VI Fund – Chinese Regulatory Clampdowns: the Breakdown

Dear Valued Clients and Partners,

In this issue, we will examine China’s Government and its regulatory actions on the business community. I will examine in my writing the underlying beliefs, context, and philosophy that drive these actions, and further on in Richard’s segment, he will dig deeper into the specifics and nuances of their implementation for industries and businesses.

“Parents know best”- this quote was a common phrase in my household when I was growing up, often heard from the mouths of my parents and the elders when I stepped out of line. While most of their advice (dispensed with good intent) was useful and valuable, not all were sound in hindsight – despite their best intentions. While that phrase might hold true to a certain extent due to the parents having a vast wealth of experience and insights behind their advice as compared to a child, the advice was given only to the best of their abilities – and not all advice may be the best as no one can know everything about the past, the present and more crucially the future. I imagine if I had taken heed of all the advice given to me, I would not have gone into business, and will not be here writing this. I’m sharing this small example to highlight that while most advice given to us is in the best intentions and is beneficial, some are best taken with a pinch of salt.

This analogy brings us back to the issue at hand: the Chinese Government is now making decisions for their society based on her own moral compass. While I am in agreement with many of them (ironically, and I understand their good intent), the manner in which it is done makes me wonder what would have happened if my parents’ commanded me (like China), instead of providing “advice”.

Taking a specific recent example of the dictating of the gaming time limit, where everyone below the age of 18 will only be allowed to play video games between 8-9 pm on Fridays, weekends, and public holidays. As a parent myself, I too am witnessing my children spending an extended amount of time on their screens (whether it is watching YouTube or playing games). However, from another point of view, the time spent can be seen as a preparation for the future; when these hours spent on the devices are the building the foundations of operating the technology that will be used in their future. If I use my parental privilege of “commanding” them to limit their time on devices, in an attempt for them to have otherworldly experiences in their environment, am I also depriving them of their ability to build their discipline and self-regulate the time spent on devices? Ultimately, my little “command” is an external factor that will cultivate the so-called acceptable and good behaviors in the current society and environment, but it may be a wrong decision in the future if this causes them to lose important technical skills in the future. Ultimately, I believe that lessons learned through one’s own actions and self-awareness have a stronger impact on shaping the person, or even business in the future, as opposed to those imposed by an external authority.

Bringing it back to the Chinese government, it is unclear if such top-down behaviors are beneficial in the long run – such restrictive actions will most certainly have future consequences for society. More often than not, the most successful entrepreneurs are those who break the rules and took the path less trodden. The actions about restricting gaming hours portray the underlying belief is that gaming behaviors are seen as a waste of time, and should be limited for more productive actions.

I have a different opinion. Playing games is a phase that many teenagers and younger adults go through, and while many may not fully grow out of gaming, it is just their chosen form of entertainment or socializing. In fact, to be a good/successful gamer, one will require many traits such as having the ability to strategize, focus, self-control, self-correction, determination, and plenty of practice. These are factors that will be important for any business endeavors for their future. In fact, Forest Li (Founder of SEA Ltd, now Singapore’s largest company by market capitalization) was (and apparently still is) an avid gamer, and so is Tan Min-Liang (Founder of Razer).

A top-down approach used in organizations or countries may be efficient and effective to make sweeping changes quickly from a big picture point of view, but these large-scale changes that can impact the people’s lives and behaviors are best left to those who are closest to the action or are walking the ground to implement accordingly as there are many intricacies. It may be effective overall, but there will be too many nuances that may cause deep-rooted issues in the future. China has thousands of years of history of civilization and prosperity, where such actions were effective especially during the agricultural age, but such ideologies caused them to lag behind during the industrial age when the “rules” of the game changed. They were able to catch up and even surpass many countries after opening themselves up over the past three decades, with the enterprising spirit of the Chinese being unleashed in the pursuit of a better economic outcome by capitalism. It will be a waste if this spirit is being curtailed back in the name of “Common prosperity” over-zealously implemented.

Nevertheless, I believe that the Chinese Government is a capable one and will make the necessary corrections to move China towards a better outcome for all. This, however, may take some years to pan out though.

As announced in our Group’s (ASX:8IH) AGM, we have been rebranded to VI Fund Management. You will see the changes and the completion soon.

Warm regards,
Clive Tan | CEO
VI Fund Management (website under construction)


Addressing the elephant in the room is the China regulatory crackdown, with massive fund outflows out of the capital markets as the regulations from the Chinese authorities keep pouring in day after day, spooking markets and providing conundrums to investors – whether to continue staying in the markets, buy the opportunities, or pull out of the markets until things stabilize. Before making such decisions, perhaps finding out the underlying reasons will provide us clarity before making any decisions for our portfolio.

China Technology Regulatory Crackdown

Beijing’s recent crackdowns on the tech sector wiped off about $1 trillion of market value from Chinese shares around the world last month, as they expanded from antitrust and e-commerce concerns to private tutoring, data security, and online content in quick succession.

On the surface, China’s “tech crackdown” is exactly that: a clash between government power — wielded by the Chinese Communist Party (CCP) — and what many call the “tech sector.” However, beneath the surface, we feel that it is really many different things bundled together, with 3 overarching themes – Antitrust issues, Data Security, and Common Prosperity amongst the people.

1) Antitrust Regulations

In 2018, China formed its market watchdog called the State Administration of Market Regulation (SAMR). For the next 2 years, they were relatively quiet. However, a week after the botched Ant Group IPO, the market watchdog has emerged out of its corner swinging, coming down with restrictions and new laws on at least 35 internet companies across a wide range of sectors. it began to introduce new draft rules to regulate internet platforms
On 10 April, Alibaba was fined a record $2.8billion, concluding the months-long investigation into their monopolistic practices, especially on the one where they forced merchants to choose one of two platforms rather than being able to work with both platforms. The fine saw Alibaba become the first and largest victim yet from China’s antitrust probe, setting the precedent for the government to use anti-monopoly rules to regulate the country’s Big Tech.

After that, 34 tech firms were summoned by regulators to address their antitrust practices, including failing to disclose mergers, signing exclusive contracts, misleading marketing tactics, and other “merger irregularities.” Almost every big platform company was called in, including Tencent (music and gaming), Meituan (retail), Didi (ride-hailing), Baidu (search), ByteDance (social media), JD (eCommerce), and New Oriental Education (education), and almost all of the 34 firms were fined by SAMR for their practices, despite many of these deals occurring prior to 2018, even before the watchdog existed.

2) Data Security

The Cyberspace Administration of China (CAC) was formed in 2014 under president Xi Jinping and oversees China’s data security, wielding China’s encompassing censorship apparatus, with the aim of ensuring that the citizen’s data that was collected by private companies do not make it out of the country.
A big concern from the Chinese is that these private and personal data are leaked to foreign adversaries, which may be used against themselves, especially with the heightened tensions with most western countries recently. These concerns have since grown and laws have been applied to foreign giants in China such as Apple and Tesla, along with domestic players such as ByteDance, Tencent, and more significantly Didi.

The ride-hailing app Didi was the largest casualty from this, as a result of going against the advice given by CAC. In the weeks leading up to Didi Global Inc.’s initial public offering in the US, China’s cybersecurity watchdog had raised the suggestion of delaying their listing to conduct a thorough self-examination of its network security, according to people with knowledge of the matter.

However, delaying the listing was not an option. They were facing investor pressure to go public after raising billions of dollars from prominent venture capitalists during its pre-offering roadshow in a matter of days in June (much shorter than typical investor pitches made by Chinese firms). As there was no outright order to halt the IPO, Didi decided to go ahead, raising $4.4billion by listing on the New York Stock Exchange, the largest stock sale for a Chinese company since Alibaba’s IPO in 2014.

This led to a chain reaction; CAC, wary of Didi’s troves of data falling into foreign hands due to increased disclosure associated with the public listing on U.S soil, acted swiftly – just 2 days after the IPO on 2nd July, CAC suspended Didi’s app for violating data security protocols. The markets reacted to this news, crashing the share price by 45% in a matter of days. The probe was widened and the other U.S-listed Chinese companies were hit by the same suspension: freight-logistics app Full Truck Alliance and recruiting platform Kanzhun.

On June 10th, China’s National People Congress Standing Committee passed the Data Security Law (DSL) that will be in effect from 1st September, giving businesses less than three months to adapt to the new data security regime. The stricter regulatory regulations include special categories of data – important data and core state data, rather than ordinary data. Companies that collect data will have a number of obligations under the law—they need to develop data security education and training, and they also need to obtain approval from a pertinent Chinese authority before responding to any data requests from foreign law enforcement authorities or judicial entities, and failure to comply may lead to businesses being terminated for mishandling “core state data.”.

Unfortunately, the Data Security Law whilst formalizing these obligations does not delve into the detailed compliance specifics. One might think that the dust has settled after the law has passed, but do note that the legislative branch would still have to follow up with the details on the implementation, which has not been released and may take months or even years.

3) Common Prosperity

During an economic leadership meeting in August, Chinese leaders came together and agreed that China must pursue a goal of “common prosperity”, where affluence is shared by everyone in material and cultural terms, not prosperity for just a few but also not an absolute equal distribution. Whilst this is not new – it was first mentioned in the 1950s by Mao Zedong and repeated in the 1980s by Deng Xiaoping – President Xi Jinping has focused on closing the country’s increasing wealth gap. He has reason to be concerned: evidenced by the wealth Gini coefficient, a country in which every resident has the same wealth would have an income Gini coefficient of 0; China’s Gini coefficient has risen from 0.599 in 2000 to 0.704 in 2020.

In the past year, President Xi Jinping’s rhetoric on common prosperity has picked up the pace, meaning to promote better governance and more balance in the economy as China strives to achieve its second centenary goal of fully building a modern socialist country. This encompasses the social and financial aspects of their citizens.

With the need to address the country’s wealth gap and improve the social aspects of their citizens, subsequent regulatory actions suggest that fat shareholder profits might become a thing of the past.
Tencent Holdings warned investors during their earnings to brace for more regulatory curbs on China’s tech sector, telegraphing that Beijing plans to expand restrictions over its Internet giants. The company’s core mobile gaming business was impacted as China cut playing time for minors, part of Chinese President Xi Jinping’s campaign to address social ills.

Another area that was impacted is education. Currently, tutors are utilized by parents to help children to perform well during their years of education. With many families viewing it as a necessity to help their children succeed academically to get into a prominent university, it has become very expensive to hire good tutors, placing a significant and unfair burden on families – which is also hindering China’s goal of encouraging couples to have larger families. On 24th July, China implemented a rule forcing most private education companies to convert into non-profit organizations, decimating the market values of China’s largest education companies, including New Oriental Education, TAL Education Group, and Gaotu Techedu, with market values evaporating more than 90% overnight.

This common-prosperity concept is expected to continue and may cover access to public services. Privatization of public services such as education, elderly care, and medical care may recede, as the government emphasizes the role of inclusiveness and affordability among these service providers, and be strict in monitoring prices. Therefore, traditionally defensive sectors like healthcare may turn out to be the worst place to invest if the government brings down the cost of healthcare, which will directly impact the healthcare companies’ profits.

For investors, we need to be clear: Beijing intends to continue strengthening regulation on a wide range of sectors of the economy for years to come, and there will be a long volatile road ahead for their investments.

Understanding the Past to Address the Future – the Impacts on Industries

Studying history enables us to develop a better understanding of past systems and ideologies and determine how we can approach the future. With that in mind, the immediate question springs to mind: have such policy changes happened before, and what was the impact, and how long was it?

Throughout the history of China’s stock market, policy changes are an important factor that shakes up entire industries; the “三公消费” or China’s Public Spending Clampdown on the “Three Public Expenses”, led to an impact on the liquor industry lasting three years, or the reforms in healthcare in 2018 with the shaking the pharmaceutical industry.

1. Impact Of Policy Changes On The Liquor Industry

On 26th March 2012, during one of the conferences held by the State Council, the then-Premier Wen Jiabao made a speech and declared an order that no public monies should be spent on buying luxury gifts, such as high-end wine and cigarettes. It is widely thought that this move from the China government on the “three public expenses” – referring to cars, banquets, and foreign travel – is an attempt to improve the government’s public image, and move towards a frugal working style. The next day, the liquor industry plummeted once the markets started trading, and none was spared.

The declaration by the Premier was impactful – public officials were notorious for their gift-giving culture, be it for cultivating relationships for business deals, impressing peers, or for other reasons, and such clampdowns meant the demand for such luxury products took a big hit. Liquor companies had to deal with changing their business strategies – instead of targeting government officials whose consumption accounted for 50% in 2012 (see the figure below) – their products had to be marketed to the public masses. The sudden evaporation in demand saw revenues being hit hard – Table 1 shows the revenues and growth of the three major liquor companies, Moutai, Wuliangye, and Luzhou Laojiao, and the varying degree of impact by the change in policy. It was not till three years later in 2015-2016, that revenue growth was somewhat restored back to the rates of growth back in 2012.

From Figure 2, the stock prices of the three major liquor stocks, Moutai, Wuliangye, and Luzhou Laojiao only recovered after three years, after much effort to adjust their target audiences and reduce the government consumption from 50% of revenues in 2012 to 5% in 2015 (in figure 1).

2. The Impact of Policies on the Pharmaceutical Industry

If you have been to the doctor’s, chances are your medical bills and medicines would have been paid by your insurance companies. In China, the arrangements are similar, with the medical insurance companies being the ones paying the most to pharmaceutical companies.

However, China’s aging population, coupled with the shrinking of the labor force has led to unsustainable expenses in the industry with the increasing costs. In view of that, controlling the country’s medical industry has become the main theme of China’s policy in recent years. In May 2018, the National Healthcare Security Administration of the People’s Republic of China (NHSA) was established. Led by the administration, China implemented a central procurement system, where they consolidated the estimated demand for medicinal drugs of the hospitals in China and mandated all pharmaceutical companies to bid to fulfill the demand for them. The centralized demand, coupled with the competitive bidding across all companies to fulfill this demand at a lower cost in order to get the order lowered the overall cost of the drugs and also eliminated the sales cost of sales representatives marketing to individual hospitals. This move successfully brought down costs for patients and medical insurance companies alike, reducing the financial burdens for society.

So far, five rounds of centralized pharmaceutical procurement have taken place, and medicine prices have decreased drastically after every round. According to the statistics published by the China International Finance Securities, the prices declined by 51% to 75% in the fourth round, with some even declining by more than 90%. Worried about the continued pressure in prices affecting the revenues of the pharmaceutical companies, markets reacted accordingly, causing the share prices to fluctuate.

Figure 3 shows the share price charts of the three famous Chinese pharmaceutical companies, namely Huadong Medicine, Sinopharm Group, and Shanghai Pharmaceuticals Holdings over the period when central procurement was first introduced till present times. The share prices of Sinopharm and Shanghai Pharmaceuticals are still languishing below the prices when it was first announced, but Huadong Pharmaceutical managed to recover, partly due to a change of their business strategy which they pivoted into the medical beauty industry to reduce the impacts of the procurements. However, the markets recently have factored in the impact of the next round of procurements.

The central procurements were not just for medicines; on 31st July 2019, a reform plan governing high-value medical consumables was announced. On 28th July 2020, medical consumables were classified into two categories: pacemakers and orthopaedic implants. In November, when the first round of procurements for coronary stents opened, the purchase price fell from 10,000 yuan to less than 1,000 yuan, falling 93% compared to the year before. Pessimism spread quickly throughout all potential companies, especially orthopaedic companies that will have their round of national procurement of artificial joints. Figure 4 below shows AK Medical, the leading domestic orthopaedic company, Beijing Chunlizhengda & Double Medical Technology’s price charts since July 2020.

With reference to the turbulence in share price experienced by the pharmaceutical companies, where it lasted 2-3 years before recovering: the impact on orthopaedic consumables companies are still in their first year, and will continue at least until the upcoming September orthopaedic procurement round.

From the examples above, we can see that regulations are now widespread across various industries, with the aim of fulfilling the strategic goals set by China, or against industries that are promoting undesirable behaviors.

Conclusion for the Impacts on Industries

We might think that these are recent shifts in regulations, but a quick look backward tells us that these are not new. In 2018, China had already taken steps on gaming, halting approval on new games and issued curfews for minors on their gaming, in a bid to clamp down on gaming addiction. The latest curfews are merely an extension of their curfews.

We believe the crackdowns might just be the start to meet their strategic goals. Following China’s crackdown on the tutoring sector, prohibiting these companies from making a profit from teaching core subjects, many believed that the healthcare sector is next, leading to investor’s panic. Specifically, health and tech companies like JD Health and Alibaba Health Information Technology could be vulnerable, as regulators crack down on monopoly powers being formed due to the network effect of such companies. Companies that contribute high medical expenses but creates little social value – like cosmetics – may also be vulnerable. Companies that have more strategic value like innovative drug makers and biotechnologies should be able to carry on.

Investors will do well to take part in companies that are aligned with China’s strategic goals for the next few years, especially those in AI, semiconductors, 5G, advanced manufacturing, and green energy.

What About the US Regulatory Crackdown?

That being said, looking at the United States, we see a completely different picture.

Antitrust clampdowns are not new, and despite government pushes to challenge the power of the Big Tech using antitrust claims, the long history of inaction has shown us that these antitrust actions might not lead to anything – particularly to the kind of impacts that China had on their companies. Even then, any actions would be long and drawn-out.

In 1956, after a seven-year legal saga, the Bell System monopoly on the local telephone service in the United States and Canada was left intact, and was only broken in 1983 after multiple lawsuits, a whole 27 years later. The Department of Justice brought its antitrust case against IBM for monopolizing the market for general purpose digital computers, which lasted 13 years without breaking up. Government actions filed against Microsoft in 1998 for bundling application programs into their dominant operating system saw a settlement and the company remains intact. Even bringing it to recent examples, the antitrust investigations into Amazon, Apple, Facebook, Alphabet’s Google, and Microsoft all failed to yield concrete results. From an antitrust perspective, China is doing what the U.S. can’t seem to: regulate its tech giants.
And the scary part is, China is doing it with just a snap of their fingers.


The recent Beijing regulatory crackdown on Chinese tech companies has highlighted the fundamental differences in the relationship each country’s government has with its corporations.
The U.S. government often acts as a “servant to business interests,” while Chinese authorities may want businesses to sacrifice profits in order to meet national development goals. Hence, to use the Western market mindset to invest in the China market is definitely not the wisest thing to do.
For those who think that these Chinese companies are undervalued after the battering, you might be right. Many of these companies are trading close to their multiyear low despite strong earnings.
However, with no visibility currently on how the companies’ business models will evolve or need to change after the finalization and implementation of the regulatory changes, any future assessment of the business will just be a prediction. Already, a tougher policy environment has forced firms to slow expansion plans, while anti-monopoly enforcement actions will expose the tech companies to greater competition.

Therefore, the dip buyers who expect a quick recovery for the companies to be similar to the rest of the US market might be in for a disappointment. Investors will likely be looking at more volatility ahead and must be prepared to hold it long-term.

Ultimately, investment is all about patience and holding power, and it will be a rewarding experience for those who are able to do it.

Warm regards,
Richard Sim | Investment Manager, CFA, CA
VI Fund Management [website currently under construction]

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