Businesses and investors now have to be well versed in the language and implications of export controls, national security interests in foreign direct investment, lists of companies forbidden to sell or trade certain products, financial restrictions, and the sanctioning of individuals, and business and other entities.
Bilateral trade tariffs now seem rather dated as measures and counter-measures have moved on to restrictions on the terms under which companies can engage with one another, especially in technology and telecommunications. The US has a lengthening ‘entity list’ of Chinese companies and other organisations with which US firms are restricted from doing business unless they have license. Restrictions apply to Chinese companies with links to the People’s Liberation Army, the implementation of repression in both Xinjiang and the National Security Law in Hong Kong, and those militarising disputed islands in the South China Sea.
A whole-of-government infrastructure of restraint has been assembled in Washington, including the Commerce Department’s Bureau of Industry and Security, which oversees technology and export controls; the Treasury’s Office of Foreign Assets Control which administers sanctions, including on individuals and entities in Xinjiang and Hong Kong; the Justice Department’s National Security Division, which authorises criminal prosecutions in relation to theft of trade secrets and intellectual property; and the interagency Committee on Foreign Investment in the United States, which polices foreign direct investment, now with a wider brief, following the Foreign Investment Risk Review Modernisation Act 2018, and the Strategic Competition Act.
In 2021, in further tit-for-tat sanctions, the US, UK, EU and Canada imposed new measures against individuals and entities deemed to be responsible for genocide in Xinjiang, to which China retaliated by imposing its own sanctions, including on European Parliament members, EU officials and a major China think tank and its employees in Berlin, and also UK parliamentarians, and other UK individuals and entities. In the wake of China’s sanctions, the European Parliament voted to freeze the Comprehensive Agreement on Investment, bilateral Sino-EU investment treaty, signed to great fanfare in late 2020.
Earlier this year, China’s Ministry of Commerce introduced Rules on Blocking Unjustified Extraterritorial Application of Foreign Legislation and Other Measures, designed to help both local and foreign firms nullify the effect of US export controls and sanctions that apply to companies outside China. These complement the previously passed Export Control Law, which restricts the sale of certain products to foreign entities, and establishment of Provisions on the List of Unreliable Entities which restrict business with foreign entities that are deemed harmful to China or its agencies and corporations. In June, the Anti-Foreign Sanctions Law was passed, ostensibly providing a legal umbrella for firms operating in China to appeal against having to comply with third party sanctions or face penalties if they do. In practice, these laws and regulations may be intended principally, not so much for rigorous implementation, but to force companies to comply with what Beijing wants. We should assume, though, there is no risk of test cases to prove a point.
Foreign investors have been drawn to China’s bond and equity markets by choice through active managers, passively as the weightings of Chinese financial assets in global benchmark bond and equity indices have risen, or through exchange traded funds. Foreign portfolio investment into China rose by over 40 per cent in the year to June 2021, reaching over $800 billion.
For institutional investors at least, the promise of growth and expanding market size has been sufficient until now to compensate for drawbacks such as the lack of transparency in company reporting and prospectuses, inadequate pricing of risk, unreliable credit ratings, and a rising number of credit events. We can imagine though that retail investors and perhaps in due course institutions will come to reconsider the nature of their exposure to Chinese firms and assets. At the very least, they will have to factor in valuations that reflect new political risks and the volatility of political and regulatory decision-making in both Beijing and Washington.
Financial sanctions have been implemented against Chinese officials and entities in Xinjiang and Hong Kong. Federal pension funds have been banned from investing in Chinese stocks. By executive order, US investors are required to divest from about 35 Chinese firms tied to the People’s Liberation Army and other surveillance agencies, and over 200 Chinese firms listed on US exchanges have been given limited time to comply with US accounting standards or be delisted under the Holding Foreign Companies Accountable Act 2020.
Conclusion
It is at present impossible to envisage how or when there might be a material improvement in Sino-US relations. Trade, technology sector, and financial and travel sanctions and restraints have already been used against entities and individuals, sometimes as signalling devices, and sometimes in anger, but with real world consequences for firms and markets, nonetheless.
For the time being, the US should be expected to want to exploit the leverage it holds over China in respect of both technology and finance. China is reliant on US technology firms and imports, and the US dollar remains the world’s principal reserve currency, used for most external funding and financing, including by China. If sensitive issues, for example in the South China Sea or Taiwan, were to deteriorate markedly, we should expect the US to use these tools more intensively.
This reality, though, is also driving Beijing to carve out space for itself beyond the reach of US financial power, by trying to construct with Russia and other nations alternatives to US dollar payments and clearing structures, and by internationalising the yuan along with its own digital currency. To these ends, it may act to both nurture and penalise, even though these goals are fraught with contradictions, and are barely achievable as things stand.
For the foreseeable future, businesses and investors will have to assume that the regulatory and financial environment will be hostage to escalation and volatility.