jack Ma, Sun Dawu (billionaire government critic), Wang Xing (Meituan founder who posted a controversial poem) shows that Chinese crackdown is designed largely to demonstrate the state's control over the economy rather than merely curbing anti-competitive practices.

But there are deeper issues to consider here. In the education sector, for instance, China believes tutoring fees are a huge burden on families. This is reportedly discouraging them from having children and hence impeding population growth, which is on an imminent decline lately. 

The government has also articulated in the past that Beijing is now inclined towards investment flow into "real technology" like microchips, batteries, robotics, etc. Rather than focusing on the growth of internet software platforms which have witnessed a "disorderly expansion of capital" in recent years.  

This is perhaps part of a bigger narrative related to China's rising aspirations towards global semiconductor hegemony that is also incorporated into its Taiwan-centric foreign policy.

Nevertheless, the "disorderly" expansion of capital is what steered the Chinese economy for decades and therefore rattling their growth with snap regulations could ultimately prove detrimental to the country's and the world's economy by extension. 


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