• Adam Harper

Putting a price on confidence

When investors' beliefs are shaken, the only way to maintain confidence is openness - and wait for the world to move on.

The dramatic sell-off in Chinese stocks this week shows just how important confidence is in the financial markets. After a regulatory onslaught against Big Tech and the education sector, investors are having to re-examine what they believe about the future for China’s private sector.

Confidence is a priceless commodity for any organisation, industry or market. It’s the cornerstone of any reputation or valuation, hard to build and easy to break. While markets managed to regain some composure towards the end of this week, recovering the value lost in the past few days will be a long process.

Confidence is a priceless commodity for any organisation, industry or market.

For companies caught up in the selloff, this confidence crisis is unusual because that it comes from regulatory interventions, rather than business failure. But the root cause is familiar: uncertainty. What investors believed to be true about certain companies and sectors – that they would be free to continue operating under the status quo – turned out not to be true. The result is that many investors now don’t know what to believe about the position of big private sector firms in China and – because they abhor uncertainty – they have simply sold.

There were warning signs, though. China’s relationship with big business has been a topic of intense debate since the IPO of Alipay operator Ant Financial was cancelled at the last minute in early November. When regulators turned their attention to newly listed ride-hailing giant Didi Chuxing at the start of July, the warning bells were already ringing loudly.

A clampdown on private education providers had been flagged for months, but the regulations that surfaced last weekend still appeared to surprise investors. The rules were stricter than expected – requiring after-school tuition companies to become non-profit organisations and even casting doubt on the Variable Interest Entity (VIE) structure used by many of China’s biggest overseas-listed firms.

The fallout has been wide – and deep. Hong Kong’s main index of Chinese stocks shed 9% in two days as investors wondered which industry would be next in the firing line.

Transparency creates trust. Trust builds confidence. Confidence powers valuations.

Companies may feel powerless to rectify this uncertainty and the “regulatory discount” it is creating, but that is not necessarily true. The remedy for uncertainty is facts. Confidence can be maintained by showing investors and business partners that their interests are still aligned in the long term because the underlying opportunity is still there. Painful as it may be, though, that means full and timely disclosure of any developments or perceived risks on the regulatory front – even if they may at first seem like bad news. Transparency creates trust. Trust builds confidence. Confidence powers valuations.

It appears that many companies will need to adapt their businesses to align with China’s vision of a more equitable future. That will be a difficult process for some, but it is one that needs to be done in the open. Without any information to go on, investors will for a time assume the worst – especially after the shock of the past week.

But time is the trump card, as in any difficult situation. China’s growing affluence and innovative companies have been compelling attractions to global investors for decades. These pull factors have been boosted over the last five years by the push factor of Chinese securities being included in global indices, encouraging asset managers who track those indices to buy Chinese stocks and bonds at a record pace as recently as earlier this month.

Time is the trump card.

We don’t yet know how long it will take for investors to get over these regulatory interventions – as they shrugged off the trade war, for example – or whether their demand for Chinese assets will fully recover. But history suggests that, in time, many investors will overcome their memories of this summer and increase their exposure to Chinese companies once again. Those companies that have best maintained investor confidence amid the chaos should be those that suffer the least until then – and recover the quickest when the tide turns.

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