United States Imposes Unprecedented Outbound Investment Controls Focused on China

On 9 August 2023, President Biden issued a long anticipated executive order imposing certain limitations, reporting requirements, and prohibitions on outbound investment from the United States into certain sensitive industry sectors in the People’s Republic of China (PRC) and the Special Administrative Regions of Hong Kong and Macau (collectively, China). The executive order, entitled Executive Order on Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern (the EO), provides for the establishment of a new and targeted national security regulatory framework to be implemented and administered primarily by the US Department of the Treasury (Treasury) and the US Department of Commerce (Commerce), focused for the time being solely on investment in China (the Outbound Investment Program or Program). The EO is not as broad in scope as some original proposals, but notably will prohibit a potentially broad swath of technology investments, as opposed to just being a notification regime as some had predicted. The exact scope of technologies, transactions, and foreign persons or entities to be covered will be set out in regulations issued by Treasury following a rulemaking process. 

This alert answers the most pressing questions about the EO and provides information on the next steps in implementation of the Program. Lawyers in the International Trade: CFIUS, Sanctions, and Export Controls practice are continuing to monitor developments with respect to the Outbound Investment Program, and are available to assist with questions related to the EO or development of the Program. We will be following up with additional insights into specific areas of the EO, in particular those that are already noted as being subject to further clarification through a comment period.

What Will the Outbound Investment Program Do?

The EO provides for the establishment of an outbound investment national security program to be implemented and administered by Treasury, Commerce, and, as relevant, other US government agencies. The EO directs Treasury, in consultation with Commerce, to issue regulations that (1) require US persons to notify Treasury of certain transactions (notifiable transactions), and (2) prohibit US persons from undertaking certain other transactions altogether (prohibited transactions), in each case when those transactions involve certain foreign persons or entities in the PRC engaged in activities related to narrow subsets of three advanced technology areas identified in the EO. 

The notification requirement and prohibition will relate to transactions that involve “covered national security technologies and products.” Treasury has issued an Advance Notice of Proposed Rulemaking (ANPRM) to solicit input from the public on the implementation of the EO and the scope of the Program before it goes into effect. 

What Are the Covered National Security Technologies and Products? 

 The EO identifies three categories of covered national security technologies and products within the scope of the Program:

1. Semiconductors and microelectronics; 
2. Quantum information technologies; and 
3. Certain artificial intelligence (AI) systems.

The specific technologies and products that will be covered are those that are “critical for the military, intelligence, surveillance, or cyber-enabled capabilities of a country of concern,” as determined by Treasury and Commerce in a rulemaking proceeding and might be defined by reference to certain end uses of the covered national security technologies and products. According to a fact sheet issued by Treasury, the impacted sectors were selected due to their “critical role in accelerating the development of advanced military, intelligence, surveillance, and cyber-enabled capabilities.” These advanced technologies were specifically identified in a 15 September 2022 Executive Order as sectors that are “fundamental to US technological leadership and, therefore, US national security.” 

As noted above, Treasury has already issued an ANPRM regarding the planned scope of the Outbound Investment Program. The ANPRM provides initial details on Treasury’s proposed subsets of technologies and products within the three categories identified in the EO:

Semiconductors and Microelectronics

Treasury is considering defining the scope of prohibited transactions in the semiconductor and microelectronics sectors to extend to transactions by United States persons, defined further below, with PRC entities involved in activities related to (i) development or production of electronic design automation software or semiconductor fabrication equipment, (ii) design, production, and packaging of advanced integrated circuits (to include those exceeding the performance threshold of Export Control Classification Number 3A090 or designed to operate at or below 4.5 Kelvin), as well as various other identified advanced integrated circuits (even beyond those restricted in October 2022), and (iii) installation or sale of supercomputers. Notifiable transactions in this sector would include those otherwise involving integrated circuit design, fabrication, or packaging. 

Quantum Information Technologies

Treasury is considering defining the scope of prohibited transactions in the quantum information technologies sector to include transactions involving PRC entities engaged in: (i) production of quantum computers and components (dilution refrigerators or two-stage pulse tube cryocoolers), (ii) development of quantum sensors for military, government intelligence, or mass-surveillance end uses, and (iii) development of a quantum network or quantum communication system for secure communications (e.g., quantum key distribution). Treasury did not detail any additional notifiable transactions being considered in this space. The restrictions are expected to be narrowly tailored to capture quantum information technologies that jeopardize military communications or similar and to exclude uses in “civilian fields such as medicine and geology” or with “no relevance to secure communications.” 

Certain AI Systems

Treasury is considering defining “AI systems” covered by the new Outbound Investment Program to include any “engineered or machine-based system that can, for a given set of objectives, generate outputs such as predictions, recommendations, or decisions influencing real or virtual environments.” A prohibition could extend to investment in PRC entities engaged in the “development of software that incorporates an AI system,” either exclusively or primarily for military, government intelligence, or mass-surveillance end uses. Notifiable transactions in this sector would include investments in PRC entities engaged in the development of software that incorporate an AI system used primarily or exclusively for cybersecurity, digital forensics tools, penetration testing tools, controlling robotic systems, surreptitious listening, noncooperative location tracking, or facial recognition. 

Who Will Be Subject to the Requirement?

According to the EO, the notification requirement and prohibition will apply to transactions by United States persons (US persons). US persons would include “any United States citizen, lawful permanent resident, entity organized under the laws of the United States or any jurisdiction in the United States, including foreign branches of any such entity, and any person in the United States.” Persons and entities meeting these criteria would be subject to the restriction even while operating outside the United States. 

Note that the definition would not cover foreign-incorporated subsidiaries of US entities or foreign entities owned or controlled by US persons. However, section 8 of the EO (Section 8) authorizes Treasury to broaden the operation of the Outbound Investment Program by (i) prohibiting US persons from knowingly directing transactions that would be prohibited transactions, (ii) requiring US persons to provide notification to Treasury of transactions by foreign entities the US person controls that would be notifiable by the US person; and (iii) requiring US persons to take “all reasonable steps to prohibit and prevent any transaction” by their controlled foreign entities, that would be prohibited for the US person to engage in. 

In the ANPRM, Treasury suggests the adoption of certain restrictions consistent with Section 8 making a foreign parent responsible for certain actions of its subsidiaries. Under the ANPRM, Treasury indicates that it expects to adopt a definition of “controlled foreign entity” to include entities in which a US person has a 50% or greater interest. Treasury may also define “all reasonable steps” as used in the EO to impose certain documentary and diligence requirements on US parent entities of foreign subsidiaries (e.g., internal policy controls, auditing, training, etc.). By this expansion, the Outbound Investment Program would have a more significant impact beyond the United States to foreign subsidiaries of US entities anywhere in the world that might engage in transactions in China. 

What Types of Transactions Will Be Covered?

As noted above, the EO provides for limitations on two separate categories of transactions: a notification requirement for some transactions, and a complete prohibition of others where those transactions involve covered national security technologies and products and covered foreign persons or entities. The specific scope of the technologies, transactions, and foreign persons or entities to be covered will be identified in the new regulations promulgated following the ANPRM. 

Based on the ANPRM, Treasury has suggested that the types of transactions covered will include acquisitions of equity interests (e.g., mergers and acquisitions, private equity, and venture capital), greenfield investments, joint ventures, and debt financing. Treasury indicates in the ANPRM that it expects that the definition will not capture standard research collaborations between universities, contractual arrangements for procuring inputs for covered national security technologies or products, intellectual property licensing, bank lending, underwriting services, and other types of services “secondary to a transaction.” Treasury also “expects to create a carveout” for certain transactions, such as those in publicly-traded securities or exchange traded funds, likely subject to a threshold equity interest. 

Although it is not yet clear, we expect that US persons will themselves be responsible for identifying whether or not they are engaging in a covered transaction. This would require independent evaluation of whether the transaction involves a party engaged in relevant activities relating to covered national security technologies and products, much like the current analysis needed in the Committee on Foreign Investment in the United States context. 

When Will the Notification Requirement and Prohibition Go into Effect? 

The notification requirement on certain transactions and prohibition on others will not go into effect until Treasury promulgates regulations further expounding on the EO as a result of the rulemaking proceeding. However, Treasury has noted in the ANPRM that it may, after the effective date of the regulations, request information about transactions by US persons that were completed or agreed to after issuance of the EO to better inform the development and implementation of the Outbound Investment Program.

How Will the Notification Requirement and Prohibition be Enforced?

The EO authorizes Treasury to “take such actions and to employ all powers granted to the President by [the International Emergency Economic Powers Act  (IEEPA)] as may be necessary to carry out the purposes of [the EO].” In addition to the ability to use civil administrative subpoenas and make other requests for information into transactions, the EO explicitly authorizes Treasury to nullify, void, or compel divestment of prohibited transactions entered into following the effective date of the Outbound Investment Program regulations, similar to the current capabilities of the Committee on Foreign Investment in the United States. 

What Is the Justification for the Outbound Investment Program?

President Biden has declared a “national emergency” pursuant to authority of IEEPA, the National Emergencies Act,  and 3 U.S.C. § 301 to deal with “an unusual and extraordinary threat” to US national security resulting from the “advancement by countries of concern in sensitive technologies and products critical for the military, intelligence, surveillance, or cyber-enabled capabilities of such countries”. According to the EO, as part of this strategy of advancing the development of these sensitive technologies and products, “countries of concern” are exploiting or have the ability to exploit certain US outbound investments, including certain intangible benefits that often accompany US investments and that help companies succeed, such as enhanced standing and prominence, managerial assistance, investment and talent networks, market access, and enhanced access to additional financing. 

President Biden has identified China, to include Hong Kong and Macau, in an annex to the EO as the sole “country of concern.” Other locations could be added to the annex in the future.

What Is the Next Step in Implementation?

As detailed above, Treasury must promulgate regulations in consultation with Commerce and other relevant agencies consistent with the EO to define the complete scope of the Outbound Investment Program, including the specific types of transactions that will be covered and the industry sectors and technologies that will be covered. Treasury issued the ANPRM at the same time the EO was issued, and has requested comments on a long list of questions regarding the potential impacts and unintended consequences of its intended regulatory interpretations as well as the scope of the notifiable and prohibited transactions. Comments on the ANPRM must be submitted by 28 September 2023, after which Treasury will promulgate draft regulations.