Retirement Funds Are in the Crosshairs of US-China Conflict
Art by A Richard Allen
The Trump Administration wants to bar a federal retirement fund from investing in Chinese companies. But the idea is getting pushback from critics who say the plan is not in the interest of US investors.
At issue is the Thrift Savings Plan, which is a defined contribution plan for federal civil service workers, retirees, and members of uniformed services is considering adding an MSCI index that includes China-A shares. Plan assets totaled $590.8 billion for 5.6 million participants as of this past April.
“I would be much more comfortable with the US blocking the Thrift board from investing in particular entities that may be complicit in a human rights violation or that has stolen technology rather than saying the Thrift board can’t invest in China,” said Derek Scissors, a China expert at the American Enterprise Institute (AEI), of the governing body one of the biggest federal-worker retirement programs. “The US government shouldn’t be involved in across-the-board bans.”
The debate is the potential for US government retirement funds financing China’s economic rise. According to Bloomberg, the administration wants to force stock indexes to drop firms that the administration considers a material risk to US investors. Lawmakers and China hawks outside the government have joined the fight as well.
Some Chinese firms, the White House believes, duck regulatory oversight. The administration argues that these firms either committed human rights violations or are national security risks. The retirement board is meeting on October 28 and China is expected to be a topic on the agenda.
Cutting off US investment in China, which comprises one-third of the world’s economic growth, will harm US companies more than it does the Chinese, critics say. “The US is making a political statement rather than having an actual impact on capital flow,” said Maggie Ralbovsky, managing director for Wilshire Consulting. “Chinese companies will look for substitute sources of capital and there’s plenty of it.” Sovereign wealth funds and European funds are likely targets.
Ralbovsky said that brinksmanship is no longer a viable option for the US, which should opt for engagement. China now holds around 6% of US Treasury obligations. If the US isolates China, some fear it could retaliate by selling Treasury bonds, which would disrupt the capital markets. An isolationist sentiment eventually could have a negative impact on the supply chain that will hurt US companies, she said.
Outside the US, China tensions are having no significant impact on investment decisions. “Other investors who don’t share a negative view of China for a few basis points difference are willing to step in and take the place of those who do participate,” said Rich Nuzum, president of the wealth business at Mercer. “I don’t think this particular act will materially affect the cost of capital for these companies.”
In April 2018, index sponsor MSCI added about 230 China-listed A-shares to its emerging market benchmark. About $20 billion flowed into these stocks.
A-shares are the main designation of stock listed in mainland China, and since 2003 some foreign institutions have been allowed to buy them.
As of August, there are 260 China A-share companies listed, an increase of 0.15%. China A-shares have a weight of 7.79% in the MSCI China Index and 2.46% in the MSCI Emerging Market Index, which will be increased to 3.3% in November.
China comprises less than 4% of the MSCI ACWI ETF, which covers 85% of the global capital markets. It tracks over 2,800 large and mid-cap stocks in 23 developed markets and 26 emerging markets. The share of emerging markets in the ACWI is about 11%.
If the MSCI emerging markets index stops including Chinese companies, critics say that they will look for funding elsewhere. It is unlikely to affect capital flow or the ability of firms to fund operations.
Last week, the US Department of Commerce placed several Chinese entities on an export blacklist that bans American firms from doing business with them without a license. In August, surveillance technology firm Hikvision, which is listed on the MSCI ACWI, was placed on a blacklist because the administration was concerned its products could allow access to sensitive systems. It has been cited as a threat to US investors.
Several US pension funds own Hikvision. As of June 30, 2018, CalSTRS owned 4.35 million Hikvision shares, according to Reuters. The New York State Teachers Retirement System also owned Hikvision, fund disclosures indicate.
In Washington, there also have been talks about delisting Chinese firms from US exchanges. A bipartisan group of senators, including Republican Marco Rubio of Florida, introduced legislation to stop foreign firms from being listed on US exchanges unless the companies grant American inspectors access to audit reports. The bill is an effort to ensure that Chinese companies comply with US accountability and transparency rules. China has a state secrets law that would preclude some companies from complying.
China has been more active in enforcing its own rules. The country has made amendments to regulations in finance sector in response to US pressure. For example, the commission will remove limits to non-Chinese stakes in the nation’s futures, mutual funds, and securities firms. The plan would permit full foreign ownership in January.
At the same time, China is distancing itself from the US economy. Foreign direct investment by China in the US fell 80% from the previous year to $5 billion, says the Rhodium Group.
There have been past US efforts to squeeze other countries economically. In July 1941, President Franklin Roosevelt seized all Japanese assets in the US. Japan lost access to a majority of its overseas trade and 88% of its imported oil. Months later, Japan attacked Pearl Harbor.
Iran, Sudan, North Korea, and South Africa have been subject to similar boycotts in the form of sanctions or exclusion lists.
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