Chinese Risk Exposure Update
Sentiment has been increasingly turning negative on China this year. Three main developments I see at play are the Coronavirus missteps, the new bill unanimously passed by the senate this past Wednesday around foreign issuers on U.S. markets and lastly the reemergence of China attempting to increase its control on Hong Kong.
President Trump has increasingly blamed China for the Coronavirus pandemic.1 Taking his thoughts to Twitter Wednesday the President had this to say:
Keeping objective, whether you agree with the blame or not, this finger pointing increases preexisting conflicts between the U.S. and China that began to kick off in early 2018. The tit-for-tat trade war with China grew from early 2018 through late 2019 when the two countries reached a preliminary trade deal which was signed in January of 2020.5 With global economies already in an increasingly vulnerable state, the reemergence of U.S./China trade frictions could be a material catalyst for a market move lower.
The “Holding Foreign Companies Accountable Act” was revised and unanimously passed by the senate on May 20th 2020. This bill has now been sent to the house of representatives and if passed there, will make its way to the President for a final say. The two core features of the bill are:
- The bill would prohibit foreign firms from being listed on U.S. security exchanges if the firm does not comply with the Public Company Account Oversight Board’s (PCAOB) audits for three years in a row.
- The bill would require public firms to disclose whether they are owned or controlled by a foreign government.2
These requirements may not be possible to meet for Chinese ADRs depending on how they are interpreted. The ownership aspect is especially noteworthy because it is commonly believed the PRC has stakes in businesses operating within China. The threat of delisting shares from U.S. exchanges should not be taken lightly by investors. Baidu, a large-cap internet search firm based in Beijing, has already floated the idea of delisting from U.S. exchanges willingly in order to bridge what the firm sees as a discounted market valuation due to China/U.S. trade tensions.4
Most recently, China has turned its attention back to solidifying its control of Hong Kong. This week, China’s Communist Party set in motion a “Hong Kong Security Law” that looks to ban “treason, secession, sedition and subversion.” Hong Kong pro-democracy protests had previously erupted in 2019 in response to an imposed extradition bill on Hong Kong by China; but Coronavirus preventative measures muted that movement in recent months. Now that the virus news is wadding a bit, Hong Kong is once again being pressured by the Chinese Communist Party. “Pro-democracy activists fear that China pushing through the law could mean “the end of Hong Kong” – that is, the effective end of its autonomy and these freedoms.”3
These three Chinese developments (Coronavirus blame, potential increase of foreign security regulation by the U.S., and Chinese reaching for increased Hong Kong control) increase the risk premium needed on related investments. Those investments include but are not limited to, direct Chinese ADRs, ETFs that hold these ADRs, as well as mutual funds that hold these ADRs.
In light of these ongoing events I have taken the opportunity to decrease my exposure to some of the investments outlined above and will continue watching to see how these situations works out.
- https://hongkongfp.com/2020/05/21/donald-trump-blames-china-for-mass-worldwide-killing/
- https://www.kennedy.senate.gov/public/2020/5/senate-passes-kennedy-and-van-hollen-s-bill-to-kick-deceitful-chinese-companies-off-u-s-exchanges
- https://www.bbc.com/news/world-asia-china-52762291
- https://uk.reuters.com/article/uk-baidu-delisting-exclusive/exclusive-baidu-considers-leaving-the-nasdaq-to-boost-its-valuation-sources-idUKKBN22X1HI
- https://en.wikipedia.org/wiki/China%E2%80%93United_States_trade_war
