China ETFs Could Look Different as the U.S. Blacklists Military Companies

Index providers and exchange traded fund issuers that track Chinese markets will have to trim some China state-owned holdings after the U.S. restricted investments in companies backed by Beijing.

Late Friday, FTSE Russell announced the removal eight Chinese companies from its FTSE Global Equity Index Series, the FTSE China A Inclusion Indexes, and other associated benchmarks by Dec. 21, the Wall Street Journal reports.

FTSE Russell said it would drop companies, including Hangzhou Hikvision, China Railway Construction Corp, and China Spacesat.

The actions are in response to President Donald Trump’s signed executive order barring Americans from investing in Chinese companies that the U.S. Defense Department says supply and otherwise support China’s military, intelligence, and security services.

Rival index provider MSCI Inc previously stated its products would “reflect any necessary changes” depending on U.S. law.

All companies come from a list of “Communist Chinese Military Companies” compiled by the Pentagon, which include China Communications Construction Co Ltd, China Nuclear Engineering & Construction Corp Ltd, CRRC Corp Ltd, Dawning Information Industry Co Ltd, and China National Chemical Engineering Co Ltd.

Hong Kong-listed shares of China Communications Construction Co. and China Railway Construction Corp. both exceeded decline for the city’s Hang Seng Index after the announcement.

“We would expect all index providers to ultimately remove some Chinese securities in an effort to comply with the U.S. restrictions,” Todd Rosenbluth, head of ETF and mutual fund research for CFRA, told Reuters, adding that the actions seem to have limited impact on most U.S. investors since few large Chinese companies have been restricted so far.

These index changes will affect index-based ETFs, notably those tracking China A-shares markets, such as the Xtrackers CSI 300 China A-Shares ETF (NYSEArca: ASHR), one of the most popular ETFs that tracks mainland Chinese markets. ASHR targets the 300 largest and most liquid stocks in the China A-shares market that trade on the China Securities 300 Index.

The question will be how deep the restrictions will go. If it’s just a few names, it will send a message, but not cause major market damage. It remains to be seen whether or not the incoming Joe Biden administration will expand on these restrictions, or even maintain them going forward.

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