Reining in the tech tycoons

According to the Confucian value system the social standing of businesspeople, no matter how wealthy, was below that of farmers and artisans. The most esteemed social group – apart from those with royal connections, of course – were the scholars who excelled in imperial examinations. Families from the same clans groomed generations of talent to sit for the civil service exams, which were hugely competitive. The highest achievers were revered as the zhuangyuan – or people who came first in the nationwide examinations.

In our own era there is more of a fashion for college dropouts that start their own businesses. But Qing high society was shocked when Zhang Jian, the zhuangyuan from the 1894 imperial exams, ditched senior officialdom to turn his hand to business.

Yet in doing so, Zhang claimed a patriotic motive. The power of the Qing court was crumbling under the pressure of encroaching foreign powers and Zhang had concluded that industrialisation was the only way to save his country from oblivion.

He founded one of China’s earliest cotton mills, as well as a conglomerate that developed Nantong port in Jiangsu province. The venture turned him into one of the richest men in China but he donated much of his profit to charitable causes, including the establishment of nearly 400 schools.

Zhang left an enduring legacy – such that even Mao Zedong mentioned his contribution to China. And last week Xi Jinping was invoking the memory of the industrialist once again. That was likely no coincidence: the remarks come at a time when the government is trying to exert more control over the nation’s largest tech firms and send a message to today’s crop of billionaire tycoons.

What did Xi say about Zhang Jian?

“He was a virtuous man from a previous era and a model for all private sector entrepreneurs,” the Xinhua news agency quoted the Chinese leader as saying.

Making a stop at a museum in Zhang’s home city of Nantong, Xi called for other businesspeople to learn from how Zhang had helped the country by developing its industrial base and funding education.

Xi called for the museum, one of the oldest in China, to become a focal point of ‘patriotic’ education in order to stir a “sense of social responsibility” among entrepreneurs and younger people.

The powerful anti-corruption watchdog, the CCDI, then ran an article on its website, highlighting how Xi had also lavished praise on Zhang during a seminar with businesspeople three months ago. A key point was how important it was for entrepreneurs to be “loyal to the Party”. It also noted how Zhang saw industrialisation as a way of standing up to foreign imperialism, with his earliest factories focusing on cotton and steel – China’s biggest imports of the time – so that the domestic economy could reduce some of its reliance on foreign suppliers.

Substitute cotton and steel with semiconductors, and it’s not hard to see how the central government is trying to rekindle the spirit of Zhang in more modern times. Amid the trade and tech rows with the US, Beijing has been rallying efforts to achieve tech self-sufficiency most notably in the area of computer chips.

So there are lessons for internet tycoons too?

As Zhang Jian is positioned once again as a role model for China’s entrepreneurs, the inference is that people like Jack Ma, the country’s best-known internet tycoon, could learn something important from the Qing industrialist.

Ma is one of China’s richest men, with Forbes estimating his personal worth at $60 billion as of this week. Since retiring as chairman of internet major Alibaba last year the former teacher has said he will focus on philanthropy, primarily through education. His new business card is said to be headed with the title of laoshi, or teacher, followed by 11 other titles for his different roles with charitable foundations.

But Ma has just suffered a serious slapdown from Chinese regulators, with potential repercussions for the internet sector in general.

Things started to go awry when a set of draft rules was published on November 3 tightening restrictions on microloans. On the same day that the proposal was put out for consultation, Ma and other senior executives from Alibaba’s fintech unit Ant Group were summoned for a yuetan meeting (the term literally means ‘to set a date and talk’). When this happens to a company, it signals that regulators are unhappy with its behaviour. The next day came the even more shocking news that the Shanghai stock exchange had postponed Ant’s much-heralded IPO because of “significant changes” in the regulatory environment for the fintech sector. The Hong Kong bourse made a similar announcement, shelving Ant’s $35 billion dual listing indefinitely.

If that was not bad enough, the State Administration for Market Regulation (SAMR) issued another set of draft rules on November 10 aimed at preventing monopolistic behaviour by “internet platforms”. There is a feedback period until November 30 for comments on the draft regulations and it will take more time for the new antitrust framework to be formally implemented.

However, the action was enough to send the share prices of internet firms tumbling. Alibaba has been one of the hardest hit, with its market value dropping nearly 20% this month.

What is going to change for the internet sector?

Some analysts are talking about this as a watershed moment in which capital starts to be reallocated: switching out of pricey internet stocks and back to more “old economy” plays such as banks. But at the very least Ant Group’s wings have been heavily clipped: even if it can revive its listing plan soon, it will struggle to reach the astonishing valuation touted by its sponsors before its IPO was derailed (the six year-old firm’s listing price gave it a worth of more than $300 billion, making it more valuable than the biggest bank in both China and the US).

Microfinance contributes nearly 40% of Ant’s revenues (see WiC516). But the proposed rule changes are set to cripple the growth forecasts of China’s biggest provider of online microloans, with the government likely to require that online lenders provide at least 30% of the loans that they co-finance with the traditional banks.

As of today, only 2% of the Rmb2 trillion ($304.6 billion) in consumer lending through Ant’s platform sits on its own loan book.

The new regulations also mandate that a lender’s financing – after the issue of bonds and asset-backed securities – should not exceed four times its net assets. Ant’s current leverage, according to Huang Qifan, an influential figure in financial policy circles, could already be as high as 100 times (commercial banks are capped at 25 times).

Huang’s previous remarks on Ant have been getting more widespread attention in the aftermath of the IPO debacle. For instance, at a financial forum back in June he pointed out that the registered capital for Ant’s two key microloan units, Huabei and Jiebei, was only Rmb3 billion but that their lendable capital had been quickly inflated to nearly Rmb300 billion after multiple securitisations.

Under the new draft regulations, Ant might need to provide Rmb600 billion of the Rmb2 trillion in loans it originated in the first half of this year. Capped by the proposed four-times leverage rule, Huabei and Jiebei would be required to beef up their net asset value to Rmb150 billion from Rmb36 billion currently.

Huang has a longer history in the Ant story?

Huang actually played a part in Ant’s emergence. In Structural Reforms, a book he published in August, the former mayor of Chongqing reveals that the Alibaba boss asked for his help in setting up a couple of microloan lenders in Chongqing in 2013 (Ma’s home province in Zhejiang was at the time cracking down on P2P lending and microloans).

Huang said he could secure the appropriate licences in three days as long as the new units didn’t engage in P2P lending. Those lenders became Huabei and Jiebei, he says, which now provide nearly half of the parent group’s earnings.

Since then most of the Chinese internet majors have registered their own microfinance units in Chongqing, such that the giant municipality accounts for more than 50% of microloans nationwide. China Business News reckons there are about 250 online microlenders currently registered there.

The new rules mean that many of the weaker lenders could struggle to survive. Ironically that could work to Ant’s advantage as the market converges in a smaller group of larger players. But there are also clear dangers in becoming too dominant, given the tone of the draft regulations proposed by the SAMR and their scope to break up anti-competitive online ecosystems. The proposals effectively extend existing antitrust laws to cover the internet industry, which had been largely exempt previously. The shadow of the new legislation could be far reaching, with new guidelines on everything from data collection to price setting.

“The move is a signal that policymakers want to prevent monopolies and oligopolies from forming that stifle market competition and innovation,” the Global Times explained in an op-ed this week.

Ownership of internet firms is now in the spotlight too?

The SAMR’s proposals also make clear that companies with VIE structures (typically offshore holding firms that allow investment that bypasses Chinese laws on foreign ownership) must now submit their future acquisitions for antitrust review as well. Alibaba itself is a VIE and it has pulled off some blockbuster deals, like the takeover of food delivery giant Ele.me, without the strictures of an antitrust review, the Financial Times points out. The Economist goes further, highlighting how the new rules may mean an end to VIEs altogether (these ownership structures have existed in a legal grey area, tolerated by the authorities but never legitimised).

“The threat of withdrawing tacit approval for a VIE [by antitrust regulators] is another way the state can intimidate firms and their owners,” the magazine warned, noting how the bulk of the VIEs are internet firms.

So Beijing is going after the biggest internet firms?

The Chinese government isn’t alone in working on plans to curb the influence of the most powerful tech firms. In the US Google is facing the biggest antitrust case in decades, raising concerns that it might be broken up akin to how the American government treated AT&T decades earlier, while Amazon is undergoing an antitrust review of its own in Europe.

Four years ago the Chinese government also took direct action against a band of headstrong bosses – on that occasion at ultra-acquisitive conglomerates including HNA, Anbang and Wanda, fearful that their high-octane spending on trophy assets like the Waldorf-Astoria hotel in New York might eventually imperil the country’s financial security.

Likewise, the shelving of the Ant IPO and the censure of a billionaire businessman like Jack Ma has been linked to concerns that new lending practices in the fintech sector could unsettle China’s financial system.

Away from Ant’s ambitions to dominate the world of consumer lending, there is wider anxiety about the extraordinary reach of the internet giants across other sectors, like retail, where Alibaba already accounts for three-quarters of China’s online sales and nearly a fifth of its total retail sales.

“Beijing has felt that tactics by e-commerce companies are not leading to healthy development of the retail industry. . . They don’t want three or four companies [dominating], they want 1,000s of companies,” Wong Kok Hoi, chief investment officer at APS Asset Management, told the Financial Times this week. “This is big, this is a game changer.”

Of course, many of the same internet and tech firms have been key drivers in the remaking of the Chinese economy. Tech bosses have shaken up moribund and inefficient sectors, built wholly new industries and accelerated the adoption of transformational new technologies. In building globally recognised brands and expanding into international markets, particularly in Southeast Asia, their performance has also been a source of pride for the Chinese government.

Their successes overseas has been a positive from the policymaking perspective. And with this backdrop the internet giants will be hoping that the draft regulations are more of a warning shot than a wholesale challenge to their wider influence in the Chinese economy.

Much will depend on how top players like Alibaba and Tencent are able to prove their national loyalties once more. In fact, Jack Ma has been pretty adept at toeing the line politically, despite his role in launching hugely disruptive businesses that challenge the status quo in many industries. Yet there is always the danger of an unanticipated slip – like his undisguised critique of the state banks at the Bund Summit last month (see WiC516), which is said to have infuriated senior government circles, including Xi Jinping himself.

That high-profile mistake in besmirching the policies of the one monopoly wholly acceptable to the government – the Chinese Communist Party – has now triggered a wider review of the internet sector.

In a broader lesson for China’s businesspeople, Ma will have to choose his words more carefully in future. He will also have to figure out how to portray his commercial ventures in a more positive political light – if he wants to position himself in the same category as Zhang Jian, the patriotic industrialist that Xi has elevated to model status.

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