A MATTER OF ANTITRUST

After years of liberal regulation that allowed China’s internet innovators to become powerful, profitable and dominant players in the market, authorities are now adopting a new playbook that aims to root out monopolistic practices. 　

Following these first fines, the SAMR made public 41 cases of similar violations by major companies between March and July. It eventually reported 45 violations, with some acquisitions made as early as 2011, and fined each company 500,000 yuan (US$77,480). 　

Under China’s Anti-monopoly Law, which went into effect on August 1, 2008, monopolistic behaviors include abuse of market dominance and concentrations that might exclude and limit competition. Under the law, mergers and acquisitions that would lead to concentrations of operators are subject to pre-merger approval. 　

According to Wei Shilin, secretary-general of the Competition and Anti-Monopoly Law Commission of the Beijing Lawyers Association, a major reason many internet companies do not file M&As for regulatory approval is their use of variable interest entities (VIE). 　

Under a VIE structure, a Chinese company sets up an offshore company to list overseas, which allows foreign investors to buy stock. The offshore company then enters a series of contractual arrangements with owners of a local Chinese company to exercise control over the businesses operated by the Chinese company in China. 　

VIEs circumvent China’s foreign investment restrictions, which allow Chinese domestic companies to get financing and file IPOs overseas and foreign investors to become majority stakeholders of Chinese companies. While technically illegal under Chinese law, authorities largely overlooked the practice. 　

“The assumption in the internet sector is that there is no need for pre-merger filing if it involves a VIE structure,” Wei told NewsChina. “Even if filed, authorities would simply not accept it because it would force them to clarify the VIE structure’s legal status.” 　

But that changed when the SAMR issued a notice in April 2020, announcing it would conduct a merger review of a joint venture between Shanghai Mingcha Zhegang Management Consulting and Huansheng Information Technology – a first for the regulator. 　

Although the SAMR approved the merger in July, the review signaled a more proactive regulatory transformation on the way. 　

But so far, authorities have been rather cautious about stepping up enforcement. Among the 45 violations announced by the authorities, only one case, Tencent’s acquisition of China Music Corporation in 2016, which allowed the company to control over 80 percent of China’s exclusive music streaming rights, was deemed anti-competitive. Even in this case, Tencent was merely fined 500,000 yuan (US$77,480) and ordered to give up its exclusive rights contracts with music labels.　

According to Wei Shilin, under China’s Anti-monopoly Law, authorities could order a company to split to restore their pre-merger status, though there has been no precedent. 　

Qian Xiaoqiang, a partner at Haiwan & Partners, a Chinese law firm specializing in M&As, told NewsChina that it is unlikely authorities would adopt harsh penalties like splitting up past acquisitions. “The economic damage derived from such penalties could considerably outweigh the economic benefits,” Qian said. 　

But China will probably adopt a tougher stance toward future mergers and acquisitions. On July 10, the SAMR denied the merger of Huya and Douyu, China’s two most popular video game streaming platforms, saying the merger would strengthen the dominant position of Tencent, which owns around one-third of both Huya and Douyu, and may eliminate market competition. 

Professor Wang Xianlin, director of Center for Competition Law and Policy at Shanghai Jiao Tong University, told NewsChina the regulatory focus will likely target the vertical integration of major tech giants. “The tech markets are winner-take-all in nature, so tech giants can easily extend their dominant position cross-market,” Wang said. 　

Both Alibaba and Tencent, China’s two biggest internet companies, eyed a closed ecosystem through massive cross-market acquisitions. It is estimated the two companies have made 785 and 440 acquisitions since 2008. 　

A source close to the SAMR told NewsChina that in the past, the regulator’s primary consideration was how a deal will affect the market shares of stakeholders. In the future, the agency will shift its focus from horizontal expansion to vertical expansion to prevent platforms from establishing ecosystem monopolies. 　

The agency concluded the company had abused its monopoly status by imposing exclusivity agreements that prevented merchants from selling products on rival e-commerce platforms, a practice known as “choosing one from two.” 　

While such deals have long been controversial, authorities had adopted a passive position despite frequent complaints from merchants and rival platforms. 　

According to Wang Xiaoye, a former member of the consultative expert team of the Anti-Monopoly Commission of the State Council, there has been debate over which market criteria to apply when calculating Alibaba and other e-commerce companies’ market shares. 　

As Alibaba initially emerged as a challenger to traditional retailers, its market share was calculated as the ratio of the total retail sales of social consumer goods. Fastforward to 2020, although transactions conducted on Alibaba’s platforms made up about 80 percent of China’s e-commerce market, it accounted for only around one-fifth of the total retail sales of consumer goods excluding vehicles. 　

But as internet companies have become industry giants, the regulator finally changed its stance. In the antitrust guideline issued in February, it specifically stated that the market applicable to Alibaba and other e-commerce companies will be the domestic online retail market. 　

On October 8, the SAMR imposed a fine of 3.44 billion yuan (US$530m) on Meituan, an online food delivery giant, following an investigation into “monopolistic practices” similar to Alibaba’s “choosing one from two.” The amount is equivalent to 3 percent of the company’s domestic sales in 2019. 　

The fine was announced amid increasing pressure on China’s tech giants to open their platforms to rival companies. In a meeting held on April 13, days after Alibaba’s fine, the SAMR emphasized that a key focus of its regulation is to “ensure internet ecosystems are open and inclusive” and to “prevent the establishment of closed systems.” 　

Aiming at establishing their own tech ecosystems and spheres of influence, Chinese tech giants have been guarding their realms. It is common practice for internet companies to block links from rival products and services on their platforms. 　

For example, some of China’s most powerful companies – Tencent, which dominates social media via WeChat, Alibaba with e-commerce platforms Taobao and Tmall, and more recently, ByteDance with its video-sharing apps TikTok and Douyin – block links from within their services to rival platforms. 　

Now these practices have increasingly come under scrutiny. On September 13, the Ministry of Industry and Information Technology told media that it summoned executives from the country’s tech companies to discuss the need to open their services to one another. According to ministry spokesperson Zhao Zhiguo, companies are encouraged to “voluntarily correct their actions” according to the guidelines. He warned the ministry would resort to other measures if companies do not comply. 　

According to Xu Ke, a professor at the University of International Business and Economics in Beijing and executive director of the school’s Digital Economy and Legal Innovation Research Center, with the heavy fines meted out against Alibaba and Meituan, authorities hope the two cases will serve as deterrents to minimize the future costs of regulatory enforcement. 　

So far, progress appears limited. Although executives from Tencent and Alibaba acknowledged the importance of keeping their platforms open, and both have reportedly unblocked links to their rivals on smaller apps they own, their flagship platforms such as WeChat, Taobao and Tmall remain closely guarded. 　

It remains unclear whether authorities will adopt tougher measures. But most experts believe China must carry on with its antitrust crackdown. “As China’s internet companies have become more powerful, changing people’s ways of life, the risk they will grow out of control can no longer be ignored,” Xu said. “This is now a global challenge.”