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Under Joe Biden, tapping US capital markets will get even tougher for corporate China

Jodi Xu Klein jodi.klein@scmp.com
·8 min read

As the Biden administration takes the reins in Washington, the stakes have never been higher for the US relationship with China and the rest of Asia. In the latest in a post-election series, Jodi Xu Klein explores the challenges facing US-listed Chinese companies.

When large indices provider MSCI increased China shares a year ago to the highest single country weight in its emerging market benchmark, the Trump administration lent support for legislation to cut off corporate China from American investors. That financial decoupling from China is still deepening.

In November, US President Donald Trump signed an executive order barring Americans from investing in 31 Chinese companies deemed to have military ties. That number has since risen to 35.

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"Those companies raise capital by selling securities to United States investors that trade on public exchanges both here and abroad, lobbying United States index providers and funds to include these securities in market offerings," Trump said in an executive order signed on November 12.

"People's Republic of China is increasingly exploiting United States capital to resource and to enable the development and modernisation of its military, intelligence and other security apparatuses," he said.

At the heart of the decoupling is the fear in Washington about military-civil fusion, a Chinese strategy designed to develop a world-class military by 2049, partly by tapping its private companies' tech capabilities to accelerate the growth of its defence industry. Under the incoming Biden administration, that focus to contain China's military rise and its potential threat to American national security will hardly let up.

"The main concern is about not allowing US money to finance military developments that will be bad for the United States," said Anna Ashton, senior director of government affairs at the Washington-based US-China Business Council. "I don't think with President-elect Joe Biden, it's going to be a return to the previous status quo before the Trump administration. Restricting US investment in companies that have clear ties to China's defence industry is the issue that matters most to most people on the Hill."

Source: US-China Economic and Security Review Commission alt=Source: US-China Economic and Security Review Commission

In the last few months, Republicans on the House Foreign Affairs Committee issued the China Task Force Report, the Senate Foreign Relations Committee introduced the Strategic Act and Democrats on the Senate Foreign Relations released the Leads Act, all of which addressed this issue of US capital funding Chinese military-civil fusion goals.

The inclusion of Chinese stocks and bonds by global investment indices - MSCI, FTSE Russell, Bloomberg Barclays and JPMorgan - means hundreds of billions of additional US capital was added to finance Chinese companies because fund managers mirroring these indices as a strategy are obligated to increase their holdings as the weight increases.

In Washington's view, the murky nature of the businesses behind these investments poses more danger than ever, at a time when tensions between the countries has risen over flash points including trade, technology, the military and human rights.

US securities regulator pushes plan that could delist Chinese firms

MSCI reversed course on Tuesday, announcing the removal of 10 Chinese securities from its benchmarks after more than 100 market participants they surveyed said Trump's executive order "may have a significant impact" as it "would effectively challenge the investability of the impacted securities".

The London Stock Exchange said earlier this month that it was dropping eight Chinese companies' stocks - including Hangzhou Hikvision, China Communications Construction and China National Chemical Engineering - from two of its major indexes starting December 21.

In the following days, the S&P Dow Jones indices and Nasdaq announced the removal of some Chinese firms.

To further restrict Chinese firms from accessing US capital by selling shares on American exchanges, Congress approved listing rules as part of the must-pass national defence bill in early December.

President Donald Trump has used an executive order to bar Americans from investing in 35 Chinese companies deemed to have military ties. Photo: AFP via Getty Images/TNS alt=President Donald Trump has used an executive order to bar Americans from investing in 35 Chinese companies deemed to have military ties. Photo: AFP via Getty Images/TNS

A separate bipartisan bill - the Holding Foreign Companies Accountable Act - has also cleared Congress and Trump has signed it into law on Friday.

The law compels Chinese companies either to provide audits to be reviewed by US regulators, disclose ties with the Chinese government or stop trading their shares in the US in three years.

"The law is not going to get repealed under the Biden administration," said Jesse Fried, a professor at Harvard Law School who focuses on corporate governance.

The passage of the legislation, said Fried, wasn't "just because of Trump" - "it was because there was an underlying problem. We've had a lot of China-based companies in the United States defrauding investors."

US bill to delist Chinese stocks could backfire on American firms

The US securities regulators have battled with China for decades for not handing over its companies' audits, rules followed by all foreign and domestic firms with stocks trading on US exchanges.

Luckin Coffee, a Starbucks rival in China, agreed on Wednesday to pay US$180 million to settle SEC charges of accounting fraud to make its revenue appear better than it was.

Under Biden, financial market policies are likely to be as tough or even tougher for China, Fried said.

"The new administration is not going to make things easier for Chinese companies; if anything, it will make it harder," he said. "The Biden administration will be less connected to Wall Street. The securities regulator appointed by the new president is going to be more interested in protecting investors and less interested in protecting Wall Street."

Workers at a China Communications Construction Company site in Malaysia in August. The company has been blacklisted by Trump and dropped by the London Stock Exchange. Photo: Xinhua alt=Workers at a China Communications Construction Company site in Malaysia in August. The company has been blacklisted by Trump and dropped by the London Stock Exchange. Photo: Xinhua

Biden, however, will need to grapple with the robust investment interests Americans have in China and their national security implications.

Since last year, China has been opening up its financial services industry to allow foreign firms to have majority control of their businesses there. Goldman Sachs and Morgan Stanley received approval from Chinese regulators in March to take 51 per cent stakes in their mainland businesses. On December 8, Goldman said it planned to acquire 100 per cent of its Chinese joint venture.

"One hundred per cent ownership of our franchise on the mainland represents a significant commitment to and investment in China," David Solomon, Goldman's CEO; John Waldron, its chief operating officer; and Stephen Scherr, its chief financial officer, said in an internal memorandum seen by the Post. "This focuses on growing and strengthening our existing China businesses, expanding our addressable market and investing in talent and technology."

Others like BlackRock echoed that perspective. "There is a clear case for greater portfolio allocations to China exposed assets for returns and diversification, in our view," vice-chairman Phillipe Hildebrand said in a report this month about the 2021 investment outlook.

US lawmakers urged to put 'reciprocity' at heart of China relationship

"Risks to China-exposed assets include China's high debt levels, yuan depreciation and US-China conflicts. But we believe investors are well compensated for these," he said.

A leading congressional panel has heeded caution however. In its annual report to Congress released in December, the US-China Economic and Security Review Commission warned that China's effort at financial opening was part of a "calculated strategy" to secure foreign capital to shore up the domestic economy.

"Rising exposure to China's financial system presents unique and significant risks to US investors, savers and retirees," the report said. "Of particular concern is the rising inclusion of Chinese securities in global investment indices. These inclusions are funnelling hundreds of billions of US investment dollars toward a financial system that lacks transparency, adequate pricing of risks and regulatory oversight."

President-elect Joe Biden will take office on January 20. Photo: Getty Images/TNS alt=President-elect Joe Biden will take office on January 20. Photo: Getty Images/TNS

"China is an adversary presenting unique and immediate threats to our economic and security interests," Robin Cleveland, the commission's leader, said in the opening statement. She said the report reflected "an understanding that the challenges posed by the Chinese Communist Party are not partisan - they are American concerns".

Lawmakers' unanimous support of the delisting bill was evidence of strong bipartisan support on China issues in a Congress that has disagreed on most other issues.

"Everyone in Congress is more hawkish about China than they were four years ago or eight years ago. It's one of the only things that Democrats and Republicans agree on," said the US-China Business Council's Ashton.

Under Biden, the matter is likely to be handled more thoughtfully, but still, Ashton said, "decoupling is going to continue to be a theme."

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2021 South China Morning Post Publishers Ltd. All rights reserved.

Copyright (c) 2021. South China Morning Post Publishers Ltd. All rights reserved.