On August 9, 2023, President Biden issued Executive Order 14105, targeting certain US investments into Chinese companies or Chinese-owned companies engaged in three advanced technology areas (Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern, the “EO”).
The EO directs the US Department of the Treasury (“Treasury“) to issue regulations that will (1) prohibit certain categories of US outbound investments and (2) require notification of other investments involving the People’s Republic of China, Hong Kong, and Macau (collectively “China”). Treasury has simultaneously issued an advance notice of proposed rulemaking (“ANPRM”) addressing how Treasury intends to implement the key elements of the EO, along with a companion fact sheet and press release. The ANPRM devotes substantial commentary to the proposed treatment of companies seeking to make or support covered investments, including companies with existing investments in China, companies contemplating expansions into China or Chinese-owned companies, venture capital and private equity firms, funds, investment managers, lenders, underwriters, and other financial intermediaries.
The long-anticipated EO adds to the US national security measures that focus on China’s advanced technology development efforts, including the US inbound investment review process administered by the Committee on Foreign Investment in the United States (“CFIUS”), US export controls that were expanded in October 2022 to target China’s advanced computing and semiconductor sectors, and a number of legislative initiatives aimed at the implementation of a China-focused outbound investment screening regime.
The EO
The EO tasks Treasury with the promulgation of the regulations that prohibit certain categories of investments and impose mandatory notification requirements on other investments, involving certain entities located in or subject to the jurisdiction of a “country of concern,” and certain other entities owned by persons of a country of concern, engaged in activities related to subsets of the following technology fields:
- semiconductors and microelectronics;
- quantum information technologies; and
- “certain” artificial intelligence systems.
The EO only defines China as a country of concern. For clarity, China is hereafter referred to in place of “country of concern.”
The ANPRM
The ANPRM does not implement the EO. Rather, Treasury issued the ANPRM to solicit public comment to assist in Treasury’s drafting the EO’s regulations. The public will have 45 days to provide comments to the ANPRM. Treasury did not provide an estimated timeline for the issuance of regulations. Retroactive coverage of pre-existing investments is not under consideration; however, Treasury has noted that it may request information about investments that occur after the EO but prior to the effective date of the EO’s implementing regulations and is also considering how to treat certain “follow-on” transactions involving pre-EO investments.
The ANPRM and the resulting regulations are to be administered by Treasury’s Office of Investment Security, which also administers the CFIUS inbound investment screening process. The ANPRM reflects the framework Treasury anticipates when issuing regulations, with some highlights as follows:
Prohibition and notification regime: Treasury intends either to prohibit or to require a notification of investments into Covered Technologies engaged in by Covered Foreign Persons. As currently contemplated, the notification, where required, would be due within 30 days post-closing. The ANPRM specifically delineates between Covered Technologies subject to the prohibitions and those under consideration for notifications only. The practical challenges of differentiating between the two, as applied to the specific technologies that are described, are beyond the scope of this blog but are plainly apparent and implicitly acknowledged through the comments solicited in the ANPRM.
- No transaction-specific review: Unlike the US inbound investment screening process administered by CFIUS, Treasury does not contemplate a case-by-case review of investments.(Although, there may be a limited avenue by which petitioners can obtain an exemption from the prohibition upon showing an “extraordinary benefit” to US national security or US national interest with respect to a particular transaction). Treasury also does not contemplate case-by-case determinations of whether an individual transaction is prohibited, subject to the notification requirement, or not subject to the US outbound investment program in the first instance.
- Possible enforcement options: The EO authorizes a range of Treasury enforcement options, including divestment orders and monetary penalties, where prohibited transactions occur or required notifications are not made on a timely basis. However, Treasury states in the ANPRM that it is considering the possible use of civil monetary penalties for most violations, including prohibited transactions, but seeks comments on the use of divestment orders in the event of prohibited transactions.
Jurisdictional reach: The ANPRM addresses or defines Covered Technologies, Covered Transactions, Covered Foreign Persons, and US Persons. It also provides extensive commentary on the assertion of jurisdiction over activities indirectly involving Covered Foreign Persons and US Persons.
- Treasury is considering the following subsets as Covered Technologies:
- Semiconductors and microelectronics: The development of electronic design automation software; semiconductor manufacturing equipment; design, fabrication, or packaging of advanced integrated circuits; and the installation or sale of supercomputers. The design, fabrication and packaging of “less advanced” integrated circuits are also under consideration.
- Quantum information technologies: The production of quantum computers and certain components; the development of certain quantum sensors; and the development of quantum networking and quantum communication systems. The end-use, distinguishing between acceptable fields (medicine) and prohibited fields (cryptography), are also under consideration.
- Artificial intelligence systems: Software incorporating an AI system and intended for military or intelligence end uses, as well as possibly a limited set of activities relating to AI software systems designed for national security-sensitive end uses.
Covered Transactions: Treasury anticipates tailoring the regulations to cover activities involving Covered Technologies that convey intangible benefits, such as managerial assistance, talent networks, and market access. Covered Transactions may include the acquisition of equity interests (mergers and acquisitions, private equity, and venture capital), “greenfield” investments (creation of a new foreign subsidiary of a US parent), joint ventures, and equity-convertible debt financing.
- Possible exclusions from Covered Transactions: Importantly, the ANPRM indicates that certain categories of activities involving covered technologies are not intended to be captured as Covered Transactions, including, among other things, university-to-university research collaborations, intellectual property licensing arrangements, underwriting services, and bank lending and the processing or clearing of financial transactions.
- Possible exceptions to Covered Transactions: Treasury is also considering excepting certain types of US investments that may otherwise fall within the definition of Covered Transactions, including the acquisition of publicly traded securities, index funds, mutual funds, exchange-traded funds, as well as certain activities and investments by limited partners, committed but uncalled capital investments, and intracompany transfers of funds from a US parent to its subsidiaries.
Covered Foreign Persons: Treasury anticipates the EO’s restrictions to apply to Covered Transactions involving persons that are organized under Chinese law, have a principal place of business in China, or are majority-owned by Chinese individuals or entities (this last prong serving to extend coverage to non-Chinese subsidiaries of Chinese parents). Covered Foreign Persons could also include a person located or incorporated outside of China but whose direct or indirect subsidiaries or branches independently qualify as Covered Foreign Persons and which, individually or in the aggregate, comprise the majority of that person’s consolidated revenue, net income, capital expenditure, or operating expenses (e.g., a Singaporean entity whose Chinese subsidiary(ies) comprise the majority of its consolidated revenue).
US Persons: The prohibition and mandatory notification requirements would be triggered by Covered Transactions engaged in by “US Persons.” The term “US Persons” will likely incorporate the standard definition applicable in most US sanctions regimes: US citizens and permanent residents, wherever located, entities organized under US federal or state law and their foreign branch offices, and persons located in United States.
The ANPRM contemplates multiple features to extend the prohibitions and notification requirements to Covered Transactions indirectly involving Covered Foreign Persons or US Persons.
- Transactions knowingly directed by US Persons: Treasury may prohibit US Persons, wherever located, from knowingly directing non-US Person transactions if such transactions were prohibited if engaged in by a US Person. The prohibition is intended to apply to a scenarios in which a US Person “orders, decides, approves, or otherwise causes to be performed” such transactions. This prohibition, if included in the regulations, may carry broad implications for US Persons operating in managerial or executive positions in multinational enterprises, regardless of an enterprise’s headquarters location or jurisdiction of incorporation.
- Transactions by US Person-controlled foreign entities: Treasury is also considering extending “certain” obligations of US Persons under the prohibition and notification regime to transactions involving US Person-“controlled foreign entities.” As contemplated, US parent companies would be required to notify Treasury of any transaction engaged in by their controlled subsidiaries if the transaction were notifiable if engaged in by a US Person and to take reasonable steps to prevent its controlled subsidiaries from engaging in prohibited transactions. The term “controlled foreign entity” would likely encompass for these purposes foreign entities in which a US Person owns, directly or indirectly, a 50% or greater interest.
Outbound Investment Screening Regime: A Work in Progress
US interests in an outbound investment review mechanism dates back to at least 2018, when legislative drafters considered including an outbound investment review mechanism to the Foreign Investment Risk Review Modernization Act (“FIRRMA”). FIRRMA ultimately was enacted without an outbound investment review mechanism.
More recently, a bipartisan group of legislators have attempted to pass the National Critical Capabilities Defense Act (“NCCDA”). After failing to pass prior iterations of the NCCDA in 2021 and 2022, the NCCDA’s Congressional supporters sent a letter to President Biden requesting the issuance of an outbound investment review executive order in September 2022.
Congress is still working on codifying an outbound investment review bill. On August 2, 2023, the US Senate passed an amendment to the draft National Defense Authorization Act of 2023 (“NDAA”), titled the Outbound Investment Transparency Act (“OITA”), requiring notification to Treasury of investments in “countries of concern” (China, Russia, Iran, and North Korea) relating to listed technologies such as semiconductors, quantum technology, artificial intelligence. Treasury would have authority to expand the categories of covered technologies under the OITA.
Due to discrepancies between the Senate and House of Representatives versions of the NDAA, differences in the NDAA—including the OITA—will have to be reconciled in conference. There is no guarantee that the OITA will be included in the enacted version of the NDAA.
Additionally, a 2023 iteration of the NCCDA has also been introduced, involving expansive definitions of covered activity (including acquisition of equity interest, provision of credit, and supply arrangements) and covered technology (including critical minerals and materials, active pharmaceutical ingredients, and automobile manufacturing). As both Congress and the Executive Branch weigh their options in designing an outbound investment review mechanism, the issuance of the EO and its initial regulations may be just the starting point setting a stage for a new regulatory regime.
