10 BARRON’S July 12, 2021
value on July 6, and rattled other Chi-
nese internet shares. The Krane-
Shares CSI China Internet exchange-
traded fund (KWEB) has fallen 15%
since June 30, as investors braced for
more scrutiny of tech companies’ data
practices and other regulatory moves.
“We now know this is a regulatory
minefield, and those who expose them-
selves to the sector are taking on a lot
of volatility,” says Arthur Kroeber,
Gavekal Research’s head of research.
“If your horizon is long term, this is
going to be one of the growth stories of
the next decade and you have to ride it
out. But if you are more short term,
you may say it’s too complicated and
come back in a year when things have
calmed down.”
The wave of regulatory measures
has created the type of uncertainty that
draws bargain hunters. Technology
giants like Alibaba Group Holding
(BABA), whose shares are down 11%
this year, are popping up on value
managers’ radars. But caution is war-
ranted, especially for investors in U.S.-
listed shares of Chinese companies.
Regulatory pressures could continue.
“It’s probably just the start of the en-
forcement actions,” says Kenneth
Zhou, a partner at law firm Wilmer-
Hale in Beijing.
Fund managers have described
China’s regulatory drive as a move to
gain better control and set up guard-
rails for fast-growing digital industries
and internet titans. It’s also a way for
Beijing to deal with escalating U.S.-
China tensions, in part resulting from
recent legislation in Washington that
sets the stage for delisting Chinese
companies if they don’t offer more au-
diting disclosures within three years.
One concern for China’s regulators:
the valuable troves of data collected by
Chinese tech companies listed in the
U.S., creating a possible national secu-
rity threat.
“Control of data is shaping up to be
a major domestic and geopolitical issue,
with direct equity market implications
for firms operating on both sides of the
Pacific,” Rory Green, head of China
and Asia research at TS Lombard, said
in a recent research note.
Beijing is trying to gain better con-
trol of Chinese companies, including
those listed abroad. Many of the largest
Chinese techs, like Alibaba, Tencent
Holdings (700.Hong Kong) and
JD.com (JD), are registered in the Cay-
man Islands and use a variable interest
entity (VIE) structure, allowing them
to get around Chinese restrictions on
I
nvesting in China is even trick-
ier than usual these days, lead-
ingsometowonderifit’sworth
the trouble. And it’s not likely
to get easier in the near term,
though volatility over the next
couple of months could create
bargains for long-term investors.
Since scuttling the anticipated pub-
lic offering of Ant Group last fall, Chi-
nese regulators have been targeting the
country’s biggest and most widely held
internet companies. On July 2, Beijing
struck again, launching a cybersecurity
review of DiDi Global (ticker: DIDI)
and ordering its app to be pulled from
mobile stores, as it tightened controls
over data security and rules for compa-
nies listed overseas.
The move, just days after DiDi had
raised $4.4 billion in the year’s biggest
IPO, led the stock to lose a fifth of its
By RESHMA KAPADIA
A driver for ride-sharing company
DiDi follows a map on his smartphone
to reach his destination in Beijing.
foreign ownership. Though largely
ignored by investors, the complex
structure is a gray area because, under
it, foreigners don’t actually own a stake
in a Chinese company. Instead, they
must rely on China honoring contracts
that tie them to the company.
For decades, China has largely
turned a blind eye to the extralegal
structure, but it’s paying more atten-
tion now. Bloomberg News reported
this past week that Beijing is consid-
ering requiring companies that use
this structure to seek its approval
before listing elsewhere. Already-
listed companies might have to seek
approval for any secondary offerings.
Analysts and money managers say
they don’t expect China to unravel the
VIEs, which are used by the country’s
largest and most successful companies
and would take decades to undo. Many
are also skeptical that the U.S. will fol-
low through with its delisting threat.
But Beijing could use VIE scrutiny
to exert increased control over compa-
nies and to push back against U.S. reg-
ulators’ calls for more disclosure. Indi-
rectly, the scrutiny will likely bolster
Beijing’s efforts to lure domestic com-
panies back home—a drive that’s al-
ready led to secondary listings in Hong
Kong for Alibaba, Yum China Hold-
ings (YUMC), and JD.com.
Analysts also expect the heightened
scrutiny to slow, if not halt, the number
of Chinese companies coming public in
the U.S. in the near term. It could also
shrink the tally of U.S.-listed Chinese
companies—more than 240 with over
$2 trillion in combined market value—
that appeal to do-it-yourself retail in-
vestors. Any of these unable to secure
secondary listings in Hong Kong or
China might go private, says Louis Lau,
manager of the Brandes Emerging Mar-
kets Value fund.
U.S.-listed stocks could see volatility
as a result. Increasingly, fund managers
and institutional investors—Lau in-
cluded—have been gravitating toward
stocks listed in Hong Kong or mainland
China whenever possible. For retail
investors, the best way to access these
foreign listings, as well as the more
domestically oriented stocks that
some fund managers favor, is through
mutual or exchange-traded funds.
Money managers are better posi-
tioned to navigate some of the logistical
complications created by U.S.-China
tensions, such as the fallout from a
recent executive order that banned U.S.
investment in companies that Wash-
ington says has ties to China’s military Nicolas Asfouri/AFP/Getty Images
How to Navigate China’s
Regulatory Minefield
Some China stocks are starting to look like bargains, but beware:
Volatility could persist as Beijing steps up regulatory scrutiny.
iShares MSCI China ETF vs. S&P 500
Keeping Pace
The U.S. and China are leaders of global growth, giving
investorsareasontostickwithChinaforthelongterm.
Sources: FactSet
S&P 500 Index
iShares MSCI China ETF
2017 ’18 ’19 ’20 ’
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50
100
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