In recent months, China has prevented what would have been the world’s largest initial public offering, launched probes into some of its biggest technology companies, and helped erase more than $1 trillion in market value, causing investors to scramble for cover.

The China crackdown is a culmination of growing perception in Beijing in recent years that — following years of phenomenal, near-unchecked expansion — online businesses are amassing valuable data, minting billionaires and creating private business strongholds with enough resources and popular followings to perhaps someday threaten the Chinese Communist Party’s grip on power.

The government is now employing various avenues, as part of the China crackdown — including anti-monopoly investigations, new laws, and direct communications with top executives — to rein them in. With Didi, that campaign is now pivoting to take direct aim at the source of their power: The enormous amounts of data that they hoover up daily from hundreds of millions (in some cases, upwards of a billion) users both at home and abroad.

President Xi Jinping’s government wants to find a way to harness that data to fuel more broad-based economic growth over the next few decades. The moves have chilled the global investment community.

Among the moves were scuttling Ant Group Co.’s blockbuster listing; Levying fines on sister company Alibaba Group Holding Ltd., a record $2.8 billion for antitrust failings; and blocking a Tencent Holdings Ltd.-backed merger.

Just days after DiDi Global Inc. raised $4.4 billion in a New York initial public offering, Beijing started an investigation over the ride-hailing giant’s data security practices. DiDi has lost about $29 billion in market value in less than a month.

MSCI China Index

Source: FactSet; staff reports. WSJ

In a private meeting with representatives of global banks and investment firms on July 28, the vice-chairman of the China Securities Regulatory Commission, Fang Xinghai, told attendees that recent crackdowns were meant to fix industry-specific problems and that China has no intention of decoupling from global markets, according to people familiar with the discussions.

Some financiers who attended said they weren’t persuaded. They noted that Beijing had effectively torpedoed a multibillion-dollar industry—after-school tutoring—with a single administrative order.

In tech, China’s concerns to some extent mirror those of Western governments about market power, data usage, and other problems. Beijing also saw the sector’s power as a challenge to its own, factoring into the China crackdown.

From a peak in February, some $1.1 trillion of market value has vanished from the stocks of six top Chinese technology companies, including Alibaba and Tencent. That is a drop of more than 40%.

We are now experiencing the ATM effect: large-cap liquid stocks are being sold first. Thus, the drop in Chinese tech behemoths, such as Tencent Holdings, Alibaba Group Holding, and Baidu Inc. But other companies are also in the crosshairs as liquidity is quickly evaporating for lower-volume stocks. Indeed, there has been a notable increase in "southbound" liquidation — that is, domestic Chinese investors selling off Hong Kong-listed stocks. The percentage of domestic equity trading on margin is also climbing rapidly towards 2015 highs. It is a potential yet precarious setup for an extended market correction.

It seems possible. Xi has declared he will go after “platform” companies that amass data and market power. His administration is particularly concerned about eradicating systemic risks — such as unsupervised growth of consumer debt — in part to ensure the Communist Party’s dominion. In addition:

• The cyberspace watchdog expanded its national security review beyond Didi to apps operated by Full Truck Alliance Co. and recruitment firm Kanzhun Ltd., both of which had recently been listed on the NYSE.
• In April, regulators told Tencent, Meituan, and others, including TikTok owner ByteDance Ltd., search leader Baidu Inc. and shopping portal JD.com Inc. to “heed Alibaba’s example” and curb anti-competitive practices such as exclusivity requirements.
• Most businesses trying to go public outside of China now need to get approval from Beijing first.
• Beijing may also seek greater oversight over mergers and acquisitions, including the hundreds of startups backed by the biggest technology firms.
• Regulators have begun issuing token fines for deals closed years ago, spurring fears of a bigger probe into M&A.
• The government is said to have proposed a state-backed venture with the tech giants that would oversee the lucrative data they collect from hundreds of millions of consumers.

BofA Securities strategists have recently recommended investors shift holdings from Chinese growth stocks into shares elsewhere in the Asia Pacific region and called the recent history of foreign investors participating in China’s high-growth stocks “incompatible with likely upcoming strategies.”

Some other investors and analysts see the recent crackdowns as likely to benefit China in the long-term — and see investment opportunities in the meantime, too. Many companies that are listed on China’s domestic exchanges in Shanghai or Shenzhen focus on sectors that are more closely aligned with national priorities, such as semiconductors, electric vehicles, and artificial intelligence.

According to ETF Trends CEO Tom Lydon, China’s regulatory crackdown on some of its largest companies likely won’t deter U.S. investment in its markets. “There’s no way that we’re going to separate the capital markets of China and the U.S. They’re too intertwined at this point. But everybody’s in a competitive spirit,” Lydon told CNBC’s “ETF Edge” in August.

“It is going to be all about choice,” he said. “If you’ve got a problem with China, there’s some great indexes out there that are ex-China. But China is the second-largest power in the world and they’re going to continue to innovate.” The race to build new and better technologies has continued to draw investor interest despite regulatory uncertainty, with the popular KraneShares CSI China Internet ETF (KWEB) raking in more than $2 billion as it fell in response to Chinese authorities’ initial actions, Lydon said.

“I think a lot of people are buying on the dip for all the right reasons,” he said. “China wants U.S. investors. They may be competitive, they may fight back and forth with words, but, again, the amount of money we bring to China companies is huge for their overall economy.”

For now, at least, not all hedge funds are willing to join Ark Investment Management’s Cathie Wood in taking their Chinese stock exposure to zero.

“It’s a mistake to believe that China is uninvestable,” said Cory Lester, managing director at Morgan Creek Capital Management, which has stakes in hedge funds, including some that invest in China. “The current environment is very much shoot first, ask questions later.”

The keys to investing in China are to be less concentrated and stay nimble to potential policy changes, he said in an interview.

Tiger Global Management may be a case study in navigating the crosscurrents out of Beijing. Chase Coleman’s $65 billion firm, which has invested in China for two decades, has the most exposure to Chinese ADRs among hedge funds that disclose such holdings.

In the second quarter, Tiger Global added 22.5 million shares of Chinese cosmetics maker Yatsen Holding Ltd., making it the largest public holder. The ADRs dropped 24% in the three months through June and have plunged an additional 39% since then. Its $4.1 billion stake in JD.com remained its largest holding as of June 30.

Yet Tiger Global’s hedge fund slid less than 1% in July, likely mitigated by large stakes in U.S. technology companies such as Microsoft Corp. and Carvana Co.

There are many signs it isn’t over yet.

Investors, analysts, and company executives believe the government is just getting started in its push to realign the relationship between private business and the state, with a goal of ensuring companies do more to serve the Communist Party’s economic, social, and national-security concerns.

The government’s far-reaching ambitions under Xi Jinping promise serious and often unpredictable implications for business, these people say — and keeping foreign investors happy isn’t a priority.

That means more risk for people who have plowed billions of dollars into China’s fast-growing companies hoping to capitalize on the only tech industry that can rival Silicon Valley.

While some investment managers may liken this crackdown to an earthquake, there are others, like Ray Dalio of Bridgewater Associates, who insist that the swings in Chinese markets are little more than “wiggles.”

Source: The Wall Street Journal, Aug 2021. “China’s Corporate Crackdown Is Just Getting Started. Signs Point to More Tumult Ahead.”; Bloomberg, July 2021. “China Doesn’t Care How Much Money You Lose.” ; Bloomberg, July 2021. “How China Is Reining in Its Mighty Tech Firms.” ; Bloomberg, Nov 2020. “Why China Is Cracking Down on Its Technology Giants: QuickTake.”; CNBC, Aug 2021. “China’s crackdown likely won’t force U.S. investors out of its markets, market analyst says.”; Bloomberg, Aug 2021. “Hedge Funds Blindsided by China Risk With New Warning.”; The Wall Street Journal, Aug 2021. “Chinese Stocks Slide as Beijing’s Crackdown Shows No Sign of Abating.”.