Key U.S. commission announces upcoming capital wars

If there’s one thing Republicans and Democrats can agree on, it’s that China is America’s greatest long-term strategic threat. And yet, US financial firms couldn’t be more optimistic about the Middle Kingdom. Banks like Citigroup, Goldman Sachs and JPMorgan Chase are expanding their businesses there, as are asset managers like BlackRock. But what will happen when Wall Street’s aspirations for wealth in China meet the political realities of Main Street America?

It’s a question that was brought to the fore by the annual report of the US-China Economic and Security Review Commission, delivered to Congress last week, which recommended a host new limits on business between the two countries, not just on goods and labor, but also capital flows.

The commission, whose members are appointed by minority and majority leaders in Congress, has a good track record for predicting legislative and regulatory trends. He was the first to raise Huawei as an issue (in 2004), highlighted the risks within crucial supply chains in areas such as pharmaceuticals as early as 2010, and brought the issue of forced labor to Xinjiang. on the political map.

As the most recent report states, not only does the Chinese Communist Party use economic coercion and tighten state control to advance its own political model, but “Chinese policymakers are courting foreign capital and fund managers as they work to ensure that China’s capital markets serve as a vehicle to finance the CCP’s technological development goals and other policy goals.

The 32 new recommendations to combat this include: limiting investments in variable interest entities (VIEs) linked to Chinese entities; empower the Securities and Exchange Commission to require companies to disclose whether they source from or invest in companies that use forced labor in Xinjiang or are on the U.S. Commerce Department’s Entity List or Complex Companies military-industrial Treasury; and requiring U.S. state-owned companies to report whether there is a Chinese Communist Party committee in their operations. There are also suggestions to limit the use of cloud computing and data service operations owned by Chinese companies.

The potential implications for the market if such rules become law are myriad. Just consider the idea of ​​requiring “listed U.S. companies with facilities in China” to report on an annual basis “whether there is a Chinese Communist Party committee in their operations and summarizing actions and decisions. in which these committees may have participated”. This may seem like an extreme move, but the overlap between non-state enterprises and the Communist Party in China has increased dramatically in recent years.

Citing figures used by the CCP’s own organization department (and also quoted by Western scholars), the report notes that “in 1998, just 0.9 percent of non-state enterprises had CCP committees, a this figure rose to 16% in 2008. In 2013, the presence of committees in non-state enterprises increased to 58% and in 2017 it reached 73%, which represents 1.9 million enterprises. Assuming these numbers are correct, it’s hard to imagine a Western company or financial institution doing business in China that wouldn’t have a potential problem. It is also hard to imagine that Western financial institutions claiming to prioritize ESG concerns will not come under increasing pressure to justify the hypocrisies of working with an autocratic government.

On the other hand, the commission also recommends protections for US investors in Chinese assets. In particular, the report points to VIEs, which are used by Chinese companies to circumvent rules barring them from having foreign investors. These vehicles include the largest percentage of Chinese issues by value sold on US exchanges. But they are opaque; regulators like the SEC have expressed concerns about the risks they pose to investors, who often don’t get the same amount of information as typical listed companies and have no oversight of governance.

If that were to happen, the combination of VIE regulation, index providers that have had a huge impact on fund flows to China, and the approach of US-China capital flows as an ESG issue could move the market. Indeed, I would wager that capital will become the next front of the US-China economic decoupling.

Some would say this will increase geopolitical friction and hurt the global economy. It may be true. But while Wall Street understandably wants to tap into the largest pool of new international investors, and Beijing needs capital to cover its own local debt troubles, it’s hard not to see the rush of financial firms in China as a reflection of continued willful blindness to the “one world, two systems” paradigm.

It should be noted that the US China Economic and Security Review Commission was created by Congress in 2000 to monitor the development of relations between the two nations, even as China was in the process of to become a member of the World Trade Organization. There were high hopes – but also doubts, even then – that China would become freer as it grew richer. Of course, the doubts turned out to be well founded.

Anyone who thinks there won’t be more constraints on business between the two countries would be well advised to read the report carefully.

[email protected]

Aurora J. William