With tensions between the United States and China heating up over the global pandemic, the White House and Congress have recently taken steps that would make it more difficult for Americans to invest in China’s publicly traded companies. 

On Wednesday, the United States Senate unanimously passed legislation that would force the delisting of Chinese firms on U.S. exchanges, unless China increases cooperation with U.S. regulators and makes audit documents available. The House has yet to schedule a vote on a similar bill introduced after the Senate measure passed.

And just over a week earlier, under pressure from the Trump Administration, the Federal Retirement Thrift Investment Board, which manages a $600 billion federal retirement fund, said that it would delay plans to shift money into buying shares of Chinese stocks listed in mainland China. 

Advocates of delisting Chinese stocks trading in the U.S. say the proposed legislation would protect American investors, and guard against episodes like the recent accounting scandal at Luckin Coffee, a U.S. listed Chinese company whose share values plummeted by more than $10 billion after it acknowledged fabricating revenue. And the White House argued that federal employee retirement plans shouldn’t support listed companies, some of which have allegedly aided in human rights violations or supported the Chinese military.

But many fund managers worry the moves could backfire and hurt America’s global standing. Analysts say the moves could slow or even begin to reverse China’s integration into the global financial markets, forcing some of the country’s biggest companies to depart from U.S. stock exchanges, but also stifle efforts to connect China’s own stock exchanges to Wall Street and America’s biggest fund managers.

“The U.S. capital markets are a global standard,” says Brendan Ahren, chief investment officer at Krane Funds Advisors, which manages China-focused funds. “Capital controls threaten that viability, and that has repercussions well beyond China.”

While it’s still unclear whether Congress will force Chinese companies off America’s major stock markets, the moves by the White House and Congress step up pressure on China’s government to respond, and they also put some of China’s most valuable companies, including Alibaba and Baidu, on notice that they could be seriously affected by the increasingly strained relations between the two superpowers.

Baidu, the Chinese search engine giant listed on the Nasdaq is already considering delisting and moving to an exchange near China, according to Reuters.

In addition, the decades-long effort by China to build its own stock markets, and allow domestic and global funds to invest in it, is facing new roadblocks, just as Beijing was promising to grant greater access to global investors. In recent years, for instance, China has been more eager to tap foreign capital, and has allowed foreign investors to buy shares of mainland listed companies through special qualifying programs, as well as through a tie up with the Hong Kong Stock Exchange called Stock Connect.

The U.S. capital markets are a global standard. Capital controls threaten that viability, and that has repercussions well beyond China.

Brendan Ahren, chief investment officer at Krane Funds Advisors

Scott Kennedy, an expert on China and senior advisor at the Center for Strategic and International Studies, says that while the immediate impact is small, the moves send a strong message. “They’re significant because they open the door to further action,” he said. “They eliminate the expectation that our financial markets are going to remain integrated.”

To understand what’s at stake, consider this: China only really began to embrace capitalism in the 1980s, and it did not have a stock market until 1990. Today, the country has nearly as many listed, or publicly traded, companies (about 4,000) as the United States, and those public companies were worth an estimated $15 trillion dollars at the end of last year. Its firms trade on bourses inside and outside of China, in Shanghai, Shenzhen, Hong Kong, New York, Singapore and Toronto.

As a result, American — and global — portfolios are now stuffed with some of China’s hottest companies, including its state-owned telecom and oil giants China Mobile and Sinopec. And Chinese startups routinely ring the opening bell at the Nasdaq and New York Stock Exchange.

Experts caution that Washington may have a difficult time dismantling a system that is backed by Wall Street’s biggest investment banks and global asset management firms. But political and economic tensions have created an unpredictable set of circumstances, including talk of “decoupling,” or breaking some of the ties that have been built up over the past three decades, in everything from manufacturing and supply chains to telecom and internet standards.

The Trump administration has stepped up pressure on China over trade practices and intellectual property protections, and has moved to blacklist the Chinese telecom giant Huawei and block its efforts to expand its inroads into the U.S. and elsewhere. And growing tensions over Covid-19 seem to have emboldened Congress to call out China more on human rights and other issues.

Analysts say there’s a growing sense in Washington that China is not just a strategic rival, but a threat to national security, and that helping finance even its publicly traded companies could harm America’s national interest.

In early May, Lawrence Kudlow, an assistant to the President on economic matters, and Robert O’Brien Jr., President Trump’s National Security Advisor, wrote a letter to the managers of the Federal Retirement Thrift Investment Board warning that allocating money to buy more shares of Chinese companies trading in mainland China “would channel federal employees’ money to companies that present significant national security and humanitarian concerns because they operate in violation of U.S. sanction laws and assist the Chinese Government’s efforts to build its military and oppress religious minorities.”

Meanwhile, Sen. Marco Rubio, the Florida Republican, has for several years been calling for the U.S. to delist Chinese companies from American stock markets if they cannot comply with U.S. laws on proper disclosure. As it now stands, Chinese companies listing in the U.S. do not make their auditing documents available to U.S. regulators or entities outside China because Beijing contends that granting access to those papers could reveal national secrets.

---

Like what you’re reading? Subscribe today for more in-depth, data-driven storytelling and expert analysis.

---

The bill that passed the Senate is called the Holding Foreign Companies Accountable Act and, among other things, would require companies to disclose whether they are owned or controlled by a foreign government.

Even if the U.S. moves to delist the Chinese companies trading in the U.S. markets, it could take years to go into effect. But analysts say the growing pressures could already influence Chinese companies listed in the U.S. to begin searching for offshore alternatives, possibly in Hong Kong or London. The threat of delistings could also disrupt the huge pipeline of Chinese startups that have plans to list outside of China, some of whom would be aiming at the Nasdaq and New York Stock Exchange. 

President Trump hinted at this a few weeks ago, when he said he was “looking” into whether Chinese companies should be forced to comply with U.S. accounting standards or face being delisted. But he also said he was reluctant to press forward because of concerns that some companies could select Hong Kong or London over the U.S. 

The effort to restrict American federal retirement funds — money put aside as a benefit for U.S government workers and veterans — could have far reaching consequences, especially when it comes to so-called China A shares, or renminbi-denominated stocks listed in China on the Shanghai and Shenzhen stock exchanges. Wall Street banks and American asset management companies have pressed aggressively in recent years for greater access to China’s financial markets, in the hopes of tying them into the global capital markets. China’s integration into those markets had also been backed by U.S. officials in the George W. Bush and Obama administrations.

And in recent years, global funds that track emerging markets have begun to include more China A shares. In 2018, for instance, MSCI Inc., one of the most widely followed global index providers, added Chinese A shares to its flagship Emerging Markets Index and All Country World Index. Soon after, other global index providers followed with similar moves. Today, about $13 trillion in assets under management are benchmarked to the MSCI indices.

The popularity of index-fund investing steers huge capital flows into the shares underlying MSCI indexes. MSCI has been gradually ramping up the weight of Chinese equities in global indexes to reach the full share they should hold according to MSCI’s formulas, which factor in the market capitalization of companies and the size of a given country’s economy.

“The Chinese capital market has grown enormously in the last 20 years, and it has become a huge share of the emerging market universe,” said Johannes Petry, a fellow at the Economic and Social Research Council in the United Kingdom who researches Chinese capital markets. By adding China A shares to major indices, index providers make it easier for investors to benefit from China’s growth, he added. 

CSOP Asset Management, a Hong Kong-based asset manager, estimates by the year 2028, about $400 billion in new money from outside China will flow into the Chinese A shares, so long as MSCI increases their weighting as planned, in its emerging markets index.

The China A share companies, however, look very different from Chinese stocks listed in the U.S. or Hong Kong, which include tech giants such as Alibaba and Tencent, and property companies like the Evergrande Group. Mainland Chinese stock exchanges are dominated by state-owned enterprises, banks, and energy firms. They also include companies that have recently been blacklisted by the U.S. government for abetting human rights abuses in Xinjiang region, where authorities have placed Muslim minorities in internment camps. That troubles some on Capitol Hill.

“It is incredibly troubling that a company like Hikvision, which is complicit in China’s human rights abuses in Xinjiang … or AviChina Industry & Technology Ltd., which is building missiles and other weapons designed to kill American service members, can get access to the U.S. capital markets through an MSCI index,” Sen. Rubio told The Wire in an email. “As a result, millions of retail investors and pensioners are unwittingly investing in opaque Chinese firms engaged in human rights abuses and a wide range of military-related activities.”

(Hikvision is traded on the Shenzhen Stock Exchange and AviChina is listed in Hong Kong.)

With the U.S. pushing for significant changes in the U.S.-China relationship, Kennedy, the expert at CSIS, says it’s unclear to what extent the U.S. and China will remain integrated. “This is now open for debate. Those who want to have Chinese companies remain integrated in the U.S. and have the opportunity to invest in China will now have to argue those positions are beneficial to the American economy and not detrimental to American values or national security,” he said.

But Mr. Kennedy also cautioned about the troubles these battles may bring. “If someone just stops and breathes, they might realize that some of these plans don’t make much sense and aren’t necessarily going to protect American investors,” he told The Wire. “Hopefully that type of conversation will occur before we go much further down this path.”

---