Trends in U.S.- China Trade Relations and Capital Markets: Decoupling or A New Normal?

Blacklists, export controls, investment restrictions and transitions create uncertainties for Chinese and U.S. companies alike

In the final weeks of the Trump administration, we’ve seen more swipes at China, and some expected retaliation.  While there are signs that both President-elect Biden and President Xi are seeking areas of cooperation and to reduce tensions, that doesn’t change the fact that the U.S. still sees China as a major competitive threat, nor that China still objects to any interference in its “internal affairs.”  Biden has publicly stated he will not move immediately to remove the 25% tariffs on Chinese goods or renegotiate the Phase I trade deal.  Foreign Minister Wang Yi’s recent comments to the U.S.-China Business Council calling for a resumption of dialogue and for U.S. companies to play a larger role in improving bilateral relations seemed to strike a relatively conciliatory tone.  

While the rhetoric will likely change after January 20, there is currently broad bipartisan consensus in Washington and among the general public in the U.S. for an increasingly competitive dynamic with Beijing. 

Given the above, what is the trend line for the business community in both countries?  See our round-up of important developments below.  If you would like to discuss how these might impact your future plans and communications strategies, please get in touch.

 

CAPITAL MARKETS DEVELOPMENTS

The De-listing Debate
On December 2, 2020, Congress passed the Hold Foreign Companies Accountable Act, and Trump is expected to sign it into law.  The bill gives any foreign issuer listed on Nasdaq or NYSE a three-year grace period to comply with the Public Company Auditing Oversight Board (PCAOB) audit review requirements or be delisted.  It also requires companies to certify “they are not owned or controlled by a foreign government.” In practice, this means disclosing whether executives and board members are Communist Party members and noting whether the Party is referenced in a company’s articles of incorporation.  While, theoretically, this affects an estimated $1.8 trillion in market cap of Chinese firms, our take is this:

Perspectives from China
This bill is no surprise; it has been years in the making.  While this Act increases political risk, it doesn’t fundamentally alter the game or force Chinese companies to de-list.  SEC accountants have been fighting for access to Chinese audit papers for years – only to be told that handing them over violates China’s state secrets laws.  This dispute is above the pay grade of any individual Chinese CEO, because he or she cannot comply without Chinese government permission.  Many companies have privatized in recent years and/or gone for secondary listings in Hong Kong or China, but that’s not primarily because of this Act.  The decision on where to list is based on a variety of factors including comparative valuations, location of peer group, and market liquidity.  For Chinese firms debating listing locations, it’s still “multiple choice.”  According to bankers, the appetite for certain firms to list in the U.S. (e.g., the electric vehicle industry) is as strong as ever.  

Perspectives from the U.S.
The situation may end in compromise before the end of the three-year period.  Big Four accounting firms have already been in discussions with Chinese and U.S. regulators, including the PCAOB, on how to exchange information while staying in compliance with Chinese law.  This has been the approach favored by U.S. Treasury Secretary Steven Mnuchin, but it remains to be seen how Treasury Secretary nominee Janet Yellen will approach the issue.

PLA-Linked Investment Prohibitions
The White House on November 13, 2020, issued an executive order prohibiting Americans from investing in any “Chinese Communist military company” designated by the Department of Defense as supplying or otherwise supporting China’s military. The number of qualifying entities on this list has continued to grow as the Trump administration has added names. 

Who’s on the list?  Primarily (but not exclusively) state-owned enterprises, most of which are listed companies. The list includes some very well-known companies such as Huawei, Hikvision, China Mobile, China Telecom, SinoChem, ChemChina, CRCC and CRRC (China Rail affiliates), CGN (China General Nuclear), CETC, and Norinco. The latest additions on December 3 were SMIC (Semi-conductor Manufacturing International) and CNOOC (China National Offshore Oil Corporation), bringing the total number to 35.

This impacts asset owners, asset managers, index providers, and the corporations themselves in a significant way.  Already the FTSE Russell Index has said it would drop eight Chinese companies from its indices, including CRRC, China Communications Construction Company, and Hikvision, on December 21. The S&P Dow Jones Indices followed, saying it would remove 21 “explicitly named” Chinese companies from more than four dozen equity and bond indices on the same day, and 11 additional companies from its fixed income benchmarks on January 1. MSCI will drop SMIC, CCCC, China SpaceSat, CRCC, CRRC, Hikvision, and Dawning Information Industry from relevant indices on January 5. Nasdaq will remove CCCC, CRCC, CRRC, and SMIC on December 21. The removal of these huge companies (worth US$204 billion in market cap as of December 9 according to SCMP) would likely hurt the share price of each, while benefitting those who stay or are newly added.

 

IMPORT/EXPORT CONTROLS AND XINJIANG

Xinjiang and Entity Lists
For two years now, the situation in Xinjiang has been an area of focus for global activists and politicians due to alleged forced labor practices and human rights abuses in the region.  

First came the Entity List designation of eight leading Chinese artificial intelligence companies in October 2019, which are subject to U.S. export control restrictions.  These include Megvii, Sensetime, Yitu, Huawei, Hikvision and Meiya Pico; some of these companies have appealed but all are still on the list. 

In June 2020, nine others were added to the Xinjiang Entity List for human rights reasons, including tech companies CloudWalk, NetPosa, and SenseNets, as well as the garment company Aksu Huafu. Twenty-four “military” designees, including Qihoo 360 and a mix of universities and other entities, were also listed due to national security concerns.

On July 22, 2020, eleven Chinese entities were also placed on the Entity List, nine in connection with forced labor, including Esquel and O-Film, and two allegedly involved in the collection of biometric data and genetic analyses in Xinjiang, including two subsidiaries of BGI.

These designations affect the entities themselves, their U.S. suppliers, and any partners and advisors.  In particular, U.S. suppliers to Huawei and other tech firms such as Nvidia and Qualcom are impacted, as many of the sanctioned companies try to source chips and other components elsewhere.  Some of the designated companies have had to delay or change IPO plans.  Companies with an international profile and investors, such as Esquel and Sensetime, have suffered reputational damage.

Xinjiang Cotton Withhold Release Order (WRO)
Trouble has been brewing for those in the textile and garment business in both the U.S. and China for quite some time.  Related to the Entity List designations, because both reference human rights abuses, the U.S. Customs and Border Protection (CBP) withhold release order (WRO) prohibits U.S. imports of cotton or other materials from Xinjiang Production and Construction Corps (XPCC), a giant state-owned enterprise.  While that order is relatively narrow in scope, the U.S. Senate will soon be voting on another measure, the Uyghur Forced Labor Prevention Act, that would prohibit the import of all goods made in Xinjiang with forced labor, a condition that is extremely difficult to audit.  According to the U.S. Department of Agriculture, in 2019/20,  22% of the world’s cotton came from China, of which 86% comes from Xinjiang (just under 20% of the world total).  Xinjiang cotton is everywhere in global supply chains and some have estimated it is in one out of every five garments.  Companies (especially MNCs) should ask themselves how exposed they are and whether they can answer questions about their own track records and supply chains in the Xinjiang Autonomous Region.

South China Sea Entity List Designations
On Aug. 26, 2020, 24 state-owned firms, including several subsidiaries of China Communications Construction Company (CCCC), were placed on the U.S. Entity List for land reclamation activities in the South China Sea.  

 

APPOINTMENTS, INDIVIDUAL SANCTIONS, AND RESTRICTIONS

Biden Cabinet Picks
Clues about what to expect in 2021 can be gleaned from the Biden administration’s top personnel nominations and appointments to date

  • Antony Blinken
    The Secretary of State nominee has a reputation for multilateralism and can be expected to work with U.S. allies, both in Europe and Asia, on any future policy initiatives related to China.
  • Janet Yellen
    The Treasury Secretary nominee will play a key role in any future policy moves related to investment prohibitions and/or securities exchange restrictions.
  • Jake Sullivan
    The National Security Advisor designee will play a key role in shaping how the U.S. Government advances the Biden Administration’s stated goal of a foreign policy for the middle class. There will be extensive interplay between domestic and foreign policy, which will impact a wide range of economic and trade issues at the core of the structural differences that impact the U.S.-China relationship.
  • Katherine Tai
    The U.S. Trade Representative nominee, an Asian-American, is currently the U.S. House Ways and Means Committee trade lawyer and previously served in the USTR office as chief counsel for China trade enforcement and litigation in U.S. disputes with China at the WTO.  She is a skilled negotiator, knowledgeable about China, and fluent in Mandarin.
  • An Asia Czar?
    President-elect Biden is reportedly contemplating the appointment of an “Asia Czar” in the National Security Council, working under National Security Advisor designee Jake Sullivan. This would potentially shift coordination on China policy, involving multiple cabinet agencies like State, Commerce, Treasury, and Defense, more toward the NSC and closer to the White House.    

Chinese appointments
China has brought in a new generation of personnel in their late 50s to assume ministerial and provincial positions, including new Minister of Commerce Wang Wentao and new Minister of Agriculture Tang Renjian.  New appointees will be responsible for advancing the country’s 2035 development vision and add to the feeling of a fresh start for both Washington and Beijing next year.

U.S. Visa Restrictions on CCP Members
Right now, it’s extremely hard to travel anywhere due to the pandemic, but politics provides another barrier.  Both China and the U.S. have canceled certain multiple entry visas and may deny entry or require quarantines due to virus concerns.  But the U.S. has gone even farther when it comes to Chinese Communist Party members: as of December 3, 2020, the 90+ million members of China’s Communist Party are limited to one-month, single entry B-1/B2 (visitors for business or pleasure) visas to the U.S. Previously, these B-1/B2 visas allowed multiple entry over 10 years.

Tit-for-Tat
On Dec. 8, President Trump imposed sanctions on 14 Chinese officials over their alleged role in Beijing’s disqualification of elected opposition legislators in Hong Kong, subjecting them to asset freezes and barring them entry to the U.S.  In retaliation the next day, China halted visa-free travel for U.S. diplomats traveling to Hong Kong.

 

CONCLUSION

These developments pose significant challenges for Chinese and U.S. companies alike, and we therefore believe that many companies will need to work harder to pursue and defend their strategies while maintaining compliance with both countries’ laws.  Finsbury Glover Hering is well positioned to help you from our offices in Beijing, Shanghai, Hong Kong and Washington, DC.