US institutional investors may face restrictions on owning Chinese stocks.
US institutional investors may face restrictions on owning Chinese stocks.
U.S. Congressional Examining Chinese Stock Holdings in BlackRock Funds
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In a recent development, a U.S. congressional committee has launched an examination into Chinese stock holdings in BlackRock funds built on MSCI indexes. Analysts speculate that this investigation may signal a broader clampdown on U.S. institutional investment in such shares, as there are concerns in Washington that American capital could potentially aid Beijing in gaining military or technological advantages.
The relationship between the United States and China is currently strained, with tensions arising from various issues including Taiwan and the Ukraine war. In response, the Biden administration is contemplating new restrictions on outbound private investment in China, in addition to the existing bans on certain technology sales and other trade measures.
The congressional committee has raised questions regarding BlackRock and index provider MSCI’s facilitation of investments in companies linked to Chinese human rights abuses or its military. This scrutiny extends to products such as BlackRock’s iShares MSCI Emerging Markets exchange-traded fund, which includes Chinese shares.
It is not only BlackRock and MSCI that are being questioned. The committee has initiated inquiries into other companies regarding their China ties. Analysts suggest that more such investigations and increased restrictions on U.S. investing in Chinese shares are likely to follow.
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Jo Ritcey-Donohue, an attorney advising institutional investors, warns clients to anticipate additional and more stringent actions that may prohibit or complicate investing in China, as well as greater scrutiny of existing investments. As cross-border tensions persist, U.S. businesses should brace for continued pressure.
BlackRock responded to the examination by stating that it is one of the 16 asset managers offering U.S. index funds holding Chinese companies. The company maintains compliance with all U.S. laws and has expressed readiness to engage with the select committee. Similarly, MSCI is reviewing the committee’s inquiry.
The Rush of Money
A long-standing issue of concern is the extent to which Western capital enables authoritarian regimes. This issue has been further intensified by the influx of money into low-cost index funds.
For institutional investors, China, as the world’s second-largest economy, plays a crucial role in international portfolios and indexes. Notably, Chinese companies such as Tencent and Alibaba accounted for 31% of the MSCI Emerging Markets index in July.
Committee Chair Mike Gallagher clarifies that U.S. companies involved are not engaged in illegal activities. However, he emphasizes the need for Congress to address any existing loopholes. Gallagher commented that he is not advocating for a complete cut-off of the economic relationship with China. Nevertheless, the committee is actively deliberating on implementing “guardrails on outbound capital flows.”
Notably, the committee has the authority to make policy recommendations, with bipartisan support for taking a firm stance against China.
Todd Rosenbluth, head of research for financial analysis firm VettaFi, explains that while BlackRock and MSCI are the prominent firms in the index-investment space, laws or regulations that emerge from the examination are likely to apply across the industry. Competing products, like the Vanguard FTSE Emerging Markets ETF, would be subject to such rules as well. Vanguard declined to comment on the matter.
Red-Flagged Companies
In 2020, MSCI and its competitors removed seven Chinese companies from global indexes due to U.S. ownership restrictions. A similar move was made by MSCI and FTSE Russell with Russian equities following Russia’s invasion of Ukraine. A representative from FTSE Russell declined to comment on the current situation.
The committee’s recent correspondence refers to contractors with ties to China’s People’s Liberation Army that were identified in BlackRock funds or MSCI indexes. Some of these companies have been flagged, appearing on the U.S. Treasury’s “Chinese Military-Industrial Complex” companies list. While these companies face purchase and sale restrictions, divestment requirements have not been imposed on U.S. persons and asset managers.
Notably, several subsidiaries of these flagged companies remain eligible for U.S. investment, at least for now. However, they are subject to other sanctions such as the Department of Commerce’s Military End User list, which restricts certain trade with these entities.
In conclusion, the ongoing U.S. congressional examination into Chinese stock holdings in BlackRock funds has far-reaching implications. It sets the stage for potential broader restrictions on U.S. institutional investment in Chinese shares, aligning with Washington’s concerns over national security and human rights. As the investigation unfolds, companies and investors need to be prepared for further actions and increased scrutiny in this tense economic landscape.
