U.S. Congressional Report Warns Investors, Banks of China Risks

(Bloomberg) -- A body advising the U.S. Congress warned of growing risks for domestic investors from strains in China’s banking system and questioned Wall Street’s push into the Communist Party-ruled nation as it opens its capital markets.

The report comes at a time of growing tension between the U.S. and China with a protracted trade dispute still far from a resolution. The U.S. administration is examining whether to keep government pension funds from investing in Chinese equities and mulling a range of sanctions to punish it over a crackdown on Hong Kong. The Senate last week passed a bill that would limit the ability of Chinese companies to raise capital from U.S. investors, while Nasdaq Inc. also moved to limit Chinese listings.

At the same time, the biggest U.S. financial firms from JPMorgan Chase & Co to BlackRock Inc. and Goldman Sachs Group Inc. have mapped out expansion plans in China as it opens its $45 trillion market.

“Ultimately, Congress must decide if the extent of market access on offer is worth the potential risks to U.S. investors,” the U.S.-China Economic and Security Review Commission said in a report on Wednesday to Congress. “It must also evaluate the desirability of greater U.S. participation in a financial market that remains warped by the political priorities of a strategic competitor.”

Even as investments in China are limited by capital controls, the congressional report highlighted that U.S. investors have been gaining exposure to Chinese banks after they were included in widely tracked benchmark indexes put together by MSCI Inc. and FTSE Russell.

It warned that such banks may have political priorities “misaligned with their fiduciary duty to U.S. shareholders” while highlighting the difficulty for U.S. investors and creditors to determine the true level of risk.

As the coronavirus outbreak shuttered the world’s second biggest economy at the start of the year, China’s state-owned banks, led by Industrial & Commercial Bank of China Ltd., were called on to prop up activity and help borrowers. They are now bracing for an unprecedented drop in profits this year as lenders grapple with trillions of yuan of potential credit losses.

China’s opening of its financial market this year will allow global banks such as Goldman to take full control of ventures in the country as a way of luring more capital to cushion a slowdown. By dismantling the wall to its market, China is counting on foreign financial firms to plow $1 trillion in fresh capital into the nation over the next few years.

“The fate of Chinese banks is of growing relevance to the U.S. because Beijing has slowly expanded market access for foreign financial companies and portfolio investors,” the report said.

A deterioration in asset quality and profitability at China’s banks is raising concerns that more lenders will come under pressure after at least three regional banks were rescued last year. In September, Beijing-based ICBC, the world’s largest lender which is included in MSCI Emerging Market Index, invested 3 billion yuan ($420 million) as part of a government rescue of Bank of Jinzhou Co.

Such episodes demonstrate how China’s banking system “remains captive to state and Party interests, and banks may make decisions on a political basis that harm U.S. investors’ financial interests,” said the commission, which was set up in 2000 to monitor and investigate potential national security threats.

It warned that the opacity of China’s non-performing loan market poses a challenge for U.S. distressed asset investors, who beginning to buy soured debt directly from Chinese banks. Without access to accurate market and pricing information, investors may wind up footing the bill for China’s financial cleanup, the report said.

Residents had $203 billion of long-term mainland Chinese financial assets as of June last year, little more than double that held in South Africa, according to the U.S. Treasury. Far bigger is the more than $1 trillion market capitalization of Chinese companies listed on the three key U.S. exchanges.

©2020 Bloomberg L.P.

With assistance from Bloomberg