Geopolitical tensions between the U.S. and China, along with the recent surge of investor interest in artificial intelligence, are ramping up the need for more disclosure about U.S. private investments in China.
“How do we deal with this issue of really investing against our own interest?” Marianne Dwight, the chief development officer of the Strategic Insight Group, asked during a panel discussion at a Securities and Exchange Commission Investor Advisory Committee meeting on Thursday. Strategic Insight Group is a private intelligence firm.
Dwight, the former general counsel and investment committee member of Texas Treasury Safekeeping Trust Co., which manages money for the state of Texas, suggested that the SEC revisit the Investment Advisors Act and come up with “some definitions where the GP [general partner] cannot contractually do away with its fiduciary responsibility.” Among others, VC firms currently are exempt from certain provisions of the 1940 Act.
“There isn’t a lot of transparency,” added Sarah Bauerle Danzman, associate professor in international studies at Indiana University in Bloomington. “Ending reporting exemptions for private market investors, at least with respect to their China holdings, can achieve some important policy goals.”
Peter Harrell, until recently the senior director for International Economics and Competitiveness for the National Security Council, said he expects private investors soon will have to disclose more about technology investments to the federal government. The disclosures will likely include such issues as the size of the investment, the counterparties — and what contractual provisions are in place to prevent the Chinese from using the technology for military purposes.
“The U.S. government and U.S. investors currently lack sufficient information about the status of U.S. company investments in China and the risks they pose,” said Harrell.
The new rules are likely to be in the form of an executive order that places more reporting requirements or restrictions, or both, on general and limited partners of venture capital, according to Bauerle-Danzman.
While investors might not be concerned about national security issues “because they’re pursuing financial return,” such shortsightedness could hurt them, added Harrell. Investors “may be under-appreciating the risks of a U.S. conflict with China over Taiwan, which could lead to large investor losses due to Chinese expropriation or U.S. sanctions,” he said.
That worry has been heightened by recent experiences with Russia, which led to estimated losses of $100 billion for investors and companies following the imposition of sanctions when Russia invaded Ukraine last year.
“It’s very clear that the capital markets have become the front edge in a geopolitical conflict, and that we can have our capital shut down and locked into a country if we’re not careful,” said Christopher Ailman, the CIO of the California State Teachers’ Retirement System.
But there doesn’t have to be an outright military conflict with China to trigger U.S. action, as the explosion of investor interest in AI has the U.S. government on high alert.
One recent example of what can go wrong is the Chinese facial recognition AI company, SenseTime, that allegedly collaborated with Chinese police forces in their surveillance of China’s Uyghur population.
In 2018, several U.S. venture capital firms invested in SenseTime. But before the company was set to go public in 2021, the U.S. government barred U.S. entities from buying or selling securities of the company. Shares of SenseTime are down more than 60 percent since its initial public offering.
VC investors in SenseTime were powerless to stop the company’s pivot away from commercial applications to military activities because they did not have enough control over the company, said Bauerle Danzman. “And at the same time, the illiquid nature of venture meant that they could not easily or cheaply exit the transaction when the business rationale started to change.”
Several states have since passed laws prohibiting their public pension funds from investing in China. And at least one big VC fund, Sequoia, is looking at restructuring its funds to separate its Chinese investments from the rest.
Increased disclosure could provide both the U.S government and the public the ability to track just how much investment from the U.S. is in Chinese private markets, and in what specific companies and sectors, said Bauerle Danzman. That information would help create better policy, “rather than what we have now, which is policy making without a whole lot of knowledge of the underlying problem.”
More disclosure would also allow investors to better understand the risks inherent in such investment strategies, she said. “This will ultimately provide better protection for investors and reduce overly aggressive de-risking.”
