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US investors sceptical of ESG, Hindenburg targets Loop, EU rises as green leader 



One thing to start — last week the Global Reporting Initiative announced that its chief executive Tim Mohin was stepping down. All eyes in the environmental, social and governance space will be watching for his replacement, as the company plays a key role in the push to clean up the alphabet soup of disclosure standards.

Today we have:

  • US perception of ESG performance lags behind Europe

  • Short-seller targets recycling company

  • EU sets pace for global sustainability regulation

  • Asset owner giants plot decarbonisation pathway

  • University of Tokyo enters sustainable bond market

A continental divide on ESG performance

It is a truth universally acknowledged among sustainability converts, to paraphrase Jane Austen, that investing in ESG can produce decent returns. Indeed, during the recent months of the Covid-19 shock, there have been a host of studies showing that ESG has performed as well, if not better, than non-ESG investments. That is partly due to the avoidance of fossil fuels but also because any company that tries to meet ESG standards is forced to do a full-blown audit of their supply chains and internal processes, which helps boost resilience.

But are ESG enthusiasts so excited about these findings that they have failed to spot that others outside their bubble see things differently? It is a point worth pondering given the findings of a recent survey from RBC Global Asset Management, to be released this morning. This poll of 800 institutional asset owners, consultants and managers shows that in most parts of the world the Covid-19 crisis has left financiers with an increased faith that ESG improves returns. Apparently, 97.5 per cent of investors think this in Canada, up from 90 per cent last year, while in Europe the figure is at 96 per cent (up from 92 per cent) and in Asia it is 93 per cent (up from 78 per cent).

The outlier, though, is America: just 74 per cent of US investors think ESG improves performance, which is down from 78 per cent the previous year — and 24 per cent think it harms performance. It is not entirely clear why that gap exists. It may reflect Republican politics, which have been sceptical about environmental issues. It may also stem from the mistrust of ESG which seems to be afoot at the Securities and Exchange Commission, or the fact that the Department of Labor seems to have defined fiduciary duty in a way that is not very ESG-supportive either. “When it comes to ESG, Europe is way ahead of the US,” Carmine di Sibio, head of professional services group EY, told a Milken Institute conference yesterday. “The sustainability issue became a very political issue starting 10 years ago in the US — views are different depending on what party is in office.”

Either way, the finding should give ESG activists pause for thought. “This is an area which should be driven by facts and not ideology and emotion,” points out Roger Ferguson, head of TIAA. Quite so. But, in the meantime, investors should ask another question: how might sentiment and market pricing change if Joe Biden wins the election — and policy suddenly changes? (Gillian Tett)

Short-seller report sends shares in plastic recycler plummeting


Hindenburg Research, the short-seller that made headlines alleging that electric truck start-up Nikola was an “intricate fraud”, is coming after another ESG company. This time it has issued a scathing report on Loop Industries, a Canadian plastics recycler, alleging that the company’s technology is “fiction.”

On its website, Loop claims to be able to recycle plastic from sources that would typically be considered garbage, including “plastic bottles and packaging, carpets and polyester textiles of any colour, transparency or condition and even ocean plastics that have been degraded by the sun and salt”.

Hindenburg, which makes money by betting against share prices, said Loop’s claims were “technically and industrially impossible”.

Loop responded that Hindenburg’s claims were “unfounded, incorrect, or based on the first iteration of Loop’s technology”.

However, the company has never reported any revenue. And despite striking numerous high-profile partnerships with companies such as Coca-Cola, it has not yet delivered the recycled plastic it said it would.

If Loop’s technology does not work, as Hindenburg alleges, it will be another blow to the struggling plastic recycling sector. As NPR reported last month, much of the plastic waste separated out to be recycled in the US is just thrown away.

Loop’s share price plummeted after the announcement, which should serve as a warning to ESG investors who do not want to see their portfolios end up in a landfill (like an unrecycled plastic bottle, one might say). But companies making public sustainability pledges should also take note — especially if their plans hinge on technology that has not yet been proven to work. (Billy Nauman)

$5tn investor group shows mettle with decarbonisation goals

© AFP/Getty Images

Thirty of the world’s largest investors have unveiled details of how they intend to strip damaging carbon emissions from their portfolios by 2050, setting ambitious interim targets that, if delivered on, would have ripple effects across the economy.

The UN-convened Net-Zero Asset Owner Alliance, which comprises investors overseeing $5tn in assets under management, pledged this week to reduce emissions linked to their portfolios by between 16 per cent and 29 per cent by 2025.

The target is the first interim milestone set by the investors since they came together last year with the aim of using their collective heft to push the companies they own to reduce their overall emissions to zero.

Coalition members, which include German insurer Allianz, the largest US pension fund Calpers and France’s Caisse des Dépôts Group, will set individual five-year objectives early next year. The extent of the cuts will depend on the progress that investors have already made in decarbonising their portfolios.

To achieve these goals, the investors, whose focus is on lobbying for change at polluting companies rather than divesting, have committed to engaging with the top 20 emitters in their portfolios or those responsible for the majority of carbon emissions.

Allianz’s chief investment officer Günther Thallinger, who chairs the coalition’s steering committee, said the group would draw inspiration from Climate Action 100+, the $47tn investor group that has succeeded in pushing groups such as Royal Dutch Shell to set carbon reduction targets, applying its tactics to a broader set of companies.

Mr Thallinger said the fact that the investors were bound to concrete decarbonisation targets would give them added leverage in pressuring companies to change. “We are not just sending a letter and asking for change,” he said. “We need these changes to meet our objectives. That gives us a certain credibility.” (Siobhan Riding)

EU green leadership ripples through finance

The EU is securing its status as the global leader for green investments and regulations — and its efforts have global banks scrambling to identify winning and losing companies.

Today, the European Commission is unveiling the latest piece of the European Green Deal, which was announced in December and remains a key priority for president Ursula von der Leyen amid the Covid-19 pandemic. Wednesday’s report aims to reduce methane emissions (though it remains unclear how rigorous the plan will be in cutting methane).

Other parts of the EU’s multi-faceted Green Deal programme have tantalised investors. The clean hydrogen provisions, for example, benefit UK conglomerate Johnson Matthey, said Morgan Stanley analysts in an October 13 report.

“The announcement of the EU Green Deal shows political willingness to move away from fossil fuels,” Bank of America analysts said in a September report. “This could ultimately end a chicken-and-egg problem whereby prohibitive costs have deterred investments in hydrogen which, in turn, prevented the realisation of economies of scale.” 

On Tuesday, ArcelorMittal announced a host of green steel projects, including large-scale green hydrogen production in Germany to be deployed in a blast furnace.

The US elections next month might help accelerate America’s sustainable investing development (see the Morgan Stanley survey responses below). But for now, Europe is leading the way.

Q: Which of these is going to be most impactful for sustainable investing over the next 12 months?

“I expect that after five years there will be a lot of countries across the world who are following us,” Kadri Simson, the EU’s top energy official, said in a recent FT interview. “This is not just about climate, but about competitiveness.”

(Patrick Temple-West)

Tips from Tamami

Nikkei’s Tamami Shimizuishi keeps an eye on Asia to help you stay up to date on stories you may have missed from the eastern hemisphere.

The growing popularity of social bonds has reached the ivory tower in Asia. The University of Tokyo will become the first national university in Japan to issue social bonds on October 16.

The money raised will be earmarked to fund research for the university’s Future Society Initiative, which aims to contribute to the UN’s Sustainable Development Goals. In particular, the bonds are going to help Japan’s top university to promote global strategies for the post-Covid-19 world.

The University of Tokyo has promised to disclose the usage and impact of the money once a year.

With solid ratings by notable investment agencies, the 40-year debts have been flying off the shelves. Investor demand was six times bigger than the original offer size of ¥20bn ($190m), according to lead underwriter Daiwa Securities. Investors include Nippon Life Insurance, technology company NEC and Japan Women’s University.

“Our brief [stating] that the university can work with capital markets while leading social change is well received by investors,” said Makoto Gonokami, University of Tokyo’s president. He added: “I want other universities to follow.”

While the university has historically enjoyed the top spot in Japan, it is only ranked 36th among global peers in the World University Rankings, behind those in China and Singapore. So becoming competitive academically and financially is very important for the university — and for Japan, too.

In June, the country relaxed rules to allow national universities to tap the bond market to finance research and projects. As government funding declines, other educational institutions in Japan are likely to follow the University of Tokyo’s lead, creating new kinds of investment opportunities for ESG investors.

Chart of the day

Companies communicate honestly about sustainability performance

Citizens’ trust in companies’ sustainability disclosures has increased, but there are significant differences from country to country, according to a report from GRI, a disclosure adviser, and GlobeScan, a consultant. Their survey asked 1,000 people to indicate whether they agree that companies are honest and truthful about their social and environmental performance. Respondents in Asia were most favourable, while those in Europe and the US were a bit more sceptical.

Smart reads

  • JPMorgan Chase, known in its earlier incarnation as the “Rockefeller Bank”, is facing pressure from three fifth-generation members of the Rockefeller family to stop fossil fuel financing. The trio’s comments in the New York Times came days after JPMorgan pledged to shift its portfolio away from fossil fuels.

  • Please check out our special report on impact investing, which includes Gillian Tett’s analysis on the number-crunchers leading the charge to get corporate boards up to speed with ESG. “The direction of travel is clear: finally, more accounting firepower is emerging in the world of impact investing, ESG and sustainability.”

Further reading

  • Boohoo ditches another Leicester supplier ‘in light of’ BBC probe (FT)

  • Companies tread a fine line on executive pay (FT)

  • Black Lives Matter provokes change on Wall Street (FT)

  • Why start-ups are more likely to dodge greenwashing label (FT)

  • The legacy of slavery made my grandmother fear investing (Washington Post)

  • The Short Tenure and Abrupt Ouster of Banking’s Sole Black C.E.O. (NYT)

  • Crunch Time: Global Standard Setters Set The Scene For Comprehensive Corporate Reporting (Forbes)

  • Investor rebellion at Procter & Gamble over environmental concerns (FT)

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What’s in a name? DWS eyes ESG refresh for funds




Hello from New York, where I am hoping you are looking forward to some rest and relaxation this month. While it might be fun-and-games time for some of us, Deloitte’s employees are headed to school — climate school.

Deloitte has started to roll out a new climate learning programme for all 330,000 of its employees worldwide. The new programme, developed in collaboration with the World Wildlife Fund, is designed to help Deloitte advise clients. Remember, in June rival Big Four firm PwC said it would add a whopping 100,000 staffers to capture the booming environmental, social and governance (ESG) market.

Clearly, people are eager for ESG information, and we hope we can help fill the void with this newsletter. Read on. — Patrick Temple-West

DWS re-engineers European ETF to lure ESG investors

Corporate name changes are often the focus of public snickering. Standard Life Aberdeen’s switch to Abrdn in April, for example, was widely mocked on the Financial Times website. The FT’s Pilita Clark has even argued that corporate rebranding is a waste of time.

Last week, DWS, Deutsche Bank’s asset management arm, announced the renaming of nine of its ETFs to incorporate the ESG label and track a new index. The new index provided by MSCI, which includes ESG screens, replaces Stoxx indices.

The move is part of a larger trend to appeal to ESG investors. JPMorgan and Amundi were among the companies that overhauled more than 250 conventional funds to add sustainability language and investment criteria in 2020, according to Morningstar. 

Companies that have failed to capture investor interest are now adding “a coat of green paint” on funds, says Ben Johnson, director of ETF research at Morningstar. The changes are “an attempt to revitalise this particular product,” Johnson said.

© Bloomberg

DWS is also adding securities lending activities to the ETFs, the company said. Funds will often lend shares to short sellers to liven up returns, but the practice could raise concerns from ESG investors. In 2019, Hiro Mizuno (pictured), the former head of the world’s largest pension fund, stopped lending out securities from the Japanese scheme because he believed shorting was antithetical to his mission of long-term value creation.

Refurbishing existing funds to give them an ESG-friendly look has limitations, Johnson said.

“There are ESG-like exclusionary screens that are hardly what we would think of as best in class ESG intentional index strategies,” Johnson said. 

And renaming a fund to hoover up ESG money has caught the eye of regulators. Last week, Securities and Exchange Commission chair Gary Gensler said he wanted the agency to revisit its “names rule”, which prohibits funds from using materially deceptive or misleading names.

“Labels like ‘green’ or ‘sustainable’ say a lot to investors,” Gensler said. “Which data and criteria are asset managers using to ensure they’re meeting investors’ targets — the people to whom they’ve marketed themselves as ‘green’ or ‘sustainable’?” (Mariana Lemann)

Climate campaigners allege central banks aren’t doing enough to avoid a ‘hothouse world’

© AP

When the Federal Reserve in December finally joined the Network for Greening the Financial System (NGFS), all systemically important banks worldwide fell under the organisation’s climate risk oversight. With the US onboard, the NGFS can command significant influence over the financial industry’s role in climate change mitigation.

NGFS research is already being used by central banks around the world. To build their stress tests, the Banque de France, European Central Bank and Bank of England have used NGFS forecasts, including the frightening “hothouse world” scenario in which global warming imposes extreme costs on everyone.

© S&P Global Ratings

And companies are taking the financial implications seriously. For example, Global Partners, a US petrol company, has warned shareholders that bank financing could get more difficult as NGFS’s climate stress tests are implemented. 

But the NGFS has flaws, according to Reclaim Finance, a Paris-based activist group founded in 2020 by Lucie Pinson. In a report provided exclusively to Moral Money, Reclaim Finance argued that NGFS climate risk forecasts rely too heavily on carbon capture and storage, which would not sufficiently reduce fossil fuels investment enough to limit global warming to 1.5°C.

In July, NGFS updated its climate risk scenarios to limit global warming to 1.5°C. However, Reclaim Finance takes issue with NFGS’s assumptions about how banks would reduce their carbon footprint to get there. A false sense of security could prompt companies to decelerate efforts to reduce their fossil fuel assets.

NGFS scenarios could allow for significantly more fossil fuel extraction investments in the 2030s, Reclaim Finance said. The International Energy Agency said in May that energy companies must stop all new oil and gas exploration projects from this year to halt global warming.

“These scenarios rely too heavily on carbon capture and storage and permit ongoing investments in fossil fuels, a recipe for climate chaos and stranded assets,” said Paul Schreiber, a campaigner at Reclaim Finance. (Patrick Temple-West)

Inside the fight to eliminate microplastics

© Getty Images

Polymateria, a London-based company, has published findings this month identifying a new type of plastic that can decompose into harmless wax.

Imperial College London scientists proved the technology worked in the Mediterranean, home to the world’s highest global microplastic concentration, according to Niall Dunne, chief executive of Polymateria.

Microplastic, a traditional plastic, is harmful to the environment because over time it fragments into tiny particles less than 5mm in size. These particles are easily digested by aquatic animals and can travel through the food chain.

While there is significant interest and demand for an alternative to plastics, innovation has lagged, Dunne told Moral Money.

Convenience store chain 7-Eleven has begun implementing the sustainable plastic into its packaging, as has Pour Les Femmes, a clothing brand created by House of Cards actress Robin Wright.

“Our awareness on the issue is thankfully rising but sadly robust research and innovation is still lagging behind,” said David de Rothchild, the British environmentalist known for building a plastic boat and sailing it around the Pacific Ocean.

(Kristen Talman)

Tips from Tamami

Nikkei’s Tamami Shimizuishi helps you stay up to date on stories you may have missed from the eastern hemisphere.

To attract more foreign investors, the Tokyo Stock Exchange is instituting the biggest reform of Japan’s stock markets in a decade.

From next April the exchange will require companies to be more aligned with global corporate governance and financial standards. As part of the overhaul, the Tokyo bourse will split into three sections — prime, standard, and growth. To list in the prestigious “prime” section, companies must meet tighter criteria, such as liquidity standards.

Companies in the prime group are also recommended to fill a third or more of their boards with external directors and to disclose climate risk.

Approximately 30 per cent of the companies that are listed on the top-tier group in the exchange fall short of the requirements for staying in the prime section, Nikkei said.

To stay in the top group, some companies are scrambling to unwind long-criticised practices such as cross-shareholdings and cash-hoarding. The new requirement triggered harsh competition among companies to find qualified candidates for their boards. Weekly Toyo Keizai magazine estimates that Japan Inc will face a shortfall of 3,000 outside directors next year.

The companies that failed to qualify for the prime section this time around can apply again with new information by December.

The reshuffle in the exchange is creating new investment opportunities as well as risks. If you are an investor in the Japanese stock markets, it is a good time to take a look with fresh eyes.

Chart of the day

Global impact fundraising activity

With TPG and Brookfield launching $12bn for new climate funds, the impact investing space has never been hotter. Globally there are 675 impact funds representing about $200bn in commitments so far in 2021, according to a July 27 report from PitchBook, a data provider.

These funds include private equity, and early-state venture capital. “We estimate that there is about $73bn in dry powder targeting impact investments,” PitchBook said.

Grit in the oyster

  • DWS has struggled to implement an ESG strategy and allegedly exaggerated ESG claims to investors, according to the company’s former sustainability chief, Desiree Fixler. Fixler, who provided internal emails and presentations to the Wall Street Journal, said she believed DWS misrepresented its ESG capabilities. The former sustainability chief was fired on March 11, one day before DWS’s annual report was released.

© AFP via Getty Images
  • Hundreds of Activision Blizzard workers walked out in protest last week at the company’s handling of a California state lawsuit alleging sex discrimination, harassment and retaliation. The case alleged a “pervasive ‘frat boy’ workplace culture” at the Santa Monica-based company. On Tuesday, J Allen Brack, a top executive at Activision Blizzard left the company in a management shake-up that promised to bolster “integrity and inclusivity”. Read the FT’s story here.

Smart reads

  • As the SEC drafts unprecedented regulations to require ESG disclosures, the oil and gas industry is ramping up an effort to dilute the climate reporting rules, Myles McCormick and Patrick Temple-West wrote this week. Some fossil fuel companies are lobbying the SEC for the first time.

  • John Browne, a point person on General Atlantic’s new $3bn climate solutions fund, has written in the FT that one of its key goals is to avoid greenwashing.

“Business has a reputation for clinging to the past and greenwashing its way through the climate debate,” Browne said. “Now is the time for businesses, and the investors who back them, to play a decisive role in the greatest challenge humanity is likely to face this century.”

  • Electric cars are celebrated by investors and customers alike as causing less environmental damage than their combustion engine counterparts. But, their supply chain is muddled with a mining and manufacturing process that could be become an “environmental disaster”, FT’s Patrick McGee and Henry Sanderson write. Advocates for a circular economy are hopeful that an increase in urban mining, or breaking down and repurposing batteries, “can close the emissions gap and ease supply chain concerns”.

Recommended reading

  • ESG Returns Emerge as Key Focal Point for US Institutional Investors (Fund Fire)

  • Inequality Has Soared During the Pandemic — and So Has CEO Compensation (New Yorker)

  • US forest fires threaten carbon offsets as company-linked trees burn (FT)

  • Beyond Meat boss backs tax on meat consumption (BBC)

  • Does Positive ESG News Help a Company’s Stock Price? (Northwestern School of Management, Kellog)

  • Olympic sponsors need to ‘walk the talk’ on values (FT)

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US stocks rise as investors weigh strong earnings against spread of Delta variant




Equities updates

Stocks on Wall Street edged higher on Tuesday as strong company earnings and economic data offset worries about the spread of the Delta coronavirus variant and fears over another regulatory clampdown from Beijing.

The blue-chip S&P 500 was up 0.7 per cent by mid-afternoon in New York, its best performance in more than a week. The tech-focused Nasdaq Composite climbed 0.3 per cent.

Investor sentiment was lifted by June data for US factory orders, which typically feed into estimates of gross domestic product. New orders for goods rose 1.5 per cent on the month before, well above the consensus estimate of 1 per cent.

In Europe, another wave of strong earnings results helped propel the continent’s stocks to a fresh record. The region-wide Stoxx 600 index rose 0.2 per cent after Paris-based bank Société Générale and London-listed lender Standard Chartered reported profits that beat analysts’ expectations.

London’s energy-leaning FTSE 100 index rose 0.4 per cent, aided by oil major BP, which rallied after announcing a $1.4bn share buyback programme and an increase in its dividend.

Line chart of Stoxx Europe 600 index showing Strong earnings help propel European shares to record high

On both sides of the Atlantic, earnings have been strong. More than halfway through the US reporting season, 86 per cent of companies have topped expectations on profits, while in Europe 55 per cent have outperformed so far, according to data from FactSet and Morgan Stanley.

“The continued healthy earnings outlook is a key driver of our view that the equity bull market remains on solid footing,” analysts at UBS Wealth Management wrote in a note. Such a growth rate is, however, “flattered by depressed levels in the year-ago period,” they said. “But the results are still impressive compared with pre-pandemic earnings.”

Oil slipped in a choppy session as the global benchmark Brent crude fell 0.7 per cent to $72.37 a barrel on fears that the spread of the Delta variant could depress demand for fuel.

The seven-day rolling average for new coronavirus cases in the US, the world’s largest economy, have hit nearly 85,000 from about 13,000 a month ago, according to the Financial Times coronavirus tracker. Similar trends have taken hold in other countries as well as authorities race to vaccinate larger swaths of their populations.

A log-scale line chart of seven-day rolling average of newcases showing that US coronavirus case counts rise from just over 10,000 in mid-June to nearly 100,000 by early August

In Asia, investors were again focused on regulation after Chinese state media criticised the online video gaming industry, calling it “spiritual opium”. Shares in Tencent, the Chinese internet group, fell 6 per cent before announcing it would implement new restrictions for minors on its gaming platform. NetEase and XD, two rivals, dropped 7.8 per cent and 8.1 per cent, respectively.

The Hang Seng Tech index, which includes Tencent and its peers, dropped 1.5 per cent, lagging behind the wider Hong Kong bourse, which slipped 0.2 per cent. The CSI 300 index of large Shanghai- and Shenzhen-listed stocks was flat.

Unhedged — Markets, finance and strong opinion

Robert Armstrong dissects the most important market trends and discusses how Wall Street’s best minds respond to them. Sign up here to get the newsletter sent straight to your inbox every weekday

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Why it might be good for China if foreign investors are wary




Chinese economy updates

The writer is a finance professor at Peking University and a senior fellow at the Carnegie-Tsinghua Center for Global Policy

The chaos in Chinese stock markets last week was exacerbated by foreign investors selling Chinese shares, leaving Beijing’s regulators scrambling to regain their confidence while they tried to stabilise domestic markets. But if foreign funds become more cautious about investing in Chinese stocks, this may in fact be a good thing for China.

In the past two years, inflows into China have soared by more than $30bn a month. This is partly because of a $10bn-a-month increase in the country’s monthly trade surplus and a $20bn-a-month rise in financial inflows. The trend is expected to continue. Although Beijing has an excess of domestic savings, it has opened up its financial markets in recent years to unfettered foreign inflows. This is mainly to gain international prestige for those markets and to promote global use of the renminbi.

But there is a price for this prestige. As long as it refuses to reimpose capital controls — something that would undermine many years of gradual opening up — Beijing can only adjust to these inflows in three ways. Each brings its own cost that is magnified as foreign inflows increase.

One way is to allow rising foreign demand for the renminbi to push up its value. The problem, of course, is that this would undermine China’s export sector and would encourage further inflows, which would in turn push China’s huge trade surplus into deficit. If this happened, China would have to reduce the total amount of stuff it produces (and so reduce gross domestic product growth).

The second way is for China to intervene to stabilise the renminbi’s value. During the past four years China’s currency intervention has occurred not directly through the People’s Bank of China but indirectly through the state banks. They have accumulated more than $1tn of net foreign assets, mostly in the past two years.

Huge currency intervention, however, is incompatible with domestic monetary control because China must create the renminbi with which it purchases foreign currency. The consequence, as the PBoC has already warned several times this year, would be a too-rapid expansion of domestic credit and the worsening of domestic asset bubbles. 

Many readers will recognise that these are simply versions of the central bank trilemma: if China wants open capital markets, it must give up control either of the currency or of the domestic money supply. There is, however, a third way Beijing can react to these inflows, and that is by encouraging Chinese to invest more abroad, so that net inflows are reduced by higher outflows.

And this is exactly what the regulators have been trying to do. Since October of last year they have implemented a series of policies to encourage Chinese to invest more abroad, not just institutional investors and businesses but also households.

But even if these policies were successful (and so far they haven’t been), this would bring its own set of risks. In this case, foreign institutional investors bringing hot money into liquid Chinese securities are balanced by various Chinese entities investing abroad in a variety of assets for a range of purposes.

This would leave China with a classic developing-country problem: a mismatched international balance sheet. This raises the risk that foreign investors in China could suddenly exit at a time when Chinese investors are unwilling — or unable — to repatriate their foreign investments quickly enough. We’ve seen this many times before: a rickety financial system held together by the moral hazard of state support is forced to adjust to a surge in hot-money inflows, but cannot adjust quickly enough when these turn into outflows.

As long as Beijing wants to maintain open capital markets, it can only respond to inflows with some combination of the three: a disruptive appreciation in the currency, a too-rapid rise in domestic money and credit, or a risky international balance sheet. There are no other options.

That is why the current stock market turmoil may be a blessing in disguise. To the extent that it makes foreign investors more cautious about rushing into Chinese securities, it will reduce foreign hot-money inflows and so relieve pressure on the financial authorities to choose among these three bad options.

Until it substantially cleans up and transforms its financial system, in other words, China’s regulators should be more worried by too much foreign buying of its stocks and bonds than by too little.

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