Growing Crackdown Sparks Foreign Exodus From Chinese Stocks

By Emel Akan
Emel Akan
Emel Akan
reporter
Emel Akan is White House economic policy reporter in Washington, D.C. Previously she worked in the financial sector as an investment banker at JPMorgan and as a consultant at PwC. She graduated with a master’s degree in business administration from Georgetown University.
July 27, 2021 Updated: August 2, 2021

WASHINGTON—China has escalated its regulatory crackdown on its private sector, sending shockwaves across global markets. The move, which has wiped out more than $765 billion of value from U.S.-listed Chinese companies in recent months, sends a stark message to dozens of domestic firms that seek to tap into U.S. capital markets.

Beijing’s crackdown on Chinese firms is growing by the day, with private education companies becoming the latest target. China unveiled a sweeping overhaul of its $100 billion education technology sector last weekend, which banned firms from making profits, raising capital, or going public. Fast-growing online tutoring companies were among the targets.

Share prices of U.S.-listed Chinese companies TAL Education, Gaotu Techedu, and New Oriental Education dropped sharply due to the policy shift. Each company lost nearly 80 percent in value within days on the New York Stock Exchange.

The reform announcement came on the heels of a cybersecurity review of DiDi Chuxing, which sent the shares of the ride-hailing giant down by more than 40 percent since its initial public offering (IPO) in late June.

Many tech companies faced the wrath of the Chinese regime this year. Beijing authorities have moved against several prominent Chinese firms, including e-commerce giant Alibaba.

Alibaba Group agreed to pay a record $2.8 billion antitrust fine earlier this year after regulators launched a probe into the company. Jack Ma, the company’s founder, went missing for a few months around the time of the crackdown.

The Nasdaq Golden Dragon China Index, which tracks 98 of China’s largest firms listed in the United States, lost more than $765 billion in value since its peak in February, according to Bloomberg.

The Chinese regime has announced a different regulatory concern for each of the moves they’ve made. The clampdown, however, is a sign of the communist regime’s ambitions to tighten its grip on the private sector and restrict foreign investments in Chinese companies, according to experts.

Beijing’s action has “a lot to do with the fact that China remains a planned economy and the Chinese Communist Party does not want any development that it can’t, at least, have influence on,” economist and market strategist Milton Ezrati told The Epoch Times.

“To me, the amazing thing is how the CCP’s thwarting what seems to be its own interests.”

In the wake of the Great Recession of 2008–09, the Chinese regime ramped up its effort to dominate the global economy. The key to this effort was to create corporate champions through government subsidies and access to global capital markets.

Since the 2000s, hundreds of Chinese companies have entered the U.S. stock exchanges to benefit from deeper pools of capital. This has played a crucial role in the growth of these companies and the economy.

In the first half of this year, 34 companies from mainland China and Hong Kong raised a record $12.4 billion by going public in the United States, according to Dealogic data.

With the recent sharp selloff, however, investors will likely be more concerned about investing in China-based companies, and it will make their foreign listings more difficult.

“It certainly is very expensive if you move forward and then are effectively blocked by your own government. So I think there will be a chilling effect on this,” Ezrati said.

And the avenue for Western investors to enjoy economic exposure to the world’s largest consumer market through these companies will likely be “shut down or curtailed dramatically,” he said.

TikTok owner ByteDance, health care data company LinkDoc Technology, and popular fitness app Keep were among the Chinese companies that shelved their IPO plans in the United States after Beijing broadened its crackdown.

“I believe that the crackdown will be fairly lengthy,” Robert Johnson, professor of finance at Creighton University told The Epoch Times. “It is certainly not good news in the short and long term for the amount of IPO deals that will be brought to the market.”

‘A great miscalculation’

While some believe that the sharp drop in the value of Chinese tech stocks could be a good buying opportunity, many fund managers are wary of those assets.

Big global asset managers are starting to materially pull out of China and Hong Kong, Kyle Bass, founder and chief investment officer of Hayman Capital Management told CNBC on July 27.

Beijing’s endgame is to shift Chinese listings from New York to Hong Kong, according to Bass, calling it “a great miscalculation” on Beijing’s part. Hong Kong has become less attractive as an investment destination after China enacted a national security law in the city last year.

“I expect Chinese-listed stocks to remain volatile for the foreseeable future,” said Stoyan Panayotov, founder of Babylon Wealth Management, based in California.

Even before the government crackdown, investors didn’t have true protection, as most Chinese listed firms use a variable interest entity (VIE) to go public in the United States, Panayotov told The Epoch Times.

Almost every Chinese company is listed through a VIE structure outside of China. For two decades, this structure has helped to skirt Beijing’s restrictions on foreign investment in sensitive industries, such as telecommunications, media, and education.

For an overseas listing, a Chinese company sets up an offshore entity, which controls the business in China through contract agreements instead of direct equity ownership. Hence, unlike U.S.-based companies, investors don’t own the actual underlying Chinese company. Instead, they own interest in these VIEs.

Under Chinese law, however, the VIE structure is illegal. Therefore, any contract that aims to provide de facto foreign shareholder ownership is worthless.

“I have always had concerns about this legal structure, and most of my clients do not own US-listed Chinese stocks directly,” Panayotov said.

Emel Akan
Emel Akan
reporter
Emel Akan is White House economic policy reporter in Washington, D.C. Previously she worked in the financial sector as an investment banker at JPMorgan and as a consultant at PwC. She graduated with a master’s degree in business administration from Georgetown University.