# U.S. SECURITIES AND EXCHANGE COMMISSION

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- **Document type:** Agency decision

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U.S. SECURITIES AND EXCHANGE COMMISSION
Division of Economic and Risk Analysis

DERA
Economic
and Risk
Outlook
S.P. KOTHARI
Director and Chief Economist
and
DERA Research Staff

JULY 15
2020

Table of Contents
Key Highlights...................................................................................................................................1
The Path of New COVID-19 Cases Is Uncertain.............................................................1
The Impact of COVID-19 Across Sectors Remains Uneven......................................1
The Recent Paths of the Economy and the Stock Market Have Diverged........2
Market Signals Suggest Sustained Low Interest Rates Going Forward.............3
Financial Market Risk Proxies Remain Elevated.......................................................... 4
Macro-Financial Overview...........................................................................................................5
Economic Fundamentals and Growth.............................................................................5
Monetary Policy and Interest Rates..................................................................................8
Financial Market Signals..................................................................................................... 12
Market Segments.......................................................................................................................... 15
Markets...................................................................................................................................... 15
Mutual Fund, ETF and Money Market Fund Investors............................................. 17
Borrowers, Securities Issuers, and Capital Formation............................................20
Spotlights........................................................................................................................................ 25
Credit Ratings, Procyclicality and Related Financial
Stability Issues: Select Observations............................................................................ 25
U.S. Investors’ Exposure to Domestic Chinese Issuers............................................ 31

The Division of Economic and Risk Analysis (DERA) advances the Commission’s statutory mission to protect
investors, maintain fair, orderly, and efficient markets, and facilitate capital formation through sound economic
analysis and rigorous data analytics. DERA engages across the entire range of the agency’s functions, including
rulemaking, examination, and enforcement. Its multi-disciplinary analyses are informed by research insights and
they rely on the knowledge of institutions and practices when examining regulatory and risk-related matters. DERA
assists the Commission in its efforts to identify, analyze, and respond to economic and market issues, including
those related to new financial products, investment and trading strategies, systemic risk, and fraud. DERA’s data
analytics work develops a variety of financial and market data analysis tools, gathers economic statistics, and
promotes data standards. DERA economists publish regularly in top peer-reviewed journals, including the Journal
of Financial Economics, the Journal of Labor Economics, and the Review of Financial Studies.
DERA Research Staff: Chandler Lutz (Lead Economist), Giulio Girardi, Chunfang Yang, Gregory Allen, Daniel
Hiltgen, Vladimir Ivanov, Andy Kim, Igor Kozhanov, and Pamela Urban.
OPA Design Team: Chris Gamboa-Onrubia, Zehra Sikandar, and Jennifer White.
Disclaimer: The SEC disclaims responsibility for any private publication or statement of any SEC employee or
Commissioner. This article expresses the authors’ views and does not necessarily reflect those of the Commission,
the Commissioners, or members of the staff. This report contains a non-exhaustive aggregation of information and
is one of several elements of the SEC’s risk and market monitoring efforts.

sec.gov/dera

Key Highlights as of June 30, 2020
U.S. Economic Activity Is Resuming Following the COVID-19 Induced Economic Slowdown:
As the rate of new confirmed U.S. COVID-19 cases fell in April and May 2020, policymakers
began a phased-in reopening of certain local economies. This reopening has allowed
economic activity to resume in the hardest hit industries, with employment recovering
slightly in these sectors. Moreover, since peak financial market distress in March 2020, the
S&P 500 increased 35% from March 23 to June 26, equity market volatility as proxied by
the VIX index fell from March highs, and credit conditions eased. Yet material uncertainties
remain: New confirmed COVID-19 cases are rising again after previously trending downwards,
unemployment remains high, and financial risk proxies, such as the VIX index and the
corporate default spread, remain elevated.

The Path of New COVID-19 Cases Is Uncertain
After Falling for Several Weeks, the Rate of New U.S.
COVID-19 Cases is Again Trending Upwards: The number
of new confirmed COVID-19 cases peaked at over 210,000
per week in April 2020 and then dropped to a weekly rate of
less than 150,000 by mid-June (Figure 1.1). Similarly, newly
reported deaths dropped to a rate below 5,000 per week
after reaching more than 15,000 per week in mid-April. The
declining rate of new COVID-19 cases and deaths allowed
policymakers to begin a phased-in reopening of certain local
economies. Yet data as of June 26 show that the number of new confirmed COVID-19 cases has risen to
a weekly rate of more than 250,000, highlighting uncertainty over the impact of COVID-19 going forward
and prompting some local and state authorities to revert or delay reopening protocols as a response.

The Impact of COVID-19 Across Sectors Remains Uneven
The Industries that Suffered the Largest Employment Losses
Through April 2020 Gained Back More Jobs as Local
Economies Began to Reopen in May: Employment in food
services, one of the hardest hit sectors in the wake of
COVID-19 public health restrictions, fell nearly 50% during
March and April 2020, compared to a 14% decline for U.S.
employment overall (Figure 1.2). In historical context, these job
losses are staggering: During the Great Recession, food service
and total employment fell by just 8.4% and 6.3%, respectively. Other industries suffering from outsized
COVID-19 impacts and severe employment losses include the leisure and hospitality and retail trade sectors.
As local economies have lifted COVID-19 related restrictions and partially resumed activity in displaced

DERA ECONOMIC AND RISK OUTLOOK | 1

sectors, the most affected industries experienced the largest job gains. Food services employment
grew 21.9% during May, compared to 1.9% for U.S. employment overall. Yet employment across
all industries remains substantially below its pre-COVID-19 levels, with overall employment down
12.5% and food services employment having fallen over 35% from January to May 2020.
The COVID-19 Economic Fallout Has
Had An Outsized Negative Effect on the
Equity Returns for the Energy, Financial,
Industrial, Transportation, and Metals
and Mining Sectors, But It Has Had a
Positive Effect on Sectors that Facilitate
Physical Distancing such as Online
Retail: Figure 1.3 proxies COVID-19
equity market impacts by sector, using
exchange-traded fund (ETF) returns
from February 10 to June 26, 2020. The
hardest hit sectors (red lines) include the
energy, financial, industrial, metals and
mining, and transportation sectors. The
energy, industrial, and metals and mining
Figure Notes: Red lines are the five industries with the lowest (most negative)
sectors have faced large demand declines,
returns from February 10 to June 26, 2020. Green lines are the top performing
while oil firms have been further impacted
industries in terms of returns from February 10 to June 26, 2020. Data source:
Datastream.
by increased price and supply competition.
Financial companies are facing uncertainty related to borrower debt service, the ability to generate
new business due to COVID-19 induced economic turmoil, and Federal Reserve mandated dividend
and share buyback restrictions intended to boost bank capital. Likewise, physical distancing is directly
reducing travel and transportation across the country. In contrast, physical distancing and remote
work have benefited companies in several sectors such as online retail, technology, and telecom.
Indeed, ETF prices for these sectors have recovered to at least their pre-pandemic levels, with an
online retail ETF gaining more than 20% from aggregate market highs in February 2020.

The Recent Paths of the Economy and the Stock
Market Have Diverged
S&P 500 Performance Increasingly Depends on the Largest Firms: The S&P 500 is a value-weighted
index that is rebalanced quarterly, meaning each company’s share in the overall index depends on
its market cap during the previous quarter. As a result, larger firms receive higher initial weights,
and better-performing firms are rewarded with increased importance in the index. Thus, when large
firms outperform smaller ones, large firms’ weight in the overall S&P 500 index soars. Indeed, Figure
1.4 documents that the relative market cap share for the 10 largest companies calculated by each
year-quarter rose from 18.1% in 2015Q1 to 27.1% in 2020Q1. Hence, larger firms have recently
outperformed smaller ones, and so the 10 largest firms’ performance is currently responsible for
about one-quarter of the overall S&P 500 returns. Moreover, the sectoral makeup of large firms may

2 | U.S. SECURITIES AND EXCHANGE COMMISSION

contribute at least in part to their recent outperformance in
2020Q1 and 2020Q2. The largest firms in the S&P 500 by
market cap are technology companies with business models
that may be well suited, at least in the near term, to cope
with the economic effects of the COVID-19 pandemic. The
health policies implemented to battle COVID-19 have altered
broader production and consumption patterns towards
remote work, internet shopping, and physical distancing—all
trends that could favor large technology companies, at least in
the short run. Moreover, the largest companies maintained strong balance sheets in the lead-up to the
pandemic, which may have allowed them to avoid seeking short-term funding during the March 2020
tightening in corporate credit markets and to position themselves for strong financial performance.
The Paths of Recent Economic Indicators and Equity Prices
Have Diverged: Although recent economic data have been
weak, with employment down 12.5% from February to
May 2020 (Figure 1.2), equity market performance coming
off recent lows in March 2020 has been notable. Figure 1.5
highlights the divergence between the real economy and the
equity market by plotting the growth in actual values and
forecasts of GDP tabulated by MarketWatch (panel A) and
the S&P 500 (panel B) from 2019Q4. GDP forecasts from
MarketWatch suggest that economic output is expected to
fall about 7.5% by 2020Q2. A rapid GDP decline of this
magnitude is unprecedented; in comparison, during the Great
Recession, GDP fell only 4% from peak to trough over a 2-year period. In contrast, the S&P 500 has
nearly recovered from its March lows, increasing 35% from March 23 to June 26. Several factors in
isolation or in combination may have contributed to the recent run-up in equity prices, including (1)
expectations of a rapid economic recovery in the latter half of 2020, as evinced by the sharp increase
in forecasted economic output (Figure 1.5, panel A); (2) COVID-19 induced increases in the frequency
of internet shopping and remote work—trends that favor large technology firms (Figure 1.3), which
constitute a substantial portion of value-weighted equity indices (Figure 1.4); (3) low expected interest
rates (Figure 1.6) that increase the present value of future profit streams; and (4) perhaps elevated
equity market purchases by retail investors.

Market Signals Suggest Sustained Low Interest
Rates Going Forward
Low Expected Short-Term Interest Rates and Unprecedented Monetary Stimulus Have Coincided
with Historically Low Interest Rates for Governments, Firms, and Households: Since the Federal
Reserve (Fed) lowered the target fed funds rate by 1.5 percentage points to a range of 0–0.25%,
futures market traders now expect the fed funds rate to stay at its zero lower bound into 2022 (Figure
1.6). These low expected interest rates reflect market participants’ expectations that the Fed will hold

DERA ECONOMIC AND RISK OUTLOOK | 3

interest rates low in both the short- and medium-term to
counter the COVID-19 induced economic slowdown. Along
with low short-term interest rates, the Fed has announced
unprecedented monetary stimulus via unlimited purchases
of U.S. Treasury and agency mortgage-backed securities
(MBS), as well as numerous facilities to provide liquidity
and further monetary stimulus in corporate credit and other
markets. Following these actions, a broader easing of credit
market conditions and perhaps concerns over the path of
the economic recovery, borrowing rates for governments,
households, and firms are now historically low (Figure 1.7).
Indeed, after spiking at the height of COVID-19 induced
economic distress, both mortgage rates and corporate bond
yields have returned to their pre-pandemic levels, with
mortgage rates reaching all-time lows. In Treasury markets,
the yield on the 10-year Treasury declined over 50 basis points
relative to early February, perhaps reflecting an investor flight
to safety as well as Fed monetary actions.

Financial Market Risk Proxies Remain Elevated
The Corporate Default Spread and the VIX Index Have
Declined from their COVID-19 Induced Highs but Have
Not Returned to their Pre-COVID-19 Levels: After spiking
during the peak of COVID-19 related financial distress in
late March, two broad proxies of financial market risk, the
corporate default spread (Baa - Aaa bond yields) and the VIX
index (equity market uncertainty) have recently fallen (Figure
1.8). The reduction in these risk proxies indicates that previous
financial market tightness and uncertainty have eased. Yet
both indices remain well above their pre-COVID-19 levels,
suggesting that material uncertainties remain.

Data Sources: Figure 1.1: The New York Times, based on reports from state and local health agencies (available at https://
github.com/nytimes/covid-19-data); and Johns Hopkins University CSSE (available at https://github.com/CSSEGISandData/
COVID-19). Figure 1.2: Bureau of Labor Statistics (BLS), retrieved from The Federal Reserve Economic Database
(FRED) (IDs: PAYEMS, CES7072200001). Figure 1.3: Datastream. Figure 1.4: Compustat and Wharton Research Data Services
(WRDS). Figure 1.5: Bureau of Economic Analysis (BEA), retrieved from FRED (ID: GDPC1), and “Marketwatch Economic
Calendar” available at https://www.marketwatch.com/economy-politics/calendar. Figure 1.6: Fed Board, retrieved from FRED
(ID: DFF), and Datastream. Figure 1.7: Moody’s, retrieved from WRDS; Freddie Mac and Fed Board, retrieved from FRED (IDs:
MORTGAGE30US, DGS10). Figure 1.8: Moody’s, retrieved from WRDS; Chicago Board Options Exchange (CBOE), retrieved from
FRED (ID: VIXCLS).

4 | U.S. SECURITIES AND EXCHANGE COMMISSION

Macro-Financial Overview
The macro-financial environment is encapsulated in three key aggregate drivers of financial
decisions: (1) economic fundamentals and growth; (2) monetary policy and the interest rate
trajectory; and (3) financial market signals and credit conditions.

Economic Fundamentals and Growth
Key Takeaway: In the wake of peak of COVID-19 related financial distress in late March,
the U.S. unemployment rate increased to 14.7% in April 2020, and economic output
declined substantially. The U.S. reached peak business cycle activity in February 2020
before entering a COVID-19 induced recession that has had outsized adverse
employment effects on the leisure and hospitality and retail trade sectors. Likewise,
consumer confidence has tumbled, and proxies for durable consumption purchases
remain weak. Economic growth is forecasted to turn positive again by 2020Q3.

The number of new confirmed COVID-19 cases peaked at over
210,000 per week in April 2020 and then dropped to a weekly
rate of less than 150,000 by mid-June (Figure 2.1). Similarly, newly
reported deaths dropped to a rate below 5,000 per week after
reaching more than 15,000 per week in mid-April. The declining
rate of new COVID-19 cases and deaths allowed policymakers to
partially reopen certain local economies. Yet data as of June 26 show
that the number of new confirmed COVID-19 cases has risen to a
weekly rate of more than 250,000, highlighting uncertainty over the
impact of COVID-19 going forward.
To fight the COVID-19 pandemic, local and federal U.S. policymakers
issued stay-at-home guidelines for nonessential workers and
encouraged physical distancing. Although health experts deemed
such actions as necessary for public health, they severely limit
everyday economic activities. Figure 2.2 plots real quarterly gross
domestic product (GDP) dating back to the Great Recession, as well
as forecasted GDP for 2020Q2–Q4 (median forecasts tabulated by
MarketWatch). While the U.S. economy was consistently expanding
at a 2–3% annual rate prior to COVID-19, during the first half of 2020 forecasters expect GDP to fall
over 7.5% from its peak in 2019Q4. Indeed, the National Bureau of Economic Research (NBER) Business
Cycle Dating Committee announced that the peak in U.S. economic activity occurred in February 2020
and that a recession began thereafter. Assuming that the economy would have otherwise grown at 2%, the
lost economic output due to the COVID-19 outbreak just through 2020Q2 will be nearly $460 billion. In
historical terms, a two-quarter GDP drop of this magnitude is unprecedented. During the Great Recession
of 2008–09, GDP from peak to trough fell only 4%.

DERA ECONOMIC AND RISK OUTLOOK | 5

As local economies reopen, the severity of the COVID-19 economic damage will hinge on how
quickly the United States and its principal trading partners can resume normal economic activity
in whole or in part. Many factors will determine the time for recovery, including frictions in labor
market search and matching, firm failures, housing and mortgage market activity, consumer
confidence and spending, as well as behavioral changes that are a direct result of the pandemic.
Indeed, the resumption of economic activity will require a recommencement of both supply and
demand. As firms restart production, households might be hesitant to venture out to consume
available output, while physical distancing practices may alter both production and consumption
patterns with cascading effects across various industries. For example, when restaurants reopen,
unless customers walk in to dine in those establishments in the same numbers or with the same
frequency as before the slowdown, economic activity will not match pre-COVID-19 levels.
Likewise, an acceleration of remote work, for example, may move production from urban
clusters to suburban areas, with geographic implications for real estate prices, local retail and
restaurant spending, as well as travel and transportation. Households may also not quickly
return to their normal pre-COVID-19 consumption patterns because of the economic fallout of
the pandemic. If severely affected consumers only slowly regain employment or if their savings
dwindled as the economy contracted, they may forego some durable purchases immediately after
the crisis. Nonetheless, forecasts as of mid-June collected by MarketWatch (see Figure 2.2) expect
the United States to register robust economic growth at an annual rate of 18% in 2020Q3 and
10% in 2020Q4, but with output remaining below pre-COVID-19 levels at year-end.
The sudden and unprecedented impact of the COVID-19 shock
immediately surfaced via the sharp rise in initial unemployment
claims, which reached over 6 million per week in late March and
early April (Figure 2.3). As local economies have reopened and
financial market stress has ameliorated, initial unemployment
claims have fallen to about 1.5 million per week but remain above
their pre-COVID-19 levels.
The substantial number of initial jobless claims corresponded with
a large reduction in total employment and a higher unemployment
rate. Figure 2.4 shows that after non-farm U.S. payrolls peaked at
about 152 million in February 2020, the U.S. subsequently lost over
22 million jobs during March and April. U.S. employment bounced
back somewhat during May, but non-farm payrolls remain 20
million off their February peak. The adverse impact of the recent
economic downturn is also seen in the sharp rise in the U.S.
unemployment rate (Figure 2.5). Following its historically low
levels in 2019 and early 2020, the unemployment rate jumped to
14.7% during April as COVID-19 induced job losses mounted. As
local economies partially reopened in May, the unemployment rate
fell slightly to 13.3% but remains at its highest rate since the Great Depression.

6 | U.S. SECURITIES AND EXCHANGE COMMISSION

COVID-19 has also impacted industries
unevenly, as seen in Figure 2.6, which
plots the growth in employment by
industry from February 2020. The
hardest hit industries (red lines) include
the traditional information (e.g., noninternet publishing, motion picture,
and non-internet broadcasting), leisure
and hospitality, mining and logging,
and retail trade sectors. Employment
growth in the leisure and hospitality
industry is especially depressed, falling
50% with little recovery to date. Because
the number employed and the number
rendered unemployed differ greatly
across industries, each industry has a
Key Figure Takeaway: The COVID-19 induced
different weight in the computation of
recession had the largest adverse employment
U.S. total employment growth. Thus, the
impacts on the information, leisure and hospitality,
classification of U.S. total employment
and retail trade industries.
growth as a bottom performing category
Figure Notes: Red lines are the 5 industries with the lowest (most negative)
in Figure 2.6 (top-left panel) means that job
total employment growth from February to May 2020. Green lines are
losses were highly concentrated in certain
the top performing industries in terms of total employment growth
from February to May, 2020. Data source: BLS, retrieved from FRED
COVID-19 affected industries that employ
(IDs: PAYEMS, USMINE, USCONS, MANEMP, USWTRADE, USTRADE,
a substantial number of people, leading to
CES4300000001, USINFO, USFIRE, USPBS, USEHS, USLAH).
larger employment declines for the United
States overall than for the median industry. The key implication is that in order for the United
States to return to full employment, employment will have to grow markedly from its current low
base in severely affected industries, the share of employment in less affected industries will have to
increase relative to the overall labor force, or a combination of the two. Policies that limit labor
market frictions along these two dimensions will speed economic recovery.
The large employment declines may have also tempered consumer
confidence and stymied durable consumption. Figure 2.7 shows
that the consumer confidence index dropped from 130 to 90, a
35% decline in the wake of the onset of the COVID-19 recession,
with no rebound to date. Similarly, motor vehicle sales, a proxy
for durable goods consumption, sank nearly 50% during February
and April, as jobs losses accumulated and as physical distancing
limited onsite shopping (Figure 2.8). Vehicle sales have recovered
partially in May, but remain substantially below their preCOVID-19 levels. Moreover, a greater reliance on remote work,
which might continue for quite some time, might permanently
dent the demand for automobiles.

DERA ECONOMIC AND RISK OUTLOOK | 7

Monetary Policy and Interest Rates
Key Takeaway: Due to COVID-19 induced financial market distress, the Fed lowered the
target range for the fed funds rate to 0–0.25% and announced unlimited purchases of
Treasury securities and agency MBS. In addition, the Fed, in conjunction with the U.S.
Treasury, initiated various liquidity and purchasing facilities targeting corporate bonds,
small-and medium-sized businesses, municipal securities, asset-backed securities (ABS),
dollar swaps, commercial paper, and repo markets, among others, to provide further
monetary stimulus and battle market illiquidity. As of June 24, 2020, the size of the
Fed’s balance sheet has already surpassed $7 trillion, with U.S. Treasuries constituting
the bulk of the purchases. In line with accommodative monetary policy and a flight
to safety, the Treasury yield curve suggests a low risk-free rate for the foreseeable
future. At the height of COVID-19 induced financial market stress, yields on a variety
of lower rated debt instruments rose as default probabilities increased and market
liquidity fell. Yet as credit conditions eased, yields across debt securities fell and credit
spreads have narrowed but remain higher than pre-pandemic levels.

As the COVID-19 pandemic unfolded, the Fed lowered the
fed funds rate initially by 50 basis points to a target range
of 1–1.25% on March 3, 2020 and then to a target range
of 0–0.25% on March 15, 2020. Figure 2.9 plots the recent
path of the fed funds rate, along with the expected fed funds
rate as implied in futures market prices. Futures traders
expect the fed funds rate to stay at its zero lower bound
into 2022; hence, the Fed’s monetary stance is expected
to remain accommodative as the economy recovers from the
COVID-19 crisis.

Note: More information and term sheets
associated with the Fed’s extraordinary monetary
policy actions can be found at https://www.
federalreserve.gov/newsevents/pressreleases/
monetary20200323b.htm.

To support market liquidity and provide monetary stimulus,
For the most recent Fed press releases,
the Fed also announced unlimited purchases of Treasuries and
see https://www.federalreserve.gov/newsevents/
pressreleases.htm.
agency MBS (both commercial and residential). These largescale asset purchases coincided with the formation of numerous facilities. The Fed programs
include facilities to support liquidity in various markets and target corporate bonds and ETFs in
the primary and secondary markets (rated BBB-/Baa3 or higher as of March 22, 2020, and BB-/
Ba3 at the time of purchase). The programs also target AAA-rated ABS backed by certain loans,
including student loans, auto loans, credit card loans, loans guaranteed by the Small Business
Administration (SBA), commercial mortgages, (leveraged) corporate loans through collateralized
loan obligations (CLOs), or related securities; money market funds; municipalities; and loans to
small- and medium-sized businesses. Fed measures also have consisted of dollar liquidity swap
lines with foreign central banks and lowering the primary credit rate to 0.25% to encourage
banks to borrow from the discount window.

8 | U.S. SECURITIES AND EXCHANGE COMMISSION

With the onset of the
pandemic, the size of the
Fed’s balance sheet rose
substantially. Figure 2.10
plots the change in Fed assets
by category from February
3 to June 24, 2020. While
total assets increased by
$2.8 trillion, the bulk of the
increase has consisted of
Treasury purchases (60%),
agency MBS purchases
Key Figure Takeaway: In response to the COVID-19 pandemic,
(20%), and central bank liquidity
the Fed has increased its balance sheet by about $2.8 trillion.
swap lines (10%). Together,
The increase in Fed assets has consisted mostly of Treasury
these three categories constitute
and agency MBS purchases as well as liquidity swaps with
90% of the total increase in
foreign central banks.
the Fed’s balance sheet. New
unconventional monetary
Figure Data Source: Fed Board
policy tools, such as the purchase
of corporate bonds (“Corporate Credit Facilities”), make up a relatively tiny portion of Fed assets to date.
However, the mere announcement of such Fed programs can have a large impact on markets, even if
purchases have yet to materialize.
While the recent asset
purchases are sizable,
Figure 2.11 places the data
in historical perspective by
showing data going back to
the Great Recession. Following
the Great Recession, Fed
assets grew from just under $1
trillion to approximately $4.5
trillion, an addition of $3.5
trillion, which is larger both
in absolute and relative terms
Figure Data Source: Fed Board, retrieved from FRED (IDs: WALCL, TREAST,
WSHOMCB, WORAL).
than the Fed’s recent actions.
Also, in response to the housing crash and Great Recession, the Fed purchased both MBS and Treasuries in
large numbers, whereas during the response to the current COVID-19 pandemic the increase in Fed assets
has been due mostly to Treasury purchases. As the economic effects of the COVID-19 crisis linger, the Fed
may further increase asset purchases. Indeed, the former head of the New York Fed, Bill Dudley, speculated
that the size of the Fed’s balance sheet may reach $10 trillion by the end of 2020.

DERA ECONOMIC AND RISK OUTLOOK | 9

Despite the recent Fed stimulus, inflation expectations have plummeted. To provide historical
context, Figure 2.12A shows that the core inflation rate rarely reached the Fed’s symmetric 2%
inflation target over the last decade, with the annual inflation rate falling to just 1% in April
2020. Figure 2.12B plots inflation expectations over the next 5 and 10 years from a given point
in time computed from Treasury nominal and inflation protected securities. The graph documents
that prior to the crisis the expected inflation rate typically fluctuated between 1.3% and 2.1%.
However, with the onset of the pandemic, inflation expectations sank; as of April 2020 market
participants expected an average annual inflation rate below 1% over the following 5 years. Since
then, expected inflation has rebounded somewhat, but the anticipated annual inflation rate over
the next 10 years still remains well below the Fed’s 2% target.

Key Figure Takeaway: Following the COVID-19 outbreak, inflation expectations
have declined sharply.
Figure Data Source and Notes: U.S. Treasury, retrieved from FRED (IDs: PCEPILFE, T5YIE, T10YIE). Breakeven inflation rates are
computed from Treasury Inflation-Protected Securities (TIPS) and Nominal Treasury Securities.

The dramatic decline in economic
activity after the COVID-19 outbreak,
the Fed’s large monetary stimulus,
and diminished inflation expectations,
coupled with perhaps an elevated
demand for U.S. Treasury securities,
collectively presage exceptionally
low U.S. Treasury interest rates. Figure
2.13 plots the current yield curve for
U.S. Treasury securities (blue line)
versus its average over the past 10 years
(red line) by maturity horizon. Not only
are rates historically low at the short
end of the yield curve (e.g., for shortterm securities), but they are also low
for longer maturities. Long-term yields

Figure Notes: The blue line is the current Treasury yield curve; the red line
represents the past 10-year average, computed by taking the mean by each
maturity date. For more on Term Premia, see newyorkfed.org/research/data_
indicators/term_premia.html.
Figure Data Source: U.S. Treasury, retrieved from FRED (IDs: DGS1MO, DGS3MO,
DGS6MO, DGS1, DGS2, DGS3, DGS5, DGS7, DGS10).

10 | U.S. SECURITIES AND EXCHANGE COMMISSION

comprise the current short-term rate plus the sum of market participants’ expectations of future
interest rate changes, as well as a term premium (the additional interest that investors demand
in exchange for being locked into a longer-term bond rather than just continuously investing in
short-term bonds). The relatively flat current yield curve suggests that the term premium and
investors’ expectations of future interest rate increases are low.
Although Treasury yields have fallen to historic lows, interest rates
on other assets have not all experienced comparable declines. The
likely reason is that credit risk has risen because of diminished
economic activity following the slowdown. Figure 2.14 documents
that yields on Baa-rated corporate bonds increased beginning in
late March, likely because of elevated default probabilities. From
there, Baa yields fell as market credit conditions loosened and the
Fed, along with Treasury, announced corporate credit liquidity
facilities. Yet the spread between Baa yields and Treasuries remains
well above pre-pandemic levels, congruent with lingering credit
risks. Likewise, Figure 2.15 plots the average 30-year U.S. mortgage
rate and its spread relative to the 10-year Treasury. The 30-year
mortgage rate has declined from about 3.5% in mid-February to
just over 3% in the most recent data.
Mortgage rates represent a key link between financial markets and the real economy, as a
decline in mortgage rates spurs mortgage refinance and purchase activity that often translates
into durable consumption purchases and follow-on real economic activity. While mortgage rates
have fallen, the spread between the average 30-year mortgage rate and the 10-year Treasury
yield jumped more than one-half of a percentage point between February 15 and April 1. This
increase in the spread between the mortgage rate and the Treasury yield is due in part to a glut of
mortgage refinance demand immediately after rates declined and greater uncertainty about the
employment prospects for many mortgagees. In addition, a lack of financial market liquidity also
likely contributed to higher borrowing costs, at least initially following the pandemic outbreak,
across a number of debt instruments, including MBS. Following Fed announcements of further
large-scale purchases of agency MBS and a broader easing of credit conditions, the mortgage-rate
Treasury spread has fallen modestly but is still about a half percentage point above its preCOVID-19 levels.

DERA ECONOMIC AND RISK OUTLOOK | 11

Financial Market Signals
Key Takeaway: In mid-March 2020, at the peak of COVID-19 financial market distress,
the VIX equity market volatility and uncertainty index reached levels last seen during
the Great Recession of 2008-09. The VIX has retreated since then, but remains at
elevated levels. Similarly, the corporate default spread (Baa – Aaa yields), a broad credit
market risk proxy, rose sharply before trending downwards beginning in mid-April, as
credit conditions eased. Yet the corporate default spread remains well above its preCOVID-19 levels. The corresponding higher interest rates for lower rated bonds reflect
higher expected default probabilities from the perspective of bond market investors, but
also perhaps market illiquidity. Indeed, credit ratings downgrades increased substantially
in March 2020, but the pace of downgrades slowed markedly during 2020Q2.

The impact of the COVID19 pandemic on financial
markets is apparent in the
path of the VIX volatility
index. During the height of
COVID-19 induced financial
market stress in mid-March,
the VIX reached values
Key Figure Takeaway: The VIX Index reached levels last
around 80, corresponding
seen during the Great Recession, suggesting high levels of
to historical highs last seen
uncertainty over expected economic output and firm profits,
during the Great Recession
but recently it has retreated.
(Figure 2.16A). These peak
VIX realizations signaled
Figure Data Source: Chicago Board Options Exchange, retrieved from FRED (ID: VIXCLS).
extreme investor uncertainty
about firms’ future profits and economic output related to the COVID-19 recession. Recently,
uncertainty proxied by the VIX index has retreated (Figure 2.16B), owing to fiscal and monetary
stimulus, as well as hopes that the total duration of the COVID-19 pandemic might not be
too long. However, current
VIX realizations are higher
than pre-pandemic values,
suggesting that material
uncertainties remain.
Figure 2.17 plots the corporate
default spread, Baa – Aaa
corporate bond yields, an
aggregate proxy of credit
risk in the corporate bond
market. After the onset of the
COVID-19 crisis, corporate

Key Figure Takeaway: The corporate default spread (Baa –
Aaa corporate bond yields) increased in the wake of
COVID-19 induced financial market stress but has not reached
levels last seen during the Great Recession.
Figure Data Source: Moody’s, retrieved from WRDS.

12 | U.S. SECURITIES AND EXCHANGE COMMISSION

default spreads rose sharply in March, meaning that yields on lower rated corporate debt increased
relative to those on higher rated bonds. This widening credit spread was due largely to increased
default probabilities on lower rated corporate debt. Specifically, as economic activity faltered with
the COVID-19 slowdown, investors feared that various income streams might dry up and firms
might find it difficult to refinance their debt obligations. These factors make debt service difficult
and costly, boosting the likelihood that a borrower may miss a payment and subsequently default.
Figure 2.17A also shows that while the recent rise in the corporate default spread is notable,
current values remain well below those seen during the Great Recession and perhaps suggest credit
markets are less strained than in 2008-09. Figure 2.17B plots the recent path of the corporate
default spread. Like the VIX index (Figure 2.16B), the corporate default spread fell in mid-April.
This trend reversal in the corporate default spread tracks various Fed announcements regarding
liquidity facilities, suggesting that credit conditions ameliorated with Fed actions along with
a broader reduction of financial market stress. Yet Figure 2.17 also shows that the corporate
default spread remains above pre-COVID-19 levels and thus that material credit risks or material
uncertainties persist. Indeed, investors may expect lower rated corporate borrowers to struggle
to service and repay debt in the upcoming months, relative to higher rated borrowers, as the
economic fallout from the COVID-19 recession unfolds.
The economic downturn has affected credit ratings that reflect
long-term views on the credit quality of fixed income instruments
(rating through the cycle). Credit rating agencies, which are
important intermediaries in providing information in securities
markets, started to change their views in March 2020, in response
to rapidly changing economic conditions. As recently as February
2020, rating agencies anticipated a modest slowdown with a low
recession likelihood. However, the events of March 2020 have
changed their views. As shown in Figure 2.18, rating agencies lowered U.S. corporate debt issuers’
ratings at a rapid clip following COVID-19 induced financial market distress. As credit conditions
improved, the pace of downgrades slowed. Yet downgrades still outnumbered upgrades as of June
1, perhaps indicating continued uncertainty as regards borrower debt service going forward.
The probability of debt default also varies across sectors. Figure 2.19 plots the change in prices for
credit default swaps (CDS) from February 1, 2020, by category. CDS prices, often referred to as
spreads and quoted in basis points, track the cost to insure an entity’s debt against future default.
Thus, a CDS spread of 200 basis points indicates that the cost to insure $100 million dollars of
debt would cost $2 million per year (100 * 0.02). Broadly, rising CDS spreads signal
increased expectations in the probability of default.

DERA ECONOMIC AND RISK OUTLOOK | 13

While CDS spreads have increased across
a wide range of entities, the magnitude
of these changes varies starkly across
the categories listed in Figure 2.19. The
categories with the largest increases in
CDS spreads and hence expected default
probabilities (red lines) are those of
sectors whose future revenue streams
may be most threatened by the economic
fallout from the COVID-19 recession.
The most affected debt instruments
emanate from emerging markets and
developing sovereigns, as well as the
oil and gas industry. Other entities
experiencing an increase in expected
default probabilities span the consumer
cyclical industry, financial firms, along
with U.S. states, counties, and cities.

Key Figure Takeaway: The COVID-19 induced
recession has greatly increased expected default
probabilities for emerging market and sovereign
debt, the oil and gas industry, and consumer
cyclical sectors.
Figure Notes: Red lines are the five categories with the largest (most positive)
CDS price changes from February 1 to June 24, 2020. Green lines are the top
performing categories in terms of total price change (lowest price change)
from February 1 to June 24, 2020. Data source: S&P Capital.

Data Sources Not Previously Mentioned: Figure 2.3: U.S. Employment and Training Administration, retrieved from FRED (ID:
ICSA); Figure 2.4: BLS, retrieved from FRED (ID: PAYEMS); Figure 2.5: BLS, retrieved from FRED (ID: UNRATE); Figure 2.7:
Datastream; Figure 2.8: Bureau of Economic Analysis (BEA), retrieved from FRED (ID: TOTALSA); Figure 2.15: Freddie Mac, and
Fed Board retrieved from FRED (IDs: MORTGAGE30US, DGS10); Figure 2.18: Refinitiv DataScope.

14 | U.S. SECURITIES AND EXCHANGE COMMISSION

Market Segments
The U.S. Securities and Exchange Commission’s mission is to protect investors, maintain
fair, orderly, and efficient markets, and facilitate capital formation. Below we examine the
underpinnings of economic growth through the lens of these three mission areas and study
(1) markets; (2) investors; and (3) borrowers, securities issuers, and other entities that raise
capital. The chart below illustrates the interlinkages between these three segments.

Markets
Key Takeaway: Because of the COVID-19 pandemic, key equity indices plunged
between 30-40% from January to March 2020. Investor expectations of weak
corporate earnings following the COVID-19 induced economic slowdown likely led to
this fall in equity prices. Then the S&P 500 nearly recovered from March lows, while
indices of smaller companies have underperformed. In fixed income markets,
AAA-rated corporate securities have outperformed other lower rated bonds, where
the yields on AAA-rated securities are below their pre-pandemic levels. Yields on
non-investment grade debt have climbed substantially during the period of COVID-19
induced financial market distress, likely reflecting investor concerns over increased
default probabilities, but also perhaps market illiquidity. Recently, yields on lower rated
debt have fallen but spreads relative to higher rated securities remain elevated, perhaps
indicating that investors are identifying material risks among these borrowers.

Asset Values
After a historically long bull market, equity market prices fell sharply
in the immediate wake of the COVID-19 induced economic recession. Figure 3.1 plots equity returns from January 2020 for the S&P
500 and the Russell 2000, an equity index of smaller companies.
Both the S&P 500 and the Russell 2000 fell in late February as investors increasingly anticipated a decline in economic activity that would
ultimately depress corporate profits. Thus, valuations as measured by
the cyclically adjusted price-to-earnings ratio (CAPE) fell relative to
historical earnings but remained higher than they were at the depths
of the Great Recession (Figure 3.2). By mid-March, the S&P 500 had
fallen over 30%. In comparison, the Russell 2000 declined nearly
40%, coinciding with COVID-19’s likely outsized impact on the

DERA ECONOMIC AND RISK OUTLOOK | 15

often more volatile income and revenue streams of smaller companies. By June, the S&P 500 nearly
fully recovered from its earlier lows, while as of July 1 the Russell 2000 index remains 14.3% below its
January 1, 2020 level. As noted in our Key Highlights section, the relative outperformance of the S&P
500 may be related to the outperformance of large technology firms that constitute a notable share of
the S&P 500 index and the strong financial position of large firms in the lead up to the pandemic.
For fixed income markets, Figure 3.3 displays total bond market returns and yields by credit rating.
First, Figure 3.3A shows that bonds across asset classes have appreciated considerably since 2010,
coinciding with a broad decline in interest rates. In particular, lower rated B and CCC (or lower) bonds
nearly doubled in value before the COVID-19 outbreak. However, lower rated bond prices are more
volatile, as seen by the large drops in late 2011, 2016, 2018, and, most recently, in 2020. Because of
an expected decline in economic activity due to the COVID-19 slowdown and thus increasing credit
risk concerns and default probabilities, total returns on the lower rated B and CCC bonds fell between
15% and 25% by mid-March (Figure 3.3B). These credit risk concerns likely outweighed a broader
decline in the risk free interest rate (e.g., U.S. Treasuries). Indeed, the poor returns for lower rated
securities through March coincide with a spike in yields (Figures 3.3C and 3.3D) that began to abate
in April 2020. Yet yields on lower rated securities remain elevated, especially compared to the recent
declines in higher rated bonds. The high yields on lower rated bonds signal that investors likely expect
a greater incidence of defaults for lower rated debt, but diminished liquidity may have also impacted
interest rates immediately following COVID-19 induced financial distress in late March and early
April. Conversely, AAA-rated bonds have outperformed and, as of June 26, their yields were about
one percentage point below their pre-COVID-19 levels in early January 2020. The combination of
persistently high yields for lower rated bonds but declining interest rates on higher rated debt translates
into wide credit spreads between lower and higher rated securities. These wide credit spreads may
signal higher than usual default risks for lower rated debt. Last, while BBB-rated corporate bonds
experienced a drop in total returns and an uptick in yields, the changes are relatively smaller than those
for lower rated debt. Yields on BBB-rated bonds returned to their pre-COVID-19 levels as of June 26.

16 | U.S. SECURITIES AND EXCHANGE COMMISSION

Mutual Fund, ETF and Money Market Fund Investors
Key Takeaway: With COVID-19 induced financial market volatility, investors
increasingly moved assets away from bond and equity market investments, including
those held through mutual funds and ETFs, and into assets like cash and money
market funds backed by U.S. government agency or Treasury securities beginning in
March 2020. Then, as credit conditions eased and the Fed implemented unprecedented
monetary stimulus, investments returned, particularly into taxable bond funds, though
total net fund flows for 2020 remain negative for both equity and taxable bond funds
as of June 16, 2020.

Figure 3.4 presents weekly
net fund flows into select
classes of mutual funds and
ETFs from January 7 to
June 16, 2020. Prior to the
COVID-19 pandemic, there
were substantial fund inflows
into taxable and municipal
bond funds, outflows
from domestic equity funds,
and slight inflows into commodity funds. Then as
the COVID-19 pandemic
unfolded and the corresponding economic
slowdown became imminent,
investors in net redeemed assets
from both bond and domestic
equity markets.

Key Figure Takeaway: Both equity and bond funds experienced
outflows following COVID-19 induced financial market stress.
However, capital flowed back into funds, particularly taxable
bond funds, which had seen the most significant decrease, as
credit conditions eased and the Fed expanded its various

monetary policy and liquidity programs.
Net withdrawals from equity
funds following COVID-19
Figure Data Source: Investment Company Institute (ICI), retrieved from Datastream.
induced financial market distress
Other Notes: Taxable bonds include, for example, corporate bonds. ETFs sell large
continue a longer-term trend.
blocks of shares to redeem them from authorized participants, who may transact on
their own behalf or act as agent for others, while individual ETF shares trade on the
In contrast, taxable bond funds
secondary market.
experienced sizable inflows until
late February 2020. Then, investors withdrew approximately $300 billion from taxable bond
funds, as default probabilities increased for lower rated bonds and as investors may have sought
to increase their cash positions. Investors’ preference to move assets away from this market may
have resulted in their selling bonds held directly. Outflows may have also indirectly prompted
funds to sell assets in response to redemption requests. This trend, however, reversed beginning
in April as credit market stress attenuated and as the Fed, in conjunction with the Treasury,

DERA ECONOMIC AND RISK OUTLOOK | 17

announced corporate bond liquidity facilities. Indeed, net fund flows into taxable bond funds
increased by about $130 billion from mid-April to mid-June 2020. A similar, albeit muted trend
occurred in municipal bond funds.

Money Market Funds
A money market fund (MMF) is a type of mutual fund that invests in short-term, high quality
debt securities. Investors in the main categories of MMFs (prime, Treasury and government
agency), which invest in different asset types, react differently to changing market conditions.
For example, at the height of the Great Recession, dollars flowed out of institutional prime
MMFs and into institutional Treasury MMFs, while retail prime MMFs saw comparatively little
outflows. In March, COVID-19 induced financial market dislocation also, broadly speaking, saw
an initial period during which institutional prime MMFs saw outflows while Treasury MMFs
saw inflows, as described below.
Indeed, as the COVID-19 economic slowdown began and financial conditions worsened, prime
MMFs, which invest in assets such as commercial paper as well as certificates of deposits, saw
aggregated outflows of $160 billion ($120 billion from institutional prime MMFs) from March 9
to April 3. In contrast, net inflows into Treasury and government agency MMFs during this same
period exceeded $800 billion.
Furthermore, in response
to deteriorating liquidity
conditions in short-term
funding markets, the Fed
also created three liquidity
facilities, including the
Money Market Mutual
Fund Liquidity Facility
(MMLF) on March 18,
which makes available
funding to U.S. depository
institutions and bank
holding companies to
finance their purchases of
certain types of assets from
money market mutual funds
under certain conditions.
The MMLF helped support
liquidity in the markets for the
assets held by money market
mutual funds. As of June
30, only around $20 billion
in MMLF loans remained

Key Figure Takeaway: Since March 2020, net asset inflows
to government agency and Treasury money market funds
have stabilized, while net outflows from prime institutional
money market funds reversed.
Figure Data Source: Crane Data
Other Notes: Government money market funds invest in securities such as government
agency debt. Prime money market funds invest in a broad range of short-term, high
quality debt securities, such as commercial paper issued by corporations.

18 | U.S. SECURITIES AND EXCHANGE COMMISSION

outstanding, down from $51 billion on April 14. Prime MMFs reduced their holdings of
commercial paper and certificates of deposits from 56% of their portfolio in February to 44%
in May and increased their holdings of Treasury securities. In mid-April, investors started to
return to prime MMFs, and so aggregate AUM of prime MMFs as of May 21 exceeds the
pre-pandemic levels seen in March.
After 2 months of rapid inflows, the size of the MMF industry as a whole peaked at the end
of May with $5.2 trillion in AUM, but then new headwinds started to emerge for MMFs.
After the Fed’s March interest rate cuts, the net yields for MMFs and short-term Treasury
yields are near zero in June, as seen in Figure 3.6, while the equity market indices such as the
S&P 500, for example, have rallied, recovering most of their March losses as the broader credit
conditions eased. Although media reports speculated that investors pulled approximately $100
billion from Treasury and government MMFs in June for possibly higher yielding securities,
most of the inflows since remain, which may signal continued market uncertainty surrounding
the COVID-19 pandemic.
Operationally, the volatile flows and the low interest rate environment for MMFs have had
several consequences. First, a few Treasury MMF advisers have temporarily closed their funds
to new investors since cash received from new investors would be invested in lower yielding
securities, reducing further a fund’s yield. Second, some prime institutional MMF advisers have
decided to liquidate their funds, citing shrinking assets and investors fleeing during times of
stress. Third, advisers are beginning to waive fees to keep net yields at zero or positive.
The average expense ratio in 2019
was 0.25%, which is higher than
the current yields on many eligible
MMFs securities. According to
the Investment Company Institute
(ICI), aggregated fee waivers
for MMFs peaked in 2014 at
$6.3 billion at the end of the
low interest rate environment
after the Great Recession, only
to fall to $1.2 billion in 2019 as
interest rates increased. Lastly,
some advisers to Treasury and
Key Figure Takeaway: Taxable MMF net yields have fallen
government MMFs, which have
to near zero. Short-term Treasury yields briefly went
stable NAVs, may be thinking
negative in March.
about how their funds would
operate in an environment where
Figure Data Source: Fed Board, retrieved from FRED (IDs: DTB3, DTB4WK)
interest rates go negative, as they
and Crane Data.
did briefly in March (Figure 3.6).
Other Notes: MMF net yields are 7-day SEC yields.

DERA ECONOMIC AND RISK OUTLOOK | 19

Borrowers, Securities Issuers, and Capital Formation
Key Takeaway: Money in bond markets flowed to the industries hardest hit by the
COVID-19 downturn and also to the safest and financially strongest borrowers within
each industry. These patterns are consistent with increases in corporate demands for
precautionary savings, increases in borrowing among financially healthy firms to obtain
cash to make future transactions, and increases in investors’ demands for safe lending
opportunities. In equity markets, established firms whose stock prices had been the
least negatively affected by the downturn rushed to raise funds in seasoned equity
offerings (SEOs). Markets for initial public offerings (IPOs) were relatively quiet.

U.S. Corporate Bond Issuance
Corporate demand for cash increased substantially in the first quarter of 2020, especially among
firms in the industries hit hardest by the pandemic-related disruption and among firms that were
financially strong before the pandemic. In the first 5 months of 2020, public corporations issued
bonds at nearly twice the pace of 2019, with more than 80% of that activity occurring from
March to June. During the first quarter of 2020, the cash holdings of nonfinancial corporations
also increased at the fastest year-over-year rate since 2010.
One important motivation for holding cash is precaution—having rainy day savings in case of
unexpected increases in expenses or decreases in revenues. Accordingly, the data show that more
bonds were issued by the industries most exposed to the pandemic. The following figures plot
the total amount of bonds issued during 2020, by industry, against two stock market measures
of each industry’s exposure to the pandemic. The first measure is the industry’s stock return from
March to mid-June, which captures investors’ beliefs after about 16 weeks of learning about the
risks of COVID-19 in general and the possible risks specifically with respect to particular industries. The second measure is the industry’s stock return during the initial market downturn from
February 19 to March 23, 2020, when the S&P 500 lost more than one-third of its value. This
measure captures investors’ initial reaction to the COVID-19 outbreak.

Figure Data Source and Notes: Data are from S&P Capital IQ. Data points are computed for two-digit SIC industry codes, and
industry stock returns are value-weighted.

20 | U.S. SECURITIES AND EXCHANGE COMMISSION

Figure 3.7A plots bond issuance during 2020 by stock price performance over the longer period.
Stock prices in the real estate industry fell 17% between March and mid-June, and the industry
issued bonds equal to 18% of enterprise value, or the value of debt plus equity. In contrast, miscellaneous retail—including drug stores, liquor stores, and stores selling books, jewelry, and sporting goods—enjoyed a 36% stock price appreciation and sold bonds equal to less than 0.25% of
enterprise value.
Figure 3.7B plots issuance during 2020 by stock price performance during the initial downturn.
Real estate stocks lost more than 50% of market value over this period and issued the most bonds
relative to total enterprise value. In contrast, grocery store stock prices were flat, and this sector’s
issuance amounted to only 1.1% of enterprise value.
During times of uncertainty, investors generally prefer to lend to safe borrowers in what is known
as flight to quality. Figure 3.8A shows that within each of six major industry groups, firms with
investment-grade ratings (BBB- or higher) raised much more money in bond markets than firms
with speculative-grade ratings or no rating.

Figure Data Source and Notes: Data are from Capital IQ. Credit ratings are current as of bond issuance date, and market-to-book
ratios are computed at the end of calendar year 2019.

Along with credit rating, another characteristic associated with firm quality is a firm’s marketto-book ratio, or the ratio of the market value of assets to the book value of assets. A high value
means investors consider the firm to be worth much more than accounting statements reflect,
possibly because important assets do not appear on accounting statements or because investors
believe the firm will grow faster in the future than other firms. Figure 3.8B shows that firms with
higher market-to-book values issued more bonds than lower market-to-book firms in all industries except finance/insurance, where low market-to-book firms issued slightly more.

DERA ECONOMIC AND RISK OUTLOOK | 21

A second important motivation for holding cash is having it available for transactions, such as
acquisitions or share buybacks. Cash (internal capital) is often a faster and easier way of making
transactions than borrowing (external capital) or using other forms of payment (like stock shares).
A firm may believe that if a wave of bankruptcies is indeed coming, then many corporate assets
will be available for purchase or acquisition. Building up cash is one way that a firm can prepare to
acquire these assets. Figures 3.8A and 3.8B are also in line with this motivation, as they show the
firms most likely to be buyers in the future (that is, financially strong firms) raising more debt in
bond markets than the firms most likely to be sellers (that is, financially weak firms).
Between December 31, 2019 and March 31, 2020, U.S. corporations raised money in public bond
markets at the fastest rate in a decade. Patterns in the data suggest that the surge in borrowing was
related to both changes in firms’ demand for cash and changes in investors’ demand for safe lending opportunities.

U.S. Equity Issuance
Equity markets also witnessed a surge in issues, perhaps as firms saw a need for cash to cope with
the pandemic-induced slowdown. From May 1 to June 26, 2020, U.S. corporations raised more
funds in SEOs than in the previous 10 months combined (Figure 3.9A). This increase in fundraising
activity was confined to firms with which investors are already familiar (via SEOs), as IPO markets
were relatively quiet (Figure 3.9B), with the possible exception of June 2020.

Figure Data Source: Capital IQ

While firms with negative stock returns during the pandemic were more likely to issue bonds, the
opposite was true for SEOs. Firms were less likely to raise money by issuing stock after their share
price fell, possibly because managers believed their stock was undervalued. These firms may have
chosen to raise capital in bond markets instead of equity markets (Figures 3.7A and 3.7B). Figure
3.10A plots firm-level SEOs during May and June by stock-price performance from February 19
to April 30, 2020. Figure 3.10B plots SEOs by stock price performance during the initial market
downturn from February 19 to March 23. In both figures, SEO amounts are scaled by the firm’s
market capitalization as of December 31, 2019, in order to make data points comparable.

22 | U.S. SECURITIES AND EXCHANGE COMMISSION

Figure Data Source: Capital IQ.

The regression line is positively sloped in both figures, especially in Figure 3.10B. This indicates
that firms were less likely to raise cash by selling stock when their share prices had been depressed.

Data Sources Not Previously Mentioned: Figure 3.1: Datastream. Figure 3.2: Datastream. Figure 3.3: Ice Data Indices, LLC,
retrieved from FRED (IDs: BAMLCC0A1AAATRIV, BAMLCC0A3ATRIV, BAMLCC0A4BBBTRIV, BAMLHYH0A1BBTRIV,
BAMLHYH0A2BTRIV, BAMLHYH0A3CMTRIV, BAMLC0A1CAAAEY, BAMLC0A3CAEY, BAMLC0A4CBBBEY, BAMLH0A1HYBBEY,
BAMLH0A2HYBEY, BAMLH0A3HYCEY.

DERA ECONOMIC AND RISK OUTLOOK | 23

Spotlights
Credit Ratings, Procyclicality and Related Financial
Stability Issues: Select Observations
COVID-19 Market Monitoring Group*
July 15, 2020
On April 24, the SEC announced the formation of an internal, interdisciplinary COVID-19 Market
Monitoring Group.1 This temporary, senior-level group was formed to assist the Commission and
its various divisions and offices in (1) developing Commission and staff analyses and actions related
to the effects of COVID-19 on markets, issuers and investors—including in particular our longterm Main Street investors, and (2) responding to requests for information, analyses and assistance
from fellow regulators and other public sector partners on market matters arising from the effects
of COVID-19.
One of the COVID-19 Market Monitoring Group’s initial initiatives2 has been the exploration
of whether credit assessments and credit rating agency downgrades—and market anticipation of,
and responses to, those ratings actions—may (1) contribute to negative procyclicality in certain
circumstances and (2) have implications for financial stability. The interrelationships between
ratings actions, procyclicality and financial stability is a topic that other members of the global
financial regulatory community are also examining,3 and we have benefitted from our ongoing
coordination and sharing of analysis and observations with them.
While our work on this topic—and more broadly, other issues relating to COVID-19’s effects on
markets, issuers and investors—is ongoing, we have several initial observations concerning ratings
actions, procyclicality and financial stability issues that we believe would be helpful to share with
the public. Specifically, and as discussed in more detail further below, our initial observations are:
1. Analysis of potential effects of ratings actions should focus on current circumstances. Given
the idiosyncratic nature of the health and economic effects and consequences of COVID-19,
we believe that analogies to the role of rating agencies in the 2008 global financial crisis should
be approached with caution. We note that, in addition to substantially differing economic
conditions and stresses, the relevant analytical assumptions and methodologies used by rating
agencies in that period also were substantially different.
2. Cost of debt capital is driven by a wide range of financial and non-financial factors and forces;
ratings downgrades are generally lagging indicators of cost of debt capital.
3. Observable bunching just above and below the investment grade level may be attributable to
various macroeconomic trends, including policy, regulatory and investor choices.

DERA ECONOMIC AND RISK OUTLOOK | 25

4. When considering the effects of credit ratings on market structure, including potential
procyclicality of ratings downgrades, it is important to take into account the wide and diverse
spectrum of our credit markets and all major credit market participant types.
5. The procyclical effects of credit ratings used in bilateral specialty finance also are appropriate
areas for continued monitoring.
We welcome information, data and comments from market participants and members of the
general public—both on this specific topic and other matters and issues relating to COVID19’s effects on our capital markets. Submissions can be made by email to COVID-19.Market.
Monitoring.Group@sec.gov.

1. Analysis of potential effects of ratings actions should focus on current circumstances. Given
the idiosyncratic nature of the health and economic effects and consequences of COVID-19,
we believe that analogies to the role of rating agencies in the 2008 global financial crisis should
be approached with caution. We note that, in addition to substantially differing economic
conditions and stresses, the relevant analytical assumptions and methodologies used by rating
agencies in that period also were substantially different.
In response to the broad and varied effects and unparalleled response to COVID-19, rating agencies
have made, and continue to make, adjustments to the analytical assumptions and other inputs that
they use when assigning and maintaining ratings. This includes, for example, adjusting the baseline
macroeconomic scenarios and sector outlooks that their models and analysts apply, as well as
modifying other key qualitative and quantitative assumptions used in their methodologies. Also,
speaking more generally, rating agency models and methodologies—as well as the marketplace’s use
of ratings—have evolved significantly in the years following the 2008 global financial crisis.
In light of these differing factors and changes, as well as the significant post-financial crisis changes
to the marketplace itself and the regulatory scheme governing ratings and financial services
generally, we believe that analogies to the 2008 global financial crisis era—including the analytical
assumptions and methodologies rating agencies used in that period—should be approached with
caution and, in themselves, are not likely to provide useful decision-oriented analyses or insights.
In our view, it is a more effective use of regulatory resources to focus, in the first instance, on (1)
identifying and understanding the policies, procedures, methodologies and practices of rating
agencies today (including the economic forecasts and assumptions applied) and (2) the ways in
which all significant classes of investors and other market participants use ratings in their asset
allocation, credit provision and other decisions.
When exploring the role of credit ratings in today’s market structure, including potential regulatory
actions, it is important to understand a key aspect of the U.S. legal and regulatory construct.

26 | U.S. SECURITIES AND EXCHANGE COMMISSION

Congress explicitly prohibited the SEC and the states from regulating the substance of credit
ratings or the procedures and methodologies by which they are determined.4 The statute and
rules applicable to SEC-registered rating agencies require rating agencies to establish, maintain,
enforce, and document an effective internal control structure governing the implementation of and
adherence to policies, procedures and methodologies for determining credit ratings, and provide the
SEC staff with authority to examine rating agencies’ compliance with such provisions. Operating
within this framework, the SEC staff has focused its recent efforts in this area on, among other
things: (1) understanding how rating agencies are responding to the economic effects of COVID-19,
including monitoring ratings actions and related public disclosures to understand the overall
market impact of the actions, and (2) examining rating agencies’ adherence to their own policies,
procedures and methodologies for determining credit ratings.
2. Cost of debt capital is driven by a wide range of financial and non-financial factors and forces;
ratings downgrades are generally lagging indicators of cost of debt capital.
We have observed in discussions with other regulators, that there are perceptions that the
procyclical effects of increases in the cost of debt capital are the result of ratings downgrades. This
is unlikely to be a strong or dominant causal relationship in, for example, the bank lending or
the new issue bond market. A firm or issuer’s cost of debt capital—be it through bank/non-bank
financing and/or debt capital markets—is driven by a wide array of geopolitical, economic and
credit conditions and other industry- and firm-specific factors. Rating agency actions—including
(1) changes in rating outlook, (2) placement on or changes in “watch” status and (3) changes in
ratings—are generally lagging indicators of cost of debt capital.
Generally speaking, before a rating downgrade occurs, market participants observe—and take
into account by commanding (generally) higher credit spreads—the relevant conditions and
circumstances that eventually contribute to the ratings action—e.g., (1) broad conditions and
factors, such as the state of the business climate and credit markets, the regulatory environment, and
the competitive landscape affecting the firm or its industry, and (2) firm-specific information and
circumstances, such as the demand for the firm’s goods and services, as well as the entity’s growth
prospects, asset quality, funding and profitability, and management approach—some of which is
commonly available in public financial statements and regulatory filings.
Indeed, most of the credit spread widening for downgraded issuers occurs before the downgrade.5
As the Coronavirus spread globally in early 2020, the cost of debt capital for many companies shot
up, as the marketplace observed the virus’ effects on economic activity—before the rating agencies
began to drop companies’ ratings.
We do, however, recognize that in certain circumstances an adverse ratings action may have some
negative effects on the cost of debt capital. For example, in the case of collateral-based financing
such as a receivables facility, if the ratings of the borrower or the entities that owe the borrower
the receivables is downgraded, additional collateral may be required which would increase the
borrower’s cost of capital. In addition, while we would expect the market to anticipate the ratings

DERA ECONOMIC AND RISK OUTLOOK | 27

action and adjust accordingly, a move from investment grade to below investment grade could have
significant effect on cost of debt capital (see below for further discussion of issues related to the
potential investment grade / below investment grade discontinuity in the market).
3. Observable bunching just above and below the investment grade level may be attributable to
various macroeconomic trends, including policy, regulatory and investor choices.
There has been observable segmentation of the credit investment universe for certain types of
investors, including between investment grade and non-investment grade credits. There also has
been observable concentration of credit in the area around the line between investment grade
credit and below investment grade credit. It is important to note that this segmentation and
concentration (as well as, in some cases, a relatively significant credit spread differential between
low investment grade and high non-investment grade credits) is attributable, in large part, to
various fundamental business differences, investor demand, macroeconomic factors and monetary
and regulatory policies.
The factors that have driven this segmentation and concentration of credit in the area around the
line between investment grade credit and below investment grade credit include, among others:
(1) a market-wide recognition (and incorporation into investment strategies) of the significant
differences in historical default rates6 between the highest non-investment grade and lowest
investment grade ratings, (2) long-running accommodative monetary policy, which caused
investors to seek increased yield within their mandates and, in turn, provided corporates with the
opportunity to increase their debt financing at low absolute rates, (3) investor demand focused
on the highest yielding investment grade credits, (4) regulatory capital requirements on banks,
insurance companies and other entities that pushed lower investment grade and below investment
grade credits off regulated balance sheets and (5) investment guidelines and index investing that
themselves incorporate segregation. Over the period following the 2008 global financial crisis,
these policy positions and regulatory actions, coupled with relatively stable investor preferences,
facilitated easier and predictable credit conditions, which incentivized borrowers in various
segments to optimize their balance sheets to achieve ratings in the low investment grade range.7 This
type of balance sheet optimization may have significantly contributed to the current concentration
of credit in and immediately above (as well as immediately below) the BBB-/Baa3 categories. In
other words, examining ratings and ratings actions in isolation from these other factors is unlikely
to provide meaningful insight.
4. When considering the effects of credit ratings on market structure, including potential
procyclicality of ratings downgrades, it is important to take into account the wide and diverse
spectrum of our credit markets and all major credit market participant types.
Certain portions of our credit markets, including fixed income mutual funds and ETFs, leveraged
loans and CLOs, have grown significantly in recent years and attracted increased regulatory
attention.8 We believe that these aspects of the credit markets are worthy of continued monitoring
and examination, including in particular whether they will continue to grow in absolute and

28 | U.S. SECURITIES AND EXCHANGE COMMISSION

relative terms. Other issues that warrant monitoring in these portions of the market include where
leveraged loans and CLOs are held (i.e., who are the principal investors), the purposes for which
they are being held (e.g., long term or short term investing) and their relative credit and liquidity risk
tolerances (e.g., how willing or able are they to withstand periods of price dislocation and/or limited
liquidity). At the SEC, we are monitoring these areas, and are engaging in related inter-agency
discussions to gain a better understanding of these evolving issues.
However, when considering credit markets generally, and the extent and effects of reliance
on ratings within areas of our credit and financial markets, including procyclicality of ratings
downgrades, we believe that the broad spectrum of credit markets and institutional investor types
active in these markets must be considered—including insurance companies and pensions, among
others. For example, registered investment companies (a category that includes money market
funds and other mutual funds, as well as ETFs) account for approximately: 21% of the U.S. and
foreign corporate bonds market, 14% of the U.S. and government agency securities market, 29%
of the U.S. municipal securities market and 25% of the commercial paper market.9 Other types of
institutional investors, therefore, both individually and collectively, play a significant role in these
markets. It is only with a wide lens—that looks across all significant market participant types—that
we can collectively identify, monitor and evaluate the key trends, developments and risks across
these markets, including potential procyclical effects of credit ratings. We recognize that data
availability for these other significant market participants may be more limited but data availability
should not drive the focus of our analysis.
5. The procyclical effects of credit ratings used in bilateral specialty finance also are appropriate
areas for continued monitoring.
Many members of the global financial regulatory community have focused on the procyclicality
of investment guidelines, performance benchmarks and other rating-oriented portfolio
construction rules.10
While these areas deserve ongoing attention, we also believe that the potential procyclical effects
of credit ratings used in bilateral specialty finance also are worthy of continued monitoring.
Fundamentally, these types of financing arrangements are asset-backed and secured.
While industry has made significant strides to reduce the use of credit ratings especially in broadly
distributed asset-backed financing deals,11 some types of bilateral financing, short term funding and
supply chain financing arrangements continue to rely in various ways on credit ratings, at times
directly, but in most cases indirectly. For example, in receivables financing arrangements, or other
similar arrangements where the reference collateral pool or borrowing base itself has ratings, there
are usually contractual provisions to post additional or substitute collateral if posted collateral no
longer maintains a specified rating, so as to maintain the borrowing base and the advance rate. In
other cases, there is an indirect, but tangible impact of a downgrade of the corporate entity related
to the bilateral asset-backed financing agreement as result of (1) servicing obligations of the entity,
(2) serving as a counterparty to the financing trust (such as a swap counterparty), or (3) general

DERA ECONOMIC AND RISK OUTLOOK | 29

confidence of the financing provider on the ability of the entity to access the non-secured financing
markets. In addition, market participants, especially in bilateral settings, usually impose credit
rating style financial criteria, which while not mechanistically linked to ratings, are likely to mimic
ratings outcomes.
In all of these examples, ratings downgrade or other credit events could result in increased financing
costs or reduced access or liquidity pressures on the corporate entity.12 These and similar types
of scenarios could contribute to negative procyclicality and market disruptions. We believe these
matters are worthy of continued examination.

*

This document expresses the views of the SEC’s COVID-19 Market Monitoring Group and does not
necessarily reflect the views of the Commission or the Commissioners.

1

SEC Press Release, “SEC Forms Cross-Divisional COVID-19 Market Monitoring Group” (April 24,
2020), available at https://www.sec.gov/news/press-release/2020-95.

2

SEC Press Release, “COVID-19 Market Monitoring Group – Update and Current Efforts” (May
13, 2020), available at https://www.sec.gov/news/public-statement/statement-clayton-kotharicovid-19-2020-05-13.

3

See Financial Stability Board, COVID-19 Pandemic: Financial Stability Implications and Policy
Measures Taken – Report submitted to the G20 Finance Ministers and Governors (July 15, 2020),
available at https://www.fsb.org/wp-content/uploads/P150720-2.pdf (noting the FSB’s plans to
continue its analysis of certain vulnerabilities, including those relating to procyclicality of credit rating
downgrades).

4

Exchange Act Section 15E(c)(2).

5

See generally Morgan Stanley, Corporate Credit Research – North America, “The Nature of the
BBBeast” (October 5, 2018), available at https://www.sec.gov/spotlight/fixed-income-advisory-committee/morgan-stanley-nature-of-the-bbbeast.pdf.

6

See generally Moody’s Investors Service, Sector In-depth, “Annual default study: Defaults will edge
higher in 2020” (January 30, 2020).

7

See generally BlackRock, Policy Spotlight – “US BBB-Rated Bonds: A Primer” (August 2019), available at https://www.blackrock.com/corporate/literature/whitepaper/policy-spotlight-us-bbb-ratedbonds-a-primer.pdf and Capital Advisors Group, Inc., Investment Research – “Corporate Leverage:
Par for the Course or Harbinger of an Upcoming Crisis?” (February 22, 2019), available at http://www.
capitaladvisors.com/wp-content/uploads/2019/03/Corporate-Leverage-Par-for-the-Course-or-Harbinger-of-an-Upcoming-Crisis.pdf.

8

See generally Financial Stability Oversight Council, 2019 Annual Report, available at https://home.
treasury.gov/system/files/261/FSOC2019AnnualReport.pdf.

9

Investment Company Institute, 60th edition – 2020 Investment Company Fact Book, available at
https://www.ici.org/pdf/2020_factbook.pdf.

10 See, e.g., European Systemic Risk Board, “Issues note on liquidity in the corporate bond and commercial paper markets, the procyclical impact of downgrades and implications for asset managers and insurers” (undated), available at https://www.esrb.europa.eu/pub/pdf/reports/esrb.
report200514_issues_note~ff7df26b93.en.pdf.
11

We recognize that financing agreements have evolved significantly in the wake of the 2008 global
financial crisis—and their direct reference to, and/or use of, credit ratings has diminished.

12 Because credit ratings are generally lagging indicators of cost of capital, counterparties in financing
agreements may in some cases amend the terms of their agreements in advance of a downgrade
(although we do not know how often that occurs in practice).

30 | U.S. SECURITIES AND EXCHANGE COMMISSION

U.S. Investors’ Exposure to Domestic Chinese Issuers1
Introduction
More than 150 China-based companies with a combined market value of $1.2 trillion2 were listed on
U.S. stock exchanges at the end of 2019. As more China-based companies have listed in the U.S., there
has been growing concern about the lack of transparency into accounting and governance standards
of Chinese firms, which policymakers and certain market participants have warned put U.S. investors
at increased risk because of the inability of the Public Company Accounting Oversight Board (PCAOB)
to inspect audit work and practices of PCAOB-registered auditing firms in China (including Hong
Kong-based audit firms, to the extent their audit clients have operations in mainland China) with respect
to their audit work of U.S.-listed companies with operations in China.3
Policymakers and market participants are discussing how to address these issues.4 This note highlights
an important area for those policy discussions: the increasing exposure of U.S. investors to the Chinese
domestic issuer market. Compared with China-based companies listed in the U.S., Chinese domestic
companies present potentially greater risks. The domestic Chinese financial markets have historically
not been very accessible to non-Chinese investors, but that is changing, with accessibility increasing
for, among others, U.S. investors. Over the past two years, providers of global financial market indexes
have increased the weight on those indexes of Chinese domestic stocks and bonds. Accordingly, U.S.
investors holding shares in investment products that track those global indexes are now increasingly
holding Chinese domestic stocks and domestic bonds. Other than passive index investors, active
fund managers, including pension funds and private funds, may also have access to Chinese domestic
securities. U.S. investors, and especially U.S. retail investors, might not be fully aware of these increased
weightings or how such changes may be substantively changing the risk profiles of their international
investments. In addition to the risks regarding an inability to conduct due diligence to verify the
soundness of accounting and governance standards noted above, the design and control of the Chinese
financial market by Chinese authorities creates a series of potential concerns for U.S. investors related to
disclosure, liquidity, volatility, fraud, and risk management. This risk spotlight sheds light and provides
data on the exposure of U.S. investors to Chinese domestic markets.

U.S. Investors’ Exposure to A Shares and Domestic Bonds
Companies that are incorporated in China can issue three different classes of shares: A Shares, B Shares,
and H Shares.5 A Shares are listed on either the Shanghai or Shenzhen stock exchanges and are traded
in renminbi (CNY). B Shares are listed on the Shanghai stock exchange and are traded in U.S. dollars
(USD), or they are listed on the Shenzhen stock exchange and are traded in Hong Kong dollars (HKD).
H Shares are listed on the Hong Kong exchange and are traded in Hong Kong dollars (HKD).6
U.S. investors have always been permitted to purchase and sell B Shares and H Shares, but A Shares
were limited to mainland Chinese investors until the launching of the Qualified Foreign Institutional
Investor (QFII) program in 2002.7 Controls on A Shares have been periodically relaxed since the launch
of QFII, including the 2014 introduction of the Stock Connect and the Bond Connect trading programs
that permit two-way trading between Hong Kong and China.8

DERA ECONOMIC AND RISK OUTLOOK | 31

As the Chinese domestic financial market became more accessible to foreigners, in recent years,
providers of global financial market indexes started to increase the weight of Chinese markets in some
of their indexes.9 For example, as of June 2020 all three major equity index providers (MSCI, FTSE,
and S&P) have included A Shares in their emerging markets indexes. Between May and November
2019, the MSCI Emerging Markets index increased its coverage of A shares listed on the Shanghai
and Shenzhen stock exchanges from 5% to 20%, and as of November 2019 its resulting overall index
weight in A Shares became approximately 4%.10 By adding A Shares, the MSCI Emerging Markets
index weight on China rose from about 28% to about 33%.11 Other indexes beyond these three have
also started to include A Shares, with different degrees of weights depending on their geographical
focus and/or risk profile.
Foreign investors also have easy access to certain parts of the fixed income markets in China thanks
to the inclusion of Chinese sovereign and policy bank bonds12 by some major global financial market
indexes. Chinese corporate bonds and other types of bonds13 are also available through QFII or Bond
Connect. Panel B of Table 1 reports statistics for select indexes that include Chinese domestic bonds
(hereafter, Domestic Bonds).
Table 1. Selected Global Indexes’ Weights on A Shares and Domestic Bonds
Panel A. A Shares
Index

Inclusion Process

Stock Inclusion Change

New Weight of A Shares

MSCI Emerging Markets

May 2019 - Nov 2019

from 5% to 20%

4%

FTSE Emerging Index

Jun 2019 - Jun 2020

from 0 to 25%

5.4%

S&P Emerging BMI

Sept 2019

from 0 to 25%

5.5%

a

b

c

Panel B. Domestic Bonds
Inclusion Process

Securities Type/Quantity

New Weight of
Domestic Bonds

Bloomberg Barclays
Global Aggregate Indexd

Apr 2019 - Nov 2020

386 Chinese government
and policy bank bonds

from 0 to 5.5%

JPM GBI-EM Global
Diversifiede

Feb 2020 - Nov 2020

9 Chinese
sovereign bonds

from 0 to 10%

FTSE Government Bond
Index (WGBI)f

Inclusion decision
expected in Sept 2020g

Unknown number of
Chinese sovereign bonds

from 0 to 6% (expected)

Index

a https://www.msci.com/www/blog-posts/emerging-markets-since-china-a/01662775315
b https://www.ftserussell.com/blogs/china-shares-inclusion-seven-key-points
c https://www.indexologyblog.com/2019/03/28/are-you-ready-for-china-a-share-inclusion/
d https://www.bloomberg.com/company/press/bloomberg-add-china-bloomberg-barclays-globalaggregate-indices/
e https://www.reuters.com/article/china-markets-bonds/update-2-jpmorgan-adds-china-to-emergingbond-index-from-february-2020-idUSL5N25V3F4
f https://markets.jpmorgan.com/research/email/fhqqi299/EVQJuomMYOQFhWtrQNiDkA/GPS3120982-0#research-document-GPS-3120982--section_16
g FTSE Russell would keep China on its watch list until a planned review in September 2020.
https://research.ftserussell.com/products/downloads/Fixed_Income_Country_Classification_
March_2020_Results.pdf

32 | U.S. SECURITIES AND EXCHANGE COMMISSION

In Table 2, we estimate the dollar exposure of U.S. mutual funds to A Shares and Domestic
Bonds. We identify $43.5 billion of these securities held across 664 funds at the end of April
2020, out of which there were $37.2 billion in A Shares and $6.3 billion in Domestic Bonds.
This dollar exposure will likely increase as A Shares and Domestic Bonds are included in more
global indexes in the coming months and years.
Table 2. U.S. Mutual Funds’ Current Exposure to A Shares and Domestic Bonds
Security

# of U.S. Funds

AUM ($ billion)

Exposure ($ billion)

A Shares

586

2,477

37.2

Domestic Bonds

95

673

6.3

Total

664

2,959

43.5

Source: Morningstar holdings reported at the end of April 2020 and DERA staff calculations. The exposure is
based on holdings tagged by Morningstar as Chinese and traded in local currency only. (A Shares trade in renminbi.) The sum of number of funds and AUM across A Shares and Domestic Bonds does not add up to the total
because some funds have exposures to both A Shares and Domestic Bonds.

Table 3 reports our estimated 2020 year-end size of U.S. mutual funds’ investments in A Shares
(Panel A) and Domestic Bonds (Panel B). Our estimates are simply the product of current fund
size (as of April 2020) and the expected year-end index weights of the index chosen by the fund
as its benchmark.14 These figures are imprecise for several reasons. First, we include only funds
that use as their benchmarks certain indexes from the six index providers listed in the table.
Second, the index providers might not implement the changes that they have announced. Third,
mutual funds might not allocate their Chinese investments in the same proportion as the index.
By the end of 2020, we estimate that there will be $38.9 billion of investment in A Shares across
the three major equity indexes (Panel A). We also estimate that there will be $15.8 billion of
U.S. mutual funds’ exposure to the Domestic Bond market via Bloomberg, JP Morgan, and
FTSE global market indexes (Panel B). The IMF estimates that the expected inclusion of Chinese
domestic securities into major global indexes will generate up to $450 billion net inflow into the
Chinese economy, which equals 3 to 4% of China’s GDP, in the next two years.15
Table 3. U.S. Mutual Funds’ Estimated 2020 Year-End Exposure to A Shares and
Domestic Bonds via Selected Indexes
Panel A. Exposure to A Shares
Index

# of US Funds

AUM ($ billion)

Exposure ($ billion)

1,179

1,851

27.6

FTSE Russell

25

492

10.4

S&P

72

62.7

0.9

Total

1,277

2,346

38.9

MSCI

a
b

c

DERA ECONOMIC AND RISK OUTLOOK | 33

Panel B. Exposure to Domestic Bonds
Index

# of US Funds

AUM ($ billion)

Exposure ($ billion)

Bloomberg Barclays
Globale

95

114.0

7.4

JPM GBI-EMf

34

15.9

1.6

FTSE WGBI

47

110.4

6.9

Total

176

240.4

15.8

g

Source: Morningstar holdings reported at the end of April 2020 and DERA staff calculations.
a Expected weights of A Shares in different MSCI indexes are as follow: ACWI = 0.4%, ACWI ex US =
0.9%, EM = 4%, Asia Pacific = 2.5%, Asia ex Japan = 4.0%, Golden Dragon = 7.4%, China All = 10.3%,
China A = 100%.
b Expected weights of A Shares in different FTSE Russell indexes are as follow: Global (All World) =
0.6%, Global ex US = 1.3%, EM = 5.4%, EM All cap = 5.7%, China All = 15%, China A = 100%.
c Expected weights of China A shares in different S&P indexes are as follow: Global (BMI or property) =
0.6%, Global ex US = 1.3%, Emerging BMI = 5.5%, China (Total China or BMI or 500) = 15.1%.
e Expected weight in Bloomberg Barclays Global Aggregate = 5%, Bloomberg Barclays Global Aggregate Ex US = 9%.
f Expected weight in JPM GBI-EM Global Diversified = 10%.
g Expected weight in FTSE World Government Bond Index = 6%. (The following indexes included China
in 2017, but no funds are currently following them: 52.6% in the FTSE EMGBI, 10.0% in the EMGBICapped, 58.9% in AGBI and 20.0% in AGBI-Capped)

In addition to mutual funds, there are a number of other large U.S. investors that might look to
global financial market indexes when making investment decisions, including public and private
pension funds, endowments, foundations, and hedge funds. For example, the Federal Thrift
Retirement Investment Board (FTRIB) that oversees retirement savings for U.S. government
employees voted last year to change the benchmark index on one of its large funds from an index
that excludes A Shares to one that includes A Shares,16 though implementation of that decision
has since been delayed.17
As shown in the Appendix, out of the ten largest state level public U.S. pensions, we identify
that nine have allocated some of their funds to track one or more benchmark indexes that have
exposure to A shares (mainly MSCI indexes with A exposure) or their investments include
holding A Shares directly. For one of the pension funds we examined, such information is
not available, based on the latest financial reports of these funds.18 As of September 2019, the
federally administrated Pension Benefit Guaranty Corp. (PBGC)’s portfolio includes a sizable
emerging market allocation that has exposure to A Shares because that allocation tracks the
MSCI Emerging Market Index.19 Other public pension funds may also have exposure to Chinese
companies via investments in venture capital funds that invest in A Shares.20

34 | U.S. SECURITIES AND EXCHANGE COMMISSION

Risks of Investing in A Shares and Domestic Bonds
Various market participants have identified certain heightened risks associated with investing in
A Shares and Domestic Bonds, including the following:
Fraud. Fraud is a commonly expressed concern with respect to Chinese firms, whether
incorporated inside or outside China. With frequent government intervention and limits on
credible standards in corporate governance, the risk of insider dealings, market manipulation and
other misconduct increases.21
Default Risk. China’s debt ratios are steadily increasing. Its non-financial debt-to-GDP ratio
rose from approximately 150% in 2008 to approximately 250% in September 2018.22 With the
recent slowdown in economic growth, this material debt load poses an increased default risk.
Over the last two years, China reached back-to-back record years of bond defaults with the
2019 level ($18.6 billion) being four times higher than the 2017 level. Defaults are concentrated
among privately owned enterprises, which are facing tightening in credit conditions and lower
levels of government support. The default rate on bonds was over 4% in the first 11 months of
2019, up from 0.8% in 2017.23
Volatility. Compared with the U.S. equity market, which with the size of mutual funds and
ETFs is largely an institutional market, the mainland Chinese equity market is dominated by
retail investors who account for over 80% of the trading volume.24 These investors tend to have
shorter holding periods for their investments and are more likely to respond to short-term price
movements than institutional investors. The different nature of China’s investor base, along
with the underlying riskier nature of Chinese issuers, is viewed as having contributed to trading
activity that, in turn, led to episodes of high volatility in the Shanghai and Shenzhen markets,
especially during market stress.25, 26
Corporate Incentives. Article 19 of China’s Corporate Law stipulates that “In companies,
Communist Party organizations shall…be set up to carry out activities of the Party.”27 Thus,
Chinese companies’ priorities may be different from those of U.S. shareholders. As an example
cited by market participants, the Industrial and Commercial Bank of China (ICBC), which is
the world’s largest bank in terms of total assets and is included in the MSCI Emerging Market
Index, deployed $430 million (RMB 3 billion) to shore up the Bank of Jinzhou in response to
governmental direction. ICBC’s investor announcement regarding this transaction provided only
a very brief and general explanation for the investment.28
Lack of Transparency in Bond Markets. Bond ratings in China have been characterized as
systematically skewed upward, reflecting both minimum rating requirements for issuance
and implicit guarantees. More than 80 percent of all Chinese bond issuers are rated AA and
above.29 Many accounting or market practices with respect to bond issuers are not in line
with international standards. For example, firms that appear stable or growing may in reality
be exposed to large, undisclosed risks. Without access to accurate market and accounting
information, investors are limited in their ability to accurately assess asset values.

DERA ECONOMIC AND RISK OUTLOOK | 35

Lack of Hedging Tools. Regulatory constraints, capital requirements, and operational costs
are among the reasons few hedging products are currently available to investors wanting to
protect against downside risk in the Chinese market. The lack of a Chinese stock-index futures
market that covers medium and small-cap stocks is particularly problematic for foreign investors
seeking to protect their positions. Given that the Chinese government concluded that much of
the 2015 market turmoil was due to derivative products,30 it is an open question as to whether
developments are forthcoming in this regard.
Macroeconomic Shocks. Other than the long-term inherent risks in China’s financial system,
there are also economic shocks that may interrupt China’s (and sometimes the global) economy,
like the COVID-19 pandemic. Given the country’s large, low-income population with limited
purchasing power,31 and a growth model that relies heavily on fixed investments and exporting,32
the economic impact of global macroeconomic shocks can have more significant consequence
for the Chinese economy and its domestic financial market and capital flow than for those of
other countries.33
National Security Risk. The increasing exposures of U.S. investors to Chinese financial markets
that are intertwined with the Chinese government’s political agenda has raised national security
questions for the U.S.34, 35 For example, certain domestic Chinese companies are included in
global financial market indexes, despite being directly involved in activities contrary to U.S.
interests. Table 4 reports Chinese companies that are in the MSCI China A Index and that are
also either in the U.S. government’s Entity List or have been designated as a “national security
threat” by certain U.S. agencies. Companies on the Entity List are deemed to have been “acting
contrary to the national security or foreign policy interests of the United States” or are a “threat
to the national security of the U.S.”36 Despite official U.S. policies banning a number of these
companies from doing direct business with U.S. persons, their increasing index inclusion has led
to an indirect flow of investments from U.S. investors into these companies.
Table 4. MSCI China A Index Companies that Are on the Entitle List or Have Been Banned
Company

Entity List or Banned

Dahua Technology

Entity List

Hikvision

Entity List

IFLYTEK

Entity List

FiberHome

Entity List

ZTE

FCC Designates it as National Security Threat*

Source: https://www.msci.com/index-consultations and https://www.bis.doc.gov/index.php/policyguidance/lists-of-parties-of-concern/entity-list and https://www.fcc.gov/document/fcc-designateshuawei-and-zte-national-security-threats
* Currently banned by the Federal Communications Commission from purchase of equipment using
U.S. public funds

36 | U.S. SECURITIES AND EXCHANGE COMMISSION

U.S.-China Policy Adjustment. Over the last few years, U.S.-China trade relationships have taken
a center stage. Recently, the president issued a memorandum directing the President’s Working
Group on Financial Markets, which includes officials from the Commission, the Treasury
Department, the Federal Reserve Board, and the Commodity Futures Trading Commission,
to study issues relating to, among other things, risks to U.S. investors and financial markets
posed by differing practices of Chinese companies listed on U.S. markets.37 Following Beijing’s
decision to impose its national security law in Hong Kong, the administration also announced
plans to revoke the special trade status of Hong Kong, as it is deemed no longer maintaining a
high degree of autonomy from China. Table 5 shows that at the end of April 2020, U.S. mutual
funds’ exposure (equities and bonds) to Chinese firms available in different exchanges totals
approximately $385 billion, with $183 billion available via Hong Kong’s market. Total U.S.
mutual funds’ exposure to Hong Kong dollar denominated security holdings are approximately
$264 billion. These holdings may be subject to increased volatility to the extent that Hong
Kong’s special trade status is revoked.
Table 5. U.S. Mutual Funds’ Exposures to Chinese Securities and HKD Denominated Securities
Panel A. Exposure to Chinese Firms Headquartered in China
Currency

Exposure ($ billion)

Renminbi (Shanghai, Shenzhen)—
A Shares and Domestic Bonds

43.5

Hong Kong Dollars
(Hong Kong)

183.2

U.S. Dollars (New York)

156.5

Other Currencies

2.1

Total

385.2
Panel B. Exposure to Hong Kong Dollar Denominated Securities

Location of Headquarters

Exposure ($ billion)

China

183.2

Hong Kong

71.8

U.S.

4.0

Others

4.8

Total

263.7

Source: Morningstar holdings reported at the end of April 2020 and DERA staff calculations.

DERA ECONOMIC AND RISK OUTLOOK | 37

Conclusion
The inclusion of Chinese domestic securities (A Shares and Domestic Bonds) into global financial
market indexes has raised a series of concerns for U.S. investors related to the transparency,
functioning, and integrity of the Chinese market. With the increasing number of Chinese
domestic securities becoming eligible for inclusion in various global financial market indexes,
there is significant risk of U.S. investors becoming more exposed to companies potentially subject
to U.S. policies, sanctions, and/or tariffs. While many of these issues are geopolitical in nature,
it is nevertheless important for U.S. investors to be cognizant of the risks. The evolution of
weighting in these indexes and the broader considerations discussed above warrant continued
monitoring. The issues discussed above are further complicated by the ongoing COVID-19
global pandemic, which has already caused significant effects in global financial markets and
global policy discussions.
Appendix: Large U.S. Public Pension Funds’ Exposure to China A Shares
Pension

AUM ($ bil)

Benchmark with China A Share Exposure
(in bold)

Link to Recent
Financial Report

California Public
Employees

$376.86

Five out of its seven sub-funds track
MSCI ACWI IMI (Net) (among other
benchmarks).

https://www.calpers.ca.gov/
docs/board-agendas/
202006/invest/item06c01_a.pdf

California State
Teachers

$230.209

International equity include 55 China A
share companies, with a total market value
of $332 mil

https://www.calstrs.com/
investment-table/international-equities

$213.241

Public Equity fund is benchmarked to MSCI
All Country World Index (ACWI). Its Total
Non U.S. Equity Composite fund ($27 bil)
tracks the MSCI ACWI Ex U.S. IMI (MSCI
ACWI Ex U.S. to 1/1/17)

https://www.osc.state.ny.us/
sites/default/files/retirement/
documents/pdf/2019-11/comprehensive-annual-financialreport-2019.pdf

$163.135

Its Global Equity Fund tracks a custom
version of the MSCI All Country World
Investable Market Index (ACWI IMI), in
dollar terms, net of withholding taxes on
nonresident institutional investors, adjusted
to reflect the provisions of the Protecting
Florida’s Investments Act.

https://www.sbafla.com/fsb/
Portals/FSB/Content/
Performance/Annual/
2018_2019_AIR.pdf?ver=
2020-02-20-125811-027

$153.126

External Public Total World Equity - Invests
in equity securities in countries represented
in the MSCI ACWI Value Index, as well as
certain other global markets

https://www.trs.texas.
gov/TRS%20Documents/
cafr_2019.pdf

$122.5

Its international equity portfolio, which represented 17.2% of System assets, generated
a return of 1.3%, in line with its benchmark,
the MSCI ACWI Ex-U.S. index. The global
equity portfolio, which represented 2.1% of
System assets and is exclusively actively
managed, returned 1.2% trailing its benchmark, the MSCI ACWI index, by 4.5%.

https://www.nystrs.org/
Library/Publications/AnnualReports/2019CAFR.pdf

New York State
Common

Florida State
Board

Texas Teachers

New York State
Teachers

38 | U.S. SECURITIES AND EXCHANGE COMMISSION

Wisconsin
Investment
Board

Washington
State Board

North Carolina

Ohio Public
Employees

$114.63

na

https://7ffb9e60-f2dc4359-b148-1db6b9d76c71.
filesusr.com/ugd/69fc6d_e0c
664dc85964d78953e358163
b6a534.pdf

$112.47

Its Collective Investment Trust Funds are
composed by three parts, each tracking 1)
Morgan Stanley Capital International (MSCI)
U.S. Investable Market Index (passive); 2)
the MSCI Emerging Markets Investable
Market Index (passive); 3) MSCI Emerging
Markets Investable Market Index (active)

https://www.sib.wa.gov/
financial/pdfs/annual/ar19.pdf

$111.37

Its Equity Collective Investment Trusts follows five equity index funds. Out of which,
the BlackRock International Index Fund
seeks to replicate the composition and performance of the MSCI ACWI Ex-USA Index.

https://files.nc.gov/retire/
documents/files/Reports/
June_30_2019NC_CAFR.pdf

$100.71

As of December 31, 2019, its Non-U.S.
Equity Benchmark (net) include: 55%
MSCI World Index x U.S. Standard (net),
31% MSCI Emerging Markets Standard
Index (net).

https://www.opers.org/
pubs-archive/financial/
cafr/2019-OPERS-Comprehensive-Annual-FinancialReport-CAFR.pdf

Source: The 2018 AUMs are based on this research paper, https://www.thinkingaheadinstitute.org/en/Library/Public/Research-and-Ideas/2019/09/P_I_300_2019_research_paper. New York City Retirement System is excluded in
the above table, as the AUM reflected in its financial report is less than $100 billion (the AUM in the research paper
may have included a few other pensions in New York City).

1

This is a spotlight by the staff of the Division of Economic and Risk Analysis (DERA) of the U.S. Securities and Exchange Commission (Commission). The Commission, as a matter of policy, disclaims
responsibility for any private publication or statement of any of its employees. The views expressed
herein are those of DERA staff and do not necessarily reflect the views of the Commission or other
members of the Commission staff.

2

Some of those listed companies are very large. For example, Alibaba Group Holding Ltd (BABA.N),
Baidu Inc. (BIDU.O) and JD.com Inc. (JD.O), have a combined U.S. market capitalization of more than
$500 billion (https://www.uscc.gov/sites/default/files/Chinese%20Companies%20on%20U.S.%20
Stock%20Exchanges.pdf).

3

Critics have also argued that China-based companies listed in the U.S. have an unfair advantage
compared with U.S. corporations as they de facto circumvent the accounting and governance
standards to which U.S. corporations are subject. See, e.g., https://www.cnbc.com/2020/04/03/
luckin-coffee-debacle-is-a-painful-reminder-of-fraudrisk.html and https://www.realclearpolitics.com/
articles/2019/10/19/why_are_american_investors_funding_chinese_fraud_141540.html and https://
tax.thomsonreuters.com/news/president-trump-criticizes-chinese-firms-refusal-to-follow-auditrulesseeks-solutions/. As of April 2020, out of the 269 unique issuers that PCAOB identifies on its website
as being public companies whose PCAOB-registered auditor is located in a jurisdiction having
obstacles to PCAOB inspections, 239 have auditors based in mainland China or Hong Kong (https://
pcaobus.org/International/Inspections/Pages/IssuerClientsWithoutAccess.aspx).

4

See, e.g., https://www.sec.gov/news/public-statement/emerging-market-investments-disclosurereporting

5

Shares in Chinese companies that are incorporated and listed outside of China are referred to by
other names, including Red Chips, P Chips, S Chips, N Shares, L Shares, and G Shares. In prior years,
U.S. investors who wanted exposure to China got it by investing in N Shares or American Depositary
Receipts, both of which trade on U.S. exchanges. See https://research.ftserussell.com/products/
downloads/Guide_to_Chinese_Share_Classes.pdf

DERA ECONOMIC AND RISK OUTLOOK | 39

6

Before 19 February 2001, domestic Chinese citizens were prohibited from trading B Shares.
See http://www.lehmanlaw.com/resource-centre/faqs/securities/what-are-b-shares.html

7

See http://www.szse.cn/enqfii/aboutqfii/

8

The QFII program’s initial capital controls have been relaxed over the years, and the quotas were
removed on 07 May 2020. See https://www.safe.gov.cn/en/2020/0507/1677.html, https://www.
law360.com/articles/1279403/china-s-relaxed-financial-sector-may-aid-foreign-investors. See also
https://www.hkex.com.hk/Mutual-Market/Stock-Connect?sc_lang=en and https://www.marketwatch.
com/story/heres-what-investors-need-to-know-about-mscis-inclusion-of-china-a-shares-in-itsindexes-2018-05-31

9

“How China Pressured MSCI to Add Its Market to Major Benchmark”, https://www.wsj.com/articles/
how-china-pressured-msci-to-add-its-market-to-major-benchmark-11549195201

10 Inclusion is different from weight. The former is the proportion of Chinese stocks that is included in
the index, while the latter is the proportion of the overall index that is based on Chinese securities.
11

See Panel A of Table 1 for the corresponding statistics for the FTSE Emerging Index and the S&P
Emerging BMI.

12 Policy bank refers to China Development Bank, the Agricultural Development Bank of China,
and the Export-Import Bank of China, see e.g. http://www.chinadaily.com.cn/a/201909/11/
WS5d788406a310cf3e3556afaa.html
13 Other bond types available through Bond Connect include Negotiable Certificate Deposit (NCD),
asset-backed security (ABS), etc., see https://www.chinabondconnect.com/en/Primary/PrimaryInformation/Onshore.html
14 For example, a $100 million fund that tracks an index that has an expected 5% weight at the end
of 2020 will have a projected exposure of $5 million. The expected year-end index weights used
in our estimates are either what the equity index providers have implemented, or the weights
announced by the relevant bond index providers (Bloomberg and JP Morgan) or market expectation
(FTSE Russell).
15 https://blogs.imf.org/2019/06/19/china-deepens-global-finance-links-as-it-joins-benchmark-indexes/
16 https://www.msci.com/documents/1296102/12275477/China_A_Further_Weight_Increase_
Feb_2019_Presentation.pdf and https://www.msci.com/documents/10199/822e3d18-16fb-4d239295-11bc9e07b8ba
17 https://www.tsp.gov/whatsnew/Content/index.html#ifundDefer
18 The ten largest state public pension funds that we examined are as follows (2018 AUM in parentheses): California Public Employees’ Retirement System ($376 billion), California State Teachers Retirement System ($230 billion), New York State Common Retirement Fund ($213 billion), Florida State
Board of Administration ($175 billion), Texas Teachers Retirement System ($153 billion), New York
State Teachers Retirement System ($122 billion), Wisconsin Investment Board ($114 billion), Washington State Board ($112 billion), North Carolina Retirement Systems ($111 billion) and Ohio Public
Employees Retirement System ($101 billion). Source of the pension funds’ AUM: https://www.thinkingaheadinstitute.org/en/Library/Public/Research-and-Ideas/2019/09/P_I_300_2019_research_
paper
19 About a quarter of PBGC’s International Public Stock fund, which accounts for 9.6% of its total AUM
of $119 billion, tracks MSCI EM, see https://www.pbgc.gov/sites/default/files/pbgc-fy-2019-annualreport.pdf
20 U.S. Teachers and Firefighters Are Funding Rise of China Tech Firms, https://www.bloomberg.com/
graphics/2019-china-tech-money-threatened-by-trade-war/
21 https://www.realclearpolitics.com/articles/2019/10/19/why_are_american_investors_funding_chinese_fraud_141540.html, https://www.wsj.com/articles/that-calm-chinese-stock-market-its-engineered-by-the-government-1527775089 and https://www.cnbc.com/2018/09/11/
chinas-stock-market-is-still-immature-so-volatility-is-to-be-expected-former-pboc-governorsays.html
22 https://www.internationalinvestment.net/opinion/4001647/china-debt
23 https://www.ft.com/content/068a83e0-27a7-11ea-9305-4234e74b0ef3 and https://www.reuters.
com/article/china-markets-default/chinas-private-firms-face-record-default-risk-to-stay-high-in2020-fitch-idUKL4N28K1YM

40 | U.S. SECURITIES AND EXCHANGE COMMISSION

24 In terms of size, the China equity market remains relatively small at only 46.5% of GDP, compared
with over 100% of GDP for most developed economies (https://cammackretirement.com/knowledge-center/insights/china-a-shares-the-implications-for-u-s-investors and https://www.ceicdata.
com/en/indicator/china/equity-market-index).
25 See, e.g., https://blog.alliancebernstein.com/library/will-china-export-volatility-as-equity-marketsopen, https://www.cnbc.com/2015/07/02/why-are-chinas-stock-markets-so-volatile.html, https://
www.cnbc.com/2018/09/11/chinas-stock-market-is-still-immature-so-volatility-is-to-be-expectedformerpboc-governor-says.html
26 DERA staff calculations show that the daily price volatility on the Chinese stock markets has been
higher than that for other Asian markets over the last 5, 10, 15 and 20 years. Moreover, using data
from the last nine years, the CBOE China ETF Volatility Index had a standard deviation of 6.7, while
the S&P 500-based CBOE VIX had a standard deviation of 5.3.
27 See https://www.ilo.org/dyn/natlex/docs/ELECTRONIC/92643/108008/F-186401967/CHN92643
Eng.pdf
28 “China’s Banking Sector Risks and Implications for the U.S.,” staff report by U.S.-China Economic
and Security Review Commission. (https://www.uscc.gov/research/chinas-banking-sector-risks-andimplications-united-states)
29 See https://www.wsj.com/articles/s-p-rating-is-landmark-for-chinese-bond-market-11562835842
30 https://www.bloomberg.com/opinion/articles/2019-12-01/msci-raises-bar-on-china-stocks-underincreased-u-s-criticism
31 “600 million Chinese earn 1,000 RMB a month — so are the Chinese rich or poor?”, https://www.
thinkchina.sg/600-million-chinese-earn-1000-rmb-month-so-are-chinese-rich-or-poor
32 https://www.imf.org/en/News/Articles/2017/08/09/NA081517-China-Economic-Outlook-inSix-Charts
33 https://www.iif.com/Portals/0/Files/content/1_IIF_Capital%20Flows%20Tracker_April.pdf
34 See, e.g. “The emergence of China, Inc.: behind and beyond the trade war” (https://www.researchgate.net/publication/341357034_The_emergence_of_China_Inc_behind_and_beyond_the_tra de_
war), “Congress Urged to Block Certain Chinese Investments in the U.S.” (https://www.pillsburylaw.
com/en/news-and-insights/congress-urged-to-block-certain-chinese-investments-in-the-us.html),
and “How China’s Economic Aggression Threatens the Technologies and Intellectual Property of the
United States and the World” (page 11, https://www.whitehouse.gov/wp-content/uploads/2018/06/
FINAL-ChinaTechnology-Report-6.18.18-PDF.pdf)
35 The China Securities Regulatory Commission requires listed companies to “set up Chinese Communist Party and carry out Party activities”. Furthermore, China’s 2017 National Intelligence Law states
that any organization shall support and cooperate with state intelligence and that the state protects
any organization that aids See, e.g., https://www.theepochtimes.com/china-requires-all-publiclylisted-companies-to-establish-communist-partybranches_2565214.html and https://www.reuters.
com/article/us-china-governance-party/chinas-listed-firms-need-tobeef-up-communist-party-building-activity-regulator-says-idUSKBN1JB16F.
36 The U.S. Department of Commerce’s Bureau of Industry and Security (BIS) first published the “Entity
List” in 1997 to inform the public of entities engaging in activities that could result in an increased
risk of the diversion of exported, re-exported, and transferred (in-country) items to weapons of mass
destruction programs. Since then, grounds for inclusion have expanded to activities sanctioned by
the U.S. State Department and activities contrary to U.S. national security and/or foreign policy interests. (https://www.bis.doc.gov/index.php/policy-guidance/lists-of-parties-of-concern)
37 https://www.whitehouse.gov/presidential-actions/memorandum-protecting-united-states-investorssignificant-risks-chinese-companies/

DERA ECONOMIC AND RISK OUTLOOK | 41

U. S . S E C U R I T I E S A N D E XC H A N G E CO M M I SS I O N

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Asec%3A7c0b48ae16ce872d. Public record. Not legal advice.