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BlackRock and Vanguard face heavy burden of US sanctions on China

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BlackRock and Vanguard face having to offload billions of dollars worth of investments in order to comply with the US government’s decision to blacklist Chinese companies with military connections.

The order, which came into effect on Monday, has forced index providers, including MSCI, FTSE Russell, S&P Dow Jones Indices and JPMorgan, to announce the removal of several Chinese companies from their indices.

The world’s two largest passive fund managers are particularly affected because of the amount of money they manage in funds tracking those indices.

The Vanguard FTSE Emerging Markets ETF/Index Fund is among the top three mutual fund shareholders in five blacklisted Chinese firms — CRRC Corp, China Communications Construction Company, China Nuclear Engineering & Construction Corporation, China Railway Construction Corporation, Semiconductor Manufacturing International Corporation — according to Morningstar data.

This article was previously published by Ignites Asia, a title owned by the FT Group.

The Vanguard Total International Stock Index Fund, which tracks more than 7,000 stocks in its composite of MSCI and FTSE indices and had $407.1bn in assets at the end of November, is one of the largest fund allocators to four of the blacklisted firms.

The US-listed Vanguard FTSE Emerging Markets ETF/Index Fund, which has $71.69bn in assets as of January 6, had an exposure of more than 43 per cent to the Chinese market.

Vanguard did not respond to questions on its strategy and timing for offloading relevant blacklisted Chinese securities from its funds.

“Since the executive order was first announced, we’ve been keeping our client-facing associates prepared with a response for enquiries on the topic. In short, Vanguard will fully comply with the executive order and will continue to monitor the situation to ensure ongoing compliance,” it said in a statement to Ignites Asia.

BlackRock’s US-listed iShares Core MSCI Emerging Markets ETF, which had about $70bn in assets, also has an exposure of 36 per cent to the Chinese market.

The fund had a 1 per cent, or estimated $700m, exposure to the blacklisted Chinese securities before the changes announced by its index, according to calculations from Morningstar data.

BlackRock also declined to answer Ignites Asia queries regarding the company’s strategy and timing for offloading blacklisted Chinese securities from its funds, but sent a statement saying: “BlackRock is monitoring index providers and studying the guidelines issued by US regulators. We are taking all necessary actions to follow benchmarks accordingly, and to ensure compliance with applicable laws and regulations.”

A Morningstar report shows 11 BlackRock iShares ETFs, and two Vanguard ETF and index funds with assets totalling billions of dollars, all have significant exposure to the sanctioned Chinese securities.

Jackie Choy, Hong Kong-based director of ETF research at Morningstar, said that while index providers routinely conducted rebalancing to comply with index adjustments, the recent removal of blacklisted Chinese companies had increased pressure on ETF providers and given them a much shorter timeframe for decision-making and execution than normal.

Mr Choy said that if ETF managers did not drop the blacklisted firms after their respective indices’ moves, they risked tracking errors regardless of any potential legal consequences that could arise.

Even if managers decided to hold on to some of these Chinese companies’ shares — which they are entitled to do, because the executive order only specifically bans buying more shares after January 11 — managers risk losing investors, especially US ones, because they will not be able to buy more shares of the fund.

Other large asset managers also have significant passive exposure to the blacklisted Chinese companies including Invesco, HSBC, State Street, Deutsche Bank’s DWS and Hang Seng Investment Management.

However, most global asset managers have yet to make public announcements about their exact ETF or index fund readjustments.

Krane Fund Advisors, a New York-based, China-focused ETF provider, announced on the first day of the year that of its six ETFs with exposure to the blacklisted securities, four will have sold their positions in the companies by January 11, while the other two would liquidate securities before January 5 to optimise portfolios.

Its largest two exposures were the KraneShares CICC China 5G & Semiconductor ETF, which had a 5.8 per cent weighting exposure to the blacklisted securities via its FastINDX index on December 29, while the KraneShares Bosera MSCI China A Share ETF had a 3.46 per cent weighting exposure via its MSCI index.

Mr Choy noted that the removals had affected almost all China-related and even emerging market indices across all major index providers, and it was nearly impossible to determine the number of total products and issuers that will be affected.

A senior executive for one overseas index provider based in Hong Kong said ETF managers would have to exit the holdings in good time to make sure there were sufficient market makers to trade the shares.

The US Department of the Treasury has said the Office of Foreign Assets Control “will continue to update” its list of sanctioned Chinese firms.

Some asset managers believe that even though President Donald Trump instigated the original sanctions against Chinese companies, the incoming Biden administration will continue with the same approach.

“If anything, trade and investment may actually become more challenging as the new US president is going to be much more willing to co-ordinate policy with Europe and other major trading partners. Attitudes within Europe towards China have similarly become more negative,” said Brian Bandsma, New York-based emerging markets and Asia-Pacific equities portfolio manager for Vontobel Asset Management.

*Ignites Asia is a news service published by FT Specialist for professionals working in the asset management industry. It covers everything from new product launches to regulations and industry trends. Trials and subscriptions are available at ignitesasia.com.

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Analysis

Covid paralyses Asia as western economies prepare for blast-off

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Throughout 2020, Asia’s success in controlling Covid-19 made it the champion of the world economy. While Europe and the US were mired in deep recessions, much of Asia escaped with a shallower downturn or even kept growing.

But as western economies gear up for a vaccine-induced rebound which is set to take their output back to its pre-pandemic scale by the end of this year, parts of Asia are still paralysed by coronavirus. As a result, although the region’s output is already above its pre-pandemic level, slower growth is expected in the coming months.

As it launched its new regional outlook last week, the Asian Development Bank said that the region’s economies were diverging and that more Covid-19 waves were a big risk.

“New outbreaks continue, in part due to new variants, and many Asian economies face challenges in procuring and administering vaccines,” said Yasuyuki Sawada, the ADB’s chief economist.

The ADB projected growth of 5.6 per cent across developing Asian economies in 2021, led by growth of 8.1 per cent in China and 11 per cent in India. But the continued threat of coronavirus means risks to that outlook are skewed to the downside.

“Six months ago, or eight months ago, I would have said Asia is going to be ahead of the game because Asia can control Covid,” said Steve Cochrane, chief Apac economist at Moody’s Analytics in Singapore.

But the picture has changed, with India suffering a severe wave of the virus, and cases still high in countries such as Indonesia, the Philippines and Thailand. Thailand is unable to reopen its crucial tourist industry.

More subtly, countries such as Japan are only controlling the virus with restrictions that keep parts of the economy in hibernation. “Some countries need vaccines to control Covid,” said Cochrane. “Others need it so they can open up to international travel and tourism.”

The promise of more than 6 per cent growth in the US this year, as a result of President Joe Biden’s fiscal stimulus, would normally have Asian exporters licking their lips.

Line chart of GDP rebased (2019 = 100) showing Asian economies were less affected by the early stages of the pandemic

The outlook, however, is more subdued than record US growth would usually imply: Americans already bought plenty of goods during the pandemic, while higher US interest rates would mean tighter financial conditions in Asia.

“Adding stimulus at this stage, from the goods perspective, is a real test of whether wants are insatiable,” said Freya Beamish, chief Asia economist at Pantheon Macroeconomics. As the economy opens up, US consumers will probably pay for the services they were denied during lockdown — such as meals out and haircuts — rather than replacing their television again.

There will still be some spillover from the US stimulus, said Beamish, noting that service providers needed equipment, too. “We suspect that people will find new goods to buy and that Asia will benefit from that.” But she added: “We suspect that China will benefit proportionately less from the services recovery than from the manufacturing recovery.”

Whether the extra US demand for goods turns out to be large or small, it is clearly positive. By contrast, higher US interest rates and a stronger dollar would threaten many emerging Asian economies with a repeat of the 2013 “taper tantrum”.

Increased financial integration and foreign currency borrowing mean that the pain of rising US interest rates is quickly felt on the other side of the Pacific.

“A stronger dollar is no longer an unalloyed blessing for Asia,” said Frederic Neumann, co-head of Asia economics at HSBC in Hong Kong. “It helps exports but tightens financial conditions.”

However, inflation is subdued across most of emerging Asia, and the ADB said the risk of a US-induced shock to financial conditions “remains manageable at present”. It said economies such as Sri Lanka and Laos would be vulnerable if such a shock occurred.

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Some Asian economies are well-placed for the next few years, especially Taiwan and South Korea, which are exposed to the semiconductor cycle. “Judging from semiconductor shortages, it doesn’t look like the electronics cycle will break down in the next two or three quarters. That tides them over this rough patch,” said Neumann.

But other Asian economies will find themselves in the less familiar position of relying on domestic demand to grow. One of the biggest question marks is China itself, where first quarter numbers suggest the economy has lost a little momentum.

“Chinese domestic demand still has a way to go,” said Cochrane. “Our forecast right now is for 8 per cent growth in China in 2021, but it depends a lot on policymakers and how quickly they pull back on stimulus and introduce frictions in areas like construction.”



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Has Venezuela’s economy bottomed out?

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After one of the biggest economic meltdowns in Latin American history, there are signs that Venezuela may finally be turning a corner.

According to some economists, the socialist government’s decisions to loosen currency controls, relax import restrictions and encourage informal dollarisation have breathed a modicum of life into an economy that has shrunk by about 75 per cent since 2013.

The change of government in the White House has also raised hopes that a solution might be found to the country’s long-running political stalemate, which might lead to an easing of US sanctions and in turn fuel a further rebound.

Credit Suisse recently predicted the Venezuelan economy would expand by 4 per cent this year, which would be its first year of growth since 2013. The bank acknowledged this was in part due to the resumption of economic activity after last year’s hit from the coronavirus pandemic, but this was “not the whole story”.

“The revival in domestic demand, which we have long been noting, is becoming more apparent in the data,” Alberto Rojas, the bank’s chief economist for Venezuela, wrote in a note to clients.

“The easing of controls and widespread use of foreign currencies in everyday transactions has rekindled economic activity — even if just slightly.”

Rojas forecasts further growth of 3 per cent in 2022. “In our view, the growth this year is not just a dead cat bounce,” he wrote.

In Caracas, people were sceptical that this amounted to any sort of meaningful recovery. According to the IMF, per capita gross domestic product in Venezuela has dropped a staggering 87 per cent over the past decade, from $12,200 a year in 2011 to $1,540 now. For the first time, the average Venezuelan is poorer than the average Haitian.

“When you’ve fallen so low, eventually you’re bound to see some sort of correction,” said Adán Celis, president of Venezuela’s manufacturers’ association Conindustria. “The government has introduced some anarchic measures of economic flexibility and that’s provided us with a little bit of oxygen but the structural problems remain.”

But a handful of other banks and consultancies also expect output to increase. Two Venezuelan consultancies, AGPV and Dinámica Venezuela, predict growth this year of 1.9 per cent and 2.3 per cent respectively.

UK-based Oxford Economics forecasts growth of 0.2 per cent this year followed by a jump of 13.1 per cent next year, although it stresses this recovery needs to be seen in context.

“This follows two years in a row [2019 and 2020] when GDP fell by a third or more,” said Marcos Casarin, OE’s chief Latin American economist. “Given the magnitude of the collapse seen since 2014, Venezuela could grow at double-digit rates for several years in a row and still not recover its pre-crisis GDP level.”

Column chart of GDP change (%) showing Venezuela's economy has been shrinking for years

For every economist predicting growth, there are plenty who say Venezuela will suffer more pain before things finally improve.

FocusEconomics, a provider of economic consensus forecasts, recently polled 21 banks and consultancies for their views on Venezuela. The consensus was for a fall in GDP of 3.1 per cent this year followed by a rebound of 2.7 per cent next year. The IMF predicts a contraction of 10 per cent this year and 5 per cent next.

The huge differences between forecasts reflect uncertainty over the consequences of the pandemic, the impact and timing of the rollout of Covid-19 vaccines and the future of the sanctions regime.

“The evolution of US sanctions under the Biden administration remains the key determinant of the outlook,” wrote Stephen Vogado, economist at FocusEconomics.

The sanctions prohibit Venezuela from selling oil to the US and make it difficult for it to export elsewhere, although the government has found ways to get round the measures. Venezuela’s oil exports have risen slightly in each of the past five months, hitting a 10-month high in March — although they are still feeble compared with historical highs.

While oil has been the mainstay of the Venezuelan economy for the past century, the country also used to produce cacao, coffee and rice in significant quantities. It boasted a textile industry and produced chemicals, cement, steel and aluminium. Most of those industries have been decimated in the past two decades of revolutionary socialist rule.

At an outlet selling car accessories in a petrol station in the Las Mercedes neighbourhood of Caracas, store manager Alfredo Barrera said informal dollarisation had brought some degree of price stability after years of hyperinflation.

“The economy has adapted to the country’s problems,” he said. “Right now, it’s fair to talk about relative stability in terms of the currency but we’re a long way from seeing real improvement.”

At La Alicantina, a bakery that has been in business for more than 30 years, manager Douglas Palencia said sales had been hit hard by the pandemic. The shop’s windows, usually full of cakes and pastries, were empty. “I don’t have great expectations for this year,” he said.



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Sturgeon taps Scottish resentment over Johnson and Brexit

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Kenny Paton, the postman in Dumbarton, has been criss-crossing the west coast town near Glasgow, delivering flyers for all the parties contesting Scotland’s parliamentary elections this Thursday. But he is only listening to one.

For all the shortcomings of the Scottish National party’s 14 years in power, the recent turmoil surrounding its handling of sexual harassment claims against former leader Alex Salmond and the destructive nature of its cherished goal of breaking the 314 year union, the party is on course for victory once again.

That is in large part because the SNP, with first minister Nicola Sturgeon at its helm, has been speaking to the heart, tapping into the deep resentment many Scottish people feel at being ruled from Westminster by Conservatives whose leader Boris Johnson and policies, notably Brexit, they did not vote for.

Dumbarton, Scotland map

For some Scots, the economic arguments against independence — and these have only grown with the sharp deterioration in Scotland’s fiscal position since Brexit and the onset of the coronavirus pandemic — are no longer cutting through. 

“You can get into all the intricacies about the border and the currency but at the end of the day who do you want to run the country Boris Johnson or Nicola Sturgeon?” said Paton, who once supported Labour, but is now rooting for the SNP.

Nicola Sturgeon campaigns in Dumbarton © Jeff J Mitchell/AFP/Getty Images

If opinion polls in the run-up to Thursday’s vote are correct, the party is sure to remain the largest in the devolved Holyrood parliament and will possibly gain the slender majority it wants to continue pressing Westminster, for its second chance in seven years of winning independence in a referendum.

There is also the probability that with the Scottish Green party, and Salmond’s newly launched Alba party, the SNP will form part of a bigger block in favour of Scotland going its own way.

Chart tracking voting intention polls for the constituency vote in the Scottish Parliament election

But to get across the line to an SNP majority, Sturgeon may need to win marginals such as Dumbarton, where Jackie Baillie, the deputy leader of Scottish Labour and a popular constituency MSP is defending a majority of just 109, the most vulnerable in Scotland.

As well as her appeal to Scottish identity, Sturgeon has a number of other things in her favour. One is Labour’s weakness, and the perception that it could be long before the party Scotland once voted for en masse returns to power.

“I have been an advocate for Scottish independence since the Conservatives won a majority in Westminster. They do not reflect our views — Scotland is a progressive place,” said Ross Crawford, a 28-year-old IT consultant. “It will be a while before Labour can collect themselves — that’s what makes it so discouraging. It means yet more Conservative rule,” he said.

Labour’s Jackie Baillie in Dumbarton © Jeremy Sutton-Hibbert/FT

Most of all Sturgeon has Brexit and the indifference shown by first Theresa May, the former prime minister, and then Johnson to the majority in Scotland who voted to remain in the EU and who wanted to retain close relations.

“In 2019, the polls began consistently showing higher levels of support for the SNP. The rise occurs entirely among Remain voters,” said John Curtice, professor of politics at the University of Strathclyde. “Whatever the preferences of Boris Johnson, and Michael Gove [Cabinet Office minister], the brutal reality is that their pursuit of Brexit has undermined support for the union,” he said. 

Julie Reece: ‘We felt safe with her [Nicola Sturgeon] during Covid’ © Jeremy Sutton-Hibbert/FT

For most of last year backing for independence in Scotland polled at 50 per cent or higher when undecided voters are excluded. But while it has slipped back since then, support for Sturgeon in Dumbarton remains high. This has much to do with her more assured performance during the pandemic, which has helped the SNP avoid an awkward reckoning for its less than stellar longer term record in areas such as education and health. 

“We felt safe with her during Covid,” said Julie Reece, a bus company manager and former Labour supporter now backing the SNP.

Like many people strawpolled in the constituency, Reece was unfazed by Sturgeon’s alleged mishandling of sexual harassment claims against her former ally. “They have tried to make her a scapegoat for Alex Salmond’s affairs,” she said, adding, with a nod to how the first minister has brought women like her behind the SNP cause: “She has engaged women better — it switches you on that bit more,” she said.

But the stakes are high and the tightness of the contest is also galvanising Scots who support the union and are passionately against the rupture it would cause. This has led to unlikely alliances in Dumbarton, with some staunch supporters of the Conservative party even promising to vote tactically for Labour — a rare occurrence in UK politics.

Chart tracking voting intention polls for the regional vote in the Scottish Parliament election

“Anything that keeps the SNP out,” said Carl Vickers, who works at the Faslane naval base further up the Clyde estuary, where thousands of jobs could be lost if Scotland breaks away. The SNP opposes the use of Faslane to store the UK’s nuclear deterrent.

Vickers described himself as a Conservative by nature but said he would be voting for Baillie on the day.

“It’s all about stopping them [the SNP] getting another referendum,” said Trish Collins, a headhunter and Tory who was also planning to vote for the Labour candidate in the constituency vote, which the Conservatives have little chance of winning.

In Scotland, members of the parliament in Edinburgh are elected using a hybrid voting system: constituency representatives elected using the first past the post voting system while additional representatives are elected according to the proportion of votes a party secures in a region comprising several constituencies.

On the banks of the river Leven, Baillie herself remained defiant. “My seat on paper should go to the SNP but I am a seasoned campaigner so I am not stopping until polls are closed,” she said.

A pro-Scottish independence rally in Glasgow last Saturday © Jeremy Sutton-Hibbert/FT

“Our number one priority should be recovery and then we can argue about the constitution,” she added, warning that when Westminster pulls the plug on the job protection scheme, there could be a surge in unemployment.

“Brexit has been a mess,” said Baillie. “Leaving the UK could be 10 times worse.” 

That need to focus on recovering from the pandemic — the core of Labour’s campaign — does appear to have resonance, even among some SNP supporters. But for those already convinced about the risks involved in breaking up the UK union, the feelings were even more emphatic.

“We’d just got over one independence vote then Brexit was thrown at us. Now the SNP have got a good chance of coming out with a majority — the whole of Scottish politics is a joke,” said Bryan Burn, a wholesaler for fishing tackle.

He was speaking an hour south by car from Dumbarton in the relatively prosperous town of Ayr, where Conservative MSP and former farmer John Scott is defending another slender majority. A life-long Labour supporter, Burn was visibly distressed at the way things are headed. “If I were younger I would be looking to move elsewhere,” he said.

But Sturgeon is picking up votes in Ayr too.

“I like what she stands for. She’s great at what she does,” said Chris Hughes, a self-employed software engineer, who hoped an independent Scotland could rejoin Europe, and who along with his wife was voting SNP.

Scott, the Conservative incumbent who is defending a majority of just 700 votes, acknowledged that the odds were even. “It will be very, very close,” he said. “The independence issue has become an issue of the heart. Many people don’t take into account the grim realities it might hold for Scotland.”



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