Decoupling the US Capital Market from China, Now or Never?

October 31, 2019 Updated: November 6, 2019

A Joint Production of Zooming In and the Epoch Times

Narration: The chief investment officer of the California Public Employees Retirement System, (CalPERS), held a similar position in China while working for the State Administration of Foreign Exchange.

Frank Qin: Anyone who holds such a post in the State Administration of Foreign Exchange has to be competent both ideologically and professionally. Being ideologically competent means being loyal to the Chinese Communist Party (CCP).

Narration: CalPERS is funding Chinese military contractors and human rights abusers. How big is China’s footprint in the U.S. capital markets?

Roger Robinson: The number of companies that are in our capital markets today that are Chinese, we find that some 600, over 650 such enterprises are there.

Steve Bannon: You tell me wall street…doesn’t know the human rights abuses? Sure, they know, They don’t care.

Narration: Besides national security concerns and human rights abuses, the real danger associated with investment in China is fraud.

Frank Qin: Almost all Chinese companies have 2 sets of accounting records. One is for internal use, the other is for the Tax bureau.

Title: Decoupling the U.S. Capital Market from China—It’s Now or Never

Host: Welcome to Zooming In, I am Simone Gao. If you ask any American whether hundreds of billions of U.S. tax dollars–including federal employee pension funds–should go into Chinese companies that pose national security threats to the U.S., are human rights abusers and engage in fraudulent practices, they would say no, of course not. But that’s exactly what has been going on for years. And the appalling fact is that it is very hard to stop that practice because Wall Street is making tons of money from it; everyone else is doing it, there seems to be no other viable alternatives, and it might be too late to decouple now. But is it really too late? What’s the true face of these investments? Can they bring financial securities to Americans, or will they make the country more vulnerable? Is now the last chance to change it? We will explore these questions in this episode of Zooming In.

Part One: Chief Investment Officer of Large US Public Pension Fund Has Deep Ties to Chinese Regime

Narration: In a person’s life, if there is an opportunity to work for the motherland, this responsibility and honor is unmatched by anything. —- Ben Meng

Narration: His name is Ben Meng. He is the chief investment officer of the California Public Employees Retirement System (CalPERS). CalPERS is one of the country’s largest pension funds that manages more than $350 billion for public employees either retired from or currently working for most of the state and local public agencies in California.

Narration: When The People’s Daily quoted Mr. Meng’s pledged allegiance to his “Motherland”, he was referring to the People’s republic of China. Meng was born and raised in China and came to the U.S. to study at the University of California Davis in 1995.

Narration: Prior to his position at CalPERS, Meng served as the deputy CIO at the State Administration of Foreign Exchange of China,(SAFE), for three years. SAFE is a Chinese administrative agency under the State Council tasked with drafting rules and regulations governing foreign exchange market activities, and managing the state’s foreign-exchange reserves. These reserves, held by the People’s Bank of China, stood at 3.01 trillion dollars at the end of December 2016. Tightly controlled by the regime, China’s foreign reserve system is one of the key institutions for the world’s second-largest economy.

Frank Qin: In order to work in such an organization he had to be eligible ideologically and professionally. The former means being loyal to the CCP while the latter means meeting professional standards. For the CCP, ideological requirements are more important since many core secrets are involved in working in such organizations.

Narration: Mr. Meng does have a prestigious background. Before he first joined CalPERS in 2008, he worked at Barclays as a senior portfolio manager at Lehman Brothers Holdings as a risk officer, and he was also a fixed-income trader at Morgan Stanley.

Narration: Meng’s experience in the United States qualified him to be a candidate for the Chinese government’s prestigious headhunting program “Thousand Talents Plan” – TTP.

Narration: The TTP recruits and hires professionals who hold high-level positions, mainly in the United States, but also throughout the Western world.

Narration: Individuals recruited by the TTP, according to an FBI report, have been experts or scholars in prestigious universities or research institutes, senior managerial professionals in internationally known financial institutions, or entrepreneurs holding IP rights. Once recruited by the TTP, they are required to work at least 6 months per year in China. The TTP, according to the same FBI report, is a program that allows China to gain access to and benefit from advanced technology from the United States and to “severely impact the U.S. economy.”

Narration: Meng was officially hired by SAFE through the Thousand Talents Plan in November 2015.

Frank Qin: Experts recruited by the Thousand Talents Plan are required to do more than just working in China for a certain period of time. The CCP authorities try every means to butter them, e.g. by helping them starting their own business in China or granting them corporate shares. The CCP also encourages them to steal intellectual property from foreign companies or research institutions. This, in fact, constitutes a criminal act. For example, Tesla reportedly sued its ex-staff for taking away its more than 100,000 documents and forwarded them to its Chinese competitor Xpeng Motors. Such cases are abundant in China. Considering their business and market in China, a host of affected companies are reluctant to make their stories public. There are other cases of plagiarism not yet exposed.

Narration: Meng worked at SAFE for 3 years before he returned to California. According to a Bloomberg report, Meng said it was a relatively easy decision for him to move back to the U.S. since he felt like a visitor when he worked in China. Based on the TTP requirement, Meng would no longer be officially associated with TTP once he moved back to the U.S.

Host: CalPERS declined our request to interview Ben Meng and the company’s board. Although it’s unlikely that Meng is still officially involved with the TTP, his China experience gives him leverage at his current post as the Chief Investment Officer of CalPERS. China, after all, is THE hot area to invest in nowadays. How did it happen and what does it mean? Stay tuned for Part 2 of this report.

Part 2:US Pension Funds and Endowments Are Funding Chinese Tech Rise

Narration: The days that investors can earn 7% in U.S. bonds are long gone. In a decade long, low rate environment, from university endowments to government pension funds, institutional investors have been challenged to achieve decent returns through a large allocation to the U.S. bond markets. This investment community sought after similar approaches to deal with the changing landscape. It unanimously increased riskier asset class investments such as emerging markets and private equity. This demand increase for riskier assets induced many beneficiaries. China in particular attracts attention. The sheer size of its economy, the rosy prospect for its future growth, especially against the memory of the 2008 financial crisis when China shined as the only bright spot in the world economic landscape, all make China a perfect candidate for an investment community desperately seeking the next chapter for growth.

Narration: But this China hustle does come with a price.

Narration: Based on its 2017–2018 annual investment report, CalPERS invested in more than 100 Chinese companies. Among them are companies related to China’s military, cyberwarfare, human rights abusers, and defense industries. Some of them have been cited for unethical business practices outside China.

Narration: China Communication Construction Co. One of the largest contractors of China’s “One Belt, One Road” initiative. Military island builder in the South China Sea. Offender of corruption, labor abuse, and fraudulent bidding practices.

Narration: China Aerospace International Holding Ltd, China’s largest space contractor.

Narration: China Unicom, the reason North Korea’s Internet exists.

Narration: Aviation Industry Corporation of China, aircraft and drone builder for the People’s Liberation Army. Frequently sanctioned by the U.S. government.

Narration: Hikvision and Dahua, the world’s largest video surveillance system provider whose technology is widely used in surveilling Chinese citizens. Both are on the entity list of the U.S. Department of Commerce.

Host: CalPERS’ governance guidance does command the company to operate in support of universal human rights. It also requires the company to do business with parties that enjoy political freedom and freedom of speech, which a number of the Chinese companies CalPERS invested in clearly violate. Zooming In asked CalPERS if these investments jeopardized the company’s fiduciary responsibilities to their clients. CalPERS did not give us an answer. CalPERS’ China investment is not an exception among institutional investors but rather, a common practice. In fact, billions of dollars from U.S. pension funds and college endowments have channeled into Chinese technology companies in search of investment returns.

Narration: After the Chinese Communist Regime’s bloody crackdown of the 1989 Tiananmen pro-democracy movement, the American government put various sanctions on China. Those sanctions were quickly relaxed as the Bush, Clinton and Obama administrations pursued a policy of engagement with China. American technology and capital flow to China facilitated China’s technological rise. Particularly in the past 5 years, China has made great advancements in Artificial Intelligence, big data, drone technology, etc. U.S. pension funds and endowments have been a big financial proponent of that development.

Narration: According to a Bloomberg report, The Delaware Public Employees Retirement System and the State of Michigan Retirement System have been funding Shen Zhen DJI Technology Corporation, the world’s leading drone maker whose products are banned by the U.S. Army.

Narration: SenseTime, based in China, is considered the world’s most valuable AI startup. It has raised money from venture firms including those backed by CalPERS, the Washington State Investment Board, and the Teacher Retirement System of Texas.

Narration: ByteDance Ltd., a leading developer of AI apps, headquartered in Beijing, has benefited from the backing of funds raised from the New York State Teachers’ Retirement System, the Oregon Public Employees Retirement System and the Minnesota State Board of Investment.

Narration: These investments have paid off. The Washington State Investment Board posted an internal rate of return of 24% from its investment in the Warburg Pincus China Fund between early 2017 and 2018. By comparison, the fund’s private equity portfolio returned 15.3% in 2018.

Narration: In fact, More than 90% of U.S. foundations and endowments have some exposure to China that range from millions to billions of dollars in 2018 alone.

Host: With the prospect of high investment returns, China looms particularly large for institutional investors in the emerging markets. It represents an uncomfortably outsized stake in U.S. pension funds and endowments, and an overpowering influence. Stay tuned for Part 3 of this report.

Part 3:MSCI Index Includes China A-Shares–Is It an Irreversible Trend?

Narration: An MSCI decision only further excited this dynamic. On June 20, 2017, The Morgan Stanley Capital International Index (MSCI) announced that it will include China A-Shares in the MSCI Emerging Markets Index starting in June 2018. Next, it will be including those shares in its All Country World Index and China Index. The company also announced that it will increase the weight of China A shares in the MSCI Indexes by increasing the inclusion factor from its initial level of 5% to 20% in three steps. This is the fourth time China’s A shares have applied for membership, after the first three were rejected.

Narration: 234 A-shares were included in the MSCI index system. A-shares are stocks of Chinese companies incorporated on the mainland, quoted in renminbi, and listed in Shanghai and Shenzhen.

Roger Robinson: When you look at the indexes, like the MSCI emerging market index, it is tracked by 2 trillion dollars of funds it manages and it is mimicked by 14 trillion more. Every time they add a Chinese company, and they are doubling the number in the next 12 months, as 14, 16 trillions of dollars automatically buy those stocks.

Host: That was Roger Robinson at the newly formed “Committee on the Present Danger: China.” He was Senior Director of International Economic Affairs at the National Security Council during the Reagan administration and later served as chairman of the Congressional U.S.–China Economic and Security Review Commission. He pointed out it was difficult for funds to change course on their China investments. The biggest boost from the American federal pension funds to Chinese tech firms is yet to come.

Narration: The Federal Retirement Thrift Investment Board, FRTIB, manages nearly $600 billion of U.S. federal employees retirement funds, making it one of the world’s largest of its kind. Its Thrift Savings Plan, TSP, is the federal-government equivalent of a 401(k). Any federal employee who has a retirement fund through his or her job, is a member of the TSP.

Narration: One of the most important investment components of the TSP is an international fund known as the I Fund. In 2017, the FRTIB board voted to shift the I Fund Index from the MSCI EAFE (Europe, Australasia, Far East) index to the MSCI All Country World ex-U.S. investable Market Index (ACWI ex-U.S. IMI), which is poised to include China A-shares. The index also includes Russian companies. Set to take effect next year, the transition will force the FRTIB to invest about $3.3 billion of federal employees’ savings in state-owned and state-directed firms in China.

Roger Robinson: Now, the alarming part of this is that the sheer pace of the money we are talking about now. We are talking about hundreds of billions of dollars moving rapidly towards 1 trillion dollars. So we are not talking about a few tens of billions here, we are talking about hundreds of billions. Now it raises a question, given the fact that the United States has never put up any kind of security-minded screening mechanism over our cap market like we have with Serphias and Ferma in the trade portfolio, where at least we are making an effort to vet Chinese investment in the United States to find out who these people are, what are their true intentions, do we have a national security threat there that’s worthy? Nothing happened there in the Vis-a-vis cap market. Never has and that’s the root of the problem.

Narration: Under the current system, federal employees have little control over where their pension money is invested. Federal retirees’ dollars flow freely to companies such as Hikvision, which is under U.S. Commerce Department sanctions because of its human-rights abuses.

Narration: Jim Banks, a U.S. congressman from Indiana introduced HR2903 , the “Blocking Investment in Our Adversaries Act” with the intention of reversing the controversial decision by the Federal Retirement Thrift Investment Board in 2017.

Narration: Congressman Bank’s bill is still under review in the House Committee on Oversight and Reform.

Narration: In July 2019, Senators Marco Rubio and Jeanne Shaheen wrote to the board of FRTIB to urge it to reverse its decision to adopt the All Country Index. The result? Senator Rubio’s office told Zooming In that they did not receive a response to their questions. They did receive a reply from the chairman of FRTIB saying they would consider his suggestion. (we have the letter). On October 24, 2019, right before the FRTIB board met again, Rubio sent a second letter urging the board to reverse its decision to track the MSCI All Country Index. The FRTIB board met on October 29. When Zooming In called FRTIB on the day of the meeting, the company representative said they could not comment on the board meeting but the company is scheduled to switch to the MSCI All Country Index sometime in 2020.

Host: There are 3 major concerns regarding investment in Chinese companies: National Security concerns, Human rights concerns, and concerns about non-transparency and fraud. While the first two categories undermine America’s national interest and American values, the third category poses a direct threat to American taxpayers’ financial security. And the longer we wait, the less likely any substantial changes could be made. How is this so? Stay tuned for the next episode in this special series.

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