Seemingly private technology companies lead China’s military modernization efforts. Not surprisingly, the national security community and the American public are suspicious of them, but Wall Street continues to finance them.
Wall Street provides Chinese firms with access to American markets and capital through initial public offerings (IPOs) and listings on major indices. Through an IPO, Chinese companies receive money directly from U.S. financial institutions, which then sell those shares to the public. A major index listing typically increases demand for a company’s security, diversifies the investor pool, and reduces price volatility – all positive indicators when financing business operations and expansion. In either case, this access has earned financiers a role in today’s geopolitical competition.
The previous administration took aim at this access and China’s military modernization with an executive order that sought to limit American investment in “Communist Chinese military companies” (CCMC). The order empowers the Defense Department to identify such firms that contribute to the modern arms race. Many alleged CCMC’s are private firms that develop technologies ranging from artificial intelligence to 5G network infrastructure. Despite the order’s efforts, it faces both implementation headwinds and fails to meaningfully restrict access to capital.
President Biden’s team has the opportunity to develop an approach, rather than a one-off measure, to affect the ongoing technology race as an element of strategic competition. Given the dual-use potential and financing of these technologies, the United States must take a multilateral approach. The administration should lay out clear standards for assessing a company’s alleged links to the Chinese military as well as address the globalized nature of financial markets.
An Arms Race with Tech Characteristics
Today’s “arms race” spans multiple industries and produces civilian and military-use technologies. Unlike nuclear weapon development, which drove the arms race with the Soviet Union, the ecosystem for modern technology is financed by governments and both domestic and international investors. As a result, commercial data producers and consumers, hardware and sensor manufacturers, and software developers each have the potential to contribute to military modernization.
According to U.S. national security analysts, this entanglement is problematic because Chinese technology companies are alleged to be part of the CCP’s military modernization strategy which aims to remove “barriers between China’s civilian research and commercial sectors, and its military and defense industrial sectors.”
Given the close ties between these civilian corporations, national security, and financial markets, growing legalization of the problem set has emerged. Courtrooms, not embassies, are becoming the fora for resolution. Xiaomi, a smartphone manufacturer and alleged CCMC, highlights this struggle.
Xiaomi brought a suit against the Defense Department, alleging that it exceeded its authority under the order. The U.S. government argued that Xiaomi had been investing in 5G and AI, technologies the Defense Department noted are “essential to modern military operations.” Additionally, Xiaomi’s founder and CEO was awarded the title of “Outstanding Builder of Socialism with Chinese Characteristics.”
These arguments fell short in U.S. District Court. The Court noted that 5G and AI investments were standard industry practices and the potential for military applications is not enough for a CCMC designation. Furthermore, the title had been awarded to over 500 entrepreneurs, including those in industries that would implausibly be considered part of military-civil fusion.
The Court granted a preliminary injunction, preventing Defense from designating Xiaomi as a CCMC, which effectively prohibits the Executive Order from being enforced against the company – at least until the case is settled.
Wall Street Sees Green in Red China
The rise of robo-advisors, retail investment services, and passive investing has provided individual investors with unparalleled market access. In an effort to remain relevant, financial services companies seek opportunities to “beat the market”. In the past, access to untapped and growing markets drove these sought-after returns.
Enter China. Its growing middle class, rise of private-sector companies in the emerging technology space, and national shift to market-financing has made China the new frontier for Wall Street managers.
iFlyTek, Hikvision, and Dahua are examples of Chinese companies that accessed U.S. capital to develop technologies with national security implications. iFlyTek is a partially state-owned speech recognition company that is “generating huge amounts of proprietary data—the essential ingredient for improving AI and machine-learning algorithms.”
Hikvision is a sensor hardware company specializing in camera manufacturing. And Dahua Technology not only produces surveillance products, but also operates business lines that integrate data, hardware, and algorithms to produce machine learning systems. Previously, each of these companies had been able to access U.S. capital through its listing in the Morgan Stanley Capital International (MSCI) Emerging Markets Index.
Others are directly listed on the New York Stock Exchange (NYSE), where American investors trade securities in a specific company. Notable examples include China Mobile, China Unicom Hong Kong and China Telecom, all part of the oft-vilified Chinese telecom industry. These telecom companies are building 5G networks, whose speed and reliability, offer the network infrastructure necessary to support the autonomous systems under development.
The NYSE ultimately delisted the three aforementioned telecom companies after some initial flip-flopping. However, this decision-making process, combined with the Xiaomi case, has revealed the competing interests and challenge of regulating dual-use technologies.
Ban-ding Together
The irony is that the Executive Order fails precisely because of the qualities that are fundamental to the U.S.-led rules-based financial order. Solo hardball tactics fail in a globalized marketplace because if one market refuses to play, others will. In other words, China’s technology companies are still able to pursue funding through capital markets – located in London, Hong Kong, and elsewhere – because the United States has sponsored a financial system that values broad access.
Companies with public securities can access global investors in two ways. One, they can be listed on multiple stock exchanges, much like China Telecom in Hong Kong (HKEX) and the NYSE before the latter delisted it. Two, they can utilize global depository receipts (GDRs). A GDR is a certificate issued by a financial institution and represents an interest in a foreign company. The bank holds the underlying foreign security, and the GDR may be bought and sold much like a stock. A company may prefer this because GDR’s increase their global visibility and internationalize their investor base without meeting more stringent listing requirements.
Xiaomi, the smartphone manufacturer mentioned above, trades its stock in the HKEX, but also has ADRs – a U.S.-only GDR equivalent. It bears repeating that even if these suspected CCMCs are effectively foreclosed from operating in U.S. markets – whether they be dual-listed or utilizing GDRs – foreign markets and traders are outside the Executive Order’s reach and still offer opportunities to acquire capital.
For the Biden Administration to limit alleged CCMC’s access to capital, improving the process for designating CCMCs will help avoid challenges in the courtroom and provide a stronger case for allies to cooperate. In the original order, President Trump defined CCMC’s in the context of American national security under broad authority. However, this approach may prove to be too vague and risks failure in U.S. courts. It also likely falls flat with Western and Pacific partners who are still balancing their interests between Washington and Beijing.
A potential path forward is to tie alleged CCMCs to objectionable Chinese conduct. For example, technology developments have been used against the Muslim-minority Uighur population in Xinjian. To date, the U.S., U.K., Canada, and E.U. have imposed sanctions against officials in response to the human rights abuses occurring in the region. In addition to targeting individuals, the United States could spearhead support among Western allies to restrict capital market access to companies whose technologies facilitate these abuses.
Sovereignty concerns are another potential point of interest to organize multilateral support. These include companies that expand China’s sphere of influence on the India-China border or in the South China Sea. Publicly traded construction and infrastructure firms, such as those included in the original CCMC list, could be held accountable for violating international agreements, such as the Law of the Sea. These interests may align best with the emerging “Quad” partnership in the Pacific.
America’s security interests are uniquely tied to shared values and commitment to a rules-based order. Fundamentally, this requires cooperation and multilateralism. Restricting CCMC access to Wall Street without complementary action from other governments with international market power – and aligned interests – moves the United States to the outside of the system it created.
Biden’s Burden
On the surface, limiting Chinese firms with military relationships access to U.S. capital markets makes sense. But action that unilaterally moves to decouple American markets from China’s as the latter “opens up” to international markets risks contributing to rising spheres of financial influence.
Identifying and counteracting CCMC access to American capital markets plays a small part in the technology element of strategic competition between Washington and Beijing. It uniquely highlights, however, both the role of global financial markets and the need to build coalitions as the United States competes with a growing China.
Johnathan Falcone is a naval officer and previously worked as a financial analyst at an investment bank. He is a graduate of the Princeton School of Public and International Affairs and Yale University.
Patrick McDonnell is a JD / MPA candidate at Harvard Law School and the Princeton School of Public and International Affairs and an Army reservist. Previously he spent five years as an Army intelligence officer with deployments to Europe and Afghanistan.
The authors’ opinions are their own, and do not reflect the official stance of their current or former employers or organizations.
