China Regulatory Framework: U.S. Tightens Tech Investments

Introduction

On August 9, 2023, President Biden unveiled an executive order titled “Addressing U.S. Investments in Certain National Security Technologies and Products in Countries of Concern” (referred to as the Executive Order or E.O.). This initiative underscores the potential threats that specific technologies and products pose to U.S. national security. It also points to the escalating rivalry between the U.S. and China. The E.O. mandates the formulation of regulations that limit U.S. investments in the Chinese tech sector, expected to be implemented promptly. Furthermore, it instructs U.S. secretaries of state and commerce to collaborate with international allies, assessing the security risks of advancements in specified national security technologies and products by countries of concern.

This briefing offers insights into the Executive Order, emphasizing:
1. The potential national security technologies and products affected.
2. The entities expected to adhere to these regulations.
3. The nature of transactions that will, or won’t, fall under these rules.
Additionally, this document provides an analysis of possible implications and next steps within this regulatory context.

Background

The Executive Order asserts that specific nations, chiefly China (inclusive of Hong Kong and Macau), capitalize on U.S. investments to foster the development of vital technologies and products with potential military, intelligence, and cyber applications. This includes leveraging the intangible perks accompanying such investments, like market access, networking, and enhanced financing. The primary technological areas of concern are semiconductors, quantum information technologies, and artificial intelligence (AI).

To address these concerns, the Treasury Department is tasked with devising a fresh regulatory program. In the early stages of this initiative, the Treasury has issued an Advanced Notice of Proposed Rulemaking (ANPRM) to gather public opinions on the planned program’s nuances. This proposed framework will complement existing U.S. investment procedures and current sanctions/export control mechanisms. Public feedback on 83 detailed questions related to the E.O.’s execution is anticipated by September 28, 2023.

Who Needs to Comply?

The ANPRM outlines that any “U.S. person” might need to notify the Treasury or be restricted from certain transactions involving a “covered foreign person,” primarily entities or individuals from China, as designated by the Executive Order.

U.S. Person: Based on the ANPRM, a “U.S. person” encompasses U.S. citizens, permanent residents, entities organized under U.S. jurisdiction, and anyone residing in the U.S. The Treasury aims to have a comprehensive approach, covering both direct and indirect transactions influenced by U.S. entities.

Covered Foreign Person: The Treasury’s guidelines are crafted to ensure investments aren’t indirectly funneled through Chinese corporate structures. The term “covered foreign person” incorporates entities or individuals engaged in certain activities related to national security technologies or those deriving significant revenues from such activities.

What Transactions are Covered?

General Overview: The proposed program will mainly scrutinize U.S. entities partaking in transactions that might offer intangible ownership benefits, such as equity acquisitions, greenfield investments, joint ventures, and specific debt-financing deals that can convert to equity.

Exceptions: The ANPRM suggests exempting certain low-risk investments to prevent unintentional ramifications. Passive investments, some U.S. stakes in publicly traded entities, and transactions involving banking organizations typically fall outside the purview of this new rule. The precise scope of these exceptions will be determined based on feedback to the ANPRM.

In sum, this Executive Order and its ensuing regulations aim to fortify U.S. national security by closely monitoring and possibly restricting specific investments related to countries of concern, primarily China.

Types of Technologies and Products Addressed in the New Regulatory Framework

1. Semiconductors and Microelectronics

– Concern: U.S. investments in Chinese entities associated with:
– Electronic design automation software or semiconductor manufacturing equipment.
– Design, fabrication, or packaging of advanced integrated circuits.
– Installation or sale of supercomputers.
– **Notification Requirement**: Necessary for transactions linked with integrated circuit design, fabrication, or packaging not prohibited by the above criteria.
– **Public Comment**: Treasury seeks feedback on U.S. investment trends into countries of concern, and emerging trends in U.S. outbound investments.

2. Quantum Information Technologies

– Concern: U.S. investments in Chinese entities engaged in:
– Production of quantum computers and some components.
– Development of specific quantum sensors.
– Development of quantum networking and quantum communication systems.
– Limitations: Prohibitions are specified for quantum sensors used exclusively for military, intelligence, or mass surveillance, and quantum systems exclusively for secure communications.
– **Public Comment**: Treasury inquires if restrictions should be for products “designed to be exclusively used” or “designed to be primarily used”.

3. Artificial Intelligence (AI) Systems

– Concern: U.S. investments in Chinese entities developing software with AI systems for military, intelligence, or mass-surveillance purposes.
– **Notification Requirement**: Needed for transactions with foreign persons involved in developing software using AI for specific applications, like cybersecurity, digital forensic tools, control of robotic systems, and others.
– **Public Comment**: Treasury queries about adopting a “primarily used” standard instead of “exclusively used” for AI systems.

Key Takeaways:

– A new U.S. regulatory framework is introduced to limit outbound foreign investments, coexisting with existing U.S. regulations against perceived Chinese national security threats.
– The exact details of which transactions are prohibited and what notifications are required are yet to be finalized.
– Some technology businesses may still be affected even if they fall outside the ANPRM’s scope if they use covered national security technologies or products.
– Unlike CFIUS, ANPRM does not require a case-by-case review. Instead, it puts the responsibility on the U.S. investor and involved parties to decide on the transaction’s nature.
– The regime will focus on enforcement over approvals, with severe consequences for noncompliance, such as penalties and unwinding of transactions.
– Given the current U.S. policy focus, robust and aggressive enforcement is expected, especially for investments that might threaten U.S. national security.
– For foreign trade-related compliance and foreign direct investment issues, consultation with experienced counsel is recommended.

Legal Disclaimer

The information provided in this article is for general informational purposes only and should not be construed as legal or tax advice. The content presented is not intended to be a substitute for professional legal, tax, or financial advice, nor should it be relied upon as such. Readers are encouraged to consult with their own attorney, CPA, and tax advisors to obtain specific guidance and advice tailored to their individual circumstances. No responsibility is assumed for any inaccuracies or errors in the information contained herein, and John Montague and Montague Law expressly disclaim any liability for any actions taken or not taken based on the information provided in this article.

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