Understanding the way China is governed, and why.

Congress, Huawei, and ZTE

In the Hutong
Catching up post holiday
1108 hrs.

If you have been following the news, you will have heard that a U.S. Congressional committee has issued a report urging U.S. firms not to do business with either Huawei or ZTE. Those two companies, respectively the second- and fifth-largest manufacturers of telecommunications equipment in the world, are accused of a range of offenses. In my opinion, the real offenses for which those companies have been placed in the Congressional mush-pot have little to do with the reasons outlined in the Congressional report. The companies real offenses are:

  1. They are from China, and this is an election year;
  2. They are the first companies in 70 years to challenge American companies for dominance in a core US industry that have not been from an ally or a client state;
  3. They have failed to be sufficiently transparent when doing business in a country that demands transparency from all companies, and even more from those that hail from competitor economies.

If Huawei and ZTE are guilty of anything, it is that they have built their U.S. businesses and ambitions before they have laid a foundation of trust with the American public and its elected officials. Ideally, no company should have to do that as a prerequisite do doing business in America, but trust is the price for any company stepping into a new country. The two companies are learning a lesson that must be absorbed by every Chinese company expanding overseas. China as a nation may or may not be successful in its efforts to reform the global system to suit its ambitions. Even if it is, though, Chinese companies must still conduct themselves in a manner that is acceptable to the governments and consumers in the markets they seek to enter.

At the same time, there is also an effort underway to tar Huawei and ZTE as a malevolent presence in the telecommunications industry, an effort that steps beyond fact and into the realm of speculation and rumor. As I noted in Making the Connection: The Peaceful Rise of China’s Telecommunications Giantsit behooves both the U.S. government and the U.S. telecommunications industry to stop relying on politics and the F.U.D. pump to preserve their markets. Instead, it is essential that American companies focus on Huawei as a competitive threat where it counts: in the market. A failure to do so only postpones their inevitable implosions.

I’ve spent much of the morning talking to reporters about the report, so I won’t belabor this. If you are interested in some balance about the issue, I talked about this this with Kaiser Kuo, Jeremy Goldkorn, and Will Moss on the Sinica podcast recently. Take a listen – I think the podcast covers the issue far better than 60 Minutes did. For a more U.S. policy-oriented viewpoint, I also covered this in The Pacific Bull Moose, my U.S. politics blog.

Caixin and China’s Great Equity Repatriation

LG Twin Towers, Beijing
Can’t see the ground through the haze
1018 hrs.

Just under a year ago I suggested that a large number of Chinese companies that are listed on stock exchanges in the United States and Europe were going to be de-listing, buying out their offshore investors and bringing the equity home. This has now become a large enough trend to capture the attention of mainstream media, and China’s excellent Caixin picked up the story this week (“Overseas Listed Firms Seek a Path Home.“)

Under the increased pressure of competition and regulatory oversight in the U.S. market, many Chinese companies that are primarily listed on overseas markets are returning home. One by one these companies have fled overseas markets seeking the high prices and loose regulatory environment in China’s A-share market.

The constant public oversight, pressure of short-sellers, and the persistent difficulty of dealing with investors who have only a vague idea of what you do is trying for even the best-run companies. If you’re not so well-run, regulations are a burden as well, especially the dreaded audit requirement.

Which brings us to the less-discussed political issues. The Party is concerned about foreign auditors digging into domestic companies, not because the CCP wants China’s companies to be poorly run lash-ups that systematically deceive investors, but because the Party is concerned about the political fallout from “unmanaged” revelations that result from public audits. In the past year the CCP has had their fill of such revelations in the Bo Xilai/Gu Kailai case, and the leadership is rightfully concerned about the effect of such disruptions.

Further, though, the Party would like the soft-power win of having its stock exchanges match, then exceed, the power and importance of the world’s leading exchanges. You can’t do that when your best companies head offshore for their indirect capital. For this reason, expect the CCP to grease the ways for the Great Equity Repatriation.

The New Public Affairs

Enroute HND – PEK
Dodging thunderstorms
0811 hrs.

A lot of the talk in the public relations industry relates to how much the media business is changing, and what that means to a craft that has traditionally placed a heavy emphasis on informing and (hopefully) influencing journalists. That focus remains viable in markets like China and India, where the media – especially traditional media – retain tremendous influence. In places like America and in Europe, that influence is in decline.

One aspect of public relations that is going through a huge change, however, is what we like to call public affairs. Despite a racy name that implies exhibitionistic behavior, public affairs is the term applied to the craft of understanding the government decision process and effectively influencing policy on behalf of a company or organization.

Whether through direct lobbying or indirect communications, the idea of a company or a special interest group influencing policy does not go down well among the citizens of free and open societies. Events of the past several years have cast this process as a bit underhanded, and perhaps nefarious, and much of the reason for that is that the practice of public affairs was formed at a time where some degree of behind-the-scenes sausage-making was expected in governance. A lot of people simply didn’t want to know about the ugly process, they were interested in the result.

But in the wake of two economic downdrafts in the past decade, alleged commercial-governmental collusion on a vast scale, the failure of regulatory institutions to act in the public benefit (particularly in the US and Europe), and growing public expectations of procedural transparency (thank you, Internet), the process of governance is now a public sport. Public affairs, as practiced, has to catch up. Discretion is no longer the better part of valor: it is suspect.

Updating this practice is going to demand some radical steps and a lot of discussion. In order to start the process, I suggest we alter our approach to government relations worldwide to conform to the following guidelines:

1. Transparency to the greatest possible extent. This means standing up in public and telling the world exactly what you are telling the government, and why. The agenda must be in the clear and open to both scrutiny and debate, as should be the tactical approach the company is taking. This also means that public affairs becomes more than a matter of speaking to government officials about company input on policy: it means involving the public as well.

2. Behavior and actions that withstand public scrutiny. The public is going to find out what you are doing to influence the process. Just ask Big Tobacco, Big Oil, Enron, and the Nuclear Power industry. In addition to making clear what you intend to do, conduct yourself in the process as if an overweight socialist documentary filmmaker from Detroit was following you around with a camera. Forget chummy dinners and back-room deals. When you are influencing public policy, you are going about the public business, and you need to behave accordingly.

3. Avoid behavior for which others have received opprobrium or censure. If someone else has done it before and gotten in trouble for it, why are you taking the risk?

4. Stop playing moneyball politics. Yes, the Citizens United decision in the United States has given corporations an unprecedented opportunity to influence the political process with money, and the opportunity for money or favors to influence the process exists in nearly every market in the world. Don’t do it. Let me say that again: don’t do it. Just because something is permissible doesn’t make it right in the eyes of your publics. The more you use money to influence the process, the more liability you are building in the bank of public opinion, and in each market a reckoning will come, rest assured. Find another way that does not hang a sword over your company’s head.

5. All of this means you will have to create a new set of tactics and techniques for conducting government relations. The way to start the process is to find a way to align your interests with those of the public at large, and keep them there. This will not be easy, but we have ample examples in the history of business to prove that it is not only possible, it is the best way to do business.

Let the discussion begin.

Jacques and the Need for China to Change

Deng Xiaoping bust in the Zhuhai High-Tech Zone
Deng Xiaoping bust in the Zhuhai High-Tech Zone (Photo credit: Wikipedia)

China’s path to reform | Martin Jacques | Comment is free | The Guardian.

In this well-written editorial, Martin Jacques captures why the Party’s next generation of leaders needs to engage in a rethink. The key graf:

First, the era of cheap labour and low value-added production is coming to an end as the economy becomes increasingly sophisticated: a major shift in economic strategy is under way. Second, China has acquired a panoply of global interests that require its foreign policy, presently based on keeping itself to itself, to be rethought. Third, the enormous growth in social inequality, combined with mounting corruption, has fostered a sense of grievance that, if unchecked, could threaten the country’s stability. And fourth, major political reform must be instituted.

The important takeaway here: this is not a matter of a change in a single dimension of national power, but a change in all of them. The fundamentals of the policy legacy left by Deng Xiaoping are now in question.

The Economist Nails the Case for Elections in Hong Kong

Consultation Document on the Methods for Selec...
Consultation Document on the Methods for Selecting the Chief Executive and for Forming the LegCo in 2012 (Photo credit: Wikipedia)

Leaving aside any ideological preferences one might have, The Economist makes a realist’s case for elections in Hong Kong.

In this case, though, there are practical reasons for China allowing a proper election, with non-acceptable candidates running too. It would bolster the mainland’s pitch to Taiwan: that “one country, two systems” means what it says. Full democracy may also be the safest option in Hong Kong. The uneasy coalition of Beijing’s supporters on the island—tycoons, party hacks, trade-unionists—could fracture under the weight of another ludicrous selection process. As for everyone else in Hong Kong, they showed in 2003 that when denied electoral outlets for their frustrations, they will take to the streets.

via Hong Kong’s chief-executive “election”: The worst system, including all the others | The Economist.

I can add two more: it would offer the world an opportunity to see the Party administering a high-profile local election, thus adding a much-needed bit of buoyancy to China’s bid for global soft power; and it would provide a laboratory for the Party in its own efforts to evolve.

When Life Should Imitate Art

Meryl Streep in St-Petersburg, Russia
Image via Wikipedia
In the Hutong
Mahndei, Mahndei
0815 hrs.

In a brilliant essay in The Atlantic by Orville Schell, the Arthur Ross Director of the Center on U.S.-China Relations at the Asia Society, the venerable China scholar captures a spontaneous moment in a performance in Beijing by Meryl Streep and Yo-Yo Ma and turns it into the best deconstruction of Chinese international relations that I have read in a very long time.

Every paragraph in the essay is a gem, but my favorite by far is this one, which elegantly encapsulates the conundrum of international relations in the 21st century:

From here on, as China’s wealth and power increases, its national challenge will be to start letting itself feel sufficiently reinstated in the congress of great nations that it does not need to wallow in narratives of victimization, or be so militant about grasping symbolic demonstrations of its equality or superiority. The highest stage of evolution for any truly great power is to reach that point where it is possible to transcend the notion of both inferior and superior, the better to cultivate a self-confidence that leads to modesty. This is a lot to ask of China, or any country. Even the United States, the strongest nation on the globe today, has only rarely demonstrated such national maturity.

Without descending too deeply into moral equivalence, Schell has taken both China and the U.S. to task for their failings in international relations: America, the global power made insecure by the Cassandras of national decline; and China, the emerging global power made insecure by its own, lovingly nurtured national inferiority complex. In one paragraph, Schell tells both countries to get over it, to accept their station, and to begin behaving like mature adults.

The Meryl Streep/Yo-Yo Ma performance that Schell refers to was intended as a piece of privately-funded public diplomacy organized by the Asia Society and the Aspen Center. It succeeded better than its organizers could have hoped, and captured the potential for public diplomacy to accomplish a very great deal. In a single moment, two artists offered proof that if China and America would just grow up, that new-found maturity would go over as well at home as abroad.

Television Regulations: New Bottle, Same Wine (With Corrections)

State Administration of Radio, Film & Televisi...
State Administration of Radio, Film & Television offices in Beijing (Photo credit: Toby Simkin)

In the Hutong
Black Lung Control
1047 hrs.

In the Valentine’s Day edition of The New York Times, Andrew Jacobs describes the new regulations issued yesterday by the State Administration of Radio, Film, and Television (SARFT), most specifically including two key restrictions: the prohibition of foreign programming during prime time, and the limitation of foreign programming to no more than 25% of the total air time on a channel.

There is some new content in the regulations issued yesterday, but contrary to the NYT headline, the major issues addressed vis-a-vis foreign content are not new: indeed, they harken back to regulations that have been in force since 1995. From the unpublished manuscript of a guidebook on Chinese television that I co-authored with William Soileau and Jeane-Marie Gescher in 1998, according to regulations then in force:

Foreign programming must not be distributed between 6:00 p.m. and 10:00 p.m., although actual enforcement varies according to the broadcaster.


Foreign programming must not take up more than 25% of total broadcasting time on a station basis.  In reality, while the rule is nominally honoured, many networks apply the quota on a channel by channel basis. Unofficial figures indicate that foreign programming may account for as much as 50% of programming.

The rules governing television are not increasing, as the Times suggests. What seems to be increasing is the degree to which they are openly flaunted by broadcasters. Let me explain.

China has had a wide range of laws and regulations restricting media (and many other industries) in place for a long time. What varies is not the regulations, but the degree to which they are enforced. Laws and regulations, as such, are not de facto restrictions of behavior so much as they are tools for the government to use when political conditions demand it. For that reason, what SARFT does on a fairly regular basis is issue notices designed to remind broadcasters that the regulations exist, and signal to them that enforcement looms. Usually, such initiatives come either when things get too far out of hand (i.e., 25% becoming 50%, as suggested above), or when something happens to make it an issue (Chinese producers complaining about access to TV time, or, say, a  leadership change.)

This is not dissimilar to the way I get my ten-year old to clean his room: I let him know an inspection is coming, and by the time I get there, behold! A clean room! The requirement to keep his room clean always existed. What was lax was the enforcement. What caused me to issue the edict to my son was either the room was getting too messy, or guests are coming over.

Jacobs quoted one Chinese citizen posting his disgust with the regulations on Weibo:  “They should really put Sarft in charge of food safety and have the State Food and Drug Administration regulate TV shows — that way we’ll have safe food and good entertainment.”

I would wager the person posting this was either very young or unborn when the regulations were actually issued. The issue that has provoked SARFT (an underfunded, undermanned, out-gunned agency if there ever was one) is the same that caused the food problem: China is ruled less by policy than law, and political expedience trumps enforcement – until the political expedients change.

UPDATE: Please read the comments conversation between Li Yuanyuan and myself. He raises some excellent points to rebut my point of view. He disagrees that enforcement was ever lax, suggests that it was always tight, and he explains why. We do not share the same memory of events, but he does point out that the prime time ban on foreign programming and the restriction of quantity of content was not in the 1995 Regulation #549.

Deconstructing China’s Nationalists

To Screw Foreigners by Geremie R. Barmé

In an essay from 15 years ago that remains one of the best background pieces on Chinese nationalism that I have ever read, professor Jeremy Barmé of the Australian National University delves into the historical and philosophical underpinnings of this rising ethos.

There is a growing consensus among Beijing-watchers that nationalism has replaced economic development as the primary driver of domestic Chinese politics on the eve of a generational leadership transition. For that reason, there is no better time than now to dive beneath the surface of this phenomenon and understand it from the roots.

I read Barme’s piece with great interest. While I didn’t come away with any profound conclusions, I see what is happening today with somewhat greater clarity. It also helps peer behind the Red Rhetoric of Bo Xilai’s campaigns to see something older and more elemental at work.

Not a short read, but a great one.

US Listed Chinese Companies: The Clock is Ticking

U.S. Regulators Push Chinese to Resume Auditor-Inspection Talks – Businessweek.

The U.S. is ratcheting up the rhetoric in the battle to improve the quality of auditing being done on Chinese firms listing or listed on U.S. stock exchanges.  The Securities and Exchange Commission and the Public Company Accounting Oversight Board (PCOAB) are trying to get the China Securities Regulatory Commission to require joint inspections of auditors from both the US and China for Chinese firms listed in the US.

The Chinese, claiming concerns over the revelation of “state secrets” are having none of it, seeing the US request as a violation of Chinese sovereignty.

PCOAB Chairman James Doty is apparently getting frustrated with his Chinese counterparts, who have abruptly cancelled bilateral discussions on the issue.

‘We can’t simply pretend that China is different,; he said. ‘You can’t come sell your securities here and ignore the fact that the law requires and people want to know that the auditor’s been inspected.’

Doty is not a paper-tiger bureaucrat that the Chinese can afford to just ignore:

The [PCOAB], which was created by the Sarbanes-Oxley Act of 2002 after accounting scandals contributed to the collapses of Enron Corp. and WorldCom Inc., has authority to de-register China-based auditors, which could start a chain reaction leading to companies being unable to list on U.S. exchanges.

Doty, SEC Chairman Mary Schapiro, and Senator Chuck Schumer all seem to believe that this tough talk will compel China to give in, believing that China is more afraid of losing access to the capital in US markets than they are of giving auditors a glimpse at the dirty laundry of Chinese state-owned enterprises, or even of China’s actual level of defense spending.

They may be right. But many Chinese policymakers, offered the choice of putting state secrets at risk or funding Chinese firms outside of U.S. equity markets, will be motivated to take the latter course. As I noted in an earlier post, the growing complexity of listing Chinese companies in the US and the maturation of China’s own equity markets make the repatriation of offshore listings an increasingly tempting option both for regulators and companies.

Don’t get me wrong: I think that whatever else might be motivating them, Doty, Schapiro, and Schumer are right to be trying to protect the interests of investors. At the same time, though, they have to recognize two hard truths.

First, it is still unclear whether U.S.-based auditing firms operating in China are passing PCOAB inspections. Not only should the PCOAB attend to that task first, it should make the results of those inspections public. Failing to do so makes US regulators look hypocritical.

Second, the long-term outcome of this effort is less likely going to be a major improvement in corporate transparency in China than to hasten the shift of Chinese equities out of the U.S. and into Chinese exchanges. While US bourses boast far greater liquidity than China, the Shanghai and Shenzhen exchanges have access to a large, relatively undemanding pool of capital hungry for hot new listings. PRC exchanges could easily absorb a steady, modest stream of Chinese companies de-listing in the US and listing (or conducting new offerings) in China.

Doty et al are to be commended for their efforts. Sadly, corporate transparency in China will only improve when the Chinese government demands it in order to protect Chinese investors and/or the global position of Chinese markets.

Eight Questions the WSJ Could Have Asked KPMG China

Managing in Asia: KPMG Audit Chief Benny Liu Faces China Risks – WSJ.com.

As a public relations professional myself, I want to congratulate the KPMG PR team on their coup in today’s Wall Street Journal. In an interview with the Journal‘s Duncan Mavin, Benny Liu, the head of the Audit practice at KPMG China is given an singular opportunity to deliver his messages in what was clearly a very friendly discussion.

This interview could have been much more challenging for Liu. At a time when Chinese companies that are listed offshore are facing uncomfortable questions about the accuracy of their accounting, you would expect a newspaper that is ostensibly an advocate for investors to come down on a senior China auditor with some very hard questions. Alas, those question were not forthcoming. Not today, anyway.

But the recent wave of scandals around U.S.-listed Big Four-audited Chinese companies suggests that the time will come when harder questions will be asked. Mr. Liu and his PR team would do well to prepare for such questions as:

1. What measures does your firm have in place in your China practice to ensure that auditors and their reports are not influenced by the pressure to retain and please the client?

2. Has your firm ever altered its audit reports on a Chinese company under pressure either from the client or from a senior KPMG executive?

3. Has your firm ever reprimanded, transferred, or terminated an employee in China because of a refusal to alter an audit report to reflect more favorably on a client?

4. What does your “risk management” department do, exactly? In layman’s terms?

5. Have you personally ever intentionally overlooked or failed to report client accounting practices that do not conform to GAAP? Have you ever done so for a company that was listed or was about to be listed in the U.S.?

6. What do you feel should be done to auditors and firms who overlook, ignore, or fail to report illegal, unethical, or ineffective accounting procedures practiced by their clients?

7. Is there a need for a independent professional accreditation body for auditors in China? Why/why not?

8. What would you change about the auditing profession to ensure that investors and the public are better protected?

This is not to pick on KPMG China: any big-four auditing firm with operations in the PRC would do well to keep this list of questions close, build on it, and be ready with something more than a holding statement when – not if – these questions come up.

VIEs: The Long Resolution

In the Hutong
Prepping the Pack Meeting
0917 hrs.

In the course of some debates about China, all you learn is how strong peoples opinions are. Yet in a few cases, the debate itself is a socratic-style graduate seminar not only on the topic but on China. The back-and-forth online around the status and eventual fate of Chinese companies who have listed abroad via a structure called a Variable Interest Entity (VIE) has been just such a debate. The most prominent participants have been:

  • Digicha, the blog by Bill Bishop, Beijing-based investor, former China online game company executive,  co-founder of CBS MarketWatch, and MVP of the China Twitterverse.
  • China Hearsay, by Beijing-based Stan Abrams, a technology and intellectual property attorney and law professor; and
  • China Law Blog, Dan Harris’ award-winning forum that chronicles the intersection of Chinese law and global business, among other things.
  • In particular, take a look at this post on China Law Blog, “China VIEs: The End of a Flawed Strategy – an Update/Rebuttal,” along with all of the comments, which alone are a seminar on a very hot topic.

Rule of Policy

I had started to see this issue as a matter wherein the rule of law clashes with the political expediency of accommodating elites. But the aforementioned post on China Law Blog convinced me that this is not the case. As with most Chinese legal codes, the statutes are vague, there is huge room for political and administrative interpretation, and there are overlaps and conflicts among the laws that leave in question which agency has the authority to make or enforce a ruling against any or all of the companies involved.

The matter will be decided not on the basis of law, therefore, but on the basis of policy, and probably at the State Council level. Bishop, correctly, notes that no bureaucrat has the political cojones to take on the wall of entrenched interests that protect the VIE-based companies, and suggests that the easiest way to handle the situation would be to issue clarifying regulations about the legality of VIEs and to grandfather all current VIEs.

I agree, and I suspect that is what will happen, but I also suspect that this will not be the end of the matter. Even though no policy maker would be willing to risk his or her career by slamming the door on VIEs, if such structures are considered politically undesirable by China’s leaders, then we still have a problem.

Bringing the Capital Home

As someone quite wise once said to me, “the Chinese government likes to boil its frogs slowly, not all at once.” What this sage meant was that when dealing with any issue that affects a wide range of powerful interests, Chinese policy makers tend to eschew immediate and radical solutions in favor of a gradualist approach. In a system that depends increasingly on tenuous consensus, this is perhaps the only possible approach. Each step taken moves the matter closer toward resolution without causing severe disruptions for any of the interests involved. All that is necessary to understand whether a solution can be considered temporary or permanent is to look for the larger national goal that is driving the change in the first place.

An idea of what might be driving the government’s efforts around VIEs can be found in an article in New Century magazine last week that sums up the current state of play with the VIE issue. The article quotes a situation report provided to attorneys and the industry three weeks ago as saying that in the early days of the development of the internet in China, the local A-share market was inadequate to the capital needs of the industry, thus it was decided that overseas listings of these companies offered more good than harm. The report goes on, however, to suggest that it would be in China’s interest to arrange the earliest possible return of the shares of such “leading enterprises” to China’s own local exchanges in Shanghai and Shenzhen.

If repatriation of share ownership is (or becomes) the goal of the government, that is a more reasonable target than abruptly pulling the plug on VIEs, but it does point to a long-term dissolution of those arrangements by substituting offshore capital with capital from China’s own markets, either via domestic listing, private placements with domestic enterprises or sovereign funds, or all of the above. To give a simple example, were Jack Ma to recover the 40% of Alibaba that Yahoo! currently owns, he could replace the cash thus expended by a domestic share issue in China. Using similar mechanisms, the VIEs could be dissolved in a manner that would harm none of the powerful interests involved, yet would satisfy the government’s policy goals.

None of this would take place quickly, nor should it, and I do not think that regulators have come to an agreement yet on how to proceed, and things may roll out quite differently. The point is that a short-term accommodation with the VIE structure in the name of political expediency neither institutionalizes the structure as a long-term funding option, nor signals a change in the fundamental drivers of policy. It should, rather, be seen as the high-water mark in China’s effort to tap offshore capital to fund the growth of the nation’s leading online enterprises, and perhaps the beginning of the next phase in the maturation of China’s own domestic capital markets.

But it is Bigger than All of This 

If you think this is an issue of parochial interest to lawyers and China geeks only, think again. The reason the VIE issue is important goes beyond the effect the recent uncertainty has had on nearly 100 Chinese companies that have listed abroad (and their shareholders.) It is more important to anyone doing business in or with China because of the implications that the issue and its eventual resolution will have on foreign investors and business in the PRC in the coming decade.

A recurring theme of this blog of late has been the apparent shift in attitudes in China toward foreign enterprises and capital. Since the beginning of reforming and opening, foreign participation and foreign investment in the Chinese economy has always been seen as an expedient means to hasten development. What has changed is not the attitude, but China’s perception of itself and the extent to which it still needs the necessary evils of foreign capital and expertise. China still needs both more than either the Party or the people are willing to admit publicly: alongside other considerations, what will slow movement toward a resolution of the VIE issue is disagreement within China’s leadership over how much the door to such structures needs to remain open, and how much local capital is actually available to local high-growth businesses.

But the long-term goal should not be in doubt, and it is that desire for financial self-sufficiency, followed by global financial leadership, that guides the evolution of policy (and law) toward VIEs and all offshore listings.

Update: In what may be the first step in that share repatriation, Shanda Interactive’s founder Chen Tianqiao, his wife Luo Qianqian, and his brother Chen Danian have formed a group to buy the publicly-owned shares of Shanda (NASDAQ: SNDA) that they do not already own. J.P. Morgan is issuing the debt to finance the transaction.

It’s Media, Chief, But Not As We Know It

In the Hutong
Hoping rain will clear the air
1224 hours

In late July I noted in “The Alipay Warning” that an overlooked editorial from Xinhua might be an early warning to foreign investors in many Chinese online companies that the party is almost over. My point was that the government is signalling that virtual ownership structures have run their course, and are now more liabilities than assets. Signs that this is the case have become more common in the time since, as Bill Bishop notes over at DigiCha:

In the space of a few weeks we have heard from various official or semi-official media about the dangers of online rumors, the risks from excessive foreign ownership of China’s Internet companies, new rules that could potentially invalidate the corporate structure of most Chinese Internet companies, rumors of a real name registration policy for microblog and other social media users, and the launch by Sina of new rumor busting features. Tightening is coming, the question is how far it will go.

In other words, while the hammer has still not fallen, evidence is growing that the blacksmith seems ready to strike.

I am betting that the hammer is coming for several reasons, but one important one: the way China’s regulators look at and understand internet companies has changed.

Laissez Tech-Faire

Ever since the early days of China’s internet in the late 1990s, regulators have seen a distinction between online services and media. Internet companies tended to be stuffed with engineers, work closely with the computer and telecommunications industries, and offer services just slightly beyond the comprehension of cadres in their 50s and 60s. The bureaucrats were not entirely credulous: they enacted regulations restricting foreign investment in Chinese online firms. At the same time, though, they turned a blind eye to companies that used highly contrived investment structures to channel foreign capital and expertise into China’s online giants.

I see three reasons why they allowed a high degree of virtual foreign ownership of these companies. First, they saw foreign investors as unwitting accomplices in a government plan to ensure that local companies dominated the Chinese internet. Foreign capital and the Silicon Valley-sourced know-how that came with it would create local champions in an industry that was unlikely to get much support from state-owned policy banks. Indeed, with time and a little luck, some of these local companies might even turn out to be global players.

Second, ever since the start of reforming and opening, the government’s approach to new developments has been to allow a new practice, a new industry, or a new kind of company to grow first, and then step in and regulate only when such experiments got out of hand. Did the foreigners want to invest a little through a multi-layered ownership structure? Hmm. Let’s see how that works out – we might come up with something that can be used elsewhere in the economy.

Third, though, is that many regulators saw online services as, to borrow from Douglas Adams, “mostly harmless,” the technological playthings of a young generation out to find love, diversion, and a little shopping. Sure, the potential for misbehavior was there, but the people running the services were near at hand, easy to rein in if things started to go awry. They were not, therefore, like film or television.

Not Your Father’s Media

Imagine the reaction of these leaders in late July, in the wake of the train wreck, when they wake up and realize that there are a half billion Chinese citizens online; that a quarter billion spend more time watching TV online than watching state-owned, Party-controlled broadcasters; and that a quarter billion now get at least as much “news” from Weibo and QQ as they get from newspapers or TV. What must have been even more sobering was realizing that the demographic most affected by online services is the very demographic that has driven every popular rising in modern Chinese history.

Suddenly, these aren’t “telecommunications value-added services,” or “online sites,” or “technology companies.” They are media, privately-owned media in a country where media must be state-owned; partly owned, influenced, and controlled by foreign interests in a sector where foreign ownership is explicitly forbidden; and influential media largely outside of the control of the Party. Such a situation calls for a change. But what?

The Art of the Possible

The question that faces China’s regulators, then, is not merely whether to continue to allow variable interest entities to exist, but whether an entire sector of the telecommunications and technology industries has been transmogrified by growth and events into media, and thus whether and how to extend Party control and state ownership into the hearts of these companies. What stays the hammer is not, I would argue, any hesitation about whether to make a change, but how to unravel the ownership and control issues without destroying online properties that are of immense potential value to the nation.

Politics complicates matters further. There are powerful people and entities in China with a vested interest in the outcome, and in a nation governed by consensus these interests must be addressed rather than ignored. That this is all taking place on the cusp of a generational change in national leadership is sauce for the goose.

Together these factors mean that action taken will be more incremental than sudden. That is both good and bad. It is good in that it offers foreign investors who catch the wind soon enough to work through the problem, create new and fair structures that recognize the value of the investments, and possibly even to influence thinking in Beijing on the problem. But it is bad in that the heat will build slowly, allowing many companies and investors to deny that anything is changing until they find themselves completely boiled.

“Hope,” Bill Bishop correctly notes, “not an investment strategy, and given the current political climate, including the buildup to the 2012 leadership change, investors would be justified in wondering if something bigger is going on.”

Something bigger is going on, and the appropriate strategy if you are invested in any of these entities is to go out and learn all you can, accept no easy answers or placation from the executives of the companies in question, and start thinking about what you will need to do to ensure the best possible outcome.

Railway Reform is Coming to Town

In the Hutong
Managing Chaos
1311 hrs.

In a characteristically articulate editorial last week, Caixin called for an extensive overhaul of China’s Ministry of Railways (MoR) in the wake of the high-speed train crash in Wenzhou on July 23rd. The publication called for an open investigation into the accident conducted by experts from outside the control or influence of the MoR, for the functions of railway development, construction, operation, and regulation to be divided among independent entities, and for the folding of the resulting regulator into a larger ministry with a purview over the wider transport sector.

These changes are not without precedent in China. Aviation went through a similar change in the early 1990s, the telecommunications sector was similarly reformed five years later, and the energy sector has gone through a series of reforms that have separated the regulatory function from the business of generating and distributing energy. There are so many examples of where this has happened, in fact, that not only is the MoR something of a relic of China’s pre-reforming-and-opening past, it is also a matter of suggestive speculation as to why the MoR was left alone for so long.

So this sort of reform is overdue, and it looks like the higher organs of the Chinese government will try to unravel the hairball of conflicts-of-interest and mismanagement that serve as China’s railway industry.

Quis Custodiet Ipsos Custodes?

Unfortunately, even the measures suggested in Ciaxin’s excellent piece will not be enough. The world is replete with examples of industry-specific regulators who have become intertwined with – and co-opted by – the very industries they were created to regulate. One need look no further than the U.S. financial industry and its relationship with the Federal Reserve, the Department of the Treasury, and the Securities and Exchange commission to find proof, and there are ample additional examples.

The lesson of history is that regulators are most effective when they themselves are watched from the outside. While Caixin’s editors would be too modest (or timid) to say so, it is Caixin and all of the others who are watching the regulators from the outside who provide the best guarantee of a better and safer railway system for China.

Understanding Xinhua

Xinhua News Agency
Image by xiaming via Flickr

Hutong West
Planning August
1943 hrs.

In an superb article on veteran New York Times media reporter David Carr, Tom McGeveran quoted legendary media watcher Gay Talese:

“I consider The New York Times news,” he said. “Fascinating news. It has been sitting in judgment of America for more than a century and it, too, should be looked at in detail with the same objectivity.”

As the New China News Agency, Xinhua, takes over a 60 foot by 40 foot billboard in Times Square in New York, the same could be said for that media outlet. Xinhua is news. It has been the media mouthpiece of the world’s largest nation for over six decades, and it should be looked at in objective detail.

Why Xinhua is Important

This is more than just China-watcher or media maven esoterica. As we move into the fifth generation of Party leadership in the coming 24 months, we will be taking a further step away from the rule-by-individual that characterized the first four post-revolutionary decades. We are well into an era where China’s single-party state is run by the construction of a consensus on an issue-by-issue basis. Where once sat rubber-stamp toadies now sit leaders whose support is required for every significant initiative and action taken by the central government.

The consensus-building usually takes place behind closed doors, but when a particularly contentious issue arises, or when a relatively small group is trying to champion an initiative and is having a hard time building support, the process bursts out of those rooms and into certain government media in the form of an isolated quote in an innocuous article, in an editorial, or in an analysis piece.

The challenge for those of us trying to navigate our way through China’s political fog is deciding whether one of these journalistic tidbits means we should sit up and take notice, or whether it is so much positioning. To understand this, we have to understand how Xinhua’s role is changing.

Not Just Aparatchik Heralds Anymore

Is Xinhua a government mouthpiece to the extent that its positions reflect those of the Party? Is it more independent, and thus free to post articles like this without regard to policy? Or is it somewhere in the middle: that Xinhua is a tool used at will by various Party leaders to incite or test wider support for a possible policy change?

While it was once the former, I suspect that it is becoming a combination of both the former and the latter. And for that reason Xinhua demands study. We have to understand when Xinhua is floating a trial balloon on behalf of, say, a vice-minister of Finance, or when it is presaging a critical policy change. Regardless of your vocation, if China touches you or your work, that is an essential distinction.

So rather than continue to dismiss Xinhua as a hand-in-glove extension of the Party (which I have to confess I have long done myself), we need to recognize that it is becoming one of the most important media companies on the planet, offering more than just prepackaged propaganda for the Chinese masses, but actionable insight into the Chinese polity and society. The microscope that media watchers once turned to The New York Times, The Washington Post, Time-Warner, Disney and News Corporation must now be focused on the most enigmatic specimen of all.

Any takers?

The Winds Are a Changin’

Russian communist in China to set up Chinese C...
Image via Wikipedia

Hutong West
Staying awake for a conference call
2259 hrs.

In making the case that the business climate for foreign businesses in China is changing for the worse, I have been challenged by people I respect greatly to “prove” it. There is no shortage of large foreign enterprises doing well in the PRC, something I have to admit as a few of them are my clients. As such, it seems that the complaints of the various foreign chambers of commerce that there is a tilt against foreign companies should thus be dismissed as the groundless whining of a privileged and ungrateful elite.

Yet while there is no shortage of success among foreign companies in China, only willful ignorance would allow anyone to deny that the winds are shifting in China, and in Beijing in particular. A case in point comes from an article I read recently in The China Daily about how Unilever was slapped with an RMB¥2 million fine for making statements that caused panic buying of staples in some parts of China. Reading through the article, I was initially struck at how clearly the government’s case was laid out, and how reasonable the action seemed.

Then came this paragraph, completely out of context:

“Foreign companies get too many benefits compared to local companies, it’s time to make a change,” Pan Ping, a white-collar worker at a private company in Shanghai told China Daily.

I have lived in China too long to believe that this was an accidental inclusion, and I know too much about The China Daily to think this is some reporter or editor playing a prank. The China Daily is the English-language mouthpiece of the Chinese Communist Party. If the quote attributed to the worker was not a statement of policy, it was certainly a statement of position.

I have argued in these pages that despite all efforts to establish a consensus-based orthodoxy, neither the Party nor the Chinese government is not as monolithic as they are often portrayed. What articles like this suggest is that even if the government has not reached consensus about the future role of foreign companies in the Chinese economy, at the very least there are those in positions of power who question whether they have been too successful for too long here.

Be assured that the raison d’etre for foreign firms in China is one of the issues that will be addressed in the coming changeover in Party leadership, and is another reason why foreign enterprises, journalists, trade associations, and bloggers will be spending so much time reading the tea leaves in the coming months.