Iafter parallel the CloudWalk universe may have raised hundreds of millions of dollars in Hong Kong or New York. The company is one of the world’s leading facial recognition systems: its technology can recognize people in milliseconds with astonishing accuracy. But modern geopolitics has pushed it in another direction. America has sanctioned the company for alleged human rights violations, due to alleged ties to the Chinese military. So instead of listing on the nasdaq in New York, CloudWalk chose the one in Shanghai rigid Market, an exchange established in 2019 to attract rising Chinese technology companies. The company’s stock price has risen by a fifth since its debut in May.
CloudWalk’s list is one of hundreds that have entered Shanghai’s rigid and Shenzhen’s ChiNext, another technology-focused marketplace, the focus of global initial public offerings (hypos) this year. The companies raised $63 billion on Chinese stock exchanges, compared to just $21 billion in New York and $6 billion in Hong Kong. The vast majority of the proceeds were raised by semiconductor manufacturers, AI and business software startups, robotics firms, and other companies developing high-end technology. A flurry of smaller telecom companies has flocked to the Beijing Stock Exchange, which launched last year under the leadership of Chinese leader Xi Jinping.
At first glance, this suggests that Xi’s plan to pair a thriving tech industry with bubbling capital markets — part of a larger effort to make China a leader in next-generation technologies — is progressing flawlessly. Look a little deeper, however, and the picture is darker. State capital, or “lead capital” in Communist Party parlance, is flooding the stock markets. Our analysis of the 38 largest hypos in Chinese markets in the first three quarters of this year, which together accounted for 242 billion yuan ($34 billion), or about 50% of the money raised, found that state-owned entities invested 22% of the funding. A review of a similar sample of hypoState capital provided 14% less last year. The CloudWalk deal is typical. State investors, including the Shanghai city government, an arms manufacturer and local government funds, raised more than 500 million yuan for just under a third of the company’s shares.
While China’s capital markets are increasingly being driven by the Communist Party, the boom has other causes as well. Some observers simply see a surge of innovative firms meeting the demand of fluid capital markets. Nicolas Aguzin, chief executive officer of the Hong Kong Stock Exchange, called the flurry of technology hypoknows the “big bang of finance”. Even state media in China highlight tensions with America. Several Chinese tech companies besides CloudWalk have been fined. New York markets have all but closed to Chinese companies this year (although there are some signs that the situation is starting to improve).
Meanwhile, China’s regulatory regime has become friendlier. Not long ago, costly revisions were required for new listings. This led to a backlog, sometimes extending to thousands of companies, and prevented private equity investors from exiting investments. A new system, tested in rigid and ChiNext exchanges, will be rolled out to others later this year. It is more in line with international standards, setting requirements for listings, but abandoning arduous inspections. Liquidity and stability have also improved. Over the past five years, reforms have encouraged the professionalisation of investment. Retail trading volatility was reduced on Chinese stock exchanges. All of this fits into the vision Mr. Xi has publicly outlined, in which financial markets are freer from meddling, operating more like America’s.
Yet the influx of state money can hardly be ignored. While some of the money comes from insurers and pension funds, the majority comes from government-backed funds tasked with investing in public and private markets, often tasked with supporting certain industries, such as semiconductor manufacturers or industrial robots. As Ngor Luong of the Center for Security and Emerging Technology, a think tank, notes, this money signals to other investors which companies are worth funding, which means it carries extra weight.
Using state money to channel private investment is an approach that has spread from private to public markets. Between 2015 and 2021, government-backed private equity firms raised more than 7 trillion yuan. A firm that takes on state capital in its early stages becomes more attractive to private investors later on, as it indicates that the firm fits the official vision of innovation. These businesses often benefit from other forms of government help, including tax breaks, lower rents, and less paperwork. Likewise, secure state-backed investors in a hypo now it can make or break business. According to a banker who works on Chinese hypos, this means that policy makers are increasingly successful in directing private capital to the sectors they wish to prioritize.
Companies involved in technologies deemed important by policy makers can now receive state capital throughout their lifecycle. Take Loongson, a Beijing-based semiconductor company that designs central processing units. Most of the company’s shares are held by Hu Weiwu, its founder. But the company was launched in 2008 with the capital of the Chinese Academy of Sciences and Beijing City Government. State funds, including a semiconductor advocate investing 200 billion yuan, have subsidized Loongson in recent years, despite its privately owned status. When the company went public rigid this year, state-owned investors have piled into the hypobuying at least 10% of the offer.
This type of investment is not just about boosting favored industries. Officials have long been sending a message about the importance of state capital in the market, notes Pan Fenghua of Beijing Normal University. Last year regulators started talking about a “capital disorder” that allegedly led to economic imbalances. Free-market capital has brought many evils, claimed a recent editorial in a state-run newspaper. These include a growing wealth gap, environmental problems, financial risks and monopolies. In a socialist market economy like China’s, the editorial states, capital must be led by the Communist Party.
Because so many companies have taken state-owned investments, investors must now buy the Party plan or stay out of it, says an investment manager in Shanghai. Buying the Party floor can be an unattractive proposition. Even before the government started playing a bigger role, Chinese markets underperformed. Aside from a few rapid booms and busts, China’s major stock indexes have hardly gained value over the past decade. About 27% of publicly traded companies rigid between 2019 and 2021 they are now trading below them hypo price. That figure rises to 44% among those who went public most recently, as state capital has poured onto the market. On the Beijing Stock Exchange, born from an idea of Xi, it reaches a paltry 60%.
Shanghai and Shenzhen may have become the top global destination for technology hypos, but they did so with significantly reduced global capital. Due to concerns over China’s draconian covid-19 rules and faltering property market, foreign investors have fled the country in droves. According to the Institute of International Finance, a trade association, a net $7.6 billion of international capital exited the country’s stock markets in October alone. Market booms in New York and Hong Kong typically attract smart capital from a wide range of global investors. By contrast, Xi’s big bang looks painfully insular. He believes the state can fill the role played by foreign financiers. It is, to say the least, a bold experiment. ■