Treasury’s Weak Denial Acts as Confirmation: US Weighs Crackdown on Capital Flows to Chinese Companies, Stocks & Bonds, Listed in the US or China

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Wolf Richter,

Stocks of Chinese companies listed in the US have turned into a fiasco.

The US Treasury Department’s denial on Saturday focused on only one item, omitted to deny the other crucial items, and made the denial even soggier by ending it with “…at this time.” With this statement, sent to Bloomberg on Saturday, the Treasury was reacting to revelations by Bloomberg on Friday:

“The administration is not contemplating blocking Chinese companies from listing shares on U.S. stock exchanges at this time.”

According to sources, a group led by Peter Navarro, Assistant to the President and Director of the Office of Trade and Manufacturing Policy, is pushing a multifaceted and broad crackdown on capital flows from US investors to Chinese companies.

The National Security Council and the Treasury are part of the discussions. The National Economic Council has been chairing meetings on the issue and is working on an analysis of the potential impact of any limits on these capital flows.

According to Bloomberg’s sources, action is not imminent, but the officials are discussing options and repercussions, and “even more dovish advisers have rallied behind some of their suggestions.”

The benefits and risks of a financial decoupling from China — including how it could even be done and what impact it might have on American investors — was discussed last week at a dinner hosted by the Center for Strategic and International Studies in Washington. Attendants included White House economic adviser Larry Kudlow; Number 2 on the National Security Council Matt Pottinger; and members of Congress.

The measures that the Trump Administration is contemplating are running roughly in parallel with efforts by Florida Republican Senator Marco Rubio and others in Congress who have already put forward legislation to that effect. The Trump Administration is discussing its plans with Rubio and is considering backing his legislation.

Rubio said in a statement: “This administration deserves credit for their efforts to deal with the threat that the Chinese government and Communist Party poses to U.S. national and economic security, including how Beijing takes advantage of its access to U.S. capital markets for predatory purposes.”

Among the items contemplated by the Trump Administration:

Delisting Chinese companies from US stock exchanges. Most of these companies trade as American Depositary Receipts (ADRs) in the US that do not convey ownership in the company in China, but only in some kind of off-shore entity. This includes Alibaba.

The dollars involved are big. According to the US-China Economic and Security Review Commission, cited by Bloomberg, the combined market capitalization of ADRs of 156 Chinese companies traded in the US was $1.2 trillion as of late February. This includes at least 11 state-owned companies. Alibaba alone accounts for $432 billion of this, as of Friday.

Curtailing Americans’ exposure to Chinese companies via US government pension funds. These are retirement funds administered by the Federal Retirement Thrift Investment Board. “According to several people involved in the discussions,” there is new momentum among lawmakers on this issue as these funds are facing a deadline next year to plow billions of their beneficiaries’ dollars into Chinese companies.

Imposing limits on Chinese companies included in stock indices managed by US firms. There are many funds that track these indices. Americans that buy these funds, indirectly own shares of the hundreds of Chinese companies that have been included in these indices. These may be companies listed in China or in the US. It includes Chinese bonds that have filtered into bond funds sold to Americans.

One of the reasons for curtailing capital flows from American to Chinese companies is that with these investments, unwitting Americans – they only know that they bought some broad equity or bond fund – are supporting the Chinese Communist Party and an increasingly difficult strategic and economic rival.

Other reasons are focused on protecting unwitting Americans from being indirectly exposed to the risks of Chinese companies with their opaque and sorely lacking financial disclosures.

Chinese ADRs have been a fiasco recently for US investors.

In reaction to the news on Friday, the ADRs of Chinese companies traded on US exchanges sank even further. Here are some of the legitimate Chinese companies that I track. There is a slew of toxic ones traded in the US, but I don’t bother with them. This is the cream of the crop. All but one have plunged from their peaks, and some went public in the US fairly recently:

  • Alibaba [BABA]: -5.2% on Friday; -20% since its peak in June 2018
  • com [JD]: -6% on Friday; -44% since its peak in January 2018.
  • Baidu [BIDU]: -3.7% on Friday; -59% since its peak in May 2018.
  • Weibo [WB]: -3.1% on Friday; -68% since its peak in February 2018.
  • Pinduoduo [PDD]: -4.2% on Friday; -15% since its peak on September 13. Its US IPO was in July 2018.
  • netEase [NTES]: -4.6% on Friday; -43% since its peak in December 2017.
  • Tencent Holding [TCEHY]: -2.6% on Friday; -33% since the peak in January 2018.
  • Tencent Music [TME]: -1% on Friday; -33% since its peak in April 2019. Its US IPO was in Dec 2018.
  • Sina Corp [SINA]: -3.8% on Friday; -68% since its peak in March 2018.
  • Tal Education Group [TAL]: -4.5% on Friday; -28% since its peak in June 2018.
  • com [CTRP]: -2.7% in Friday; -51% since its peak in Jul 2017.
  • New Oriental Education [EDU]: -7.45 on Friday, from a new high on Thursday.
  • iQiyi [IQ]: -4.1% on Friday; -59% since its peak in Jun 2018, three months after its US IPO in Mar 2018.
  • NIO [NIO]: -10.7% on Friday; -83% since its peak in Mar this year. The collapsing EV maker had its US IPO in October 2018, when it extracted $1.1 billion from US investors.

This is why no one should be an unwitting investor in Chinese companies! If you make a conscious decision on the risk and rewards of investing in NIO, and you get your face ripped off, so be it. But no one buying an equity fund or bond fund should be exposed to Chinese companies until they get their act together – that includes financial disclosures and scrutiny in the US on at least the same level as US companies face in the US.

But hundreds of Chinese companies – those traded in the US and those traded in China – have recently been added to indices that are tracked by mutual funds, ETFs, and pension funds that Americans have their money tied up in.

How to do it, that’s the question.

How to turn any proposals put forward into action is not going to be easy under US law, and the mechanism for some of them have not been worked out yet, according to sources cited by Bloomberg. The proposed mechanisms include:

  • Imposing the same financial disclosure and transparency rules and the same scrutiny on Chinese companies that US companies are subject to in the US. And if they fail to comply, delist them in the US.
  • Creating a level of reciprocity between China and the US.
  • Raising national-security concerns over some Chinese companies that US pension funds are exposed to.

One source told Bloomberg that President Trump has given the green light for the discussions, but if a plan emerges, he would still need to approve it. The administration – particularly the Treasury Department and the National Economic Council – is hesitant to pursue this, fearing that investors could get spooked, and “that the already fragile economic relationship between Beijing and Washington could collapse.”

Those hesitant officials want to convey to stakeholders that the rule of law in the US can be trusted and that any such policies are directed against companies that have persistently been out of compliance with US laws.

These are layers of complex ideas that are difficult to implement, though some of them – such as putting Chinese companies under greater scrutiny and imposing US transparency and disclosure requirements – should have been implemented years ago.


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