What happens when a Chinese AI startup tries to sell itself to a major U.S. tech company, but Beijing decides it doesn’t like the deal?
In this week’s episode, Trivium China Podcast host Andrew Polk is joined by Trivium’s Head of Tech Policy Research Kendra Schaefer to unpack the latest in the Meta-Manus acquisition saga and what it reveals about China’s evolving approach to tech regulation and national security.
The two discuss:
Why Chinese regulators ordered the Meta-Manus deal unwound
How Beijing is using dormant foreign investment review powers in new ways
The role of VIE structures and “Singapore washing” in cross-border tech deals
China’s growing concerns around technology outflow
What this all means for Chinese startups, founders, and the future of U.S.-China tech competition
Andrew and Kendra also explore how both Washington and Beijing are increasingly converging around the same core question: who gets to control strategically important technology?
Transcript
Andrew Polk: Hi, everybody. Welcome to the latest Trivium China Podcast, a proud member of the Sinica Podcast Network. I’m your host, Trivium Co-Founder, Andrew Polk, and I’m joined today once again by Trivium’s Head of Tech Policy Research, Kendra Schaefer. Kendra, how are you doing?
Kendra Schaefer: I’m doing good. How are you?
Andrew: I’m great. Good to have you back on. You’re a pod favorite, a fan favorite, so you got to give the people what they want. And excited to talk to you today specifically about our key topic, which is going to be the recent reporting around the Meta-Manus deal, which Beijing has taken exception to and effectively decided to unwind. So, we’ll get into the details. For anybody who’s unfamiliar with it, Kendra will run down the details behind the deal, but I assume most of our listeners will know about that. But it’s got big implications for U.S.-China tech. It’s got tech competition, it’s got big implications for the U.S.-China tech competition.
It’s got implications for domestic tech environment and innovation in China. So, we think it’s an important news development in its own right, but there’s a lot of other things going on here that we want to get into, which we will do shortly. But of course, before we get into it, we have to start with the customary vibe check. Kendra, how’s your vibe? I’m jazzed right now, actually. My summer travel plans are coming together. I am going to be in Taiwan with the Brookings Institution delegation on the first week of August.
Andrew: Amazing.
Kendra: Yeah, I’m excited about that. And then I’m going to go to the Mainland, and I’ll be there for three whole weeks. So basically, the whole month of August, I’ll be in Asia. So, if anybody’s going to be around, please reach out. I’d love to hang.
Andrew: Nice. Well, you will definitely get some emails on the back of that. I have found that narrating my travels through the world, through the podcast, definitely helps to get some meetings. So, I’m sure some folks will reach out to you. That’s great. That’s exciting. My vibe is similarly upbeat. I don’t know. Maybe it’s just the weather, right? Weather getting sunny. I feel like we’re really in the heart of spring in D.C., a lot of interesting things happening in our business. So, I’m just like really excited about everything. And then the weather being good on top of it — I don’t know, it’s the cherry on top.
So, definitely good vibes for me today. I’m mostly though, going to be asking the questions, just asking questions. So, we’re here for your expertise, which we’ll get into momentarily after we go through the other quick item up top, which is the housekeeping. Got to go through that quickly. So, first, a quick reminder, we’re not just a podcast here. Trivium China is a strategic advisory firm that helps businesses and investors navigate the China policy landscape. And that includes policy towards China out of Western capitals like D.C., London, Brussels and others.
So, if you need help on that front or on domestic policy, understanding domestic policy in China, please reach out to us. You can find us at hq@triviumchina.com. We’d love to have a conversation about how we can support your business or your fund. Otherwise, if you’re interested in receiving more Trivium content, check out our website. Again, triviumchina.com, where we have a bunch of different subscription products, both free and paid.
You’ll definitely find the China policy intel option you need on our website. And finally, tell your friends and colleagues about Trivium. We really do mean that. It helps us out a lot. It helps us to grow the business. It helps us to grow the listenership for the pod, which also helps us to grow the business. So, we really appreciate any word-of-mouth recommendations that are out there. All right. With that, let’s get started here, Kendra. Tell us about the Meta of the Manus deal. Why don’t you start with sort of the background? What deal are we talking about? Why is it important? And then we’ll get into the most recent development. So, what happened?
Kendra: All right, cool. Well, I’ll keep the background short because I imagine many of our listeners probably already know what it is. But basically, a few months ago, Meta announced that it was going to be acquiring Manus, this Singapore-based AI agent startup that was originally founded in China. And that deal was reportedly worth about $2 billion, right? It was crazy because Manus is barely nine months old at the time that the acquisition was announced and basically invisible to consumers.
But it had built this general purpose AI agent that runs in a sandbox virtual computer and can actually sort of plan and execute tasks and produce real outputs, similar bucket of technologies to OpenClaw, which is exactly the kind of thing Meta wanted to plug into its AI assistant. Unfortunately, after the deal was announced, things got a little spicy. In January this year, China’s Ministry of Commerce launched a probe into the deal, and it only got worse from there.
On April 27th, so that was just this Monday, China’s National Development and Reform Commission formally ordered Meta and Manus to unwind the transaction, with Chinese authorities basically saying that the foreign acquisition had sort of violated domestic regulations. And so, this left us with a bunch of open questions, but two in specific – One, how is China claiming jurisdiction over what is presumably a U.S.-Singapore deal, right? And then secondly, what does this mean for Chinese startups and cross-border acquisitions in the future? So, that’s sort of the backstory.
Andrew: Thank you for that. That’s super helpful. And we’ll get into those questions, but I think maybe before we get into these what-does-it-all-mean questions, why don’t you talk to us specifically a little bit about what Chinese regulators, specifically the National Development Reform Commission, said when it came out and said, “Okay, we are officially not cool with this deal.” What did they say and what were the ramifications?
Kendra: Right. So, I’m actually going to get really in the weeds here because getting in the weeds, it’s going to help everybody understand why we think what we think about what’s going on behind the scenes on the deal. And so, I’ll start by actually reading out loud the text of the announcement that the NDRC released. And it’s only one line long. It said, “The Office of the Working Mechanism for Foreign Investment Security Review at the National Development and Reform Commission has made a decision to prohibit foreign investment in the Manus project in accordance with laws and regulations and has required the parties involved to withdraw the acquisition transaction.”
So, that word-for-word was what it said. And even though that’s only one line long, we actually get a lot of information from the way that it was worded. Specifically, there were three interesting parts of that that I’ll call people’s attention to, right? So, the first one is the part where they say, “…in the Manus Project, in accordance with laws and regulations.” And the reason that’s weird is because past announcements like this, past announcements from Chinese regulators in which the regulator is announcing that they’re kicking off some kind of investigation into a foreign company almost always include a list of the specific laws and regulations upon which that investigation is based.
And this one did not. In fact, when DiDi, I guess this was, God, when did they launch the Didi investigation? It was like 2019 now, 2021?
Andrew: I think it was 2020… I was in the States. So, it was after the pandemic had started. I think it was 2020.
Kendra: Yeah. I’m going to go with 2021.
Andrew: Yeah. Maybe 21. Yeah.
Kendra: But when they first announced that they were going to launch the investigation into DiDi after DiDi, you’ll remember, tried to list on the U.S. stock exchange after regulators specifically told them not to, and they kind of gave regulators a finger and tried to list anyway, and then, bam, they got slapped with this cybersecurity probe. That announcement was also one line long. But it said, I have the text here in front of me, it’s actually quite different, it said, “To prevent national data security risk, safeguard national security, and protect the public interest in accordance with the national security law of the PRC and the cybersecurity law of the PRC.”
They said it’s this law and this law, and they name a couple of regulations as well that it’s based on. And so this announcement, nada, zit, bupkis. And so, what that kind of tells us was, or it gave us a little clue, they don’t want to lock themselves in to a specific set of laws and regulations that this is based on because it’s a little bit shaky.
Andrew: We’re mad about it and we don’t know why yet.
Kendra: Right. But yes, in that bucket, we don’t want to explicitly say which rules yet because we’re still figuring that out. So that was clue number one.
Andrew: I do this with my kids all the time.
Kendra: Because I said so?
Andrew: Can’t do that. Well, you can’t do that. Why? Yeah, I don’t know. But I’ll get back to you. Anyway.
Kendra: So that was one thing, the accordance with laws and regulations piece. And the second part that’s a little bit weird is you’ll notice that they call Manus a project. They don’t call it a company. They said – has made a decision to prohibit foreign investment in the Manus project in accordance with laws and regulations. That’s a bizarre phrasing. Put a pin in that, so I’m going to come back to it later. But the third and arguably most important piece of this was that they explicitly specified which office in which regulator was releasing this rule. So, which one was responsible for this investigation. And that is the Office of the Working Mechanism for Foreign Investment Security Review. And we saw that name, and everybody in the kind of team was like, who’s that? We don’t hear from these guys very often.
This isn’t a very big and visible regulator like the CAC or the, you know, CAC is kind of the office that does the cybersecurity investigations or SAMR’s Anti-Monopoly Bureau, which does a lot of anti-monopoly investigations. So, we know who those guys are, but these guys are sort of new, new to us. So, we started digging into that, and that’s a whole…
Andrew: Well, let’s get into it. What is this office, and where did it come from? What did you find?
Kendra: Okay, I’ll skip the story of how we backtrace this. But basically, in 2019, so the starts in 2019, China’s legislature passed the foreign investment law. And that foreign investment law, I think it’s like Article 35, blah, blah, required the state to establish a review mechanism for foreign investments into Chinese companies into sensitive sectors so that the order to create this mechanism comes out in 2019. In 2020, the NDRC creates the mechanism. It was around the end of the year, December 2020. And so, basically, they released this regulation called the Measures of the Security Review of Foreign Investment.
Those measures take effect in 2021. They basically do two things. They create the office that runs these foreign investment investigations, and they also list the rules by which an investigation has to take place and the powers the investigators have and the penalties they can kind of impose and what triggers that investigation, that kind of thing. Basically, this office, I mean, the headline is that this office was set up six years ago as a regulatory weapon into foreign investment, but has basically been lying dormant this whole time. We couldn’t find any evidence that they have done any major, certainly no investigations that have made headlines over the last six years.
We found a little bit of interesting evidence that the NDRC had already been conducting foreign investment investigations prior to the formation of the office. So, like pre-2020, they’d been doing a couple. We saw some like disclosures on some of the stock exchanges that they were doing that. But obviously nothing related to like a major foreign investment deal. So, here comes this new investigatory weapon. And according to these rules, basically the way that the investigations work is that both parties to any covered transaction are required to voluntarily file a declaration with the Office of the Working Mechanism, blah, blah, blah, prior to an acquisition, a foreign acquisition of a company in any one of a list of sensitive sectors.
And of course, those sensitive sectors are super broad, right? Science and technology is one of the sectors, could be any number of things. And then what’s supposed to happen is that the NDRC and MOFCOM are supposed to jointly decide by looking at this declaration whether or not they need to conduct a full review. If they say they do, then they proceed, I’m shortening things here, but they proceed with conducting the review and then they make a determination on whether or not the investment can happen.
And here’s the interesting piece, right? If they say an investment cannot happen, companies got to unwind it. Even if it’s already taken place, they have to unwind it and they have to, what’s the exact quote? “Restore the situation to its pre-investment state and eliminate the impact on national security.” And that’s basically what Meta and Manus are being ordered to do, right? Unwind the transaction and return the situation to its pre-investment state. So, interesting tool. Interesting tool.
Andrew: I’ve got so many questions. So you’re required to report after the investment’s made? Is that what?
Kendra: No, no. You’re supposed to report before the investment’s made. You’re supposed to not proceed with the investment until you receive some kind of decision back. But if the investment has already been made and you make the declaration, if by chance the acquisition has already gone through, you need to return it back if they tell you to, basically.
Andrew: I mean, this sounds like the CFIUS process in the U.S.
Kendra: That’s exactly what it is.
Andrew: Which is kind of weird because I kind of feel like some of the more recent documents that just came out, which I talked to, I think we’ve written about, I’ve talked to Cory about, I think on the pod. They’re using other mechanisms to sort of beef up a CFIUS-like mechanism. So, it’s weird if they already have one that they’re also pursuing other mechanisms for this. I mean, I don’t know. Do you have any reaction to that?
Kendra: I do, actually. And I was going to talk about it a little later in the pod, but I’ll just give you a preview, which is that actually this mechanism is really weak. They wrote it a long time ago. They wrote it pre-crackdown.
Andrew: Pre-tech crackdown.
Kendra: Pre-tech crackdown in 2021 when they went after Alibaba and DiDi and the other tech platforms for a couple of years there. So, they wrote it pre-tech crackdown. And so, the penalties in here are weak. I’ll talk about that in a bit. And the remedies in here are weak. So, they might take this and strengthen it and plug it into some of those other mechanisms, and they might work in concert with each other, et cetera.
Andrew: Yeah. Wow. Interesting. It’s weird that they had this sort of toothless CFIUS mechanism at all, right?
Kendra: I know.
Andrew: Anyway, well, we can get into more of that in a sec. But I do want to talk about sort of the jurisdiction that this office has. Can this office investigate actions that took place outside of China? I mean, you’ve already said it’s a pretty weak mechanism. I mean, obviously, this transaction took place outside of China. So, what’s the jurisdiction deal?
Kendra: Right. That’s actually one of the biggest open questions about this case. We have heard some super interesting speculation, which I’m excited to talk about. But the question is, Manus, for all intents and purposes, as far as the outside universe understands, it was a Singaporean company. So, can this regulation allow China or allow a Chinese regulator to get involved in the acquisition of a U.S. firm and a Singaporean company. And if you just look at the text of the regulations themselves, the answer is unequivocally no. No, they cannot.
The first sort of three lines of the regulation where they talk about what types of transactions these rules apply to and what can be investigated by this office, they’re very clear that it can only apply to companies within the territory of the PRC. And so, we immediately read that and thought, well, there must be some kind of footprint that Manus has or some kind of touch point that regulators think they can reach or activate that has some kind of mainland Chinese footprint if they’re using this set of regulations to go after the deal. And so, we’ve been thinking about it. We’ve been reading some pieces that some Chinese legal scholars have written about it as well. And I’m going to repeat maybe the most interesting piece of speculation from the Chinese legal universe right now.
And this comes from Professor Cui Fan. For those of you who don’t know him, he’s a very well-known sort of regulatory scholar in China. And so here’s his, you’re going to have to follow me for a second because this gets a little complicated, but here’s his speculation. Manus, the project, and we’ll come back to that term in a minute, the technology that is Manus was developed by a company in China called Butterfly Effect. I think they’re registered in Beijing. They have a branch in Wuhan. And that company, Butterfly Effect, is owned by a WFOE, a wholly foreign-owned enterprise within China. That WFOE is owned by a Hong Kong company. And that Hong Kong company is owned by a Cayman Islands company.
Andrew: Is this like the VIE structure?
Kendra: That’s right. So, that’s the supposition. And then the Cayman Islands company, according to Cui Fan, owns the Singaporean entity. So, basically, what he thinks they’re probably arguing is that if Meta bought part of the Cayman Islands entity, then if you follow the chain down, the actual controller of the Chinese mainland entity also changed. And that acquisition should have been registered. That is his guess.
Andrew: Wow. Well, I don’t want to deviate too far onto the VIE structure, but it’s like, that’s a super interesting piece of this that I don’t think is really out there. Do you want to explain VIE structures, or do you want me to?
Kendra: No, you do it.
Andrew: Okay. Well, I was hoping you did.
Kendra: Yeah, I know you, too.
Andrew: Basically, for listeners who don’t know, VIE stands for Variable Interest Entity. And it’s a way, it’s a mechanism that basically Chinese companies have used for years and years to allow foreign investment into basically the Chinese tech sector, which is barred from foreign investment. Basically, like foreigners can’t invest in certain parts of the Chinese technology sector and parts of the economy. And, basically, what you do is you set up an entity in the Caymans, usually, or somewhere offshore, and it owns an entity onshore, usually a W WFOE UFI, a wholly foreign-owned enterprise. That WFOE then has these very complex contracts with a domestic Chinese firm.
So, it doesn’t typically own the domestic Chinese firm, but it has contracts that basically give it the right to the economic output from the Chinese firm. So, now this Chinese WFOE, or this wholly foreknown enterprise in China, has this contract with a Chinese company. The WFOE is owned by the Caymans, and then foreigners can invest in the Caymans entity. This, for example, is how most foreign investors invest in big, massive Chinese companies like Alibaba. So, the issue for American investors or other Western investors when they invest in “Alibaba” aren’t investing in Alibaba at all. They’re investing in this strange structure that supposedly gives them the right to the economic output from Alibaba.
And that’s obviously a very tenuous legal claim and could be challenged both in court or through Chinese regulations. And Chinese regulators have, over the years, kept looking at the VIE structure, knowing that it’s a way to skirt the rules, wanting to crack down on it, but at the same time saying, “But it also kind of accomplishes a goal we want, which is to channel foreign capital into our tech sector without breaking these rules.” So, it’s kind of always been operating in a regulatory gray zone, and regulators kind of keep inching up to regulating it.
But simply the fact that if the Manus thing, if Cui Fan is right, the Manus thing, the VIE structure plays a role here, that just makes it even more regulatorily precarious for Manus. And I think to your point, to Cui Fan’s point, it opens them up to some real regulatory liability, which it looks like maybe that’s why the NDRC went that route. Let me ask two questions — did that make sense? Was that explanation okay?
Kendra: Yes, that was exactly right. You did great.
Andrew: Okay. And then any thoughts on the back of those comments?
Kendra: Yeah, I mean, I’ll just go on to say that it gets even more complicated than that in this particular case. Because, okay, so let’s say that you go after… everything you said is correct. It does open up the VIE structure to additional scrutiny and questions. But in this case, I just want to underscore, they’re not going after the VIE structure. What they’re basically saying is the VIE controlled a Chinese company. It also controlled a Singaporean company. And if shares, like equity shares of the VIE changed, then the Chinese company ownership changed in that company, like that should have been declared.
So, just to kind of make that clear. But there’s another piece of this. So under these rules, they can order, if that’s what they’re doing, they can order the deal unwound. But that does not solve the problem of closing the door on the egress of Chinese technology. It doesn’t fix that problem. It fixes this one deal, but it doesn’t shut the door on like, I don’t think regulators care about Manus, right? It’s like, what if DeepSeek does this? So, they need to prevent this sort of technology outflow in this way.
And so, that’s where I think another bucket of regulations is probably going to come into effect. So, now we come back to the phrasing Manus Project, right? Man, we’re down the rabbit hole right now.
Andrew: Yeah, I love it. It’s great.
Kendra: So, a project is not a company. It’s a bucket of technologies, algorithms, know-how, IP, people, right? That can be illegally exported. So, that phrasing makes me think that what they’re basically doing is saying there’s been an illegal acquisition. And on top of that acquisition, there has additionally been an illegal egress of Chinese technology that was required to, not sure which bucket of rules yet, but maybe export laws, right? Export control laws. You were supposed to get a license before you exported the Manus algorithm. You were supposed to get some kind of approval before you proceeded with the packaging and egress of this technology from the mainland entity to a Singaporean entity.
I don’t know that we have this exactly right, but I think we’re pretty close to sniffing around the edges of how they’re thinking about this framework based on that, which is a lot to get out of a single sentence, but that’s how the sausage gets made.
Andrew: Yeah, it’s fascinating. So, you’re saying this toolkit allows China to order the transaction unwound, but it does not allow China to prevent the outflow of technology developed in China to a company abroad. Is that what you’re saying as well?
Kendra: Yeah, I’m basically saying that this investment security review, the Chinese CFIUS mechanism we’re looking at right now that’s kind of just been sitting there for a while, specifically allows them to investigate a transaction of a foreign acquisition, and it allows them to unwind the transaction, but it doesn’t allow them to do much else. And on top of that, you know, it really doesn’t allow them to do much else. It doesn’t allow them, for example, to issue any kind of… there’s no financial penalties in there. That regulation doesn’t say anything. Like, if companies refuse to do this, they owe a bajillion dollars. The worst penalty listed in that reg is that the state can force a divestment by a given timeline. I mean, that’s kind of weak sauce, honestly.
Andrew: Totally. Well, and this is like, I don’t know, maybe we can get into this later, but a lot of The commentary is like, why is Meta even agreeing to this? Clearly, they could press the Chinese. And also, if this was happening in the U.S., they would go to court to try to fight the U.S. government. And they don’t appear to even be trying to fight the Chinese government. And maybe that’s because they think it was a bad investment. Or maybe that’s because the Chinese government has a bunch of leverage over them just in terms of how profitable their advertising revenue is from the China market. I don’t know. Do you want to get into that now or do you want to hold that?
Kendra: I mean, we can get into that. I don’t have too much to say about that, except I agree with you. And I think also, I mean, again, I’m just riffing here. But even though the investment regulation does not have any teeth, the export control regulations most definitely do. There are criminal penalties. There are major fines. So, if that’s true, right, and they’re basically saying you illegally exported China-developed technology from one entity to the other, and they decide to go with that as a supplementary to the investment issue, then a lot of the Manus staff are Chinese citizens, right? It’s like those people are subject to the law and they could be criminally liable for exporting technology illegally.
I’m sure Meta’s got plenty of dependencies, but at the same time, it’s like, I mean, if staff go to jail, if Butterfly Effect’s staff go to jail, I mean, that doesn’t really behoove anybody. It’s not a good outcome for anybody involved.
Andrew: Yeah, totally right. I hear you. I also just have to quickly just comment on the irony of, again, me being in D.C. and people throwing up their hands and saying, “Oh, I can’t believe China’s unwinding this deal and getting involved in the market,” which the U.S. government hasn’t done that all over the past couple of years. And also, we, the U.S., has an increasingly restrictive environment for U.S. investment into China, right? So, we’re trying to say American companies can’t invest in Chinese technology in sensitive areas. And China is basically saying American investors can’t invest in Chinese technology in sensitive areas. And we’re saying, I can’t believe China would say that when we’re saying the exact same thing. It drives me nuts. But any thoughts on that part of it?
Kendra: I mean, no. I actually totally understand why Chinese regulators are so mad. Because if you really think about it, it’s kind of like China spent the last two decades tweaking its innovation ecosystem, pouring subsidies into the innovation ecosystem, changing the way the entire sci-tech funding structure works, playing with the entire catalog of college majors to graduate more STEM students, right? I mean, this is a 20-year effort to generate companies like Manus that are globally competitive, that are desirable acquisition targets by foreign companies. And now all of a sudden, it’s like the dog that caught the car. It’s like, well, now they’ve got them. And the sudden outflow, right?
So, they incubate these companies with all of this effort and all of the state funding. And then those companies take their toys and they go get acquired by a big foreign player. And so, I understand the state basically waking up to the fact that this is a major loophole. It’s kind of a national security issue. Again, Manus is not frontier technology necessarily, but DeepSeek is.
Andrew: Right, right, right. It’s more about if this becomes a pattern and then... Right.
Kendra: Right.
Andrew: Yeah, totally. And I mean, to that point, if you just flip it around, I’m not trying to say like any kind of moral equivalency or anything like that, but if OpenAI decide to sell a key chunk of its technology to Alibaba, you think the U.S. government would be happy about that? Pretty sure they’d stop that transaction.
Kendra: Or if like a Chinese company tried to buy OpenClaw. I think that’s like the kind of equivalent. Yeah, no, it’s really interesting stuff. It’s an interesting situation. It’s a novel situation.
Andrew: Well, and regulators on both sides are trying to figure it out in real time. But speaking of figuring it out, let’s now get into a little bit further, the technology outflow question, which we’ve touched on. But what other tools does China have to prevent technologies develop in China from being transferred abroad? I mean, obviously, the point here is to nip this in the bud, right?
Kendra: The point here is to nip this in the bud. So I think, first of all, what’s coming under scrutiny is a practice that is being called Singapore washing. The actual Chinese translation is like Singapore laundering. The idea that you scrub yourself of Chinese affiliation by moving your company to Singapore. And I’ve heard a few people be like, “How could Manus be so stupid?: And I actually don’t think that’s a good argument.
I totally understand why Manus did this because hundreds of companies we’ve looked at in the past do this all the time. They just weren’t in sensitive sectors. Chinese e-commerce companies, Shein, for example, had a Singapore subsidiary and then I think they went to Ireland. There’s all these big kind of Chinese firms that have supply chains in China or were founded in China and grew up in China and then wanted to engage more with the international market.
And so, they went ahead and they launched an entity in Singapore and they went and they maybe re-headquartered to somewhere in Europe or somewhere favorable foreign transactions or tax base or whatever. So, I think the process of doing that is going to come under scrutiny. I think it’s a really interesting open question whether or not they look back at any companies that have done that in the past that I don’t think like textile companies are going to be particularly problematic.
But if any other companies have considered a similar move in the past or have executed on something like that, they’re probably a little bit nervous right now. But I don’t think it’s a matter of prevention, right? It’s like the state wants to have an approval touch point on everything that goes out. It wants to be able to say no when it wants to say no. And this just went right under the radar.
Andrew: Yeah. But I mean, just to push back a little bit, it wants to say no so it can say no, right?
Kendra: Totally, totally, totally. Oh, no. 100%. 100%. 100%. Yeah, no, I’m not saying that. I’m just saying that, like, I don’t think they want to say no companies can domicile in Singapore from now on or redomicile in Singapore. I think they want probably like an approval process where you have to submit a declaration to this body and get a stamp of approval before you re-headquarter or something like that in specific sectors or at a specific revenue target. But I don’t think it’s just going to be companies. I was talking to somebody about this the other day, and she had talked to a couple of Chinese founders who had said, “Well, then maybe it’s a bad idea to start a company in China. Don’t start it here and move it. Why don’t you just start it somewhere else? If your goal is to get acquired, right, this is just going to incentivize people to do that.”
And so, I think the bigger picture is that China’s really waking up to the fact that innovation outflow, losing innovations that they incubated is going to become a problem. And so, that might relate to licensing. It might relate to IP outflow. It will be really hard for a Chinese citizen to develop zero IP in China and fully found their first company outside of China and then develop all their IP under that external firm. So, I think probably a bunch of choke points are probably coming over the next, I’d say this is a long-term push, probably five years or 10 years of looking at the stops they can put in place to prevent that.
Andrew: Well, and are there broader implications for the Chinese kind of tech and innovation ecosystem or specifically the startup ecosystem? Because I guess I’m sitting here thinking just, I think most of our listeners will know this, but sometimes I just like to point out most of the incentives for the average person in China are the same as they are anywhere else. People are starting companies because they want to get rich, right?
Kendra: Yeah, exactly.
Andrew: They want to sell to a large technology company, whether it’s American, Chinese, European, whatever, and become a tech billionaire, right? Like that’s the dream, right? And so, they’re just trying to do whatever they can to realize that dream. And then, of course, the regulatory apparatus thinks differently. They think, well, we created the environment for you to produce this technology, and we want that technology to redound to the domestic economy and to domestic security and all of that.
And that’s exactly how American regulators think about it as well. There are tons of founders starting companies in America just because they want to get rich, but the U.S. government is like, that’s our technology. Ultimately, that’s American technology. It doesn’t matter who owns it. It’s for the benefit of America. And I don’t know. What do you think about that? Does that have a material impact on your average Chinese founder? Or are they mostly looking for exits in China? I am obviously not being very articulate.
Kendra: I understand what you’re saying. I mean, is there enough money in China to make it worthwhile? Or do founders essentially say, “Well, I’m never going to make $2 billion on an acquisition from a company here. So, meh.” I don’t know that it has that kind of chilling effect, to be honest. I mean, I’m actually torn on this. Because in one respect, I see this as very similar to what happened to DiDi. What happened to DiDi is that was vibes-based, right? A domestic company demonstrated that they weren’t acting in alignment with the spirit of the law, that they weren’t in line with the political environment, right?
They made a big, loud move that was so incongruous to what the state wanted from them, wanted them to demonstrate in terms of values, basically, right? Loyalty to patriotism and contributing to the domestic innovation ecosystem. It’s kind of embarrassing for China that some U.S. company comes along and snatches up your technology. And so, not only can the state not let that slide, lest it set a bad example, they’ve also right now, of course, they’ve identified this as well. So, I think in some respects, founders are probably going to look at this and say, well, duh, if you’re going to do something like that, you need to couch it in a way that appears to support Chinese goals.
So, one instance like that, is that going to have an entire chilling effect on the market over the long term and people decide not to start companies? No.
Andrew: Of course not.
Kendra: Of course not. But could regulators overclock on this and tighten exits so much that it becomes exhausting for a Chinese company to even try to do that, and they essentially decide that their upside potential just isn’t that far up? Sure. I think so. I think Chinese regulators are great at overdoing it.
Andrew: Yeah. Well, exactly. Someone once said to me that Chinese regulators are good at direction, bad at magnitude. And I was like, that’s right. They generally get the direction right, but they kind of over-torque. One more question before we get into the final thoughts, but what about the idea of the penalty? There is no real penalty. You talked about the part of that is because… I mean, they have to unwind the deal. But there’s no fine, right? There’s no additional fine. And there’s no mechanism for that.
Kendra: I’m waiting for the other shoe to drop.
Andrew: First of all, is that a big regulatory weakness? Will they fix that? And how do you think, I don’t know… Basically, I guess the question is, did they make a deal with Manus? Did the regulators just come to Manus and Meta and say, “Listen, this has to happen and we’re not going to fine you”? What do you make of that aspect of it? Because certainly they could have come up with some mechanism to say, “Oh, and you owe us a billion renminbi.”
Kendra: So, first of all, it’s too early to say whether or not another shoe is going to drop. I think it very well could. And if you look at past investigations, that’s exactly what happened. An announcement was made and the penalty was clarified later. We could even, I’m stretching here, but we could even look at the fact that they didn’t name which laws and regulations they were basing this on and go, maybe they haven’t figured out what the appropriate penalty is. But penalties often come months after the fact, weeks or months after the fact. So we haven’t hit a safe zone where I think everything’s cool.
I do think that because this deal is so unusual, actually, I don’t have an opinion on this. I’m repeating one of our head of policy research opinions on this, where he basically said, I think a deal was struck before the announcement was even made. I think they sat down with both sides, got them to agree to unwind it, set a series of conditions, and then made the announcement that they were asking the companies to unwind it to be sure that it was going to smoothly because, can you imagine if the state announced that this was going to occur and then both of those companies said no and then things get really, really messy?
So, I imagine that some kind of groundwork has already been laid. How far that went, no idea. But you’re raising a really good question which is like what is the or else that is on the back of all of this? So, that’s still totally unanswered i don’t know whether they say y’all violated the export control law, and therefore you’re being issued a fine based on this. And I don’t know, Butterfly Effect has to pay the fine. Does Meta have to pay the fine? Are both parties fined? I’m not sure how that necessarily works. So, that’s something to watch. I would urge listeners to keep your eye on any upcoming fines. Do you have any thoughts on maybe one thing?
Andrew: I don’t. I was just going to ask you, do you think they will make moves to give themselves the regulatory toolkit to a more robust regulatory approach to, I mean, you’ve sort of hinted at it, but where will that come from? It seems weird to me. I guess the NDRC makes sense in terms of outbound investment. NDRC has always been a little bit involved in that, but it seems like MOFCOM might be more of a natural regulator for this kind of thing.
Kendra: Well, first of all, let me answer your first question. Yes. So, before the tech crackdown, most regulations and laws had pretty low or weak penalties, and this was written before the tech crackdown. And so, during the tech crackdown, one of the that happened is regulators went through laws like the anti-monopoly law and the cybersecurity law and raised penalties from basically nothing to eye-watering amounts. Here’s one example. A violation of the anti-monopoly law, you know, if you had a merger that you weren’t supposed to have and you didn’t check with regulators when you did it, similar sort of thing, used to cost a company 500,000 renminbi, that’s like $70,000 per violation.
That’s a line item. You do a $2 billion deal, who cares if you have to pay $70,000 for that? So then when they did the revision of the law, there’s tiered penalties, but it can go like 5% of last year’s annual revenue, 10% of last year’s annual revenue. I think in extreme cases, it’s up to like 50% of last year’s annual revenue if you really, really screw up. Yeah. That’s the like-
Andrew: That’s like a death sentence, basically.
Kendra: It’s a death sentence. They’ve never come anywhere close to that. Even the most record-breaking fines on the biggest companies have only come in close to like 4% of last year’s annual revenue. They haven’t even approached their highest. But the order of magnitude difference is ridiculous, like huge, right? So, we went and read this regulation, which has no financial penalty, and then the law on which it is based, the foreign investment law, same deal, 500,000 renminbi per violation, same era of like fines, right? And so, I think it’s absolutely possible that the legislature over the next few years puts a revision to this law on the agenda and violations are no longer 500,000.
They maybe take a page out of this cybersecurity law into monopoly law book, and it’s like a percentage of last year’s annual revenue for the parties or something like that. That would take a few years to do. Legal changes take years, whereas regulatory changes can be faster. I also think it’s totally possible they add a couple of articles into this regulation that allows for criminal penalties, civil penalties, and administrative fines as a stop gap measure. So yeah, I think they absolutely could strengthen this one. And if they do that, that’s going to make this weapon just as strong.
It goes in the tool belt. It goes in the sort of weapons cabinet with the cybersecurity investigations, with the anti-monopoly stuff, et cetera.
Andrew: And do you have thoughts on like MOFCOM versus NDRC, like who’s regulatory turf this makes sense for?
Kendra: Well, my understanding is that NDRC, like as part of the investment, foreign investment investigation, NDRC is the sort of organizing agency. They organize between all the other agencies. And my understanding is it’s under them because they can tap in other agencies to participate in that investigation if they need to. MOFCOM being the primary kind of support body.
Andrew: Yeah, yeah, yeah. That makes sense. Yeah. I mean, again, for listeners, this one’s been pretty wonky generally, but this one gets really wonky where we’re like, which Chinese regulator has the turf or authority? I mean, but that’s how it works. That’s how the world works, right? Same thing in the U.S. government is you got a bunch of overlapping authorities. You got to be clear on who’s taking point and who’s doing what just to make sure the laws work appropriately. And then the other thing I wanted to say on the fines piece is, I mean, it’s a tried and true methodology in China and elsewhere.
At the beginning of last year, so beginning of ‘25 in January, I was on a trip to Southeast Asia and we were in Ho Chi Minh, Vietnam. And new party secretary, a guy named Toh Lam, had come in and really, I believe he was a new party secretary, had really consolidated power, was really kind of trying to, and is still trying to replicate the China model in a lot of ways. Vietnam feels like China in the 1980s in a way, where there’s a communist party and it’s like getting more, I don’t know, aggressive or kind of trying to increase its control, but there’s still a lot that’s permissible that’s not in China.
Anyway, they had a traffic problem. And very simply, they just raised the fines if you run a red light to like a, even if you’re on a motorbike to a crazy high amount. And guess what happened? Now the problem is that light turns yellow and everybody slams on their brakes because-
Kendra: Really?
Andrew: Yeah, almost overnight solved basically a big chunk of the traffic issues. So, it’s a pretty tried and true regulatory path. We’ll see how Chinese regulars use this in this specific area to try to keep technological outflow from happening. But it seems inevitable that they’re going to take that path. Any last thoughts before we wrap up on all this? I really appreciate you walking me through everything here.
Kendra: No, this has been a really fun podcast. Great to hang out.
Andrew: Yeah, well, we’ll see where it all goes. I’m sure there will be more developments here. We’ll have you back on to talk about them, more implications as we kind of get a clear understanding of those implications. We’ll discuss them for our listeners. So, thanks a bunch, Kendra. I appreciate it.
Kendra: Yeah, totally. And just, you know, final thought is that all of this came from one sentence. I’m just going to say it one more time. None of this has been confirmed or verified yet. So, this is just us speculating. I’m very curious to see what happens when we get some actual clarity from regulators or from the reporting over the next few weeks and months.
Andrew: Well, we’ll be here for it. Thanks a bunch, Kendra. I really appreciate the time. And thanks everybody for listening. We’ll see you next time. Bye, everybody.
Kendra: Bye.
