The tightening Chinese regulations that have surprised equity market participants this year are expected to continue to be a concern for investors over the next 12 months. Yet the longer-term outlook is brighter.
“We believe the recent regulatory efforts are aimed at reforms that are important to drive more sustainable and balanced growth in the longer term, foster fairer competition which is crucial for innovation, and lower systemic risk in the highly leveraged sectors,” said Sean Taylor, chief investment officer for Apac and head of emerging market equities at DWS, at a media briefing this week.
While he believes the regulatory overhang will likely remain over the next year, it will have less of a negative impact on the Chinese equity market as investors have started to factor in the regulatory uncertainty, he added.
Since the beginning of 2021, the MSCI China Index has underperformed MSCI World by 30%, eventually reflected in downward pressure on the Apac market index as well.
Eye on China’s future
Looking forward, DWS expects cyclical regulatory change in 2022, which usually happens before a political transition every three to four years. Although President Xi is likely to remain in his role, some of his main advisors may not, which may lead to some changes in decrees.
China’s regulations are also likely to be in line with policy priorities such as common prosperity and social equality. After China has declared a “complete victory” in its campaign to end rural poverty, its focus will shift to increasing the average salary and the GDP per capita, said Taylor.
This highlights the extent to which China is changing from “growth at all costs” to higher quality, safer growth.
This is regulated in four areas identified by DWS. Anti-trust restrictions, for example, are aimed at ensuring fair practices among tech giants and promoting healthy competition. Data security policies implemented on ADR and overseas listings, meanwhile, will reduce national security risks and strengthen cybersecurity among software companies.
Fintech companies are also likely to be affected as the government continues to stem regulatory arbitrage and financial stability risks.
In light of recent events, tech giants, education companies and the healthcare sector will all likely be impacted by increased social inequality regulations, such as improving workers’ welfare, and lessening the burden of parents in terms of children’s education expenses.
Sector focus
DWS is overweight A shares as the firm said it is less exposed to regulatory risk and could benefit from upcoming policy easing.
The firm also prefers some policy-friendly sectors such as renewables, electric vehicles, semiconductors and industrial automation. These are all aligned with national development objectives which should continue to enjoy government support and are likely to face fewer policy risks.
Despite attractive valuations in tech names, DWS said it remains cautious and underweight the sector as growth, profitability and risk premium are affected by the high regulatory uncertainty.
