The China Divestment Chorus Gets Louder as Texas Becomes the Latest State to Call for Restrictions

On November 21, 2024, Governor Greg Abbott of Texas sent a letter to state agencies prohibiting them from making any new investments of public funds in the People’s Republic of China (China) and directing them to divest their current holdings at the first available opportunity. It is unclear whether the letter impacts indirect investments through investment funds or if it only applies to direct investments.  Governor Abbott’s order is the latest example of an emerging trend where (mostly) Republican lawmakers and state officials prohibit and/or seek to unwind public investments tied to China and the Chinese Communist Party (CCP) based on national security concerns. According to the Governor’s letter, the CCP “has initiated belligerent actions across the Southeastern Pacific region and the world, which have increased instability and financial risk to [Texas] holding investments in China.” Furthermore, China has been the subject of various U.S. sanctions due to its alleged human rights abuses, illicit narcotics trafficking, cyber-attacks, weapons proliferation and corruption. 

This is not the first time that Governor Abbott has sought to restrict investments linked to China and the CCP. In 2023, he joined the governors of Iowa, Mississippi and South Dakota in encouraging a leading asset manager to create a new emerging market fund that barred exposure to China, and he also instructed the University of Texas/Texas A&M Investment Management Company to divest its holdings from the country. Earlier this year, the Teacher Retirement System of Texas switched its equities benchmark from the MSCI ACWI Investable Market Index to the MSCI ACWI IMI ex-China/Hong Kong Index in order to remove China.

Over the last two years, there has been a significant uptick in the number of bills and regulatory actions seeking to divest public funds in and contracts with Chinese-domiciled companies and, to date, such measures have been effectuated in Indiana, Missouri, Kansas, Oklahoma and Florida. This trend is likely to continue in 2025. In Texas, we expect the state legislature may codify Governor Abbott’s directive by introducing formal divestment legislation when the new session begins in January.   Any legislative action may provide important clarifications on the scope of the prohibition, including what constitutes an investment in China and whether indirect investments through commingled funds are included.

Other State Initiatives on China Investing

Indiana

Indiana became the first state in the United States to enact a China divestment law when it passed SB.268 in May 2023 requiring the Indiana Public Retirement System (INPRS) to divest within five years from “any investment that is domiciled, issued, incorporated or listed in the People’s Republic of China or the Chinese Communist Party.” The law includes an exception for indirect holdings in actively managed investment funds, but if a manager creates a similar actively managed investment fund without the restricted entities, the INPRS board is required to replace all applicable investments with investments in the similar actively managed fund in a period of time consistent with prudent investing standards. Additionally, the law provides that, with respect to actions taken in compliance, including all good faith determinations regarding restricted entities and restricted investment products, the INPRS Board of Trustees is exempt from any conflicting statutory or common law obligations, including any obligations with respect to choice of asset managers, investment funds, or investments for fund investment portfolios.

As of July 1, 2024—just one year after adoption—the INPRS pension fully divested the $1.2 billion of investments it had in covered Chinese entities. According to a statement from Indiana State Comptroller Elise Nieshalla and Treasurer Daniel Elliott, who are both INPRS Board members, “China is one of the foremost threats against our country’s national security, and INPRS has nobly exceeded the parameters set forth in the law by divesting Hoosiers pension dollars from China ASAP…[b]y divesting from China and focusing on investments in countries that value the principles of democracy, capitalism and freedom, we are safeguarding the best financial interest of Hoosiers and our nation.” 

Missouri

At the end of 2023, in a special meeting called at the urging of Governor Mike Parson, the 11-member Missouri State Employees’ Retirement System (MOSERS) Board of Trustees voted in favor of a motion by state Treasurer (and MOSERS Board member) Vivek Malek to divest the pension fund’s investments in China. Treasurer Malek’s motion stipulated that the MOSERS staff shall divest from all Global Public Equity investments in China within 12 months of the motion’s approval, with limited extensions permitted in order to (i) avoid aggregate transaction costs in excess of $500,000, (ii) avoid selling Global Public Equity interests at a loss on the secondary markets, or (iii) otherwise comply with legal requirements. The nine-to-two vote reversed a decision the Board of Trustees made one month earlier to reject Treasurer Malek’s initial proposal to sell off any MOSERS investments in Chinese stocks and other securities. After the subsequent motion was approved, Treasurer Malek said he hoped “the MOSERS Board of Trustees vote [would] inspire the Missouri General Assembly…to take additional steps to ensure public dollars are not invested in China.”

Coming on the heels of the MOSERS vote, in January 2024, state lawmakers introduced at least two bills that sought divestment from China-linked investments, although neither passed before the end of the legislative session. HB.1869, which largely mirrored the text of the Indiana law described above, would have required state or local retirement plans to refrain from investments in an entity that is domiciled, issued, incorporated or listed in China, and to divest from existing China-based holdings within five years from when the pension board determines that the investment is in a restricted entity or restricted investment product. HB.2143 (also known as the “Foreign Adversary Divestment Act”) would have prohibited all state-managed funds from holding investments in any (i) foreign adversary (the bill defined this term as including China, Russia, Iran, North Korea, Cuba, the Venezuelan regime of Nicolás Maduro, the Syrian Arab Republic, or any other entity designated by the governor in consultation with the attorney general), (ii) state-owned enterprise of a foreign adversary, (iii) company domiciled within a foreign adversary, or (iv) a company owned or controlled by any such entity. HB.2143 also would have prohibited state-managed funds from investing or depositing public funds in any bank domiciled or principally located within a foreign adversary, and any state-managed fund in violation would have been required to immediately begin divestment of any public holdings and to be fully divested within two years of the effective date. 

Even though Treasurer Malek publicly endorsed HB.2143, the legislation ultimately failed.  The fiscal analysis for the bill showed its estimated annual cost to MOSERS being $77.6 million and that it would result in an estimated 10-year cumulative loss of $1.07 billion in value to the MOSERS portfolio (which would be on top of the one-time cost of $99.6 million for divestment of MOSERS’ existing holdings), which may have contributed to the legislation’s failure.

Oklahoma

Governor Kevin Stitt of Oklahoma issued Executive Order 2024-11 (EO 2024-11) in June, which “outlines a comprehensive series of measures aimed at protecting Oklahomans and their tax dollars from CCP aggression and escalating tensions in the Indo-Pacific region.” By issuing this order, Oklahoma’s leader became the first governor in the United States to take executive action to “proactively safeguard state assets from Chinese influence and aggression.” Among other things, EO 2024-11 directs all employees and officers managing state funds, including, funds of the Oklahoma retirement systems, to notify the Treasurer no later than 90 days from the date of EO 2024-11 of all state assets at risk of substantially losing value or being frozen, seized or appropriated by foreign adversaries (including, China, Iran, North Korea, Russia, Cuba and Venezuelan dictator Nicolas Maduro) because “they have engaged in a long-term pattern or serious instances of conduct significantly adverse to the national security of the United States or the security and safety of United States persons.” It also directs the state’s retirement systems to review their portfolios to determine any exposure to, or investment in, countries considered foreign adversaries. For any assets so identified, the retirement systems shall, in coordination with the Treasurer, develop divestment plans and electronically submit them to the governor’s office, as well as the leaders of the state legislature.  

EO 2024-11 was issued just a few weeks after Governor Stitt signed SB.1705 to further restrict foreign governments from owning land in Oklahoma. That legislation amends existing state law that restricts foreign-land ownership in Oklahoma by specifying that no foreign government adversary may purchase land in Oklahoma, which includes any country designated by the U.S. Secretary of State as hostile or a “Country of Particular Concern.”

Kansas

In April 2024, the Kansas legislature passed HB.2711 (the “Countries of Concern Divestment Act”) with large majorities in the Republican-controlled House and Senate, and it became law without the signature of Governor Laura Kelly (a Democrat).  The legislation (i) directs state-managed funds to remove any investments held in “countries of concern” (China, Cuba, Iran, North Korea, Russia and Venezuela), (ii) prohibits investments and deposits with a bank or company domiciled in a country of concern and (iii) indemnifies state-managed funds with respect to actions taken in compliance with the Act.  At least 50% of such assets must be removed from the state-managed fund’s assets no later than July 1, 2025 (unless the state-managed fund determines that a later date is more prudent based on a good faith exercise of the state-managed fund’s fiduciary discretion), and full divestment must be achieved no later than January 1, 2026.

HB.2711 requires state-managed funds to divest from any indirect holdings in actively or passively managed investment funds containing publicly traded securities of any country of concern or person owned or controlled by or subject to the jurisdiction of a country of concern. The state-managed fund is permitted to submit letters to the managers of each investment fund containing publicly traded securities of any country of concern requesting that they remove such publicly traded securities from the fund or create a similar actively or passively managed fund with indirect holdings devoid of any such publicly traded securities. If a manager creates a similar fund with substantially the same management fees and same level of investment risk and anticipated return, HB.2711 authorizes the state-managed fund to replace all applicable investments with investments in the similar fund in a time frame consistent with prudent fiduciary standards (but no later than the 450th day after the fund is created). If a manager does not create a similar fund, the legislation requires the state-managed fund to divest from its indirect holding in actively or passively managed investment funds.

The legislation also provides an exception to the divestment requirements for any real estate or private equity investment commitments made by a state-managed fund prior to July 1, 2024, or to a real estate or private equity investment commitment made by a state-managed fund prior to the date either established by the legislation or later amended to include a country of concern. The legislation prohibits a state-managed fund from making any new real estate or private equity investment commitment in a person owned or controlled by or subject to the jurisdiction of a country of concern.

Since the law took effect in July, the Kansas Public Employees Retirement System pension fund has liquidated nearly all of its holdings (approximately, $300 million) deemed to be affiliated with or tied to countries of concern, which represented approximately 1% of the pension fund’s total investments.

Florida

In an article we published in March 2024 addressing Florida’s efforts to halt investments tied to the CCP, we noted how Florida Governor Ron DeSantis described China as “the United States’ greatest geopolitical threat.” Florida lawmakers have targeted China through divestment legislation over the last four years. In May, the legislature enacted, and Governor DeSantis signed into law, HB.7071, which requires the State Board of Administration (SBA)—the entity responsible for investing the assets of the Florida Retirement System (FRS) Pension Plan and administering the FRS Investment Plan—to develop a divestment plan for all “direct holdings” in China-owned companies by September 1, 2024, and further requires that the complete divestment must occur by September 1, 2025 or at such later time if necessary for it to implement the divestment plan consistent with fiduciary duties. 

The bill prohibits the SBA from acquiring, on behalf of the FRS Trust Fund, “direct holdings in a Chinese company.” A “Chinese company” is defined as a company that is publicly known to be majority-owned by the government of the People’s Republic of China, the CCP, the Chinese military, or any instrumentality, or any combination thereof. Notably, all securities of that company that are held indirectly—that is, held by a commingled fund or other collective investment, such as a mutual fund, in which the FRS Trust Fund owns shares or interests, together with other investors—are not subject to the law. The law further specifies that the SBA is exempt from its typical fiduciary duty to only invest based on pecuniary factors when divesting from Chinese companies.

Conclusion

To date, China divestment measures have only been adopted in Republican-controlled states, but such policies are not the exclusive province of the red states—similar proposals have also been introduced in the Illinois, Maine and New Jersey legislatures in recent years. Furthermore, while these initiatives have usually included carveouts for commingled funds or indirect investments such as private equity funds, it is conceivable that future bills and policies could take a more restrictive approach by prohibiting new investments in such indirect vehicles that have connections to China or other deemed foreign adversaries along the lines of what the Kansas legislation requires.  

For further insights or information on what is happening in this space, please reach out to one of us, or any other member of the Ropes & Gray state ESG team. Also, please refer to our white paper titled State ESG Update and Analysis for Asset Managers and Financial Institutions, which includes selected commentary on some of the state developments our team has tracked this year and provides summaries of what has happened on the ESG front in each of the states in 2024.

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