Didi Fiasco Foretold Cautionary Tale

Three months after Chinese President Xi warned that Beijing would go after “platform companies” that collect data, investors were “shocked” at the regulatory crackdown on ride-sharing group Didi and other recent NYSE tech IPOs. The actions by the Cyberspace Administration of China were clearly foreshadowed, beginning with the moves against Ant’s planned Hong Kong/Shanghai offering in November and its forced restructuring, and Alibaba’s USD 2.8 billion fine for breaking the anti-monopoly law. The emphasis on “national security grounds” also should not have come as a surprise. Late last year the National Development and Reform Commission announced rules for reviewing foreign investments in various sectors, including internet technology and financial services.

The crackdown on the local tech sector is part of Xi’s larger move to reduce the influence and size of the private sector, which contributes nearly two-thirds to GDP. As the Chinese Communist Party celebrates its 100th anniversary, it is increasingly placing party members in private and foreign firms.  For years, China’s largest bank was also one of its biggest companies but today Alibaba’s market capitalization is more than double ICBC’s. It is also a protective reaction to the US ban on investing in 59 Chinese defense and surveillance technology companies including telecom tech company Huawei and SMIC, the largest chipmaker.

Analysts are now debating whether the Didi fiasco will deter Chinese companies from listing in New York or overseas investment in China’s local stock and bond markets.  In the first half nearly three dozen Chinese companies raised USD 12.4 billion in New York, an all-time high, according to Dealogic data. Bloomberg data indicate that there are as many as three dozen pending filings for US listings by Hong Kong and mainland firms. As of May there were 248 Chinese companies listed in the US, 8 of which are central government-controlled state-owned enterprises, with total market capitalization of USD 2.1 trillion, according to the US-China Economic and Security Review Commission. 

Foreign net purchases of mainland shares via Stock Connect topped USD 34 billion through the half year, more than all last year.  On the debt side, foreign inflows to local bonds totaled some USD 78 billion, with activity moving beyond sovereign debt to riskier but higher-yielding local government debt, according to ChinaBond.  In response to the massive onshore US liquidity from foreign portfolio investment, the PBOC last month hiked the FX bank reserve requirement from 5% to 7%, the first increase since 2007. It also approved USD 10 billion in new QDII allocation, the highest single amount ever, to allow more capital to leave the country, despite the fact that the limit for holding foreign securities has never been met.  Total QDII approvals now total USD 147 billion. With the inflows the RMB was up almost 1.5% against the greenback in the first half. However, even if portfolio flows continue to be strong, the RMB is likely to weaken over the next couple of months. Dividend payouts this month total USD 22 billion and spike to USD 27 billion in August, according to Bloomberg data. 

While global investors focus on the accelerating Chinese tech sell-off – with the combined market cap of the big firms down more than USD 800 billion from the February peak according to Bloomberg data – trouble continues to mount in the offshore USD bond market for some Chinese issuers. Yields on junk bonds average 10%, and exceed 20% for real estate giant Evergrande’s 2022 on a series of ratings downgrades and lack of access to fresh credit.  State-owned asset management giant Huarong is also flailing. Its total debt exceeds USD 40 billion of which more than half is owed to foreign investors, including USD 4 billion this year.  Huarong will test the “keepwell deed” notes program that says parent companies will help pay back investors should an offshore subsidiary default.  They back some USD 90 billion of the USD 630 billion in offshore bonds outstanding, including USD 22 billion for Huarong.

As emerging market investors look for value and chase high yields – with many tracking indices adding Chinese government bonds — increasing attention to ESG-related issues is in the mix.  Even ESG bonds issued on- and offshore by Chinese corporates are suspect. In the first 5 months of the year, companies issued USD 20.7 billion in “green” bonds, but accusations of greenwashing are rising, especially for onshore notes where in some cases up to half of proceeds can be used to fund cash needs instead of climate-related projects, according to Dealogic.  While yields of 10-20% may be attractive in USD terms – just as the tech firms in the world’s second largest economy were to equity investors – the equally suspect corporate and public governance rinse cycle is set for selloff despite headline economic spin.

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