In One Sentence

• The U.S. Treasury Department released a Proposed Rule to implement President Biden’s Executive Order of August 2023 on outbound investment controls.
• The Proposed Rule prohibits U.S. investment in China and Chinese companies that the U.S. government determines as posing “a particularly acute national security threat because of its potential to significantly advance the military, intelligence, surveillance, or cyber-enabled capabilities” of China.
• The Proposed Rule lists a number of industries and technologies that are either barred for U.S. investors or trigger a notification requirement, but does not provide an explicit definition for “national security.”
• China expressed “deep concerns” and “firm opposition” to the United States’ proposed rules on outbound investment controls, adding that it “reserves the right to take corresponding measures.”

Mark the Essentials

• The release of the Treasury Department’s Proposed Rule comes 10 months after President Biden signed Executive Order 14105, which tasked the Treasury to issue specific regulations that ban or require prior notification for certain U.S. investments in China. It constituted the first instance ever of the U.S. government seeking to regulate outbound capital flows for national security reasons.   
• Specifically, U.S. citizens, companies and foreign subsidiaries under their control are prohibited from certain investment, acquisition or business expansion in China or related to Chinese companies if they engage in, among others: the development of semiconductor design software; front-end semiconductor fabrication equipment; high-performance, advanced or cutting-edge semiconductor; supercomputer and quantum computer; high-performance artificial intelligence (AI) systems; and AI systems that is designed exclusively for military end use, governance intelligence or mass-surveillance. 
• The Proposed Rule has been generally welcomed by the business community given its tailored approach. In a statement, the U.S.-China Business Council (USCBC) noted that it “supports the Biden administration’s efforts to protect U.S. national security while also ensuring robust commercial exchange with China for the benefit of American companies, workers and our economy.”

Keeping an Eye On…

• Later this year, the other shoe will drop with regard to investment controls and China. In August 2018, Congress and the Trump administration expanded CFIUS’ (Committee on Foreign Investment in the United States) jurisdiction beyond transactions that could result in foreign control of a U.S. business to also sweep non-controlling minority investments within CFIUS’ inward investment screening remit. The authority applied to non-controlling investments in U.S. businesses that were developing critical technologies, owned or operated critical infrastructure, or maintained or collected sensitive personal data of U.S. citizens—collectively known as TID (technology, infrastructure, and data) businesses. By denying foreign investors of “countries of special concern” from having access to material nonpublic technical information in the possession of that U.S. business, the aim was to shut down gaps and loopholes that could enable the said foreign investor to exploit a minority investment position in an early-stage technology company to obtain cutting edge IP and trade secrets. Chinese FDI in the United States cratered from that point on, in part due to the chilling effect of the measure. Almost six years later, the Treasury Department has now flipped its focus. On June 21, the department issued a 165-page Proposed Rule to control U.S. outbound investments to China. The Proposed Rule follows an outbound investment-related Executive Order issued by President Biden in August 2023 and an Advanced Notice of Proposed Rulemaking later that month. As per the Proposed Rule, U.S. investors are to be prohibited from engaging in transactions that facilitate the advancement of sensitive technologies or products critical to military, intelligence, surveillance or cyber-enabled capabilities by entities that are either: (a) registered and based in China (“country of concern”), (b) placed on any of the U.S. government’s restricted lists (e.g. Entity List, Military End User List, SDN List, etc.), or (c) tied to China, by way of substantial interests in Chinese companies, in other jurisdictions (say, via the variable interest entity structure in the Caymans or routed through Middle Eastern investments). The prohibition extends to investments in existing operations too in China insofar as the investment involves a business expansion or pivot to these proscribed technologies or products. The technologies or products listed (the “covered activities”), which are accompanied by highly technical parameters, belong to the semiconductor and microelectronics, quantum information, and artificial intelligence (AI) sectors. On the other hand, the threshold for being deemed to have engaged in a proscribed “covered activity” in China has been kept at the high end (50% of revenue, capital expenditure, operating expenses, or net revenue must be derived from China), meaning that only a narrow subset of U.S. investments in third country firms that have exposure to the Chinese market will fall within the ambit of the Proposed Rule. And exemptions have been built into the rule too – for full buyouts, for intra-company transactions, for certain Limited Partner investments, and for publicly traded security investments. Given that public market investments represent the majority of U.S. capital flows to China, the impact of this outbound investment rule will, as the Treasury Department has maintained, remain tailored and targeted. For better or worse, the Trump and Biden administration’s foreign inbound and U.S. outbound investment controls, respectively, on China are here to stay. Since the two sides were never quite ‘coupled’ in the advanced node chips, quantum, and AI sectors, it would be improper to characterize the proposed measure as an instance of ‘decoupling’. That said, the gap between the two ecosystems in these sensitive technologies and sectors will only get wider with the passage of time. In September 2022, NSA Jake Sullivan had identified “three [foundational] families of technologies” in which the United States would strive to “maintain as large a [technological] lead as possible.” Also that month, the administration issued an Executive Order that premised the flow of investments and technology exchanges on their underlying impact on U.S. technology leadership. The Proposed Rule on outbound investment controls, which is expected to be finalized and issued in almost-unaltered form later this year, is a continuation in this vein.

Expanded Reading

• U.S. May Tighten Quantum Investment Restrictions On China, The Quantum Inside, June 26, 2024
• OpenAI Taking Steps to Block China’s Access to Its AI Tools, Microsoft, June 25, 2024
• McHenry Statement on Treasury’s Outbound Investment Proposed Rule, Financial Services Committee, June 21, 2024
• US Moves Closer to Restricting Outbound Investment in China for Chips, AI Tech, Bloomberg, June 21, 2024
• US Treasury Department Moves Closer to Implementing Outbound Investment Restrictions Through Latest Proposed Regulations, The National Law Review, June 26, 2024
• Treasury Issues Proposed Rule to Implement Executive Order Addressing U.S. Investments in Certain National Security Technologies and Products in Countries of Concern, U.S. Department of the Treasury, June 21, 2024