As the U.S. government mulls restrictions on outbound investment into China, a particular area of controversy is financial products through which millions of ordinary investors funnel billions of dollars into the country — index tracker funds.

Such funds enable those who put money into them to track the fortunes of a particular index, like the S&P 500. The funds do this by investing their assets into the companies in proportion to the weighting that each stock has in that index.

Members of Congress are now worried that Americans who put money into such funds that track Chinese stock indexes may be unwittingly providing funding to China’s technological and military advancement. 

“Policymakers are concerned that ordinary Americans will end up giving money to China or investing in China when they don’t want to,” says Derek Scissors, senior fellow at the American Enterprise Institute (AEI). “They’re buying what they think is innocuous, like [a hypothetical] Emerging Markets Technology Index Fund, and some of it goes to China. There aren’t clear disclosures and some of these funds have weird names that don’t give a sense of what they’re investing in.”

Using WireScreen, The Wire has done a deep dive into the companies listed on the iShares MSCI China Exchange Traded Fund (ETF), a listed tracker fund which has net assets of more than $4.3 billion and has exposure to large and mid-sized companies in China. 

Our findings show that more than one in five of the 601 companies included in the index the ETF tracks as of July 29 are majority-owned by the Chinese government, while dozens of others have had involvement with a company included on one of the U.S. government’s various entity lists. These lists impose license requirements to do business with Chinese companies accused of involvement in conduct that the U.S. seeks to restrict. MSCI is due to delete 60 entries from the index on August 30.

The second category we looked into was companies in the MSCI China ETF flagged as being directly involved with, or linked to companies that have ties to China’s military-civil fusion. That’s a strategy long promoted by Beijing and aimed at bolstering China’s capabilities by linking its military with private sector companies, in particular those that develop or acquire advanced technologies. 

Using WireScreen we further identified companies that have business relationships with entities believed to be linked with China’s use of forced labor in the western province of Xinjiang.

The U.S. Export Restricted Entity List flag identified companies that have business relationships with firms on the Entity list maintained by the U.S. Department of Commerce. The list includes firms engaged in activities deemed detrimental to U.S. national security.

The most recent congressional attempt to prohibit index funds from investing in Chinese companies is the No China in Index Funds Act, introduced in March by Brad Sherman (D-CA), and Victoria Spartz (R-IN). If enacted, the bill would introduce civil penalties for funds that continue to include Chinese companies on their indexes. However, with new business entities being established constantly, Scissors warns that a company-by-company approach has limited impact.

“Your list is going to become outdated, and it is legitimate for the service providers to say ‘what are we supposed to do in this situation?’,” says Scissors. “My solution has always been that the government says — ‘these are the technologies we’re looking at, and we’ll give you an updated list of technologies, and when in doubt, don’t include them in your index.’”

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