Investors in China Should See Russia’s Current Situation As a Warning

After waiting several decades and watching other multinationals profit from its huge market and manufacturing prowess, China has over the last few years finally started opening up its financial sector. High expectations among leading American financial firms such as Goldman Sachs and BlackRock have prompted a rush to expand into the country and its markets. Western investors are quickly making up for lost time.  

But Russia’s surprise invasion of Ukraine, and the shocking speed at which investors have fled Russian assets, shows the perils of investing in an authoritarian nation, especially one with active border disputes. China is not Russia. The former is far more integrated into the global economy and has a far larger market. But the Russian maelstrom has important lessons for investors in China, both as it relates to the war in Ukraine, and for how to manage the risk of a widespread decoupling brought on by growing tensions, and a major confrontation, including over any future Chinese invasion of Taiwan. 

First, it’s not just Russian assets that are at risk. Investors seeking to reduce their exposure to Russia are learning that they are exposed indirectly through stakes in global companies headquartered elsewhere. Companies such as AstraZeneca and Credit Suisse, which have maintained their operations in Russia, now pose a slightly higher partnership and investment risk than they would otherwise. Companies staying in Russia, in other words, might interact with sanctioned entities, a risk that is passed on to their partners or investors globally. This is doubly true for Chinese companies, who have had a much slower exit from Russian markets. Take China’s commodity traders, such as ​​state-owned Jidian International Trade, and material manufacturers, such as Xibao Metallurgy Materials Group. Many are rushing to take advantage of the withdrawal of Western firms, increasing their imports from or even investments in Russia despite the elevated risks this will bring. 

As regulatory scrutiny on China grows, either because of its relationship with Russia or because of its human rights violations or disputes with Taiwan, it won’t just impact Chinese companies, but U.S. and other global companies with high China exposure, such as Apple, Boeing, and Volkswagen.

Second, neither D.C. nor Moscow is likely to be sympathetic to the plight of companies caught aiding their adversary. Washington is unlikely to protect companies—say, by lenient interpretation of legislation—that are servicing Russia’s military, or aiding Moscow in monitoring dissent. The same will likely occur in a battle between Washington and Beijing. As tensions rise, expect more U.S. regulation that forces a reduction of exposure to repressive parts of the Chinese system. A good example is December’s Uyghur Forced Labor Prevention Act, which restricts imports from companies tied to Xinjiang. Beijing will act with similar goals in mind, but with less transparency and with a difference in method: It will pick one or two global companies in key sectors that it treats well, so it can (inaccurately) claim openness and fairness. Everyone else will have to swim harder as the tide goes out. 

Third, Russian President Vladimir Putin has shown disregard for Russia’s economic health. Chinese Chairman Xi Jinping is similarly unlikely to prioritize China’s economic interests over its military and political ones. Putin seems to be gambling that the long-term geopolitical gain of a subservient Ukraine overweighs short-term economic and diplomatic cost. Beijing has done so in the past and will likely do so again. In 2021, for example, Beijing opted to aggravate the country’s worst power shortage in a decade rather than end an import ban it had imposed on Australian coal in retaliation for Canberra’s call for an international investigation into the origins of Covid-19. Many factories temporarily closed, hurting growth for several months. Given the Chinese Communist Party’s long-term focus on forcing the reunification of Taiwan with the mainland, Beijing will likely accept far greater economic and political costs to secure its interests there.

The Russian invasion has incited a debate about environmental, social, and governance standards. Can investors sit on the sidelines as defense stocks—often excluded from ESG portfolios—continue to rise? And what about the increased reliance on polluting coal sparked by forsaking Russian oil and gas? But what’s missing from the Russia ESG debate is missing from the China ESG debate as well: country of origin needs to be an important consideration for ESG metrics, especially as it relates to issues of social performance and especially governance. Because Russian (and Chinese) laws permit less transparency, and because they must heed both the written and unwritten rules of authoritarian states, they deserve far more scrutiny before belonging in an ESG portfolio. Investors are waking up to the fact for Russia. It’s time they do so for China too. 

By Isaac Stone Fish and Seth Kaplan Via