[House Hearing, 117 Congress]
[From the U.S. Government Publishing Office]
TAKING STOCK OF ``CHINA, INC.'': EXAMINING
RISKS TO INVESTORS AND THE U.S. POSED
BY FOREIGN ISSUERS IN U.S. MARKETS
=======================================================================
VIRTUAL HEARING
BEFORE THE
SUBCOMMITTEE ON INVESTOR PROTECTION,
ENTREPRENEURSHIP, AND CAPITAL MARKETS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTEENTH CONGRESS
FIRST SESSION
__________
OCTOBER 26, 2021
__________
Printed for the use of the Committee on Financial Services
Serial No. 117-56
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
__________
U.S. GOVERNMENT PUBLISHING OFFICE
46-245 PDF WASHINGTON : 2022
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MAXINE WATERS, California, Chairwoman
CAROLYN B. MALONEY, New York PATRICK McHENRY, North Carolina,
NYDIA M. VELAZQUEZ, New York Ranking Member
BRAD SHERMAN, California FRANK D. LUCAS, Oklahoma
GREGORY W. MEEKS, New York BILL POSEY, Florida
DAVID SCOTT, Georgia BLAINE LUETKEMEYER, Missouri
AL GREEN, Texas BILL HUIZENGA, Michigan
EMANUEL CLEAVER, Missouri ANN WAGNER, Missouri
ED PERLMUTTER, Colorado ANDY BARR, Kentucky
JIM A. HIMES, Connecticut ROGER WILLIAMS, Texas
BILL FOSTER, Illinois FRENCH HILL, Arkansas
JOYCE BEATTY, Ohio TOM EMMER, Minnesota
JUAN VARGAS, California LEE M. ZELDIN, New York
JOSH GOTTHEIMER, New Jersey BARRY LOUDERMILK, Georgia
VICENTE GONZALEZ, Texas ALEXANDER X. MOONEY, West Virginia
AL LAWSON, Florida WARREN DAVIDSON, Ohio
MICHAEL SAN NICOLAS, Guam TED BUDD, North Carolina
CINDY AXNE, Iowa DAVID KUSTOFF, Tennessee
SEAN CASTEN, Illinois TREY HOLLINGSWORTH, Indiana
AYANNA PRESSLEY, Massachusetts ANTHONY GONZALEZ, Ohio
RITCHIE TORRES, New York JOHN ROSE, Tennessee
STEPHEN F. LYNCH, Massachusetts BRYAN STEIL, Wisconsin
ALMA ADAMS, North Carolina LANCE GOODEN, Texas
RASHIDA TLAIB, Michigan WILLIAM TIMMONS, South Carolina
MADELEINE DEAN, Pennsylvania VAN TAYLOR, Texas
ALEXANDRIA OCASIO-CORTEZ, New York PETE SESSIONS, Texas
JESUS ``CHUY'' GARCIA, Illinois
SYLVIA GARCIA, Texas
NIKEMA WILLIAMS, Georgia
JAKE AUCHINCLOSS, Massachusetts
Charla Ouertatani, Staff Director
Subcommittee on Investor Protection, Entrepreneurship,
and Capital Markets
BRAD SHERMAN, California, Chairman
CAROLYN B. MALONEY, New York BILL HUIZENGA, Michigan, Ranking
DAVID SCOTT, Georgia Member
JIM A. HIMES, Connecticut ANN WAGNER, Missouri
BILL FOSTER, Illinois FRENCH HILL, Arkansas
GREGORY W. MEEKS, New York TOM EMMER, Minnesota
JUAN VARGAS, California ALEXANDER X. MOONEY, West Virginia
JOSH GOTTHEIMER. New Jersey WARREN DAVIDSON, Ohio
VICENTE GONZALEZ, Texas TREY HOLLINGSWORTH, Indiana, Vice
MICHAEL SAN NICOLAS, Guam Ranking Member
CINDY AXNE, Iowa ANTHONY GONZALEZ, Ohio
SEAN CASTEN, Illinois BRYAN STEIL, Wisconsin
EMANUEL CLEAVER, Missouri VAN TAYLOR, Texas
C O N T E N T S
----------
Page
Hearing held on:
October 26, 2021............................................. 1
Appendix:
October 26, 2021............................................. 43
WITNESSES
Tuesday, October 26, 2021
Chu, Claire, Senior Analyst, RWR Advisory Group.................. 8
Lorber, Eric, Senior Director, Center on Economic and Financial
Power, Foundation for Defense of Democracies................... 10
Ross, Samantha, Founder, AssuranceMark, The Investors' Consortium
for Assurance.................................................. 7
Sutter, Karen M., Asian Trade and Finance Specialist,
Congressional Research Service (CRS)........................... 5
APPENDIX
Prepared statements:
Chu, Claire.................................................. 44
Lorber, Eric................................................. 68
Ross, Samantha............................................... 77
Sutter, Karen M.............................................. 85
Additional Material Submitted for the Record
Hill, Hon French:
Written statement of the American Securities Association..... 100
McHenry, Hon. Patrick:
Written statement of the Coalition for a Prosperous America.. 103
Written statement of the Center for Capital Markets
Competitiveness, U.S. Chamber of Commerce.................. 112
Committee on Capital Markets Regulation, ``Assessing the
Future of U.S. Listings by Chinese Companies: A Call for
Structured Dialogue''...................................... 116
Meeks, Hon. Gregory W.:
Written responses to questions for the record submitted to
Eric Lorber................................................ 152
Written responses to questions for the record submitted to
Karen Sutter............................................... 153
TAKING STOCK OF ``CHINA, INC.'':
EXAMINING RISKS TO INVESTORS
AND THE U.S. POSED BY FOREIGN
ISSUERS IN U.S. MARKETS
----------
Tuesday, October 26, 2021
U.S. House of Representatives,
Subcommittee on Investor Protection,
Entrepreneurship, and Capital Markets,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:06 a.m.,
via Webex, Hon. Brad Sherman [chairman of the subcommittee]
presiding.
Members present: Representatives Sherman, Scott, Himes,
Foster, Vargas, Gottheimer, Gonzalez of Texas, Axne, Casten;
Huizenga, Wagner, Hill, Emmer, Mooney, Davidson, Hollingsworth,
Gonzalez of Ohio, Steil, and Taylor.
Ex officio present: Representative Waters.
Also present: Representative Barr.
Chairman Sherman. The Subcommittee on Investor Protection,
Entrepreneurship, and Capital Markets will come to order.
Without objection, the Chair is authorized to declare a
recess of the subcommittee at any time. Also, without
objection, members of the full Financial Services Committee who
are not members of this subcommittee are authorized to
participate in today's hearing.
Today's hearing is entitled, ``Taking Stock of `China,
Inc.': Examining Risks to Investors and the U.S. Posed by
Foreign Issuers in U.S. Markets.''
I will now recognize myself for 4 minutes for an opening
statement. I believe the Chair of the Full Committee,
Chairwoman Waters, will be here soon for a 1-minute opening
statement as well. If not, I will also claim her 1 minute and
reiterate some of the same points.
The intertwining of the American and Chinese economies has
given China substantial power here in the United States. It
really hasn't given America any power, political power in
Beijing.
We have great witnesses here today, but the most articulate
witnesses are those who are not here today. Their decision to
pull out of this hearing due to pressure, economic pressure,
speaks loudly to China's strong economic power over politics
and economics here in the United States.
There are those who think that we shouldn't encourage or
allow investment in China because it means American capital is
flowing to their economy, but let us remember that this is a
two-way street. Some $1.2 trillion of American capital is
invested in China in their securities, not to mention $116
billion of direct investment. But some $2 trillion of Chinese
capital is invested in American securities.
But we do have to make sure, if it is going to be a two-way
street, that it is a fair street. We have heard of Luckin
Coffee, Evergrande, and DiDi.
Luckin Coffee tells us that we need good audits and good
oversight of those audits, and that the Public Company
Accounting Oversight Board (PCAOB) needs to oversee the audits.
DiDi illustrates the issue of whether the boards of
directors of companies are loyal to the shareholders, and
whether the corporations have property rights that are
protected by the courts of China, or whether you, in fact, are
investing in a company whose assets could disappear due to
capricious government action.
The SEC has created special rules for foreign private
issuers, based on the idea that, say, that private issuer from
abroad is from the United Kingdom, where you get all of the
investor protection from the host country. And then, we will
just add a little bit of American investor protection; we don't
need all of the usual American investor protection. That model
obviously needs to be turned on its head in dealing with China,
where you get little or no investor protection from the home
country.
We see that China is able to pressure index funds to
include Chinese companies, but it is not Chinese companies that
are in the index funds. An index fund may choose to put the
1,000 biggest companies in the world in the index, but you
can't buy Alibaba; you buy Alibaba of the Cayman Islands.
Now, Alibaba is one of the 1,000 biggest companies in the
world, but Alibaba Cayman Islands--the Cayman Islands isn't
even one of the thousand biggest islands in the world. You are
investing in a shell company, that invests in another shell
company, that has a contractual relationship with Alibaba. Does
that belong in an index?
But we do see that China is able to pressure Morgan Stanley
and others to include these questionable entities in indexes.
Now, when you invest in China, you are investing in a police
state to some degree, one that imprisons a million Uyghurs in
Xinjiang.
We will be discussing a number of bills here before us, two
that were noticed early, the Accelerating Holding Foreign
Companies Accountable Act, and a second one which deals with
the Uyghur Forced Labor Disclosure Act.
I have also quickly, in advance of this hearing,
distributed bills designed to force a review by the SEC of the
special status they give private foreign issuers to see if that
is relevant to companies based in China. And a bill to prohibit
a phony name from being used; you shouldn't call yourself,
``Alibaba,'' if you are not, ``Alibaba,'' but you are really,
``Cayman Islands Alibaba.'' And finally, we will get into the
variable interest entities (VIEs), which are not real
companies, and whether they belong in indexes.
At this point, I will recognize the ranking member for his
opening statement, and I wonder whether I should recognize him
for 4 minutes or for 5 minutes? Do you have the whole
Republican time?
Mr. Huizenga. Yes, at this point, I do and--
Chairman Sherman. Then, I will recognize you for 5 minutes.
I now recognize the ranking member of the subcommittee, the
gentleman from Michigan, Mr. Huizenga, for 5 minutes.
Mr. Huizenga. Thank you, Mr. Chairman.
Actually, before I get into my comments, I am curious if
you could clarify two things? One, those bills that you were
just talking about, were they noticed for this hearing, or did
you just introduce them? Because we were not aware of them.
Chairman Sherman. Those are, at most, discussion drafts
that I circulated just yesterday. And--
Mr. Huizenga. Okay.
Chairman Sherman. --they are among the many things that
will be discussed here today.
Mr. Huizenga. Okay. Well, I am looking forward to getting
our hands on those and having that conversation. And then, I
would appreciate it, too, if you would clarify--you mentioned
the four witnesses that we have before us, but you mentioned
that there were some others who either refused or didn't come
or felt pressure, because I fully believe that. We have seen
that with, whether it is entertainment companies, others, the
NBA. There has been a lot of pressure, but I am curious if you
could clarify that?
Chairman Sherman. I am not here to end any careers on Wall
Street by explicitly identifying names. There are those with
whom we were in discussions, some who had actually agreed to
come testify, then notified us that they decided it was in the
interest of their careers that they not appear before us. We
decided not to have one of those witnesses in the House Foreign
Affairs Committee, where we have had people who might be
subject to torture. We have had screens and muffled voices
there, but we chose not to do that here.
Mr. Huizenga. Understandable. I am going to reclaim my
time, because I do need to get through my statement, and I,
too, am not in the business of endangering that, but certainly
that is a significant, serious accusation that is getting
thrown out. So, I think it is important that we begin this
hearing by level setting and acknowledging what is really
happening with China and the Chinese Communist Party (CCP). We
often just use the acronym and kind of blow over what it
actually stands for.
China is gearing up for a fight to attempt to replace the
U.S. as the premier world leader, both economically and
geopolitically. China's preparation to compete with us relies
on ensuring that the CCP's control is absolute. That is exactly
what the CCP has been working towards. It is critical that we,
as policymakers, acknowledge this fact. If we don't, we are
missing a bigger picture and a bigger threat, and doing so will
lead to short-sighted half measures in response to China's
threat.
I am a little afraid we may be losing sight with today's
hearing. I just want to make sure that we are not. China's
threat is far greater than just that of investment-related
risk. It is far more multidimensional, and therefore, we have
to be far more multidimensional.
Legislation like the Holding Foreign Companies Accountable
Act (HFCAA), which passed on a bipartisan basis last Congress,
represents one of the important pieces that should be a well-
rounded, multi-pronged approach from Washington. It properly
corrected an investor protection imbalance whereby China- and
Hong Kong-based companies were operating under different rules
than everyone else. That certainly cannot stand.
But we should be focusing on how to complement the HFCAA
with policies pulled from a diverse toolkit beyond the
securities laws. For example, attempting to deal with the
threat of China through mandatory disclosures that are
unrelated to financial materiality for foreign policy purposes,
I believe is also a bit shortsighted. These disclosures will
not likely change China's behavior, especially considering
these disclosure requirements would be applicable to all public
companies, no matter where they are incorporated.
The SEC tends to be the wrong agency to address national
security and human rights issues, and we have seen that before
with things like the failed conflict minerals provisions of the
Dodd-Frank Act, et cetera.
For example, we should be sanctioning Chinese firms instead
that pose national security threats, and imposing export
controls to deprive these Chinese firms--(government)--of
advanced technologies needed for their quest for global
dominance.
Fostering entrepreneurship and encouraging business
activity should be another policy priority of ours to deal with
China's threat. Chinese regulators have been cracking down on
their own entrepreneurs and shutting them off from foreign
investment. So, we have an opportunity here, folks.
In response, doubling down on American economic growth
through innovation and promoting economic freedom would be a
tremendously effective approach for us in contrast to the top-
down authoritarian approach of the CCP.
Again, we have an opportunity. Let's seize it. Fostering
entrepreneurship and encouraging business activity are squarely
within our subcommittee's jurisdiction and explicitly within
the SEC's mission.
So, let's discuss those policies. Outcompeting China in the
long term will depend on American economic growth. If we are
only focused on addressing China through ineffective mandatory
disclosures, and not growing our economy, then we are choosing
to face the threat of China with both hands tied behind our
back.
And with that, I yield back.
Chairman Sherman. I thank the distinguished ranking member
for his statement.
I will now recognize the Chair of the full Financial
Services Committee, Chairwoman Waters, for 1 minute, and also
indicate that if Chairwoman Waters wants to be the first
questioner, that would be my honor as well.
Chairwoman Waters. Thank you, Chairman Sherman. I am very
pleased that you are holding this hearing today.
Our capital markets are the envy of the world, raising
trillions of dollars for large and small businesses, and
supporting the retirement and savings of investors. Our markets
work because participants have to play by the rules.
For example, companies that want to raise capital, gain the
trust and confidence of investors by providing access to
reliable and accurate financial information. Our regulators
then have unhindered access to both this information and those
who audit the information.
However, some jurisdictions, like the People's Republic of
China, have created obstacles to this effective oversight and
are undermining the bedrock of investor confidence. So, I look
forward to reviewing the actions that Congress and the SEC can
take to protect our markets.
I thank you, and I yield back my time.
Chairman Sherman. Thank you.
Today, we welcome the testimony of our distinguished and,
in some cases, courageous witnesses: Karen Sutter, a specialist
in Asian trade and finance with the Congressional Research
Service; Samantha Ross, the founder of AssuranceMark, The
Investors' Consortium for Assurance; Claire Chu, a senior
analyst with RWR Advisory Group; and Eric Lorber, the senior
director of the Center on Economic and Financial Power at the
Foundation for Defense of Democracies.
Witnesses are reminded that their oral testimony will be
limited to 5 minutes. You should be able to see the timer on
your desk in front of you that will indicate how much time you
have left. When you have 1 minute remaining, a yellow light
will appear. I will ask you to be mindful of the timer, and
when the red light appears, to please wrap up very quickly.
And without objection, your written statements will be made
a part of the record.
Ms. Sutter, you are now recognized for 5 minutes.
STATEMENT OF KAREN SUTTER, SPECIALIST IN ASIAN TRADE AND
FINANCE, CONGRESSIONAL RESEARCH SERVICE (CRS)
Ms. Sutter. Good morning. Chairman Sherman, Ranking Member
Huizenga, distinguished members of the subcommittee, thank you
for inviting the Congressional Research Service to testify
today.
I would like to raise six points today for your
consideration.
To start, I would like to discuss how China is selectively
opening its financial markets to a few U.S. investment firms,
allowing them to expand China offerings to U.S. investors.
These firms see growth opportunities in China, but their market
participation is still curtailed by Chinese government controls
and the dominant market position of China's large state banks.
Some U.S. firms and investors may profit from investments
in Chinese companies, but these transactions appear to leave
U.S. investors in a passive role in three respects.
One, U.S. financial investors cannot leverage the
productive industrial or technological capabilities that their
capital may help China to develop.
Number two, U.S. financial investments do not appear to
open China's economy to U.S. competition, especially in
strategic industries that they fund.
Number three, the Chinese government can exercise control,
influence, and discretion over U.S. investments and the
underlying business operations and assets that are in China.
Next, I would like to discuss the limited and targeted
nature of China's financial investment openings to date which
appear designed in part to attract capital, U.S. capital to
areas where China's economy is weak, such as bad assets and
debt. Increased U.S. capital flows to China's debt markets
could create growth opportunities, but also could create
increased U.S. risk exposure by placing more U.S. capital in
areas where there are systemic market risks. The Chinese
government's current efforts to address debt and overcapacity
in its property market highlights an example of such risks.
Third, the Chinese government appears to be seeking U.S.
capital and expertise to fund its strategic and emerging
industries, to strengthen China's capital markets, and to
position Chinese firms as global leaders and competitors. U.S.
investors are funding some companies that are tied to the
Chinese government's dual use industrial policies, such as Made
in China 2025.
Similarly, China is investing in some U.S. firms that have
technologies and capabilities that the government is seeking to
advance its goals. While these investments may promote economic
growth, offer strong returns for some U.S. investors, and
provide financing for certain firms, at the same time, they
also may develop competitive Chinese capabilities.
Fourth, the role of the state in China's economy and
business ecosystem has increased dramatically since 2014, under
China's leader Xi Jinping. This is intensifying the potential
challenges and risks in financial and commercial ties with
China for U.S. companies, U.S. investors, and the United States
more broadly. A significant increase in two-way financial
investment could give the Chinese government greater influence
over U.S. companies, as well as the U.S. and global
marketplace.
Fifth, the corporate structures that Chinese firms are
using to expand overseas and invest in U.S. capital markets,
such as the variable interest entity (VIE) are complex. These
structures appear to make it difficult for U.S. investors to
assess potential risks. While U.S. underwriters, accountants,
or legal counsel may have insights into these risks, they may
not share this knowledge fully with U.S. investors, who
ultimately bear the costs of these risks.
These complex corporate structures also separate the
underlying Chinese company and its operations and assets from
U.S. investors. This potentially limits the ability of U.S.
investors to exercise their rights, including the right to seek
full legal recourse if necessary.
In closing, I would like to discuss nonpublic transactions.
There appears to be a lack of transparency on deals and an
absence of publicly available data on the main and growing two-
way investment pathways, which include private equity, venture
capital, and private placements. This situation is complicated
by U.S. and Chinese monies that appear to be increasingly
commingled through funds that operate in the United States and
China.
Without greater transparency, it is difficult to assess how
some financial transactions may support related deals that
could involve the transfer of technology or know-how.
Transparency gaps also potentially affect the U.S. Government's
ability to assess aggregate U.S. financial and economic
exposure to China and potential risks.
Thank you for your consideration. I look forward to your
questions.
[The prepared statement of Ms. Sutter can be found on page
85 of the appendix.]
Chairman Sherman. Ms. Ross, you are now recognized for 5
minutes.
STATEMENT OF SAMANTHA ROSS, FOUNDER, ASSURANCEMARK, THE
INVESTORS' CONSORTIUM FOR ASSURANCE
Ms. Ross. Thank you.
Chairman Sherman, Ranking Member Huizenga, Chairwoman
Waters, and members of the subcommittee, I am pleased to appear
before you today to discuss the significant risks that
investors face from China-based companies that benefit from
access to U.S. markets but do not comply with the important
investor protections under U.S. law.
My testimony is based on my experience of over 18 years
serving in the Division of Enforcement at the SEC, where I
gained firsthand knowledge of fraudulent accounting practices
by foreign private issuers, and at the Public Company
Accounting Oversight Board (PCAOB), where I helped design audit
oversight rules and initiatives that laid a framework to
protect investors in foreign companies that issue securities in
U.S. markets.
The PCAOB's job is to oversee and inspect the auditors of
companies that access U.S. public capital markets. Eight
hundred and forty non-U.S. accounting firms from more than 80
jurisdictions are registered with the PCAOB in order to be able
to prepare or participate in the preparation of audit reports
provided to U.S. investors and submitted to the SEC.
Not all of these firms actually do so, though, but when
they do, the PCAOB is required to inspect their work to ensure
that their audits comply with our standards. Both independently
and through numerous cooperative agreements with local
authorities, the PCAOB is able to inspect firms in all relevant
jurisdictions except Mainland China and Hong Kong.
The People's Republic of China's (PRC's) resistance to the
PCAOB's inspections is not just a theoretical compliance issue.
Our markets are being tested by a string of frauds by China-
based companies that obtained capital from our markets but
failed to comply with our investor protection rules.
By enacting the Holding Foreign Companies Accountable Act
and continuing vigilant monitoring through hearings such as
this one, Congress is playing a critical role in signaling that
companies that seek access to capital from U.S. markets must
adhere to our rules.
I also commend the SEC and the PCAOB for the decisive
approach they are taking to implement the Holding Foreign
Companies Accountable Act.
A great body of research documents the benefits that
foreign private issuers obtain by issuing securities in the
United States. Those benefits include a lower cost of capital
than they would face in their home-country capital markets. The
linchpin of these benefits is the binding commitment companies
make to our standards, including high-quality financial
reporting requirements and a reliable third-party audit.
Enforcement of this commitment, rather than relying on mere
assertions of compliance, is what distinguishes U.S. listings
and produces their capital market benefits.
PCAOB inspections are a critical component of our
enforcement regime. Inspections examine whether third-party
auditors are, in fact, holding companies to their commitments
to produce high-quality and reliable financial reports. There
is empirical evidence that capital markets find financial
reporting more credible following introduction of PCAOB
inspections in non-U.S. jurisdictions. That is, investors put
more faith in financial reporting when the PCAOB is able to
inspect.
China-based companies free-riding on U.S. markets, without
complying with U.S. audit regulations, increases fraud risks
for investors in those companies. But that is not the only
reason why it is important to stop the free-riding. It also
harms our markets more broadly. The benefits I have described
exist because participation in our markets means something. It
is a signal of the quality and reliability of the financial
reporting of the companies that list here.
As we saw in the days of the Enron scandal, when any group
of participants fails to comply with our standards, that sends
a signal that weakens confidence in the whole market. For the
benefits to continue to flow to compliant U.S. and non-U.S.
companies, it must be clear that we enforce our standards
across-the-board.
In conclusion, audit regulators around the world cooperate
in PCAOB inspections of registered firms' audits of companies
that offer securities in the United States. The PRC is the only
government that blocks them. This causes serious harm to both
investors in such companies, as well as our public capital
markets more broadly.
I commend the work you have done to put an end to these
harms, as well as the work the SEC and the PCAOB have done to
implement the Holding Foreign Companies Account Act. Based on
the heightened risks evident from a string of frauds that have
already been revealed, it will also be important to ensure that
China-based companies that are prohibited from trading on our
public markets do not turn to other ways to access U.S.
capital. And therefore, I commend your continued vigilance.
Thank you.
[The prepared statement of Ms. Ross can be found on page 77
of the appendix.]
Chairman Sherman. Thank you for your testimony.
Ms. Chu, you are now recognized for 5 minutes.
STATEMENT OF CLAIRE CHU, SENIOR ANALYST, RWR ADVISORY GROUP
Ms. Chu. Chairman Sherman, Ranking Member Huizenga, and
distinguished members of the subcommittee, thank you for the
opportunity to testify before you today.
I am a senior analyst at RWR Advisory Group, a research and
advisory firm based here in Washington, D.C., where I
specialize in the geopolitical and national security risk
implications of China's commercial activity and overseas
engagement.
I have been asked to provide some context on the nature of
Chinese corporate actors and their role in China's state-led
economy. I will also lay out several risks to investors and the
United States, followed by recommendations.
The Communist Party of China's (CCP's) involvement,
influence, and control over the commercial sector means that
Chinese companies are beholden to the party-state and can be
compelled to sacrifice corporate interests for government
favor. Corporate actors are directed to meet state planning
targets, and CCP officials are embedded within the operations
of large companies to ensure regulatory compliance.
The government essentially has the power to determine
whether a company is allowed to raise capital, provide goods
and services, or even continue to operate as a for-profit
enterprise. There are clear incentives for companies to welcome
CCP guidance and to operate in ways that are conducive to the
state's interests. Companies can also be subjected to coercive
and arbitrary punishment for crossing party-state lines.
The heavy-handed, reactive nature of the Chinese regulatory
apparatus can sometimes undermine its own companies and, by
extension, American investors in those very companies. China's
recent regulatory broadside has left the U.S. financial
industry grappling with the challenge of quantifying the effect
of government corporate intervention. This kind of uncertainty
has a material adverse impact on companies and investors, who
cannot be sure if IPOs will go ahead or if entire industries
will be banned from raising funds in the capital markets.
What really amplified the impact of this latest spate of
regulatory action and made it front-page news was the high
level of global financial exposure to the stocks of those
affected companies. The Chinese government prioritizes state
stability and social control over commercial gains. The more
intertwined the U.S. and Chinese markets become, the more
acutely U.S. investors will feel the aftershocks of Beijing's
politically driven market interventions.
The U.S. commitment to high-quality, reliable disclosures
and financial reporting is a key element of its ability to
protect investors and market participants.
The Chinese party-state's sweeping bureaucratic authority,
opaque legal system, and complex corporate structures obscure,
often intentionally, a Chinese company's beneficial ownership
and financial realities. Beijing also uses lack of transparency
as an economic advantage, creating information asymmetries to
control and moderate foreign flows into the Chinese market.
These China-specific risk factors make it particularly
challenging for U.S. regulatory authorities to conduct proper
due diligence and can prevent U.S. investors from being able to
make informed investment decisions.
Variable interest entities (VIEs), for example, are legally
ambiguous corporate structures used by Chinese companies to
list on U.S. exchanges. VIE shareholders have no recourse. The
operating company's underlying assets and the moral hazard
risks are substantial.
Chinese companies seeking to issue unregistered securities
in the United States are able to circumvent strict standards by
taking advantage of the SEC safe harbors, like Regulation S and
Rule 144A.
With the rapid inclusion of China A-shares into major stock
indices, the expansion of Stock Connect schemes, and the
quadrupling of A-share weighting in certain benchmarks, U.S.
investor access to the publicly-traded Chinese companies has
expanded dramatically over the past few years. Index providers
like MSCI and FTSE Russell have become a power force, serving
as intermediaries and gatekeepers between Chinese companies and
U.S. markets, exercising virtually unchecked, unregulated
authority over the volume of U.S. capital flows to China.
The criteria evaluated by index providers to support
inclusion and weighting decisions are limited to standardized
attributes, like market cap and liquidity, and neglect to
consider the reputational and China-specific factors like
state-sanctioned human rights abuses or financial exposure to
party-state policymaking.
U.S. retail and institutional investors are consequently
exposed to a wide range of Chinese companies engaged in
activities that are contrary to the national security and
foreign policy interests of the United States. Many are already
sanctioned by the U.S., but not subject to any capital markets
restrictions, no investment restrictions, or divestment
mandates, and are thus able to continue raising capital in the
U.S. markets.
The current U.S. securities regulatory framework will need
to evolve with greater, more targeted oversight, disclosure
enforcement, China-specific due diligence, and sanctions
alignment to respond in kind to the unique risk associated with
this influx of securities listed overseas in institutional
environments where the disclosure requirements and corporate
governance practices don't offer the same protections for
investors as in the United States.
Thank you, and I look forward to your questions.
[The prepared statement of Ms. Chu can be found on page 44
of the appendix.]
Chairman Sherman. Thank you.
And Mr. Lorber, you are now recognized for 5 minutes.
STATEMENT OF ERIC LORBER, SENIOR DIRECTOR, CENTER ON ECONOMIC
AND FINANCIAL POWER, FOUNDATION FOR DEFENSE OF DEMOCRACIES
Mr. Lorber. Chairman Sherman, Ranking Member Huizenga, and
distinguished members of the committee, I am honored to appear
before you today to discuss the risks to investors and the
United States posed by Chinese issuers in U.S. markets.
I come before this committee as a sanctions and compliance
professional, having worked at the U.S. Department of the
Treasury, and advised financial institutions, corporations,
humanitarian organizations, and individuals on ensuring they
operate in compliance with their legal sanctions obligations.
As part of my work in both the public and the private sectors,
I have seen firsthand the power of U.S. economic sanctions in
furthering U.S. foreign-policy objectives, and while sanctions
are not a panacea, they can be used in narrow and targeted ways
to great effect.
One area where the United States has increasingly used this
tool is in the global competition with China. As Congress and
the Biden Administration consider ways to protect U.S. markets
from abuse and push back against certain Chinese activities
that threaten U.S. national security, sanctions remain one of
the top policy levers to consider pulling.
Safeguarding transparency in the global financial system
and in U.S. markets is critical to protecting U.S. national
security and the strength of the U.S. financial system. A core
part of providing this transparency is ensuring that U.S.
investors have access to relevant material information about
foreign companies in order to make informed decisions. Over the
last few years, the United States has taken important steps to
ensure that Chinese companies attempting to access U.S. markets
must play by the same rules as U.S. companies, and do not
produce significant material risk in U.S. investors' portfolios
due to their lack of financial transparency.
At the same time, we must balance those considerations
against the risk of creating an onerous set of disclosure
requirements that deter companies from seeking to access U.S.
markets or that make it overly burdensome to do business here
in the United States. Such burdens can deter legitimate
companies from seeking financing on U.S. capital markets. This
is a delicate balance to strike.
As Congress and the Administration weigh whether to create
new reporting and disclosure requirements and determine how to
best protect U.S. investors, they should likewise consider the
use of narrowly-targeted sanctions which offer a well-
established tool to ensure U.S. companies and U.S. national
security are protected from certain threats.
The United States has a range of sanctions tools to target
specific Chinese companies whose activity it believes poses
national security risks. In particular, over the last few
years, the United States has deployed limited, but powerful,
prohibitions on trading in public securities of certain Chinese
companies allegedly associated with the People's Liberation
Army, or otherwise alleged to be involved in China's civil
military fusion program.
Likewise, for companies or individuals who are alleged to
engage in particularly egregious actions, this targeted
approach may be a narrow and effective way to limit these
companies' or persons' access to U.S. markets and to U.S.
capital more broadly.
In addition to sanctions designations, the U.S. Department
of the Treasury also has effectively promulgated advisories and
guidance warning the private sector of doing business with
certain companies or in certain sectors, including in Chinese
industries. For example, the Treasury Department, along with
its interagency partners, issued a supply chain advisory
designed to warn the private sector about the risk of human
rights abuses and forced labor in Xinjiang.
These tools could provide a narrow, targeted way to warn
U.S. companies and investors of the risks of doing business
with certain Chinese companies or in particular industries, as
well as limit the ability of those Chinese companies that
threaten U.S. national security from securing capital on U.S.
markets.
I look forward to your questions, and thank you again for
the opportunity to testify.
[The prepared statement of Mr. Lorber can be found on page
68 of the appendix.]
Chairman Sherman. I want to thank all tof he witnesses for
their testimony.
I now recognize the Chair of the Full Committee, Chairwoman
Waters, for 5 minutes for questions.
Chairwoman Waters. Thank you very much, Mr. Chairman.
Ms. Sutter, it is reported that many China-based companies
desire to be listed on the U.S. stock exchanges not only
because our markets are large and liquid, but because our stock
exchanges permit initial public offerings, or IPOs, with
something called dual class share structures. Dual class
structures allow elite shareholders, most often company
founders and executives, to have a disproportionately large
portion of the company voting power.
This structure has been used by many companies from
Mainland China. In fact, at least 5 of the top 10 U.S.-listed
China-based companies have dual class structures. What I find
interesting is that China's own exchanges, or the London Stock
Exchange, for example, ban the practice of dual class
structures for IPOs.
Ms. Sutter, how does the dual class share structure
permitted by our stock exchanges create risk to our investors?
Why do China-based companies make use of this structure? Should
our exchanges limit China-based companies' ability to offer
dual class share structures?
I find this situation very interesting, and I question
whether or not we can question China, when we use the same
structures? And if we are questioning them because, as I am
told, China has more control over these big business, these
owners, these top business people, and they direct them and
they can tell them what to do, and somehow that is a difference
between what they do and what we do, can you help me out with
this discussion?
Ms. Sutter. Sure. Chairwoman Waters, thank you very much
for the question.
I think with the dual class share issue, generally there
are broader considerations that I do not focus on. I will
narrow in on the China element in particular.
As you mentioned, the Chinese companies do take advantage.
They do use the dual class share structure. This has also
become a competitive issue within China. Since 2018, the Hong
Kong exchange, and then, starting in 2019, the China exchanges
have started to consider and adopt this dual structure.
The one thing I would highlight in considering how the
Chinese companies may use this structure is that in addition to
this legal element, this formal element of dual class shares,
that within the Chinese system itself, not all shareholders are
equal. I would highlight to you that in looking at the
government restructuring of companies like the property
developer Evergrande, or the restructuring of companies like
HNA Group, at the end of the day, the government is also often
a shareholder or has a direct economic interest in a lot of
these companies. It does not always play kind of a
disinterested role, shall we say, and so I think it is
important that even if the dual class share issue were to be
resolved, that underlying this structure are these inherent
asymmetries in the role of the state in a lot of Chinese
companies.
In the case of HNA, basically what they determined is that
although there were 300 or more subsidiaries that had been
created for the company, at the end, the Chinese government was
the actual controlling shareholder.
Chairwoman Waters. Do you think that dual class share
structures are basically good for us, as opposed to China, and
that we should support what we do because somehow it advantages
our economy in some way or it advantages the way that we treat
investors? Do you think it is good?
Ms. Sutter. I don't have a specific opinion on the
structure itself. I think the main point I would emphasize is
that in addition to the formal structure, there is an informal
structure in Chinese companies that, regardless of how they
list, this influence of the state and actual controlling
shareholders and ultimate beneficiaries is embedded within the
corporate system, either formally or informally, separate from
even how they list in China or then how they might list on a
foreign market such as the United States.
Chairwoman Waters. Thank you very much.
Mr. Chairman, I am going to yield back my time, but I think
this is an issue that needs a lot more discussion. I yield
back.
Chairman Sherman. I couldn't agree with you more.
And I now recognize the ranking member of the subcommittee,
Mr. Huizenga, for 5 minutes.
Mr. Huizenga. Thank you, Mr. Chairman.
Before I get into my time, I do have a parliamentary
inquiry. It is the Minority's belief that the inclusion of this
list that your staff had sent over to us of three bills that do
not even have bill numbers at this point actually doesn't
qualify as congressional testimony. It is not properly noticed
for us, and frankly, even more important, not properly noticed
to the public and those affected by that.
I guess I would just note that these bills were not
properly noticed because, at least at this point, it looks like
they don't even have bill numbers, and do you then intend to
have an actual hearing on these bills?
Chairman Sherman. It is the practice of the committee to
circulate discussion drafts. Of course, discussion drafts do
not have bill numbers. Some of the most important legislation,
I believe, has been discussed as drafts without H.R. numbers.
Discussion drafts of bills at today's hearings do satisfy
the McGovern Rule, which requires that a bill has a legislative
hearing before it goes to the Floor. That being said, it is my
expectation that either the full committee or more likely the
subcommittee will have a more general hearing on capital
markets issues, which will provide a second opportunity to
discuss these bills before they go to the Floor.
Mr. Huizenga. Furthering my parliamentary inquiry, the
rules do state a 3-day notice. That was not what happened, just
so we are clear, and all on the same page with that. So, at
this point, I guess I would like to--unless you have something
more to add on the parliamentary inquiry, I am happy to take my
time for the questioning now.
Chairman Sherman. You are recognized.
Mr. Huizenga. Thank you.
Mr. Lorber and others, you have made some interesting notes
on what has been happening with China. Obviously, we have seen
large tech companies like DiDi and Ant Group, Chinese companies
that either have or were planning to go public in the U.S.,
have been targeted by Beijing. It is clear that China believes
it is ready to directly compete with U.S. markets for the title
of premier global economy.
What I am curious about is your take on how serious is the
CCP at all on this crackdown, and are we looking at kind of a
financial version of Tiananmen Square here with their
entrepreneurs and their folks that have been innovative? And
along those lines, what can we do here in the U.S. to improve
the market situation to make sure that we are competitive?
I don't want to be Gulliver among the Lilliputians, with a
whole bunch of other people who have terrible policy and we
have slightly better policy. I want to have the gold standard,
the U.S. dollar gold standard of policy here in the U.S. to
make sure that we are the leading economic force.
Mr. Lorber. Thank you, Ranking Member Huizenga.
I agree with your assessment and the assessment of other
members of this panel when they suggest that you have seen a
tightening of control over certain companies within China, and
it appears to be led in part by the government or in full by
the government.
But I want to focus on the second part of your question
because I think that is exactly right. Ensuring that the U.S.
capital markets space remains robust has all types of
downstream economic, positive economic impacts for the United
States. It increases innovation. It ensures that the cost of
borrowing here in the United States is low. It incentivizes
non-U.S. companies to come and work in the United States. And
so, I think from sort of a perspective of ensuring that the
U.S. financial system remains strong, trying to keep our
financial markets as streamlined and as attractive as possible
is an incredibly important goal.
Mr. Huizenga. I am curious, and along those lines, do
increased mandatory SEC disclosures not related to financial or
investment risk--I believe this has been a significant part of
our conversation on the subcommittee, and there was one of
those that is proposed here today that applies to all U.S.-
listed companies, not just those from China. What does that do
to encourage U.S. economic growth, or does it discourage it?
Mr. Lorber. It is a good question. I do think that there is
a risk of, if requiring nonmaterial disclosures, that the
burdens and the obligations that are imposed on U.S. and non-
U.S. issuers will certainly create some degree of additional
compliance obligations and some degree of deterrence for
companies seeking to find financing on U.S. markets. So, I do
think that there is a risk in particular of requiring, again,
disclosure related to nonmaterial information.
Mr. Huizenga. Ms. Ross, in your introductory materials and
biography and those types of things, you talk about materiality
of disclosure. I am curious if you could very quickly touch on
that as well?
Ms. Ross. Thank you so much, Ranking Member Huizenga.
Yes, I agree. With respect to these issues with China, it
is really not a matter of needing more new disclosures. The
problem is that these China-based companies are not even
complying with our existing rules. So, I don't think adding new
disclosures will address it. I think what we need to do is to
actually enforce the existing rules and send the signal to
Chinese companies and the Chinese government that these are
rules that pertain to our markets that they must adhere to when
they are in our markets.
Mr. Huizenga. What about a targeted sanction or something
along those lines to address the weaker situation, would you
view that more effective versus a blanket sort of SEC? Quickly,
if you want to answer that, and then I want to get to Mr.
Lorber.
Ms. Ross. Yes, sure. I agree with Mr. Lorber's testimony
that targeted sanctions can be very effective tools. I also
think when we are talking about these China-based companies
that are listed in the U.S. markets, across-the-board they are
not complying with our rules. So, I do think across-the-board
enforcement of our rules against all of them is appropriate.
Mr. Huizenga. Mr. Lorber, enforcement, quickly, in my last
seconds.
Mr. Lorber. Yes, I agree with the assessment of sanctions.
I think you saw--particularly in the Xinjiang region, you saw
the designation in 2020, I believe, of the XPCC, the Chinese
paramilitary organization that was involved or alleged to be
involved in those activities, as well as the publishing of
guidance to warn about the supply chain, and I think that had a
major impact on sourcing of goods, in particular from that
area.
Mr. Huizenga. My time has expired, but I just do want to
commend the Chair. I am glad we are having this conversation.
This is a conversation we need to have. We have had it in the
past, but I think the seriousness of this issue has become more
crystal clear for everyone, and I am encouraged to have this
ongoing conversation.
I yield back.
Chairman Sherman. The gentleman has gone over time, but if
he wishes more time to praise the Chair, he will be yielded it.
Mr. Huizenga. The gentleman is obviously a good-looking,
wealthy, serious-minded person who is--keep going? Okay. I
think I--
Chairman Sherman. The gentleman's time has expired. I now
recognize myself for 5 minutes.
Ms. Sutter, I want to pick up on your comment about
selective access, because this is one way in which China has so
much power here in the United States. I represent the movie
industry in my district, and they only allow 40 movies into
China, so if you run a studio, you want to be one of those 40
movies. And you know that if you make a movie about Tibet, that
movie isn't getting into China. And you know if you make a
movie about Tibet, none of your movies are getting into China.
If you are Morgan Stanley, and you want to do banking in
China, you know that you may be one of the banks that gets into
China if your global index includes Chinese companies to a
sufficient degree, and if you officially notify all of your
customers that they should include China to the 15-percent
level or whatever level in their portfolios.
You know that you will be allowed to do business in China
if your lobbyist is here on the Hill lobbying for China. China
doesn't need to hire a lobbyist. They have all of them through
this selective access system.
I want to thank Ms. Ross for focusing on the importance of
the already-passed Holding Foreign Companies Accountable Act,
and the need for us to pass the officially, definitely,
explicitly-noticed Accelerating Holding Foreign Companies
Accountable Act that is pending before this committee, and
point out that the original bill passed the Senate in light of
Luckin Coffee and that it was so--and people wonder, is there a
benefit to short-selling? There is at least one, and that is
short-sellers, in this case Muddy Waters, LLC, that focused on
Luckin Coffee, and discovered the problem there, that there was
$300 million of fraudulent sales. They brought that to their
attention. They, of course, made money by discovering that, and
that short-selling can be a way to discover those issues.
Ms. Chu, I want to thank you for pointing out to us clearly
that when you invest--we in the United States grow up with this
idea that you buy a share in a company that owns assets. Those
assets are managed in the interest of shareholders by a board
of directors loyal to the shareholders, and those assets are
controlled by the corporation, and their property interests are
protected by the courts. That is 300 years, 400 years of common
law. We just assume that. oh, that is what a corporate share
is.
Whereas in China, the board may or may not be loyal to
shareholders, may be more loyal to the goals of the Chinese
Communist Party, and the courts may or may not enforce the
property rights of the corporation vis-a-vis expropriation or
arbitrary punishment or seizure. And yet, I don't think
Americans instinctively--they just look at earnings per share
and say oh, that company is doing well, it must be a good
investment.
Ms. Sutter, I want to focus on including VIEs in indexes
and the deceptive name. If I wanted to raise some money, I
would call my company, ``GameStopped.'' I would add an, ``E-
D.'' It is a hot company. A lot of people like GameStop.
You can call a company, ``Alibaba of Cayman Islands,'' and
register shares here, and everybody thinks that is, ``Alibaba
of China.'' But what you are really buying is a Cayman Islands
company that owns a Chinese company that has some sort of
contractual relationship with Alibaba. Everybody in China has a
contract with Alibaba, if you have them on your phone.
Should we allow these phony names--should we allow people
to use the name Alibaba if they are not Alibaba, and should we
allow people to say that you are in an index because you are a
big company when you are really just a Cayman Islands shell?
Ms. Sutter. Thank you for the question. Would you like me
to answer--
Chairman Sherman. Yes.
Ms. Sutter. Okay, I just wanted to be sure. It is
interesting, when you read a Chinese company disclosure that is
submitted to the SEC, they often will talk about the VIE
structure and risks associated with the VIE structure,
sometimes going on for 5 or 10 pages, and it is an interesting
question about, is, ``Baidu, Inc.,'' ``Baidu,'' or is, ``China
Mobile, Inc.,'' ``China Mobile,'' in the sense of how the
company is advertising to investor? So, that is an interesting
question to consider. I think the other--
Chairman Sherman. I am going to have to ask you to respond
for the record. My time has expired. It is my fault, but I have
to go on to the next questioner.
Ms. Sutter. Okay.
Chairman Sherman. I now recognize the gentlewoman from
Missouri, Mrs. Wagner.
Mrs. Wagner. Thank you, Mr. Chairman, and on that point, I
think maybe that is why we have copyright laws, and perhaps it
is up to the private entity and the company to exercise their
copyright laws.
Mr. Chairman, I think today's hearing topic is extremely
timely and necessary. America faces continued health challenges
and an economic crisis that was brought on by the Chinese
government suppressing, misrepresenting, and falsifying
information concerning the spread of COVID-19 in the beginning
of 2020. We must hold China accountable for their actions,
which is why I have introduced H.R. 3882, the Compensation for
Americans Act.
I also have authored an essay with Representative Andy
Barr, whom I know will be speaking on this topic later on,
which outlines the need to strengthen the U.S. sanctions
regime, which is a key tool to denying our adversaries the
resources they need to continue their illicit behavior.
The increased mandatory risk disclosures being discussed
today will not change China's behavior. Instead, we should be
focusing on how to better use a more targeted tool, such as
sanctions or export controls.
Mr. Lorber, America's ability to counter China's global
dominance is only effective if we focus on our strengths and
leverage America's economic might to counter malign Chinese
activities. As has been discussed today, using our securities
disclosures to advance foreign policy goals can be
counterproductive.
Specifically, I think adding excessive reporting and
compliance burdens not based on information that is material to
investors' investment risk calculus typically undercuts
companies' ability to expand, innovate, and generate jobs. Will
you describe, sir, how the use of U.S. investment disclosures
rules to accomplish certain policy goals compromises the
strength and credibility of America's capital markets?
Mr. Lorber. Thank you for the question, Representative
Wagner. It is a good one.
I think to a certain extent, if there are additional
nonmaterial reporting requirements put into place for
companies, it will, as I mentioned earlier in the conversation,
potentially reduce companies' willingness to list--companies
that want to list on U.S. financial markets or to access U.S.
financial markets to seek that access. So, I do think there can
be a direct impact on the competitiveness of those markets if
there are nonmaterial reporting requirements and obligations
that are put into place.
Mrs. Wagner. Will you comment, sir, also, on why the
strength of the U.S. economy and our capital markets is key to
our effectiveness abroad?
Mr. Lorber. Absolutely. As we were talking about earlier,
and as I believe Ms. Ross mentioned in her testimony, U.S.
capital markets are something of a crown jewel of the U.S.
economy, right? They allow for low-cost capital to be accessed.
They are attractive for companies that are abroad. They
increase innovation here in the United States. They bolster our
economy here.
And so, I think that to a certain extent, especially when
viewed vis-a-vis the sort of control that the Chinese
government is now exercising over its companies and some of the
crackdowns that we have seen, those markets are increasingly
attractive, and I think we should do everything we can to
bolster them.
Mrs. Wagner. Mr. Lorber, the Holding Foreign Companies
Accountable Act was enacted last year because the Chinese
government has actively not allowed Chinese companies listed on
U.S. exchanges to comply with our securities laws. Is it just
naive to think that Chinese companies will comply with the
Democrats' mandatory SEC disclosure discussion drafts proposed
today?
Mr. Lorber. I do think that additional disclosure
requirements may not be impactful in compelling Chinese
companies to comply. That is why, with the Holding Foreign
Companies Accountable Act, the 3-year cutoff enforcement
mechanism, I think is an appropriate mechanism, and for those
companies that the U.S. believes pose serious national security
threats, so maybe not just misleading on their financials but
are actually involved in, for example, the Chinese civil
military program, I think targeted securities sanctions would
make sense for policymakers--
Mrs. Wagner. In my limited time, how do other tools like
sanctions and export controls eliminate the question of whether
or not our rules will be, in fact, followed by the Chinese
Communist Party?
Mr. Lorber. It is a great question. I think sanctions are a
natural tool that have been employed by both of the last two
Administrations, the Trump Administration and the Biden
Administration, to target companies that the U.S. Government
believes pose a national security threat. And in addition to
that, one other thing I would say is guidance. The Treasury and
other interagency partners have been really, really good in the
last few years about putting out informative guidance to
private sector actors to warn them of sanctions in illicit
activity risks, and those companies that have read that
guidance take that into account when making risk-based
decisions.
Mrs. Wagner. Thank you, Mr. Lorber. My time has expired. I
yield back.
Chairman Sherman. I now recognize the gentleman from
Georgia, Mr. Scott, who is also the Chair of the House
Agriculture Committee, for 5 minutes.
Mr. Scott. Thank you very much, Mr. Chairman.
This is an extraordinarily important hearing. Right now,
China's role in the global economy is just massive. China is
the largest exporter of goods in the world, with 9.6 percent of
the entire global share, and while the country's GDP grew at
its slowest pace last quarter, expanding just 4.9 percent from
the previous year, China's $15 trillion economy remains the
second-largest in the world, second to us in the United States.
Ours is number one.
In your testimony, Ms. Sutter, you cite several factors
regarding China's attempt to reduce debt and curtail market
risk among several large firms. Here is the question for you
that I think the nation and the world is waiting on: Can you
explain what the impact would be for not just us, but for all
of the global markets if a Chinese economic collapse were to
occur?
Ms. Sutter. Thank you, Congressman, for the question.
I think there is a lot of attention right now on the
situation of China's second-largest property developer,
Evergrande. Their total debt is about 2 percent of China's
national debt. I think it provides some insight into some
overcapacity and China's continued dependence on fixed asset
investment for growth, that this is a systemic weakness in the
economy.
A lot of people argue that right now, the U.S.'s potential
risk exposure is manageable, but we are looking at a situation
where a lot of financial firms now having new licenses to move
into China--it has been discussed, putting more Chinese
companies into fund indices--what comes ahead. So, I think
Evergrande is a case study to look at the potential systemic
risks in the market, how U.S. exposure could grow over time,
and what would be the U.S. recourse in these types of
situations.
Mr. Scott. Let me ask you this. How exactly is the dramatic
slowdown in Chinese construction projects and manufacturing,
those two things, how are they related to the growing warning
signs that we are getting of a possible shock to the global
financial markets?
Ms. Sutter. I would say in response, I think the main thing
to keep in mind is the trouble that Evergrande and other
property developers have in China arguably was started by the
Chinese government. These are highly-leveraged companies.
Evergrande's assets, 60 percent are unbuilt, unsold properties,
and these companies rely on money to continue to flow so that
they can continue to pay. So, when the government stops the
ability for new fundraising, it creates crisis in the system.
I think what you see the Chinese government doing now is
trying to avoid market contagion in property, the market more
broadly, but they are also trying to avoid moral hazard. They
don't want to signal to companies like Evergrande that they can
continue business as usual.
The local government in China is very dependent on these
property developers for income for local government mandates.
So there is a symbiotic relationship. In the case of
Evergrande, the Xinjiang government is a direct shareholder in
Evergrande.
So, I think it is the interrelationship, it is a challenge
for China to get out of this situation, and I would say the
situation for the United States is less our current exposure,
it is more about we seem to be at a juncture where there is a
lot of discussion about increasing financial exposure in areas
like this in the economy. What would that look like going
forward?
Most people seem to think the current exposure, if the
Chinese are able to handle the situation, is fairly contained
at this point, although that depends on how the Chinese
government handles it going forward. It is an issue-to-watch
type of scenario right now.
Mr. Scott. Thank you very much. That was very good
information. Thank you.
Chairman Sherman. Thank you. I now recognize the gentleman
from Arkansas, Mr. Hill.
Mr. Hill. I thank the chairman, and I appreciate your work
in preparation of this hearing. It is certainly a topic of
interest, strong interest to Members of both parties, and I
appreciate our witnesses' preparation and being here
personally. It is good to see witnesses in person, Mr.
Chairman, and not on a Zoom screen.
In the late 1980s, I spent a lot of time traveling in Asia,
including in China, and I can remember distinctly John Phelan's
famous trip to Beijing in 1986 trumpeting the New York Stock
Exchange as a potential place for Chinese companies to list.
Americans had seen the success of the Asian Tigers by the
1980s, and I think U.S. policymakers really believed that if we
demonstrated and modeled good behavior and opened up our
markets, capital markets to China, that we would get a good
response.
And in fact, China's capital markets did grow, access to
capital was there, and there is no doubt that free markets and
capitalism and the open trading system allowed China to create
hundreds of millions of people and move them into the middle
class, and certainly, China has benefitted from this past 3
decades.
But that 30 years of progress from the open door is now
seeing that door slam shut since President Xi has turned his
country into a more authoritarian state, and turned his back on
the norms in capital markets. Consumers are no longer
benefiting, but they are now pawns in a surveillance state. The
business sector is no longer benefiting as much because markets
are volatile, rules are inconsistent, and the state demands
full control of entrepreneurship.
I don't know if investors are benefiting or not. I think
the purpose of this hearing is to demonstrate that maybe they
are not, because they are not getting the kind of information
that a good market like the American markets provides. The
third world and emerging markets are not benefiting due to the
predatory neocolonial belt-and-road policies of China, and
finally, their attitude about the capital markets would make
the founders of Enron blush.
So, I want to say thank you to our ranking member and our
chairman for calling this hearing.
I want to start with Ms. Sutter. You have provided
excellent testimony. You brought a lot of good information to
the committee on the VIE structure, and also using an ADR
structure, which we have done for years and years successfully
in many markets, we have allowed liquidity for foreign
companies. Tell me what you think we ought to do that is fair-
minded, and that is compliant with WTO obligations on improving
disclosure for the use of a VIE or even the ADR structure.
Ms. Sutter. Congressman, thank you for the question.
There has been a lot of interest around the challenges the
United States faces with China, not just in this area, but
across-the-board, and an interest in looking at greater
transparency. There are a couple of ideas that I hear discussed
that may be of interest for consideration for you and the
committee: the issue of requiring a 20-F or 10-K equivalent for
all firms, not just those who list, but also those who have
secondary listings; the issue of more detail on the corporate
structure; all of the beneficial owners, all of the different
contracts and ties across the owners is another area that some
have discussed; the issue of quarterly as opposed to only
annual reports on a company's financial situation--
Mr. Hill. Let me interrupt you there. Do you think if that
were the status, it would make America a less effective market,
say, for American depository receipts, or would you think--not
just China, but as a general matter, would that be something
that would be met with appropriately, since companies want
access to U.S. retail investors?
Ms. Sutter. I would say that I believe the issues I just
raised are the same for what a U.S. lister would have to do--
Mr. Hill. Right. Thank you for that.
Ms. Sutter. Sure.
Mr. Hill. Now, let me turn to Ms. Chu. You made, again, an
excellent presentation. You commented on SEC Commissioner
Hester Peirce's speech where she was open to additional
disclosure for index providers and exchange-traded funds
(ETFs). Tell me what you think would be appropriate there?
Ms. Chu. Thank you for the question.
At present, the criteria used by index providers who,
again, exert overwhelming power over where U.S. investors are
able to invest in China, which companies have access to U.S.
capital, the criteria that they use is based on market factors.
They have no consideration for reputational risks like human
rights or national security, sanctions regimes, or trade
conflict, and these are all things that pertain--
Mr. Hill. Thank you. If you would, submit for me your
additional thoughts on that to the record.
Mr. Chairman, I yield back to you.
Ms. Chu. Okay.
Chairman Sherman. The gentleman from Connecticut, Mr.
Himes, who is also the Chair of our Subcommittee on National
Security, International Development and Monetary Policy, is
recognized for 5 minutes.
Mr. Himes. Thank you, Mr. Chairman, and a big thank you to
our witnesses for really compelling and interesting testimony.
I want to use my 5 minutes to really zero in on the China
issue here. Look, there is a long list of things that concern
us all about China that have to do with strategy and
geopolitics and military and IP theft, and it goes on and on
and on. But this is the Financial Services Committee, and I am
not a priori persuaded that variable capital arrangements are
inherently problematic. Lots of U.S. companies, as the
chairwoman points out, use variable capital structures. We are
hearing about Luckin Coffee. I had never heard of Luckin
Coffee, but dodgy accounting leading to bankruptcy is hardly a
uniquely Chinese problem.
Let me start with you, Ms. Ross, because you did
enforcement. If I am wrong about that variable capital or
particular intensity of bankrupt companies in China, I would be
interested to know, but I am sensing that there is an
allegation floating around that perhaps the Chinese are getting
special treatment in the face of the sanction mechanisms that
the markets already have. In other words, hundreds of companies
are delisted every couple of years. The specific question is,
are the Chinese somehow getting special treatment with respect
to bad behavior not leading to delisting? And more generally
speaking, what is the narrowly Chinese issue within capital
markets, or are they more broad capital markets issues that we
should be focused on?
Ms. Ross. Thank you for that question, Congressman Himes.
I think there is an uniquely Chinese issue here, which is
that we have investor protections in this country that require
inspections of audits of companies that are listed here. These
protections are known to have economic benefits both for our
markets, our investors, and the companies that are listed here.
Almost all non-U.S. companies that are listed here are
subject to and cooperating with those protections, and the
jurisdictions that they are in are cooperating in those
protections. The People's Republic of China (PRC) is the sole
jurisdiction in the world that is blocking that investor
protection. So in that respect, companies from Mainland China
and Hong Kong that are listed here are getting a different deal
than all other companies both in the U.S. and non-U.S.
jurisdictions. That is what needs to be fixed, and that is why
I commend your Holding Foreign Companies Accountable Act.
Mr. Himes. And what is the right way to address that? There
are well-established pathways--SEC action, private rights of
action, delisting. What is the right way to address that?
Ms. Ross. Right. You have mentioned delisting. That is the
pathway that is embodied in the Holding Foreign Companies
Accountable Act. What you have done is put forward a very
straightforward and orderly process for managing these
companies if they don't come into compliance within the next 3
years, and if you enact the Accelerating Holding Foreign
Companies Accountable Act, that will be 2 years. You have given
ample time for companies and for the Chinese government to
understand what the pathway is, and we are already seeing
investors in markets and even the Chinese government taking
that seriously.
Mr. Himes. And what about the exchanges, who ultimately
would do the delisting, are they particularly hesitant to take
this up with Chinese issuers?
Ms. Ross. In this case, it is actually the SEC that would
issue orders prohibiting trading in these companies, and that
is a very standard procedure, as you have mentioned.
Mr. Himes. Okay. And so, again, trying to get at the
uniquely Chinese problem here, this is not an unusual action
for the SEC. Is the SEC somehow--has it been hesitant to take
this action with respect to Chinese companies, or should this
committee be tightening up across-the-board SEC enforcement
against failure to be sufficiently transparent?
Ms. Ross. Great question. These are traditional tools the
SEC uses, which is why I think they are going to be very useful
in this case. What is unique about this situation is that the
PRC has resisted inspections of audits of all China-based
companies that are listed here. That is a unique situation. You
have designed this act to take advantage of longstanding, well-
understood SEC processes to address it.
Mr. Himes. And just in my remaining moments, I was actually
interested to learn that, I guess, the London Stock Exchange
prohibits variable capital companies. Is that an idea that
would have support amongst these witnesses for adoption here in
the United States?
Ms. Ross. I do think there are risks associated with
variable interest enterprises. I think that they are very
opaque. I do not think that the average investor understands
that when they are investing in a VIE, a listed company that is
based on a VIE, they are not investing in the operating company
that is based in China. They have no voting rights, and they
have no say over what management does and no rights to
information. That is very different from most U.S.-listed
companies, and I think that presents very big risks to
investors.
Mr. Himes. Thank you. My time has expired.
Chairman Sherman. The gentleman from Ohio, Mr. Davidson, is
now recognized.
Mr. Davidson. I thank the chairman, and I thank our
witnesses. And I appreciate your testimony, both written and
oral.
And Ms. Ross, I just want to say thanks for your dialogue
there with Mr. Himes. I think you did a great job of
highlighting the specific problems where China really is
getting a different set of rules, and the disclosure regime,
and hopefully, how legislation passed here could change that
and apply an evenhanded set of policies that are already in the
standard toolkit for the SEC. I hope we see some real results
towards that. So, thank you for your dialogue.
I am concerned about the Office of Foreign Assets Control
(OFAC). Frankly, we have done a lot of sanctioning since 1975
when this law was applied, and I am also concerned about China
and, frankly, the conflation of market risk, which our
committee dealt with and Ms. Ross highlighted really well, with
policies that are really foreign policy, for example, the
treatment of Uyghurs.
And Mr. Lorber, I in particular just want to know how
effective has OFAC been at identifying and addressing national
security risks, and is OFAC a more appropriate way to deal with
China's human rights abuses than the Securities and Exchange
Commission, for example?
Mr. Lorber. Thank you, Representative Davidson. It is a
great question.
I will say that OFAC has been particularly effective both
generally, but also specifically related to human rights. After
the passage by Congress of the Global Magnitsky Act and the
implementation of that Act in December 2017, the Treasury
Department and OFAC have targeted a wide range of human rights
abusers and oftentimes caused them to lose hundreds of millions
of dollars in assets. So, there has been a real impact that
OFAC has achieved with the use of human rights-related
sanctions.
I do think that to your second question of whether or not
OFAC should be, for example, the body that goes after human
rights abusers versus something like the SEC, I do think OFAC
has expertise and the Treasury Department, more generally, has
expertise. They have an intelligence collection function, for
example, that allows them to identify and successfully target
human rights abusers.
Mr. Davidson. Yes, thank you. And frankly, it is a national
security problem dealt with by America's Government with the
people with the toolkit and the intelligence to do it, and the
passive approach is to say, well, these publicly traded
companies are going to do it.
That is what was done on conflict minerals, for example.
And at the time, I remember one of the companies had about 30
employees, and I am filling out forms on conflict minerals when
I buy steel. A small business in Western Ohio isn't really in a
position to assess the supply chain risk of steel mills, and so
everyone just signs off on the form. It is a very passive
approach versus a very active approach to diplomacy.
And in general, that has been kind of the challenge, hasn't
it? With China, America has been a little too passive. We have
hoped for all of these good things from China, but in spite of
the fact that we see China's abuse of the World Trade
Organization (WTO), for example, we haven't forced them to
honor their existing commitments, and we haven't forced them to
play by a standard set of rules.
And that is what I love about the idea that if you want to
stay listed, you have to be subject to our accounting policies
just like anybody else, and if you want normal trade relations,
you have to be compliant with human rights standards around the
world. I think it is long overdue that we apply that to China.
Now, inside China, of course China is concerned about their
own domestic market, and they have lots of attention focused on
Evergrande, for example. But we are watching a meltdown in
China that may be similar to a real estate meltdown in the
United States. They had a massive boom. They have definitely
inflated asset prices in many of their real estate markets, and
Evergrande has been at the center of that.
Ms. Sutter, I just wanted to maybe finish with you. Your
testimony does an excellent job of laying out the development
surrounding Evergrande. As you state, about 60 percent of their
assets are unbuilt and unsold properties, and the firm counts
loan interest payments as assets. This has empowered Evergrande
to become shockingly leveraged, and now Evergrande owns about
$305 billion in debt, 2 percent of China's GDP.
We have already seen developments where Evergrande has
failed to repay some of its obligations. However, there hasn't
been contagion effects we would expect when an entity of this
size goes into default. Why do you believe that is? Is China
actually subsidizing it directly, or do you anticipate things
by the People's Bank of China to deal with it?
Ms. Sutter. Congressman, thank you for your question.
I think the government is directly involved in
restructuring Evergrande. They have set up a committee, and it
is very similar to what they have done with other companies
that have gotten into financial trouble--Anbang, HNA, Fosun--
and I think what they are trying to do is discipline the
company while not having contagion in the broader markets,
property market and broader markets. And so, I think it is a
little bit of push-pull--
Mr. Davidson. Thank you, and--
Chairman Sherman. Thank you.
Mr. Davidson. --if we can follow up in writing, my time has
expired, and I appreciate the chairman.
Chairman Sherman. The gentleman from Illinois, Mr. Foster,
who is also the Chair of our Task Force on Artificial
Intelligence, is now recognized for 5 minutes.
Mr. Foster. Thank you, Mr. Chairman, and thank you to our
witnesses.
There are three functions of our capital markets--to
allocate capital, to do so efficiently, and to control risk--
and the opacity of Chinese financial products puts at risk all
three functions.
American capital markets are the premier venue for issuers
due to our deep liquidity and broad investor base, both of
which are substantially the products of the high information
transparency established by our regulatory regime. Essentially,
here, more than anywhere else, you know what you are buying
into. We must uphold these standards, and there should be
consequences for not complying with transparency measures,
which is why I was a proud co-sponsor of Chairman Sherman's
Holding Foreign Companies Accountable Act, and I look forward
to further bipartisan action on this front.
Now, when we take action, one key question is whether the
U.S. should act unilaterally, bilaterally, or multilaterally.
If we unilaterally start delisting China-based companies, per
the Holding Foreign Companies Accountable Act implementation,
do we risk triggering a regulatory race to the bottom where the
delisted companies would just relist in London, Germany,
Singapore, Hong Kong, or even dodgier locations? Or are we
better off acting multilaterally, very much like President
Biden's recent successful negotiation of global minimum
corporate tax rates?
And so my question is, I guess, to all of our witnesses, is
there any significant discussion of multilateral agreements on
minimum transparency standards for listed companies, and if so,
what are the venues in which these are discussed, at least
among the free democracies of the world?
Ms. Sutter, do you want to take a swing at it?
Ms. Sutter. Sure. Thank you, Congressman, for the question.
There is competition among exchanges, and that is a
consideration about when one market takes moves, how companies
shift potentially to another. I would mention that under
China's leader, Xi Jinping, there has been a big push for
Chinese companies to come home to list either on Hong Kong and
China, either as their only listing or as a dual listing.
One issue for consideration could be to look at U.S.
standards with like-minded, open, transparent markets that lean
on the rule of law in the sense that we do and to compare those
standards--
Mr. Foster. My question is, what are the venues at which
those might be discussed or could be being discussed now? Are
there groups that are looking into this sort of thing?
Ms. Ross, did you want to--
Ms. Ross. I agree with Ms. Sutter's description of this
situation, particularly in China, that the Chinese government
is actually pulling the companies home. But to your question,
Congressman, the SEC is a very active member in the
international organization of securities regulators known as
the International Organization of Securities Commissions
(IOSCO). IOSCO includes almost all major securities regulators
around the world, and has many committees that develop all
kinds of model rules, model legislation, and share information.
That has proven to be a very proactive and successful forum to
raise standards across-the-board and address some of these
risks that you are talking about, for example, a race to the
bottom.
Mr. Foster. Yes, is China a member of this? And what would
be their reaction if we raised standards that would effectively
delist their companies in the United States? Would they insist
on letting those lower standards still apply in China?
Ms. Ross. None of the members of IOSCO are obligated to
follow the requirements of IOSCO. IOSCO is really a body to
share and develop best practices, and the members then have--
Mr. Foster. They pick and choose, right?
Ms. Ross. They pick and choose, but it is still a very good
forum to--
Mr. Foster. To discuss, and there would have to be a
separate new group that said, okay, we are all going to agree
to common standards to avoid this sort of regulatory race to
the bottom.
Ms. Ross. If you wanted to do that, yes.
Mr. Foster. Yes. Ms. Chu?
Ms. Chu. I would just like to jump in to note that the EU
recently enacted a regulatory framework for index providers. I
think that is the first time they have done anything of the
sort, and I would encourage the United States to consider
enacting similar legislation, similar regulatory policy, or to
seek out commonality.
Mr. Foster. Mr. Lorber, any comments, sir?
Mr. Lorber. I don't have information on whether or not
there is a multilateral body to prevent the sort of regulatory
arbitrage that you are mentioning. I will say I do think at a
high level while, honestly, regulatory arbitrage of this nature
would be a potential issue and a concern, there would be
certain companies that I think pose national security risks
that even if they were to say we are going to go to another
exchange, we would want to prevent them from accessing U.S.
capital markets in any event.
Mr. Foster. Understood. I will yield back.
Chairman Sherman. Mr. Hollingsworth is now recognized for 5
minutes.
Mr. Hollingsworth. I am excited to be here and I appreciate
all of the testimony that has been given thus far throughout
the course of this hearing. There are a lot of issues on the
table, and in this constellation of issues before us, I wanted
to break a few things apart and better understand both the aims
which we are trying to accomplish and the means by which we
might get there.
It seems in my conversations with colleagues on my side of
the aisle and colleagues across the aisle as well, that there
are a couple of different things that are being talked about.
Number one, there is deep concern that China may be
appropriating technology from U.S. private firms, and certainly
from the U.S. Government as well, for use in its own design.
Number two, there is some concern about protecting U.S.
investors from Chinese companies that may list here but, in
fact, not be engaged in the business practices that they say
they are or not be audited in the manner in which we believe
they should be.
Number three, there are some concerns that firms that might
be gaining the advantage of U.S. capital are deploying that in
unethical ways--Uyghurs, for example--that probably isn't
specific to China, but around the world, no matter where it may
be and what its geography may be, of which we would disapprove.
Number four, there is also this lingering sense that is
hard for me to shake that perhaps we are just out to deprive
Chinese companies of U.S. capital, period, instead of U.S.
technology. And I want to make sure that I understand all of
those different aims so that the mechanisms by which we might
accomplish that truly get us there.
Mr. Lorber, I wanted to talk about one of those
specifically with you, which is the deprivation of
technological transfer from U.S. firms to Chinese firms that we
believe may be a threat to our national security, and the means
we have currently in place in law by which to stop that. Could
you speak a little bit about that?
Mr. Lorber. Yes, thanks. It is a great question,
Representative Hollingsworth, and I like your sort of framing
it in the bucket system that you have approached us with.
On the first bucket, which is the concern that China may be
appropriating technology and what we have in place to prevent
that, I think there are a couple of different mechanisms that
exist. One is surely private causes of action. So, this may not
be a U.S. Government approach, but there are lawsuits that can
be filed.
Likewise, there are criminal causes of action, too, that
the Department of Justice can pursue, and part of this process
during the last Administration was undertaken with the
Department of Justice's, I believe the China Espionage Unit was
the name of it, or something akin to that.
The second primary body that you can think about when it
comes to technology theft or concerns about technology
appropriation could be in the context of the Committee on
Foreign Investment in the United States (CFIUS), and of course,
this body's revision of CFIUS with the passage of the Foreign
Investment Risk Review Modernization Act (FIRRMA) in 2018.
Mr. Hollingsworth. Right.
Mr. Lorber. And then, there could also be potential
targeted sanctions that could be focused on particular Chinese
companies if the Administration decided to do so--
Mr. Hollingsworth. Is there a gap today that exists that we
should solve for in the prevention of that important technology
transfer?
Mr. Lorber. I think I would have to go back and take a
little bit of a deeper look at it. I think one of the concerns
is that on the private cause of action front, there are
challenges. I know there have been instances where Chinese
companies that have been accused of IP theft have employed
certain legal measures here in the United States, like the
Foreign Sovereign Immunities Act, as a way to try to prevent
private litigants from accessing it, and I know there has been
a major debate about that over the last few years in the legal
community.
Mr. Hollingsworth. But much of that work is ex post facto,
right? The technology transfer has already occurred, and they
are trying to recoup their losses as a private enterprise or
private persons, right? Much of our work up here is the
prevention of that rather than the putting together of Humpty
Dumpty.
I wanted to better understand, is there any area where we
need to do work from a legal standpoint in the prevention of
technological transfer that threatens our national security?
Mr. Lorber. I take your point that it is kind of an ex-post
thing, but I think that even if it is solved for ex-post, it
could have a deterrent impact moving forward, for example, if
companies are thinking about stealing U.S. IP and they
recognize that if they do so, there is a decent chance that not
only will they get sued, but that they will--
Mr. Hollingsworth. Yes. Well, that only counts if that suit
renders a judgment, and that judgment is collected upon, which
is a real challenge--
Mr. Lorber. Yes, 100 percent.
Mr. Hollingsworth. I think what I am trying to make sure I
understand is, I don't believe that we should solve these
problems in the financial sector, but I believe we should solve
them with very vigorous laws that prevent this and real
penalties in the event those laws are broken. Call the sheriff
if someone is stealing, don't call the local bank to try to
prevent them from depositing it in their bank account.
With that, I will yield back.
Mr. Casten. [presiding]. Mr. Vargas is now recognized for 5
minutes.
Mr. Vargas. Thank you very much, Mr. Chairman.
Mr. Chairman, I have to say that I think today's hearing
has been excellent. I agree with most of the things that have
been said on both sides of the aisle. However, I also think
that whenever we talk about China, there is a great disconnect
between what we say and what we do.
For example, I fully agree with everything that Mr. Hill
said today. Mr. Hill is a good friend, and I know he has great
experience in this, and I think he is absolutely right that
China has become very aggressive, has become an authoritarian
state, and they collect a whole lot of data that they shouldn't
be collecting.
However, at the same time, I am from California, and I can
tell you that we have ships way out in the ocean now waiting to
be unloaded. With all of the Chinese products coming to the
United States, we can't seem to buy enough. It is incredible
that we say that they cheat, they do all of these things, we
have a great nation competition, yet at the same time, we don't
seem to say that, well, we are not going to buy all their
stuff.
We do, in fact, do that, whether they come here and they
cheat, or they treat Uyghurs terribly and abuse them and have
horrible human rights issues and spy on all of their people. It
doesn't matter. We still buy their stuff. I try not to. I try
very hard. But at the same time, it even drives me crazy that
my iPhone is not manufactured there necessarily, but it is put
together there.
We say one thing, and we do another, when it comes to
China. And I think we have to understand that they are not only
competing with us, but they are becoming a real threat, and we
have to do more than what we are doing. That is why I think it
is very good that we are looking at them frankly, and looking
at them holistically, and saying, wait a minute, first of all,
okay, a lot of our companies, as Mr. Sherman said quite well,
want to be in China because of the market there. I get that. In
fact, it seems that every time a movie goes there from the
United States, they make more money in China than they do in
the United States.
So, I get that. But at the same time, we have to understand
that they are not only our competitor, but they cheat. And when
they want to access our capital markets, they don't want to
play by our rules. We have to change the rules. We have to go
after them. I think that is a good thing. But at the same time,
we don't seem to; we say that we will, but we don't.
Ms. Ross, they don't play by our rules, so what should we
do?
Ms. Ross. Thank you, Congressman, for that question. I
couldn't agree with you more.
When the PCAOB was first formed in 2003, the PCAOB--as I
said in my testimony, the PCAOB undertook the task of reaching
out to countries around the world who had foreign private
issuers who were listed in our markets to work out arrangements
so that we could make sure that the PCAOB could implement its
own responsibilities in an appropriate way, and that has worked
out. It has taken many years, but it has worked out in every
single jurisdiction where we have U.S.-listed foreign private
issuers based in other countries.
The sole outlier is the PRC. Mainland China and Hong Kong
firms are not complying with our rules. We have had ample
time--many, many years--to resolve these differences, and I
think that the actions that Congress has taken with the Holding
Foreign Companies Accountable Act are critical to signaling
that we have to put a stop to that situation and enforce our
rules across-the-board with all companies. So, I think that was
a very positive step that you took.
Mr. Vargas. Thank you. And again, I just believe we have to
get more aggressive and understand the situation that we are in
now.
Certainly, it is a terrible thing that we had the Cold War,
but we understood we had a fight at the end of the day, and we
won. We are in a situation now with China where they are quite
aggressive all around the world, and even militarily now, when
they team up with Russia, they surround Japan militarily, they
are doing things that are very belligerent, and we have to
understand that and we have to push back.
I know that our companies want to be there, I know that
they are a big player, but at the same time, we can't continue
down this road and think things are going to be okay. So,
again, I appreciate what everyone has said today. I think that
there is a great discussion going on, but I also think that
there are a lot of things that we can do together here, because
I think both sides see Communist China somewhat the same, not
completely. I think there is a lot we can do.
And again, I thank the chairman, and I thank the ranking
member. And I see that I have 7 seconds left, so I will yield
back. Thank you.
Chairman Sherman. I thank my fellow Southern Californian,
and I now yield 5 minutes to the gentleman from Ohio, Mr.
Gonzalez, whom, I might add, was the Republican lead on the
Holding Foreign Companies Accountable Act.
Mr. Gonzalez of Ohio. Thank you, Chairman Sherman, and
thank you for your leadership on that important issue. And
thanks for this hearing, and to our witnesses, I think this is
a tremendously important topic that, frankly, we are going to
be dealing with for a very long time.
I want to start my questions with Ms. Chu. In this
subcommittee, we often talk about how the U.S. capital markets
are the envy of the world, and I think that is accurate. And
there are a lot of reasons for that--the liquidity, the access
to various different types of investors, et cetera. One
argument we hear against cracking down on China in a meaningful
way is that companies and investors will flee, that they will
go to other jurisdictions, and therefore, we shouldn't do
anything because we put at risk that incredible U.S. capital
market structure.
Ms. Chu, where do you fall on that? And then, what sort of
steps, if any, do you see China taking in order to replicate
the U.S. markets and to try to keep Chinese companies from
listing in the United States?
Ms. Chu. Thank you for the question.
On the first point, with regard to Chinese companies
fleeing the U.S. markets, of course, we have seen a couple of
companies already leave. There are four--China's four AI
dragons who are known for surveillance technology. I think at
least three of the four were planning to IPO in the United
States as of the end of last year, and after the entity list
designations, have decided to either go to the Shanghai STAR
market or to the new Beijing exchange.
So, yes, that is a possibility, but at the same time, I
believe that enforcing capital market sanctions and
restrictions on investment is critical to U.S. foreign policy
objectives. At the end of the day, incongruent policy is
ineffective policy.
When you have a company that has been identified as, for
example, building missiles in China or building hypersonic
missiles, and we decided that U.S. companies are not allowed to
supply them technology or services or knowledge, and then you
are allowing the U.S. investors to invest in those same
companies so they can build up those R&D capabilities, that is
a significant flaw and a significant gap in our ability to
enforce any sort of policy goal.
Mr. Gonzalez of Ohio. Thank you. Just to interrupt quickly,
I couldn't agree more. I think there is sort of a question
which is, if somebody is on the entity list, and the company is
designed essentially to give China a competitive advantage
militarily against the United States, should we really be that
upset if they decide to list in Shanghai? My view is, no, we
should not. Thank you for that.
Mr. Lorber, I want to switch to you. In your testimony, you
mentioned targeted blocking sanctions against specific
individuals. What has been the overall effectiveness in these
situations where the U.S. has targeted specific people?
Mr. Lorber. Obviously, it depends on the target, but there
have been many situations in which the targeted blocking
sanctions that we have employed have been particularly
impactful. In the example I mentioned earlier, the XPCC, the
way that OFAC sanctions regulations work is that essentially,
if you target an entity, anything that entity owns 50 percent
or more is also, by law, sanctioned. And in the context of the
XPCC, it actually had I think hundreds of subsidiaries spread
around the world that were all blocked, so if there was U.S.
jurisdiction, you couldn't do business with them. So, it
actually had a major impact on the entity.
Mr. Gonzalez of Ohio. Great. So, that's definitely
something to consider going forward.
Ms. Chu, back to you, I want to talk about DiDi and the
Chinese government's crackdown, ranging from their security
overreach into the company and their efforts to exert more
state control. Is this a sign of a new trend by China, and how
do you see that trend playing out vis-a-vis the capital
markets?
Ms. Chu. I would respond that these are not new trends
necessarily. The Chinese government has always exercised its
regulatory apparatus to crack down on social ills, crack down
on companies posing threats to state control, and also to
address problems that maybe have been festering under the
surface of Chinese society for a long time and have just now
come to a head, and they are forced to take brisk and just
really strong action, maybe capricious action to address them.
What has happened is that U.S. investors are now exposed to
these companies, are increasingly exposed, and are, therefore,
increasingly exposed to these regulatory risks and crackdowns.
Mr. Gonzalez of Ohio. Quickly, do you think we need to do
more from a disclosure standpoint to help U.S. investors
understand when a DiDi or another Chinese company is
compromised in various ways as they come public in U.S.
markets?
Ms. Chu. Yes, I think that is absolutely necessary, and
beyond that, I do think that disclosure requirements would
serve as a deterrence for Chinese companies that are involved
in serious human rights abuses or national security problems.
For example, in the Hong Kong Stock Exchange, in I think 2015,
China Communications Construction Company's dredging entity
sought to IPO. When they were asked at that point if they were
involved in South China Sea militarization activities, after a
period of time they postponed, and I think they ultimately
withdrew their IPO application, because in the Communist Party
of China's party-state, you can't disclose, and you are not
supposed to acknowledge that these are risks.
Mr. Gonzalez of Ohio. Thank you, Ms. Chu. I will follow up
directly, and I yield back.
Chairman Sherman. Thank you.
I now recognize the gentleman from Illinois, Mr. Casten,
who has received so many honors in his life, but none more
important than being Vice Chair of this very subcommittee.
Mr. Casten. Nothing prouder than being under your
leadership, Mr. Chairman. Thank you so much, and thanks to all
of our witnesses.
Ms. Sutter, I want to start with you and just pick up on
some things that you had mentioned about Evergrande. The
headlines, and I think you have said this, their $300 billion
of debt, potentially a default, 2 percent of China's GDP, 2
percent of, I guess their debt as well, national debt, real
estate exposure, maybe 30 percent of Chinese markets. And if I
am doing the math correctly, 190 Chinese-based companies, $2.4
trillion of market cap, so maybe 10 percent of the New York
Stock Exchange (NYSE) is exposed there.
Maybe that is too much. What do you think is the systemic
risk to financial markets we should be thinking about if
Evergrande were to default on their $300 billion? Are those
about the right metrics? Are we thinking about possibly 10
percent of the U.S. stock market exposed? Is it bigger? Is it
smaller? What do you think about the systemic risk there?
Ms. Sutter. Thank you for the question.
I have not done the math on the stock exposure, but I think
that, to me, the important issue that it raises is kind of what
it shows about how the Chinese government gets involved when a
company is in trouble, because it shows what are the rights of
investors vis-a-vis the Chinese state when you have exposure to
a Chinese company.
I think, as I mentioned earlier, right now the parameters
of exposure seem somewhat manageable, but there is an issue
about who gets paid, in what priority order, how are you paid.
We have looked at this in China since the failure of the
Guangdong Trust, Gzitic, in 1999, as far as just trying to
preference domestic or international investors, and I think, to
me, it highlights something to watch about how the government
is a direct investor in Evergrande as much as it is a regulator
of Evergrande.
Mr. Casten. I want to sort of put this somewhat more
qualitative version of the question to you, Ms. Ross. In the
absence of our ability for the PCAOB to go in and audit the
auditors, how confident are you of our ability to answer the
fundamental question, whether for Evergrande or someone else,
what is our systemic exposure in the U.S. economy to situations
like Ms. Sutter described, the specific case of Evergrande, how
confident are you--what are the error bars around that in your
view?
Ms. Ross. Thank you for that question, Congressman Casten.
It is a very important question.
Our understanding of systemic risk comes largely from our
access to information so that we can analyze those risks. That
is what Ms. Chu does everyday, trying to access the
information. But when companies list in our public markets, we
depend on those disclosures to understand the risk, and then on
a whole basis of all companies from a particular jurisdiction
or in a particular industry, we use the disclosures, investors
use the disclosures, markets use the disclosures to assess the
systemic risk.
Mr. Casten. Yes. Okay.
Ms. Ross. We can't fully do that without compliance, and
that is why it is so important that we be able to enforce our
accounting and auditing rules.
Mr. Casten. Okay, and I am sorry to cut you off, but I want
to get to a question with enough time to answer it.
We have talked a lot about the Holding Foreign Companies
Accountable Act as being targeted at China, but I think it is
important for us to be clear that it doesn't actually say
China. It says if the PCAOB can't go in and audit the auditors
for 3 years, they have to be delisted. And of course, you are
nodding, this only applies right now to China, right? But in
theory, if another country decided to do that--but right now,
we are just limited to that exposure in China.
So, here is my question that I am building to. I want to
make sure we are not playing whack-a-mole. Let's say that all
the provisions of the Holding Foreign Companies Accountable Act
get implemented. All of the good ideas that both sides of the
aisle have run up here are addressed. It seems to me that we
still have this huge gap because all of these rules don't apply
to get into these questions of exempt offerings. Right? Because
if a company is going to list under one of these exempt
offerings, all of a sudden, all of these other rules of SEC
disclosure and what have you don't get there.
So, how should we be thinking about--because if we address
this all for sort of conventional, old-timey offerings and
China still wants to do all of the things we are talking about
doing that they do do in these hearings, don't they just have a
back door to come in there through these exempt offerings?
Ms. Ross. Absolutely. I agree with your line of thinking
there. We not only have to protect our markets for public
securities, but we also have to be concerned that if the
companies are delisted, they will take advantage of our system
of exempt offerings that allows companies to sell securities
here to specific kinds of investors under different
circumstances and not follow our normal disclosure rules.
Mr. Casten. I am out of time, but maybe just for the record
afterwards, what I would like to understand is if the Holding
Foreign Companies Accountable Act only applies to China, how
much does that potential back door apply to a lot of countries
beyond China that have a way to back-door in through our exempt
offering rules?
And I would welcome a response in writing for the record.
Thank you, and I yield back.
Chairman Sherman. I thank the Vice Chair.
The gentleman from Texas, Mr. Taylor, is now recognized for
5 minutes.
Mr. Taylor. Thank you, Mr. Chairman. I appreciate the
testimony today.
One thing that I think we may want to get a more detailed
taxonomy on, and Mr. Lorber, I will start with you, what did
the Trump Administration do vis-a-vis China? In terms of
securities, China sanctions, there has been some mention of the
Holding Foreign Companies Accountable Act, S. 945, which he
signed into law last year. What did the Trump Administration
do?
Mr. Lorber. The Trump Administration did quite a bit on
China when it came to sanctions. In terms of securities and
publicly traded securities, in November of 2020, the
Administration issued Executive Order 13959, which essentially
prohibited U.S. persons from trading in specific publicly
traded securities of identified companies that were considered
Communist Chinese Military Companies (CCMC), an identified list
of Chinese entities that the Trump Administration determined
posed a national security threat.
In addition, there are a range of other sanctions that the
Trump Administration imposed related to Hong Kong, as I
mentioned with the XPCC related to activities in Xinjiang, and
a host of other specific blocking sanctions and designations.
But the one specific item which related directly to securities
was that Executive Order.
And then, finally, in addition, the Administration put out
a range of guidance and advisories to warn U.S. companies of
the sanctions and illicit finance-related risks that it
assessed were emanating from China, and particularly there was,
as I mentioned, a Xinjiang supply chain advisory that they put
out, among a series of others as well.
Mr. Taylor. One of the bills that showed up on my desk when
I walked in here this morning was H.R. 2072, which deals with
Xinjiang and the Uyghurs. What did the Trump Administration do
on this, and which company did they target?
Mr. Lorber. They designated the XPCC in, I think again, it
was July 2020, and the XPCC is, according to the Treasury
Department, the paramilitary organization that runs many of the
camps, the forced labor institutions within Xinjiang. And so,
as I mentioned, when they designated them, that entity had
hundreds of subsidiaries spread around the world, and so there
was a major impact on companies that were sourcing products
from Xinjiang to realize, well, we may not be able to source
that product anymore because it could expose us to U.S.
sanctions. And in addition to that, they also released the
supply chain advisory to make clear to companies that were
sourcing from that area that there were real sanctions and
other risks associated.
Mr. Taylor. Are we aware of other companies that should
have been sanctioned, that the Trump Administration perhaps
missed?
Mr. Lorber. I am not personally aware of others that were
not sanctioned, that the Administration missed.
Mr. Taylor. Ms. Chu, do you want to--
Ms. Chu. Thank you.
The 13949, and I think 14032, the two bills that give
legislative authority to the China company sanctions program,
the lists under those, as well as the Department of Defense's
Section 1260H list, include a total of maybe 80-something
individual unique companies that are designated as Chinese
military companies. I have identified hundreds more.
That includes subsidiaries and direct parents of these
companies, many of which are directly involved in weapons
programs and high-tech surveillance, but also in just generally
China's military modernization drive. That includes companies
that are building missiles, companies that are developing
unmanned aerial vehicles (UAVs) in the South China Sea that are
directly countering U.S. forces.
So, yes, there are significant gaps in the implementation
of those sanctions, especially because I think the text of both
suggested that they would be living, breathing documents
updated regularly with new information. But neither of those
lists--the annex of the recent Executive Order, nor the DOD
Section 1260H list--have been updated since they were released
this past June. So, I would like to see a consistent effort to
keep those updated to include new companies and make sure that
the U.S. goal of sanctioning and prohibiting Chinese military
companies from accessing U.S. capital is enforced throughout.
Mr. Taylor. I would appreciate getting that list and
working with you on that, making sure that we are updating
that. But I will point out that I think the Trump
Administration did a good job of going after Chinese military
companies, working to try to help the Uyghurs. The Trump
Administration really deserves a lot of credit for what they
have done, and I appreciate, Mr. Chairman, that we want to
build on that success.
I yield back.
Chairman Sherman. Thank you. I ask unanimous consent to put
in the record a letter from Muddy Waters Capital, LLC,
highlighting their work to research fraud involved in Chinese
publicly traded companies, including Luckin Coffee, that I
mentioned earlier. Without objection, it is so ordered.
The Chair now recognizes the gentleman from Wisconsin, Mr.
Steil, for 5 minutes.
Mr. Steil. Thank you very much, Chairman Sherman and
Ranking Member Huizenga, for holding today's hearing.
The rise of China is one of the most serious economic and
geopolitical challenges we face. The Chinese Communist Party
has embarked on an aggressive campaign to expand its influence
around the world. A key part of the campaign is Made in China
2025. Through this initiative, the CCP aims to make China the
dominant player in high-tech manufacturing.
Thinking of the important goods that power our modern
economy--cars, computers, IT, aircraft, agriculture,
technology, and medical devices--China wants to dominate all of
those industries. In order to do this, Beijing is prepared to
deploy subsidies, back foreign acquisitions, and impose forced
technology transfer agreements. It is a direct challenge to
American workers and manufacturers, but it is a challenge that
we can overcome.
I find it interesting, though, that we are holding this
hearing as my colleagues across the aisle are considering
massive tax increases on American workers and on American
manufacturers. This Made in America tax will make it even
harder to outcompete China.
If we are concerned about Made in China 2025, the last
thing we should do is impose a Made in America tax. My
colleagues across the aisle are putting forward policies to
destroy jobs in America, weaken the U.S. economy, and put us at
a further disadvantage to Communist China.
Let me shift gears. Mr. Lorber, I want to reference an op-
ed published by my colleagues, Mr. Luetkemeyer and Mr.
Huizenga, in which they argued that capital controls and
delistings alone won't change China's behavior. They argued
that we need to bring sanctions into the policy toolkit
specifically for dealing with China.
In your testimony, you described some of the ways our
Government has sanctioned China-based individuals and companies
engaged in activity that the U.S. opposes. In targeting
sanctions, could you add some color as to how we should draw
the line between truly benign companies and those actually
involved in activities against U.S. interests?
Mr. Lorber. Yes, it is a great question, and candidly, it
can be a challenging line to draw.
For example, companies that don't provide sufficient
financial information or financial disclosure, frankly, may not
be the best target of targeted sanctions because they are not
engaged in potentially, actual national security threatening
activity, whereas other companies, for example, as assessed by
both the Trump and the Biden Administrations, and as Ms. Chu
was talking about, are involved in the Chinese civil military
fusion program and are working to bolster the Chinese military.
And in that situation, I think sanctions would be potentially a
more appropriate use of the tool--
Mr. Steil. I appreciate your point and context. Looking at
the U.S. sanctions regime in particular, to hold some of these
types of companies accountable, are there any tweaks or changes
that you would recommend in the sanctions regime under U.S.
law?
Mr. Lorber. I don't think I would recommend specific tweaks
or changes. I think the question is, are there other entities
that the U.S. Government believes pose national security
threats, to Ms. Chu's point from earlier, that may justify
targeting? I think that would be the way I would frame it.
Mr. Steil. Let me shift gears once again. As you are well
aware, China is the largest official creditor in the world, and
although the Chinese development finance hasn't yet eclipsed
the World Bank or the IMF, a heavily U.S.-influenced
institution, I think it does pose a pretty significant
geopolitical and economic challenge. What are the steps that
you think Congress should be taking to counter Chinese
influence in developmental finance?
Mr. Lorber. I apologize, but I probably need to defer on
that question and get back to you. That is not my area of
expertise in development finance, so I would want to take a
look at that question a bit more deeply.
Mr. Steil. We will continue the discussion offline. I
appreciate you all being here today.
Mr. Chairman, thank you for holding today's hearing. I
yield back.
Chairman Sherman. Thank you.
I now recognize Mr. Mooney, the gentleman from West
Virginia.
Mr. Mooney. Thank you, Mr. Chairman.
One of the great problems of today is how free-market
societies should confront the rising threat of China, a
Communist authoritarian state with increasing power on the
world stage. Our trade deficit with China was $310 billion last
year, an alarming reflection on China's economic power.
What makes China such a unique adversary is that, unlike
the Soviet Union, their leadership has not been as
ideologically rigid. China's leadership has been willing to
manipulate market forces to their geopolitical advantage.
My question is for Ms. Sutter. In your testimony, you wrote
about how American investors have limited access to passive
investments in China. You talk about the differences between an
American investor holding passive Chinese investments, and a
Chinese company and a Chinese investor holding shares directly
in the same company. Do passive investments give Americans the
same control as a typical shareholder?
Ms. Sutter. Thank you, Congressman, for the question.
I think in my remarks what I was trying to emphasize is
that China is highly restricted and closed in strategic
sectors, a lot of the areas of growth in the economy, and that
they may be using financial investment in tandem with
technology licensing to get the capital and know-how they know
without having to let U.S. competitors actually compete within
the Chinese market.
The other point I would like to make on passive investment
that we haven't talked about is under Made in China 2025, the
government's use of government guidance funds, which is a
private equity model, in how the Chinese government, the
Ministry of Finance basically pushes state money into the
Chinese economy, which is also used in the overseas markets,
including for acquisitions and investments in other firms. I
think this private equity model is something to think about as
it touches the U.S. economy.
Of course, financial investment, portfolio investment is by
nature passive, but I think the concern I was trying to raise
for consideration is, is China using this as a substitute for
allowing productive U.S. competition on the ground in the
Chinese market?
Mr. Mooney. Okay. As a follow-up to that, in your
testimony, you wrote at length about how China seeks U.S.
capital to fund its strategic interest. So, how does that work?
Can you explain that further?
Ms. Sutter. Yes, and this has been raised in various areas
of concern that a lot of the Chinese companies who list on U.S.
exchanges or who are included in U.S. funds increasingly are
participants in the Made in China 2025 and other Chinese
industrial policies. So, U.S. capital going into these
companies could be supporting these programs more broadly.
And I would like to raise for consideration that because
China's Made in China 2025 policies are codeveloped by the
People's Liberation Army (PLA), by the party, and by the state,
that it poses a challenge for the United States to delineate
what is truly a company that is military, what is truly a
company that is of concern. Especially as you get into dual use
and strategic and emerging technologies, I think this becomes
increasingly grave potentially.
Mr. Mooney. Thank you. Let me just say in conclusion that
free-market competition is what leads to growth and prosperity.
Those who succeed in a free market are tested by the rigors of
their competitors and how they serve their clients and they
serve the people.
China does not believe in capitalism. China does not
believe in free markets the way we understand them in America,
but China is willing to use our financial markets against us.
They are more than willing to steal our intellectual property
and tap into our wealth in order to further their nationalistic
designs.
On the surface, China is one to make it seem as though they
are merely participating in the global markets as equals, but
in reality, they are manipulating our openness for their own
ends. So to understand how to best react to China's threats, we
must first come to terms with who they are. They are a
geopolitical adversary that is always looking for a weakness to
expose in order to gain an edge.
Thank you, Mr. Chairman, and I yield back.
Chairman Sherman. Thank you.
I now recognize the gentleman from Kentucky, Mr. Barr.
Mr. Barr. Thank you, Mr. Chairman, and I appreciate the
chairman allowing me to waive on to this subcommittee.
As a member of the National Security, International
Development and Monetary Policy Subcommittee of this Full
Committee, the Ranking Republican on the National Security
Subcommittee, a member of the House China Task Force, and a
member of the Asia, the Pacific, Central Asia, and
Nonproliferation Subcommittee of the House Foreign Affairs
Committee, this topic is of acute interest to me, and I want to
thank the witnesses for the outstanding testimony. It has been
very, very helpful as we consider a legislative response to the
challenge of China and Western capital flows to China.
Earlier this year, I introduced the Chinese Military and
Surveillance Company Sanction Act, which has received broad
support from my colleagues on both the Financial Services
Committee and the Foreign Affairs Committee. The bill seeks to
address one of the problems we are discussing here today,
malign Chinese entities using American capital to fuel efforts
that directly counter U.S. national security interests.
The bill expands on President Trump's Executive Order
targeting Chinese military companies as amended by President
Biden's Executive Order, and my bill takes it a step further.
Instead of simply banning investment in public equity issued by
these companies, it directs the President to actively sanction
them.
Mr. Lorber and Ms. Chu, can you each elaborate on why a
bill like mine, which leverages the U.S. sanctions regime, is
preferable to a ban on public equity investment, as was the
case with the Executive Orders, or enhanced disclosures such as
the Holding Foreign Companies Accountable Act?
And by the way, Mr. Chairman, I supported your bill, the
Holding Foreign Companies Accountable Act, because Chinese
companies are not playing by the same rules as other foreign
companies, and I support your bill to accelerate the timeline
to 2 years. But that legislation is an investor-protection
bill. It is not a foreign policy or national security bill.
So, what do sanctions achieve that these disclosures do
not, Mr. Lorber?
Mr. Lorber. Thank you, Representative Barr.
The primary differences between the current Executive
Orders that are in place that you referenced, and the proposed
legislation, is the scope of the prohibition. Right now, under
the current Executive Orders, the companies that are
identified, U.S. persons are prohibited from transacting in
publicly traded securities, but that is it.
By actually designating the entities that are contained on
the list, you actually prohibit U.S. persons from transacting
with them in any way. In addition, the scope of the Executive
Order is limited to the specific companies that are identified
on the list, but by blocking them by adding them to the SDN
list, you would automatically include any companies that those
listed entities own or control. So, the scope of it would be
much, much broader.
Mr. Barr. And Ms. Chu, when you answer the question, could
you also explain the mechanics of OFAC designations? In other
words, take an index like MSCI or BlackRock's announcement on
August 30th that it would triple American investments in China,
and explain how that might change and alter the composition of
these index and these investments?
Ms. Chu. Thank you for the question.
In the past 3 years--I believe it was May 2018 when MSCI
began or announced it was going to begin including Chinese A-
shares in its indices. The exposure of U.S. investors to A-
shares, which are companies listed on the Shanghai and Shenzhen
exchanges, has shot up exponentially. There were none at that
point, only eight shares in ADRs.
So, I believe that applying sanctions to Chinese military
companies and Chinese surveillance companies in addition to
existing restrictions on capital investment would be an ideal
way to align national security objectives across sanctions
programs.
Mr. Barr. If OFAC sanctioned these entities, the MSCI and
the index would presumably have to pull out those designated
firms from their index. Is that correct?
Ms. Chu. Right. I believe that the Executive Orders and the
Office of Foreign Assets Control (OFAC) implementation require
divestment by securities or exposure to the securities. But it
was unclear, and there are a lot of index providers and
investment companies that were struggling for a long time--it
just ended last year--to figure out if they were supposed to
implement this, if there were any sort of enforcement measures.
So, I believe those factors should all be made more clear and
potentially an amendment to the ways that these capital market
sanctions and restrictions can be applied.
Mr. Barr. And Mr. Lorber, can you talk about the force
multiplier of sanctions versus U.S. securities disclosures in
terms of preventing a circumvention and a rerouting of capital
to foreign exchanges?
Mr. Lorber. Yes, it is a good point. There is the usual
occurrence where the U.S. Government, for example, OFAC,
sanctions somebody. As long as there is U.S. jurisdiction, non-
U.S. companies are obliged to follow those rules and
regulations. So, what you would see is oftentimes non-U.S.
persons, non-U.S. companies operating in foreign jurisdictions
wouldn't touch those securities because they would be blocked
property, so there would be a significant extension of the
impact beyond just U.S.--
Mr. Barr. It would have a multilateral impact.
Mr. Lorber. Yes.
Mr. Barr. My time has expired. But Mr. Chairman, thank you
very much, and I appreciate your leadership on the disclosures
front. We are just making the point that OFAC is another
important tool. I yield back.
Chairman Sherman. Thank you.
As is our tradition, I will be recognizing the ranking
member, then myself, for very brief closing comments.
The ranking member of the subcommittee, Mr. Huizenga, is
now recognized.
Mr. Huizenga. Thank you, Mr. Chairman, and I want to thank
the panelists for being here today. It has been very
illuminating and informative and helpful.
One special person I do want to recognize--I know Ms. Ross
has a special guest assistant with her. And sorry, it is our
jobs as parents to embarrass our kids. I have kids about the
same age, but I'm glad you have participated, and frankly, I
will note that you had more stamina than most of the Members of
Congress, making it through a 2 hour-plus hearing.
But this is why we are doing this. This is why we are all
here, is to make sure our kids and our grandkids have a better
future than what we have, and that is why this question, this
issue is so important to what we are talking about, and that
really is, I think, the common motivator for so many of us.
I did hear a couple of common themes today. Common theme
one, China cheats. Not just China writ large--it could be the
Chinese Communist Party, it could be the Chinese Army, it could
be all of the business entities that are either shell or they
might be partially related, or whatever they are, but we know
that China does cheat.
Common theme two, we also know that China controls things
as much as they possibly can. And common theme three, China is
out for China. They are not out for their investors. They are
not out for their citizens. They are not out for the world
economy. They are out for China and their way of life and their
governmental structure.
And I would think that if you can accept one, two, and
three, then you have to ask the question, how will additional
rules, requirements, demands, temper tantrums, whatever it is,
how is that going to change China's actions? And that is what
this is about, and I don't think those things will.
What does get China's attention is sanctions, economic
pressure, sanctions and a strong, robust U.S. economy that can
not just compete but can actually outdo, can offer even better
options than what they can--not just in our country, but around
the world. So, we need a positive environment for our
entrepreneurs, our small innovators, our risk-takers, the
things that have made the U.S. such a powerful force in this
world, and a force for good, by the way.
There are more people who have been lifted out of poverty
with capitalism versus socialism or communism. There are more
opportunities that have happened across-the-board for every
single citizen of any country that has taken that route, and we
need to encourage that, and I just want to emphasize that as we
are looking at lots of discussions outside of this committee as
well, what is going to be getting done here in our economy. We
need to be conscious of this.
What is separating us from other areas and other countries
in the world like China, and how are we going to maintain our
edge? And it is through creating an environment that allows
others to succeed and for us to succeed.
With that, Mr. Chairman, I do appreciate you holding this
hearing today, and I look forward to the conversation, and I
look forward to learning more about your bills that you are in
the process of drafting, and I look forward to this
continuation.
Chairman Sherman. I look forward to working with you.
Mr. Huizenga. With that, I yield back.
Chairman Sherman. Before I took over this subcommittee, I
chaired the Subcommittee on Asia over on the House Foreign
Affairs Committee, working with Mr. Barr. And I came to the
conclusion that on the big issues that affect China across-the-
board--South China Seat, belt and road, the running of a huge
trade surplus for them with the United States, their theft of
IP, the big things--nothing is going to change Chinese behavior
except across-the-board tariffs on their entire economy, that
even sanctions on one or two companies won't be enough to
change their overall policy. But that is outside the
jurisdiction of this Subcommittee, and the Full Committee, for
that matter.
Focusing on the jurisdiction of this subcommittee, we have
seen an illustration of the power that China has through
selective access. By allowing some banks, some investment banks
to have access to China but not others, they have control over
what Morgan Stanley advises its clients and what Morgan Stanley
publishes in its index, which then makes us wonder whether
those who publish indexes should be required to register as
investment advisers so that we get that fiduciary
responsibility in that process to counterbalance the power that
China would otherwise have.
I believe it was Mr. Gonzalez who pointed out that whatever
we do in our markets, American investors can always go
elsewhere. And that is true. We are a free country. You can
take your life savings, sell your house, put all the money in a
suitcase, go to Monaco, and put it all on double zero.
But the purpose of this subcommittee is to protect those
investors who are investing in U.S. markets, U.S. exchanges,
trust funds regulated by U.S. laws, ERISA plans and mutual
funds, et cetera. Those who do that expect to have some
investor protection. Those in Monaco, you are dependent upon
the laws of that principality.
Mr. Himes points out that we have had accounting frauds in
the United States. I was here for Enron and WorldCom. That is
why we passed Sarbanes-Oxley and established the PCAOB. We
needed it. That is why we passed it. We needed it to protect
American investors.
And it isn't just China that didn't cooperate. Belgium
didn't cooperate either. But we passed the bill last year, and
we got tough with Belgium and, ``big waffle'' folded, and now
we have the deal with Belgium. Hopefully, we will get the same
out of China as well.
The purpose of that bill and the acceleration bill is to
protect investors by getting the same kinds of controls that we
found we needed after WorldCom and Enron, and that we clearly
need for Chinese companies as well.
The VIE structure means that you are not a shareholder.
People should understand that, and you are not one of the
thousand biggest companies in the world if you are Alibaba
Cayman Islands. You don't belong in indexes. You are not even a
company. I don't know what you are. You are a shell that
invests in another shell that has a contractual relationship.
When you invest in a Chinese company, you may not have any
right to elect the board. Even with those who do elect the
board, the board may put the interest of the Chinese Communist
Party above those who elect them. And even if the board seeks
to deploy the assets of the company to further the interest of
the shareholders, the government is free to sanction, seize,
and redirect, all without the protections of a legal system
designed to protect private property.
So, we have a lot to do to protect American investors who
invest in China, and even more to do with the overall
relationship with China.
The Chair notes that some Members may have additional
questions for these witnesses, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
This hearing is adjourned.
[Whereupon, at 12:23 p.m., the hearing was adjourned.]
A P P E N D I X
October 26, 2021
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