Since Jack Ma’s infamous speech in October 2020, China has been undergoing a regulatory shakedown. The oversight has risen dramatically, and the internet giants are being cut to size. Given that China chooses to be an information black box, understanding the developments had been a challenge for watchers across the globe. A recent paper by Angela Huyue Zhang, an Associate Professor of Law and Director of the Centre for Chinese Law at the University of Hong Kong, throws some light on the subject. Zhang argues that the Chinese crackdown on firms like Alibaba and Tencent in fact follows the global trendsReport “These are the US antitrust cases facing Google, Facebook and others” [The Wall Street Journal] and “House bills seek to break up Amazon and other big tech companies” [ibid] of an increased discomfort with and heightened scrutiny of big tech but given the authoritarian set-up, the pace of clampdown has been much faster in ChinaReports “China joins global push to rein in tech companies” and “China’s tech clampdown is spreading like wildfire” [ibid]. The dramatic swing from a lax and accommodative stance to an aggressive and hawkish one has surprised many. Although, she points out that such policy swings should not surprise the observers and that such volatile policymaking is deeply ingrained in its authoritarian governance system, where regulatory authorities need to adhere to central policy initiatives and administrative power is subject to few institutional constraints.
She further explains, “When public discontent mounts and a regulatory crisis spirals out of control, the top leadership intervenes to avoid threats to social stability. In response to the call from the central top leadership, Chinese regulators at all levels then quickly react by taking an aggressive stance to tackle the regulatory problems”.
This volatility in the policy sector is not a one-off but deeply rooted in CCP’s guerrilla history when Mao had to face threats and uncertainty. The Chinese tech giants have created a similar uncertainty. Zhang posits that such a volatile policy style is likely to persist as it is deeply seated in China’s political governance.
This policy shift is accompanied by a shift in politburo’s priorities fostering economic prosperity to addressing nationalism and social stability. The regulatory crackdown has given the Chinese government sufficient leeway to steer its tech firms towards a more innovative path to come out on the top in the US-China tech war.
Policy turnaround in China
The lax regulatory environment of yesteryears coupled with the great Chinese firewall ended up creating tech goliaths. Zhang points out several reasons for the shift in the stance of the Chinese regulators. Firstly, serious cases involving personal safety and financial stability issues started to emerge soon after the introduction of new platform products and services, posing a threat to social stability. For example, in 2015, Didi launched Shunfengche, a ‘hitchhiking’ service that matched car owners who were willing to offer a free ride to those needing a lift. In a few years, problems started to emerge when a few female passengers using the Shunfengche service were raped and murdered by their drivers. In 2015, Ezubao, one of China’s largest P2P lenders, was found to be engaging in a Ponzi scheme. As of January 2016, Ezubao had defrauded over 900,000 users who lost almost RMB 50 billion.
Secondly, Chinese regulators must find a way out of the moral hazard issues with platform operations. As online platforms serve as intermediaries connecting buyers and sellers, it is often not entirely clear what their legal responsibilities are regarding conflicts arising from their platforms. As such, online platforms have the incentive to engage in excessively risky transactions without bearing any liabilities. According to Ant’s IPO filing, banks extend almost 98% of the loans and Ant does not need to bear the risk of default. As Ant has no skin in the game, this generates concerns that Alibaba might engage in excessively risky lending. Meituan and Ele.me, two major food delivery companies, have been criticised for using smart algorithms to set up routes and impose tight deadlines on delivery drivers, leading to many traffic accidents. As most of these drivers are crowdsourced couriers rather than full-time employees, they cannot receive social security or compensation for work-related injuries. The absence of formal legal protection for drivers resulted in many labour disputes, some of which escalated into strikesReport “In China, delivery workers struggle against a rigged system” [Sup China].
Thirdly, the Chinese digital economy has grown to be highly concentrated, giving rise to a whole host of antitrust and competition issues. In the past few years, Tencent and Alibaba have become China’s most formidable competitors.
Operating like a duopoly in the Chinese digital economy. Over the years, the intense rivalry between Alibaba and Tencent has carved up China’s tech sector into two competing ecosystems, each side blocking users from sharing content to the other’s ecosystem. For instance, users of WeChat cannot open a link to a product from Taobao; they must copy and paste the URL in a browser to access the content. Taobao, on the other hand, does not allow Tencent’s WeChat Pay as a payment service. Because of the lack of interoperability between these two ecosystems, most new start-ups have no choice but to join either the Alibaba or the Tencent camp. Alibaba and Meituan imposed restrictive conditions to force merchants to stay on their platforms.
Lastly, increasing concentration in the tech sector has generated growing concerns about income inequality. By leveraging the vast amount of data collected from their consumers, Chinese e-commerce platforms employ smart algorithms to price discriminate and extract more surplus from Chinese consumers. Due to the high concentration of the Chinese tech industry, large online platforms can behave like a monopsony by exploiting their suppliers, contractors, and employees. In 2020, the Guangdong Restaurant Association publicly accused Meituan, a top food delivery app of significantly increasing the commission for restaurants since the outbreak of the pandemicReport “Meituan refutes claims its delivery fees are hurting restaurants amid coronavirus downturn” [SCMP].
The last straw
On 24 October 2020, Jack Ma made a highly controversial speech at the Bund Financial summit in Shanghai. Ma scathingly criticised Chinese financial regulation, chiding state banks for operating with a ‘pawn shop’ mentality and referred to the Basel Accords as a “club for the elderly”. Ma had trodden beyond the boundaries of CCP’s comfort. On 3 November 2020, the Shanghai Stock Exchange halted the IPO of Ant.
In the regulatory battle between the tech giants and regulators, the scales had tipped in the favour of the latter. In recent years, the Chinese financial regulators have grown increasingly wary of opaque ownership structures and the regulatory arbitrage of nonfinancial institutions providing financial services. In the aftermath of the financial fallouts involving HNA Group and Anbang Insurance Corp Co., and the P2P frauds, the central government created the Financial Stability and Development Commission headed by Vice Premier Liu He to coordinate the various financial Regulators (2017). The next year saw further consolidation of financial regulatory power with the merging of the banking and insurance regulators.
There has been strong pushback against the tech from the state-owned banks, a very large, vested interest group. This contrasts with the e-commerce and social media sector where there is no existing and organised interest group and consumers are highly dispersed and heterogeneous. As Ant Group expanded from online payments to other financial services including investment, credit and insurance, it started to encroach upon the services that have traditionally been serviced by Chinese state banks.
Another reason for regulatory discomfort was the aggressive regulatory arbitrage sought by firms such as Ant. Since its establishment in 2014, Ant has created many new financial products in microlending, insurance, and wealth management, none of which seem to fall within the existing regulatory framework. This allowed Ant to seek arbitrage among different regulatory authorities and find room to grow and expand very quickly. Although almost 90% of Ant’s revenue is derived from financial services, Ant has been trying hard to label itself as a technology company. Ant’s IPO was highly oversubscribed, gaining the firm a high valuation as a technology company rather than as a bank. Zhang posits that Jack Ma’s controversial speech in Shanghai appears to have been the entrepreneur’s last attempt to lobby for favourable regulatory treatment in anticipation of tightening regulation over his business.
Concerned about the risk of moral hazards, the People’s Bank of China (PBOC) has long been pressing for legislation to regulate Ant as a financial holding company. In 2018, the PBOC was already drafting regulations that proposed increased regulation of fintech companies via stricter capital-reserve requirements and risk management rules. During the summer of 2020, the PBOC issued a spate of regulations, guidelines, and notices to curb excessive digital finance risk. During Ant’s IPO process, the PBOC and other financial regulators grew more alarmed as Ant’s high valuation as a tech firm rather than as a bank stoked fears of a bubble.
Law enforcement campaign
Campaigns are a very powerful governance tool in the pocket of the CCP to overcome bureaucratic resistance and rigidity. Campaigns usually involve imposing legal sanctions swiftly and severely to create strong deterrent effects.
PBOC kicked off the campaign against Ant. PBOC published three days of commentaries in Finance News which rebutted Ma’s Shanghai speech argument by argument and explained the systematic financial risks posed by Ant and other fintech companies. PBOC also rebuked Ant for regulatory arbitrage.
On 31 October 2020, the Financial Stability and Development Committee headed by Liu He decided that all kinds of financial activities and similar businesses should be regulated in the same way, clearing the way for regulators to tighten their scrutiny of Ant. This message was further reiterated by Politburo on 11 December 2020, when it declared “strengthening antitrust regulation and preventing the excessive expansion of capital” to be a work priority.
On 2 November 2020, four financial regulators jointly released draft rules on micro-lending which required microlenders, among other things, to contribute at least 30% of the loans they fund jointly with their partner bank. This new rule was aimed at ensuring that microlenders such as Ant would have skin in the game.
About a week later, the antitrust authority of the SAMR released draft antitrust guidelines on the platform economy, which aimed to tighten the antitrust regulation of online platforms. In July 2021, SAMR blocked a merger between Huya and Douyu, the two largest live-streaming video game platforms in China. It imposed remedies on the 2016 merger between Tencent Music and China Music Corporation. On Christmas Eve of 2020, the SAMR announced an investigation into Alibaba for conducting a “choose one from two” business practice which concluded with a $ 2.8 billion fine on Alibaba. In late April 2021, the SAMR launched another antitrust investigation into Meituan, an online delivery company for conducting exclusionary practices like Alibaba.
On 2 July 2021, the Cyberspace Administration of China (CAC) announced a cybersecurity investigation into Didi Chuxing, two days after the ride-hailing giant’s debut on New York Stock Exchanges. This action appears to be a deliberate and strategic tactic to inflict a reputation sanction on the firm in retaliation for its failure to heed the CAC’s earlier advice to postpone its IPO. Chinese regulators have been tightening scrutiny over cross-border data transfer in recent years. The CAC reportedly urged Didi to conduct a thorough cybersecurity review before its US listing but the firm went ahead with its listing at a lightning speed. This prompted the regulator to escalate its action by publicly announcing the investigation and ordered the removal of the Didi app from Chinese app stores.
Impact of the flip
According to Zhang’s assessment, the actions of the successive governments of China seem headed in the right direction. Chinese tech firms’ vulnerability to regulatory challenges incentivises them to adhere to the government’s objective by investing in foundational sciences and technology. The more useful these firms are to the government, the more protection they can seek, and the more room they will have to lobby for favourable policy treatment.
The Chinese government has utilised antitrust enforcement deftly to steer the tech giants towards a more innovative path and diversify their portfolios. Since the campaigns, Alibaba has pledged $1 billion to nurture 100,000 developers and tech startups over the next three years, and another $ 28 billion to boost its cloud computing division to invest in technologies relating to operating systems, servers, chips and networks. The campaigns have also allowed smaller firms opportunities to grow and succeed outside of the Tencent or Alibaba ecosystem.
On the flip side, China’s dramatic policy swing in regulating big tech has imposed a negative externality on global investing. Since February 2021, Chinese tech firms had experienced over $ 800 billion loss of market capitalisation. The Chinese cyberspace regulator’s high-profile and unexpected probe into Didi dealt a further blow to international investors.314 China’s sudden ban on for-profit home-schooling and private tutoring companies, many of which were backed by Chinese tech giants, caused panic among foreign investors and generated a sell-off of Chinese stocks.
Through its increased oversight over cross-border data transfer, the Chinese government has gained significant leverage in steering Chinese tech companies away from overseas exchanges. while foreign investors used to play an outsized role in funding the first generation of Chinese tech firms such as Alibaba, Baidu and Tencent, they are now locked in fierce competition with home-grown funds, state-sponsored incubators, as well as Chinese internet giants to fund China’s booming tech sector.
As the United States tightens securities regulation of Chinese companies listed in US stock exchanges, this has prompted China to accelerate its efforts to develop its own capital market to reduce its reliance on the Americans, further exacerbating financial decoupling between the two largest economies.
|↑1||Report “These are the US antitrust cases facing Google, Facebook and others” [The Wall Street Journal] and “House bills seek to break up Amazon and other big tech companies” [ibid]|
|↑2||Reports “China joins global push to rein in tech companies” and “China’s tech clampdown is spreading like wildfire” [ibid]|
|↑3||Report “In China, delivery workers struggle against a rigged system” [Sup China]|
|↑4||Report “Meituan refutes claims its delivery fees are hurting restaurants amid coronavirus downturn” [SCMP]|