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China’s Regulatory Clampdown – What Is Next For Investors To Look Out For?

You can’t invest in China without being concerned about regulatory risk.

Over the past few weeks, there has been much chatter in the market over the seemingly iron hand that the Chinese Government has over sectors such as gaming and education. This immense regulatory pressure has everybody questioning and guessing – what is going on?

More importantly, investors all around the world are also wondering just how much influence the Chinese government has on these specific sectors, and how their influence can directly or indirectly affect companies that are operating in these spaces.

Today, we will have a quick look into what exactly is going on.

Online Video “Spiritual Opium” Games

An article that was published in early August by the Economic Information Daily newspaper, run by state news agency Xinhua, said online video games had grown into “spiritual opium worth hundreds of billions”. The article also mentioned that online gaming addiction among children is “widespread” and could negatively impact their growth. In it, there was also a mention of Tencent’s flagship title “Honor of Kings”.

After this article was published, shares in Tencent fell as much as 10.8% in Hong Kong, wiping almost US$60 billion from its market capitalisation. Other companies that were in the same category and sector also took a plunge due to this: – NetEase dropped more than 15%, XD Inc fell 8.2%, and mobile gaming company GMGE Technology Group dropped 15.6%.

New Restrictions By Tencent

In response to the article, Tencent took swift action and announced new restrictions to how long minors can play its online games. They published a social media post stating that it was introducing measures after “relevant authorities” requested for greater protection of minors in gaming and for companies to carry out their “societal responsibility”.

The new “self-restrictions” by Tencent, which will initially apply to its flagship title Honor of Kings, will further reduce the duration that minors are allowed to spend gaming each day, from 1.5 hours to 1 hour during normal days, and from 3 hours to 2 hours on holidays. The company will also prohibit anyone under the age of 12 from in-game spending and clamp down on minors playing on adult accounts. Tencent also raised three proposals for the entire industry including strengthening systems to tackle gaming addiction and to also call for a complete ban for children younger than 12 years old.

Beyond this article, however, this negative sentiment towards gaming is not new. In 2018, Beijing froze new game approvals over concerns that gaming was affecting young people’s eyesight and in 2019, China had rules that banned those under 18 years old from playing online games between 10 pm and 8 am, with further restrictions and reduction on the time they could spend on gaming.

China Crackdown On Education And The US$70billion Tutoring Business

In July 2021, the State Council banned tutoring firms from making a profit by teaching core subjects after school. This was a move by China’s cabinet to reduce and restrict foreign investment in such education companies and such a move essentially unravels the private tutoring sector in China that is worth billions of dollars.

This crackdown was also seen as an attempt to reduce inequality in the country, as costs spiral in the tutoring and enrichment industry.

Social Impact Of Private Education

The tutoring industry is seen by many well-off families, and the nation’s growing middle-class to a better life and enhanced social status. By making such a move, the central government is sending a signal that education needs to draw a clear line from capital because excessive capital involvement will reignite social injustice and is inconsistent with the government’s philosophies.

President Xi in 2018 mentioned that the after-school tutoring sector has increased the ‘financial burden’ of students and families and “violated the laws of education”, as well as ‘disrupted the normal order of education” and that “The conscientious industry cannot turn into a profit-seeking industry’ where these institutions should be regulated by the law so that they can return to the normal track of educating people”.

As China’s population ages, the state wants to boost the country’s declining fertility rate, which many Chinese attributed to the high cost of raising a child, in education and childcare expenses. Therefore, the above measures are seen as some as a mean that indirectly reduce pressure on families as excessive tutoring services have been straining the finances of Chinese parents.

What Caused This Trigger?

As China becomes more competitive with its national exam Gaokao or college entrance exams, more emphasis and resources are spent by parents to ensure that their children can enjoy the maximum advantage over their peers. This has led to overheating in the private tutoring businesses where technology giants like Alibaba and Tencent, through their investments in EdTech companies, start imprinting their presence in a bid to be more active in this profit-making sector.

Amid this explosion of online learning, it has also led to charges of malpractice against the industry. In June, China’s market regulator fined 15 private tutoring firms millions of dollars for false advertising and pricing fraud.

What’s Next For Affected Ed-Tech Listed Companies?

Education companies have two additional options going forward: to delist or to go private. These companies can remain listed if they can successfully spin-off the regulated entities into a non-profit, while pivoting to new educational ventures. Companies such as New Oriental and TAL would likely have to spin-off some businesses to meet the non-profit requirements. Both education providers could also invest in non-academic tutorings such as art, sports and music so that they could remain listed.

The Broader Impact Of These Regulatory Crackdowns

Since November last year, Beijing has also been active in reining Big Tech’s influence and power with some high-profile names such as:

  • Alibaba – Ant Financial Group’s $35 billion Initial Public Offering (IPO) because of the potential disruption in the banking sector;
  • Didi’s cybersecurity watchdog’s investigation which resulted in its mobile application being pulled out from the stores;
  • Ban on Tencent’s exclusive music copyright agreements and a fine for unfair market practices.

The Chinese government has also called for a new overseas listing’s regime, imposed data security reviews on companies seeking to sell shares abroad.

Foreign investors are now starting to feel the brunt of the bureaucracy and may have an impression that no sectors are off-limit, especially after witnessing how the entire tutoring industry got shut-down in such a short period. The question is almost always about where regulators might strike next, and if markets are properly discounting regulatory risk.

Previously, tighter rules for property-management and food-delivery markets also led to speculation that these are the next in line. Evergrande Property Services dropped by 12% after Chinese policy-making bodies issued a 3-year timeline to bring ‘order’ to the property sector, after scrutiny due to excessive leverage among homebuyers and developers.  Meituan’s stock prices tumbled as much as 15% after the government posted notices that online food platforms must respect the rights of delivery staff and to ensure that workers must earn at least the local minimum income.

Read Also: 10 Largest China Companies That We Can Invest In Today

Amidst the tightening across various sectors, investors are seeking out shelter in strategic sectors viewed as beneficiaries of Xi’s policies. These include electric vehicle (EV) makers, and companies that are involved in clean energy that helps China’s plans to become carbon neutral by 2060. Investors are also looking towards the semiconductor makers as the nation seeks to be technologically advanced and to be self-sufficient instead of relying on imports.

Therefore, moving forward – navigating across businesses and investments in the Chinese market might bring across another key factor that all entrepreneurs should also be aware of. This is the influence of key Government policies and the macroeconomic shocks that come alongside it.

Read Also: Investing in Chinese Companies: 5 Things To Know About The Launch Of The Lion-OCBC Securities China Leaders ETF

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