While a broader decoupling between the United States and China is underway, terms from the military have entered the financial encyclopedia, signaling a growing rift between the two nations.
“Armed financial networks”, referring to the US imposing financial sanctions to address critical chokepoints in the financial architecture, to allusions to the “nuclear option” that threatens excommunication from the US dollar-dominated SWIFT messaging system, are now often joked about. The hardening rhetoric marks a remarkable shift for the financial sector, which until this point has stood as an oasis of cooperation that promotes meaningful cooperation rather than accentuating a broader systemic rivalry.
Although many point to China’s gradual withdrawal of the dollar and the development of the cross-border interbank payment system (CIPS), a homemade alternative to the SWIFT network, as a sign of financial decoupling, the reality is that throughout its ongoing history, China has always and will always continue with setting out a separate and distinct course.
What would a broader economic decoupling look like? The looming danger to the decoupling narrative stems from bills and regulatory mandates that pose a threat to free one of the remaining bastions of bilateral financial cooperation and bring it out into unknown waters.
In the United States, a growing chorus of lawmakers is calling for greater control over incoming investment from China in the United States and outgoing U.S. investment in Chinese companies. By early 2021, U.S. investors had about $ 1.2 trillion in Chinese equities and bonds, while Chinese entities had invested $ 2.1 trillion in public U.S. debt and equity securities, according to US China Investment Project.
Caught in the crosshairs is a review of certain government pension vehicles with hundreds of billions of dollars at their disposal, which have allocated funds to Chinese public equity investments. And while the stock market grabs virtually the entire spotlight, Chinese debt markets have been almost as active and adept at luring U.S. capital from investors seeking higher returns.
Currently, there is no disclosure obligation for private equity and venture capital funds to disclose their holdings of Chinese assets. But if the constant drumming of proposals from China hawks finds a receptive audience on Capitol Hill, it is not inconceivable to imagine future disclosure from private investment firms under the guise of national security.
Unchecked decoupling could rise in a nightmare scenario where US investors would lose $ 25 billion a year in capital gains and a one-time GDP loss of half of US foreign direct investment (FDI) in China. up to $ 500 billion according to a joint report issued by the US Chamber of Commerce and the Rhodium Group.
For its part, the Securities and Exchange Commission (SEC) has increased its vigilance toward Chinese firms seeking to list in the United States. Bulk-up registration statements that expand and highlight the risk of investing in China – are now the norm. Last year, SEC Chairman Gary Gensler temporarily closed the valve on the constant flow of Chinese cross-border IPOs, to allow a thorough review of the listing process. These days, any entity that prepares a registration statement as a precursor to a public listing will notice a major study of risks related to the structures and rules of variable rate entities (VIEs) and rules subject to conducting business in China.
A long-running dispute between China and the United States has undermined Beijing’s rules on audit secrecy and is pushing back Washington’s bid for access to those audits. Since last summer, officials at the SEC and their counterparts at the China Securities Regulatory Commission (CSRC) have been trying to devise an audit cooperation model that would be available to both governments, all to stop the twisted clock on the first wave of Chinese companies that are subject to delisting in 2024. A lone ray of hope broke through the dead end recently when Beijing announced a revision of its audit secrecy laws, which had become obsolete and no longer serve today’s dynamic listing environment.
Common sense regulation is clearly understandable. But for Chinese companies, alternative investment channels are still available. Local businesses can take advantage of the original markets of Shanghai, Shenzhen, Hong Kong and the newly launched Beijing Stock Exchange, which acts as a launching pad for small and medium-sized businesses. As the chorus for delisting has gotten louder, the constant march of secondary listings is back to Greater China.
Suppose the doomsday scenario where a large cluster of Chinese companies are systematically pushed away from US stock exchanges and knocked back to the mainland. In addition to additional restrictions, U.S. investors will still be able to invest in these firms on their home exchange. Investor portfolios would simply replace American Depository Receipts (ADRs) traded in New York with ORDs (common stock) traded on the local Chinese market. The larger argument is that restricting Chinese companies from U.S. capital markets does not block them from accessing U.S. capital. Capital is global.
Another route may be to take Chinese companies on a trip to international liquidity venues, such as those in London or continental Europe, to seek a stock exchange listing. If all else fails, companies can take themselves out of the stock market. Private equity firms would be too eager to facilitate a “going private” transaction, in which existing shareholders in the listed entity are bought out, likely at a premium, as the company is transformed into a private company.
In this context, Beijing has taken steps to slow the growing pace of companies listed abroad. New rules, including a multi-step review by the Cyberspace Administration of China (CAC) for companies in sensitive sectors, contribute to an already lengthy approval process. Highly publicized regulatory measures taken against Didi and other technological high-flyers, along with concerns about hidden risks in the real estate sector, have dampened the appetite of foreign investors. These influxes are washing up against an opposite wave of reforms and the opening up of the financial sector, with gradual progress being made to liberalize the capital account and ease foreign financial institutional ownership boundaries in domestic companies. These competing forces have resulted in a staggering whiplash of emotion – investors are attracted to the long-term investment thesis, while being repulsed by arbitrary regulatory enforcement.
Political actions that disrupt economic relations entail great costs for both nations. The sparse but continuing hint of a disruption of bilateral portfolio flows is enough to raise capital costs and redirect these flows to other recipients. Some investors may even voluntarily divest Chinese assets to circumvent political landmines. A turnaround in portfolio investment to China may intensify over time contagious effect on the exchange rate, weakening it and increasing imbalances in the bilateral trade flow. Ultimately, a firm hand is needed to protect itself from the patina of legitimacy given to proposals that until recently have been on the edge. Doing so will ensure that Sino-US financial commitments in the future are rock solid and securely anchored.
Joel A. Gallo is CFO of ETAO International Group and Adjunct Faculty at New York University Shanghai.
The views and opinions expressed in this section are those of the authors and do not necessarily reflect the editorial views of Caixin Media.
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