Financing China: Reading Between the Lines
When one thinks of the China of the last decade, increasing sentiment depicts an image of a growing superpower, be it cultural or economic. With Chinese corporations generally growing and increasing their global market share of the world economy, it seems like China’s rise to the top is inevitable. The Chinese government has made it a priority to increase global economic partnership, whether it be through its new Belt and Road Initiative, physically connecting over 64 countries using Chinese capital as the link, or its new major trade deal with the EU, which promises significant increases to the already $700 billion a year market between the two.
China was the only major economy that did not contract in 2020, posting a GDP growth rate of 2.1%, which is a major difference from the U.S.’s -3.5% GDP growth rate and even worse than the EU’s -6.8% GDP growth rate. The Chinese stock market (Shenzhen, Shanghai, and Hong Kong) has a total market capitalization of over $14 trillion, and while not as big as the total American stock market, is still the second-largest in the world. In 2019, China accounted for 41% of all total global economic growth.
With all this momentum, it may seem like a great idea to invest in Chinese corporations. Unfortunately, One reason for this lack of understanding is that, for a wide range of industries, the Chinese government prohibits non-Chinese nationals from investing in them directly. To circumvent these laws, Chinese companies have utilized VIEs (Variable Interest Entities), which are, essentially, shell companies based offshore, that allow one to use financial instruments as a go-between to fund the actual Chinese companies. While it allows foreigners to access Chinese companies, it’s also a very grey area in both Chinese and American law. Further, while on paper, an investor owns a portion of that company, in reality, they actually own much less and have no voting rights.
There have been significant cases in which Chinese companies went through major decisions without consulting their foreign investors. In 2010, Alibaba decided to sell off its Alipay division without Yahoo’s consent (which owned up to 40% of Alibaba), leaving Yahoo with no legal recourse. Even though Alibaba claims that Yahoo gave their consent on the deal Yahoo disagreed, releasing a statement stating that the deal was “... without the knowledge or approval of the Alibaba Group board of directors or shareholders.”
Aside from the legal difficulties in owning Chinese stock, an investor also has to consider China’s political climate. China is a one-party state being governed by the Chinese Communist Party (CCP), which dictates the country according to its whims. In fact, there is a legal mandate maintaining that any corporation with over 50 employees must have a party representative on staff. The party has no issues with possibly tarnishing its image in the global market to maintain control. Recent examples include their complete takeover of Hong Kong, which entirely dismissed the Sino-British Joint Declaration, a legally binding document, and, in the process, destroying a beacon of political and economic freedom. Another example of China’s strong governing tactics is the prevention of Jack Ma’s Ant Group from going public (projected to be the biggest IPO in history) because of his comments directed at the CCP a few months earlier. Additionally, there are issues with China’s trading partners, border disputes, and a major trade war with the world’s largest economy.
Ultimately, while the Chinese economy will continue to grow, a smart investor should be wary about investing in a market where they aren’t legally allowed to fully own stock and where the lack of checks and balances allow the government to have an uncontested final say on all matters.
Photo Credit: Pixabay
Photo Caption: The Chinese economy, while growing, may pose potential issues for investors.