Decisions in Washington are affecting the derivatives market here in Hong Kong, on the other side of the world. That's as U.S. investment banks scramble to comply with the restrictions slapped on Chinese companies in the dying days of the Trump administration.
In Hong Kong, Goldman Sachs (GS) , J.P. Morgan (JPM) and Morgan Stanley (MS) are in the process of delisting a combined 500 derivatives. The banks consider the products to fall afoul of the requirement for U.S. investors to cease buying the shares of 35 companies identified as having ties to the Chinese military.
The products are callable bull/bear contracts, derivative warrants and inline warrants. Those are based on an underlying security, which in turn may be based on another underlying security, eventually leading to an instrument listed by the 35 companies.
The actions taken by J.P. Morgan, Morgan Stanley and Goldman Sachs are based on wording in Trump's executive order issued on November 12. It states that as of January 11, it is prohibited to make "any transaction in publicly traded securities, or any securities that are derivative of, or are designed to provide investment exposure to" companies ruled to be linked to the Chinese military.
The list of 35 companies can be expanded, and currently includes of China's three main mobile-phone companies: China Mobile (CHL) , China Telecom (CHA) and China Unicom (CHU) . The intention was surely to hit the shares of those companies. But if taken literally, the ruling bars the purchase of any Exchange Traded Fund or other index product or mutual fund that has any exposure whatsoever to, say, Asian telecoms, if they include those companies at all. Trades are allowed both on the buy and sell side until November 11 if the trades are made only to divest of those securities in the end.
The derivatives being delisted by the U.S. banks are sometimes based on the Hong Kong-listed shares of the three phone companies which are all listed here. Simple enough. But other products that the U.S. investment banks are delisting are bullish or bearish positions based on generic indexes such as the Hang Seng, which is Hong Kong's main benchmark, or the CSI 300, which tracks the 300 largest companies listed in Shanghai and Shenzhen.
China has the world's largest 5G network by far. So investors into telecoms would likely want to get exposure to China Mobile, which at US$116.7 billion is equivalent in size to Oracle (ORCL) , making it the sixth-largest telecom in the world. China Telecom at US$22.5 billion and China Unicom at US$17.6 billion would also rank among the 20-largest telecoms in the world.
The operator of the Hong Kong stock market, the for-profit company Hong Kong Exchanges and Clearing (HKXCF) , says the delistings are "as a direct result of the U.S. imposed sanctions." It says it is working with the issuers on an "orderly delisting," and to facilitate buyback arrangements as necessary. It claims there should be no "material adverse impact" on a Hong Kong derivatives market that has more than 12,000 listed products.
Index providers are also rushing to keep up with a flurry of executive orders from outgoing President Trump. S&P Dow Jones Indices is removing mainland-listed, Hong Kong-listed and American Depositary Receipts of affected companies from its indexes and index products. FTSE Russell and MSCI are doing the same, stripping China Mobile, China Telecom and China Unicom from their benchmark indexes either for China or the world, sending the shares into a tailspin.
The Chinese side are doing their best to respond. The Chinese Ministry of Commerce this weekend issued rules that allow government departments to order Chinese people and companies to ignore or not comply with foreign laws. That's when China decides they prevent Chinese citizens, legal entities or other organizations from "engaging in normal economic, trade and related activities" with a foreign entity.
Chinese citizens and companies would also be allowed to sue other people or entities (which don't have to be Chinese) for complying with foreign laws and sanctions, if that compliance hurts their interests or causes them to suffer losses. In other words, the Beijing-based TikTok operator ByteDance could theoretically sue Apple (AAPL) for failing to offer the app on its store, even if Apple is complying with U.S. law in doing that.
The new rules, which have been approved by China's cabinet, the State Council, also require Chinese entities to report any way that they are affected by sanctions and other trade-related foreign legislation to the Chinese government within 30 days.
The Trump administration appears to be trying to tie the hands of incoming President Biden by implementing anti-China policies. Although Biden could undo the executive orders instigated by Trump with the stroke of a pen, he may not want to expend political capital to do so at a time both Democrats and Republicans support a tougher stance on China.
The moves on derivatives and indexes follow through on the decision by the New York Stock Exchange to delist the shares of the three Chinese telecoms. After flip-flopping, and a call from the Treasury Secretary to top management, the NYSE has finally decided to delist the companies after all.
The NYSE delisting appears to be going beyond the scope of the November 12 executive order, which stated that U.S. investors should not be permitted to buy the shares of 31 military-linked companies. It does not state that the shares cannot trade in the United States, or must be delisted.
The United States subsequently added another four companies adjudged to be controlled by or linked to the People's Liberation Army (PLA), and therefore covered by the order, as are any companies designated as linked to the Chinese military in the future.
The lawyers will be working overtime scrutinizing what's sometimes vague or ill-defined language. Trump on January 5 issued an executive order to ban U.S. individuals and companies from transacting with "persons that develop or control" eight Chinese apps. The order goes into effect 45 days from the date of issuance.
The apps are the Alipay service that spun out of Alibaba Group Holding (BABA) , the Tencent Holdings (TCTZF) apps WeChat Pay and QQ Wallet, and the apps CamScanner, SHAREit, VMate and WPS Office. Trump said the apps are able to capture "vast swaths" of personal and sensitive information from users, making them a national security threat. But Alipay and WeChat are omnipresent in China, where U.S. retailers such as Walmart (WMT) and Starbucks (SBUX) make extensive use of them.
The wording of that order is a little strange, stating that transactions are forbidden with "persons" that develop those apps and software, "or with their subsidiaries." A "person" can be an "entity," which can be a corporation, trust or joint venture. So it's possible to read the wording in an expansive way that extends to the subsidiaries of Alibaba and Tencent, and a host of other companies.