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“API Geoeconomic Briefing” is a weekly analysis of significant geopolitical and geoeconomic developments that precede the post-pandemic world. The briefing is written by experts at Asia Pacific Initiative (API) and includes an assessment of burgeoning trends in international politics and economics and the possible impact on Japan’s national interests and strategic response. (Editor-in-chief: Dr. HOSOYA Yuichi, Research Director, API & Professor, Faculty of Law, Keio University)
This article was posted to the Japan Times on August 31, 2021:
API Geoeconomic Briefing
August 31, 2021
Why the U.S.-China conflict is threatening the future of Wall Street
OYA Shin, 
Senior Research Fellow, Asia Pacific Initiative (API)
During the U.S. presidential campaign last year, Jake Sullivan, who is now national security adviser to President Joe Biden, criticized the administration of then-President Donald Trump for having prioritized policies beneficial to Wall Street.
“Why, for example, should it be a U.S. negotiating priority to open China’s financial system for Goldman Sachs?” he asked.
Similar sentiments were expressed by Biden himself. In his address to a joint session of Congress in April, he received a round of applause when he said, “Wall Street didn’t build this country. The middle class built this country.”
Trump had former executives of Goldman Sachs Group Inc. in his administration, including Gary Cohn, who served as head of the National Economic Council, and Treasury Secretary Steven Mnuchin.
Mnuchin was the Trump administration’s top negotiator in the U.S.-China trade talks along with U.S. Trade Representative Robert Lighthizer.
In a “phase one” trade agreement signed by the two nations at the beginning of 2020, China agreed to loosen restrictions on foreign financial services companies, eliminating foreign equity limits in the country’s financial services sector, among other measures.
The Trump administration was also focusing on the working class, as getting support in the industrial Rust Belt regions is indispensable in winning the presidential election.
Both the Democrats and the Republicans attach importance to workers in the manufacturing industry, but the Biden administration has leaned even more in their direction.
There are some former executives of asset management firm BlackRock Inc. in the Biden administration, such as Brian Deese, head of the National Economic Council, and Deputy Treasury Secretary Wally Adeyemo, but few former executives of investment banks like Goldman Sachs.
Gary Gensler, chair of the U.S. Securities and Exchange Commission (SEC), is a former Goldman Sachs executive, but he is known for his harsh stance against Wall Street as chair of the Commodity Futures Trading Commission (CFTC) in former President Barack Obama’s administration.
Insufficient inspections
The general public in the United States casts a stern eye on Wall Street, where wealth is concentrated as a result of globalization.
The challenges faced by Wall Street amid rising U.S.-China tensions can be discussed from two perspectives: the U.S. financial market and the financial markets in Hong Kong and mainland China.
Chinese firms’ initial public offerings in the U.S. market are an attractive business for U.S. investment banks.
As many as 34 Chinese companies filed an IPO in New York in the first half of this year, raising a total of $12.4 billion, leading to commission income of $460 million.
But there have been concerns that inspections of Chinese firms are insufficient.
The Public Company Accounting Oversight Board (PCAOB) has the authority to inspect auditors of firms listed in the U.S., but Chinese accounting firms have rejected the board’s inspections, citing Chinese laws that treat such corporate information as state secrets.
While there were criticisms over their treatment, they continued to be exempted from the rules backed by Wall Street which saw great business opportunities in IPOs of Chinese firms.
However, it was revealed in April last year that Chinese coffee chain Luckin Coffee Inc., which was listed on the Nasdaq, fabricated its sales.
The incident, along with the deepening confrontation between the two nations, led the U.S. to sign into law the Holding Foreign Companies Accountable Act in December, banning transactions of the securities of a company listed in the U.S. if the firm can’t prove it is not under the control of a foreign government and if the PCAOB cannot inspect its audit papers for three consecutive years.
Also in November, Trump signed an executive order barring U.S. investors from buying exposure to firms thought to be linked to the Chinese People’s Liberation Army (PLA). The Biden administration has basically maintained the same stance.
Entities identified by the U.S. as being linked to China’s military include major firms such as Huawei Technologies Co., China Mobile Ltd., China Telecommunications Corp. and China United Network Communications Group Co. (China Unicom).
Cybersecurity probes
The U.S. moves are based on the belief that all the companies listed in the U.S. must follow the country’s rules and that local markets should not help provide funds for the strengthening of the PLA, which would be detrimental to the U.S.
Meanwhile, Beijing is also becoming nervous about Chinese firms listing in the U.S.
China’s largest ride-hailing app operator, Didi Global Inc., went public on the New York Stock Exchange on June 30. Two days later, the Cyberspace Administration of China announced that it would launch an investigation into the firm.
And on July 4, the CAC ordered China’s app stores to remove Didi’s app, citing serious violations on its collection and usage of customer information.
U.S. investors who suffered losses due to a plunge in Didi shares filed class action lawsuits against the firm, claiming that Didi’s disclosure of risk information was insufficient.
Chinese authorities also opened cybersecurity probes into other firms, including subsidiaries of New York-listed truck-hailing app operator Full Truck Alliance.
On July 30, the Chinese Communist Party’s politburo decided in its midyear meeting to tighten oversight of overseas share listings by Chinese firms in order to prevent an outflow of data to other countries such as the U.S.
When going public in the U.S, Chinese firms often use a scheme known as a Variable Interest Entity (VIE) to get around China’s foreign ownership restrictions.
Under the scheme, a Chinese firm sets up a shell company in a tax haven, such as the Cayman Islands, and establishes a relationship in which the VIE receives a contractual right to the Chinese company’s profits.
That shell company then issues in the U.S. market an American depositary receipt — a way for U.S. investors to purchase stocks in overseas companies.
The scheme, which has existed for decades, might come into Chinese regulators’ crosshairs in the future — and if that happens, the impact will be huge.
Wary of such a possibility, SEC head Gensler issued a statement on July 30, referring to recent developments in China to strengthen restrictions on firms raising capital offshore, and called on offshore issuers associated with Chinese companies to prominently and clearly disclose the overall risks, including those related to the VIE structure.
Human rights
U.S. financial institutions are eager to expand business in the Chinese market with its high savings rate and large population of wealthy people.
In May, Goldman Sachs received approval in China to set up a wealth management venture with Industrial and Commercial Bank of China (ICBC), as did BlackRock with a unit of China Construction Bank Corp.
And in August, JP Morgan Chase & Co. was granted permission to take full control of a securities business in China — a first for an international firm.
Morgan Stanley saw assets in its Hong Kong unit surge 70% in the last year and Citigroup has announced plans to hire up to 1,700 people in Hong Kong this year.
However, China’s National Security Law passed in Hong Kong in June last year has led to a denial of Hong Kong’s autonomy and to a wide range of human rights violations.
The U.S. government issued an advisory this July to warn U.S. businesses about risks to their operations and activities in Hong Kong.
“Businesses operating in Hong Kong may face heightened risks and uncertainty related to PRC (People’s Republic of China) retaliation against companies that comply with sanctions imposed by the United States and other countries,” the advisory said.
“A failure to comply with U.S. sanctions can result in civil and criminal penalties under U.S. law,” it added.
In July last year, the Hong Kong Autonomy Act was signed into law in the U.S., authorizing sanctions on foreign financial institutions that conduct significant transactions with foreign people involved in undermining Hong Kong’s autonomy.
U.S. authorities are said to be cautious about imposing full-scale sanctions on major Chinese banks, as such moves can have wide-ranging consequences for international financial markets.
But the Biden administration has pledged to put human rights at the center of its foreign policy, while in June China passed the Anti-Foreign Sanctions Law aimed at retaliating against sanctions imposed by foreign governments.
Such a series of actions could lead to an escalation of U.S.-China confrontation.
Where Japan stands
Trump used to think of the U.S.-China confrontation as an issue of U.S. goods trade deficits with China.
But the confrontation is not only about goods. Nor is it something that can be described only by trade balance.
It involves a wide range of issues, including services, technology, people’s movements and values, as well as the financial market.
Wall Street — the financial market — influences Main Street, the real economy.
If the flow of funds from China to the U.S. stops, it will become one of the factors to push up U.S. interest rates.
Delisting Chinese firms from the U.S. market may become a cause of lower returns on pension funds.
Attempts to crack down on Chinese interests on Wall Street could have an adverse effect on workers in the United States’ manufacturing industry.
Japan is not unrelated to this issue.
The fall of Didi’s shares — one of the factors that pushed down prices of other Chinese shares — has also impacted its largest investor, SoftBank Group Corp.
In January, U.S. Customs and Border Protection blocked imports of Uniqlo cotton shirts for possible violation of a U.S. ban related to forced labor in China’s Xinjiang autonomous region.
Japanese businesses and financial institutions are feeling the risks of being caught in between the U.S. and China.
Japan is a U.S. ally and shares basic values with the country. And although it is important for Japan to maintain a good relationship with China, its top trading partner, it can’t disregard national security and values for the sake of economic profits, and it has to act along with like-minded countries including the U.S. based on its principles.
Even Adam Smith, the 18th century economist who believed enterprises should be able to pursue their own interests freely, said, “Defense is superior to opulence.”
At the same time, it is important to appropriately manage escalations.
There are different forms of financial sanctions. Those targeting senior government officials are a way to send a strong signal while avoiding actual harm.
But cutting off major Chinese financial institutions’ access to the dollar poses a risk of destabilizing the entire global financial system, impacting both Japan and the U.S.
Moreover, if China becomes overly conscious of the risks of financial sanctions, the nation will be prompted to move further away from the dollar, threatening its position as a key currency in the long term.
It is necessary to manage escalations properly while sticking to principles. To do so, Japan should cooperate closely with the U.S. and other like-minded countries, while continuing to engage in candid dialogue with China as well.
Disclaimer:
The views expressed in this API Geoeconomic Briefing do not necessarily reflect those of the API, the API Institute of Geoeconomic Studies or any other organizations to which the author belongs.