Thanks to the committee for giving me this opportunity to talk about Canada's pension fund investment in Chinese equity.
I want to raise a wider issue for Canada's pension funds and other institutional investors. By holding Chinese stocks of any kind, investors are taking on China's country risk. China has become a big part of the international indices. At the end of October, the MSCI Global Emerging Markets index was about 27% in Chinese stocks. Canadian pension funds invest directly in Chinese stocks, not just in passive index funds. Up until March of this year, CPPIB held 189 Chinese stocks.
Chinese stocks have in fact performed very badly in recent years because of all the problems in the economy. China's country risk has also become increasingly political. Many international investors are worried about geopolitical risks, especially after what happened when Russia invaded Ukraine. In February, international investors found their holdings in Russian stocks frozen due to international sanctions and Russian actions. Russia does not allow foreigners to buy or sell stocks or to exchange rubles for dollars, so investments in Russia are frozen. Many investors have realized big losses. BlackRock alone lost $17 billion of its investors' money.
Another example is an MSCI Russia Fund that is traded in the U.S., which invests only in Russian stocks. It is currently being liquidated, having lost 99.8% of its value this year. What if that were to happen with Chinese stocks?
Relations between the U.S. and China have become more difficult in the last few years, with several potential flashpoints. Taiwan is the biggest one, but there are several other disputed territories in the Indo-Pacific region that could trigger a conflict between the U.S. and China. If a confrontation occurs, there are various scenarios ranging from limited sanctions being placed on China to actual war between the U.S. and China. In any of these scenarios, Canadian investments in China could be at risk. The U.S. defence chiefs have warned that China could invade Taiwan in coming years. There is speculation that Xi Jinping wants the so-called recovery of Taiwan to be part of his legacy.
If China were to attempt an invasion of Taiwan, there is a strong chance that the U.S. could respond. President Biden has said that America would act, but for sure we would see sanctions. Such sanctions could see retaliation by China against foreign investors.
Many people believe that China would not risk such an attack—at least not for some years—but China may have other options to put pressure on Taiwan, such as a trade blockade. A recent report by the U.S. State Department has warned that a China blockade of Taiwan could spark $2.5 trillion in annual economic losses for the global economy. To put this into perspective, this would be larger than the global economic loss in the 2008 financial crisis, which cost the economy $2 trillion.
Again, Western sanctions would be a real possibility if this was tried, with the potential for Chinese action against foreign investors, which would damage Canadian pension funds.
Another potential trigger for Western sanctions could be if China clamps down on dissent in the country. This week there have been protests in China over the COVID lockdowns. If these escalate further or another issue arises in coming months or years, a heavy-handed response—something like the Tiananmen Square massacre in 1989—could see a Western response.
It's worth bearing in mind that a conflict between the U.S. and China at any level would likely see stock markets falling everywhere, so pension fund assets would likely be down across the board, potentially threatening the payment of pensions. Canadian pension funds could face total loss on their investments in China.
This is a major potential problem for the Canadian government. Imposing sanctions could force losses on government pension funds.
I have two recommendations.
The first is on country risk analysis. We need to know more about the size of pension fund investments in China, how they are monitored and managed, and whether investment managers fully understand the risks they are taking. Is there any regulation on disclosure? A country risk analysis should be included in the Indo-Pacific strategy.
Secondly, publicly controlled pension funds should be encouraged to avoid exposure in China.
In terms of fund tracking, there are several funds covering emerging markets in Asia, excluding China, so there is no need to hold Chinese stocks to get more emerging market exposure.
In conclusion, I would urge the committee to recognize the increasing country risk associated with investments in China and plan accordingly.
Thank you.