Online game regulation fiasco - breaking down a government PR crisis - Essay #2

Last Friday the entire China market was shocked by a newly announced draft regulation by the National Press and Publication Administration (NPPA) on the online game industry. As I claimed last week, the market reaction was so big that it’s very likely that the NPPA guys themselves hadn’t foreseen it, and very likely they would dial it down and modify it later.

As predicted, NPPA went into damage control mode and quickly issued a public statement one day later, on last Saturday:

The draft for comments is based on ensuring and promoting the prosperous and healthy development of the online gaming industry. It has clarified issues such as the entry of online gaming operators, and has established a special chapter on "Support and Incentives" proposing a series of encouraging measures. At the same time, it has made provisions for the protection of minors and consumer rights. During the drafting process of the consultation draft, opinions from relevant departments, industry associations, enterprises, and other parties were extensively solicited through various means…soliciting opinions from the public on departmental regulations is a process of listening to opinions more broadly and perfecting the clauses of the regulations. Regarding the concerns and opinions raised by various parties on Article 17, Article 18, and other content of the draft for comments, the National Press and Publication Administration will study them carefully and further revise and improve them based on continuing to listen to the opinions of relevant departments, enterprises, users, and other parties.

This statement sounds very supportive. They not only emphasize supporting the industry but are quite specific regarding what to modify, namely Articles 17 and 18 which have caused most of the anxiety (especially Article 18). In China, being specific is materially better than not being specific.

To follow up on this supportive attitude, on Monday NPPA quickly approved licenses for 105 domestic games, a move that was in such a hurry that they have even granted licenses to already dissolved entities, causing some further ridicule:

Online meme ridiculing the NPPA: “You dare to do all this and that for your games?”; “Wake up, I am issuing new game licenses“

But however ridiculous it is, the message is clear: NPPA wants desperately to pacify the market, and the market is taking the hint. After Christmas break, key gaming stocks such as Tencent and NetEase are surging back, although not yet fully reclaiming the lost value since last Friday, showing the market is still hesitant after this painful episode.

Overall, the whole story looks like a big farce. Especially ironic is the fact that this happened only 2 weeks after the CEWC emphasized managing expectations and promoting “Invest in China”. It does not look good however you look, but still it is without some silver lining. I said it before, in China, without bad news, there may be no good news. I will talk about this silver lining at the end of this post.

Since Friday, I have got emails from clients at BigOne Lab asking what I think about this. I am humbled by these questions, to the point that I have to put out a disclaimer that I am not a game expert (I don’t even play games, sadly). But I do have something to say about the complex dynamics between public opinions and government policies, and I find this episode to encapsulate really well how the Chinese government works in this 3rd decade of the 21st century.

So, this is an episode worth some dissection. And by dissecting it, I hope it will bring you more confidence next time you see similar events.

I will dissect this event in two parts: 1) what I am sure of, and 2) what I think is very probable to be true.

What am I sure of?

#1 The draft paper itself is a systematic one, and most of it shouldn’t be controversial

The whole regulation piece is a big, 64-article piece of work, covering all aspects of the online game industry including protecting minors, anti-trust, and clarification on penalty amounts. Most of these are well anticipated by the industry.

I have read quite a number of commentaries on this topic, and I find this one (in Chinese) from Chinese online game watcher GameLook to be especially insightful and balanced.

According to GameLook, some sections in the draft are actually quite good:

For example, the issue of "protection of minors," which is of high concern to gaming companies and netizens, occupies a considerable length in the "Draft for Comment" (the entirety of Chapter 4, Articles 37-44), and this is also the result of years of effort by all sectors of society.

Looking at the effectiveness of the work to protect minors, the Policy 830 [Robert: a previous policy announced on Aug 30, 2021 that tried to regulate video game addiction by minors] "stipulates that all online gaming companies may only provide 1 hour of service to minors from 8 pm to 9 pm on Fridays, Saturdays, Sundays, and statutory holidays." More than two years later, financial reports from various companies show that the duration and consumption amount of minors have both significantly decreased, and the problem of "minors' addiction to games" has been largely solved. Survey data also shows that over 80% of parents recognize the effectiveness of the current anti-addiction work.

What is even more gratifying is that Article 43 emphasizes the responsibility of guardians, which also reflects the voice of the gaming industry. "Parents or other guardians should fulfill their guardianship responsibilities according to the law, guide minors to use online games healthily and reasonably, engage in activities beneficial to physical and mental health, develop good living habits, establish correct online gaming consumption concepts, prevent and stop minors from becoming addicted to online games, and at the same time should improve their own internet literacy, standardize their own online gaming behavior, and strengthen the guidance and supervision of minors' use of online games."

#2 Of all 64 articles, most of the strong reaction is related to Article 18

Most of the strong reaction has to do with Article 18.

It reads (highlights are of my own):

第十八条【限制游戏过度使用和高额消费】网络游戏不得设置每日登录、首次充值、连续充值等诱导性奖励。

网络游戏出版经营单位不得以炒作、拍卖等形式提供或纵容虚拟道具高价交易行为。

所有网络游戏须设置用户充值限额，并在其服务规则中予以公示，对用户非理性消费行为，应进行弹窗警示提醒。

Article 18 [Restrictions on Excessive Use and High Spending in Games] Online games must not set up inducive rewards such as daily logins, first-time top-ups, or consecutive top-ups.

Online gaming publishing and operating units must not provide or condone high-priced transactions of virtual items in the form of speculation, auctions, etc.

All online games must set a recharge limit for users and publicly disclose it in their service rules. For irrational consumer behavior by users, a pop-up warning should be provided as a reminder.

Within Article 18, most of the anxiety comes from the highlighted “recharge limit” line. You may notice that this one does not just apply to teenagers, but to all of the users, leading to the speculation that NPPA now is placing a cap on how much money adults can spend on online games.

But even so, this line is sufficiently vague.

How high is the limit? Is this a daily limit, or a life-long limit? Can online game developers determine the limit on their own, or it will be forced upon them by the regulator later?

The regulation is silent on all of these questions, so they actually leave open sufficient white space for industry to interpret and to adapt.

According to GameLook:

Regarding Article 18…currently, there are different interpretations within the industry.

One extreme interpretation is that "recharge limit" refers to the total amount of recharge per year/month/day. This implies that in the future, there will be a consumption ceiling for each game a player plays; another interpretation is that it refers to "single transaction recharge limit," similar to the maximum single transaction limit of 648 yuan for iOS users. If interpreted as a single transaction recharge limit, it can be said to be within the acceptable range for gaming companies.…

However, with the stock prices of gaming companies plummeting today, it seems that most people are leaning towards the first interpretation of a "total consumption limit."…

If one were to understand it as a "total consumption limit," this would bring about a question: what should the limit amount be set at? Considering the actual conditions of various games and the fact that different games should have different consumption limits, GameLook believes that this specific number needs to be determined after comprehensive research on the actual operation of domestic products and user spending power, and after widely collecting opinions from domestic gaming companies. It relates to the business model of the domestic gaming industry and the design of future products, and requires extreme caution to make a decision, otherwise serious consequences may ensue.

But if "limit" tends more towards a limit on the amount of single transaction recharges, aiming to provide paying users with some time to think about their spending, this model is actually more scientific. It's not difficult for the gaming industry to adopt and can to some extent solve the problem of irrational spending.

In this light, we really need to pause a bit and think about what we are looking at here: a big, overall okay policy paper, with 1 or 2 controversial clauses, which nonetheless leave enough maneuvering space, at least on paper.

This doesn’t sound so bad, doesn’t it? If we were living in a different time, when market-government relations were more normalized and when the market was not reeling from some PTSD from government crackdowns, then this regulation probably wouldn’t have caused such a storm.

But here is the problem: we are not living in such kind of time.

Which brings me to my third point.

#3 The market, with a very low level of confidence, is worried that this is yet a new round of regulatory crackdown

I have emphasized before that there is currently a severe trust deficit in how the market is looking at the Chinese government right now, especially after the 2021 education crackdown.

This trust deficit, along with the controversial handling of Covid in 2022 and deflationary pressure due to real estate implosion, made market sentiment especially weak at the moment. It can be said that the market has been 惊弓之鸟 (a bird who is afraid of the bow) at the moment. Irrational fear? Maybe. Over-reaction? Perhaps. But it is understandable. Given the torture of the last 3 years, everyone is really tired.

I also pointed out (here, here) that at the root of this lack of confidence is arbitrary rule-making and arbitrary rule implementation.

This time, it’s exactly the same kind of arbitrariness the market is afraid of. The market was practically stampeding when sniffing even just a hint of this arbitrariness.

#4 NPPA hasn’t expected such a huge impact on the capital market and they genuinely don’t want to see it happen

As I just said, the NPPA people clearly haven’t anticipated they could have caused such a storm, and have been in full damage control mode since. They know fully well that the way this event is playing out is not in line with the spirit of CEWC, a high-level conference attended by Xi and all other 6 Standing Committee members.

I don’t think there is any doubt about that.

I guess the reason for this failure was that, when they drafted this document, they only had the online game industry in mind. They didn’t seem to put this document into the wider context of economic development and business confidence.

If they didn’t, who did? This brings me to my next point.

What is probably true?

#1 This regulation has not been reviewed by government agencies related to economic management, such as the NDRC (>90% probability)

According to this important recent post by

Yang Liu

of

Beijing Channel

, a reporter from Xinhua, after the disastrous crackdown on the after-school tutoring industry of 2021:

Han Wenxiu, a senior official of the Central Committee for Financial and Economic Affairs, warned of the “fallacy of composition” in an interview.

To avoid recreating the scenario, in practice government agencies now need to internally evaluate regulatory documents (规范性文件), and then submit them to the NDRC for a final review.

This observation is quite crucial.

Zichen Wang

of

Pekingnology

commented that this means “China's National Development and Reform Commission (NDRC) now has de facto veto power over other ministries' policies, if the NDRC finds them to be inconsistent with the macroeconomic policy orientation.”

This begs the question: has NPPA submitted this draft to NDRC for review? If so, why hasn’t NDRC caught the problem?

My best guess is that NPPA has not asked for NDRC’s opinion.

After the 2018 institutional reform of party and government organs, NPPA fell under the purview of the Publicity Department中宣部 (a.k.a Propaganda Department) of the Party, no longer part of the State Council (a.k.a the Government). So, if we assume Liu Yang’s report is right (which I strongly believe), there is also ample institutional reason for NPPA not to submit this draft to NDRC, an arm of the State Council, for review.

This may well be the reason why economic planners have failed to catch this one, despite the consensus to “manage expectations” and to avoid the “fallacy of composition”. They simply hadn’t seen it.

A “small” glitch that has caused an enormously outsized trouble. Oops.

#2 Companies such as Tencent and NetEase know about this new regulation beforehand, likely to be consulted (>80% probability)

This is less talked about by all the commentators I have seen.

Chinese regulators do not make rules out of a vacuum. It takes a lot of study, research, discussions, and industry-wide consultations to formulate a piece of regulation.

Before implementation, every piece of regulation will go through at least two stages. The first stage is semi-public consultation with key industry stakeholders and experts. In some instances, those stakeholders even help draft certain parts of the regulations. In any case, those “stakeholders” will include the largest members of the industry, and in this case, big boys such as Tencent and NetEase.

The second stage is the public consultation stage, which was the stage that set off the storm we saw last Friday.

It is simply unthinkable that top industry players such as Tencent and NetEase have not been consulted with for this, and that NPPA just pulled out a piece of paper on their own to shock everybody. This is simply not how the Chinese government works these days.

So if those companies knew of it beforehand, and were even actively involved in policy formulation, why haven’t they objected to Article 18?

There are 2 possible explanations.

The first explanation is, that they saw it, objected to it, but got overruled by NPPA in the end. I think this is not likely.

The second explanation, which I think is more likely is the following:

#3 The companies themselves don’t think this is that serious. (>70% probability)

I can’t say for sure this is the case, thus only assigning a >70% probability. But this is a possibility I am willing to bet my money on.

I have explained above, that even the controversial Article 18 has enough white space for those companies to maneuver around. Maybe they already have plans to adapt. Maybe they already know they can just decide a “recharge limit” on their own.

Again, I think the fault of NPPA this time is not the regulation itself, but how to see this regulation within the wider context of sagging business confidence. In this light, it’s possible that even the gaming companies themselves haven’t anticipated this could create such a big reaction from the market (although unlike for NPPA, this overreaction is good for those companies).

Why do I think this is likely? One piece of evidence is the very aggressive share buyback by these companies in the last few days. Last Friday when Tencent shares tumbled by a whopping 15%, Tencent itself also bought back its own shares very hard. When the market was closed, they had bought HK$1 billion (~$130m) of shares on that single day, which was almost triple the daily average of the previous days, and they have been buying at this new level in every trading day now since last Friday. And Tencent is not the lone case here. Kingsoft, another game operator, has also been buying back its own shares much more aggressively than before.

It is hard to imagine that these people have been caught off-guard by this regulation when they have been so quick (within a matter of minutes), so resolute and so uniform in upping their share buyback game. At the end of the day, it’s their own money they are dishing out here. Money doesn’t lie.

#4 Controversial sections such as Article 18 will be heavily modified (>90% probability)

With all of the analysis above, it is only natural for NPPA to heavily modify the controversial sections.

On the one hand, this issue has been politically toxic. On the other hand, it may be no more than a non-issue to begin with. It is inconceivable to hold on to a politically toxic non-issue for no good reason.

How will they modify it? Maybe they can make it clear that gaming companies can set the recharge limit on their own, or maybe they can make it clear it’s a recharge limit for single transactions. There are many ways to do that.

My overall take, and the silver lining

Overall, I think the root cause of this disaster on the part of NPPA is that they are too narrowly focused on the industry they regulate. There is very poor coordination with other government agencies and a general lack of understanding of capital markets and economic confidence. But then again, this is no different from any bureaucratic agency in the world. One only cares about what they are designed to care about. Although laughable, nothing is shocking here.

For people who know me, I am someone who always manages to find a silver lining in whatever shitty situation. And there is also a silver lining in this very shitty case:

It’s a live lesson on “expectation management” in this integrated economy age. All these pains, debates, and live discussions (including the court paper disclosure case I commented on last week) are great learning materials for forming a consensus on how economic expectations can actually be managed. Those learning materials can’t be dictated or recited. They can’t be taught. They can only be learned the hard way. From now on, all government ministries, under State Council or not, will be even more careful with their regulatory work. It is a painful lesson for the market, but so it is for the regulators themselves.

No bureaucrat would ever like to be crucified in this way. This is the kind of stuff that can get heads rolling. By now, many of them have probably realized the real cost of just a few words, if they hadn’t already.