The Biden Administration has issued an Executive Order (EO) directing the US Treasury Department to prohibit some investments in certain entities located in, organised in, or in some cases owned by foreign persons of a “country of concern" where relating to national security technologies or products. The only “country of concern” currently identified is China, including the Hong Kong and Macau administrative regions. The EO further calls on the Treasury Department to establish requirements for notification of US outbound investments in other technologies and products that also may present US national security concerns. The outbound investment prohibition and notification programme, established by the EO and to be implemented by Treasury Department regulations, at present is effectively limited to US investment in Chinese entities engaged in three areas deemed vital to US national security: semiconductors and microelectronics; quantum information technologies; and artificial intelligence.
No restrictions are in effect currently – but they are coming. It remains possible the EO is but the first of several directives to establish, and perhaps expand, the geographic and technological scope of restrictions on US outbound investment. Although the regulations to be issued by the Treasury Department will not have retroactive effect, the Treasury Department has indicated it may “request information” about transactions by US persons completed or agreed to after the EO was issued “to better inform the development and implementation of the program".
The decision by the Biden Administration will also be closely watched by the EU, with Brussels seeking to mirror the regime with its own controls on outbound investment amid increasing security fears.
The Executive Order
We recently reviewed the background of US efforts reaching back to at least 2018 to enact or impose outbound investment restriction and/or notification regimes, including recent actions in July 2023 by the US Senate approving an outbound investment screening programme. We also noted there that President Biden was considering an EO regulating outbound US investment.
That EO, issued 9 August 2023 and titled “Executive Order on Addressing US Investments in Certain National Security Technologies and Products in Countries of Concern,” declares a “national emergency” under federal law to address what the EO deems an “unusual and extraordinary threat to [US] national security” in respect of China’s advancement in sensitive technologies and products critical to military, intelligence, surveillance, or cyber-enabled capabilities. The EO requires the Treasury Department to establish via regulations a programme that would:
- Require US persons to provide notification of certain transactions involving covered foreign persons that “may contribute” to a threat to US national security (notifiable transactions).
- Prohibit US persons from engaging directly or indirectly in a narrower set of transactions involving covered foreign persons that are determined to pose “a particularly acute national security threat because of their potential to significantly advance the military, intelligence, or surveillance, or cyber-enabled capabilities of countries of concern” (prohibited transactions).
As noted, the EO identified three technology areas that would trigger this US outbound investment programme, namely semiconductors and microelectronics, quantum information technologies, and artificial intelligence, as these areas are considered vital to military decision-making and logistics, encryption and cybersecurity, and surveillance capabilities. The EO does not appear to authorise the Treasury Department to expand the categories of “covered national security technologies and products,” and indeed suggests this term may be “limited by reference to certain end-uses of those technologies or products.”
Significantly, the EO authorises the Treasury Department to require US persons to take all “reasonable steps” to (i) “prohibit and prevent any transaction by a foreign entity that is controlled by the US person,” if such transaction would be a “prohibited transaction” if engaged in by a US person; and (ii) provide notification of any transaction by a foreign entity that is controlled by the US person, if such transaction would be a “notifiable transaction” if engaged in by a US person. The Treasury Department has posed several questions regarding the scope of these, and other, obligations for public comment.
In addition, the EO authorises the Treasury Department to prohibit US persons from “knowingly directing” transactions if the transactions would be prohibited if engaged in by a US person. The Treasury Department has indicated that its proposed approach in the forthcoming regulations will be “narrower than the authority afforded the Treasury Department under the [EO]” in implementing the prohibition on “knowingly directing” transactions.
Finally, unlike the recent version of the Outbound Investment Transparency Act passed by the Senate in July 2023, the EO specifically authorises the Treasury Department to “nullify, void, or otherwise compel the divestment of any prohibited transaction entered into after the effective date of the regulations issued under this [EO].”
In a statement accompanying the EO, the Biden administration noted this outbound restriction and notification programme complements the existing US export control regime and the inbound screening of foreign (non-US) investment undertaken by the Committee on Foreign Investment in the US (CFIUS), with “a ‘small yard, high fence’ approach to address the national security threat posed by countries of concern advancing such sensitive technologies.”
Treasury’s public consultation
As directed by the EO and in its immediate wake, the Treasury Department issued a public consultation (known in US regulatory parlance as an advance notice of proposed rulemaking, or ANPRM) seeking stakeholder comments regarding the outbound investment programme. An ANPRM is not a draft regulation and does not implement the EO; rather, as noted in an accompanying Treasury Fact Sheet, it is a means by which the Treasury Department can share, and solicit comments on, its initial views of the outbound investment program, including its potential scope and implementation.
As drafted, the EO would appear to apply to Chinese-owned entities wherever they are located. The Treasury Department is seeking public comment on the scope of the term “covered foreign person". However, it has proposed a definition which would broadly include any citizen or permanent resident of a “country of concern (which per the EO means China); any entity with its principal place of business in, or incorporated under the laws of China; various Chinese government entities; or any entity in which such persons or entities hold, directly or indirectly, a 50% or greater interest.
Other elements of the programme framework currently under Treasury Department consideration include the following:
- Covered transactions: While the EO addresses “prohibited transactions” and “notifiable transactions,” the Treasury Department is considering using the term “covered transaction” (a term familiar to CFIUS practitioners as a prerequisite for CFIUS jurisdiction) to mean a US person’s direct or indirect involvement in the following:
- Acquisition of equity interests in a covered foreign person, which under the EO is essentially limited to Chinese entities (this includes acquisitions via merger, private equity, venture capital, and other arrangements).
- Provision of debt financing to covered foreign persons that are convertible to equity.
- Greenfield investments that could result in the establishment of a covered foreign person.
- Establishment of a joint venture, wherever located, with a covered foreign person or that could result in the establishment of a covered foreign person.
The ANPRM has listed ten categories of information that would be required to satisfy the notification obligation for covered transactions, which notification would be due no later than 30 days following the closing of the covered transaction, ie, unlike the CFIUS notification process, the new regulations would not necessarily impose a pre-transaction notification requirement.
- Excepted transactions
- Certain transactions by US persons in a covered foreign person potentially may be excepted from the outbound programme. These include: transactions in publicly-traded securities; investments that afford US persons standard minority shareholder protections; intracompany fund transfers from a US parent company to a subsidiary in a country of concern; and acquisition of the equity interest 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 such interests held by the covered foreign person.
- Sub-sets of national security technologies/products prohibited or subject to notification requirements within the three EO categories
- Semiconductors and microelectronics
- Potential prohibition: The Treasury Department is considering a prohibition on US persons undertaking certain transactions involving Chinese entities engaged in activities involving sub-sets of advanced semiconductor and microelectronic technologies and products, including technologies that enable advanced integrated circuits, eg, software for electronic design automation and integrated circuit manufacturing equipment; advanced integrated circuit design and production; and the installation or sale of supercomputers enabled by advanced integrated circuits.
- Potential notification: Notification requirements are being considered for US investments in Chinese entities undertaking the design, fabrication, and packaging of integrated circuits that do not fall within the above prohibitions (ie, less advanced circuits).
- Quantum information technologies
- Potential prohibition: The Treasury Department is considering a prohibition on US persons undertaking a transaction with a Chinese entity engaged in activities involving the production of quantum computers and components; the development of a quantum sensing platform designed to be exclusively used for military end uses, government intelligence, or mass surveillance end uses; and the development of a quantum network or quantum communication system exclusively used for secure communications.
- Potential notification: Perhaps indicating the perceived sensitivity of quantum information technology, this category is currently not being considered for notification requirements.
- Artificial intelligence
- Potential prohibition: The ANPRM does not articulate proposed areas of prohibition in respect of AI, though it notes that a “potential approach” is to focus on US investments in Chinese entities engaged in the development of software that incorporates an AI system and is designed to be exclusively (or primarily) used or military, government intelligence, or mass-surveillance end uses.
- Potential notification: The Treasury Department is considering a requirement for US persons to notify it if undertaking a transaction with a covered foreign person engaged in the development of software that incorporates an AI system designed to be exclusively (or primarily) used for: cybersecurity applications, digital forensics tools, and penetration testing tools; the control of robotic systems; surreptitious listening devices that can intercept live conversations without party consent; non-co-operative location tracking (including international mobile subscriber identity catchers and automatic license plate readers); or facial recognition.
The (potential) way forward
In a release announcing its issuance of the ANPRM, the Treasury Department took care to stress the US “benefits from an open investment climate and this new program will not change that. It is narrowly targeted at investments in highly sensitive technologies and products for the purposes of protecting U.S. national security.” Comments will be received for 45 days after the ANPRM’s formal publication in the US Federal Register. Under standard US administrative procedures, the Treasury Department would subsequently issue proposed regulations, receive further comments, and then issue final regulations that implement the EO.
The EO (and the accompanying Treasury Department consultation) will undoubtedly and justifiably receive significant attention, since the EO ends months, if not years, of speculation as to whether the White House would invoke national emergency powers to levy restrictions on US outbound investment. This recent action will eventually result in prohibition of and notification requirements on certain US investments into China. It is also probably not the last word on the matter, and it is possible that future technological developments and ever-evolving national security concerns will result in expansion of the jurisdictions covered by the US outbound investment regime as well as the technologies deemed especially critical to the national security of the US and its allies and partners.
If the version of the Outbound Investment Transparency Act approved by the US Senate in July 2023 becomes law (discussed here), it is not clear how the Senate outbound investment notification regime would coexist with the regime contemplated by the EO. Among other differences, the Senate regime does not contemplate the prohibition of transactions or the unwinding of transactions. The Treasury Department would be responsible for drafting regulations for both the Senate regime and the regulations to implement the EO.
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We continue to monitor developments in this area. Please contact the authors or your usual Herbert Smith Freehills contact for more information.