New restrictions on outbound US investments in China unveiled by Biden Administration

President Joe Biden has signed an Executive Order (EO) that restricts investments into China involving sensitive technology, with the goal of preventing American capital and associated intangible benefits from contributing to advanced industries and applications that could support China’s military modernization and threaten US national security.

The long-anticipated Executive Order on Addressing United States Investments In Certain National Security Technologies And Products In Countries Of Concern, signed by the President on August 9, directs the US Department of the Treasury to issue regulations imposing new restrictions and reporting requirements on the participation by US persons, including private equity and venture capital firms, as well as operating companies, joint ventures, and other US persons, in transactions involving “covered foreign persons" from “countries of concern” engaged in activities involving “covered national security products and technologies.”

China, including Hong Kong and Macau, is identified in an annex to the EO as a country of concern.

Under the EO, “covered national security products and technologies” means sensitive technologies that are critical for military, surveillance, intelligence, or cybersecurity applications within three priority sectors:

• quantum computing^[1]
• artificial intelligence (AI)^[2] and
• advanced semiconductors and microelectronics.^[3]

Pursuant to the EO, US persons will be required to notify the US government of all such transactions (thereby providing the US government with a more extensive information on the nature and extent of US investments involving sensitive technologies and Chinese parties), while those involving products or technologies determined to “pose a particularly acute national security threat” are to be prohibited.

Treasury begins drafting regulations

The Treasury Department concurrently released an Advance Notice of Proposed Rulemaking (ANPRM) seeking public comment by September 28, 2023 on its implementation of the EO.

The ANPRM requests comments on the key components of the rulemaking, including the types of transactions covered, the definition of a US person subject to the restrictions, due diligence challenges, the scope and definitions of covered technologies and products, and a variety of potential exceptions.

The ANPRM currently contemplates that the specific categories of covered transactions will include:

• acquisitions of equity interests, such as via mergers and acquisitions, private equity, venture capital, and other arrangements
• greenfield investments
• joint ventures and
• certain debt financing transactions that are convertible to equity.

The ANPRM indicates that transaction parties will have the obligation to determine whether an investment is: (1) prohibited, (2) subject to notification, or (3) otherwise permissible.

The forthcoming regulations, however, may include several important exceptions. The ANPRM states that the rulemaking will be “forward-looking, and not to cover transactions and the fulfillment of uncalled, binding capital commitments with cancellation consequences made prior to the issuance of the Order.” Other potential exceptions include (i) investments into publicly traded securities, index funds, mutual funds, or exchange-traded funds; (ii) investments as a passive limited partner in a venture capital fund, private equity fund, fund of funds, or other pooled investment funds; (iii) the acquisition of the equity or other interest owned or held by a covered foreign person in an entity or assets located outside of a country of concern where the US person is acquiring all interests in the entity or assets held by covered foreign persons; and (iv) an intracompany transfer of funds from a US parent company to a subsidiary located in a country of concern.

The ANPRM also addresses restrictions on the personal involvement of individual US persons in “directing” investments made by or through foreign entities that would be prohibited for a US investor.

The Treasury Department press release states that the ANPRM will be followed by draft regulations at a later date.

Renewed Congressional push

In addition to this executive action, outbound investment screening also remains a focus for Congress.

While voicing support for an executive order and other Administration actions, a bipartisan coalition in Congress has been working to enact a broader enforcement regime to regulate US investments in countries deemed to be of particular concern, with China generally heading the list.

Last month, an amendment to the National Defense Authorization Act (NDAA) titled the Outbound Investment Transparency Act, was approved in the Senate by a 91-6 vote. It would require US financial institutions to notify the government when they invest in Chinese companies in the areas of advanced semiconductors, AI, quantum computing, hypersonic, satellite-based communications, and laser scanning systems. Objections have been raised to the amendment by key House members, however, so it is not clear if this amendment, which has some overlap with the EO, will become law as part of the NDAA.

More extensive legislation on outbound investment has been pending in the House and Senate for some years. The National Critical Capabilities Defense Act (NCCDA) would give the government the authority to screen – and potentially block – outbound deals determined to pose national security or other risks.

This process has been termed “reverse CFIUS,” a reference to the Committee on Foreign Investment in the United States, an existing inter-agency committee charged with reviewing the national security implications of inbound investment – foreign investments in US companies or operations.

Congress has been awaiting the Administration’s action on outbound investment for months, and the President’s new policies – and Treasury’s implementation of them – will be closely scrutinized.

The Administration freely acknowledges that it is pursuing a more narrow, targeted approach, and it is possible that this will strike some on Capitol Hill as too limited and thus prompt renewed legislative efforts. However, the failure to enact the NCCDA after several legislative sessions and differences over the narrower Senate amendment in the defense bill testify to the difficulty of enacting policies that strike the right balance between protecting national security and promoting innovation.

One of the key Congressional players in this debate is the newly created House Select Committee on the Strategic Competition Between the United States and the Chinese Communist Party. Its chair, Representative Mike Gallagher (R-WI), wrote to President Biden last week in anticipation of the EO, calling for, among other priorities, including both private and public market investments flowing to China in new restrictions; forcing Chinese companies to meet the same due diligence standards as American companies; providing predictability and certainty to investors; avoiding “creating an onerous, case-by-case screening process”; and consulting with allies and partners before implementing new restrictions and urging them to adopt parallel restrictions on investing in China.

While the legislative prospects are unclear, it is likely that Congress will exercise its oversight powers regarding the Administration’s new outbound investment policy priorities. Gallagher’s committee, along with other House and Senate panels, can be expected to revisit the issue with hearings when Congress returns in September.

We are happy to assist and provide additional counsel on the impact of this new EO on current and planned investments, as well as assisting in preparing comments to the proposed rulemaking. To learn more, please contact any of the authors of this alert or other members of our National Security and Global Trade group.

^[1] Prohibitions on US investments in Chinese entities engaged in quantum information technologies could include investments in entities engaged in the production of quantum computers and certain components; the development of certain quantum sensors; and the development of quantum networking and quantum communication systems. Treasury is not currently considering a separate notification requirement for quantum information technologies.

^[2] Treasury may require notification for US investments in Chinese entities engaged in activities related to software that incorporates an AI system and is designed for certain end-uses that may have military or intelligence applications and pose a national security risk. Feedback is also being sought on the scope and appropriate tailoring of a prohibition on investments in entities engaged in a narrow set of activities related to software that incorporates an AI system and is designed for particular end uses with national security implications, such military surveillance end uses.

^[3] Treasury is considering prohibiting US investments in Chinese entities engaged in the development of electronic design automation software or semiconductor manufacturing equipment; the design, fabrication, or packaging of advanced integrated circuits; and the installation or sale of supercomputers. Notification for investments in entities engaged in the design, fabrication, and packaging of less advanced integrated circuits could also be a requirement.