Unbeknownst to many hedge fund managers, U.S. funds are operating in a complex economic sanctions environment, with serious potential consequences for inadvertent trades in banned securities. The Trump administration imposed sanctions on a list of Chinese companies identified as supporting the Chinese military industrial complex (CMIC). Those sanctions prohibit U.S. persons, including hedge funds, from trading in the securities of "CMIC companies" – even if the securities are offered only on foreign exchanges, such as the Hong Kong Stock Exchange (HKEX).
Although the CMIC list continues to grow and additional HKEX-listed securities are becoming subject to sanctions, many U.S. hedge fund managers trading in HKEX securities are not aware of the sanctions or do not understand the scope of the restrictions. Sanctions ban not only direct investments but also trading in derivatives and exchange-traded funds (ETFs) that provide exposure to the sanctioned securities. In an environment of software-managed trading, instant transactions, relentlessly shifting portfolios and little to no see through to the composition of ETFs or index funds, how do U.S. hedge fund managers mitigate sanctions risk?
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