Investors Paid the Price For Ignoring Didi’s Long-Running Compliance Issues

Original Article Published on Caixin Global

In late July, almost a month after the Chinese ride-hailing giant Didi was embroiled in a regulatory storm after its hasty New York listing, I spoke to a group of international investors in a webinar, and predicted the worst-case scenario would be a delisting.

That happened yesterday. It somehow still seemed to be a big surprise to global investors. China tech stocks tumbled in the U.S. market last night.

Many investors are asking why this would happen, and why Beijing was so determined to ignore the capital market’s reaction and insist on punishing Didi for the listing.

A good start to answering that question may lie in how Chinese internet companies used to be regulated.

It is widely acknowledged that China’s internet sector has enjoyed relatively loose regulations for almost two decades. Government departments, from central to local level, have turned a blind eye on the lack of compliance or even sometimes illegal behaviors from those companies.

It was a gilded age. But the more internet companies get, the more they want. In several cases, regulators were brushed aside. Back in 2015, Alibaba openly challenged the State Administration for Market Regulation (SAMR), accusing it of misconduct in writing a report that stated more than 63% of goods on Taobao were not authentic: in other words, counterfeited.

Another example was a major internet lending platform, which originally planned to get listed in Hong Kong. China’s central bank sent its opinions against an IPO, but the company still chose to list in the U.S in 2020.

Increasingly, Beijing has realized that uncontrolled internet companies could set bad examples for the private sector and, furthermore, pose various threats.

Jack Ma, founder of Alibaba, gave a rather impactful speech in October 2020, bashing traditional financial institutions and regulations, which was followed by the halt of Ant Group’s listing. That was a wakeup call for the tech giants and their investors.

Didi’s IPO on June 30, 2021 was a catalyst for the tightening of regulation. Following Didi’s investigation in early July, Beijing has taken sweeping regulatory actions, astonishing the global market which has lost more than one trillion dollars in market capitalization.

Didi’s delisting formally signaled that the laissez faire era is officially over. Beijing demonstrated strong willingness to the world that it will strengthen — to some extent normalize — regulation, and beef up the execution of the law and order, regardless of the cost.

One thing global investors might have overlooked is that Beijing’s decision on Didi had strong public support at home.

When noncompliance and illegal business practices become rampant in China’s internet sector, calls for greater regulatory scrutiny have grown louder. For example, Chinese consumers have been complaining about the practice of forced “choosing one of two” for more than ten years. Alibaba has long willed merchants on its e-commerce platforms to not sell products on competitor platforms. This year, Alibaba formally terminated this forced exclusivity and other practices after it was fined $2.8bn by the SAMR for abusing its dominant market position.

Didi had serious compliance and regulatory problems as well, which were included in the risk factors in its prospectus. Most investors chose to keep their eyes shut.

In China, every vehicle providing transportation services, for passengers or goods, should be locally licensed to do so. Drivers without permits are subject to fines or even jail time. More than 80% of Didi’s 13 million active drivers don’t have permits, which makes it true to say that Didi, technically speaking, is running China’s largest illegal taxi platform.

It is not surprising that Didi has been a target of public wrath over criminal homicide cases committed by Didi drivers. Didi hasn’t provided enough protection to customers. Local governments have consistently offered advice and suggestions to Didi executives to improve their compliance, and most have fallen on deaf ears.

When facing compliance issues, Chinese tech giants generally believe they are tech innovators, representing the future, and therefore should be treated differently.

Many global investors feel that China’s internet companies are being unfairly targeted and ill-treated in this round of regulation. However, this assumes that China’s internet sector should continue their noncompliance, uninterrupted, and investors can continue to ignore the legal standing of their businesses. This doesn’t sound right, anywhere in the world.

I am a tech investor with my own growth fund focusing on China’s tech sector. I also suffered a significant shrinking of the liquidity value of my portfolios in the last half year. However, any reasonable investor should look at it from a long view.

The importance of compliance and corporate governance will be most seriously valued by both the companies and investors in the future, at a level which should have been but never was. Both parties will be striving to become good corporate citizens, which will lead a healthy and resilient development. I would love to see this happen.

If that plan sounds familiar, this is exactly what ESG (environmental, social and governance) means. And yes, global investors love ESG.

In fact, like it or not, Beijing’s regulatory moves dovetail nicely with this prevailing movement, especially in the US and Europe, to integrate ESG considerations into investment decisions.

So it was confusing to see many of the world’s top asset managers trying to squeeze into Didi’s IPO shareholder list while claiming they stick to ESG principles. How did their investment committee address these legal and compliance issues in New York and London?

Regarding China’s regulatory storm, many ask when it will ease. I think we are almost there.

In addition to the final verdict on Didi, the market is eagerly awaiting two other developments: the final version of the Cybersecurity Review Methods, and new rules on how to regulate VIEs (variable interest entities), the preferred measure for Chinese companies to list abroad.

When final announcements are made about Didi, cybersecurity reviews and VIEs, I believe it will represent the end of these seismic regulatory actions. Going forward, lingering regulatory moves are still highly expected but should not be as frequent or widely impactful as we have experienced in the last five months.

Christmas and the New Year are around the corner. So let’s look forward.

Beijing will hold its 20th Party Congress in October 2022. History tells us favorable economic policies and better market performance are preferred before major party congresses. A stable economic development free of industry upheaval is likely.

We have prepared for the worst, so let’s hope for the best in the new year.