December 31, 2020

A Messy Financial Divorce for the US and China

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Even as official financial decoupling progresses, US and other financial firms are – with China’s blessing – building asset management, securities, life insurance, fintech, and custody businesses in the Chinese market. Should President-elect Joe Biden’s administration support this process or double down on decoupling?

OXFORD – Relations between the United States and China are at perhaps their lowest ebb since they were normalized in 1979. Yet, when it comes to finance, competition is only part of the story. While the US government is pursuing financial sanctions against China, American financial firms are lining up to do more business there – and China is more than happy to welcome them. Will this disconnect persist under President-elect Joe Biden?

Over the last four years, US President Donald Trump’s administration has often employed financial levers in its clash with China. For example, it has taken action to block federal government pension plans from investing in Chinese equities, and enacted sanctions against Chinese officials in Xinjiang Province (over human-rights violations) and Hong Kong (over the mainland government’s introduction of draconian national security legislation).

Trump also recently signed an executive order banning investments by US residents in 31 Chinese companies deemed to be aiding the modernization of the People’s Liberation Army. And, earlier this month, he signed the Holding Foreign Companies Accountable Act, which requires publicly traded foreign firms to comply with US auditing rules within three years or be delisted.

The HFCAA aims to bolster the transparency of financial reporting and protect investors, not least by revealing if companies are controlled by their government. While it applies to all foreign companies listed on US exchanges and selling securities to US residents, it is clearly directed at Chinese firms: The 217 US-listed Chinese firms – with a combined market capitalization exceeding $2 trillion – do not allow foreign audits for “national security” reasons.

Barring an alternative solution, a large number of Chinese firms may have to look elsewhere to raise capital in three years. Thanks to the US dollar’s status as the world’s main reserve currency, a next step could be US restrictions on China’s access to dollar payments, clearing, and custody systems, with adverse consequences for China’s trade, capital markets, and supply chains.

And yet, even as official financial decoupling progresses, the opposite is happening privately. US and other financial firms are – with China’s blessing – building asset management, securities, life insurance, fintech, and custody businesses in the Chinese market. Since last year, a few foreign financial firms (such as Allianz, HSBC, and Standard Chartered) and a flurry of US entities (including BlackRock, Bridgewater Associates, Citibank, Goldman Sachs, JP Morgan, Morgan Stanley, and Vanguard) have received China’s permission and/or licenses to establish or expand domestic operations.

Chinese officials recognize that foreign financial firms deliver capital, US dollar funding, innovation, and best practices to China’s financial markets, especially investment banking, where local expertise is relatively undeveloped. Perversely, these “imports” are especially prized if they help China to become more self-reliant in other ways – for example, in technology and in capital intermediation. Simply put, China is welcoming foreign firms, so that it can better withstand a decoupling with the US.

To this end, as part of trade negotiations with the US, China has removed restrictions on foreign ownership of securities, fund-management, and life-insurance companies, even though this will erode domestic entities’ market dominance (within carefully managed limits). China has also been working to attract more foreign portfolio capital, such as by including Chinese equities and bonds in global benchmark indices, and by promoting “connect” schemes, which increase foreign investors’ access to Chinese capital markets.

That said, US financial firms seeking to deepen their engagement in Chinese markets still face high barriers, including systemic weaknesses in management, accounting and credit-rating processes, as well as political, regulatory, and data risks. This partly explains why, though foreign holdings of renminbi-denominated equities, bonds, and loans have more than doubled – to almost CN¥7 trillion ($1.1 trillion) – since 2018, the rise is in line with that of total system financial assets.

In any case, these are matters for shareholders, investors, and creditors. Politically, the main issue is whether to reverse Trump’s policies, maintain them, or build on them to move forward on the path to decoupling.

If the incoming Biden administration and the new Congress draw new lines for technology, trade, market access, standards, and political values, US financial firms’ enthusiasm for China will become a moot point, especially given Biden’s plans to work more closely with US allies in confronting China. Of course, China will view such actions with serious concern. That would be the point – and it may not be the wrong move.

In fact, there is little reason why Biden should move quickly to clear the path into China for private US financial firms. After all, such an approach would deplete his limited political capital, while bringing virtually no returns at home, in terms of economic recovery, employment, and innovation. Rather than giving away America’s financial know-how, Biden should use it as leverage, in order to try to realize other more urgent objectives, such as getting China to open up its services market and potentially to agree to changes to its industrial policies.

George Magnus is a research associate at the University of Oxford China Centre and SOAS, University of London. He is the author of Red Flags: Why Xi’s China Is in Jeopardy.

The text has been adapted from Project Syndicate website

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