Written By David XU ( Harvest Capital )

01

Chinese Concept Stocks (CCS): A New Form of "Unauthorized Property"?

Many individuals with real estate experience have encountered the concept of "unauthorized property" when buying houses. In similar locations, with conditions almost identical, there are two communities—one is priced at half the cost, tempting buyers with affordability. Upon closer inspection, most people choose to steer clear. This type of property is commonly known as "unauthorized property," and its sole flaw lies in the absence of legal status, making it susceptible to demolition at any time. Despite the lack of legitimacy, most unauthorized properties remain standing, existing in a quasi-legal state. Essentially, unauthorized properties lack proper ownership rights, and as a result, their market value is naturally compromised.

In the recent period, individuals holding Chinese concept stocks (CCS) may find themselves grappling with serious self-doubt. The stocks have experienced multiple rounds of halving, and yet there have been no official statements, market rescues, or even repurchases by major shareholders, leaving investors to wonder—did I invest in a form of "unauthorized property" in the stock market, given the persistently low prices and the absence of major shareholder buybacks?

Chinese concept stocks have a long history, and the market has always assumed that these stocks possess legitimate ownership credentials. While investors may doubt the value of the stocks they hold, they rarely question the authenticity of the stocks themselves. However, in recent times, it seems that various overt and covert forces are pushing Chinese concept stocks toward a situation resembling "unauthorized property." Investors are beginning to question whether the stocks they hold might indeed be a form of "unauthorized property."

02

Why is there "Unauthorized Property Anxiety" in Chinese Concept Stocks (CCS)?

There is a possibility that Chinese concept stocks could be treated as unauthorized property by Americans. The recently enacted "Holding Foreign Companies Accountable Act" stipulates that if a foreign-listed company fails to submit reports requested by the Public Company Accounting Oversight Board (PCAOB) for three consecutive years, the U.S. Securities and Exchange Commission (SEC) has the authority to delist the company from the stock exchange. The first batch of five Chinese companies included in the "pre-delisting" list could potentially be delisted as early as 2024. Once kicked out of the market, they are not much different from unauthorized property.

The legal legitimacy issue of Variable Interest Entities (VIE) is a significant root cause of the "Unauthorized Property Anxiety" in Chinese concept stocks. VIE has become the foundation of the ownership legitimacy of Chinese concept internet companies. Since the case of Sina, the market has largely ignored the risks associated with the VIE structure based on the logic of "existence is reasonable." However, the recent overseas listing regulations comprehensively clarified the procedures for domestic companies listing overseas while still maintaining an evasive and ambiguous stance on the legality of VIE. This has made it challenging for the market not to have doubts about the long-term legitimacy of VIE. Until there is an official positive response from authorities, these doubts are likely to reinforce themselves, making it difficult to remove the label of "unauthorized property" from Chinese concept stocks.

Another source of "Unauthorized Property Anxiety" in Chinese concept stocks is the ongoing survival risks. Companies with revenues in the hundreds of billions are suddenly faced with a combination of uncertainties such as platform anti-monopoly measures, data security governance, and tax and social security compliance. Imagine a company investing billions to build a factory on 200 acres of land. In the process, some approval procedures were skipped due to local government incentives. After completion, the company discovers a problem with ten acres of land—post-supervision has significant flexibility: regularization of the ten acres of problematic land is an option, cutting out the ten acres is an option, and in extreme cases, demolishing the entire factory is also an option. The actual complexity of internet platform regulation far exceeds the example given. For instance, if those ten acres happen to be basic farmland and the main structure of the factory is built on that land, the regulatory flexibility will be very limited. This example helps better understand the "Unauthorized Property Anxiety" in Chinese concept stocks—market concerns that their core assets and business models are built on "basic farmland," and if the model collapses and equity value becomes zero, property rights will also lose meaning.

Despite all these doubts, day after day, they erode the confidence of Chinese concept stock investors. The doubts have not been dispelled and are occasionally partially validated by various real-world events. When combined with unfavorable external factors such as the U.S.-China confrontation and the Russia-Ukraine war, these doubts continue to reinforce themselves, leading to a self-fulfilling prophecy, causing the market to decline continuously. According to statistics from U.S. stock investors, from the historical peak of 261 Chinese concept stocks to the close on March 14, the total market value of Chinese concept stocks evaporated an alarming $4.17 trillion. The situation is critical and requires urgent action.

03

Should we or should we not hold the "property certificate" of Chinese concept stocks?

Fortunately, in the past couple of days, the Financial Stability and Development Committee proposed a series of measures to stabilize market expectations. The market responded positively, and many Chinese concept stocks reported gains of several dozen percentage points. In an extreme market atmosphere, it does require extraordinary means to quickly suppress market panic. The fact that official statements brought about a halt to the decline and even sharp rises seems to precisely confirm the inherent "unauthorized property" nature of Chinese concept stocks. When top-level statements make homebuyers feel there is hope of obtaining a property certificate, housing prices soar; but conversely, the same can happen if a leader's speech or even a red-headed document from a local government department makes homebuyers feel that what they hold may be worthless, causing housing prices to plummet. Price fluctuations are the best litmus test for market confidence. From a rational perspective, the source of market confidence should be rules, the rule of law, and a robust property rights system, rather than a red-headed document, a window guidance, or a leader's statement.

It should be noted that the "small property rights" trend in Chinese concept stocks is a complex and systemic issue. It is not as simple as whether to regulate or not. If companies violate laws and regulations, they should bear the corresponding consequences, and there is nothing to complain about or sympathize with. Objectively speaking, many of the problems with Chinese concept stocks do come from some companies and entrepreneurs themselves. Many Chinese concept stocks grew rapidly during the internet era, with business models excessively pursuing monopoly profits, neglecting corporate social responsibility and worker welfare, and even causing significant negative externalities to society. Unordered expansion is an objective reality. The assets with small property rights attributes formed by disorderly expansion should undergo necessary procedures, rectifications, and demolitions; it is only fair and just.

As for why there is disorderly expansion and how to understand "order" and "disorder," it is worth pondering. One possible understanding is that capital should self-discipline, self-consciously, and self-restrain. This discipline may even rise to the level of morality, requiring capital to become moral saints who are not swayed by money and only seek profit. Another rational understanding is that the government should provide order for market competition. If capital acts according to the rules, it is allowed. In this way, the relatively disorderly micro-competition between capitals will not hinder the overall order of the market. When policies are orderly and the market is efficient, the expansion of capital is unlikely to create a large number of assets with small property rights attributes. After all, most of the time, capital is obedient. If you don't believe it, see which investment institution has invested in K12 education after the new regulations were introduced?

04

Challenges in Solving the "Small Property Rights" Issue in Chinese Concept Stocks

The Central Economic Work Conference clearly stated that "we must correctly understand and grasp the characteristics and behavioral laws of capital" and "give full play to the positive role of capital as a production factor while effectively controlling its negative effects. It is necessary to set 'red and green lights' for capital, strengthen effective supervision of capital in accordance with the law, and prevent wild growth of capital." The central government's proposal to give a "green light" and show a "red light," specifying rules and setting boundaries, is also what the capital market and entrepreneurs are happy to see.

The practical challenges lie in the fact that in the internet and digital era, many industries and business models iterate quickly, have multiple innovative elements, and strong cross-border attributes. The relationships between various stakeholders, such as government, capital, platforms, small and medium-sized enterprises (SMEs), and workers, are complex. The speed at which regulators formulate rules is prone to lag behind the pace of change, posing significant challenges to institutional innovation and regulatory capabilities objectively. When rules lag behind, industry innovators and leaders often face a regulatory vacuum and ambiguous areas. This combination of disorder and intense competition can easily give rise to brutal development and even lead to the creation of assets with small property rights attributes. Therefore, to fundamentally solve the issue of "small property rights" in Chinese concept stocks, it is necessary to start with forward-looking, advanced, and predictable rules and focus on solidly protecting property rights and upholding contracts. This requires great wisdom and even greater determination.

It should be pointed out that efforts to enhance the orderliness of capital should not come at the expense of restricting and sacrificing capital liquidity. Capital inherently possesses liquidity, and the essence of capital flow is the movement of production factors. Reasonable capital flow can promote the creation of social wealth and increased productivity. Policies aimed at enhancing the orderliness of capital can establish rules and boundaries for capital flow through measures such as negative lists and legislation against monopolies and unfair competition. Rather than attempting to restrict, divert, or cut off the flow, these policies should facilitate a more orderly flow.

Some friends jokingly say that last year they talked about opposing the disorderly expansion of capital, but this year they might be troubled by the disorderly contraction of capital. Opposing disorderly expansion is like family planning; the policy dictates that you can't expand without permission. However, preventing disorderly contraction is like encouraging having a third child; whether or not to expand is not necessarily determined by the policy. The timing of policy implementation should fully consider the window of opportunity and external environmental factors, as this will directly impact the effectiveness of policy implementation.

Currently, the Chinese economy faces challenges such as the repeated impact of the pandemic, cost shocks on the supply side, and a shrinking demand for economic growth. Additionally, there are significant pressures from the Russia-Ukraine conflict and the China-US confrontation. Whether it's internet giants or small and medium-sized enterprises and individual businesses, most are facing a challenging operating environment. At this time, policy encouragement and support are particularly needed. As pointed out in the financial committee meeting, policies that are favorable to the market should be actively introduced, and caution should be exercised in implementing contractionary policies. Any policy that has a significant impact on the capital market should be coordinated with financial regulatory authorities. Strengthening effective capital supervision is a long-term and persistent task, and at the current stage, there is a greater emphasis on encouragement and support, which is not contradictory to the goals of medium to long-term positive supervision and governance.

In medicine, the principle is to treat acute illnesses promptly and chronic illnesses slowly. Chinese concept stocks are facing an acute illness with a continuous sharp decline, and the regulatory authorities have promptly intervened to halt the market's irrational plunge. However, the underlying issues of Chinese concept stocks are akin to a chronic illness, requiring patience and a gradual approach. Only by identifying the root causes and prescribing targeted solutions can the "small property rights" label on Chinese concept stocks be removed. This is essential for paving the way for a broader and more stable future for Chinese concept stocks.

The market value of Chinese concept stocks, amounting to trillions of dollars, has already suffered a severe setback. One can only hope that the lessons learned won't be in vain.