President Donald Trump and the U.S. Labor Department on Monday directed a board charged with overseeing billions in federal retirement dollars to halt plans to invest in Chinese companies.
Labor Secretary Eugene Scalia warned the Federal Retirement Thrift Investment Board that its current plan to invest federal savings would place "billions of dollars in retirement savings in risky companies that pose a threat to U.S. national security."
The international index that the Thrift Savings Plan is set to start tracking later this year is called the MSCI ACWI ex USA IMI, which includes equities in a broad range of developed and emerging markets, including China.
"At the direction of President Trump, the Board is to immediately halt all steps associated with investing the I Fund according to the MSCI ACWI ex USA IMI, and to reverse its decision to invest Plan assets on the basis of that international equities index," according to a copy of the letter seen by CNBC.
At issue is the management of the TSP, a retirement savings fund for federal employees and members of the military. A federal investment fund within the TSP called the I Fund, which offers federal employees exposure to international stock markets, held about $41 billion in assets out of a total of $557 billion in the TSP as of the end of March.
"There's a lot of focus on this issue from a national security standpoint, but the investor protection angle is equally important. China is an international outlier in not permitting U.S. regulators to access the audits of its companies listed on U.S. exchanges, which puts our investors at risk," wrote Clete Willems, a former trade advisor to the Trump White House and a partner at Akin Gump.
The Labor secretary, who cited bipartisan calls to restrict U.S. investment in Chinese stocks, wrote that the president is opposed to the board's 2017 decision to allow its international fund to track an index that includes China-based stocks based on national security and investor risk concerns.
"The attached letter, which is authorized by the President's principal economic and national security advisors, establishes that linking the I Fund to the MSCI ACWI ex USA IMI would place millions of federal employees in the untenable position of choosing between forgoing any investment in international equities, or placing billions of dollars in retirement savings in risky companies that pose a threat to U.S. national security," he added.
The supporting letter, which was not seen by CNBC, was penned by National Economic Council Director Larry Kudlow and national security advisor Robert O'Brien, who expressed "grave concerns with the planned investment on grounds of both investment risk and national security."
"Messrs. Kudlow and O'Brien also explain that some of the Chinese companies in which the TSP will invest 'present significant national security and humanitarian concerns for the United States, which increases the risk that they could be subject to sanctions, public protests, trade restrictions, boycotts, and other punitive measures that jeopardize their profitability,'" Scalia wrote.
The directive from the West Wing comes three years after the board in charge of the federal savings decided to switch to the China-inclusive fund during the second half of 2020 in an effort to boost returns. But a bipartisan coalition, which first began among China hawks, has pushed back on the decision both as a matter of national security and as a means to protect American investors from underhanded disclosure practices in China.
Senators including Florida Republican Marco Rubio and New Hampshire Democrat Jeanne Shaheen have led the outcry.
Rubio said in a November statement that "a bipartisan, bicameral coalition in Congress will not sit on the sidelines and allow the TSP Board to funnel the federal retirement savings of U.S. service members and federal employees to the Chinese Communist Party."
"America's investors should never be a source of wealth funding Beijing's rise at the expense of our nation's future prosperity, and the TSP Board should not force U.S. service members and federal employees to unwittingly undermine the American national security interests that they work hard every day to protect," he added at the time.
Rubio and allies assert that U.S. federal pension dollars should not back companies like Aviation Industry Corp. of China, which supplies China's military.
They also allege that China's financial disclosure requirements and audit policies are lackluster and allow companies like China-based Luckin Coffee, now known across Wall Street to have cooked its sales figures, to trick American investors hoping to ride a hot stock.
Carson Block, a longtime short seller who announced a short position against Luckin before the widespread fraud findings, spoke highly of Scalia's move. Luckin announced Tuesday that its board has fired its CEO and COO in light of the fraud.
"There are various grave problems with listings from China. While this isn't close to substantively addressing them, it's a step in the right direction," Block, founder of Muddy Waters Research, told CNBC. Though American investors have long warned about what they see as shoddy disclosure requirements in China, some found hope in an announcement from the Securities and Exchange Commission in late April.
SEC Chairman Jay Clayton warned on April 21 that Chinese companies' disclosures continue to disappoint American regulators and that all investors should be especially careful when considering an investment in such a stock. Others, such as Akin Gump attorney Willems, said they wish the SEC would advance the conversation further.
"I'd really like to see the SEC ramp up its engagement on this issue," he wrote. "It should keep pressuring China to change its behavior and should use its upcoming roundtable with stakeholders on emerging market issues to provide much-needed guidance."
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