US commission calls for stricter controls on flows to Chinese markets

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A US government committee has called for tighter controls on flows into China’s capital markets, a move that, if approved, would have profound implications for asset managers and index providers.

The last annual report of the US-China Economic Security Review Commission stressed security concerns from a huge surge in US investment. “An increase in US investor participation in China’s markets outpaces the US government’s defenses against the diverse threats to US national and economic security posed by US investments in some troubled Chinese companies,” the report said. to Congress.

“Despite ongoing tensions between the US and China, US investors, asset managers and mutual funds are increasing their participation in China’s financial markets,” it added.

It said US positions in Chinese stocks and debt rose 57.5% from $765 billion in 2017 to $1.2 trillion in 2020.

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

According to the report, “Chinese policymakers seek foreign capital and fund managers as they work to make China’s capital markets serve as a vehicle for [Chinese Communist party’s] technological development objectives and other policy objectives”.

The committee proposes broadening the scope of existing policies to close “loopholes”, noting that US institutional investors can still buy, sell and profit from Chinese military-related companies as long as they did not do that in the US and only non- US citizens.

“If we’re really interested in protecting American national security rather than just pretending, this loophole should be closed, as the committee recommends,” it argued.

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

This announcement in June seemed to allay some of US executives’ concerns that their onshore operations in China and Hong Kong could be severely impacted by US government policy.

The new commission report also focuses on how the Chinese government has opened up its capital markets to foreign investors.

“The Chinese government only allows foreign companies and investors to enter the Chinese market if it is in its national interest,” it said.

As a result, China’s nominal financial ‘opening’ is in reality a carefully managed process designed to strengthen state control over capital markets and channel foreign funding to achieve the Chinese government’s national development goals, the committee said. .

A specific issue that emerges from the committee’s analysis is asset managers’ allocation to Chinese assets through passively managed funds.

Most recently, FTSE Russell began phasing of Chinese debt in its flagship World Government Bond Index. Due to the gradual withdrawal process, which started on October 29, Chinese government bonds will make up a total of 5.25 percent of the index over three years.

The report said the substantial increase in the inclusion of Chinese securities in investment indexes automated the allocation of US investors to Chinese companies.

“Because passively managed index funds replicate these indices and actively managed funds strive to at least outperform, index providers have played a critical but unregulated role in guiding foreign portfolio investments toward Chinese companies,” it added.

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

The committee also advises Congress to provide the US Treasury with an annual update on the accurate investment position of the US portfolio in China since 2008, including money routed through offshore centers such as the Cayman Islands.

US President Joe Biden signed an executive order in early June forbid Americans are investing in 59 Chinese companies, ranging from the security and defense sectors, over alleged ties to the Chinese military, an extension of a previous order by former President Donald Trump. However, the order also appeared to limit policy space, allaying some concerns that US fund groups in Asia could be severely hampered by the restrictions.

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

Additional reporting by Echo Huang

*Ignites Asia is a news service published by FT Specialist for professionals working in the wealth 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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