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Ukraine Should Give Investors Second Thoughts on China

Russian President Vladimir Putin’s war has shown autocracies aren’t safe bets.

By , a senior policy advisor at Hong Kong Watch and director of the forthcoming China Risks Institute, which will launch in May 2022.
A commuter walks past an ad for the U.S. multinational investment bank and financial services company Morgan Stanley in Hong Kong on Sept. 30, 2021.
A commuter walks past an ad for the U.S. multinational investment bank and financial services company Morgan Stanley in Hong Kong on Sept. 30, 2021.
A commuter walks past an ad for the U.S. multinational investment bank and financial services company Morgan Stanley in Hong Kong on Sept. 30, 2021. Budrul Chukrut/SOPA Images/LightRocket via Getty Images

Russia’s invasion of Ukraine has violently shaken Western countries out of their lethargy about kleptocracy and led to the unprecedented use of coordinated punitive financial sanctions, including cutting Russian banks off from the SWIFT global financial system. Foreign investors in Russia are seeing their investments, from planes to restaurants, seized by Moscow.

All of this has serious lessons for U.S. financial institutions and their exposure to Chinese equities in a future crisis. But are investors ready to learn them?

They weren’t ready for the Ukraine war. A week before Russian tanks rolled into Ukraine and paratroopers descended from the sky, Western investors appeared bullish on the likely impact the war and Western sanctions would have on Russian equities. Rising oil and gas prices paired with the false optics that a Russian invasion had been averted offered a positive omen for investors.

Russia’s invasion of Ukraine has violently shaken Western countries out of their lethargy about kleptocracy and led to the unprecedented use of coordinated punitive financial sanctions, including cutting Russian banks off from the SWIFT global financial system. Foreign investors in Russia are seeing their investments, from planes to restaurants, seized by Moscow.

All of this has serious lessons for U.S. financial institutions and their exposure to Chinese equities in a future crisis. But are investors ready to learn them?

They weren’t ready for the Ukraine war. A week before Russian tanks rolled into Ukraine and paratroopers descended from the sky, Western investors appeared bullish on the likely impact the war and Western sanctions would have on Russian equities. Rising oil and gas prices paired with the false optics that a Russian invasion had been averted offered a positive omen for investors.

Thirty-eight exchange-traded funds (ETFs) and mutual funds that had at least 50 percent exposure to Russia, with combined assets of $8.7 billion, showed net inflows of $69.7 million as investors piled into Russian gas, gold mines, and arms manufacturers. This included BlackRock’s iShares MSCI Russia ETF, which attracted $20.6 million, according to Trackinsight

Little more than a week later, after Russian President Vladimir Putin’s brutal invasion, the picture was far bleaker. Investors rushed to exit Russian markets as almost $200 billion was wiped off its stocks after Western countries introduced coordinated and targeted sanctions. Moscow froze the stock market for weeks, only recently reopening it.

In response, leading American banks JPMorgan Chase, Goldman Sachs, Citibank, Morgan Stanley, and Bank of America halted trading in Russian equities, and the MSCI dropped Russia from its emerging markets indexes. The U.S. Treasury Department has given fund managers, including BlackRock and Vanguard, until May 25 to unpick their investments and find non-U.S. buyers for their equity and debt holdings in five Russian entities, including VTB Bank, PJSC, and VEB.RF.

The escalating cocktail of targeted sanctions against individual oligarchs, de-listing Russian companies from Western stock exchanges, and freezing the Russian Central Bank’s assets overseas—mixed with the growing number of corporate boycotts—make it difficult to survey the current losses that U.S. financial institutions have incurred at the hands of Putin’s all-out gamble of war in Ukraine. However, an MSCI index tracking Russian stocks traded in London and New York is down more than 95 percent this year, and BlackRock has reported $17 billion in losses on its Russian-exposed securities.

Yet, the fact that the U.S. intelligence community’s warning of a Russian invasion in early December 2021 fell on deaf ears should serve as a cautionary tale for those investors who willfully ignore the prospect of Chinese President Xi Jinping ordering a military invasion of Taiwan.

As with Putin, Xi’s recent track record when it comes to undermining the international rules-based system, breaking treaties, and encroaching on China’s neighbors’ sovereignty is discarded by far too many investors who are blinded by the mirage of large fees and huge returns from Chinese equities.

In 2020, a year when China flouted its reporting obligations to the World Health Organization—allowing a local epidemic to become a global pandemic—undertook a massive crackdown on human rights in Hong Kong, launched a trade war against Australia, and had violent border clashes with India, foreign holdings of Chinese government bonds topped $500 billion (an increase of nearly 50 percent).

Five of the largest U.S. banks—Bank of America, JPMorgan Chase, Citibank, Morgan Stanley, and Goldman Sachs—in March 2021 had a total of $77.8 billion invested in Chinese equities and bonds. In the case of Goldman Sachs, its holdings in China outstripped the amount of U.S. taxpayer money it received as a bailout in the 2008 and 2009 financial crisis. With Citibank and JPMorgan Chase investing $21.8 billion and $21.2 billion in China, respectively, their holdings could soon outweigh the lofty $25 billion bailouts both banks received in 2008.

Some of these financial institutions were recently burned by Xi’s surprise crackdown on Chinese technology and tutoring companies, in particular Goldman Sachs and Morgan Stanley. Both banks held substantial stakes in Chinese tutoring companies. Morgan Stanley saw its shares in two Chinese tutoring companies lose $3.7 billion of their value as a result of the Chinese Communist Party’s whims.

Undeterred and off the back of being granted approval to take full ownership of its joint-investment arm in China, Goldman Sachs has advised its investors to buy up Chinese equities as a hedge against the global instability caused by the crisis in Ukraine, including Chinese defense stocks. The same institutions that prompted the global financial crisis have lost money investing in China and failed to see the Russian war coming despite all the warnings now calling on greater exposure to Chinese equities and bonds. It should not be lost on the public, lawmakers, and regulators, who must use Putin’s war in Ukraine as a much-needed wake-up call about the vulnerabilities and risks associated with exposure to markets controlled by authoritarian governments.

They may not be able to realize—or acknowledge—their mistakes. But the public and officials should. The sad truth is that many of these financial institutions that were not predicting effective, coordinated Western sanctions on Russia let alone a military invasion are so heavily exposed to Chinese markets that many would struggle to survive if the West showed a similar backbone against an invasion of Taiwan. It’s for that reason that the financial sector downplays warnings about Chinese risk—and seeks to quash or water down measures taken against China over its current atrocities. That is why lawmakers must look seriously at regulating and limiting financial exposure to markets controlled by authoritarian governments.

In the weeks and months ahead, there will be a movement among these same investors to repair Xi and China’s reputation—especially if Beijing tries to present itself as an honest broker when it comes to establishing peace between Russia and Ukraine.

Such overtures must be opposed. As Xi has demonstrated in the last two years, China is more than willing to upend international rules, break treaties, and (where necessary) use force to meet its territorial ambitions. For investors, the global economy, and ordinary members of the public, this poses the greatest risk yet.

Sam Goodman is a senior policy advisor at Hong Kong Watch and director of the forthcoming China Risks Institute, which will launch in May 2022.

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