The House Foreign Affairs Committee said in its hearing on U.S. capital flows to Chinese military companies on Wednesday that it would push the full House to take up legislation that would restrict outbound investment to entire sectors of the Chinese economy. For now, those restrictions are either tailored to Wall Street fund managers who are banned from holding Chinese defense contractors, and to some individual Chinese companies who are restricted from having access to U.S. computer hardware, but not outright banned to obtain it.
Such restrictions against China’s advanced technology sectors started under the Trump presidency and have continued under Biden. Today, the big debate is whether or not private equity and venture capital firms will face the same restrictions as Vanguard and Intel.
To take a spin on a classic Wall Street saying, for private capital in Silicon Valley, especially, the trend is not your friend.
“The scale of global power is beginning to tip towards China in part because of the leverage we are giving them,” said former Trump administration official, Matthew Pottinger, now Chairman of the Foundation for Defense of Democracies’ China Program. Pottinger was one of two witnesses before the Committee on Wednesday. “U.S. companies and investment funds have helped to underwrite and modernize China’s military and intelligence apparatus. Americans usually don’t invest with the intent to hurt the U.S., but that is what is happening here regardless,” Pottinger said.
Last year, the Pentagon released a defense assessment on China and said that it was bigger than they expected. Much of China’s rise over the years is thanks in part to American capital and multinationals.
Chairman Michael McCaul (R-TX-10) said the U.S. had to move from an entity approach in targeting restrictions on doing business with China, to a total sector approach. He said that as the restrictions go currently, “Treasury is the weak link” in making them work. “We asked them to sanction Hikvision,” he said of the facial recognition and video surveillance manufacturer whose equipment is used at the Uyghur detention facilities in Xinjiang. “They told us in writing that they could not do that.”
“I’ve been over there to the Treasury and I know how hard they work and they are spread very thin on this issue,” Pottinger admitted. “If you say these sectors are off limits instead, it makes it simpler and it’s less resource intensive and I would argue it provides more clarity.”
Ranking Member Gregory Meeks (D-NY-5) talked about getting McCaul’s bill HR 6349 The Preventing Adversaries from Developing Critical Capabilities Act out of the Foreign Affairs Committee, saying it was ready for prime time on the House floor. The bill would ban any transaction, including venture capital and private equity investment, in companies in industries of concern listed by the White House. Most of these industries are outlined in Biden’s Executive Order 14105 in high tech sectors of the Chinese economy – namely semiconductors, quantum computing, AI platforms, with some arguing that other sectors should be added, such as some so-called green tech companies, presumably EV batteries, wind and solar.
“Republicans and Democrats can come together to solve big problems. We know Beijing is developing technologies…with dangerous implications for our national security. We know they are busy synergizing their civilian and military sectors to build up their defense industrial base. And here we are in the U.S. making their job even easier,” Meeks said.
No one on the Committee was against increasing outbound restrictions on U.S. investment into China. This included investments by Silicon Valley and New York private equity giants, many of which have offices in mainland China.
Pottinger said that the Biden Executive Order did not go far enough in blocking transactions. It used the language of “reviewing” them, which opens the door for stalling and for massive leakage of capital.
Moreover, Pottinger said the EO, or any pending legislation, needs to go one step further. “The rules should include existing venture capital and private equity investments, not just future ones, and seek to block investments rather than just review them after they’ve closed,” he said.
Peter Harrell, non-resident fellow of the Carnegie Endowment for International Peace, said venture capital has created a monster in China.
“Early U.S. venture capital investment into companies like ByteDance and SenseTime were absolutely essential in getting those companies to grow to where they are today,” Harrell said.
Harrell did not mention another company, drone maker DJI, which was funded as a start up by Sequoia Capital in Silicon Valley. DJI is on a Defense Department Entity List, meaning no defense contractor in the U.S. can buy DJI drones or contract them to make drones for the U.S. military. DJI drones can also be purchased by consumers on Amazon.
“When a VC company or the venture arm of a big company goes to China and invests, it is not just giving them money, it is probably doing some door opening to new customers, providing expertise on how to run the company effectively…it’s more than the cold hard cash,” Harrell said.
Rep. Brad Sherman (D-CA-30) talked about the Holding Foreign Companies Accountable Act, which became law in December 2022 and listed 174 Chinese companies, including solar giant Jinko, state owned oil firm PetroChina, Alibaba and China’s search engine Baidu, saying they had to comply with third party accounting rules. It is unclear if any of them have complied yet. If they do not, they are supposed to delist from the U.S. exchanges. Sherman talked about Chinese variable interest entities, which are holding companies that invest in actual companies in China, but list their shares in the U.S., meaning investors are investing in the holding company and not the company that the holding company holds. He wanted to ban those.
“There are two aspects to this story on capital markets in China. One is the question of whether China has enough capital to build its economy without us, and two: can a Chinese company get its hand on an idea, or a particular tech, regardless of these restrictions,” he asked. The answer, for the time being, was that China is at least somewhat reliant on U.S. capital flow as the world’s biggest investing country. And that yes, China is still getting its hands on technology under restriction. Worse yet, nothing is stopping U.S. private capital from Silicon Valley and New York City from investing in China’s new tech startups that are trying to build on industries being restricted by Washington – like semiconductors, for instance.
Sherman also mentioned the trade deficit as a funding mechanism.
“What’s not polite to mention is our enormous trade deficit with China,” Rep. Sherman said. “Decade after decade, they are gaining trillions of dollars in extra capital that they can deploy wherever they want. Why do they have this surplus? First, they can have tariffs against us. Second, they can tell their companies not to buy American stuff. China has higher tariffs on our goods than we have on their goods,” he said, highlighting the unsustainable, out of whack relationship that is the U.S. China commercial relationship.
“We have only one device,” he said about tariffs, “and even on that device they are using it better than we are.”
Sherman reminded the Committee about how China often has the upper hand.
A few years ago, American satellites were launched into space using China made rockets. “The insurance companies wanted better rocket technology for safety…so we gave that technology to them,” Sherman said. “Now they have better rockets. I commend HR 6349, but there is more to be done. I’m working on legislation so that every U.S. company has to disclose its China risk and tell their investors what they are doing to cover that risk in case of a problem,” he said. It was unclear if he was talking about every company or just publicly traded ones. “These companies have to start to de-risk from China. We also have to stop index funds from investing in all of China because this cannot be a paint by the numbers market. You have to pick the right companies,” he said, opposing some index companies’ current approach of just including companies of a certain market capitalization. “Companies that are sanctioned should be restricted from investments,” he said, and hinted that Chinese companies should not be on the receiving end of U.S. tax benefits.
“Yes, it is not a good idea to give tax incentives to our adversary,” Pottinger said.
“We need incentives that build the American economy, not the Chinese economy and its companies,” Sherman said.
Rep. Corey Mills (R-FL-7) said American companies can no longer treat Chinese companies as mere commercial partners like they would a Korean or Indian one.
“For far too long we have heard people talk about dealing with competition from China rather than just considering them an adversarial nation,” Mills said. “We have to understand that we cannot continue to help fund China’s growth. Outbound investment into China in critical sectors of their economy provides them with invaluable information, skills and innovation that is harmful to our economic interests,” he said. “We now know that there are obvious instances where U.S. capital has been instrumental in building up China’s advanced technological capabilities,” Mills said.