Now the Hard Work Begins: Treasury Invites Comments on Regulating U.S. Investment in China
August 16, 2023
Client Alert
By: Gregory Jaeger, Andrew J. Astuno
On August 14, the Treasury Department published an Advance Notice of Proposed Rulemaking (“ANPR”) as the first step in implementing the August 9 Executive Order (“EO”) issued by President Biden concerning the regulation of proposed U.S. outbound investments into China (including Hong Kong and Macau).[1] The proposed restrictions are not yet in effect. Stakeholders, (including foreign partners and allies), have 45 days to provide comments in response to the ANPR. Now comes the hard work of determining how the EO will be implemented.
By way of background, the EO directs the Treasury Department (in consultation with the Commerce Department, and other agencies) to:
- prohibit certain investments by U.S. persons into certain entities that are either located in, or subject to, the jurisdiction of a “country of concern” (identified as China, including Hong Kong and Macau – noting that the president may update the list of countries of concern in the future) or that are owned by “persons of a country of concern.”
- require U.S. persons to notify Treasury concerning certain types of investments into certain entities located in or subject to Chinese jurisdiction and certain other entities owned by “persons of a country of concern.”
Whether an investment is prohibited or only requires notice is likely to be determined by the technology or product targeted for investment (and the target entity’s relevant activities, capabilities, and end-uses of its products). What Treasury calls the “high-level categories” of covered national security technologies and products are:
(1) semiconductors and microelectronics: the ANPR notes that the U.S. Government is concerned with the development of semiconductor and microelectronic technology, equipment, and capabilities that will enable the production “and certain uses of integrated circuits” that will underpin Chinese military innovations. Treasury says it is considering a prohibition on transactions related to certain semiconductor and microelectronics advanced technologies and products, and a notice requirement related to other such technologies and products;
(2) quantum information technologies: the ANPR notes that the U.S. Government is concerned with the development and production of quantum information technologies and products that enable cyber attacking capabilities, including as they relate to U.S. military communications. Currently, Treasury is considering a flat prohibition of transactions related to certain quantum information technologies and products, without any carveout for technologies that would require only a notice; and
(3) AI systems: the ANPR notes that the U.S. Government is concerned with the development of AI systems that enable China’s military modernization, and that have applications in areas such as cybersecurity and robotics. Treasury says in the ANPR that it is considering both a prohibition and a notification requirement for transactions related to AI technologies and products depending on “the relevant activities, capabilities, or end uses of such technology or product.”
Underlying the recent EO and ANPR is the U.S. Government’s assessment that outbound investments “are often more valuable than capital alone because they can also include the transfer of intangible benefits.” These perceived benefits include “enhanced standing and prominence, managerial assistance, access to investment and talent networks, market access, and enhanced access to additional financing.”
Treasury has stated that it does not expect that the program, when implemented, will entail a case-by-case review of U.S. outbound investments. Rather, transaction parties will have the independent obligation to determine whether a proposed outbound investment is prohibited, subject to notification, or permissible without notification. Plainly, this imposes a significant obligation on transaction parties, and argues for clear guidance in the regulations. One purpose of the ANPR is to explore a number of issues with stakeholders to help Treasury craft the regulations. In all, more than 80 questions are presented in the ANPR for consideration addressing a number of issues, including the following:
- The definition of “U.S. person” – The EO reaches transactions by U.S. persons, a term that is defined to include foreign branches of U.S. entities, and any person (including a foreign national or entity) in the United States. In the ANPR, Treasury asks (among other things) if it should “elaborate or amend” the definition of ‘‘U.S. person’’ to “enhance clarity or close any loopholes,” whether any unintended consequences could result from the definition under consideration, and what stakeholders deem will become the definition’s likely impact on “U.S. persons and U.S. investment flows.”
- The definition of “covered transaction” – Treasury anticipates that covered transactions will include certain acquisitions of equity interests (e.g., through mergers and acquisitions, private equity, and venture capital), greenfield, joint ventures, and certain debt financing transactions. The term is intended to cover both prohibited and notifiable transactions. Here again, Treasury asks what “unintended consequences” could result from the definition of ‘‘covered transaction,’’ its likely impact on U.S. persons, U.S. investment flows, and persons and investment flows from third countries or economies. Treasury also notes that it is considering how to treat follow-on transactions into a covered foreign person and asks what the consequences could be from covering such follow-on transactions.
- Exceptions: a carveout or exception is expected for specific types of transactions that “present a lower likelihood of concern,” including investments into publicly traded securities or exchange-traded funds. (As of January 9, 2023, there were 252 Chinese companies listed on U.S. stock exchanges with a total market capitalization of $1.03 trillion.)[2] Finally, the Secretary of the Treasury is considering approving an otherwise prohibited transaction if it: “(i) provides an extraordinary benefit to U.S. national security; or (ii) provides an extraordinary benefit to the U.S. national interest in a way that overwhelmingly outweighs relevant U.S. national security concerns.” Treasury again asks what unintended consequences could result from the definition, what other types of investments, if any, should be considered ‘‘excepted transactions,’’ what the consequences would be of allowing exemptions for transactions that would ordinarily be prohibited, and what should be required for a U.S. person to substantiate the need for an exemption.
- The definition of “covered national security technologies and products”: Treasury has posed several questions, seemingly with the intention (among others) to understand how to distinguish, for example, between transactions related to those semiconductors and AI systems that should be prohibited versus those subject only to notification. In this regard, Treasury asks stakeholders to identify any areas where investments by U.S. persons in countries of concern may provide a strategic benefit to the United States, such that continuing such investment would benefit, and not impair, U.S. national security. Treasury also asks whether there are industry definitions that might be relevant, and whether it should consider adding existing definitions from other U.S. Government regulations or programs. (The definition of “critical technologies” in the CFIUS regulations comes to mind here.)
Unless extended, the ANPR comment period will close on September 28, 2023. We anticipate that the ANPR will be followed by a proposed rule, and further public comment, with likely implementation of a final rule in 2024. In any event, the comments provided will inform the final rule.
[1] See Office of Investment Security, Department of the Treasury, 88 Fed. Reg. 54961, August 14, 2023: “Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern,” available at: https://www.federalregister.gov/documents/2023/08/14/2023-17164/provisions-pertaining-to-us-investments-in-certain-national-security-technologies-and-products-in.
[2] See U.S.-China Economic and Security Review Commission, “Chinese Companies Listed on Major U.S. Stock Exchanges,” last updated: January 9, 2023, available at: https://www.uscc.gov/sites/default/files/2023-01/Chinese_Companies_Listed_on_US_Stock_Exchanges_01_2023.pdf.
August 16, 2023
Client Alert
By: Gregory Jaeger, Andrew J. Astuno
On August 14, the Treasury Department published an Advance Notice of Proposed Rulemaking (“ANPR”) as the first step in implementing the August 9 Executive Order (“EO”) issued by President Biden concerning the regulation of proposed U.S. outbound investments into China (including Hong Kong and Macau).[1] The proposed restrictions are not yet in effect. Stakeholders, (including foreign partners and allies), have 45 days to provide comments in response to the ANPR. Now comes the hard work of determining how the EO will be implemented.
By way of background, the EO directs the Treasury Department (in consultation with the Commerce Department, and other agencies) to:
- prohibit certain investments by U.S. persons into certain entities that are either located in, or subject to, the jurisdiction of a “country of concern” (identified as China, including Hong Kong and Macau – noting that the president may update the list of countries of concern in the future) or that are owned by “persons of a country of concern.”
- require U.S. persons to notify Treasury concerning certain types of investments into certain entities located in or subject to Chinese jurisdiction and certain other entities owned by “persons of a country of concern.”
Whether an investment is prohibited or only requires notice is likely to be determined by the technology or product targeted for investment (and the target entity’s relevant activities, capabilities, and end-uses of its products). What Treasury calls the “high-level categories” of covered national security technologies and products are:
(1) semiconductors and microelectronics: the ANPR notes that the U.S. Government is concerned with the development of semiconductor and microelectronic technology, equipment, and capabilities that will enable the production “and certain uses of integrated circuits” that will underpin Chinese military innovations. Treasury says it is considering a prohibition on transactions related to certain semiconductor and microelectronics advanced technologies and products, and a notice requirement related to other such technologies and products;
(2) quantum information technologies: the ANPR notes that the U.S. Government is concerned with the development and production of quantum information technologies and products that enable cyber attacking capabilities, including as they relate to U.S. military communications. Currently, Treasury is considering a flat prohibition of transactions related to certain quantum information technologies and products, without any carveout for technologies that would require only a notice; and
(3) AI systems: the ANPR notes that the U.S. Government is concerned with the development of AI systems that enable China’s military modernization, and that have applications in areas such as cybersecurity and robotics. Treasury says in the ANPR that it is considering both a prohibition and a notification requirement for transactions related to AI technologies and products depending on “the relevant activities, capabilities, or end uses of such technology or product.”
Underlying the recent EO and ANPR is the U.S. Government’s assessment that outbound investments “are often more valuable than capital alone because they can also include the transfer of intangible benefits.” These perceived benefits include “enhanced standing and prominence, managerial assistance, access to investment and talent networks, market access, and enhanced access to additional financing.”
Treasury has stated that it does not expect that the program, when implemented, will entail a case-by-case review of U.S. outbound investments. Rather, transaction parties will have the independent obligation to determine whether a proposed outbound investment is prohibited, subject to notification, or permissible without notification. Plainly, this imposes a significant obligation on transaction parties, and argues for clear guidance in the regulations. One purpose of the ANPR is to explore a number of issues with stakeholders to help Treasury craft the regulations. In all, more than 80 questions are presented in the ANPR for consideration addressing a number of issues, including the following:
- The definition of “U.S. person” – The EO reaches transactions by U.S. persons, a term that is defined to include foreign branches of U.S. entities, and any person (including a foreign national or entity) in the United States. In the ANPR, Treasury asks (among other things) if it should “elaborate or amend” the definition of ‘‘U.S. person’’ to “enhance clarity or close any loopholes,” whether any unintended consequences could result from the definition under consideration, and what stakeholders deem will become the definition’s likely impact on “U.S. persons and U.S. investment flows.”
- The definition of “covered transaction” – Treasury anticipates that covered transactions will include certain acquisitions of equity interests (e.g., through mergers and acquisitions, private equity, and venture capital), greenfield, joint ventures, and certain debt financing transactions. The term is intended to cover both prohibited and notifiable transactions. Here again, Treasury asks what “unintended consequences” could result from the definition of ‘‘covered transaction,’’ its likely impact on U.S. persons, U.S. investment flows, and persons and investment flows from third countries or economies. Treasury also notes that it is considering how to treat follow-on transactions into a covered foreign person and asks what the consequences could be from covering such follow-on transactions.
- Exceptions: a carveout or exception is expected for specific types of transactions that “present a lower likelihood of concern,” including investments into publicly traded securities or exchange-traded funds. (As of January 9, 2023, there were 252 Chinese companies listed on U.S. stock exchanges with a total market capitalization of $1.03 trillion.)[2] Finally, the Secretary of the Treasury is considering approving an otherwise prohibited transaction if it: “(i) provides an extraordinary benefit to U.S. national security; or (ii) provides an extraordinary benefit to the U.S. national interest in a way that overwhelmingly outweighs relevant U.S. national security concerns.” Treasury again asks what unintended consequences could result from the definition, what other types of investments, if any, should be considered ‘‘excepted transactions,’’ what the consequences would be of allowing exemptions for transactions that would ordinarily be prohibited, and what should be required for a U.S. person to substantiate the need for an exemption.
- The definition of “covered national security technologies and products”: Treasury has posed several questions, seemingly with the intention (among others) to understand how to distinguish, for example, between transactions related to those semiconductors and AI systems that should be prohibited versus those subject only to notification. In this regard, Treasury asks stakeholders to identify any areas where investments by U.S. persons in countries of concern may provide a strategic benefit to the United States, such that continuing such investment would benefit, and not impair, U.S. national security. Treasury also asks whether there are industry definitions that might be relevant, and whether it should consider adding existing definitions from other U.S. Government regulations or programs. (The definition of “critical technologies” in the CFIUS regulations comes to mind here.)
Unless extended, the ANPR comment period will close on September 28, 2023. We anticipate that the ANPR will be followed by a proposed rule, and further public comment, with likely implementation of a final rule in 2024. In any event, the comments provided will inform the final rule.
[1] See Office of Investment Security, Department of the Treasury, 88 Fed. Reg. 54961, August 14, 2023: “Provisions Pertaining to U.S. Investments in Certain National Security Technologies and Products in Countries of Concern,” available at: https://www.federalregister.gov/documents/2023/08/14/2023-17164/provisions-pertaining-to-us-investments-in-certain-national-security-technologies-and-products-in.
[2] See U.S.-China Economic and Security Review Commission, “Chinese Companies Listed on Major U.S. Stock Exchanges,” last updated: January 9, 2023, available at: https://www.uscc.gov/sites/default/files/2023-01/Chinese_Companies_Listed_on_US_Stock_Exchanges_01_2023.pdf.
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