China’s regulatory crackdown on education and tech companies led early this week to a dramatic sell-off that started in Chinese stocks and extended into offshore Chinese currency and credit markets. While investor concerns about unpredictable government intervention are understandable, we see a silver lining to today’s dark clouds.
First, Chinese companies that paid attention to government warnings have been bracing for closer scrutiny and tighter regulation for some time. Second, while companies that ignore Beijing’s signals can face dire consequences, those that heed the government’s warnings and align their practices with government goals will likely thrive in a tighter and more predictable regulatory environment—one conducive to lower margins but more stable cash flow. That’s a healthy environment for credit investing.
China’s Regulations: Further, Stricter, Faster
The dramatic sell-off was triggered by new regulations in China’s booming private education industry. Chinese regulators banned for-profits business in after-school tutoring, prompting a collapse in shares of private education companies that sent shockwaves through the market.
These moves came on the heels of regulatory crackdowns in other industries, especially for companies in high-growth sectors such as e-commerce, food delivery and ride hailing. These new sectors thrived in recent decades, thanks to lax regulations, technological progress, lifestyle changes and evolving demographics, and have overtaken the more traditional Chinese sectors of property, financial services and infrastructure.
To investors, the speed and stringency of China’s new regulations may seem surprising. But regulators’ underlying concerns aren’t unique to China. Indeed, they’re very similar to those of politicians and regulators in the US and Europe.
Big tech companies, for example, are under the microscope everywhere because of their huge size, anti-competitive practices, control of consumer data and potential to create financial risk. The difference between the government response in China and the government response in the rest of the world is that China’s system of governance allows it to act faster and more forcefully.