China Update: Mega cap platform companies are facing multiple headwinds, including the amended Anti-Monopoly Law in China
摘要: In this article, we consider the possibility of selling pressures on Chinese mega-cap platform companies from heightened geopolitical risks as well as the ADR delisting risk. We also discuss the potential negative impacts of the newly amended Anti-Monopoly Law in China on mega-cap platform companies.
Being widely owned by overseas investors and good liquidity could be a curse
Tension between the United States and China escalates in the midst of U.S. House speaker Nancy Pelosi’s visit to Taiwan and meeting with Taiwan’s president Tsai Ing-wen. Despite the strong-worded rhetoric, China’s responses so far are measured. China announced yesterday to ban the import of food from 100 Taiwanese suppliers and export of sand to Taiwan as gestures of angst but the economic impact of the moves may be immaterial. China also announced a series of military drills in six areas of the seas and airspaces surrounding Taiwan from August 4 to 7 and banning all vessels and flights into those areas during the period. It remains to be see how transportation and supply chain from and to Taiwan will be affected. Logistics may not be affected much as wide gaps open outside the drill areas in the sea and airspaces but risks are real for some disruptions.
China’s rhetoric so far has been carefully worded to focus on House speaker Pelosi and less reference to criticizing the U.S. global strategy or the Biden administration. How the situation will develop is still fluid as of writing. It is however almost for sure that there will be more frictions between the U.S. and China on many fronts. Both sides will be testing the reaction functions of each other and fine-tuning their grand schemes of strategies accordingly. In the midst of this, it will be reasonable to expect overseas investors to unload Chinese and Hong Kong equities in the coming weeks, if they have not yet done so in response of the weaker-than-expected economic data coming out of China, the mortgage payment boycott, and the readout from the July Politburo referring to this year’s growth in a uncommitted tone of “doing our best to get the best possible results”.
Shares of mega-cap platform companies traded in Hong Kong and U.S. bourses are widely owned by overseas investors and very liquid and trade in large volume. They are likely to be candidates to sell when overseas institutional investors reduce weighting in Chinese equities and rebalance their portfolios, especially after much of the underweight in China has been replenished between April and June when Chinese equities outperformed other equity markets upon upgrades from a number of leading U.S. investment banks.
ADR delisting risk looming on the horizon
Over the past several months, China is reported to have considered various options, including making amendment to some Chinese laws in order to give the U.S. regulators access to the audit papers of companies with deposit receipts listed in U.S. stock exchanges. Nothing has been finalized and no agreement has been yet made between the Chinese authorities and the U.S. regulators. With the escalated tension over the Taiwan strait and between China and the United States, it is increasingly unlikely for the Chinese authorities to make concessions, in particularly regarding platform companies that are deemed by the Chinese authorities as having possession of huge amount of sensitive data. The ADR delisting risk is going to rise and have investors’ attention and may trigger more selling of the shares of the mega-cap platform companies.
The amendment to China’s Anti-Monopoly Law is stricter on mega-cap platform companies
On August 1, 2022, the first amendment to China’s Anti-Monopoly Law (“Amended AML”), which was enacted in 2007, took effect. The Amended AML has the following newly introduced provisions that are particular relevant to mega-cap platform companies.
Targeting on the digital economy and large platform companies (Articles 9 & 22)
The AML adds a complete new Article 9, which provides that “[u]ndertakings shall not use data or algorithms, technology, capital advantages, or platform rules, etc., to engage in the monopolistic practices prohibited by this Law.” This provision is obviously targeted on tightening the regulation over the digital economy and large platform companies.
In Article 22, which replaces Article 17 in the 2007 version of the law, the provision that “[u]ndertakings holding dominant market positions shall not use data or algorithms, technology, or platform rules, etc., to engage in the practices that abuse dominant market positions provided for in the previous paragraph” is added. This provision echoes Article 9 with the added emphasis on prohibiting “dominant” players from abuse their “dominant market positions”. It is once again targeting on regulating mega-cap platform companies who are currently enjoying dominant market positions.
Preventing large companies from acquiring emerging innovators to eliminate future competition in the cradle (Articles 1 & 26)
The Amended AML adds the phrase “encourage innovation” to Article 1. Further in Article 26, it adds that “[w]here a concentration of undertakings does not meet the declaration criteria prescribed by the State Council, but evidence shows that it has or may have the effect of eliminating or restricting competition, the State Council anti-monopoly law enforcement agency may require the undertakings to make a declaration. Where undertakings fail to make a declaration consistent with the provisions of the previous two paragraphs, the State Council anti-monopoly law enforcement agency shall investigate in accordance with law.”
The added provision in Article 26 will have the effect of preventing what is called “killer acquisitions”, which are primarily motivated by the purpose of buying out emerging and innovative companies so as to eliminate potential future competition or disruption. Reading together with the encouraging innovation provision in Article 1, the Amended AML aims at preventing large companies from buying out innovative smaller players not for the purpose of developing the innovation but instead to kill the innovation in the cradle.
Article 26 provides the power to the regulatory authorities to proactively initiate investigations even if the size of the acquisitions are small and otherwise do not meet the threshold of voluntary notification by the acquirer to the regulator.
Favoring smaller companies to grow (Article 18)
While resale price maintenance arrangement which is also known as vertical anti-competitive will continue to be prohibited for large companies, Article 18 of the Amended AML provides a waiver to smaller companies to enter such resale price maintenance arrangement if these small companies “can demonstrate that its market share in the relevant market is below the threshold prescribed by the State Council anti-monopoly law enforcement agency, and that it meets other conditions prescribed by the State Council anti-monopoly law enforcement agency”. In effect, the Amended AML gives preferential treatment to smaller companies to enable them to protect their profit margins and have a better chance to grow.
The Amended AML aside, some other anecdotal observations also suggest that the Chinese regulatory authorities seem having a preference for enabling emerging market players at the expense of dominant market players. For example, China’s National Press and Publication Administration (NNPA) has approved a total of 241 online game monetizaition licenses (Banhao) in four batches since April this year, most companies being awarded tend to be smaller companies. Tencent (00700:xhkg) has received none in these four batches.
Strengthening regulation, regulatory power and capability (Article 11)
Article 11 is newly added. It provides that “[t]he State establishes and improves anti-monopoly rules and systems, strengthens anti-monopoly regulatory power, increases regulatory capability and the level of modernization of the regulatory system, strengthens anti-monopoly law enforcement and judicial administration, adjudicates monopoly cases fairly and efficiently in accordance with law, improves the mechanisms for linking administrative law enforcement and judicial administration, and preserves the fair competition order.” In short, Article 11 aims at strengthen regulation.
Substantial increases in penalties for violation (Articles 56, 57, 58, 60, 62, 63 & 64)
The Amended AML has substantially increased the penalties for the companies which violate the law. Article 58 of the Amended AML provides that “[w]here undertakings concentrate in violation of the provisions of this Law and have or may have the effect of eliminating or restricting competition”, the fine is increased from up to RMB500,000 in the 2007 version of the law to “a fine of up to 10 percent of their turnovers from the previous year”. Article 62 increases the fine for refusing to cooperate with an investigation from up to RMB1,000,000 in the prior version of the law to “a fine of up to 1 percent of its turnover from the previous year”.
Even more dramatically, in Article 63, the Amended AML provides that “[w]here a violation of the provisions of this Law has especially serious circumstances, has an especially heinous impact, and causes especially serious consequences, the State Council anti-monopoly law enforcement agency may determine the specific amount of fines based on at least twice but up to five times the amount of fines prescribed by Article 56, 57, 58, and 62 of this Law.” In other words, some violations, to the extreme application of the Amended AML, the penalty can be as high as 50% of a company’s prior year revenues.
Article 64 provides that “[a]dministrative punishments imposed on undertakings for violating the provisions of this Law are to be listed in their credit records in accordance with the relevant provisions of the State Council and be made public. This is also new in the Amended AML.
The management becomes personally liable the first time and could be criminal (Articles 56 & 67)
In the 2007 version of the law, the management of the company will not be held liable personally for violation under the Anti-Monopoly Law. In the Amended AML, however, Article 56 makes management personally liable as it provides that “[w]here the legal representatives, principal persons in charge, or directly responsible persons of an undertaking bear personal responsibility for concluding the monopoly agreement, a fine of up to RMB 1,000,000 may be imposed.” Further in Article 67 makes it possible for the company as well as the management individually subject to criminal liabilities with the provision that “[w]here a violation of the provisions of this Law constitutes a crime, criminal responsibility is to be pursued in accordance with law.”
The shares of mega-cap platform companies are facing multiple headwinds
First of all, the shares mega-cap platform companies are plausible candidates high up on the selling list of overseas investors who are looking for reduction of exposure to the Chinese economy and markets.
The risks of being forced to delist from U.S. exchanges are rising for platform companies as they are holding large volume of data that are considered by the Chinese authorities as highly sensitive and critical to national security. With the prospect of deteriorating relationship between China and the United States, investors will be increasing pricing in the risk of ADR delisting. Shares of the mega-cap platform companies are widely held by institutional investors in the United States and some of these investors may have restrictions on their investment mandates to prevent them from transferring their positions from ADRs to shares listed in the Stock Exchange of Hong Kong.
Further, the Amended AML represents a regulatory environment for the Chinese platform companies that is tighter rather than looser from the past.