China: predictions and predicaments in the year of the tiger

by Nana Li, ACGA

21 February 2022

The year of the Ox saw myriad twists and turns for investors in PRC firms. ACGA’s China Research and Project Director Nana Li takes a look at ten major developments during 2021 and considers how they may play out in the year of the tiger.

1. Taming the tech giants

It was a rollercoaster year for China tech stocks. Following the abrupt halt of the IPO of Ant Group in November 2020 by the Shanghai Stock Exchange which quoted “significant issues,” the State Administration for Market Regulation (SAMR) proposed new anti-monopoly rules targeting tech giants in China. By October 2021, SAMR published a draft amendment to the Anti-Monopoly Law, the first amendment since the legislation was adopted in 2007, to put more emphasis on the digital economy.

Expect monopolistic practices to be a key regulatory focus of 2022: in late December 2021, Gan Lin, chief of the State Anti-Monopoly Bureau (SAMB), vowed to further tighten enforcement against such practices in the year ahead. This is after a record fine of US$2.8 billion was imposed on Alibaba in April 2021 and another fine of US$533m was slapped on Meituan in October the same year for antitrust breaches.

Gan recently gave a speech which should be taken seriously. Beijing is determined to manage the rapid growth of the tech giants which kicked off with the Ant incident. The SAMB, which used to be the antitrust bureau inside the SAMR, is now reporting directly to the State Council. On 14 October 2021, the bureau issued a hiring announcement relating to 19 new roles, a significant increase to its workforce of about 50 staff at the time.

2. Didi’s brief encounter with the Big Apple

Less than a week after Didi made its IPO debut on the New York Stock Exchange on 30 June 2021, the Cyberspace Administration of China rebuked the company for illegally collecting users' data and demanded it takes a range of its taxi-hailing apps off the market. It also emerged that the company reportedly went ahead with the New York listing against the wishes of several Chinese regulators who asked it to “think twice about the application”.

By 3 December 2021, Didi announced plans to delist from New York and instead trade its shares in Hong Kong. Didi has signalled that it will gradually ask US shareholders to convert their shares into Hong Kong stock. In the meantime its six-month debut performance in New York was far from impressive—Didi’s shares fell from the IPO price of USUS$14 to around $5 by year-end.

It will be interesting to see how the sponsors of Didi’s NYSE IPO will convert their shares when the company is listed in Hong Kong. Another issue is how its lawyers working on the Hong Kong IPO will tackle and ultimately disclose the data security issue which so concerned PRC regulators. How Hong Kong regulators address this topic will also be of interest and may put the different listing rules of the two markets under the spotlight.

3. War is declared on tiger mothers…

China’s “Double Reduction” policy was introduced on 24 July 2021, rendering the private education sector, an estimated $120 billion industry, illegal overnight. Shares of companies within the industry plunged and several well-known firms went bankrupt.

From a corporate governance perspective, the significance of this case is to show the soaring political risk of investing in Chinese companies. Many believed the education sector would benefit from the abolishment of China’s single-child policy. It turned out to be a risky bet as Beijing deemed high private tutoring costs as one of the biggest hurdles to combatting the low birth rate.

Having said that, it is impossible to eliminate an entire industry when both supply and demand are still quite strong. The textbook reaction is to create a black market which appears to be what has happened in this case. After all, you cannot ban parents from inviting their children’s teachers over for a private dinner after school once a week. Quite how this will pan out in “reallocating educational resources” to level the playground between children from rich and poor families will only be seen in a few years.

4. …as a gaming Armageddon misses the mark

On 30 August 2021, China’s National Press and Publication Administration issued new rules to restrict under-18s from playing video games for more than three hours a week. This rule aimed to solve a perceived gaming addiction among teens in China. On 4 September 2021, the day the new rule came into effect, the server of “Honor of Kings”, the Tencent-owned online game most popular in China, crashed.

Teenage gaming addiction is a serious issue faced by governments around the world. While it is understandable that the Chinese government seeks to address the issue, the reality of the rule change is not promising. Total playtime of users under the age of 18 decreased by just 0.7% in September, according to Tencent. Children are circumventing the rule by using their parents’ or grandparents’ accounts to log in. Meanwhile, asking game makers to include anti-addiction measures in the games creates potential conflicts of interest and may not be the most logical way to solve this issue.

5. The big data grab

China announced on 22 September 2021 that credit data generated by Ant Financial’s micro loan service Huabei would be fully integrated into a government credit-reporting system run by the People's Bank of China (PBOC), China's central bank. A similar notice was made shortly for Jiebei, another micro loan service provider under Ant.

This day has been coming for some time and the reality is that the government wants to cultivate and own data to formulate economic policy and control capital flows. As data increases at a rapid pace, the financial sector’s sharing of such information fell below government expectations. Foreign investors with high data integrity standards should bear this in mind as the Chinese government ramps up the legal framework for data sharing.

6. A VIE validation, of sorts

The variable interest entity (VIE) structure favoured by Chinese firms seeking an overseas listing for many years stood on shaky legal ground. On 23 December 2021, the China Securities Regulatory Commission (CSRC) gave tacit approval to VIEs when it released draft rules to increase oversight on China companies listing overseas. While it is likely PRC companies will continue to use these structures to list in other markets, private firms in the technology and education sectors are restricted by the authorities to directly list overseas. And as both China and the US tighten up rules on PRC companies listing in New York, it will be challenging for a Chinese company with a VIE structure to raise capital overseas. For more information, please see the recently-published blog “China: live and let VIE” here.

7. The unravelling of Evergrande

The world’s most famous corporation-on-the-brink continues to enthral. Evergrande defaulted on an US$83.5 million interest payment due on some of its US$-denominated bonds on 23 September 2021. Since then every step by company management, particularly founder Xu Jiayin (otherwise known as Hui Ka Yan) is being closely watched by investors, homeowners, media and the Chinese government.

Evergrande is a poster child for excessively-leveraged property developers in China and it remains to be seen quite how the authorities mitigate its downfall. Beijing urged the company to take responsibility and properly manage its debts a few times before the September 2021 default, however, Xu and his allies did not listen.

The case serves as a barometer of moral hazard in China from a market development perspective. When the company defaulted, many related parties, including Xu himself, seemed to have full confidence that the government would bail the company out of its mounting debts to maintain a ‘harmonious society’.

Apparently, Beijing did not enjoy being held hostage, so it decided to sit tight and assess the situation. It is an essential standpoint if the Chinese government wants to take the economy in a more market-driven direction. It is hoped Evergrande home buyers will finally see their properties being delivered to them but speculators who bet on a government bailout should learn their lesson.

8. A class act

The case of Kangmei Pharmaceutical saw a court hand litigants a landslide victory in China’s first class action involving financial fraud. On 12 November 2021, the Intermediate People's Court of Guangzhou ordered Kangmei and a number of its former executives to pay 55,326 investors a total of RMB 2.46 billion (US$385.51m) for the RMB 30 billion ($4.60 billion) financial fraud at the company between 2016 and 2018.

Former Chairman Ma Xingtian has also been sentenced to 12 years imprisonment and received a fine of RMB 1.2m. Former Vice Chairman Xu Dongjin and 10 other related persons also received jail terms and fines for participating in securities law breaches related to the fraud. Five independent directors of the company were held liable for between 5% and 10% of the total compensation, equivalent to sums of RMB 123m to MB246m. This amount is equivalent to about a thousand times the directors’ annual salary.

This case set a milestone in the development of China’s capital markets as the first successful class-action lawsuit following the implementation of the new Securities Law in China in March 2020. However, it also triggered a wave of independent director resignations.

The ruling no doubt was aimed at forcing independent directors to be more proactive in improving corporate governance and scrutinising companies’ accounts, but such an effect is limited without a sufficient pool of candidates. For more about this case, please see our analysis of the case here.

9. Board supervisors on the wane?

The sixth draft amendment of China’s Company Law was published on 20 December 2021 and proposed reinforcement of Party leadership by applying clauses until now applicable only to wholly-owned state enterprises to companies with state capital.

The draft also suggested that more than half of the boards of wholly-stated owned enterprises be outside directors. It also proposed abolishing the requirement of a supervisory board in such entities in certain circumstances.

Key proposals are:

  • A requirement that board members be designated as executive or non-executive
  • Allowing companies to disperse with the requirement of having a supervisory board if more than half of their audit committee comprises non-executive members
  • To clarify that directors, management, actual controllers and controlling shareholders will be liable for any losses made if they do not uphold their fiduciary duties.

We hope the plan regarding the supervisory board structure stays in the final version of the law. We suggested such a move in our China Report published in 2018 because we saw the governance structure of Chinese companies as too complex and often the supervisory board cannot serve its purpose.

10. Ante up

President Xi Jinping wrote of his intentions for wealth redistribution in an article published in Qiushi Magazine on 15 October 2021, “Steadily promote common prosperity”. According to our calculations, Xi mentioned the term 84 times in 2021, compared to 30 times in 2020 and only six times in 2019. China’s 14th Five-Year Plan issued in March 2021 also stated that: “substantive progress will have been made toward…common prosperity [by 2035].”

A new national theme has been defined. But so far it is only impacting tech giants and property developers in China. Many large companies are making generous donations to help redistribute wealth. Founders of several tech firms are stepping down from managerial positions and board seats amid regulatory uncertainty as to the scope of the policy.

Expect further reform targeting large (private) companies in this context, perhaps in the form of official taxation, with the impact widening at different levels of enterprise in the following years, particularly after Xi’s expected re-election in the fall of 2022.

For further information please contact Nana Li:

About the Author(s)

Nana Li
Research and Project Director, China, ACGA

Nana Li
 is Research and Project Director, China for ACGA, joining the Association in February 2014. Her primary responsibilities include researching corporate governance developments in Hong Kong and China. She was the primary author of the China and Hong Kong chapters of CG Watch 2018, and project manager and one of the main authors of ACGA’s China Corporate Governance Report 2018.

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