Lawmakers propose sanctions on US index funds investing in China

US lawmakers are intensifying efforts to prohibit funds from investing in Chinese companies, in an effort to address the strategic, commercial and national security risks Beijing poses to the US economy and financial markets.

Bipartisan representatives of the US Congress’s certified public accountant caucus have unveiled a bill entitled the No China in Index Funds Act, which includes civil penalties for violations of the proposed legislation.

Index funds minimise their expenses by simply investing in all the companies in a certain market sector without carefully scrutinising individual companies, a strategy that fails to consider the “unique difficulties” in evaluating Chinese companies, said Brad Sherman, co-author of the bills and ranking member of the capital markets subcommittee, part of the US House financial services committee, in a statement.

“We keep Chinese stocks out of index funds because those funds do no research into the risks these companies pose,” he added.

This article was previously published by Ignites Asia, a title owned by the FT Group.

The bill has not detailed steps to impose these restrictions but notes that the US Securities and Exchange Commission “may issue such rules as may be necessary to carry out this section”.

Proposed penalties for this measure include a fine of up to $250,000 or an amount that is twice the amount of the transaction that is the basis of the violation.

The No China in Index Funds Act is one of four proposed measures unveiled by California Democrat Sherman and Victoria Spartz, a Republican congresswoman from Indiana.

The three other legislative bills aim to “end tax breaks for Chinese equities, restrict sanctioned Chinese companies’ access to US capital markets, increase transparency on risks to American corporations, and reduce exposure to these risks for retail investors and other Americans saving for retirement”, according to a statement from the lawmakers.

Sherman and Spartz have identified the No Capital Gains Allowance for American Adversaries Act as the “most important” of the group. This measure targets the removal of the capital gains tax break for investments in companies based in China, Russia, Belarus, Iran and North Korea.

“It makes no sense to forgo US tax dollars to encourage Americans to invest in China’s economy,” Sherman said.

“It’s also unfair because China provides tax incentives to Chinese investors but not to those who invest in American stocks,” he added.

“As a former Big Four auditor of multinational publicly traded companies, I understand the risks to financial markets and American investors posed by the lack of transparency and proper auditing of Chinese operations,” Spartz said.

“Congress has a duty to the American people to protect their hard-earned money from foreign adversaries like China by demanding transparency and eliminating perverse incentives,” she added.

The bill adds to the growing number of legislative proposals centred on curbing US private investments in China, the world’s second-largest economy.

US President Joe Biden last year signed an executive order limiting investments into three big parts of China’s advanced technology.

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Hedge funds, private equity and venture capital firms, as well as pensions, university endowments and investment giants such as BlackRock and MSCI, have been scrutinised, called for questioning or targeted by other legislative bills.

The Senate proposed the Disclosing Investments in Foreign Adversaries Act of 2023 that would require private funds, which are not subject to the same disclosure rules as publicly traded companies, to annually disclose assets invested in China to the US Securities and Exchange Commission.

US House Select Committee on China chair Mike Gallagher in August called for more stringent investment curbs on China, including restrictions on “problematic” investments, such as US holdings of Chinese stocks and bonds, and trading of investment funds that include Chinese companies.

*Ignites Asia is a news service published by FT Specialist for professionals working in the asset management industry. Trials and subscriptions are available at ignitesasia.com.

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