US Congress announces next capital wars

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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, America’s financial firms couldn’t be more bullish on the Middle Kingdom. Banks like Citigroup, Goldman Sachs and JPMorgan Chase are growing 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?

This is an issue that was brought to the fore by the annual report of the Chinese Economic and Security Review Commission, delivered to Congress last week, which recommended a host of new limits to business between the two countries, not only on goods and labor, but also capital flows.

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

As the most recent report states, not only is the Chinese Communist Party using economic coercion and increased state control to advance its own political model, “Chinese policymakers are courting foreign capital and fund managers so that they strive to ensure that Chinese capital markets serve as a vehicle for financing the CCP’s technological development goals and other political goals.

Among the 32 new recommendations to combat this phenomenon: limit investments in variable interest entities (VIEs) linked to Chinese entities; allow the Securities and Exchange Commission to require companies to disclose whether they source or invest in companies that use forced labor in Xinjiang or are on the list of entities of the United States Department of Commerce or companies in the military-industrial complex of the Treasury; and demand that US state-owned companies report whether there is a Chinese Communist Party committee in their operations. There are also suggestions on limiting the use of cloud computing and data service operations owned by Chinese companies.

The potential implications in the market if such rules were to become law are endless. Just consider the idea of ​​forcing “US listed companies with facilities in China” to report annually “if there is a Chinese Communist Party committee in their operations and to summarize corporate actions and decisions. in which these committees were able to participate ”. It may seem like an extreme move, but the overlap between non-state companies and the Communist Party in China has grown significantly in recent years.

Citing figures used by the CPC’s own organization department (and also cited by Western academics), the report notes that “in 1998, barely 0.9% of non-state enterprises had CPC committees, a figure which rose to 16% in 2008 In 2013, the presence of committees in non-state enterprises increased to 58%, and in 2017, it reached 73%, representing 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’s 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 prohibiting them from having foreign investors. These vehicles include the largest percentage of Chinese emissions by value sold on the US stock exchanges. But they are opaque; regulators like the SEC have raised concerns about the risks they pose to investors, who often do not get the same amount of information as traditional listed companies, and have no control whatsoever. governance.

If that were to happen, the combination of regulating VIEs, index providers that had a huge impact on fund flows to China, and approaching US-China capital flows as an ESG issue could move the market. Indeed, I would bet that capital will become the next front in US-Chinese economic decoupling.

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

It should be noted that the United States Economic and Security Review Commission in China was itself established by Congress in 2000 to oversee the development of relations between the two nations, even then. that China was in the process of becoming a member of the World Trade Organization. There were high hopes – but also doubts, even then – that China would become freer as it got richer. The doubts were of course well founded.

Anyone who thinks that there will not be more constraints on business between the two countries would be wise to read the report carefully.

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