On 9 August 2023, the U.S. government issued the Executive Order on Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern (“Executive Order”) , which states that “advancement by countries of concern (meaning China, including Hong Kong and Macao) in sensitive technologies and products critical for the military, intelligence, surveillance, or cyber-enabled capabilities of such countries constitutes an unusual and extraordinary threat to the national security of the United States”, “and that certain United States investments risk exacerbating this threat”. In order to curb such threats, the Executive Order authorizes the U.S. Department of the Treasury (“Treasury”), in conjunction with other federal government departments, to adopt federal regulations to implement categories of specific transactions, including: 1) require United States persons to provide notification of information relative to certain transactions involving covered foreign persons (“Notifiable Transactions”); and 2) prohibit United States persons from engaging in certain other transactions involving covered foreign persons (“Prohibited Transactions”). In addition, the Executive Order authorizes the Treasury to exercise all the powers granted to the President under the International Emergency Economic Powers Act (“IEEPA”) to ensure that the Executive Order is implemented, including the imposition of administrative penalties for violations, the referral of related criminal offenses to the Department of Justice and the repeal or rescission of prohibited transactions and divestitures of investors that were entered into after the effective date of the relevant federal statute.
At the same time, the Treasury issued an Advance Notice of Proposed Rulemaking (ANPRM) for public comment for 45 days. The ANPRM intends to define further notification requirements, enforcement measures, and penalties for non-compliance.
This article is a brief explanation and analysis of the aforementioned Executive Order and ANPRM.
1. Regulated Targets of Executive Order
1） The Executive Order primarily limits investments by U.S. subjects in “countries of concern.” A “Country of Concern” (currently China only, including Hong Kong and Macau) means that the subject is: (i) a citizen or permanent resident of a “Country of Concern” (and not also a U.S. citizen or lawful permanent resident) of ; (ii) an entity organized under the laws of the Country of Concern or having its principal place of business in the Country of Concern; (iii) the government of the Country of Concern (including any political subdivision, party, agency or instrumentality thereof, or any subject owned, controlled or directed by, or on behalf of, such government); (iv) the government of the Country of Concern (including any political subdivision, party, agency or instrumentality thereof or any subject owned, controlled or directed by, or on behalf of, such government) (iii) the government of a “Country of Concern” (including any political subdivision, party, agency or instrumentality thereof, or any subject owned, controlled or directed by, or acting on behalf of, such government); or (iv) any entity in which any of the subjects in (i)-(iii) owns, directly or indirectly, a greater than 50% interest. 2） (i) the subject is engaged in (or the U.S. subject knows or should know that it will be engaged in) activities related to specified “national security technologies or products”; or (ii) a direct or indirect subsidiary or affiliate of the entity is or will be engaged in specified “national security technology or product” activities, and the consolidated revenues, net profits, capital expenditures, or operating expenses of such subsidiaries or affiliates, individually or in the aggregate, are 50% or more of the entity.
2. Subjects subject to Executive Order
The direct subjects subject to Executive Order (and to the legal consequences of non-compliance) are primarily “U.S. subjects” including U.S. citizens and lawful permanent residents, entities organized under U.S. law (including their unincorporated branches abroad), and any U.S.-based subjects.
At the same time, the Executive Order authorizes the Treasury to require U.S. subjects to report by statute transactions conducted by foreign entities “controlled” by them or to require U.S. subjects to take all reasonable measures to prohibit or avoid transactions undertaken by foreign entities “controlled” by them if such transactions are required to be reported or prohibited when conducted by the U.S. entity. The Treasury is actively considering adding these requirements to future regulations and intends to define “control” in this context as a direct or indirect ownership interest of more than 50 percent.
In addition, any subject in the world that conspires with a U.S. subject to violating the statute’s provisions circumvents the statute’s requirements or whose actions cause a U.S. subject to violate the statute’s provisions is prohibited and may be subject to liability.
3. Scope of the Executive Order
As required by the Executive Order, the Treasury will implement the Executive Order in three technology and product areas in a hierarchical manner:
1） Semiconductors and microelectronics: the Treasury proposes to prohibit transactions related to certain advanced technologies and products and set notification requirements for transactions related to other technologies and products;2） Quantum Information Technology: the Treasury proposes to prohibit transactions related to specific technologies and products but does not intend to set notification requirements at this time;3） Artificial Intelligence Systems: the Treasury proposes setting notification requirements for transactions related to specific products and technologies for specific end uses and prohibiting certain other transactions.
In addition, the transactions targeted by the Executive Order include only investment-type transactions, i.e., Treasury has limited the restricted transactions to the following - U.S. subjects, either directly or indirectly (or at the direction of others):1） Acquisition of equity or conditional equity in a “covered foreign subjects”;2） Provision of debt financing convertible into equity to “covered foreign subjects”;3） Carrying out a newly established investment that may result in the establishment of “covered foreign subjects”; or4） It is establishing a joint venture with “covered foreign subjects” or launching a joint venture that may result in the establishment of “covered foreign subjects” (wherever located).
At the same time, Treasury expressly excludes from the restrictions (so long as they are not designed to circumvent the investment restriction rules) transactions such as inter-university research collaborations; contractual arrangements for the procurement or importation of materials (e.g., raw materials) for any covered “national security technology or product”; intellectual property licensing Arrangements; bank loans; bank services for the processing, clearing, or dispatch of payments; underwriting services; debt rating services; prime brokerage services; global custody services; equity research or analysis; other secondary transaction services; investments in publicly traded securities; investments in index funds, mutual funds, exchange-traded funds, or similar instruments offered by investment firms, including related derivatives; and investments in limited partnerships as a limited partner. Limited partnerships (limited partners may not participate in operational decisions, and such investments must fall below certain thresholds); transfers of funds from a U.S. parent company to subsidiaries located in “countries of concern” and transactions according to binding uncalled capital commitments entered into before the issuance of the Executive Order.
4. “National security technologies or products” activities
The type of “national security technology or product” activity engaged in by a “covered foreign subject” (or its subsidiaries or affiliates) will largely determine whether transactions between the U.S. subject and it are subject to notification requirements or transaction prohibitions and the Treasury is currently focusing on the following items such as semiconductors and microelectronics, artificial intelligence, and quantum technologies:
Semiconductors and microelectronics
1） The Treasury is proposing to prohibit U.S. subjects from engaging in transactions with “covered foreign subjects” that engage in the following activities:
(i) Technologies enabling advanced integrated circuits. Electronic design automation software: development or production of electronic design automation software specifically designed for integrated circuit design; integrated circuit manufacturing equipment: development or production of front-end semiconductor manufacturing equipment specifically designed for large-scale integrated circuit manufacturing.(ii) Advanced Integrated Circuit Design and Manufacturing. Advanced integrated circuit design, including integrated circuits that exceed the performance specifications of ECCN 3A090 or that, operate at temperatures of 4.5 Kelvin or less. Advanced integrated circuit design includes the design of integrated circuits that exceed the performance specifications of ECCN 3A090, or integrated circuits that are designed to operate at temperatures of 4.5 kelvins or less; Advanced integrated circuit manufacturing includes the manufacturing of integrated circuits that meet any of the following conditions, such as logic integrated circuits using non-planar transistor architectures or 16/14 nanometer or smaller technology nodes, including, but not limited to, FDSOI integrated circuits, NAND storage integrated circuits with 128 or more layers, DRAM integrated circuits using 18 nanometer half pitch or smaller technology nodes, DRAM integrated circuits, integrated circuits fabricated from gallium-based compound semiconductors, integrated circuits using graphene pintle tubes or carbon nanotubes, or integrated circuits designed to operate at temperatures of 4.5 kelvins or less; Advanced Integrated Circuit Packaging: packages to support integrated circuits for three-dimensional integration, using either silicon perforations or die vias.(iii) Supercomputer: Installation or sale to third-party customers of a supercomputer supported by advanced integrated circuits that can provide a theoretical computing power of 100 or more double-precision (64-bit) petaflops or 200 or more single-precision (32-bit) petaflops in a space of 41,600 cubic feet or less.
2） The Treasury Department proposes to require U.S. entities to file notifications on transactions with “covered foreign entities” engaged in other integrated circuit design, manufacturing, and packaging activities.
Quantum information technology
1) The Treasury Department is proposing to prohibit U.S. subjects from engaging in transactions with “covered foreign subjects” that engage in the following activities:
(i) Quantum computers and components: production of quantum computers, dilution chillers, or two-stage pulse tube chillers.(ii) Most miniature quantum sensors: development of quantum sensing platforms specialized for military end-use, government intelligence, or mass surveillance end-use.(iii) Quantum networks and quantum communication systems: development of quantum networks or quantum communication systems specialized for secure communications, such as quantum key distribution.
2) Treasury has not yet considered notification requirements for transactions with “covered foreign subjects” engaged in other quantum information technology-related activities.
1） The Treasury proposes to prohibit U.S. subjects from engaging in transactions with “covered foreign subjects” that are involved in the development of software that incorporates artificial intelligence systems and is designed for military, government intelligence, or mass surveillance end-users (in which the Treasury may replace the term “exclusively” to “primarily for”).2） The Treasury proposes to require U.S. subjects to report transactions with “covered foreign subjects” that engage in the development of software that incorporates artificial intelligence systems and is designed for use in cybersecurity applications, digital forensics tools, and penetration testing tools; robotic system control; covert listening devices that can intercept real-time conversations without the consent of the subject; non-cooperative location tracking (including IMSI capture and automated license plate readers); or facial recognition (in which Treasury may replace the term “exclusively” with “principally”).
5. Retroactivity of Executive Order
Under the terms of the Executive Order, the outbound investment review outlined in the Executive Order is not retroactive. The review of restricted transactions will begin only after the effective date of the implementing regulations issued by the Treasury under the Executive Order, and investment transactions conducted before the effective date of the specific rules will not be affected.
The Executive Order would prohibit U.S. private equity and venture capital firms from investing in several high-technology sectors and require notification and disclosure of their activities related to investments in other sectors in China to give the U.S. government a better understanding of financial flows between the United States and China. For Chinese companies in semiconductors and microelectronics, quantum information technology, and specific artificial intelligence systems, direct investments from the U.S., such as private equity, venture capital, joint ventures, and greenfield investments, will be restricted or even prohibited. As a result, Chinese companies that derive at least half of their revenue from cutting-edge fields such as quantum computing and artificial intelligence could be significantly impacted. In addition, the Executive Order’s formal rule proposal may include a “revenue requirement.” Under this provision, the Executive Order could prohibit investments in Chinese companies that derive at least half their revenue from cutting-edge fields such as quantum computing and AI. U.S. private equity and venture capital firms would still be allowed to invest in Chinese companies with cutting-edge technology divisions but derive more than half of their revenue from other sources. It is thus clear that the Executive Order is mainly targeting Chinese start-ups.
In response to these restrictions, when faced with transactions involving the U.S., Chinese companies can prepare for them by setting up a specialized legal compliance team, assessing legal risks, setting up risk management and contingency plans, and conducting internal compliance training.