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Spies, espionage and ‘lawfare’: How China is scaring away the world

September 25, 2023 — 11.59am

Earlier this year Xi Jinping’s most senior diplomacy adviser referred to the need for China to effectively use its legal weapons, “constantly enriching and perfecting our legal toolbox for foreign struggles.”

Wang Yi, a member of the Politburo, director of the Communist Party’s Central Foreign Affairs Commission and therefore China’s most senior diplomat, was referring specifically to China’s new Foreign Relations Law, which asserts China’s right to take whatever measures it deems necessary to counter actions that “endanger its sovereignty, national security and development interests.”

Xi Jinping wants to use the legal tools to direct the flow of money in line with his increasingly statist vision for China’s economy and society.

Xi Jinping wants to use the legal tools to direct the flow of money in line with his increasingly statist vision for China’s economy and society.Credit: Bloomberg

The reference to a toolbox, however, underscored that the Foreign Relations Law is only one of a number of recent laws China has enacted, both in response to the heightened tensions between China, the US and US allies and to Xi Jinping’s continuing efforts to tighten the party’s grip (and his) on China’s economy and society.

An update of counter-espionage laws earlier this year, which saw foreign consultancies raided, academic researches muzzled and economic data being withheld from public release has by itself had a chilling effect on foreign investment and on the operations of foreign businesses within China.

In the June quarter, foreign direct investment was 87 per cent lower than in the same period last year, triggering an intense effort by Chinese officials to convince foreign investors to return, an effort undermined by the deployment of its legal toolbox.

Rewards are being offered for anyone who catches “foreign spies” as part of a whole of nation attempt to control the flow of what China sees as economically-sensitive information but which Western companies would see as routine information and data that is fundamental to their ability to undertake due diligence on markets and prospective partners.

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Moreover, China’s brokerages and university researches have been directed not to speak or write negatively about China’s spluttering economy and the Hong Kong Stock Exchange has withdrawn a listing rule that required mainland Chinese companies to disclose China-related risks as a pre-condition for being able to list. Those disclosures were seen as discrediting China and harming its interests.

Then there’s what is being described as “valuations with Chinese characteristics,” or an attempt to boost the valuations of state-controlled companies that Beijing sees as being critical to its economic strategies – those designing and producing semiconductors or that are involved in the biotech, artificial intelligence or electric vehicles sectors, for instance.

It appears that “valuation with Chinese characteristics” involves state-encouraged/directed investment by state institutions and restrictions on their ability to sell their shares, as well as state subsidies and preferential tax regimes.

foreign direct investment was 87 per cent lower than in the same period last year, triggering an intense effort by Chinese officials to convince foreign investors to return.

foreign direct investment was 87 per cent lower than in the same period last year, triggering an intense effort by Chinese officials to convince foreign investors to return.Credit: Bloomberg

That’s buttressed by what appears to be a screening of companies wanting to list. Generally, those regarded as being engaged in activities with national strategic importance are being given priority to list and raise funds via initial public offerings, with non-strategic listings being discouraged.

China’s legal toolbox, much of which has been assembled this year, appears to be aimed and tightening the party (and Xi’s) control of the flow of information from within China to the West while increasing investment in sectors seen as strategically important in what has become an increasingly fractious relationship with the US and its allies.

Xi wants to use the tools to direct capital flows in line with his increasingly statist vision for China’s economy and society.

The “lawfare” is reshaping China’s capital flows and markets into what the Washington-based think tank, the Foundation for Defense of Democracies, describes as “capital markets with Chinese characteristics.”

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A paper released by the foundation earlier this month says that Beijing is re-engineering conditions for foreign businesses through the toolbox, seeking to bend investors to the party’s priorities and render overseas regulators irrelevant.

The paper said that, taken as a while, China’s new laws signal that China is executing an integrated program of “lawfare” to control information flows and force businesses to choose between Chinese and Western legal and regulatory systems that are increasingly incompatible.

It regards what China is doing as a direct challenge to US regulations and to the US Securities and Exchange Commission and other capital markets regulators.

Indeed, the crackdowns on foreign consultancies and their networks of local experts and their impact on companies’ ability to undertake what would be routine due diligence investigations in Western economies leaves companies that continue to operate in China exposed to their home regulators and potentially costly regulator and investor litigation.

The Hong Kong Stock Exchange’s decision to discard the requirement that companies seeking to list detail China-related risks is at odds with the US Securities and Exchange rules that require disclosure of China-specific risks, including their levels of state ownership, the identity of part officials involved in the board and management and the impact of party interventions on the company’s business and securities, among other things.

If companies seeking to raise funds obey China’s directives they will be shut out of the US markets and others with similar disclosure requirements. It won’t just be the SEC that enforces that outcome. Companies and institutional investors will be leery of investing in anything that doesn’t conform to Western disclosure standards.

China’s most senior diplomat Wang Yi says Beijing needs to use its “legal toolbox” to maintain control.

China’s most senior diplomat Wang Yi says Beijing needs to use its “legal toolbox” to maintain control.Credit: AP

The concept of “valuations with Chinese characteristics” – or valuations that are being manipulated by Beijing – would also deter foreign investors at a time when China has been almost begging for a reversal of the exodus of foreign capital it has experienced this year as it tries to stimulate investment and activity in its faltering economy.

Weaponising its laws to tighten Beijing’s control over businesses and the economy might, perhaps, reduce the level of insight the US government and its agencies have into what’s happening at the coal face of China’s economy.

It also threatens, however, to decouple China from the global capital markets that have played such a significant role in China’s successes over recent decades, with implications for the depth, efficiency and credibility of its own markets and their ability to support the economy.

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There is no middle road here. If China wants to assert its authority over its domestic economy and financial markets it can do so, but at the cost of colliding head-on with the US, which has a dominant role in global capital markets, capital flows and regulation of capital. China’s access to global capital and its economy would inevitably be damaged in the collision.

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