Opening of “Shenzhen-Hong Kong Connect” Exposes Foreign Investors to New Level of Security-Related Risk

With the opening of the new “Shenzhen-Hong Kong Connect” on December 5, 881 Chinese companies listed on the Shenzhen stock exchange will become accessible to foreign investment.  (The Shenzhen Exchange is often compared to the NASDAQ Exchange and is made up mostly of Chinese technology companies.)  Previously, only investors who took part in the “Qualified Foreign Institutional Investor Program” (QFII) were allowed to purchase shares in these companies.  The process for meeting this qualification standard was lengthy and complex and only major financial institutions could devote the resources required to gain QFII status.

More important than the broadening of China’s corporate financing options, however, are the risk profiles and identities of the companies that stand to benefit from access to greater amounts of global capital.  Some of them have raised security concerns and/or engaged in activities that pose elevated reputational, and possibly share value, risk for outside investors (or are subsidiaries of such companies).

Among these Chinese subsidiaries that will now be more widely accessible to foreign investors via this new mechanism are the following:

  • CAMCE: a subsidiary of the China National Machinery Industry Corporation (Sinomach).
  • AVICEM: a subsidiary of the Aviation Industry Corporation of China (AVIC), a prominent PLA military contractor.
  • Norinco International: a subsidiary of Chinese arms manufacturer, China North Industries Corporation (Norinco), a PLA contractor.

Other Chinese entities that have been subject to public scrutiny for security-related reasons that are now eligible to attract foreign investment and be placed into portfolios include:

  • Hikvision: the world’s largest supplier of video surveillance equipment, which supplies a large amount of equipment to the Chinese government and security services.  A contract to supply cameras to the UK sparked public concern earlier this year over security concerns.
  • CEFC International: the firm and parent company, CEFC Energy Company Limited, has made a number of acquisitions in the Czech Republic, a 50–50 joint venture with J&T Finance Group.
  • Guide Infrared: developer and producer of infrared cameras and optical equipment for the Chinese government and PLA.  In 2008 the firm was named an “Outstanding Military Industrial Enterprise” by China’s Commission for Science, Technology and Industry for National Defense (COSIND).
  • Zhenjiang Nayang Technology: a unit of CASC that is responsible for the development and manufacture of China’s CH Series of armed drones.  China has sold this military hardware to Iraq, Pakistan, Nigeria, UAE, Saudi Arabia, Egypt and Myanmar.
  • ZTE: the Chinese telecommunications giant that was called a U.S. “national security threat” by the Congressional House Intelligence Committee in 2012.
  • Apex Technologies: during its acquisition of U.S. technology company Lexmark, a number of Lexmark employees sent a letter to the White House pleading that the Committee on Foreign Investment in the United States (CFIUS) block the transaction on national security grounds.  CFIUS ultimately approved the acquisition.

The financial and reputational risks associated with investing in certain of these entities — and others like them – are also likely to be borne by the investment banks and other foreign financial institutions that purchase these equities.