By Jing Yang and Dawn Lim
President Trump's recent executive order prohibiting Americans
from investing in companies tied to China's military complex has
set up a fight in the highest ranks of government over how broad
the list should be.
Since November, the White House barred U.S. investors from
buying into 35 Chinese companies the Pentagon has classified as
aiding China's defense, intelligence and security apparatus. It
sparked selloffs of Chinese stocks and bonds, forced index firms to
drop companies from marquee benchmarks, and pushed Wall Street to
reassess risks from investing in China.
Now, the U.S. government is at odds over whether the blacklist
should include subsidiaries of the companies. Another battlefront
is over whether affiliates should be included. The question affects
how much teeth the ban will have.
State Department and some Defense Department officials want the
executive order to have the widest reach, said people familiar with
the matter. They are arguing that excluding subsidiaries or
affiliates creates a loophole and ignores the reality of capital
markets, some of the people said. Most Chinese companies,
especially state-owned firms, tend to list their subsidiaries and
affiliates on the stock market, and may issue bonds through these
or other units.
Treasury wants the blacklist to only include the companies
specifically flagged by the Pentagon, and not affiliates or
subsidiaries, the people familiar with the matter said. That is a
view generally embraced by many on Wall Street given the fear that
a broad list could spook markets and prompt large amounts of forced
selling to scrub portfolios of problematic stocks.
"As directed in the law, we will build out the list to include
Chinese entities owned by, controlled by, or affiliated with the
Chinese military, government, or defense industry that operate
directly or indirectly in the United States (including through
trade and investment flows)," John Supple, a Defense Department
spokesman, said in an email.
A State Department spokesperson said the department doesn't
comment on interagency deliberations. Treasury is executing the
order and coordinating with other agencies, a senior official at
the department said.
A draft version of Treasury's guidelines on how the rule should
be implemented doesn't include affiliates and subsidiaries. The
agency tried to publish the list over the past week-and-a-half but
faced pushback from State Department officials, said some of the
people familiar with the matter.
The battle pits the office of Treasury Secretary Steven Mnuchin
against that of Secretary of State Mike Pompeo, who has long said
the funding of Chinese state-linked companies by U.S. investors
undermines national security. Government officials predict that the
stalemate will only be broken when President Trump weighs in, one
of the people said.
Treasury is tasked with providing guidelines over how the rule
will be implemented, after consultation with the secretaries of
state, defense and other agencies, according to the executive
order.
"Throughout the Trump administration, the hard-liners and free
traders have fiercely fought every inch of this trade war," said Ed
Mills, Washington policy analyst at Raymond James. "Mnuchin is
trying to see if he can win the last battle."
The executive order made in November bars trades in "securities
that are derivative of, or are designed to provide investment
exposure to such securities, of any Communist Chinese military
company." But the order didn't provide specifics around how
"derivative" should be defined and whether subsidiaries and
affiliates would be included.
The list includes popular holdings such as state-owned railcar
maker CRRC Corp., China's top chip maker Semiconductor
Manufacturing International Corp., and Hangzhou Hikvision Digital
Technology Co., which sells surveillance gear to track Chinese
citizens and technology that is installed world-wide. Government
officials have seen these companies as vehicles through which
Beijing gets access to technologies and military capabilities.
"This has become a stark debate between the security community
and Treasury and who's going to be given the mandate to interpret
and execute the president's intentions," said Roger Robinson,
president and chief executive of RWR Advisory Group and former
chairman of the U.S.-China Economic and Security Review
Commission.
So far, major index providers have taken a narrow interpretation
of the executive order.
MSCI Inc. this week announced its decision to drop stocks in
seven Chinese companies from marquee indexes and specifically said
it was only deleting companies named in the order and "not any
subsidiaries or affiliated companies."
The move amounts to less than 1% of the MSCI China Index's
market cap, and leaves untouched popular holdings such as China
Mobile Ltd. and oil major Cnooc Ltd. -- both subsidiaries of
companies identified by the executive order -- which together make
up for 1.7% of the index, according to a research report by Gavekal
Dragonomics.
Similarly, FTSE Russell, another major stock index provider,
said it would remove eight Chinese companies and make amendments
according to "an official list of sanctioned securities" to be
published by the Treasury Department's Office of Foreign Assets
Control.
The State Department published its own fact sheet on index
funds' exposure to the companies at the beginning of December. It
said at least 24 of the 35 companies classified as Communist
Chinese military companies had affiliates that were part of a major
index.
Meanwhile, asset managers are reaching out to the Biden
transition team to try to understand how a new administration would
interpret the executive order. U.S. investors are barred from the
purchase or investment in stocks, funds or other financial products
that include the firms, starting Jan. 11. The order gives investors
until November 2021 to get rid of their exposure to the Chinese
securities.
--Gordon Lubold and Kate Davidson contributed to this
article.
Write to Jing Yang at Jing.Yang@wsj.com and Dawn Lim at
dawn.lim@wsj.com
(END) Dow Jones Newswires
December 17, 2020 21:57 ET (02:57 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.
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