When Politics and Economics Clash

by | August 9, 2021

A month is a long time in politics. In finance too. 

At the start of July, the Didi IPO and subsequent announcement of penalties and an investigation by China’s cyber-security authorities sparked political controversy and turmoil for investors that underscore the decoupling dichotomy running through the arteries of global capital markets. As China has cracked down on other tech, quasi-finance and data platforms, the market value of leading firms in these areas listed in Hong Kong and in New York has fallen by more than in any month since the financial crisis. They are down about 40 per cent since the peak in February. This is a shock for investors but needs watching for other reasons too. 

The political and regulatory authorities certainly gave clear warnings as far back as last November when Ant Financial’s mega-IPO was cancelled abruptly, leading to the imposition of a large fine against Alibaba, the regulatory neutering of Ant, and the orchestrated deposition of Jack Ma, Alibaba’s celebrity founder. 

In recent weeks, data and cybersecurity investigations have been launched against other firms that have issued shares overseas, Didi Global being one of the more high-profile names. Regulators have vowed to make such listings harder in the future or even prohibit them. The list of names that also includes Meituan, Tencent, and private tutoring firms such as Tal Education and New Oriental Education and Technology Group means that the crackdown extends across a broad array of sectors such as finance, artificial intelligence, private tutoring, ride-hailing, food delivery and distribution, logistics, video-streaming, and gaming. Others such as healthcare and real estate may be next in line. 

Taking each case on its own, one can see the government’s reasons for taking regulatory action ranging from anti-trust to financial stability, data privacy and even Xi Jining’s ‘social goals’ agenda in which markets that generate inequalities are fair game for the Communist Party. 

All of these initiatives are about the imposition of regulatory and political control at home, as well as keeping the prying eyes of US regulators, politicians and investors out of the books and other corporate information of Chinese firms – which are regarded in some cases as state secrets. Beijing is quite happy to restrict or prohibit Chinese firms’ access to US capital markets, to shift much capital raising to Hong Kong and other Chinese exchanges. 

Curiously, Washington is equally hostile to Chinese listings if they refuse to succumb to audit and supervision requirements with which all other firms must comply. This is just the latest example of a process of decoupling, or self-reliance, as it is known in Washington and Beijing, respectively.

Yet, seemingly oblivious to the politics, Wall Street firms, non-financial companies and investors continue to beat a path along a welcoming red mat into China. Inward direct investment and portfolio capital inflows together registered almost 3 per cent of GDP in the first half 2021, about as high as the trade surplus. A number of leading US and EU financial firms, have put money into their Chinese asset management and investment banking ventures, or gained approval for majority owned partnerships. Holdings of Chinese bonds and equities are reported to have risen sharply. 

Why the surge? One-off factors include familiar themes such as economic recovery, yield differentials, and exchange rate movements. Asset managers, after all, have a fiduciary duty to earn the best returns for investors. China is also viewed as embedding attributes investors want, including growing markets and a large pool of largely uncorrelated assets. For foreign banks, China offers a lucrative source of fee income, especially where they have comparative advantage in wealth management, and investment banking. This year, China has been in the sweet spot. 

Investors, occupying a front-row seat in this dichotomy between politics and finance, should nevertheless watch out for two important reasons.

First, they are directly exposed to the government’s crackdown against quasi-finance, technology, and data-intensive platforms to which their funds have flocked. This campaign is about a well-founded angst regarding financial instability and a determination to keep ambitious private firms and entrepreneurs in check. Public ownership, or control, is the only way to tame capital and ensure it is politically subservient. However, this also means that although these innovative firms, stripped of their growth potential or treated like banks for regulatory and capital adequacy purposes, may not be utilities as such, they shouldn’t command tech valuations either. 

Second, investors are in the crosshairs where assets and valuations are increasingly hostage to random and rogue political initiatives. Numerous companies are now restricted or barred from commercial engagement with Chinese entities. Investors are under notice to divest holdings in dozens of Chinese companies linked to the repression in Xinjiang and Hong Kong, and to the People’s Liberation Army. A growing list of US firms must comply with sanctions imposed on Chinese entities and individuals by the US government. Repression, human rights abuses and alleged use of forced labor have also triggered concerns, especially in the retail sector and among shareholder activists about the social provisions in ESG investment criteria.

Investors are also affected by new legislation that empowers the Securities and Exchange Commission to demand disclosure of shareholder information, board of director links to the Chinese Communist Party, and the release of audit records to a US-authorized audit supervision company. Failure to do so, which is likely because Chinese regulators prohibit their companies from making such disclosures under state secrecy provisions, would lead to de-listing after a proposed 2-year period, most likely entailing illiquidity and loss risks.

China also has tools to defang companies behaving against its national interests, and sanction foreign individuals and institutions. It has passed legislation this year to help firms in China nullify the effect of US export controls and sanctions that apply outside China, and recently approved the Anti-Foreign Sanctions Law, which provides a legal umbrella for firms in China to appeal sanctions, or face penalties if they comply.

This incremental build-up in decoupling rules and regulations on both sides is going to draw more companies and investors into an awkward space, where the contradiction between politics and narrower financial interests will become starker. This stand-off can continue for some time. And as conflicts of interest increase, and decisions about whose rules to obey (or flout) become starker, the unpredictability of politics is likely to prove the decisive determinant. Market valuations don’t even begin to reflect this yet. 

A similar version of this piece recently ran in the Financial Times on July 20, 2021. George Magnus is a research associate at Oxford University’s China Centre and author of RedFlags: Why Xi’s China is in Jeopardy

Filed Under: Economics . Featured . Politics

About the Author

George Magnus is an independent economist and commentator, and Research  Associate at the China Centre, Oxford University, and at the School of Oriental and African Studies, London. George was the Chief Economist, and then Senior Economic Adviser at UBS Investment Bank from 1995-2012. He had a front row seat and key managerial position for multiple episodes of boom and bust in both advanced economies and emerging markets, including notably the Great Financial Crisis of 2008. George famously anticipated it in 2006-2007 with a series of research papers in which he warned of an impending Minsky Moment. Whilst at UBS, he served for four years as the Chair of the Investment Committee of the pension and life assurance fund. For four years until 2016, he served finally as an external senior adviser with clients of the investment bank. He had previously worked as the Chief Economist at SG Warburg (1987-1995), and before that in a senior capacity before ‘Big Bang’ at Laurie Milbank/Chase Securities, and before that, Bank of America in London and San Francisco. George is closely followed nowadays for his insights and observations about the global economy in general, and China and demographics, in particular. His China focus derives from a long period of observation and study that goes back to his first visit in 1994. He also opines regularly on demographic trends around the world, as well as on key issues nowadays such as Brexit, and the US and world economy. He is a regular contributor to the Financial Times, Prospect Magazine, BBC TV and radio, Bloomberg TV and other outlets. His written work and a blog can be found on his website at www.georgemagnus.com George’s current book, Red Flags: why Xi’s China is in Jeopardy was published in September 2018 by Yale University Press. It examines China’s contemporary economic and commercial challenges and aspirations to modernity in the light of a governance system that is a throwback to much earlier times in the People’s Republic.  His earlier books are The Age of Aging (2008), which investigated the effects of the unique experience of demographic change on the global economy; and Uprising: will emerging markets shape or shake the world economy? (2011)which examined the rise of China and other major emerging markets, and questioned controversially the widely accepted narrative that China was destined to rule the world.

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