On 10 November 2020, China’s State Administration for Market Regulation announced a new set of draft rules aimed at controlling the growing influence Chinese Internet companies have over the country’s economy and society. This came right after China tightened rules on the consumer lending industry, a move that led to the suspension of Ant Group’s initial public offering (IPO).
The proposed rules cover a variety of issues ranging from the sharing of consumers’ data to the use of anticompetitive practices, such as forced exclusivity deals, and offering prices that are below cost to eliminate competitors.
The state regulator added that the main purpose of these rules is to safeguard consumers, and to promote healthy competition and the sustainable growth of China’s technology sector in the long run. It will be seeking public feedback on the draft rules until 30 November 2020.
Over the past few years, loose regulatory oversight has helped Chinese companies like Alibaba and Tencent grow into the behemoths they are today. Following the announcement of the draft rules, the share prices of Chinese tech giants plunged as investors fear that greater regulation could have an adverse impact on the future growth of these companies (Figure 1).
Figure 1: Shares prices of Chinese tech giants fell following the announcement of the draft rules
We believe that the recent sell-off is largely sentiment-driven, and we caution investors against making any knee-jerk reaction to the news. Instead, investors should remain focused on the industry’s long-term growth prospects.
Increased regulation unlikely to affect long-term growth story
On the whole, we believe that increased regulation should not significantly alter the long-term growth story of China’s technology sector, which is supported by real megatrends, such as the digitalisation of consumption, and a rapidly growing Internet population (Figure 2), which tech companies thrive on.
Figure 2: Tech companies benefit from the rapidly increasing internet population
First of all, we do not think that it is the government’s intention to freeze the growth of tech companies. Rather, because a number of tech companies have grown to become systemically important to the economy, with practically every Chinese citizen using their services on a daily basis, some form of regulation is necessary to keep them in check.
Moreover, the government has acknowledged that technology companies played a crucial role in stabilising the economy during the pandemic, allowing businesses and individuals to carry out their daily activities with as little disruption as possible. Through this, it is evident that the government recognises the value these tech companies have as the country undergoes a massive digital transformation.
Secondly, many of these tech giants, like Alibaba (NYSE:BABA) and Tencent (HKEX:700) for instance, are considered crown jewels of China’s modern economy. Without them, China’s digital landscape today would have been vastly different. If China wants to overtake the US to become the largest economy in the world, it cannot do so without the help of its technology companies.
Lastly, the majority of the successful tech companies in China today have benefitted from network effects (e.g. WeChat’s ecosystem) and superior product offerings rather than significant anti-competitive behavior, which is what the government is trying to deter. Because of this, we believe that consumers will likely continue to patronise their services.
In summary, we continue to hold a positive view on China’s technology sector. Even if the potential regulations were to be implemented, we believe that the negative impact on the long-term growth story of China’s technology sector should be minimal.
With technology companies at the forefront of China’s digital transformation, we expect to see strong earnings growth and better share price performance from them in the coming years. We continue to recommend the iShares Hang Seng Tech ETF (HKEX:3067) for investors who wish to gain exposure to China’s fast-growing technology companies.
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