Treasury Under Fire for Trying to Soften Trump’s Ban on Chinese Securities

Treasury Secretary Steve Mnuchin speaks during a news conference in Washington on Sept. 21, 2020. Patrick Semansky/Pool via Reuters

WASHINGTON—A conflict within the Trump administration has come to light over how to implement the president’s new executive order, which protects U.S. investors from “malign” Chinese companies.

The Financial Times reported on Dec. 17 that the Treasury Department has attempted to “water down” the executive order, which bans investment in companies with ties to China’s People’s Liberation Army (PLA). The Pentagon and the State Department, according to the report, have furiously opposed Treasury Secretary Steven Mnuchin’s effort to soften the ban.

Mnuchin responded to media reports that exposed the interagency fight.

“There is no disagreement between @SecPompeo and me regarding the implementation of the President’s Executive Order. We are coordinating closely on an interagency basis,” he wrote Dec. 18 on Twitter.

A few minutes after Mnuchin’s tweet, State Secretary Mike Pompeo, a China hawk, also denied the reports that alleged a clash between him and the Treasury secretary.

“We are simply working to resolve interagency mechanics of an important executive order,” he wrote on Twitter.

President Donald Trump on Nov. 12 issued an executive order to bar Americans from investing in Chinese military companies. The order came in response to rising concerns over pension and retirement fund investments in companies that support the Chinese Communist Party (CCP).

The order targets Beijing’s aggressive national strategy called “Military-Civil Fusion,” which utilizes Chinese companies to strengthen the PLA.

So far, the Pentagon has designated 35 companies as being “owned or controlled” by the PLA. Many of these companies are publicly traded on stock exchanges around the world, and billions of dollars of U.S. capital have already flowed into shares of these companies.

The Pentagon’s blacklist includes two of China’s biggest telecom giants, China Mobile and China Telecom, as well as surveillance equipment manufacturer Hangzhou Hikvision.

The Treasury is in the process of preparing guidelines as to how to implement the new rules, but it has to consult with the secretary of state, the secretary of defense, and the director of national intelligence, according to the executive order.

The Treasury prefers to limit the ban to only the 35 companies flagged by the Pentagon, while the departments of Defense and State want to expand the list to include subsidiaries and affiliates of these military companies, The Wall Street Journal reported on Dec. 17, citing the scope of the ban as a major disagreement.

A subsidiary is a business whose parent company holds a majority stake (50 percent or more of shares) and an affiliate is a company in which another firm holds a minority stake (less than 50 percent of shares).

Over 140 Public Companies

The State Department released on Dec. 5 a fact sheet titled “U.S. Investors Are Funding Malign PRC Companies on Major Indices.” At least 24 of the 35 Chinese military companies are either public or have subsidiaries or affiliates that are publicly traded, according to the fact sheet.

Another study by RWR Advisory, a Washington-based research and risk consultancy, showed that more than 140 Chinese companies will be affected if all public subsidiaries and affiliates are included in the ban list as requested by the Pentagon and the State Department. Shares of many of these companies are already in the MSCI or FTSE stock indices.

In recent years, Beijing has lobbied global index providers to increase the weighting of Chinese stocks and bonds in their benchmarks or portfolios. A dominant index provider, MSCI, for example, last year substantially lifted the weighting of Chinese shares in its emerging market and other indexes, leading billions of dollars to flow into Chinese companies.

Securities of many Chinese companies are embedded in exchange-traded funds (ETFs) and other passive investment funds benchmarked against these major indexes.

As a compromise position, the Treasury might offer to expand the ban list to include subsidiaries only, a person familiar with the talks told The Epoch Times. But this may not be a good solution, as Chinese companies can reduce their holdings in subsidiaries below 50 percent to circumvent the ban, the person said.

Another dispute is about whether passively managed index-tracking funds should be out of the scope of the executive order. The person said that the Treasury insisted on excluding ETFs, suggesting that the weighting of the Chinese securities is too small in aggregate indexes and hence doesn’t pose a significant risk to American investors.

If the Treasury’s suggestion is implemented, leading passive managers such as BlackRock and Vanguard won’t be forced to divest blacklisted companies.

Relatively speaking, these investments make up a tiny portion of U.S. funds, pensions, and insurance companies. For example, BlackRock has $7.5 trillion in assets under management but owned $2.4 billion worth of shares in the 16 Chinese military companies as of Nov. 20. That amount represents only 0.03 percent of BlackRock’s fund investments.

But in an absolute sense, billions of U.S. dollars are flowing into these companies and indirectly financing the Chinese regime, according to China hawks.

Wall Street & Beijing

There’s been a disagreement within the administration over how to deal with Chinese companies that take advantage of U.S. capital markets. The Treasury is concerned that tougher measures against Chinese securities would be disruptive to both U.S. and global financial markets.

Meanwhile, a growing number of national security policymakers and human rights advocates believe that average American investors shouldn’t be financing companies that support the totalitarian regime in China.

“The two sides are rather clearly defined: Wall Street and Beijing versus the American security and human rights communities,” Roger W. Robinson, former chairman of the congressional U.S.–China Economic and Security Review Commission, told The Epoch Times in an email.

“This time, Mr. Mnuchin and his supporters on the Street appear to have gone too far in openly seeking to eviscerate the President’s Executive Order designed to end this Chinese military funding travesty.” Robinson was also a senior National Security Council official under President Ronald Reagan.

The executive order prohibits investment in the stocks or bonds of these military companies beginning Jan. 11, 2021. If U.S. investors have already bought securities in these companies, they have less than a year, until November 2021, to exit their investments, according to the president’s executive order.

The Treasury is expected to release the guidance before Christmas.

Following Trump’s executive order, FTSE Russell announced on Dec. 4 that it would drop shares of eight Chinese companies, including Hangzhou Hikvision. The shares will be removed from its global equity indexes effective Dec. 21. The move means index-tracking funds will have to sell those shares.

MSCI announced a similar step on Dec. 16, saying that it would remove seven Chinese military companies, including China’s biggest chipmaker, SMIC, from its equity indexes on Jan. 5.

“For far too long the CCP has exploited America’s capital markets to finance its cyber army, its technology-driven elimination of civil liberties, its human rights abuses, and its destruction of the environment," Christopher Iacovella, CEO of the American Securities Association (ASA), told The Epoch Times in an email. The ASA represents small and regional financial services companies.

“This executive order rightly prioritizes our economic and national security, and it’s time for the Treasury Department to follow the President’s lead and protect every American.”