In July, China’s equity market suffered one of its worst monthly declines in a decade amid escalating regulatory pressures. The steep fall has raised concerns about the risks and outlook for investing in Chinese equities.

The latest trigger event was a policy update setting out new restrictions on China’s private tutoring industry. In recent months, China’s regulators have also been issuing antitrust fines, disallowing M&A activities of technology firms and focusing on cybersecurity. A recently passed data security law will also take effect in September.

We asked Noriko Chen, a portfolio manager and member of the Capital Group Management Committee, and portfolio manager Victor Kohn to share their perspectives on recent developments and potential investment implications. Noriko and Victor each have more than 25 years of experience investing in China and are portfolio managers on emerging markets-focused strategies.

What should we make of the recent spate of regulations, particularly those aimed at the education and technology sectors?

Looking at it in a broader socioeconomic context, China’s government wants social and economic stability. Everything related to people’s lives need to be affordable - education, healthcare and property. Anything against those efforts is likely to be tightly regulated. China’s other major goal is national security, which means control of data and great self-reliance in technology.

China wants to do more to build up and strengthen the capabilities of its domestic economy. This has been previously articulated in its dual-circulation strategy; it took on greater urgency after the US banned telecommunications giant Huawei and pressed other countries to do the same. We still think Communist party officials want to help support domestic companies that can develop superior capabilities that rival global competitors in a number of areas such as technology and health care. At the same time, they want to make sure that when and where there are sensitive issues such as data privacy that companies follow government guidelines.

Beijing is saying it wants greater control, but that does not necessarily mean government wants to punish any company that makes too much money, or to sharply curtail the profitability of some of the country’s most successful companies.

Let’s talk about a few areas that have been the focus of regulation. What about the internet platforms?

For the internet platform operators, the likely aim is to curb monopolistic and oligopolistic power and behaviour, such as forcing merchants to sign exclusive contracts, and to limit predatory marketing practices. We believe the objective of this regulation is to foster greater competition and create an environment where smaller businesses can thrive and consumers of those particular products pay lower prices, whether it be business-to-consumer or business-to-business.

This may mean the dominant internet companies have to open their mobile-based internet platforms to competitors. We could also see greater scrutiny of potential acquisitions. In the long-run, increased competition might be a healthy development but in the near term, we could see greater earnings volatility.

Some sectors of China’s equity market have seen rapid growth in market value¹

On the data front, the government has been more focused on cybersecurity and data privacy requirements since 2017 when the Cybersecurity Law went into effect. Since then, China has implemented and drafted additional laws that are increasingly strict in multiple areas, from national standards requiring localisation of cloud infrastructure in China to expanding personal information security and protection where information needs to be stored onshore in China. 

 

1. Sources: RIMES, MSCI. Data reflects market cap of MSCI China IMI sectors.

 

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