The investment risk associated with China rose further this week, as relations between Washington and Beijing became increasingly difficult.

The tense relationship between the two countries is likely to become even worse in the light of moves in the US to impose stricter disclosure rules and penalties on foreign companies listed in the country, and the apparent desire by the Chinese Communist Party to directly change Hong Kong's mini-constitution, bypassing the territory's legislative and judicial system entirely. 

On Wednesday (May 20), the US senate passed bipartisan legislation that, if it carries through into law, will put much stronger controls on foreign companies, but specifically Chinese companies, listed in the US.

One of the sponsors of the new legislation, Republican senator John Kennedy, said: “China is on a glide path to dominance and is cheating at every turn.”

The scandal around Nasdaq-listed Luckin Coffee, hailed as the Chinese Starbucks, has underlined the need for stronger controls. Shares in Luckin began trading again this week after suspension in early April after chief executive officer Jenny Qian, chief operating officer Liu Jian and six other executives admitted falsifying over $300 millions in sales. The company’s stock had been trading around $40 before the scandal broke. It is now down around $2.

As AsianInvestor has reported, US pension funds are facing increased pressure not to boost their allocations to Chinese stocks.

While the US administration has its reasons for trying to force the issue, there is also a view that pension funds and other asset owners from the country would only be increasing their risk by a higher allocation to China, at a time when the US-China dialogue is at such an impasse.

“It is indeed a risk and, in my opinion, unwise, especially for US funds, all the more so if they are managing pension funds of civil servants,” Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis, told AsianInvestor.

In the war of words with China, it is being made clear to US investors that their pension savings are potentially aiding one of the country’s chief economic and political rivals. President Trump and his senior advisers, including Secretary of State Mike Pompeo, have been pumping up the anti-China rhetoric.

What investors possibly don’t appreciate, say fund managers, is that they will come off worst if the US escalates the feud to the point of making life difficult for Chinese companies and forcing delistings.

Caroline Yu Maurer,
BNP Paribas AM

This would negatively affect stock values on top of the global economic damage it would do, Caroline Yu Maurer, head of Greater China equities at BNP Paribas Asset Management, told AsianInvestor.

“It will hurt a lot of US investors interests if they force delistings immediately without any proper justification. That is why this proposed law is expected to be a three year process. Who knows what the US-China relationship will be like in three years.”

A worst case scenario, where the US cuts off economic ties with China completely, is not something that Yu Maurer thinks is likely. “If that happens, it’s more of a black swan event for equity investors, not just in China but globally.”

Added to this risk is the news that China's government will table a motion today (May 22) for the Standing Committee of the National People's Congress to draft and pass a new national security law for Hong Kong. Such changes would circumvent Hong Kong's legislature to directly change the territory's Basic Law, heavily eroding the One Country, Two Systems political agreement that was meant to last until 2047.  

That is likely to raise the ire of the US Congress and could cause yet more retaliatory measures that further damage the investment appeal of China and Hong Kong alike. House of Representatives speaker Nancy Pelosi tweeted that China's latest "attempt to bring an end to the "one country, two systems" framework in Hong Kong is deeply alarming".  

ON THE DEFENSIVE

The increased sensitivity over Chinese investments has forced federal and state pension funds in the US onto the defensive in justifying their support for Chinese companies.

The current anti-China sentiment is escalating to the point where the country’s largest state pension fund, California Public Employees' Retirement System, has been singled out by Secretary Pompeo for its investments in Chinese military contractors. Calpers holds some $3 billion worth of shares in Chinese companies.

Meanwhile, Calpers CIO Ben Meng, who was born in China, has come under scrutiny from the FBI, with the suggestion he is compromised by having worked at the State Administration of Foreign Exchange during a secondment from Calpers.

Ben Meng, Calpers

Calpers website makes it clear that all investment decisions are the result of collective discussion: “At no time did Calpers' CIO direct investments in China.”

Yu Maurer said the US government would find it hard to force the issue with Calpers. "It’s a lot harder to put pressure on them. You’d need the state government to agree [California has long been a Democrat-controlled state]. Washington can’t just come out and order Calpers not to invest in China.”

To have a blanket ban in other states would not be impossible, she added, “but it’s difficult from a legal and a practicality point of view. There are a lot of issues with regards to investor rights and working out how you would actually force funds to divest from Chinese companies."

The negative sentiment towards China resulting from the Covid-19 outbreak has already had an effect on investment flows, according to Garcia Herrero, whose analysis shows that foreigners are not as keen on the Chinese market. “Net inflows into the stock market have slowed down substantially,” she said.

The tension between the US and China is likely to intensify even more in the second half of the year, with the US election cycle moving up the gears, said Yu Maurer.

She added that the hope is the relationship improves once the worst of the pandemic has passed, and Trump doesn’t feel under so much pressure to apportion blame. Without that, she said, “The impact on the global economy would be quite drastic. I don’t think, with the economic effects of the pandemic, that any country can afford that.”

Look out for a coming report, in which AsianInvestor looks at the increasing impact of passive indices containing Chinese securities. 

Richard Morrow contributed to this article.