Beijing shocked the financial world when it pulled the rug out from under Didi days after its IPO on the New York Stock Exchange and also announced new regulations reigning in overseas IPOs and Chinese companies already listed.
- Didi’s stock price fell as did that of other listed Chinese companies, and upcoming Chinese IPOs were put on hold.
I should say that Beijing shocked us again.
- Over and over General Secretary Xi Jinping makes ‘inexplicable’ moves for which we believe he will pay too high a high price.
- And over and over, we are shocked.
Clearly, either Mr. Xi is irrational, or he has a point of view that we don’t understand.
- My bet is on the latter.
What follows is my rough attempt at seeing Mr. Xi’s point of view.
- And from that a suggestion about how we can anticipate his moves and rather than be surprised by them, be ready for them well in advance.
1 | Xi’s ‘Inexplicable’ Actions
Over and over Xi Jinping has shown himself willing to accept losses in exchange for achieving his ends. To name a few instances:
- Favoring the State Sector - where he has more control - over the Private Sector even though this leads to lower GDP.
- Calling on (coercing?) private companies to align their objectives with those of the Party even though this could stifle innovation and growth.
- Punishing, imprisoning, or even executing business leaders who have either gotten too big for their britches or whose ambitions don’t line up with the Party’s even though business leadership might suffer.
- Doing as he likes in, for example, Hong Kong and Xinjiang – on the argument that these are China’s internal affairs, which are China’s own business - even though this leads to severe international criticism and sanctions.
- Encouraging ‘Wolf Warrior’ diplomacy and belligerent actions even though this damages or at least puts a severe strain on relations with other countries.
- Pulling the Ant Financial IPO even though this harmed China’s reputation in and Chinese companies’ ability to raise funds in global capital markets [?].
- And most recently, pulling the rug out from Didi soon after its IPO even though this might again harm their ability to raise funds in global capital markets. And again a question mark.
2| And Damn the Consequences
In other words, Mr. Xi is going his own way and damn the consequences.
- China’s economy is perking right along; private companies still seem to be innovating; business leaders are still leading; Hong Kong’s financial sector is thriving; Xinjiang is increasingly becoming Sinofied (with even mild criticism by foreign companies being turned back on them); in spite of the wolf warriors and related actions, President Biden still can’t cobble together a robust alliance of allies to counter China; and of course foreign investors may still ready to gobble up shares in Chinese companies after the dust from Didi and related issues settles.
In other words, Mr. Xi is going his own way and encountering damn few consequences.
- All while bolstering his support among his fellow citizens who love his taking stands against billionaires and foreign interference in China’s ‘internal affairs.’
Each of the examples above can be slotted into one or more of Mr. Xi’s overarching objectives.
- Quashing the Ant IPO and humbling Jack Ma could be viewed as meeting the broader objectives of reducing risk in the financial markets, bringing China’s private sector and its leaders under greater Party control, asserting primacy over the collection and ownership of private data, to name a few.
- Whatever damage that might do to Chinese companies’ ability to raise capital from international investors was secondary.
- And, as subsequent IPOs – right up to Didi’s – have demonstrated, Mr. Xi accomplished his big objectives without diminishing the appetite of foreign investors for Chinese shares.
But animating these overarching objectives and the route of all his ‘inexplicable’ is, as we will see, Mr. Xi’s core pattern: making China self-reliant.
- Self-reliant in the service of shoring up Chinese vulnerabilities and threats from the outside world.
- These aims trump the rest.
3 | Caught by Surprise
In the case of Didi, Mr. Xi is again working toward achieving some key objectives, especially to:
- ‘Safeguard national data security and protect national security,’ in the words of the Cyberspace Administration of China (CAC).
- Increase supervision of the offshore IPOs, especially the use of the Variable Interest Entities (VIEs) structure.
Unlike the reaction to Ant, the reaction to Didi (and the recent crackdown on other Chinese companies), as quotes from many institutional investors indicate, could actually dampen, perhaps permanently, their enthusiasm to buy Chinese IPO shares and could cause them to add risk premiums that have already lowered the value of companies already listed.
- These are pretty severe consequences for ends that might have been accomplished through less public and dramatic signals.
And as with Ant, Didi investors were caught by surprise.
- Caught by surprise just as policy makers in the same way have been surprised so often.
4 | ‘He’s Always One Step Ahead of Us’
This blindsiding happens so often that it reminds me of one of those detective shows where the grizzled veteran says, ‘He’s always one step ahead of us.’
- And soon after the rookie identifies a pattern the others have missed and says, ‘I know what he’s going to do next.’
With Mr. Xi, there is a core pattern – self-reliance - we’re missing, one that is right in front of us.
- By understanding this, we can at the very least create scenarios for his likely next moves.
- Let me
‘As China’s Communist Party enters its second century, it’s [a] mix of confidence and paranoia,’ writes Evan Osnos of The New Yorker in ‘After a Hundred Years, What Has Party Learned,’ with the subheading: ‘Beijing reverts to a belief that paranoia and suspicion are the best policies.’
- This characterization echoes the thinking of many China commentators.
5 | ‘Even Paranoid Have Enemies’
As the worn sentiment goes, ‘Even paranoids have enemies.’
- And if Mr. Xi ever had doubts, President Trump erased them.
One outcome of this was the Chinese leadership’s becoming aware that the U.S. could hurt trade, limit semiconductor access, hobble state-champion companies, cut off access to U.S. dollar transactions, and the rest.
- This reportedly led to China’s making a thorough assessment of its weaknesses to identify the chokepoints where China is vulnerable.
This in turn propelled policies to deal with specific threats.
- For semi-conductors, the state redoubled its push to develop its own capabilities (which try as it had for decades and at the cost of hundreds of billions of dollars, it had not been able to do).
For the Chinese economy more generally, it is the ‘dual circulation’ strategy,’ a strategy that lies at the heart of the five-year plan for 2021-25.
- In 2020, Jude Blanchette and Andrew Polk at the Center for Strategic & International Studies described explained the strategy in ‘Dual Circulation and China’s New Hedged Integration Strategy:’
‘The latest, and perhaps most consequential, development in the Xi administration’s ongoing efforts to position China to withstand volatile geopolitical exigencies is the new “dual circulation” strategy (DCS), first announced at the May Politburo meeting.’
- ‘The strategy, which envisions a new balance away from global integration (the first circulation) and toward increased domestic reliance (the second circulation), stems from Beijing’s belief that China has entered a new paradigm.’
- ‘This paradigm combines rising global uncertainty and an increasingly hostile external environment with new opportunities afforded by a floundering and listless United States, which China has long viewed as its most important geopolitical rival.’
6| Xi’s Core Pattern: Making China ‘Self-Reliant’
Whether semiconductors or the ‘dual circulation’ strategy, is aim is to shore up China’s vulnerabilities from outside threats through creating greater ‘self-reliance.’
- By focusing on China’s ‘self-reliance’ as the core pattern and one of Mr. Xi’s handful of overriding ways of thinking (we aren’t guessing: he’s said so often enough), we can begin the analyses that make us ready for – rather than surprised by - his next moves.
To be sure, the idea of a self-reliant China is not new with Mr. Xi.
- As Neil Thomas of MacroPolo argues in ‘Mao Redux: The Enduring Relevance of Self-Reliance in China’:
‘Some of the latest evidence that “Xi is the new Mao” is his supposed “revival” of the Maoist concept of “self-reliance” (zili gengsheng).’
- ‘While self-reliance was championed by Mao, it is a concept that has been supported by all subsequent leaders, even if its application has evolved over time.’
- ‘That’s because self-reliance fundamentally means that the CCP will retain ultimate control over China’s economic development—an enduring consensus that has heavily influenced policy across generations of leaders.’
7 | Analyzing Didi
Could analyzing Didi in light of Xi’s views on China’s vulnerabilities and his core pattern of enhancing self-reliance have predicted that Didi specifically would be the target?
- Not likely. But by starting with these and following them to their possible outcomes, we could have better highlighted the possible even likely risks.
- And those risks would have factored more forcefully in investors’ decisions on whether or not to invest or on how large prudent exposures should be.
Here’s the analysis of ‘why Didi’ as an example (here we put aside the data collection issues and investigations and focus just on the capital markets aspect).
The vulnerability: financial decoupling.
- After Beijing’s crackdown in Hong Kong, the Trump administration considered how it could punish China using financial weapons, such as kicking China out of the SWIFT international payments messaging system or sanction Chinese banks or foreign banks, like HSBC and Standard Chartered, which have large exposures to Hong Kong and mainland China, and the like.
But the one that had traction, even before Hong Kong, was the long-simmering issue of Chinese companies listed on U.S. exchanges not complying with audit requirements.
- This is a real vulnerability: Congress has passed legislation that would require Chinese companies listed on U.S. exchanges to allow the U.S. Public Company Accounting Oversight Board (PCAOB) to check their auditors’ work or delist from U.S. exchanges within three years.
- That China appears to have no intention of complying means that within a few years the companies will delist.
In the face of this part of financial decoupling, Mr. Xi could stand by as the companies delisted, or he could prod them toward a new venue. He chose the prod with these steps:
- ‘China's stepped-up scrutiny of overseas listings by its companies and a clampdown on ride-hailing giant Didi soon after its debut in New York have darkened the outlook for listings in the United States, bankers and investors said,’ according to Reuters.
- ‘ "It's a clear signal that the Chinese government is not particularly happy that these firms continue to decide to raise capital in the west," said Jordan Schneider, a technology analyst at research firm Rhodium Group.’
8 | Destination: Hong Kong
The next step is to push IPOs and listed companies to a new venue: Hong Kong.
- ‘Moves by China to crackdown on listings by its companies on U.S. markets are set to redirect a major portion of the IPO flow to Hong Kong,’ writes Nikkei Asia.
- ‘While U.S. capital markets have an edge when it comes to the scale and diversity of their investor base and the number of comparable peer companies, Beijing's clampdown, along with reforms by the Hong Kong Stock Exchange and ample liquidity in the city, make it an attractive alternative.’
- ‘ "China's move is aimed at controlling where companies can list," said a banker based in Hong Kong who works on initial public offerings.’
- ‘ "Authorities don't want to choke the companies off capital. Ultimately, they want them to list closer to home. It is advantage Hong Kong." ’
‘ "Undertaking an IPO in Hong Kong will be a safer bet for Chinese companies when it comes to meeting the requirements for data privacy and sharing," said Ke Yan, an IPO analyst at DZT Research,’ said Nikkei Asia.
- ‘ "While the clampdown on overseas listings is not entirely clear, it looks like it will be less risky for companies to seek a regulatory review before attempting an IPO overseas, and once again it will be easier to get the nod for a Hong Kong listing." ’
- The result: ‘Moves by China to crack down on listings by its companies on U.S. markets are set to redirect a major portion of the IPO flow to Hong Kong.’
By giving upcoming IPOs incentives to list in Hong Kong and companies already listed in the U.S. to relist there, Mr. Xi:
- Defangs the U.S. delisting threat and eliminates the vulnerability to listed Chinese companies.
- And, because of his earlier actions in bringing Hong Kong to heel increases China’s self-reliance in financial markets by concentrating Chinese companies in a friendlier – and perhaps more pliant - location.
This can be seen, in a way, like the ‘dual circulation’ strategy but applied to capital markets.
- China still maintains access to international capital markets.
- But in a domestic venue that puts that access more under its control, thus increasing self-reliance in the face of future financial threats.
9 | 20-20 Hindsight?
Is this analysis really just 20-20 hindsight?
- I don’t think so.
We had all the pieces.
- Xi’s emphasis on his core pattern of self-reliance in the face of China’s vulnerabilities is well-documented, not least in the latest Five-Year Plan.
- His objective to bring China’s financial services sector to heel both to reduce risk and to align it with Party goals.
- Chinese companies having to delist – and that includes many, if not all, of the companies planning to list – from U.S. markets, and
- Regulators being are unhappy about the way these companies employed structures like Variable Interest Entities, which put those companies effectively beyond their control.
In light of these factors, it isn’t a stretch to see how pushing Chinese companies listed abroad or planning to do IPOs onto the Hong Kong Stock Exchange is an elegant solution.
- As elegant as enforcing the National Security Law to subdue Hong Kong rather than sending in troops and tanks.
What will not result from this analysis is the specific vehicles that will be used to accomplish these objectives, in this case, Didi and the other targeted companies.
- Just as with Hong Kong, we knew that Beijing was going to crack down hard – it was our lack of imagination that didn’t include the National Security Law in our scenarios. And that didn’t include slamming Didi.
10 | ‘We Won’t Get Fooled Again’
What will result from this kind of analysis is an understanding that Mr. Xi will take steps to remedy a vulnerability - even if to the rest of us the price seems far too high.
- Now the challenge is to structure our analyses so we aren’t surprised by but rather prepared for whatever comes.
To do that:
- We begin with our understanding of the Communist Party’s ‘confidence and paranoia’ and Mr. Xi’s core pattern for dealing with China’s vulnerabilities: greater self-reliance.
- Next - and no doubt most important – is that for a specific industry or policy issue, we undertake, as the Chinese did, an examination that identifies the chokepoints. In most cases, these should be obvious.
- Then, we have to expand our imagination, to put ourselves in Mr. Xi’s shoes – who is bent on self-reliance and willing to take hits to achieve it – and consider the broad range of scenarios of how he might unblock the chokepoint.
- Finally, we should weight the scenarios and integrate them into our assessment of risk and our business and investment strategies.
In this way, like the rookie detective, we can say, ‘I know what he’s going to do next.’
- Or at least what he’s likely to do next – and that’s an improvement over being surprised again and again.