Ant Group’s Botched IPO

By Ichiro Suzuki

On November 3, only two days before what was set to be the biggest IPO in history, China suspended the $37 billion listing of fintech giant Ant Group in Hong Kong and Shanghai, sending shockwaves through China’s financial world. It is believed that President Xi Jinping was directly behind the cancellation. Since he rose to power in 2013, the communist party leader has been tightening his grip on China’s corporate world. His move began with state-owned enterprises (SOEs), of course, with their controlling stakes by the Chinese state. In more recent years, the state/ the communist party has been intruding into private sector corporations, an unsurprising development given Mr. Xi’s penchant for wielding power in every corner of the country. According to The Financial Times, an executive of China’s state-owned bank reportedly have described President Xi’s stance toward Corporate China as “if I don’t understand and can’t control you, we won’t let you grow”. To a dictator who is nearing 70, the tech world is certainly is tougher to understand than “20th century businesses” of SOEs. While Mr. Xi has a strong interest in seeing the Chinese tech sector’s brilliance, he still has no tolerance in letting these rising corporations loose. While these two wishes appear to contradict each other to an outsider, this is what the dictator wants.

Leaders of China’s tech sector need to be abundantly careful not to upset or incite anger in the dictator. But this is exactly what Alibaba Group founder Jack Ma did. At a conference that preceded the planned listing of Ant, Mr. Ma reportedly criticized the authority of their insufficient understanding of the tech sector and their backwardness as a regulator. Mr. Ma is the biggest star in the China’s tech world, on whom everybody showers praises. With his Communist Party membership, he must have been considered a good citizen of the country, too. It looked everything was going well for him. Then, Mr. Ma had overstepped by telling the truth, and have caused the wrath of the dictator.

Whether President Xi’s wrath immediately led to the cancellation of Ant’s IPO or not, exponential growth of Ant, as well as of its parent Alibaba, must have been sounding an alarm to the regulators. In the tech world of winner-takes-all, they were simply becoming too big dragons to be tamed. Regardless of what Mr. Ma said that particular day, regulator might have acted to impose tougher regulations on Ant Group even after its listing in the exchanges.

While behaving like a trendy tech firm, Ant Group reportedly generates 40% of revenue by extending credits to small retail customers. Such lending activities qualifies Ant to be regulated as a financial institution. However smart their algorithm might be, lending activities are prone to stumbling into unforeseen crises once in a while. The 2007-09 Global Financial Crisis (GFC) caused by subprime lending was exactly such a totally unexpected event that regulators failed to foresee. A few years preceding the outbreak of the crisis, it was said within the bank analyst community as follows. Each small borrower, prime borrower or not, was rated meticulously based on his/ her past pattern of behavior. Chances of default en masse are so statistically predictable that any small uptick in default rates could be met with an increase in loan loss reserves on the bank’s balance sheet. Lenders bundle those small loans into exotic securities called collateral debt obligations (CDOs) that consist of sliced and diced portions of loans of variety of qualities, of both good and not so good, then are stamped with AAA ratings and to be sold to investors who are looking for yields. Selling CDOs relieves banks from credit risks since they are passed onto investors around the world. Risks are so thinly spread that few get burned even if things go wrong. Superb. What was not understood not only by financial analysts but also by the Fed and other famed economists was what would happen to the value of these CDOs if their low grade components begin to see higher than expected rates of default. It made it totally impossible to value those assets once low grade components began to decay higher quality tranches. Thus the markets valued entire CDOs as almost worthless, overshooting the worst nightmare of the most pessimistic scenario imaginable. Worse, since CDOs were sold to a number of investors around the world, it made it impossible to locate who had what risks. Fears grew out of such opaqueness.

Standard & Poors has been treating American Express Company as a financial institution in S&P500 sector classification due to its ability to assume credit risks by extending loans to cardholders. In contrast, Visa and MasterCard have been considered as tech firms that run networks of payment processing. (Though Visa and MasterCard cardholders can draw loans on their cards, credit risks of such lending are assumed by banks that issued these cards.) In December 2008, at the height of the GFC, American Express formally became a bank holding company to allow them an access to low cost funds through the Troubled Asset Relief Program (TARP). By becoming a bank officially, Amex is under regulations and supervisions by Office of the Comptroller of the Currency (OCC) and are also subject to the rulemakings, enforcement and examination authority by the Consumer Financial Protection Bureau (CFPB). Shares of American Express receive much lower valuations than Visa and MasterCard that are under no such regulations on a bank holding company. There is no reason that China’s authority was not aware of such a development in the U.S. It is hard to understand that they did not make a move to regulate Ant until two days before its IPO. The authority has fumbled on this.

In all likelihood, Ant is going to be brought to the market in the future, after recapitalization by Alibaba, and with lower valuation than initial expection due to more stringent regulations. Nonetheless, the uproar on Ant IPO has exposed problems that investors in China have to be aware of. One, the dictator’s disposition matters in every detail of corporate activities in China. Two, bank regulators’ competence can be questioned since they failed to see risks associated with Ant’s businesses or at least acted too slowly. Three, by cancelling a mega-IPO abruptly, the authority once again had caused unnecessary volatility in the market, which investors in China have experienced more than once in the past.

* Mr. Suzuki is a retired banking executive based in Tokyo, Japan.