US commission calls for tighter controls on flows to Chinese markets

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A US government commission has called for tighter controls on flows to Chinese capital markets in a measure that, if approved, would have profound implications for asset managers and index providers.

The latest annual report from the U.S.-China Economic Security Review Commission highlighted the security problems associated with a huge increase in U.S. investment. “An increase in U.S. investor participation in Chinese markets goes beyond the U.S. government’s defense against the various threats to U.S. national and economic security posed by U.S. investments in certain problematic Chinese companies,” the report to Congress said. .

“Despite ongoing tensions between the United States and China, American investors, asset managers and mutual funds are increasing their participation in Chinese financial markets,” he added.

He said U.S. positions in Chinese stocks and debt securities jumped 57.5% from $765 billion in 2017 to $1.2 billion in 2020.

This article was previously published by Ignites Asia, a title owned by the FT Group.

According to the report, “Chinese policymakers are courting foreign capital and fund managers as they strive to ensure that China’s capital markets serve as a vehicle to finance the [Chinese Communist party’s] technological development goals and other policy objectives”.

The commission proposes expanding the scope of existing policies to close “loopholes,” pointing out that U.S. institutional investors could still buy, sell, and profit from Chinese military-linked companies as long as they weren’t doing so to United States and only involved non-US citizens.

“If we are truly interested in protecting the national security of the United States rather than just appearing, this loophole should be closed as recommended by the commission,” he argued.

Earlier this year, updated sanctions policies issued by the US Office of Foreign Assets Control stated that entities were “not prohibited” from providing management or investment advisory services to non-U.S. persons, to foreign funds or entities in connection with the purchase or sale of securities that would otherwise violate the investment prohibitions.

The announcement in June appeared to allay some of the concerns of US managers that their onshore businesses in China and Hong Kong could be badly hit by US government policies.

The commission’s new report also takes aim at how the Chinese government has opened up its capital markets to foreign investors.

“The Chinese government allows foreign companies and investors to participate in the Chinese market only when it suits its national interest,” he said.

“As a result, nominal financial ‘opening’ in China is really a carefully managed process designed to strengthen state control over capital markets and channel foreign financing towards the achievement of the Chinese government’s national development goals. “, said the commission.

A particular issue identified by the committee’s analysis relates to asset managers’ allocations to Chinese assets via passively managed funds.

More recently, FTSE Russell began phasing Chinese debt into its flagship global government bond index. The phase-in process, which began on October 29, will see Chinese government bonds account for a total of 5.25% of the index in three years.

The report said the substantial increase in the inclusion of Chinese stocks in investment indices has automated US investors’ allocation to Chinese companies.

“Because passively managed index funds track these indices and actively managed funds seek to at least outperform them, index providers have played a central but unregulated role in directing foreign portfolio investment to Chinese companies. “, he added.

The commission recommended “requiring index providers that include in their indices securities issued on mainland China stock exchanges or the Hong Kong Stock Exchange, securities of China-based companies listed on US stock exchanges through of one [variable interest entity]or derivatives of any of the foregoing types of securities, are subject to SEC regulation”.

The commission also advises Congress to mandate the US Treasury for an annual update of the precise position of US portfolio investments in China since 2008, including money funneled through offshore hubs such as the Cayman Islands.

US President Joe Biden signed an executive order in early June banning Americans from investing in 59 Chinese companies ranging from surveillance and defense sectors for alleged ties to the Chinese military, expanding an earlier executive order by the former president. Donald Trump. However, the order also appeared to limit the scope of the policy, easing some concerns that US fund groups in Asia could have been severely hampered by the restrictions.

BlackRock, Vanguard and State Street Global Advisors are all heavily invested in China, while many other US managers, including JPMorgan Asset Management and Morgan Stanley, are also rapidly expanding onshore business in the market.

Additional reporting by Echo Huang

*Ignites Asia is an information service published by FT Specialist for professionals working in the asset management industry. It covers everything from new product launches to regulations and industry trends. Trials and subscriptions are available at ignitesasia.com.

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Aurora J. William