China’s tech crackdown has wiped out trillions - and could shut a crucial door to the US

China’s crackdown on its big technology companies blindsided foreign investors and has cost them more than $US1 trillion ($1.4 trillion) of paper and real losses this year. It may also have closed down, or at least threatened, China’s access to international markets, particularly the US.

Late last week, in response to China’s decision to “reform” its private education sector – it banned the $US100 billion industry from making profits, which ignited a wipeout of the value of the shares in companies in that sector – the US Securities and Exchange Commission froze all initial public offerings of Chinese companies.

The broader picture of the Chinese authorities radically changing the landscapes for Chinese companies and their investors almost overnight with little, if any, regard for the foreign investors would be of concern for any securities regulator with Chinese companies on their boards.Credit: Bloomberg

The SEC’s chairman, Gary Gensler, said the Chinese government’s actions, including its decree that effectively all foreign listings by its tech companies would be subjected to cybersecurity reviews, were relevant to US investors and that his staff had been directed to require additional disclosures from Chinese companies before approving their prospectuses.

He raised specific concerns about the structures – called variable interest entities (VIEs) that Chinese companies use for US listings, saying many investors might not be aware that they were actually buying shares in shell companies based in tax havens rather than the underlying business.

VIEs give investors an economic interest in the company’s operations but no traditional ownership or voting rights.

He also said Chinese companies should also disclose that future actions by China’s government could significantly affect their financial performance, although that’s a lesson investors have probably already learned.

Gensler’s action produced an immediate response in China, with its securities regulator issuing a statement on Sunday calling for closer communications with the SEC “with the principle of mutual respect and co-operation.”

The China Securities Regulatory Commission said it had always been open to companies’ choices to list their securities on international or domestic markets “in compliance with relevant laws and regulations.“

It also called in a group of powerful Wall Street investors last week to try to reassure them that the reforms of private education were an isolated situation and that otherwise it was business as usual.

Those reassurances are likely to be taken with a large dose of salt given that within in the complex politics of Chinese bureaucracy, where regulators compete for Xi Jinping’s attention and favour, it is never clear which agency is calling the shots and from which direction the next grenade for investors might be launched.

Given the SEC’s intention to enforce its policy of requiring US-listed foreign companies to allow US regulators to inspect their audits under threat of de-listing – a policy at odds with China’s directive, on national security grounds, that any foreign regulator wanting to inspect the accounts of a Chinese company has to obtain the approval of its own authorities – the potential for a severing of Chinese companies’ access to the US markers is increasing.

SEC chairman, Gary Gensler said the Chinese government’s actions were relevant to US investors and that his staff had been directed to require additional disclosures from Chinese companies before approving their prospectuses.Credit: AP

For the companies the conflict over audits of the auditors, in particular, is a major threat. According to Bloomberg Chinese companies have raised nearly $US16 billion of equity in the US so far this year, with another 70 planned IPOs in the pipeline. The total value of Chinese companies listed in the US is more than $US2 trillion.

The broader picture of the Chinese authorities radically changing the landscapes for Chinese companies and their investors almost overnight with little, if any, regard for the foreign investors would be of concern for any securities regulator with Chinese companies on their boards.

The crackdown on private education isn’t an isolated situation.

Starting with Jack Ma’s planned Ant Group float and the flowing through China’s big tech company sector, the authorities have been taking decisions, on various grounds – competition policy, financial stability, national security – that have decimated the value of their shares and the bank accounts of foreign investors.

The impact of these decrees, the lack of any explicit framework to assess the likelihood of regulatory change and the absence of any avenues for appeals is why some institutional investors have declared China “uninvestable.”

While the wipe-out of private education was motivated by a number of factors – social equity, the impact on birthrates and the state’s desire to absolutely control the curriculum – as with the broader assault on technology companies (and the resistance to allowing the US to audit its auditors) there was also a desire to prevent the data being captured by these companies from being accessible outside China.

The targeting of ride-sharing giant Didi on national security grounds by the Cyberspace Administration of China last month just after its $US68 billion listing in the US was driven by concern that its vast hoard of data on its customers could be accessed by US authorities, even though Didi’ servers are in China.

There are elements of this new Chinese approach to capitalism and the way it is being implemented, however, that are fundamedntally at odds with the way Wall Street and other developed economy financial markets work.

Crackdowns on other big tech companies also reflect China’s conviction that access to “Big Data” is a both a threat to national security and a source of competitive advantage.

The sudden focus on data regulation by Beijing, and the absence of any definition of what constitutes data that has national security significance, has created a new source of power and visibility for a range of agencies that now appear to be scrambling to get a piece of the action.\

While the broad tightening of the regulatory net around the big tech companies is being interpreted by China analysts as evidence that advocates for business and a (relatively) open economy in China have lost out to those who want all Chinese businesses, including those privately owned, to operate within Beijing’s stringent views of the national interest.

The authorities are tightening control of China’s private sector while putting the billionaire entrepreneurs, like Jack Ma, whose wealth and outspokenness might have been seen as potentially destabilising within such an authoritarian regime, firmly in their places.

The reaction in markets to the wave of recent actions against the tech companies, and the SEC’s response, appears to have taken China somewhat by surprise, hence the effort to talk down their significance.

China is trying to (slightly) liberalise its financial markets and attract foreign capital and expertise to quite immature markets so it probably doesn’t want to cut off the flow of external capital.

There are elements of this new Chinese approach to capitalism and the way it is being implemented, however, that are fundamentally at odds with the way Wall Street and other developed economy financial markets work.

A complete and permanent decoupling of China’s private companies from access to US and other foreign equity possible but probably unlikely.

Until the dust settles around China’s tech sector and some clearer and more predictable framework for their regulations emerges, however, it is probable that their access will be more limited and the cost of that equity, once investors price in the new risks demonstrated by recent developments, will be materially higher.

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