China’s internet regulatory regime: competitive and pricing practices, fintech, data and labor security
China's internet regulatory regime covers anti-monopoly practices in the platform economy, competitive and pricing behavior, fintech, data and labor security. Different areas are governed under different regulatory agencies, depending on the regulatory basis and law enforcement progress. China has enforced legal action since 4Q20, when it strengthened the supervision of the internet economy. The intensive scrutiny was seen in the April and July 2021.
China has more or less completed setting up its anti-monopoly regulatory legislative framework and law enforcement system. The focus is cases of abuse of a position of dominance (e.g. Hobson’s choice) and illegal operator concentration. The scrutiny has dealt with many crucial areas. Among them, violations of Hobson’s choice are mainly represented by Alibaba and Meituan (the results have not yet been announced). In terms of illegal operator concentration, 4 sets of 43 administrative penalties were not declared in accordance with the law. In July, the Municipal Supervision Bureau banned the merger of Huya TV and DOYU. And for the first time, in order to prevent over centralization, Tencent was ordered to remove its exclusive copyright of online music and to take necessary measures to restore market competition.
The supervisory basis for unfair competition/price behavior regulations is relatively complete, and the main regulatory areas are low-priced dumping to squeeze out opponents, false propaganda to induce consumption, big data unfair pricing system, and unclear pricing rules. In December 2020, the General Administration of Municipal Supervision held a community group buying administrative guidance meeting and proposed nine prohibitions to standardize competition. Since then, the area of supervision has expanded to e-commerce, travel, and shared consumption. At present, the "Regulations on Administrative Penalties for Pricing Illegal Acts (Revised Draft)" are under review, and law enforcement experience is being transformed into clear rules, to provide greater deterrence in the revised penalties.
In 4Q20, financial supervision was extended to financial technology, and the central meeting in March 2021 stressed that "financial activities should be fully included in financial supervision". Fintech supervision mainly covers the isolation of financial holding applications, payment anti-monopoly, internet loan licensed operations and control leverage, personal credit licensed operations, internet insurance licensed operations, etc. In addition, the recent regular meeting of the State Council will set lower fees for small and micro companies, and the regulatory authorities will provide a higher rate of loan assistance. Currently, fintech regulations are in the process of establishment, so follow-up includes potential law enforcement in financial control applications, anti-monopoly practices in the payments segment, and data supervision of lenders.
With the trend of global data regulation upgrading, China's data regulation regulations are improving. We believe that data regulation mainly includes network security regulation and personal information protection.
- China's network security supervision laws and regulations are relatively perfect, the main direction of supervision for the key information infrastructure supply chain security. DIDI is the first law enforcement case after the publication of the "Network Security Review Measures" in April 2020, marking a new stage of law enforcement. Follow-up supporting rules are being set one after another, focusing on Sino-US "outside the border" regulatory competition and cooperation.
- The legal basis and law enforcement rules for personal information protection supervision in China are undergoing improvement. In 2019, four departments jointly carried out special rectification. Since 2020, special governance efforts have been continuously upgraded, and the scope of governance has been expanded. In July 2021, the Ministry of Industry and Information Technology launched a rectification program for the internet industry. The number of rectification issues and scenarios is high. Follow-up areas: 1) After the implementation of the "Interim Provisions on the Management of Personal Information Protection and Management of Mobile Internet Applications (Draft for Comment)", the implementation of the "informed consent" + "least necessary" principle, and the explicit prohibition of the "price dumping" behavior. 2) After the "Personal Information Protection Law (Draft)" comes into effect, the relevant identification and supporting rules for "entrusted processing" and "automated decision-making".
Labor security: In April, Nanjing first piloted distribution agents and their labor dispatch units to establish labor relations with part-time riders and participate in social security according to law, triggering a heated debate. On 9 July, the executive meeting of the State Council decided on a series of measures to strengthen the protection of the rights and interests of workers on flexible employment schemes, including not formulating assessment indicators that might damage the safety and health of workers, improving system rules and algorithms of order distribution and proportion, and not illegally restricting workers' employment on multiple platforms, in terms of travel, takeout and instant distribution. Pilot projects for occupational injury protection for flexible employees were carried out. Since then, the Ministry of Human Resources and Social Affairs and other departments have issued intensive guidance. Details of the pilot occupational injury insurance, platform enterprise algorithm and assessment adjustment have not yet been disclosed.
Potential impacts of Internet regulation in China – the pace of regulation is different, depending on the direction and the visibility of the potential impact
- On the whole, the impact of anti-monopoly/data supervision covers the whole industry, and price behavior/financial technology/labor security supervision mainly affect the segments. And the visibility of potential impacts varies according to different directions of regulatory policy/enforcement progress. We believe the purpose of internet regulation is to promote the healthy development of the industry, as well as fairness and improve efficiency. Some leading companies' core business is affected to a certain extent, although there are policy uncertainties in the follow-up. In the short term, the probability of a significant impact is small. On the other hand, super platform flows, capital, data and other advantages are evident, on the basis of sustained investment in scientific and technological innovation. In the new normal of Internet regulation, companies that embrace innovation would have better prospects.
- We expect anti-monopoly supervision in the new platform economy will nullify the old practices of "squeezing competitors to seize market share through subsidies in the early stage, integrating industries with capital in the middle stage, and forming monopoly platforms to obtain excess profits in the late stage". Super platforms would re-examine how to intervene in business segments such as B2C internet expansion or efficiency-driven industry integration. The long-term growth potential has shifted to B2B and hard science and technology. The relative advantages of leading suppliers in e-commerce, takeout, OTA and travel industries have weakened, and competition has intensified or led to a slowdown in the trend of monetization rate improvement.
- Price behavior supervision promotes the standardization of competition, community group buying "price wars" are restricted, and the form of subsidies has been adjusted, which will cover more SKUs and migrate to the warehouse distribution segment. Short-term order volume growth would be affected or the industry integration speed would slow down. On the other hand, industry competition has shifted from extensive "subsidy wars" to operational refinement, and it has become more difficult for latecomers to catch up.
- When the rectification of 13 online platform companies in financial technology supervision is in progress, after passing the "extensive" development stage, although the industry threshold has been significantly increased, the growth rate is expected to slow down. Judging from the current policies / cases, the impact on Tencent is limited, but it is difficult to completely eliminate policy uncertainty in financial holding applications and payment fields. In addition, regulatory authorities recently mentioned payment cuts and assistance to reduce fees, and the growth potential in the medium term has been damaged to some extent.
- The impact of data regulation also covers all Internet companies. After Didi's review, supervision in the field of network security has continued to increase, and the implementation of supporting policies is expected to accelerate. In the short term, personal information protection will focus on special rectification by the Ministry of Industry and Information Technology, the Office of the Cyberspace Administration of China and other departments. The consolidation and upgrading of violations is expected to have a relatively limited impact on leading platforms. However, it should be noted that after the implementation of the security law, whether there will be any changes in the rules and regulations on "Personal Information Collection / Use", "Entrusted Management", "Automated Decision-Making", we would not rule this out. If the new regulations are stricter than expected, it would affect the accuracy and conversion ability of online advertising, especially for the M&A market.
- In terms of labor security, the participation of flexible employees in social insurance still needs to be improved at the legal level. In the short term, occupational injury protection pilot projects may be launched in the travel, food delivery, and instant delivery industries. The details of the pilots have not yet been announced, and the Jiangsu Wujiang pilot has limited reference. Judging from current guidance, we expect that in the pilot, occupational injury insurance would increase the labor cost of companies to a limited extent. If the algorithm and evaluation mechanism are adjusted, we would not rule out a certain impact on operating efficiency.
Investment ideas: Due to major adjustments in some industry policies, the gradual implementation of anti-monopoly treatment, the market expects that the regulatory environment will become more stringent in the future, and amid the pessimistic sentiment, prices of internet H-shares and A-shares have adjusted substantially. In the next cycle after policy pressure is relieved, the panic would give way gradually to rationality, and judgment of investment value would gradually favor the fundamentals of the industry and companies. In the future, we need to pay attention to the clearer processing of financial technology and data supervision. In addition, after entering the intensive release period of 2021 Q2 financial results, focusing on the performance of US stock companies that exceeded expectations, and the performance guidance of H-shares in 2H21, as well as some companies' antitrust treatment, business growth momentum has resumed rhythm. For example, H-share internet leaders’ performance expectations for 2H21 and 2022 would gradually return to the growth curve, and revenue and profit would maintain healthy growth. With reduction in policy uncertainty, it could present higher valuation/price ratios.
Risks include: internet regulations becoming more stringent, lengthening the decision-making cycles of companies and increasing compliance costs; with anti-monopoly practices in the platform economy normalizing, competition in e-commerce and other industries would intensify, improving the pace of monetization; new regulations on data regulation; and uncertainties in online advertising; when financial regulatory companies undergo rectification, growth of medium-term payments and internet loan business would be affected to a certain extent; as pilots of occupational injury insurance in the travel, food delivery, and instant delivery industries are promoted, labor costs of platform companies could increase; and pressure to adjust the algorithms and assessments mechanism.