The Taiwan Banker

China aims to build a capital markets ecosystem that prioritizes the state’s interests over those of firms and investorsChina’s ruling Communist Party has never abandoned its deep-seated suspicion of free-market capitalism. While recognizing the need for market mechanisms to strengthen its economic competitiveness, Beijing will never fully trust markets or private firms to act in the interest of the state, which is what matters most to the Communist Party. The financial interests of firms and investors are secondary. For that reason, the optimal capitalism for China is that directed by the state, or as some scholars call it, “political capitalism.” The latter term is especially salient given that politics is in command in today’s China in a manner unseen since the Mao Zedong era (1949-1976). Under the imperious Xi Jinping, Beijing is reigning in what it sees as unbridled capitalism ostensibly to create a more equitable society, hence the new catchphrases “common prosperity” and “the prevention of disorderly expansion of capital.” Yet political calculations figure prominently in Xi’s gambit. Among the highest-profile targets of his latest purge are wealthy businesspeople affiliated with rival party factions and tech firms that have grown into juggernauts through market forces rather than the party’s directives. Xi talks about the "fair market competition order," but he is as concerned with ensuring his grip on power remains ironclad as he is with giving consumers more choice. At first, the crackdown on tech giants appeared limited to specific individuals and companies that irked Beijing, such as Alibaba founder Jack Ma and the fintech giant Ant Group. Ma tempted fate when he panned China’s financial regulators to their faces at a forum in Shanghai late last year. Although the eleventh-hour axing of Ant’s dual Shanghai-Hong Kong IPO shocked many observers at the time, given Ma’s cavalierness, it is less surprising in retrospect. However, Beijing’s punishment of Didi Chuxing for listing in New York against the wishes of regulators signaled a new phase in the party’s bid to control the private sector. Didi’s app was removed from China’s app stores two days after the IPO. Didi may also be fined and forced to restructure, with a state-owned firm taking a large stake in the ride-hailing giant. Further, a draft regulation published in July proposed that Chinese companies holding the personal information of 1 million or more users would be subject to a government cybersecurity review before being approved for an overseas IPO. That low threshold means that nearly all Chinese internet companies eligible to go public in the U.S. will be affected. At the same time, Beijing is devoting considerable effort to constructing a made-in-China capital markets ecosystem that will include Shanghai’s two exchanges, a rejigged board in Beijing and potentially a Greater Bay Area triumvirate made up of exchanges in Shenzhen, Hong Kong and Macau. The Macau exchange is just an idea at this point but could become a reality as Beijing pushes the former Portuguese colony to reduce its reliance on casino gaming. It is reasonable for China to seek to build a strong capital markets ecosystem onshore, but Beijing's rising hostility to market forces is worrying. Many reasons exist for Chinese firms to list in the U.S.: to gain access to capital unavailable onshore, achieve a higher valuation and allow certain investors to cash out in dollars. Listing on the Nasdaq or New York Stock Exchange (NYSE) also offers a certain prestige. At present, China’s domestic capital markets are much less mature than America’s and offer fewer benefits to the high-growth tech companies that favor overseas IPOs. The allure of America's capital markets remains strong for Chinese companies despite the obstacles being put up by both Beijing and Washington, which passed legislation last year that could force Chinese firms to delist from U.S. exchanges within several years if they do not allow comprehensive audits by American regulators. In September, Nikkei Asia reported that a group of Chinese firms is eager to move ahead with more than US$866 million worth of IPOs in New York. A made-in-China capital markets ecosystem One of the recurrent themes of Xi Jinping’s tenure is self-reliance. Like many of Xi’s ideas, it channels the spirit of Mao Zedong if not his actual policy directives. Mao had no use for capital markets (the Shanghai Stock Exchange closed in 1949 and did not reopen until 1990); Xi clearly does, but he wants markets to follow the party-state’s lead. Given China’s concerns over capital flight, that means many more listings onshore. It also means that regulators will make the listing process more seamless for firms in industries favored by Beijing, such as semiconductors, biotechnology and clean energy. Such industries form the so-called “real economy” that China sees as integral to its advanced manufacturing and ultimately higher per capita GDP aspirations. To that end, China launched the Shanghai Stock Exchange Science and Technology Innovation (STAR) Board in July 2019. Within two years, the Nasdaq-style board was already larger than Spain’s capital market, boasting more than 300 listings with a combined market value of US$716 billion. Shenwan Hongyuan Group estimates STAR Market companies’ first-half net income likely rose 109% year-on-year. The companies listed on the STAR board have performed well despite China’s tech crackdown because they tend to be in Beijing-approved sectors. The five largest STAR Market IPOs thus far have been SMIC (semiconductors), China Railway Signal (train control systems), Everdisplay Optronics (display panels), Qi An Xin Tech (cybersecurity) and Cathay Biotech. While the STAR Market has a tech focus, the forthcoming Beijing Stock Exchange will be oriented towards small and medium-sized enterprises (SMEs). The Chinese capital already has a financing mechanism for SMEs called the New Third Board; the exchange will be built on top of that. China’s SMEs (defined as companies with fewer than 500 employees) have historically struggled with fundraising compared to their larger counterparts yet make up 95% of registered firms in the country, according to government data. The Beijing Stock Exchange could make it easier for them to be financed by retail investors. The Beijing Stock Exchange will also address some other central government policy objectives. “The Beijing bourse will help facilitate the coordinated development of Beijing, Tianjin and Hebei province,” He Xiaoyu, chief economist of Beijing-based Zhengxin Investment Group, told the state-run China Daily in October. Dong Zhongyun, chief economist of AVIC Securities, told China Daily that the Beijing exchange would “better serve the real economy” together with the STAR board and Shenzhen’s ChiNext. The term “real economy” bears the imprimatur of Xi Jinping. In February 2019, Xi called for finance to “play its role in serving the real economy, catering to economic and social development while meeting the needs of the people,” according to the state-run Xinhua News. "The healthy development of the real economy is the foundation to prevent and defuse risks,” Xi added. Xi’s “real economy” leaves out the many internet companies ensnared in China’s tech crackdown. Ironically, these are the Chinese firms most likely to be innovators – and internationally competitive – because they have emerged in response to market needs and evolved accordingly. Alibaba and Tencent would never have developed their respective super apps (the first of their kind globally) that cover everything from chatting and entertainment to shopping and banking if they had been subject to the same level of government interference as today. In Alibaba’s case, the company has benefited enormously from being listed on the NYSE and having access to the world’s deepest and most liquid capital markets. Despite bearing the brunt of China’s fintech crackdown over the past year, Alibaba still has a market capitalization of US$450 billion as of mid-October, making it among the 20 most valuable companies in the world. Hong Kong-listed Tencent is even bigger, with a market cap of US$601 billion, the most in Asia. China’s onshore capital markets have a long way to go before they can compete with New York or Hong Kong. Auguring ill for their prospects is the creeping interference of the party-state in the private sector. Because Xi’s China puts politics first, there is no telling which company or even industry will next fall out of favor in Beijing. Today, it happens to be internet and private education companies. In the future, it could be firms or industries that currently appear safe from harm. Those who doubt that possibility should consider that Alibaba once seemed unassailable too.