The Capital War – – the big red button
A U.S. 100 dollar banknote and a Chinese 100 yuan banknote(Photo provided by:アフロ)

 Just as the latest round of trade tariffs comes into effect a more significant front in the ongoing divergence between China and the United States is expanding.  Trade negotiators finished a brief Shanghai round of discussions in late July and it looked like August would be a holiday month with little to rattle markets.  Events soon proved otherwise, and the past month has seen dramatic moves in markets and politics.  Trade talks are scheduled for some time in September but resolution of the expanding list of problems between the world’s two largest economies are not being completed any time soon.  If President Trump wanted a clean and comprehensive deal before the 2020 elections it looks like he will be disappointed.

 August saw the trade war expand into the capital war.  This should not be surprising.  In June Senator Marco Rubio introduced the Equitable Act (Ensuring Quality formation and Transparency for Abroad-Based Listings on our Exchanges Act).  This short 10-page bill is designed to ensure that overseas companies, and particularly Chinese companies, provide a level of public disclosure and transparency which US companies are required to do.  It required audits of HK and Chinese based companies to be overseen and subject to periodic inspection by the Public Company Accounting Oversight Board (PCAOB).  Both the Securities and Exchange Commission and the PCOAB had warned in 2018 that audits relating to Chinese companies could not be trusted.  The usual US disclosure standards could not be applied to these companies.  The Equitable Act further requires issuers to disclose the percentage of state ownership of the entity and the name of any Communist Party members who are on the board of directors.

 The problems around lack of PCOAB oversight are well known and have been raised for years but the rush for China exposure meant that these genuine concerns were played down by all in the rush for business.  The PCOAB cites 156 Chinese companies listed across the three largest US stock exchanges as of February 2019 although Chinese domestic information provider WIND Information gives a figure of 230.  Total listed value runs to over 1 trillion USD with Alibaba being the largest name but other high-profile companies like China Mobile, PetroChina, China Life Insurance and the elite of the Chinese internet, JD.com, Baidu, Tencent Music are all represented.  The Act was only an early taster of what was to come.

 After the inconclusive talks in Shanghai markets took comfort that at least the two sides were talking again.  That comfort was shattered on 2 August as Trump announced more tariffs only to have the Chinese respond on Monday 5 August.  A general strike had been called in Hong Kong that day as the Anti-extradition bill protests continued but more meaningfully it saw the People’s Bank of China allow the Chinese yuan to trade through the all-important 7 yuan to the dollar level.  For months the allowable trading range had been beyond 7 but the central bank had never let the currency trade through the psychologically key level.  By August month end what had been unthinkable for years had become the norm.  The currency currently trades around 7.15 yuan to the dollar.  A fall of 3.8% for the month.  The fall was seen by some as the weaponization of the renminbi and designed to help offset the trade tariffs.  Beijing is caught in a difficult position, it wants to show it can retaliate against the US and a depreciation of the currency is an easy way to do that, but it risks much greater capital flight out of China, something it wants to avoid.  China wants to be seen as taking the high moral ground in this fight and show that the Chinese yuan can be a safe haven currency.  That won’t happen it keeps devaluing it.  In response the US Treasury labelled the Chinese a currency manipulator, ignoring their own tests, they took the view that to break 7 was significant enough to warrant the status.

 The Hong Kong Protests continued and expanded through August and while the White House sent mixed messages at times about their support for free speech and democracy the Chinese side exposed clearly their view of corporate ownership and its role towards the Chinese state.  Beijing’s strong arming of Cathay Pacific, and other companies in Hong Kong, to abide by their political line on the protests showed that Beijing cares not for ownership or control.  It demands companies, private or state, Chinese or not, to accede to their political positions if they want to do business with China.  How then can Beijing try and suggest that Huawei Technologies, which is at the heart of the trade war, simply be a private company independent from the State?  This is important because Senator Rubio expanded again his capital war front but focusing on funding of Chinese companies by US capital markets.

 It has been suggested that delisting of Chinese companies from the US exchanges will benefit Hong Kong as Chinese companies will simply flip their listing into the welcoming arms of HK Exchanges.  But this is far from certain.  Firstly the continuing unrest in Hong Kong, which in part has caused Alibaba to postpone its secondary listing in the city shows no sign of abating and even if the immediate issues surrounding the extradition bill are addressed there are bigger issues around political representation and Beijing’s overreach into HK society which would indicate that Hong Kong will remain the city of protest for years to come.  But Rubio’s second line of attack is to deny Chinese companies access to US capital regardless of listing venue.  He is one of a number of lawmakers who have written to the Federal Retirement Thrift Investment Board to reverse its decision to allocate part of their funds into a passive investment strategy tracking the MSCI All World Index.  As Rubio told the Financial Times newspaper “The Federal Retirement Thrift Investment Board made a short-sighted — and foolish —decision to effectively fund the Chinese government and Communist party’s efforts to undermine US economic and national security with the retirement savings of members of the US Armed Services and other federal employees,”.  Rubio correctly points out that to track this index will require the buying of selected Chinese shares.  The senators point to three companies which cause concern due to their connections to the Chinese state.  The most prominent is China Mobile the mobile network provider which is barred from the US market on security concerns, yet the Federal funds of the Thrift Board would be investing in the very same company.  It makes no sense to take on China across a broad range of economic and security issues while at the same time allowing US Federal and private funds to be financing the very companies which are under sanction and restriction.

 International and US investors gain access to Chinese shares through three main routes.  The first is via listings of Chinese companies in the US and other non-Mainland PRC locations.  Hong Kong is the most prominent with all large State Owned Enterprises listed there.  Next comes the QFII and R-QFII programs which allow large institutional style investors direct access to the domestic A share market.  To date US firms have been allocated around 15 billion USD of investment quota via these schemes.  The most recent channel is through China Connect, an innovative facility which allows access to approximately half of the listed A shares companies via the HK Exchange trading infrastructure.  As tensions rise it is certainly plausible that the US would look to limit US inflows through all these channels.  Restrictions could be at the Federal level, individual State level, specific company sanction or indeed blanket restriction.  Ironically it has been the opening of China Connect and the genuine opening of the domestic market which has led to the inclusion of Chinese shares into the US based MSCI series of indices.  The very index which the Thrift Board seeks to track.  And Rubio has indeed asked MSCI why they have included Chinese companies into their indices given the poor quality of disclosure and ties to the Communist Party.

 Any serious attempt to restrict US funds into Chinese shares would have a dramatic impact on prices.  Removal of Chinese shares from MSCI indices would see billions of USD of outflows and an across the board dumping of Chinese shares by all investors.  Such restrictions would once have seemed farfetched but it is very plausible that in the same way coal and tobacco stocks fell out of favour with some investor groups citing moral and health concerns it is certainly possible that funds will restrict China exposure due to either concerns surrounding Xinjiang or HK or in response to US legal constraints.  The US already has the mechanism to restrict certain investment via the Dept of Treasury’s Office of Foreign Asset Control.  It has been used to target selected Russian assets and in one case US firm Bloomberg refused to publish shares prices of HK listed Rusal for fear of falling foul of the regulations.

 The consequences of such action on the part of the US would be extreme and be felt for years.  For 20 years US firms as banks or brokers or investors, have lobbied with varying degrees to access Chinese financial markets.  PetroChina one of the largest of the US listed Chinese companies came to market with CICC, a Morgan Stanley joint-venture broker, and Goldman Sachs as the lead underwriters.  Wall Street was instrumental in building today’s National level SOES.    To think that the US would now effectively outlaw US powerhouses like JPMorgan, Goldman Sachs, Bank of America or Morgan Stanley from dealing and investing in China just as China now starts to open makes no sense at all.  Yet only in the past few weeks has President Trump “ordered” US firms to find an alternative to China.  But his thinking reflects an outmoded view of the Chinese market.  China is not just a location of cheap labour, it is the world’s second largest economy and a source of sales and revenues for all large US and multi-national companies.  They have become more vocal in expressing their frustrations with China and having to operate in a such a difficult and at times hostile marketplace, but no US car producer wants to retreat from the world’s largest car market.  Apple may move production out of China, but it still wants to sell iPhones to Chinese consumers.

 Restricting capital flows really does seem to be the nuclear option given the consequences.  It will almost certainly see China start to sell it US treasury holdings in retaliation and would completely stop any ability to somehow agree a trade deal.  But selective targeting of China assets may be inevitable.  Why would the US sanction US based capital to fund companies connected to the Chinese PLA or involved in gross human rights violations?  How can a company deemed to be a security risk by the Federal government at the same time be financed by State or Federal pension funds?  There are no simple answers and the complexity of the problem shows how the US and China have become ever more intertwined over the past 20 years of economic opening.

 Rubio’s Equitable Act seems rationale and fair.  Holding listed companies to common standards makes sense and is long overdue.  Special and consistent restrictions across selected companies or even sectors could be justified but turning away entirely from the world’s second largest stockmarket just as it opens cannot be justified unless the future of US China engagement is one of complete rejection and avoidance.  Yet which global company doesn’t have substantial business in China?  Should US capital also be restricted from Australian commodity companies or Volkswagen because they all have significant dependence on China?

 The capital war has only just begun.  Senator Rubio is front and center of the push back on Chinese influence and companies.  He is instrumental is opening up the capital war front and also for calling for stronger support of the HK protests.  At present though the capital war is far from a coherent strategy, instead it is a series of related but distinct actions without a clear endpoint.  If you thought the challenge to China was only about soybeans, white goods and telecoms you are wrong.  The dollar in your mutual fund, pension fund or 401k plan is starting to take center stage.

フレイザー・ハウイー(Howie, Fraser)|アナリスト。ケンブリッジ大学で物理を専攻し、北京語言文化大学で中国語を学んだのち、20年以上にわたりアジア株を中心に取引と分析、執筆活動を行う。この間、香港、北京、シンガポールでベアリングス銀行、バンカース・トラスト、モルガン・スタンレー、中国国際金融(CICC)に勤務。2003年から2012年まではフランス系証券会社のCLSAアジア・パシフィック・マーケッツ(シンガポール)で上場派生商品と疑似ストックオプション担当の代表取締役を務めた。「エコノミスト」誌2011年ブック・オブ・ザ・イヤーを受賞し、ブルームバーグのビジネス書トップ10に選ばれた“Red Capitalism : The Fragile Financial Foundations of China's Extraordinary Rise”(赤い資本主義:中国の並外れた成長と脆弱な金融基盤)をはじめ、3冊の共著書がある。「ウォール・ストリート・ジャーナル」、「フォーリン・ポリシー」、「チャイナ・エコノミック・クォータリー」、「日経アジアレビュー」に定期的に寄稿するほか、CNBC、ブルームバーグ、BBCにコメンテーターとして頻繫に登場している。 // Fraser Howie is co-author of three books on the Chinese financial system, Red Capitalism: The Fragile Financial Foundations of China’s Extraordinary Rise (named a Book of the Year 2011 by The Economist magazine and one of the top ten business books of the year by Bloomberg), Privatizing China: Inside China’s Stock Markets and “To Get Rich is Glorious” China’s Stock Market in the ‘80s and ‘90s. He studied Natural Sciences (Physics) at Cambridge University and Chinese at Beijing Language and Culture University and for over twenty years has been trading, analyzing and writing about Asian stock markets. During that time he has worked in Hong Kong Beijing and Singapore. He has worked for Baring Securities, Bankers Trust, Morgan Stanley, CICC and from 2003 to 2012 he worked at CLSA as a Managing Director in the Listed Derivatives and Synthetic Equity department. His work has been published in the Wall Street Journal, Foreign Policy, China Economic Quarterly and the Nikkei Asian Review, and is a regular commentator on CNBC, Bloomberg and the BBC.