BLACKROCK, MSCI and other firms are bracing for tighter oversight following a congressional probe over investments in Chinese companies deemed to be national security threats and an executive order curtailing specific investments there.

More than 2,000 US mutual and exchange-traded funds (ETFs) – particularly those tracking indexes – have US$294 billion invested across Chinese stocks and bonds, according to data compiled by Bloomberg, though not all of that money is invested in companies facing lawmakers’ scrutiny.

Vanguard Group, BlackRock, Fidelity Investments and DWS Group manage funds with investments in China, some of which are the type that Congress is investigating.

The Biden administration last Wednesday (Aug 9) signed an executive order limiting US investments in China in key technology industries. Separately, on Jul 31, the House Select Committee on the Chinese Communist Party alleged BlackRock funds are investing in Chinese companies acting against US interests, demanding the asset manager hand over documents about the inclusion of Chinese firms in its funds.

The ties between the two countries’ businesses “haven’t frayed as much as a lot in Washington would like”, Martin Chorzempa, senior fellow at the Peterson Institute for International Economics, said in a phone interview. Certain lawmakers “would like to push for more of a decoupling”.

Last week’s order was narrower than expected, frustrating lawmakers who are pressing for tougher curbs on money flowing to Chinese firms. While the order applies mainly to private equity and venture capital firms, Congress may use the mandate as a springboard to grill money managers about investments in China.

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The order is “a baseline that will likely be ratcheted up over time, particularly in terms of covered technology sectors”, Laura Black, senior counsel at Akin Gump Strauss Hauer & Feld law firm, said.

‘Bigger problem’

The Biden order restricted investments in semiconductor, quantum computing and artificial intelligence firms, and was narrowed during almost two years of deliberations to a more cautious approach. The order, which will likely take effect next year, may end up excluding passive investments as well as those in publicly traded securities, index funds and other assets.

US Representative Mike Gallagher – a Wisconsin Republican and chairman of the House select committee on China – said in an e-mail that he and his colleagues are focusing on publicly listed stocks, bonds and ETFs tied to China.

“But the executive order doesn’t touch those,” Gallagher said. “If we want to stop American money funding military contractors and human rights abusers in the PRC (People’s Republic of China), then Congress needs to step up and wrestle with this much bigger problem.”

Gallagher and his committee have homed in on BlackRock, the world’s largest money manager, and MSCI, one of the country’s biggest index providers.

The select committee on China alleges BlackRock has five funds with more than US$429 million invested in Chinese companies acting against US interests.

The funds had investments in 20 companies tied to one or more of the government’s watch lists, according to the committee.

BlackRock declined to comment, and pointed to an earlier statement that it would respond to the House committee and that it complies with applicable US laws. MSCI said it’s “engaging constructively” with the House committee, and that it doesn’t manage, recommend or facilitate investments in any country.

As the world’s largest money manager, BlackRock was more likely to get the spotlight at the beginning of this investigation, according to Todd Rosenbluth, head of research at ETF data and analytics company VettaFi.

“BlackRock is one of many asset managers that provide exposure to emerging markets and the Chinese market specifically,” Rosenbluth said. “If this is something for Congress to be concerned about, it is not coming from one index provider and one asset manager – it is a broader industrywide event.”

In the past few years, the US government has ramped up oversight of investments in China, spawning a range of government watch lists that asset managers have to navigate.

The Defense Department keeps a list identifying Chinese military companies, while the Department of Homeland Security tracks Chinese companies that use forced labour.

A third list, managed by the US Treasury, restricts the purchase or sale of securities in certain Chinese military-industrial companies while also allowing money managers and US investors to maintain current holdings in those firms. The Treasury Department says the list doesn’t apply to all of a company’s subsidiaries or related entities.

US mutual funds and ETFs have many holdings in securities related to firms on different US government lists because of the different levels of restriction.

The US$73 billion Vanguard FTSE Emerging Markets ETF, for example, has almost a third of its assets allocated to China and has shares of CGN Power and Inspur Electronic Information Industry, according to Bloomberg data as at Jul 31. These two specific entities aren’t on the Treasury list; China General Nuclear Power Corporation, which Treasury says is known as CGN, and Inspur Group do appear on the list.

DWS Group’s US$2.2 billion Xtrackers Harvest CSI 300 China A-Shares ETF has about US$8 million in shares of China CSSC Holdings, according to the Bloomberg data. That entity isn’t on Treasury’s list, while China State Shipbuilding Corporation, which Treasury says is known as CSSC, is on the list.

It could get even more complicated to invest in China.

US Senators John Cornyn, a Texas Republican, and Bob Casey, a Pennsylvania Democrat, have led the effort to attach a provision to US national defence legislation requiring greater notification about US investments in China. The measure passed the Senate with broad bipartisan support.

“We’re complying with applicable US regulations and closely watching developments,” Kenny Juarez, an Xtrackers spokesperson, said in an e-mail.

Vanguard is in full compliance with the Treasury list, the company said in a statement. Fidelity declined to comment. BLOOMBERG