Addressing the Threat From Securities Investments That Finance Communist Chinese Military Companies

Overview

Context and Intent

Executive Order 13959, signed by President Donald Trump on November 12, 2020, aims to curb U.S. investments in Chinese firms that are deemed to support China's military, intelligence, and security developments. The order specifically targets companies classified as "Communist Chinese military companies," asserting that these entities, while presenting themselves as private businesses, directly contribute to the PRC’s military advancements through a national strategy known as Military-Civil Fusion. By restricting investments in these companies, the EO aims to mitigate the risk of U.S. capital inadvertently aiding China’s military-industrial complex in ways that could undermine U.S. national security and foreign policy interests.

Restrictions and Prohibitions

The EO prohibits any U.S. person from engaging in transactions involving publicly traded securities of companies identified as Communist Chinese military companies, effective January 11, 2021. It extends these prohibitions to securities that are derivatives of, or are designed to provide investment exposure to, these companies. Furthermore, the order allows for a divestment period during which U.S. persons can offload these securities to comply with the regulations without financial penalty.

Rationale and Emergency Declaration

The order cites the increasing exploitation of U.S. capital markets by the PRC as a means to further military capabilities that pose direct threats to the U.S. and its allies. By declaring a national emergency, the EO leverages the International Emergency Economic Powers Act (IEEPA) to justify its provisions. This move underscores the administration's intent to address what it perceives as an urgent and significant risk emanating from these financial interactions.

Legal and Policy Implications

Use of IEEPA and National Emergencies Act

Executive Order 13959 is grounded in the authority granted by the International Emergency Economic Powers Act (IEEPA) and the National Emergencies Act. By invoking these acts, the order underscores the perceived severity and immediacy of the threat posed by Chinese military-linked firms accessing U.S. capital. The use of IEEPA allows the President to regulate economic transactions in response to a national emergency that has foreign dimensions, reflecting a broader trend of leveraging economic sanctions as a tool of statecraft.

Expansion of Executive Power

This order represents a significant exercise of executive power by broadly defining what constitutes a threat to national security and authorizing the Secretary of the Treasury to enforce and expand upon the order's provisions. It grants powers to determine and list entities as Communist Chinese military companies, effectively barring them from accessing U.S. capital markets. This approach highlights an evolving paradigm where economic measures are increasingly intertwined with national security considerations.

Impact on Existing Regulations

The EO interacts with and potentially complicates existing securities and financial regulations. By introducing new compliance requirements for investors and companies, it has implications for how financial institutions manage their portfolios and assess risks associated with international investments. The order sets a precedent for further regulatory interventions where national security is cited as a primary concern, significantly affecting cross-border financial flows and investment strategies.

Who Benefits

U.S. Defense and National Security

The primary beneficiaries of the order's enforcement are likely U.S. defense and national security agencies, which could see a strategic advantage through the reduction of financial flows that might support the modernization of a potential adversary’s military capabilities. By curtailing capital investments in Chinese military-linked companies, the U.S. aims to limit a key resource that facilitates the advancement of technologies that may be used against American interests globally.

Domestic Financial Institutions

U.S.-based financial institutions may benefit in the long run from a clearer regulatory environment and reduced risk exposure to companies intertwined with foreign military programs. This order might drive a restructuring of portfolios to focus on investments considered to be more aligned with U.S. strategic interests, potentially promoting new avenues for growth in industries deemed crucial to national security.

Allied Nations

Allied countries that share similar security concerns about China’s military-civil fusion strategy may also benefit indirectly from the EO. The U.S.'s leadership in setting such economic precedents might encourage similar actions from other nations, thereby strengthening collective security postures against what is perceived as a common threat. This alignment could enhance diplomatic and economic ties among allied nations.

Domestic Companies Opposing China's Military Objectives

U.S. companies that compete globally with Chinese firms labeled as Communist Chinese military companies may find themselves at a competitive advantage. With the Chinese firms' access to U.S. capital constrained, domestic companies might better position themselves in markets where these adversarial firms face capital shortfalls and operational restrictions induced by the EO.

Who Suffers

U.S. Investors and Financial Firms

One significant group negatively impacted by the EO consists of U.S. investors and financial institutions holding securities in the affected Chinese companies. They face potential losses tied to the divestment from these securities, compounded by possible disruptions and adjustments required to ensure compliance with the order.

Chinese Companies and Markets

Chinese companies categorized under the EO as part of the PRC's military-industrial complex encounter immediate and potentially profound financial obstacles. Restricted access to U.S. capital markets could impede their ability to raise funds necessary for growth and modernization, thereby challenging their operational capacities and strategic ambitions.

Global Financial Integration

Beyond direct stakeholders, the EO may chill broader global financial integration. The heightened focus on national security within financial markets invites increased scrutiny of cross-border investments with potential bilateral tensions influencing market dynamics, potentially fostering an environment less conducive to free international capital movement.

Historical Context

Broader U.S. China Policy

Executive Order 13959 fits within a broader shift towards a more assertive U.S. stance on China, reflecting longstanding tensions over trade, technology, and military issues. It echoes the administration's emphasis on confronting Chinese policies that are perceived to undermine U.S. economic and security interests, an objective that has gathered bipartisan support though often differing in methods and intensity.

Precedent in Economic Sanctions

This EO continues a presidential tradition of using economic sanctions as a means of pressure in international relations. Previous administrations have deployed similar strategies to address concerns with other nations, including Iran and North Korea, demonstrating the growing propensity for economic measures to serve as an instrument of national and foreign policy.

Geopolitical Implications

The executive order underlines the geopolitical competition between the United States and China, particularly in the realm of technological and military supremacy. As the U.S. seeks to counteract Chinese influence, this EO plays into broader strategies that aim to limit China's rise as a competing superpower with equal capabilities in critical domains.

Shifts in U.S. Economic Policy

The approach exemplifies a shift from a globalized economic stance towards more protectionist policies focused on national security. This reflects a growing trend within U.S. economic policy to prioritize strategic concerns over global commitments, reshaping international trade and investment practices with potential long-term implications for globalization.

Reaction of Financial Markets and Foreign Policy

In financial and policy circles, the EO is part of a set of measures that signal an increased volatility in U.S.-China economic relations. The financial markets may interpret such actions as indicators of bigger geopolitical shifts, potentially reshaping expectations around bilateral trade agreements, economic cooperation, and collaborative global governance frameworks.

Potential Controversies or Challenges

Legal Challenges and Interpretations

The broad interpretation of what constitutes a Communist Chinese military company presents potential legal challenges. Companies—and potentially affected nations—may contest the criteria used for designation, emphasizing compliance with international norms and rights for transparent and fair treatment within global marketplaces.

Congressional Responses

The executive order could spark debates in Congress, with some members possibly questioning the breadth of executive power in matters implicating international trade and financial markets. While there is definitive bipartisan concern over China's economic and military strategies, consensus on methods of addressing these issues varies, which could lead to legislative proposals either supporting or challenging the EO's objectives.

Implementation Concerns

Operationalizing the order presents practical challenges for financial institutions tasked with ensuring compliance. Identifying which securities qualify as derivatives or indirect investments in prohibited firms necessitates the development of new compliance frameworks and monitoring systems, which might impose additional burdens on financial ecosystem stakeholders.

International Backlash

Countries aligned with China might perceive the EO as an act of economic aggression, potentially triggering retaliatory measures affecting American assets or interests abroad. Such consequences could strain diplomatic relationships and yield economic ramifications, igniting broader international debates over the role and reach of unilateral financial sanctions.

Technical and Logistical Issues

The execution of the EO also entails substantial technical and logistical considerations. Financial entities must enhance their capabilities to swiftly identify and handle the affected securities, requiring significant updates to compliance systems and processes. These adaptations could entail considerable time and financial resources, diverting attention from other priority financial tasks.