Last week, Biden used emergency powers to ban U.S. investors from investing in Chinese quantum computing and computer chip manufacturing companies. The full scope of the ban still has to be fleshed out by the Treasury Department following Biden’s executive order, but we already know that investments in essentially all Chinese quantum computing companies will be banned, as will investments in most Chinese computer chip manufacturing companies. Additionally, U.S. investors in certain Chinese AI companies will have to notify the federal government any time they make such an investment.
Fortunately, this won’t affect most people in the U.S. since publicly traded companies are currently excluded from the ban. That means if you own stock in a publicly traded Chinese company, you’re okay. However, the ban will heavily impact U.S. private equity and venture capital firms as well as hedge funds.
And this is probably only the beginning. Biden’s executive order leaves open the possibility for other technologies to be added to the list of banned investments, and even if that doesn’t happen, Congress is currently considering legislation that would also ban investments in certain Chinese biotech companies.
Somewhat strangely though, the current ban only focuses on equity investments, excluding both traditional debt financing as well as intellectual property licensing. Arguably, a combination of debt financing and IP licensing would be even more helpful than just equity investments alone.
Summary of the Ban
“[The U.S. Treasury & other agencies] shall issue… regulations that require United States persons to provide notification of information relative to certain transactions involving covered foreign persons (notifiable transactions) and that prohibit United States persons from engaging in certain other transactions involving covered foreign persons (prohibited transactions).”
Biden’s Executive Order from August 9th
The executive order authorizes the U.S. Treasury secretary to prohibit or restrict U.S. investments in Chinese entities in three sectors:
- Semiconductors and microelectronics,
- Quantum computers and other quantum information technologies, and
- Certain AI systems.
The orders target private equity, venture capital, joint ventures, greenfield investments (i.e. a U.S. company starting a new venture in a foreign country by constructing new operational facilities from the ground up), and debt financing. The Treasury’s ANPRM (advanced notice of proposed rulemaking) published 2 days ago specified an expected carve out for publicly traded securities or exchange-traded funds.
Additionally, the Treasury does not currently plan to apply any provisions of the ban (or the notification requirements) retroactively, but the Treasury may request info about transactions that occur between the date of the order (August 9th) and the date when final regulations go into effect.
Investors have until September 28, 2023 to sent comments to the Treasury regarding the ANPRM.
What is a “country of concern”?
Biden’s executive order listed 3 countries of concern:
- The People’s Republic of China
- The Special Administrative Region of Hong Kong
- The Special Administrative Region of Macau
In other words, all of China and only China is a “country of concern” for the purposes of this order.
What is a “covered foreign person”?
The executive order defines the term “covered foreign person” as a person (human, business entity, government entity, or other legal person) of a country of concern (i.e. China) who is engaged in activities identified by regulations under this order and involving one or more covered national security technologies and products.
The Treasury’s ANPRM proposes to modify this definition to the following: (1) a person of a country of concern that is engaged in, or a person of a country of concern that a U.S. person knows or should know will be engaged in, an identified activity with respect to a covered national security technology or product; or (2) a person whose direct or indirect subsidiaries or branches are referenced in item (1) and which, individually or in the aggregate, comprise more than 50% of that person’s consolidated revenue, net income, capital expenditure, or operating expenses.
The ANPRM also proposes to define “person of a country of concern” to mean (1) any individual that is not a U.S. citizen or lawful permanent resident of the United States and is a citizen or permanent resident of a country of concern; (2) an entity with a principal place of business in, or an entity incorporated in or otherwise organized under the laws of a country of concern; (3) the government of a country of concern, including any political subdivision, political party, agency, or instrumentality thereof, or any person owned, controlled, or directed by, or acting for or on behalf of the government of such country of concern; or (4) any entity in which a person or persons identified in items (1) through (3) holds individually or in the aggregate, directly or indirectly, an ownership interest equal to or greater than 50%.
Under this definition, a U.S. startup headquartered in Silicon Valley but which is majority owned by a Chinese company would be a person of a country of concern.
What are “covered national security technologies and products”?
The term “covered national security technologies and products” means sensitive technologies and products in the (1) semiconductors and microelectronics, (2) quantum information technologies, and (3) artificial intelligence sectors that are critical for the military, intelligence, surveillance, or cyber-enabled capabilities of China. Where applicable, “covered national security technologies and products” may be limited by reference to certain end-uses of those technologies or products.
“The Treasury Department does not contemplate that the program will entail a case-by-case review of U.S. outbound investments… [but rather] expects that the transaction parties will have the obligation to determine whether a given transaction is prohibited, subject to notification, or permissible without notification.”
Currently, the Treasury is considering the following types of regulations for each of the three covered sectors:
- Semiconductors — bans & notification requirements
- Quantum computers — complete ban
- AI — notification requirements only
Proposed semiconductor technologies that would be the subject of prohibited transactions:
- Software for Electronic Design Automation: The development or production of electronic design automation software designed to be exclusively used for integrated circuit design.
- Integrated Circuit Manufacturing Equipment: The development or production of front-end semiconductor fabrication equipment designed to be exclusively used for the volume fabrication of integrated circuits.
- Advanced Integrated Circuit Design: The design of integrated circuits that exceed the thresholds in Export Control Classification Number (ECCN) 3A090 in supplement No. 1 to 15 CFR part 774 of the Export Administration Regulations (EAR), or integrated circuits designed for operation at or below 4.5 Kelvin.
- Advanced Integrated Circuit Fabrication: The fabrication of integrated circuits that meet any of the following criteria: (i) logic integrated circuits using a non-planar transistor architecture or with a technology node of 16/14 nanometers or less, including but not limited to fully depleted silicon-on-insulator (FDSOI) integrated circuits; (ii) NOT–AND (NAND) memory integrated circuits with 128 layers or more; (iii) dynamic random-access memory (DRAM) integrated circuits using a technology node of 18 nanometer half-pitch or less; (iv) integrated circuits manufactured from a gallium-based compound semiconductor; (v) integrated circuits using graphene transistors or carbon nanotubes; or (vi) integrated circuits designed for operation at or below 4.5 Kelvin.
- “Fabrication of integrated circuits” is defined as the process of forming devices such as transistors, poly capacitors, non-metal resistors, and diodes, on a wafer of semiconductor material.
- Advanced Integrated Circuit Packaging: The packaging of integrated circuits that support the three-dimensional integration of integrated circuits, using silicon vias or through mold vias.
- “Packaging of integrated circuits” is defined as the assembly of various components, such as the integrated circuit die, lead frames, interconnects, and substrate materials, to form a complete package that safeguards the semiconductor device and provides electrical connections between different parts of the die.
- Supercomputers: The installation or sale to third-party customers of a supercomputer, which are enabled by advanced integrated circuits, that can provide a theoretical compute capacity of 100 or more double-precision (64-bit) petaflops or 200 or more single-precision (32-bit) petaflops of processing power within a 41,600 cubic foot or smaller envelope.
Proposed semiconductor technologies that would be the subject of notifiable transactions:
- Integrated Circuit Design: The design of integrated circuits for which transactions involving U.S. persons are not otherwise prohibited in section III.G.
- Integrated Circuit Fabrication: The fabrication of integrated circuits for which transactions involving U.S. persons are not otherwise prohibited in section III.G.
- Integrated Circuit Packaging: The packaging of integrated circuits for which transactions involving U.S. persons are not otherwise prohibited in section III.G.
Proposed quantum information technologies that would be the subject of prohibited transactions:
- Quantum Computers and Components: The production of a quantum computer, dilution refrigerator, or two-stage pulse tube cryocooler.
- Quantum Sensors: The development of a quantum sensing platform designed to be exclusively used for military end uses, government intelligence, or mass-surveillance end uses.
- Quantum Networking and Quantum Communication Systems: The development of a quantum network or quantum communication system designed to be exclusively used for secure communications, such as quantum key distribution.
The Treasury is also considering AI technologies which would be the subject of notifiable transactions (and possibly but not necesssarily prohibited transactions), but has yet to define exactly what these systems would be. If you run or invest in AI companies, you might want to submit a comment to the Treasury to weigh in on this.
What is an “excepted transaction”?
An “excepted transaction” is a transaction with a covered foreign person which is excepted from prohibition or notice requirements under the regulations promulgated under the executive order, despite meeting the definitional elements of a “covered transaction” as specified below.
The Treasury’s proposed definition of a covered transaction is an investment:
- i. into a publicly traded security, with “security” defined as set forth in section 3(a)(10) of the Securities Exchange Act of 1934; or
- ii. into an index fund, mutual fund, exchange-traded fund, or a similar instrument (including associated derivatives) offered by an investment company as defined in the section 3(a)(1) of the Investment Company Act of 1940 or by a private investment fund; or
- iii. made as a limited partner into a venture capital fund, private equity fund, fund of funds, or other pooled investment funds, in each case where
- A. the limited partner’s contribution is solely capital into a limited partnership structure and the limited partner cannot make managerial decisions, is not responsible for any debts beyond its investment, and does not have the ability (formally or informally) to influence or participate in the fund’s or a covered foreign person’s decision making or operations, and
- B. the investment is below a de minimis threshold to be determined by the Secretary.
Notwithstanding the above, any investment that affords the U.S. person rights beyond those reasonably considered to be standard minority shareholder protections will not constitute an “excepted transaction”. Such rights include, but are not limited to:
- i. Membership or observer rights on, or the right to nominate an individual to a position on, the board of directors or an equivalent governing body of the covered foreign person; or
- ii. Any other involvement, beyond the voting of shares, in substantive business decisions, management, or strategy of the covered foreign person.
Additionally, the Treasury proposes to label the following types of transactions as excepted transactions:
- 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 U.S. person is acquiring all interests in the entity or assets held by covered foreign persons; or
- An intracompany transfer of funds from a U.S. parent company to a subsidiary located in a country of concern; or
- A transaction made pursuant to a binding, uncalled capital commitment entered into before the date of the Order.
The Treasury is also considering whether to except investors or investments into funds beneath a defined threshold, based on one or more benchmarks such as the size of the limited partner’s investment in the fund or the size of the limited partner itself.
The Treasury is also considering whether to except buyouts of country of concern ownership.
Who is a “United States person”?
For purposes of this executive order and the regulations promulgated thereunder, a “United States person” is any of the following:
- Any U.S. citizen
- Any U.S. lawful permanent resident
- Any entity organized under the laws of the U.S. or any jurisdiction within the U.S. (such as a U.S. state)
- Any foreign branch of such entity
- Any person in the U.S.
What is a “covered transaction”?
The Treasury’s ANPRM proposes to define “covered transaction” as either a prohibited transaction or a notifiable transaction.
The proposed definition of covered transaction is a U.S. person’s direct or indirect (1) acquisition of an equity interest or contingent equity interest in a covered foreign person; (2) provision of debt financing to a covered foreign person where such debt financing is convertible to an equity interest; (3) greenfield investment that could result in the establishment of a covered foreign person; or (4) establishment of a joint venture, wherever located, that is formed with a covered foreign person or could result in the establishment of a covered foreign person. The Treasury currently intends this definition to 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 Biden’s executive order on August 9, 2023.
The Treasury is considering including “indirect” transactions as “covered transactions” in order to close loopholes that would otherwise result, and to clarify that attempts to evade prohibitions on certain transactions cannot find safe harbor in the use of intermediary entities are are not “U.S. persons” or “covered foreign persons”. One example of such conduct would be a U.S. person knowingly investing in a third-country entity that will use the investment to undertake a transaction with a covered foreign person that would be subject to the program if engaged in by a U.S. person directly.
The Treasury does not intend to cover the following types of activities though (so long as they don’t involve the definitional elements of a covered transaction):
- University-to-university research collaborations
- Contractual arrangements or the procurement of material inputs for any of the covered national security technologies or products (such as raw materials)
- Intellectual property licensing arrangements (personally, this seems like an odd type of activity to exclude, and I wouldn’t be surprised if the Treasury changed their mind and decided to include such IP licensing under certain conditions)
- Bank lending
- The processing, clearing, or sending of payments by a bank
- Underwriting services (you’re welcome, investment bankers)
- Debt rating services
- Prime brokerage
- Global custody
- Equity research or analysis
- Other services secondary to a transaction
The definition of “covered transaction” would also exclude “excepted transactions”.
References
[1] Executive Order on addressing United States investments in certain national security technologies and products in countries of concern. August 9, 2023.
[2] U.S. Department of the Treasury Advance Notice of Proposed Rulemaking (ANPRM): Provisions pertaining to U.S. investments in certain national securities technologies and products in countries of concern
[3] International Emergency Economic Powers Act (IEEPA)
[4] National Emergencies Act (NEA)
