Understanding China’s Complex Regulatory System Is Vital for PEVC Investors
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PRIVATE EQUITY & VENTURE CAPITAL IN GREATER CHINA’S INNOVATION ECONOMY - PAGE 24
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Personal connections or ‘guanxi’ isn’t enough – PEVC investors targeting China’s internet businesses also need to know how its regulatory agencies function
China has an extensive and complex regulatory framework. Start-ups and small businesses operating in China’s fast-growing internet sector need to be able to navigate this system. Many of these businesses have yet to familiarize themselves with the agencies regulating them, and often they look to their private equity or venture capital (PEVC) backers to bolster this competency.
That’s why it’s vital that PEVC investors possess the necessary ‘guanxi’ or personal relationships with regulatory agencies. However, personal relationships alone aren’t enough. PEVC investors also need to have a deep understanding of China’s regulatory system. This means having a strong grasp of the historical evolution of the relevant regulatory agencies, along with up-to-date knowledge of key personnel changes.
These are essential elements for PEVC investors to build a track record of success. PEVC investment teams must be able to show that they have the experience and the contacts to help their investee companies resolve potential conflicts with regulators before they escalate. The first step is knowing the roles and responsibilities of the many government institutions operating in this space.
Compliance Failures Can Have Serious Consequences
The Cyberspace Administration of China (CAC) is one of the leading internet regulators in China. The CAC works with several ministries and agencies that are responsible for routine supervision of internet businesses, including the People's Bank of China, the State Administration of Foreign Exchange (SAFE), the China Securities Regulatory Commission (CSRC), the China Banking and Insurance Regulatory Commission (CBIRC), the Ministry of Industry and Information Technology (MIIT), the State Administration for Market Regulation (SAMR) and the Ministry of Public Security (MPS).
We have noticed that government tolerance of the illegal collection and usage of consumer information through mobile apps is gradually wearing thin.
According to publicly available information, in January 2019, the CAC, together with the MIIT, MPS and SAMR, announced a joint decision to crack down on the illegal collection of personal information. Shortly after the announcement, Personal Information Protection Taskforce on Apps was established by the National Information Security Standardization Technical Committee, China Consumers Association, Internet Society of China and CAC to be responsible for supervising the collection of mobile app information.
In November 2019, the MIIT announced a special remediation act to protect app users, focusing on the illegal collection and usage of consumers’ information as well as unreasonable demands on user limits, which affected numerous apps and app stores. More than 140 apps were reviewed and 20 of them were summoned to meet regulators.
There are also cross-agency groups like China’s Internet Financial Risk Specialist Rectification Work Leadership Team, which was established in October 2016 and is led by the central bank. Members of the Team include the CSRC, the CBIRC, the MIIT and the SAMR. The Team’s supervision spans online credit platforms (including peer-to-peer lending and cash loans), online payments, online fund sales, online asset managers, internet brokerages, online insurance brokerages, and digital currency and exchange.
Failure to understand and comply with China’s internet regulations can have serious consequences. Two recent cases highlight the importance of knowing how to work with regulators to ensure compliance. The first occurred in late 2018, when local public security bureaus working with the MPS arrested the founders of five big data companies for violations involving the disclosure of Chinese citizens’ private information. The second occurred in August 2019, when SAFE notified two cross-border payment companies that they had failed to comply with existing regulations. SAFE ordered banks and other payment companies to stop cooperating with these companies, essentially putting a stop to their business.
How PEVC Investors Can Help
Educating investee companies about the importance of regulation and connecting them with specific agencies to deepen mutual understanding is critical. PEVC investors must also encourage investee companies to provide these agencies with regular updates about how their business is progressing. These updates can help to eliminate regulatory concerns.
In emergency situations, PEVC investors must be able to take quick action. This may involve contacting the head of the specific department responsible for regulating an investee company in order to facilitate communication, explain the situation, clear up any misunderstandings and avoid potential business suspensions.
Tech companies across the globe are facing increasing scrutiny from governments, and in China heavier regulation is on the horizon. By leveraging decades of experience working with various Chinese regulatory authorities, and our extensive capital markets expertise, PAC is able to help investee companies to identify and avoid potential regulatory pitfalls with foresight. Learning this proactive approach to regulation gives our investee companies a competitive edge, and adds value for our limited partners.