Chinese President Xi Jinping and the Communist Party's Central Committee recently introduced new plans that would enable the government to assert tighter controls over the private sector. These plans include over a hundred new measures that the CCP claims will redefine "socialism with Chinese characteristics" and "further strengthen the Party's leadership" over those companies.
The new rules will require companies to hire a certain number of registered CCP members. Those employees, in turn, will monitor the companies to ensure they follow the party's ideologies, regulate their "own words and deeds," improve their morals and self-discipline, cultivate positive public images, and set up channels of communication with the government.
This marks a major shift from the CCP's previous stance on the private sector, in which it imposed rules on companies but didn't directly interfere with their day-to-day operations. These new rules, along with the ongoing escalation of the U.S.-China trade war, could affect American investors in Chinese tech stocks in several major ways.
Tech stocks are in the blast zone
China has repeatedly tightened its grip on its booming tech sector in recent years. Tencent (OTC:TCEHY), Baidu (NASDAQ:BIDU), ByteDance, Weibo (NASDAQ:WB), Momo (NASDAQ:MOMO) and other companies have all been forced to suspend certain services for various reasons.
The government accused Tencent News, Baidu's news app, and ByteDance's Toutiao of spreading "vulgar" and inappropriate content, claimed Weibo was disseminating "illegal" information, and accused Momo's dating apps of encouraging prostitution.
It also started requiring all live streamers to obtain special licenses before broadcasting any content in 2016, wiped out thousands of non-compliant live streaming accounts and apps, and temporarily suspended all new video game approvals in 2018 over concerns regarding gaming addiction. In short, the Chinese government is already keeping its tech companies on a tight leash.
Back in 2016, the Chinese government considered buying 1% stakes in Tencent, Baidu, NetEase (NASDAQ:NTES), and other tech companies to gain party-controlled seats on their boards. But the government still hasn't executed that plan, which would blur the lines between the private sector and state-owned enterprises.
A growing presence in tech companies
Instead of buying stakes and gaining seats, the Chinese government started sending officials to directly monitor its top tech companies instead.
For example, the Hangzhou city government sent officials to one hundred of the region's top companies, including Alibaba (NYSE:BABA), last year. It claimed the initiative would streamline the workflow between tech companies, manufacturers, and government officials, but it also enabled the CCP to keep tabs on private sector companies.
The CCP's new rules mark an expansion of that plan on a nationwide scale. Companies that aren't aligned with the party's evolving views on socialism -- which were written into the country's constitution as "Xi Jinping Thought" two years ago -- could face stiffer penalties than fines or temporary app suspensions.
By requiring companies to hire a certain number of registered CCP members, the government wants to plant its eyes and ears everywhere -- which could disrupt the development of new apps and services at fast-moving tech companies like Tencent and Baidu.
Daring U.S. exchanges to delist its top stocks
Earlier this year, the U.S. Senate passed a bill that could force Chinese companies to delist their U.S.-listed stocks if they didn't open their books and prove they weren't "owned or controlled" by a foreign government. That bill hasn't been passed into law yet, but the CCP's new measures could make it difficult for private sector companies to prove they aren't "controlled" by the Chinese government.
Moreover, the recent flurry of secondary IPOs in Hong Kong, including those of Alibaba, JD.com (NASDAQ:JD), and NetEase; go-private offers for publicly listed companies; and the launch of the tech-oriented STAR index in Shanghai all indicate that Chinese companies could eventually abandon their U.S. investors.
The key takeaways
China's new regulations highlight a top risk for all Chinese tech stocks: They're highly exposed to government regulations. The government can indiscriminately kill off or suspend their apps, force them to hire CCP members, and guide their investments, all without buying equity stakes. Investors should keep those risks in mind before assuming that Tencent, Alibaba, Baidu, JD, and other Chinese tech titans are sound long-term investments.