A Bridge Across the Divide: Pharmaceutical Licensing Instead of a Trade War

The Chinese military strategist Sun Tzu advised always leaving an opponent a way out to avoid a hopeless battle. The United States and China appear to be following this principle in the field of biotechnology, shortly before Xi Jinping and Donald Trump meet again at the APEC summit in Shenzhen. Although neither side is abandoning its rivalry, both are keeping one crucial channel open: pharmaceutical licensing. “This shows that China and the US need each other more than they are willing to admit,” says Thorsten Fischer, Managing Director and Head of Portfolio Management at Moventum AM. Investors stand to benefit.

The US government regards business ties with the People's Republic of China as a national security risk. Washington is therefore seeking to reduce its economic dependence on China through import tariffs, technology export bans and investment controls. The pharmaceutical sector is also affected: the US Treasury has presented draft regulations restricting investment in countries such as China and Russia. Chinese pharmaceutical companies would thus become subject to the same security requirements already applied to semiconductors and artificial intelligence. “Biotechnology has now entered the national security arena,” says Fischer.

Cross-border joint ventures and direct equity investments are coming under scrutiny. “Deals such as Pfizer's $100 million investment in 3SBio are likely to become virtually impossible in future,” Fischer explains. However, Washington does not intend to burn all its bridges. Pure licensing agreements are exempt from the restrictions. US pharmaceutical companies can therefore continue to acquire licences for medicines or active pharmaceutical ingredients researched and developed in China, including innovative cancer therapies. “It is ownership, not collaboration, that is being prohibited,” says Fischer.

Licensing is nothing new in the pharmaceutical industry. Almost 50 years ago, Genentech granted Eli Lilly a licence to use its insulin technology. What is new, however, is the speed at which Chinese companies are developing new drug candidates, and at significantly lower costs than their Western competitors. As a result, the number of licensing deals has increased more than tenfold over the past five years, particularly in oncology and obesity treatments.

China has therefore established a lead in innovation. At the same time, major Western pharmaceutical companies are facing the expiry of patents on key blockbuster drugs and need to replenish their development pipelines. “Chinese research provides exactly what they need,” says Fischer. This is causing unease across party lines in Washington. “There is growing concern that the US pharmaceutical industry is becoming too dependent on Chinese innovation.”

But China is not entirely satisfied with the status quo either. Beijing fears that its own discoveries are being licensed too cheaply. After all, licensors typically receive only 10 to 15 per cent of revenues generated outside China. The risks extend beyond lost profits to the potential loss of global leadership.

China's Ministry of Commerce therefore wants to restrict exports of five types of biotechnology, while exempting licensing agreements, partnerships and research services. The reason is that China's underfunded health insurance system cannot afford many of these innovations. The domestic market is too limited, leaving licensing as the only way for many developers to generate revenue from their discoveries. “If you cannot sell at home, you have to export,” Fischer explains. This is unlikely to change until China reforms its public healthcare system or significantly expands private health insurance.

Despite their geopolitical differences, the two powers remain mutually dependent. The compromise over biotechnology should therefore be seen as a pragmatic signal ahead of the next meeting between Xi Jinping and Donald Trump at the APEC summit in mid-November. “Both sides can demonstrate their resolve without cutting off the drug development pipeline that connects them,” says Fischer.

From an investor's perspective, this is good news. Western pharmaceutical companies will continue to have access to China as a cost-effective source of innovation, albeit through licensing rather than equity investments. Chinese biotechnology stocks, meanwhile, will remain vulnerable to political volatility but retain their most important business model. Fischer concludes: “As long as China's healthcare system cannot adequately monetise its own innovations, the West will remain the most important buyer, and licensing will remain the common currency between the two rivals.” Those who lack strength must rely on ingenuity – a fitting summary of the lesson Sun Tzu taught centuries before the birth of Christ.