While the world was fixated on the US election, a bit of a coup took place in the Chinese capital markets. Ant Group was set to have the largest IPO in history, expecting to take in $37 billion in a dual listed IPO off the US exchanges that would take place in Shanghai and Hong Kong.
The IPO would have been available to both domestic Chinese as well as foreign investors. However in November 2nd, Jack Ma, founder of Ant and it’s former parent Alibaba, which still maintains a 33% stake in Ant Group, was called to Beijing to be interviewed by senior officials at the central bank. What ensued was a bizarre policy change and cancellation of the IPO, at least for now.
Stepping Back
Before I get into why this is an ominous sign for innovation and future investing in China, I want to put this in context of the global macroeconomic situation as it relates to capital markets.
Tech is hot at the moment, especially big tech in America. Companies tied to tech that include social media and manufacturing, a wider definition than the more narrowly defined by S&P account for 40% of the S&P 500 right now, surpassing an all time high of 37% that was seen during the dot com bubble.
Although as investors, we love the gains that tech is producing, these can’t last forever. Apple itself accounts for 8% of the S&P in itself. When half the global market capitalization of stocks is to be found in the US, it means a fifth of all global market cap is now in American tech, a reliance of global markets on the performance of this sector is becoming increasingly apparent.
So it would be a welcome sign to diversified, long term investors to see some other sectors or countries take some of the pressure off US tech by outperforming themselves. However, this has proven elusive. Europe saw their only small contender, Wirecard, implode in an accounting scandal. India shows promise with back office IT utilizing cheap labor but seems to send its best and most innovative engineers to Silicon Valley instead. Latin America has MercadoLibre, their answer for Amazon/EBay but that’s about it.
The tech alternative, as I described here is emerging as China. It’s tech market differs from that of the US in the sense that it is domestic, regulated differently and is able to combine services like the American tech companies can only dream of. Just as in the US, firms like Tencent and Alibaba are dominating Chinese share returns along with that of the MSCI emerging market index, which is now dominated by Chinese shares.
The media and international observers seem to think that due to their differing political ideologies, the US and China are headed for an inevitable clash. From a business and investing perspective however, China finally offers an alternative in terms of size and innovation to the US. The nationalists in the Chinese government as well as much of the population, fed by the state controlled media, seem eager to have China “take its place” among the great powers of the world. One of the ways to do this is to offer an alternative to the US in almost every facet. In terms of tech and GDP, China can now certainly claim to be a rival to US dominance but in capital markets it still lags, which brings us back to the IPO of Ant Group.
The New Nasdaq
Any Group’s IPO was somewhat unique in the sense that it was set to debut without the US or European exchanges involved. Although Saudi Aramco had achieved this feat last year, its debut was awkward with a fair amount of arm twisting of regional pension funds by the Saudi government to make it happen off the NYSE, which would have required much more disclosure than the company was willing to give.
Given the political climate between the US, the near ban of Tik Tok in September and the growth in liquidity of the Chinese A-shares market in Shanghai, bankers determined that the time was right for a large IPO in China without the US. In addition, the IPO was going to anchor the new STAR market, which is being viewed by some as the Chinese answer to the Nasdaq.
Despite the sale of the majority of Ant Group from Alibaba, Jack Ma, the founder of Alibaba is looked at as the face of Ant Group. Indeed with Alibaba’s ownership stake, the IPO was set to catapult Ma into becoming one of the richest men in the world by adding $27 billion to his fortune, but speaking at a Summit on October 24th, Ma may have rubbed regulators in China the wrong way.
The summit was attended by senior regulators in the financial industry in China including the central bank (the PBOC), securities market and insurance regulators. Ma used the platform to speak his mind and push the envelope, deriding the “pawnshop mentality” of Chinese state owned banks. What he meant by this was the collateralized lending that is required for smaller and poorer borrowers by the state owned institutions in China.
What followed was a quick series of events that derailed the IPO but more importantly showed why investors are leery of China, it’s state led capitalism model and even the Renimbi, which China is hoping to become a viable alternative to the US dollar.
Ma was summarily summoned to meet with the PBOC a few days later and by all indications the meeting did not go well. Out of nowhere a slew of regulations that restrict Ant Group’s business model were announced seemingly from nowhere. Ant’s business model essentially owns the customer with banks provided financing on the back end. After the PBOC tightened rules on asset securitization in 2018, Ant started lending to consumers through Alipay its payment service, with banks providing the funds. How this is materially different and how Ant was allowed to get away with for 2 years under the regulators eye is a mystery to me but was clearly seen as being permitted by regulators by Ant itself.
On November 2nd however, the regulators published new rules which required the originator of micro loans to hold 30% of the loans it originates on its balance sheet. This completely upends the fee model that Ant previously had where banks like Citi pay to have access to consumers and lend. It also distorts the outlook for investors. Ant looked like a conduit for access to Chinese consumers before, now it will look like a quasi bank and tech firm. The outlook for tech firms remains rosy, the outlook for banks not so much. So this move essentially slaps Ant back to a bank like model by sheer force. This is bad for Ant but even worse for China in the long run.
The Russian Way
Whatever was said in that meeting, the outcome points to the uncomfortable idea that it may have been reminiscent of that described by Ben Mezrich in his book Once Upon a Time in Russia about the rise of the Russian oligarchs and their clash with the then newly minted president Vladimir Putin. In that meeting, in July 2000, Russia’s oligarchs were summoned to Stalin’s former home outside of Moscow where Putin is said to have exclaimed “You can keep what you have….but from here on out, you are only businessmen.”
That the IPO was cancelled days before it was set to debut is unprecedented, especially for a landmark one of that size. China’s regulators look as thin skinned and petty as the Trump administration which they often criticize and it plays into the narrative that China is a place where laws and institutions don’t rule, people and personalities do. The report that Ma’s speech was delivered to Chinese president Xi himself implies this smack down could have come straight from the top.
In this sense, the Chinese authorities won the battle but made a strategic blunder in the war. It sends the message that you can innovate as long as it doesn’t involve criticizing or wading into politics, even if the politics are mundane banking regulation. This is nearly impossible when a company is all encompassing and dominating sectors of the economy as we have seen in the US. Tech companies took a lot of heat for their role in facilitating “fake news” and Russian bots in the last election, yet only had to testify before Congress. Additionally, as we just saw in California, ride hailing companies have lobbied furiously to maintain important features of their business and successfully defeated prop 22 which would have provided full time employee benefits to contract workers in California. Business does have political interests whether we like it or not.
Ma has the advantage of being powerful and has an international image. The authorities probably wouldn’t just stop at the IPO if he was a lesser figure. Either way, it just points to the fact that it isn’t just innovation or the US dollar that keeps international investors coming back to the US. For all its political disfunction and its own regulatory fickleness, the US is still regarded as a place governed by laws and institutions, not personalities. Politicians here don’t keep a second home in Vancouver as a backup plan in case they fall out of favor of the President. Don’t expect to be needing to open an account in Renimbi to safeguard your fortune anytime soon.
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