[House Hearing, 117 Congress]
[From the U.S. Government Publishing Office]
INVESTING IN OUR RIVALS: EXAMINING
U.S. CAPITAL FLOWS TO FOREIGN RIVALS
AND ADVERSARIES AROUND THE WORLD
=======================================================================
HYBRID 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
SECOND SESSION
__________
NOVEMBER 15, 2022
__________
Printed for the use of the Committee on Financial Services
Serial No. 117-103
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
________
U.S. GOVERNMENT PUBLISHING OFFICE
49-483 WASHINGTON : 2022
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 TREY HOLLINGSWORTH, Indiana
SEAN CASTEN, Illinois ANTHONY GONZALEZ, Ohio
AYANNA PRESSLEY, Massachusetts JOHN ROSE, Tennessee
RITCHIE TORRES, New York BRYAN STEIL, Wisconsin
STEPHEN F. LYNCH, Massachusetts LANCE GOODEN, Texas
ALMA ADAMS, North Carolina WILLIAM TIMMONS, South Carolina
RASHIDA TLAIB, Michigan VAN TAYLOR, Texas
MADELEINE DEAN, Pennsylvania PETE SESSIONS, Texas
ALEXANDRIA OCASIO-CORTEZ, New York RALPH NORMAN, South Carolina
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, Vice Chair BRYAN STEIL, Wisconsin
EMANUEL CLEAVER, Missouri VAN TAYLOR, Texas
C O N T E N T S
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Page
Hearing held on:
November 15, 2022............................................ 1
Appendix:
November 15, 2022............................................ 27
WITNESSES
Tuesday, November 15, 2022
Alexander, Courtney, Senior Research Analyst, United Food and
Commercial Workers International Union......................... 4
Chu, Claire, Senior China Analyst, Janes Group................... 6
Ferry, Jeff, Chief Economist, Coalition for a Prosperous America
(CPA).......................................................... 8
Sonnenfeld, Jeffrey A., Senior Associate Dean for Leadership
Studies, Yale School of Management............................. 10
APPENDIX
Prepared statements:
Huizenga, Hon. Bill.......................................... 28
Alexander, Courtney.......................................... 32
Chu, Claire.................................................. 42
Ferry, Jeff.................................................. 60
Sonnenfeld, Jeffrey A........................................ 70
INVESTING IN OUR RIVALS: EXAMINING
U.S. CAPITAL FLOWS TO FOREIGN RIVALS
AND ADVERSARIES AROUND THE WORLD
----------
Tuesday, November 15, 2022
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 2:05 p.m., in
room 2128, Rayburn House Office Building, Hon. Brad Sherman
[chairman of the subcommittee] presiding.
Members present: Representatives Sherman, Scott, Himes,
Foster, Vargas, Gottheimer, Casten; Mooney, and Gonzalez of
Ohio.
Ex officio present: Representative Waters.
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 the subcommittee are
authorized to participate in today's hearing.
Today's hearing is entitled, ``Investing In Our Rivals:
Examining U.S. Capital Flows to Foreign Rivals and Adversaries
Around the World.''
And I do want to apologize for the fact that this hearing
is taking place while the Republicans are holding their
leadership elections. We scheduled this hearing, and then,
apparently in determining when to have their leadership
elections, Mr. McCarthy didn't think that this was the most
important thing to avoid scheduling against. Still, obviously,
this would be a better hearing if we had the full participation
of the current minority party. Although, Mr. Gonzalez will
represent his party well.
I will now recognize myself for 4 minutes for an opening
statement, and then I will turn to Mr. Gonzalez.
Over a year ago, we had a hearing on China, Inc. This
hearing builds on that. Americans are investing in Russia to
some degree, not much now, and substantially in China.
There are 262 Chinese companies listed in the United
States, and of course, Americans are free to invest in Hong
Kong and Shanghai, including our index funds.
Eight Russian firms were suspended from trading in the
United States. Some $83 billion of American capital has been
invested in Russia.
This raises three types of issues: macroeconomic; investor
protection; and national security. As to macroeconomic, capital
is very good for a capitalist system. We send $1.2 trillion of
capital to China. Some would say, why don't we just stop? Well,
China provides $2.1 trillion to the U.S. economy.
But not all capital is equal. Equity capital does more.
Risk capital does more to build a capitalist economy. We send
$1.1 trillion in equity capital to China. They send only $700
billion of equity capital to the United States.
Don't take my word for it that equity capital is more
important. That esteemed institution, the U.S. Congress, has
decided to spend $200 billion every year on our capital gains
allowance to encourage equity investment.
But for some reason, we not only subsidize Americans who
invest in America, but we provide that same capital gains
allowance to those investing in the Chinese economy. I just
want to point out, that is not on us; another committee is
responsible for that.
First, on investor protection, we have the Public Company
Accounting Oversight Board (PCAOB) in Hong Kong now. Congress
passed the bill I sponsored in the House, the Holding Foreign
Companies Accountable Act. China has agreed in principle, and
now work is going on in Hong Kong to see whether they will
actually implement that important legislation. We will know
more at the end of the year.
Second, on investor protection, we have the variable
interest entity (VIE) structure. You think you are buying
Alibaba stock, but you are not. You are buying Alibaba Cayman
Islands, which then has a contractual relationship with a shell
company in China, which then has a contractual relationship
with Alibaba.
We have to see what risk that poses for investors and
particularly wonder whether index funds should be investing--
when they say they are investing in the biggest companies in
the world, Alibaba Cayman Islands is not one of the biggest
companies in the world.
And to say that with little investigation, capital should
be deployed through this VIE structure is questionable, and it
is also questionable whether index funds should go outside the
United States, invest in the Shanghai or Hong Kong exchange
perhaps, in Chinese companies that have deliberately avoided
the PCAOB by delisting from the United States.
And we then turn to the national security issues. When
Americans invest in Chinese companies, that creates a lobbying
interest here in the United States to support the success of
those companies, and ultimately, China. In addition, it can
create an incentive to transfer technologies to those Chinese
companies which are the subject of U.S. investment.
We should know which Chinese companies are raising money
here by changing our rules to say that when there is a private
placement, even if they don't choose to use Regulation D or one
of the other safe harbors, that there is some registration in
the major deals.
Not only the SEC, but under certain circumstances, other
U.S. Government agencies can look at private files and see what
is coming in. Likewise, we ought to see when a hedge fund or a
private equity fund already is required to file a foreign PF
with the SEC, and we should know whether they are getting
substantial amounts of Chinese capital or Russian capital.
With that, I will turn to Mr. Gonzalez for an opening
statement.
Mr. Gonzalez of Ohio. Thank you, Chairman Sherman. I will
be very brief. First, I would like to submit for the record the
opening statement of Representative Bill Huizenga, the ranking
member of this subcommittee.
Chairman Sherman. Without objection, it is so ordered.
Mr. Gonzalez of Ohio. Thank you.
To pick up on what Mr. Sherman was saying about our
leadership elections, to our witnesses and those watching on C-
SPAN, please do not take the absence of Republican Members
today as disinterest on the Republican side. We have been just
as engaged and aggressive, I think, when it comes to what are
the right policy measures that we should be taking vis-a-vis
China, Russia, and our adversaries, what role the capital
markets play, and what policies we should advocate for. We
simply have our leadership elections today, and there is
certainly nothing that I can do about that.
Some would say, as one person who didn't run for
reelection, I might actually be the smartest Member of Congress
in this room today. I am not saying that; some people might say
it. But with that, I will yield back. Thank you.
Chairman Sherman. Thank you. I now yield 1 minute to the
distinguished Chair of the full Financial Services Committee,
Chairwoman Waters.
Chairwoman Waters. Thank you very much for this hearing.
Each year, billions of dollars of capital from the United
States is invested into companies owned by, controlled by, or
affiliated with China and Russia, undermining our national
security.
After Putin invaded Ukraine, I wrote to groups representing
U.S. businesses and investment funds to question whether they
would divest from Russia. Unfortunately, dozens still have not.
Protecting our national interests is not a partisan issue.
We worked together to reauthorize and reform the Committee on
Foreign Investment in the United States (CFIUS) in 2018, the
Export-Import Bank in 2020, and on several measures to isolate
Russia and China earlier this year.
I hope this hearing will help us identify further ways to
ensure that our national security is bolstered by the strength
of our private markets. I yield back.
Chairman Sherman. Thank you.
We have a great panel of witnesses here today. It is not
just me saying that. The Republicans were entitled to have a
witness, but they looked at how beautiful the panel was that we
created and decided they had nothing to add, and I couldn't
agree with them more.
I do think we have outstanding witnesses. First, we have
Courtney Alexander, senior research analyst at the United Food
and Commercial Workers International Union, who has focused on
the flow of capital to China, and particularly Americans
investing in facial recognition and other technologies that
might help allow the Chinese government to impose a police
state on its own citizens.
Second, we have Claire Chu, a senior China analyst at the
Janes Group, who is focused on the rights and lack of rights
that investors have in the VIE structure, and index funds
ignoring that and investing indirectly in China.
Third, we are going to hear from Jeff Ferry, the chief
economist at the Coalition for a Prosperous America, who is
focused on decoupling from China and on the possibility of
tariffs.
And finally, to introduce our last witness, I recognize Mr.
Himes.
Mr. Himes. Thank you, Mr. Chairman, and it is a delight to
welcome a fellow citizen of the nutmeg State. From Connecticut,
we have the senior associate dean for leadership studies at the
Yale School of Management, Jeffrey Sonnenfeld.
He has had a tremendous academic career, including time at
the Emory Business School, but I seize this moment to do a
brief introduction because in addition to his academic work, he
has, in the last several months, been an extremely aggressive
leader on pushing corporate America, in his guise as a
professor of leadership, to reflect on the values that
corporate America and corporations around the world demonstrate
if they make the decision to continue to work in the nation of
Russia, and to continue to be part of the economic engine which
drives the authoritarian brutality that we see in Ukraine.
We are deeply grateful to Dr. Sonnenfeld for doing that,
and we are deeply grateful for his work in the State of
Connecticut in helping us with our economic issues, and it is a
delight to welcome him here today.
Thank you, Mr. Chairman.
Chairman Sherman. Thank you, Mr. Himes.
Witnesses are reminded that their oral testimony will be
limited to 5 minutes. You should be able to see a timer that
will indicate how much time you have left. I would ask that you
be mindful of the timer so that we can be respectful of both
the witnesses' and the committee members' time.
And without objection, your full written statements will be
made a part of the record.
Ms. Alexander, you are recognized for 5 minutes.
STATEMENT OF COURTNEY ALEXANDER, SENIOR RESEARCH ANALYST,
UNITED FOOD AND COMMERCIAL WORKERS INTERNATIONAL UNION
Ms. Alexander. Thank you, Chairman Sherman, Ranking Member
Huizenga, and members of the subcommittee. My name is Courtney
Alexander, and I work for the United Food and Commercial
Workers International Union.
I am here to address my recent work analyzing the outflow
of capital from U.S. private equity firms to China. That
capital includes public employee pension money invested by
private equity firms in a country of national security concern.
My testimony details a case study which we believe
illustrates the need for public disclosure by private equity
firms of their investments in countries of concern.
In 2017, KKR Asian Fund III founded a Chinese artificial
intelligence company called Cue Group. KKR owned and controlled
Cue until late 2021. Cue was described by KKR as, ``the first
one-stop digital marketing company for the Chinese market.''
KKR's digital marketing company went on to jointly develop
surveillance technology with an arm of the Ministry of Public
Security, the organization that oversees China's vast
surveillance systems.
In 2020, Cue had jointly developed technology with the
Video National Engineering Laboratory Zhuhai Innovation Center,
a government lab run by the First Research Institute of the
Ministry of Public Security.
Zhuhai Lab and the First Research Institute play key roles
in China's surveillance state, and the First Research Institute
works with Chinese entities sanctioned by our government for
facilitating human rights abuses or participating in the
Chinese military-industrial complex.
CUE's jointly-developed product was called the CUE Real-
time AI Facial and Body Temperature Detector, integrating
facial recognition, thermal detection, and identity data. It
was used for pandemic surveillance, reading body temperatures,
tracking 14-day migration of individuals, and identifying
companions.
CUE's technology also had potential non-pandemic uses for
recognizing, ``blacklisted persons,'' and ``to prevent
incidents involving mass gatherings.''
Additionally, Zhuhai Zhongdun Star Technology Company,
which KKR identified as an indirect KKR subsidiary, was a
strategic signatory of the government's Zhuhai Lab. Zhuhai
Zhongdun Star had participated in the, ``Safe Campus''
surveillance project. This past February, The Wire China
profiled KKR's investment in Cue and Cue's collaboration with
the public security lab.
KKR and Cue denied the collaboration to The Wire, however,
``The Zhuhai lab confirmed in an email to The Wire that it had
at one time collaborated with Cue on one of its wholly-owned
subsidiaries.''
The Zhuhai Innovation Center was formed by the National
Engineering Laboratory for Intelligent Video Analysis and
Application called NELIVA. NELIVA's laboratory director is Qiu
Baoli. Qiu was previously the deputy director of the Public
Security Bureau of the Xinjiang Construction Corps, which was
sanctioned for human rights violations.
NELIVA's ruling council also includes entities sanctioned
by the U.S., including Hikvision, Huawei, and the Institute of
Automation of the Chinese Academy of Sciences.
First Research Institute, which runs the Zhuhai Lab,
designed what it called SkyNet in Xinjiang, which it co-built
with the Public Security Department of Xinjiang, an entity
sanctioned for its role in human rights violations. To be
clear, we do not have information that Cue's surveillance
technology was used in Xinjiang, or to violate human rights.
In response to our research, KKR told me the firm conducts
very careful screening on issues of privacy, surveillance, and
geopolitics, and that former General David Petraeus leads a
team at KKR Global Institute to help assess every KKR
investment for such risks.
This process concerns us. KKR's purported risk review may
have missed Cue's own promotion of its collaboration with a lab
run by China's surveillance apparatus, even though KKR
executives served on the board, or possibly KKR's review may
have identified Cue's connections to China's surveillance lab
and still knowingly kept its investment and board seats.
Whatever the case, we find it hard to trust that private
equity can sufficiently police itself when it invests in China.
Cue's surveillance and advertising business paid its
investors well. Late last year, KKR sold a potential interest
in Cue to Baring Private Equity Asia in a deal valuing KKR's
stake at 3 times its investment.
Money talks, surveillance pays, and the American public
needs tools to protect our country's interests.
That is even more true when you consider that KKR Asian
Fund II investors include public employee pension funds, like
the Washington State Investment Board, the Florida State Board
of Administration, the Oregon Treasury, and the Texas Permanent
School Fund.
When we asked public pension funds to divest Cue, some said
they could not exit an individual investment because they were
limited partners, and one fund said it relies on the Federal
Government to flag investments of national security concern.
Therefore, we urge you to give public pension funds,
investors, regulators, and American citizens the tools to hold
private equity accountable to our own national security and
human rights interests, by mandating public disclosure of all
subsidiaries and investments in countries of national security
concern.
Last, the Cue story was uncovered through public data from
other countries. Germany, Singapore, and China all require more
public disclosure from companies than we do. So when their
firms argue that investments are proprietary, ask them why
Americans don't deserve the same information they give to China
and Singapore.
Thank you very much for holding this hearing today.
[The prepared statement of Ms. Alexander can be found on
page 32 of the appendix.]
Chairman Sherman. Thank you, Ms. Alexander.
Ms. Chu, you are now recognized for 5 minutes.
STATEMENT OF CLAIRE CHU, SENIOR CHINA ANALYST, JANES GROUP
Ms. Chu. Chairman Sherman, Ranking Member Huizenga, and
members of the subcommittee, thank you for the opportunity to
appear here today. I am the senior China analyst at Janes, an
open-source intelligence firm where I specialize in the
national security implications of China's global economic
activity.
In particular, I research how the Chinese government
manipulates private-sector interests and commercial
relationships in order to achieve strategic policy goals.
I have been asked to speak on U.S. capital flows to China
in light of Russia's invasion of Ukraine. I will also provide
recommendations for ways in which the United States can refine
its economic and financial toolkit in order to respond to the
unique risks posed by U.S. investor exposure to Chinese and
Russian companies, and conversely, posed by adversarial
nations' access to U.S. capital.
The concept of economic statecraft is not new, but it has
evolved. The playing field has expanded beyond trade sanctions
and tariffs to include options like financial sanctions and
capital flow restrictions. Not everyone is on board just yet.
The national security community has started to recognize
the international financial system as a potential warfighting
domain, although the Pentagon can be reticent to encroach on
Wall Street's territory, and financial institutions aren't
interested in what they consider to be the politicization of
private markets, and find it difficult to reconcile national
security objectives with their fiduciary responsibilities.
Following Russia's invasion of Ukraine earlier this year,
we saw how quickly the U.S. Government was able to mobilize at
not only the Federal, but also the State and local levels, as
well as in sync with allies to isolate Russia from global
financial markets.
Financial actors, including stock exchanges and global
index providers, also took swift action. Although at some
level, this was not an ethical response as much as it was a
financial choice, because Russia's stock had become
uninvestable.
The unprecedented and expansive nature of the sanctions
imposed on Moscow has raised the specter of the U.S. taking a
similar approach with Beijing if red lines were to be crossed.
The scale of U.S. economic and financial exposure to China
is significantly greater than it is to Russia, and observers
have wondered whether China's weight in a global economy
insulates it from Western sanctions. Yes, China has a larger
economy than Russia, and as Russia's stock market was valued at
780 [inaudible]. However, China had a cumulative $11 trillion
in its mainland forces.
And yet, the United States' stock market is the largest in
the world, representing nearly half of global equity, about $51
trillion, nearly 4 times the next largest market, China.
I would posit that the United States could use financial
sanctions more effectively than almost any other country in the
world.
Capital flows can have a more immediate impact than trade
flows. Capital markets are one of the United States' greatest
strengths, and we should be analyzing how to harness financial
markets, institutions, and instruments in the service of
foreign policy and national security.
U.S. investor exposure to publicly traded Chinese companies
has expanded dramatically over the past few years, with the
inclusion of mainland Chinese A-shares in global stock indices
and various investment products.
Institutional investors like public pension funds and
university endowments have all taken different approaches to
investing in China. Although nearly all have some level of
exposure, owing to the use of passive investment strategies
which allow fund managers to delegate investment decisions to
index providers that wield virtually unregulated authority over
U.S. capital flows to China.
U.S. investors are consequently exposed to a wide range of
Chinese companies engaged in activities contrary to the
national security and foreign policy interests of the United
States.
Many are already sanctioned by the United States, but not
subject to any investment restrictions or divestment mandates
and are able to continue raising capital in the U.S. markets.
Private funds, which represent a significant portion of
institutional portfolios, function as unregistered investment
vehicles that are not required to verify or disclose investors'
identities or sources of funds.
This presents an ideal environment where the U.S. Treasury
cannot enforce sanctions, where Russian oligarchs like to park
their wealth, and where Chinese state-owned firms are able to
gain non-transparent access to sensitive U.S. businesses and
technologies.
The United States should consider establishing an
interagency committee or a task force to coordinate the Federal
Government's activities in response to various global economic
and financial challenges, whether that be to capital markets
access, foreign procurement, or critical mineral security.
There should also be more clear engagement with Silicon
Valley and Wall Street stakeholders in order to create
opportunities for cooperation, and to effectively communicate
policy guidance.
U.S. regulatory authorities need to accelerate plans to
expand oversight and increase disclosure requirements for index
providers and private market actors, as well as enact China-
and Russia-specific due diligence practices in order to
identify and mitigate this evolving category of risks to
investors in the United States.
Thank you. I look forward to your questions.
[The prepared statement of Ms. Chu can be found on page 42
of the appendix.]
Chairman Sherman. Thank you, Ms. Chu. And I am glad our
witnesses are sticking to the 5-minute limit.
Mr. Ferry, you are now recognized for 5 minutes.
STATEMENT OF JEFF FERRY, CHIEF ECONOMIST, COALITION FOR A
PROSPEROUS AMERICA (CPA)
Mr. Ferry. Thank you. The Coalition for a Prosperous
America (CPA) thanks the subcommittee for holding this hearing
to explore the risk posed to American investors by nations that
are adversarial and hostile to U.S. interests, most notably
Russia and the People's Republic of China. CPA is a bipartisan,
nonprofit organization representing exclusively domestic
manufacturers, producers, and workers across many sectors of
the U.S. economy.
I am Jeff Ferry, the chief economist at CPA. In addition to
my work as an economist, I have also worked in a U.S. optical
networking company competing with Chinese companies, and as a
hedge fund analyst for a $100-million technology hedge fund.
Especially alarming to CPA and our members are the risks
posed to U.S. investors by Chinese Communist Party (CCP)-linked
companies that are actively exploiting our free and open
capital markets. In 2020, U.S. holdings of Chinese securities
neared $1.2 trillion, which is about 5 times the holdings of
any other country. The exposure of U.S. investments in Chinese
securities has never been greater, and it will continue to
grow.
My testimony will focus primarily on the problem of U.S.
investor exposure to Chinese securities, the risks this poses
to U.S. economic and national security, and potential solutions
that should be considered.
My oral testimony focuses on three main components: A-
shares and passive investment; the Federal Government's own
Thrift Savings Plan, which many of the people in this room are
invested in; and the need for closing gaps in U.S. sanctions
policy via sanctions harmonization.
Further details and policy solutions may be found in my
written testimony.
First, A-shares and passive investments. Congress, the
media, and regulators have recently focused on the risks posed
to U.S. investors from Chinese companies directly listed on
U.S. stock exchanges. While CPA welcomes this focus and
encourages further action, it does not address the bulk of bad-
actor Chinese companies that are present in American passive
investment products.
Their presence is in the form of over 4,200 A-share and H-
share companies found throughout a multitude of financial
vehicles such as exchange-traded funds and index mutual funds
that have received little or no regulatory scrutiny or
fiduciary due diligence.
Tens of millions of Americans are unwittingly exposed to
these A-shares in their investment portfolios and retirement
investment accounts. U.S. investors are inadvertently
subsidizing Chinese companies involved in activities that are
contrary to the national security, economic security, and
foreign policy interests of the United States.
We are also subsidizing the economic growth of our own top
global adversary.
For those who are unaware, A-shares are securities listed
on mainland Chinese exchanges and only accessible to American
and foreign investors via inclusion in indexes in associated
index funds.
It is similar for H-shares, which are listed in Hong Kong.
These companies are predominantly noncompliant with U.S.
security laws and financial reporting norms, and in some cases,
they have even been sanctioned by the U.S. Government for
egregious human rights and national security abuses.
The financial industry will not lead. Congress must do so.
To ensure against further American investment flowing to
Chinese companies that pose investor protection, national
security, and human rights concerns, Congress should take
action to increase transparency and accountability for passive
investing and more. I outline key recommendations in my written
testimony submitted today.
Next, the Federal Government's Thrift Savings Plan (TSP).
The Thrift Savings Plan is the largest defined contribution
pension system in the country, with more than $730 billion in
assets.
In June of this year, the TSP's administrators enabled TSP
participants to invest up to 25 percent of their savings in
more than 5,000 mutual funds via a new platform called the
Mutual Fund Window. CPA research found that 5 of the largest
investment funds in the Window had an average weight of 22
percent towards Chinese companies, and all 5 funds held
companies listed on the U.S. Department of the Treasury's list
of Chinese Military-Industrial Complex Companies, the
Department of Commerce's Entity List, the Department of
Commerce's Unverified List, and the Defense Department's
Chinese Military Companies List.
We would like to see all of these lists harmonized to
enable American investors to know and to avoid investing in
Chinese companies that are involved in Chinese civil military
fusion and other activities harmful to the United States.
I will just wrap up, as I am out of time.
In conclusion, the U.S. Government should take the
necessary steps to ensure that passive investment and
government pensions are safe and secure from adversarial,
authoritarian regimes like China. They should do so because it
is in the best interest of the U.S., from both a national
security and an economic security perspective.
The financial industry will not fix these problems which
are existential, national, and economic security risks to
America. The risks are increasing daily. Congress must pass
laws that the financial industry must comply with in the
national interest. Thank you very much.
[The prepared statement of Mr. Ferry can be found on page
60 of the appendix.]
Chairman Sherman. Thank you, Mr. Ferry.
Mr. Sonnenfeld, you are now recognized for 5 minutes.
STATEMENT OF JEFFREY A. SONNENFELD, SENIOR ASSOCIATE DEAN FOR
LEADERSHIP STUDIES, YALE SCHOOL OF MANAGEMENT
Mr. Sonnenfeld. Thank you very much. I just wanted to thank
you, Chairman Sherman, for the invitation, Ranking Member
Huizenga in absentia, and of course, Congressman Gonzalez, for
representing Ranking Member Huizenga and your party today.
Distinguished members of the subcommittee, I am honored by
this opportunity to testify. I want to particularly thank
Chairwoman Waters for her catalytic role in raising some
critical issues that we are all wrestling with this afternoon
across this panel and, in absentia, Ranking Member McHenry for
his own great interest in this topic.
And, Congressman Himes, I am quite honored by that
wonderful introduction. I think we probably will not be sitting
near each other, though, at the Harvard-Yale game this coming
weekend, unfortunately.
I should also just mention quickly that I am very honored
to be here with this distinguished panel of fellow presenters.
I agree largely with the positions that they share and admire
everything about them.
But I must admit I am very envious of their punctuality,
and I am worried that I am the only schoolteacher here, so I
will be watching the clock.
I should also mention being in this beautiful room--if
there is nothing else that gets taken away from the material
that I want to present today, it should be how important it is
that this topic be represented in this room, in this city, at
this time, because it represents a confluence of leadership
across sectors, that neither sector has the monopoly on working
successfully in diplomacy, and that the private sector has
something important to contribute here, and the public sector
does as well.
When we talk about economic blockades, sadly, it often
falls down into these corporate withdrawals, how successful are
they, or taking a look at government sanctions. It only works
when they work in concert, and I am so happy we have the chance
to take a look at how the sectors can work together instead of
throw stones at each other.
I am Jeff Sonnenfeld, senior associate dean for leadership
studies, Lester Crown Professor of Management Practice at Yale
School of Management, and founder and chief executive of the
Chief Executive Leadership Institute, which is a division of
Yale University, which is the world's first school for
incumbent CEOs.
Well before the World Economic Forum of Davos or CEO-
targeted events elsewhere, we sort of created that space as a
purely educational forum. It is noncommercial, nonadvocacy, and
nonpartisan. We have, as a matter of fact, political leaders
from all sides of the aisle. Many Members of Congress, some
with us today, have been in our forums. Four U.S. Presidents,
from President Biden to President Trump, have been regular
participants joining with our corporate leaders.
I have been working in this field of corporate
responsibility for 45 years. My first book was entitled,
``Corporate Views of the Public Interest,'' published in 1981.
It is not a bestseller. And I have published about 200
scholarly articles and 7 books in this field, advised thousands
of CEOs on corporate social impact issues, and I regularly
appear in the media on these topics.
But today, we are talking about the historic exits of
1,000-plus multinational companies from Russia right after
Russia invaded Ukraine on, of course, February 24th of this
year. And we believe we had some influence in helping to spark
an exodus, if not a stampede, of companies from there.
We identified the original 12 who exited, and the work that
I have done previously having to do with voting rights or
environmental issues or gender parity or racial representation
or immigration reform, the companies that moved first on Russia
were not generally the first movers on other social justice
issues.
I was surprised by who they were. It was Big Tech, Big Oil,
and professional services. If we have time later, we could talk
about that anomaly.
When I went to talk to the CEOs of each of these companies,
what they were most concerned about wasn't the recognition of
being a bold first-mover, but a lot in the media were giving
attention to the pretenders that were making polite noises but
actually weren't doing much in terms of pulling out of Russia.
So I went public in the media, frankly on CNBC and in
Fortune Magazine. We put the names out of the authentic
companies that pulled out versus the pretenders, and that was
akin to Justice Louis Brandeis' admonition of how sunlight is
the best antiseptic.
That helped catalyze mass movements of hundreds of
companies, and we wound up grading them on a system from A to
F, not just because we are a schoolhouse, but because we wanted
to get around some of the public relations smokescreen that
often prevails as to who was truly pulling out. And we can talk
about that later if there is time.
One of the biggest takeaways we got was that win the
companies that pulled out, the shareholders did not suffer.
These weren't woke CEOs. There was no question about somehow
with some stakeholders at the advantage of other shareholders,
is, in fact, companies that pulled out did better than those
who stayed.
In terms of that impact, it was enormous. It is a huge
impact on Russia's economy.
As I am going into extra innings right now, let me just
wind down by saying that in working with 45 volunteers with
great mastery in the languages of the countries we were
studying, we wound up being the first to puncture Putin's
propaganda that fooled many in this town. Virtually everybody
in my field, in academia, macroeconomists of every school, and
the International Monetary Fund, believes Putin's propaganda,
that these corporate exits didn't matter.
They had an enormous impact, and we are the first to reveal
that Russia's economy was not resurgent but imploding. And if
we have time later, I can talk to you about how, in fact, it
did matter, and how doing good is not antithetical to doing
well. Thank you.
[The prepared statement of Mr. Sonnenfeld can be found on
page 70 of the appendix.]
Chairman Sherman. Thank you. I will now recognize, for 5
minutes of questioning, the distinguished Chair of the Full
Committee, Chairwoman Waters.
Chairwoman Waters. Thank you very much. I would first like
to say to Mr. Ferry, the chief economist at the Coalition for a
Prosperous America, I certainly thank you for your testimony.
You were absolutely descriptive of the harm and the solutions.
And I am sitting here a bit unnerved by the fact that we
have not moved more aggressively in dealing with the issues of
our adversaries that we allow to invest and to seek investments
here in our country.
I don't know whether or not you went through all of the
solutions. If you did not, I would like you to continue, if you
have more at this time that you would like to share with us
about solutions.
Mr. Ferry. Thank you, Madam Chairwoman, for your comments.
There is more in my written testimony. I think what I would
highlight here are a couple of things.
One, on sanctions harmonization, the Department of
Commerce's Entity List includes over 1,100 Chinese companies
which are engaged in activities that are either a threat to our
national security or through taking advantage of oppression in
the Uyghur region, Xinjiang, a threat to basic human rights.
On the other hand, the Treasury's list contains a couple
dozen companies, it is a tiny list, and we need to harmonize
these sanctions so all arms of the government are operating
together and taking a resolute, comprehensive position against
investing in our adversaries, which we are not doing today.
I would also add that I think these sorts of sanctions and
Federal guidelines ought to extend not just to publicly listed
companies in either North America or China, but also private
investment vehicles, including private equity and venture
capital.
I will give you one example. The Biden Administration has
taken commendable action to restrict the export of
semiconductors and semiconductor technology to China. The
entities list has many semiconductor activities on it.
President Trump took good action to restrict semiconductors
going to Huawei.
However, when I looked at the financial records last year,
the Chinese semiconductor industry invested $8 billion in
semiconductor investment, 6 times the amount of money that this
country invested, which was about $1.3 billion.
A significant portion of that $8 billion of funds going
into China came from U.S. venture capital firms in California.
It is a ridiculous situation that venture funds, including some
funds that invested in my former company, are sitting in Menlo
Park, California, investing in Chinese high-tech companies, and
in whatever area of high-tech they are in, it will ultimately
benefit the Chinese military.
We need, first of all, more transparency to have visibility
to these things. Second, we need sanctions and guidelines from
the Federal Government. Thank you.
Chairwoman Waters. Wow. Thank you so very much, and, of
course, I thank our Chair of this subcommittee. This is very
timely, and as I indicated early on when I made my 1-minute
presentation, the letter that I sent out to all of these
companies has not been responded to.
This hearing absolutely focuses on what we need to do and
what we must do. The harmonization that you referred to is
absolutely necessary for us to move forward, and so I thank you
for being here today.
And I thank all of our panelists for being here today, and
I thank our Chair of the subcommittee for leading on this
issue. I yield back the balance of my time.
Chairman Sherman. Thank you. I will now recognize Mr.
Gonzalez.
Mr. Gonzalez of Ohio. Thank you, Mr. Chairman. And thank
you to our witnesses for your testimonies and your time.
Ms. Alexander, I want to start my questions with you. Your
union certainly has pension assets, right? Are any of those
assets invested in Chinese VIEs, or in any of the index funds
that are invested in some of the companies that Mr. Ferry was
referencing, to your knowledge?
Ms. Alexander. Thank you for your question. I think much of
the private equity investments in Chinese companies are through
some kind of structure that either is VIEs, or mirrors VIEs on
the private side. I think it is a very important question, and
disclosure is a way to get at what those investments are.
Mr. Gonzalez of Ohio. But are your pension assets invested
in any of those companies, directly or indirectly, to your
knowledge?
Ms. Alexander. I don't know the full extent of our pension
investments. I think we have tried not to be invested directly
in funds that invest in China.
Mr. Gonzalez of Ohio. I don't mean to put you on the spot,
but I have had conversations with other folks who manage money,
either pension assets, insurance companies, what have you, and
I have asked that question, and it is an uncomfortable
question, because the answer is almost certainly yes.
And by the way, it is yes for the ones that I have asked, I
assume it is yes for you all, and I think that there is a real
question here, which is, what should we do about that?
Frankly, on our side of the aisle, there are sort of two
opinions. One is, our capital markets are the most open,
deepest, and most liquid markets in the world, and that is an
enormous advantage for our country. We should do everything we
can to protect that, and so you don't want to muck around too
much with foreign policy things.
I tend to feel like if you were to poll-test most Americans
and say, hey, how do you feel about your pension assets being
invested in companies that are designed to destroy your
country, they would probably say, no thank you, to that.
And so, I guess my encouragement would be in absence of
law, to encourage your union, those managing those assets to be
more thoughtful in that regard.
Ms. Chu, I want to switch to you. It's good to see you
again. It is, I think, your second time here since I have been
a member. Last Congress, or maybe it was earlier this year, Mr.
Sherman and I--I lose track of time, he loses track of his
phone--had the Holding Foreign Companies Accountable Act, in
which the SEC struck a deal with the Chinese government to
allow for the auditing to take place in Hong Kong essentially.
I can't speak for Mr. Sherman, but my goal with that
legislation was to force Chinese companies to play by the exact
same rules on the auditing front that every other country and
every other company in our public markets has to play by.
With that as a backdrop, how confident are you in the SEC's
agreement? How confident are you that the Holding Foreign
Companies Accountable Act will be implemented consistent with
the intention I just laid out?
Ms. Chu. Thank you. It is good to see you again, too, and
it is great to be here, and realizing that we are covering a
similar topic this year as to last year. Last year, the hearing
focused a bit more on, I think, end down investment. This year
we are talking more about outflows, but it is still an
important topic, and I am just really grateful to be a part of
it as this conversation is accelerating and more stakeholders
are becoming involved.
One of the U.S.'s greatest strengths is its commitment to
high-quality, reliable disclosures, and financial reports that
protect investors, that protect stakeholders, and protect
market participants. China doesn't have that.
What China has instead is capricious domestic policymaking
that induces a very volatile market situation, as well as
nontransparent corporate structures that make it difficult to
ascertain, as Congressman Sherman had mentioned, what the true
nature of the underlying assets of security are.
And as a result, there should be China-specific due
diligence. Regardless of the results of the PCAOB audits, there
should be China-specific processes in place that evaluate
Chinese securities on their own merit, which at present are not
equivalent to those U.S. securities.
Mr. Gonzalez of Ohio. I only have 10 seconds. I would love
to know more specifically about what you have in mind. With
that, I will yield back.
Chairman Sherman. Thank you. At this point, I will
recognize Mr. Scott for his questions. I do have questions,
don't worry, but Mr. Scott will come first.
Mr. Scott. No problem. Thank you very much.
First of all, let me just say, I agree first with Chairlady
Waters. This is an extraordinarily important hearing, and
because of this fact, China is now the second-largest economic
system in the world, next to ours.
And although we have some very starkly different foreign
policy and political differences with China, as the whole world
knows, this one fact is true: China cannot be ignored as a
global power in the global economy. And China's growth and
substantial share of the global economy means that we have to
carefully consider China's role in our own financial system at
the top of the line, the United States. Investment companies
and pension funds have a fiduciary duty, best interest, to
their investors. They have to act prudently in order to
minimize the risk of large losses.
Ms. Chu, let me ask you this question. It is sort of a
three-point question, but it all comes together. Are
investments in Chinese companies inherently more risky, and
does China's OPEC regulatory regime make them more risky? And
finally, would reducing investments in Chinese-owned companies
improve pension plans' performance and stability? Ms. Chu?
Ms. Chu. Thank you. Chinese companies trading, whether
domestically or listed on overseas exchanges, are inherently
more risky for a number of reasons, some of which my fellow
panelists have spoken on, but one of the reasons being variable
interest entities (VIEs). Variable interest entities are a way
in which Chinese companies can circumvent certain domestic laws
but also enter U.S. markets using different jurisdictions. And
the way that the conversation has played out over the past
couple of months, the U.S. has been wondering whether China was
planning to actually clamp down on the use of VIEs.
They are technically legal in China, and so there is this
question, is this going to be a problem, or is the problem
going to resolve itself?
But last December, the Chinese equivalent of our SEC
released a rule saying that VIEs are actually okay. There are
certain policies in place, but business as usual.
And this type of event goes to show how much of Chinese
financial policymaking is, again, capricious and unpredictable.
A lot of times, it is led by domestic priorities rather than
market reasons, and there is a lot that goes into China's
policymaking that is not necessarily profit-driven. And because
of that, Chinese companies and Chinese securities are
inherently more risky.
And really quickly, to your last point about pension funds,
I will say that the Tennessee Consolidated Retirement System
(TCRS), might be the only pension fund in the United States
that has little to no exposure to China or Russia, and that is
because they invest in country-specific ETFs and have used a
democracy weighting system.
And they still outperform many other pension funds. So, it
is possible. It just matters whether or not an administrator is
willing to take that stand and also willing to make that shift
for all of the constituents.
Mr. Scott. Excellent. And I agree with you too, and I think
your remarks were right on target.
And now, Mr. Ferry, let me go to you. In your written
testimony, you agree that there are substantial China-specific
material risks to our investors relating to national security.
How is this a threat to our national security? That, I believe,
is on the top of the minds of all of us.
Mr. Ferry. Thank you, Congressman. Yes, there absolutely
are risks to our national security from some of the Chinese
companies that are funded by American investors. As I said, the
civil-military crossover is widespread. It spreads across many
industries.
I could give you an example of the China State Shipbuilding
Corporation (CSSC), a Chinese shipbuilding company which is
building military ships. China, as you may know, has the
world's largest navy. The United States is now number two--you
don't often hear that about the military sector, where the
United States is number two, but the Navy is an area where it
is.
CSSC takes in investment funds through these indexes and
international exchange-traded funds, and CSSC is building
ships, it is building ports, and it is building other naval
equipment to enable the Chinese navy to grow. And we are
helping to fund that, and I think that is a situation that
should change.
Mr. Scott. And, Mr. Chairman, I would ask for just a couple
more seconds because I want to ask you, Mr. Ferry, because I
think the whole nation wants to know, with all of this missile
activity, with what China is doing in the arena--
Chairman Sherman. Mr. Scott, you are already a minute over,
so I will ask that the answer be for the record. We will decide
later whether we are doing a second round, but unless the
witness feels they can answer in just 10 or 15 seconds--
Mr. Ferry. Can you summarize your question? The missile
activity over Taiwan is absolutely a threat.
Mr. Scott. I am just saying that is what is busting on the
news everywhere. I think it is appropriate for us to get some
kind of answer from all of you.
Chairman Sherman. Thank you, Mr. Scott. Your time has
unfortunately expired.
Mr. Scott. Sorry.
Chairman Sherman. I will now recognize myself for 5
minutes. There are a few comments I want to make first. First,
it is this Congress and this committee that put the pressure
on, passed the law that is getting the PCAOB access to the
audit work papers.
Right now, they are in Hong Kong to see whether this
agreement is actually going to be implemented, and if it is
not, then our law will require that many of these Chinese
companies need to be delisted.
The second is, and I think Ms. Chu pointed this out, that
the VIE structure is designed to evade Chinese laws, or avoid
Chinese laws, however you phrase it, but it puts our investors
in a position where they think they are buying Alibaba, a big
Chinese company, and instead, they have no shareholder rights,
except in Alibaba Cayman Islands, which raises the issue of
whether we should allow a company to sell stock in our country
calling themselves Alibaba, when they are really Alibaba Cayman
Islands, not the same thing as the big Chinese company.
And we have to look and see whether it is appropriate for
low-cost funds and index funds to be investing in companies
that either have fled American markets to avoid the PCAOB, or
employed a VIE structure, because when you have no money to
investigate what you are investing in, you are just doing it on
the basis of an index. And those are risks to which you
probably shouldn't subject American investors.
And in particular, Alibaba is one of the biggest companies
in the world. If you want to invest in the big countries of the
world, invest in Alibaba. But Alibaba Cayman Islands is not one
of the biggest companies in the world, and so you don't
actually meet the qualifications for the index.
Ms. Chu, I would like you to comment on the idea of whether
these low-cost, paint-by-the-numbers index funds should be
allowed to invest in VIEs that are not operating companies, but
rather a company in the Cayman Islands, that has a relationship
with a company in China, that then has a relationship with
Alibaba or another big Chinese company.
Ms. Chu. Thank you. And, no, I don't think that this should
be an option for U.S. investors, least of all because of
investor protections, but also because of the possibility that
some of these companies are engaged in activities that are
contrary to U.S. national interests, without the knowledge of,
again, the investor.
The problem with index funds is that they are beholden to
profit. The index funds, and the index providers specifically,
operate using a set of technical and financial criteria, so
criteria like market cap or liquidity or size, when they
evaluate which companies or securities to add into an index or
which ones to remove.
For example, Russian securities were all removed from MSCI,
FTSE Russell, S&P, Dow Jones, all of these indexes in early
March of this year. But they weren't removed because of ethical
concerns or because of U.S. sanctions. They were removed
because they were virtually worthless.
And there are already policies--
Chairman Sherman. I do want to move on with my question.
Professor Sonnenfeld, should index funds be investing in
companies that were listed on American exchanges and then
delisted themselves, or were delisted, because they wouldn't
allow access of the PCAOB to their audit work papers?
Mr. Sonnenfeld. I share the spirit and the content of my
fellow panelists. I do think that there should be greater
transparency, and that even sophisticated investors are
representing a lot of individual innocent people's money--
Chairman Sherman. I am going to try to sneak in one more
question. In November of 2020, the SEC required that in public
offerings, you have to disclose the unique risks that investors
face investing in China, the VIE structure, the rule of law
questions.
Should we also require that these same risk factors be
disclosed? And this is required by one of the pieces of
legislation under consideration today, that these same risk
factors be disclosed to those investing in private placements.
Mr. Sonnenfeld. Yes, I think they should be. I will say in
the case of Alibaba Cayman, I actually read the 500-page
registration papers, not in preparation for this, but when it
happened, I thought that the volume was misleading itself.
It, in fact, allowed for Jack Ma, the then-CEO, to be
emperor for life with the exception that only the Chinese
government could remove him. He had founder shares that nobody
in the U.S., that I know of, who invested in the company
realized he had, but it was just buried in so much stuff.
Sometimes, I will say, Mr. Chairman, we have disclosure,
and it is still not transparent. It was buried in the fine
print.
Chairman Sherman. Thank you. My time has expired, and I
will now turn to the gentleman from Connecticut, Mr. Himes, who
is also the Chair of our Subcommittee on National Security,
International Development and Monetary Policy, a new
subcommittee that also deals with some of the national security
issues that we are confronting here today in this subcommittee.
Mr. Himes?
Mr. Himes. Thank you, Mr. Sherman, and I am glad that the
titles don't get charged against my time here. And thank you to
the witnesses who are with us today.
I have a question that I am going to direct, not to
Professor Sonnenfeld, but to Ms. Chu and Mr. Ferry, and it is a
China capital markets-related question. It is not controversial
to me that China shouldn't have any advantage over other
international issuers with respect to disclosure in PCAOB, but
we are spending a lot of time talking about China and Russia,
two very different countries with very, very different
situations from a capital markets standpoint.
We have almost no capital market interaction with Russia.
We have very little trade with Russia. That was true when
Russia was the Soviet Union.
We have deep, deep, deep ties financially with China, $125
billion a year, roughly, of foreign-directed investment into
China, with $38 billion coming this way. China owns $1 trillion
of United States Treasury debt.
The situation is one akin to the ones that the Germans find
themselves in with respect to Russian energy, of deep
entanglement.
What I am not hearing in today's testimony and I will just
ask you--I do have one question for Professor Sonnenfeld
related to Russia, so I will ask for quick answers--what should
be our strategy with respect to these financial and capital
markets entanglements with China? Should we be looking for
less, with what that might imply for growth? Should we be
looking for more, because entanglement will also create
commercial interests against the possibility of kinetic
antagonism?
Just give me your thoughts on what our overarching
principle should be with respect to financial and capital
markets entanglement with China?
Ms. Chu. Thank you. Quickly, I want to touch on your last
point, which is the concept of peace through trade, democracy
through trade. I think it is a concept that a lot of
Administrations in the past have held up, and we have seen was
perhaps not as effective as we might have hoped.
And with the case of China, yes, perhaps trade and further
entanglement will endear diplomatic relations. At the same
time, trade goes both ways. So while the U.S. may be able to
export values such as freedom of speech, or civil liberties, to
attempt to export these to China, China is also and has also
exported concepts like censorship, for example, authoritarian
values to other countries.
Mr. Himes. Mr. Ferry?
Mr. Ferry. Congressman, I believe we ought to decouple this
economy from China, not immediately, but over time, and I
believe that will benefit the U.S. economy.
You say there are commercial gains on both sides. Right
now, we are importing from China $600 billion worth of goods
each year and exporting around $150 billion worth of goods. If
we can reduce that level of imports and redirect that demand
towards American production, you will see the American economy
grow, and you will see employment, good-paying jobs grow in
this country.
On the capital market side, I think the same thing will
follow. We do not need them to buy $1 trillion worth of our
Treasury debt. And they are buying it partly in order to keep
the dollar high so they can continue to keep Chinese people
employed, because the one thing President Xi fears more than
anything else is a revolt and a revolution of the Chinese
people against the oppressive system he has put in place.
Instead, our capital should be funding investment in U.S.
industries and in investing in friendly nations. There are the
iPath nations, India, there are plenty of friendly nations that
we could invest in as a matter of foreign direct investment, to
grow their economies, to grow trade in a balanced fashion, and
regrow our own economy.
As far as capital markets go, I always fall back on the
quote of Paul Volcker, who was Chair of the Fed many years ago,
and I believe the best Chair the Federal Reserve has ever had.
He said, ``Every time I have a meeting with financial
professionals, they tell me that free, open capital markets are
making the U.S. economy more efficient, and I ask them for an
example, and in 30 years, they have never been able to give me
one example.''
Mr. Himes. Mr. Ferry, I have a quick question to you. The
Congress, on a bipartisan basis, rejected the Trans-Pacific
Partnership (TPP) trade deal. Very, very quickly, should the
Congress reopen the discussion of something that looks like the
TPP? This is for Mr. Ferry, then I am going to Professor
Sonnenfeld.
Mr. Ferry. I absolutely do not believe that free trade
agreements benefit the United States.
Mr. Himes. Okay. Thank you.
Professor Sonnenfeld, the sanctions that have been applied
to Russia, big holds obviously associated with Chinese
purchases of Russian energy, et cetera, and in the 20 seconds I
have remaining, what more should the West collectively, the
United States in particular, be doing to isolate the Russian
economy?
Mr. Sonnenfeld. The energy deals aren't so bad, that China
and India can't buy the Russian gas the way Putin said, even
though most of the world was fooled by that, but most Russian
gas goes through pipelines. It is natural gas. It is in the
form of vapors, and he doesn't have pipelines into Asia. The
liquid natural gas that we can sell them and are selling them--
we now supply the EU with more gas than they ever bought from
Russia. Russia has fallen, just as the war broke out, from 46
percent down to 9 percent of gas on oil. It is not such a big
problem either because they are such tough bargainers in India
and in China, that they are extracting a $36-barrel discount,
on top of the fact that Russia is the least-efficient producer
in OPEC. It costs the Saudis $22 a barrel. [inaudible] They are
not making money. But there are things they can do.
Chairman Sherman. Thank you. The time of the gentleman--
Mr. Himes. I thank the chairman for his leniency.
Chairman Sherman. I now recognize the gentleman from
Illinois, Mr. Foster, who is also the Chair of our Task Force
on Artificial Intelligence, for 5 minutes.
Mr. Foster. Thank you, Mr. Chairman. This is for Mr. Ferry
and Professor Sonnenfeld. There are two general classes of
disclosures for cross-border investment flows. There are
disclosures to regulators and disclosures to the public. Can
you say something about the relative merits of either one in
terms of accomplishing what we want to accomplish here,
Professor Sonnenfeld?
Mr. Sonnenfeld. I don't think there should be differences.
I think disclosures to the public and disclosures to the
regulators should be one and the same. We don't need to look
very far from FTX to see some awfully sophisticated people who
got fooled and have lost a lot of money when they thought they
understood what they didn't. We need to have, I think, a more
equal playing ground on disclosures across sectors.
Mr. Foster. Mr. Ferry?
Mr. Ferry. I would echo what--I agree 100 percent with my
what my Yale colleague expressed, and I guess what I would add
is that I spent an earlier part of my life reading 10-Qs and
10-Ks. Disclosures to the public are a great benefit to
investors. And I would just say if you think of Bernie Madoff
and the way in which he evaded disclosure to the public and got
billions of dollars of funds, China is full of literally
hundreds of people who are just like that, using
nontransparency to attract millions and billions of dollars.
And I would hate for that to be American money.
Mr. Foster. What sort of efficiency hit would the global
economy take from a just radical transparency requirement for
all cross-border investment flows? You have to know the
beneficial owner on each end and you have to know where the
money is actually going. There is an obvious paperwork cost of
that, which I guess could be roughly quantified, but aside from
that, what would be the downside of that?
Mr. Ferry. That is--
Mr. Foster. Anyone who wants to say, even if you don't
agree with it, what would be the arguments you anticipate
against a radical transparency regime?
Mr. Ferry. Efficiency in quotes always benefits when you
strip away regulations. If in the Democratic Republic of the
Congo, there are 10-year-olds mining cobalt, boys and girls,
would you call it more efficient because the cobalt is cheaper
than if we mined it in a country that respected laws and
regulations? So, I think efficiency is an overused and
overrated word.
Mr. Foster. Ms. Chu, you mentioned something called
democracy waiting, which I found fascinating. How exactly does
that work? Do you just trace back where all of the investment
flow is starting and originating, and then find some way of
saying, okay, this much is coming from that country, it has a
democracy waiting of .5?
Is there a general mechanism here, where you could set up
not only democracy waiting, but national security waiting or
religious freedom waiting or abortion rights waiting, or
whatever you want, with enough transparency of where the money
was coming and going?
Ms. Chu. Thank you. In the case of TCRS, I can't remember
exactly what their process is. I think they use some sort of
annual report that comes out on democracy around the world.
Although there are so many great nonprofits and there are
watchdog groups that put out reports, and I think annual
research about democracy, freedom of speech, freedom of
religion and all of these other topics, environmental, so ESG
plus essentially, that one could use to formulate their own
methodology, their own waiting matrix.
Mr. Foster. Okay. But the other part of the problem is
actually seeing the flow. Waiting to assign this mine in this
country from how good and accurate it is, and then there is the
tracing of the flow.
Is the rest of the thing a potentially solvable problem,
and then let third parties estimate how to apply those waits to
the final product that someone may want to base their
investment decision on?
Ms. Chu. In this case, I think the strategy involves using
pre-existing exchange-traded funds that are attracting country-
specific indexes. And there isn't additional waiting or
analyses on the part of the fund administrator. With that said,
I do know that there are funds out there--there is one that
uses something they call freedom waiting, which are proprietary
methods that I am sure could be expanded upon by other index
providers, larger ones as well, that I think are of value and I
am hopeful will catch on.
Mr. Foster. Ms. Alexander, can you say anything about the
differences in different countries and how useful they are in
tracking down all of these issues?
What are the limits of what the U.S. can do unilaterally
versus are there gaping holes where some countries just are not
helping out with the transparency we need here?
Ms. Alexander. Thank you for your question. I think there
is a lot more information that is publicly available in other
countries that we don't have a habit of disclosing in this
country. And I do think disclosure and transparency is a way of
holding capital accountable for what it ends up getting
invested in, the patterns or the structures of transparency on
who owns companies, what the investments are in different
countries is pretty complex, but--
Chairman Sherman. I am going to have to interrupt at this
point. The time of the gentleman has expired.
I'll move onto Mr. Vargas, who is there on our screen, and
is recognized for 5 minutes.
Mr. Vargas. Thank you very much, Mr. Chairman. And I thank
the ranking member, of course, and all of our witnesses today.
Mr. Sonnenfeld, you were saying that there were gaps in our
sanctions on Russia, and then you started to say that we could
do something about it. Then, you were truncated about that
point, and you didn't tell us what those were. Why don't you go
ahead and tell us what those were?
Mr. Sonnenfeld. Thank you, Mr. Vargas. I did want to more
completely answer Congressman Himes, and I thank you,
Congressman Vargas, for giving [inaudible] Oligarchs that it
could have been better addressed than the families of oligarchs
and top public officials, and there are some sanctions groups
that have some great legislation on this, from the McFaul group
out of Stanford, and from the Kyiv School of Economics, but in
particular, the major U.S. airlines are suffering badly right
now, and it is an area that hasn't gotten much attention.
American passengers are filling the flights of American
departing planes that are flying on Qatar Air, on Etihad, on
Emirates Air, on--not just Middle Eastern carriers, Air Serbia,
Air India that are making the most-profitable U.S. airline
routes, the most-profitable paired routes so unprofitable that
they are canceling them, flying from San Francisco to New
Delhi, flying from Newark to New Delhi, JFK to New Delhi or to
the Philippines, Dallas to Seoul, these are flights that are
being canceled now by American, by United, and by others that
used to be the most-profitable.
And who's filling them? Americans. Why? Because they are
flying out of U.S. departure airports. They are flying over
Russia. Our airlines can't and shouldn't do that, but we are
allowing the non-U.S. carriers flying out of the U.S. that
nobody questions this, that is--we are also paying, by the way,
millions of dollars of overage fees that go to Russia because
of the way air traffic rules work. We pay the money to fly over
them that Americans are basically paying for that, and we are
hurting our own airlines. So, thank you, sir. That is a major
issue.
And the third one has to do with parts. There is something
going on that has not been publicly discussed until this
moment. Boeing is living by sanctions against using Russian
titanium. In fact, they had a major joint venture in Russia.
They discontinued it. I am sorry to say that I believe British
Airways has gone in and taken over what had been Boeing's
interest there. And we have other parts leakages issues, so
that Aeroflot, an F7 domestic carrier, had basically stopped in
March. They are back up in the air right now because somebody
is getting aviation parts that are being smuggled in and leaked
in. I just think that some in Europe aren't living by the same
rules as some in the U.S. when it comes to aviation. And we
have foreign carriers leaving U.S. airports that aren't being
held to the same standards as U.S. carriers.
Mr. Vargas. Okay. I do want to follow up with one question,
You published a formal analysis of the stock price performance
of publicly traded companies, which had announced formal plans
to suspend commercial activity in Russia compared to their
peers, which continued to do business there following the
Russian invasion of Ukraine.
In your findings, you observed that firms pulling out
experienced a 4-percent market capitalization increase, whereas
firms that continued to operate in Russia saw an average of a
5.5-percent decline.
Is that still the case today, do you know?
Mr. Sonnenfeld. Yes. We have a team studying that right
now, Congressman. Thank you very much for asking about that.
If you would take a look independent of the country where
it is domiciled, independent of the size of the company,
independent of the industry, you could look at an industry
sector like energy. It is not all, ``a rising tide raises all
boats.'' Energy total suffers where BP and others are soaring.
Exxon and Shell, they each wrote down billions of dollars, but
they wound up having a 13 to 20 percent surge in their stock
price, having reduced financial risk, operational risk, and
reputational risk.
So, they paid off. And in every industry, you find the same
thing, whether it is retail and consumer goods or
pharmaceuticals, the companies that stayed there are doing
worse than the companies that pulled out. Even the public and
private companies, we have looked at pricing, the debt
offerings of private companies--it is a higher risk I will say.
Mr. Vargas. My time is about up. I just wanted to point out
that corporate social responsibility, in some cases, really
does pay off. I appreciate it.
I wish you the worst of luck on Saturday. I hope Yale gets
crushed.
Mr. Sonnenfeld. Thank you, sir. It is an away game. We are
worried.
Mr. Vargas. I will be there with my daughter. So, I am
looking forward to it.
Chairman Sherman. Thank you. The time of the gentleman has
expired, although I agree with him on the game, and I now
recognize the gentleman from Illinois, Mr. Casten, the Vice
Chair of this subcommittee.
Mr. Casten. My contribution of comity on this panel is
going to a small Division 3 college that cannot compete in any
sports against the rest of you.
Thank you, Mr. Chairman. And thank you to our witnesses.
Ms. Chu, I want to follow up with you, and just follow up
on the exchange you had with Mr. Gonzalez. He had chatted with
you about the Holding Foreign Companies Accountable Act, in
which, if the PCAOB is not allowed to review these auditors,
these companies are going to be delisted within 3 years of
enactment, which is about a year from now.
Just really quickly, given how much time you have spent in
this space, are you optimistic as we sit here today that we are
going to come to some agreement with the Chinese regulators to
get through that, or are these 200-some listed firms going to
be delisted by the end of the year? What is your view of where
this sits right now?
Ms. Chu. Thank you. I think it is possible to come to an
agreement, but enforcement is a whole other issue. And in
addition, disclosure is a problem, true disclosure, and also
the fact that Chinese companies have found so many loopholes,
whether through regulations or through corporate structures to
navigate U.S. regulations on this front. I think it is possible
that it will pass, and I am hopeful, because that sets a
wonderful precedent. But I don't think that means the challenge
is over.
Mr. Casten. Just from a capital markets perspective, give
me the outer bounds here. If these 200-ish companies are
delisted, what kind of volumes are we talking about on U.S.
capital markets, in terms of dollars? Any sense of what that
is?
Ms. Chu. I think I have to defer to Mr. Ferry on this.
Mr. Casten. Mr. Ferry?
Mr. Ferry. I'm sorry. That is a good question. I don't have
at my fingertips the volume of trading or the volume of capital
involved in these 200 companies. I do agree with Ms. Chu's
point of view that an agreement is possible. Enforcement of the
agreement is going to be very difficult, given where the
Chinese economy is with deep, deep problems with debt. Their
interest is in keeping our investors' pockets open to help prop
up their economy.
Mr. Casten. Okay. I am not trying to get precise numbers,
but I am asking because we have also seen the rise in this
exempt offerings market, which, of course, would be totally
outside of these rules, and not subject to SEC compliance.
And Ms. Chu, Mr. Ferry, any of you who have any other
thoughts on this, are you satisfied if indeed this Act were to
go into force, if indeed whatever this quantum of money is,
does that actually get pulled out, or should we be concerned
that we are just going to create a venue for this money to move
over to the exempt offerings market, because I think the latest
number I was able to find was $2.7 trillion, just in 2019,
raised on those markets, which I think would be totally outside
of this agreement; is that right?
Mr. Ferry. I think so, but I haven't studied that issue in
detail. And if your point is that the money will find a way to
be domiciled in the Cayman Islands and still invested in China,
all of these leakages are possible because capital is fungible,
but we have to go step by step and protect our investors each
step of the way, and then plug the holes just like the
proverbial woman and the Dutch dike.
Mr. Casten. Any suggestions on what Congress might do to
plug those holes?
Mr. Ferry. The first thing is to enforce the Holding
Foreign Companies Accountable Act. And the next thing is to
move to sanctions harmonization to require all arms of the
Federal Government to harmonize, preferably with the Department
of Commerce's Entity List, which lists 1,100 Chinese companies
as companies in which U.S. investors should not invest.
Mr. Casten. With the time I have left, I want to move to
Professor Sonnenfeld, and just to pick up on Mr. Vargas'
question a little bit, this observation in your research that
there is a declining market cap for companies that have stayed
in Russia, obviously, they reversed the other way.
I think--and if I am putting words in your mouth, correct
me--you are saying that it is our sanctions regime that has, to
some degree, contributed to that?
Mr. Sonnenfeld. It is completely independent, but
consistent with the sanctions regime, when we have seen
disappointments in economic blockades in Cuba or North Korea or
Iran, it is because, in fact, we didn't have the sectors
working together. But these are independent decisions that have
not been, for the most part, in finance and some other areas
that were driven by sanctions. But for the most part, these
were individual decisions.
As we saw with Libya, Chile, Yugoslavia, Ceausescu in
Romania, and Erich Honecker in East Germany, we saw a profound
takedown of tyrants happen because of private-sector decisions
that matched the public-sector decisions. That is what makes
blockades work. But in South Africa, for example, there were
sanctions passed by our government--I think by a 77-22 vote
that Senator McConnell actually led the override of President
Reagan's veto on it. Still, that wasn't enough. It took 200
companies to voluntarily pull out. That was the high watermark
then, and that was independent of the sanctions; Coke, IBM, and
GM led that. And now, we have never seen anything like this in
world history, to have 1,200 companies voluntarily pull out,
either through enlightened self-interest, ethics or whatever
reason, it was--
Chairman Sherman. The time of the gentleman has expired. I
thank for your answer.
I would like to thank our witnesses for their testimony.
And I thank Mr. Gonzalez for representing his party well here.
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 now adjourned.
[Whereupon, at 3:24 p.m., the hearing was adjourned.]
A P P E N D I X
November 15, 2022
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