U.S. Investments in China: Biden Administration Executive Order Sets Stage for Increased Regulation

The Biden administration has issued a long-awaited executive order authorizing regulation of U.S. investments in Chinese semiconductor, quantum computing and AI companies.  The Treasury Department published a corresponding advance notice of proposed rulemaking describing its proposed approach to implementing the order.

Key Points for Investors

• The executive order does not impose any immediate legal requirements. It will likely be months before the government finalizes regulations to implement the order.
• The executive order is limited to investments in the Chinese semiconductor, quantum computing and AI sectors.
• The executive order contemplates prohibiting certain transactions and requiring notification of others, depending on the perceived national security threat posed by the technology involved.
• Many in Congress favor broader requirements than those the administration envisions. Final regulations could include more far-reaching requirements.

Key Questions

1. What is the immediate impact of the executive order?

The executive order does not impose any immediate restrictions or obligations relating to U.S. investments in China.  Rather, it instructs the Treasury Department to formulate regulations to administer “a new and targeted national security program” affecting U.S. investments in certain Chinese companies.  The administration therefore retains broad discretion as it resolves the scope of new legal requirements. 

The executive order does not impose a deadline on the Treasury Department to issue final regulations or initiate the program.

Although the Treasury Department indicates it may inquire about certain transactions completed or agreed to after the date of the order, it has not proposed retroactive application of the program requirements.

2. Whom will the program affect?

The program will apply to “United States persons,” which includes U.S. citizens, lawful permanent residents, U.S. organized entities (including their foreign branches) and any person in the United States. 

The order also authorizes the Treasury Department to require U.S. persons to notify it of transactions by foreign entities they control if those transactions would trigger the notification requirement if a U.S. person engaged in them and to take “all reasonable steps” to prohibit and prevent foreign entities they control from engaging in transactions prohibited for U.S. persons.

The order also authorizes the Treasury Department to prohibit U.S. persons from “knowingly directing” transactions that would be prohibited by the order if engaged in by a U.S. person.

3. What types of transactions will the regulations cover?

The Treasury Department is contemplating regulating transactions in or with companies that are organized in China, have a principal place of business in China or are 50 percent or more owned by Chinese individuals or entities.

The regulations would apply if those companies engage in an “identified activity” (to be defined) relating to specified technologies or products (or, in some cases, if the companies’ subsidiaries engage in an identified activity).

The regulations would apply to:

• Acquisition of equity interests (mergers and acquisitions, private equity, venture capital).
• Certain types of financing transactions involving debt that is convertible to equity.
• Greenfield investments.
• Joint ventures.

The Treasury Department is considering excluding U.S. companies’ investments in their own Chinese subsidiaries as well as passive LP investments and investments in publicly traded securities. 

The Treasury Department does not intend to cover university-to-university research collaborations, intellectual property licensing arrangements, bank lending, underwriting services, prime brokerage, equity research or analysis or other services secondary to a transaction.

However, the scope of covered and exempted transactions may change significantly subject to industry, congressional and other input.  The list of transactions the administration proposes regulating goes beyond PE/VC-related investment restrictions and may garner industry pushback.  On the other hand, others may consider the proposed scope to be inadequate to achieve the intended policy objectives.

4. Which transactions would be prohibited or require notification?

The executive order and the rulemaking notice contemplate:

• Prohibiting covered transactions involving certain categories of advanced technologies and products.
• Requiring notification of covered transactions involving less sensitive categories of technologies and products.The Treasury Department is considering requiring notification within 30 days of a transaction closing.

The rulemaking notice does not describe a case-by-case review of U.S. outbound investments.  Rather, the parties to a transaction would determine whether they are subject to the program requirements. 

5. What sectors will the regulations target?

The executive order instructs the Treasury Department to target technologies in three sectors: 

• Semiconductors
  • Prohibition of transactions involving EDA software, certain types of front-end semiconductor manufacturing equipment, design, fabrication and packaging of advanced integrated circuits and supercomputers.
  • Notification of transactions involving design, fabrication and packaging of mature integrated circuits.
• Quantum Computing
  • Prohibition of transactions involving quantum computers, dilution refrigerators, two-stage pulse tube cryocoolers, quantum sensing platform, quantum networking and quantum communications systems.
• Artificial Intelligence
  • Prohibition of transactions involving AI systems designed for military, government intelligence or mass-surveillance end uses.
  • Notification of transactions involving AI systems for certain other functions, such as cybersecurity, digital forensics and location tracking, among others.

This list excludes biotechnology and clean energy, which, along with the sectors identified above, the administration has characterized as “foundational technologies” of particular importance in the coming decade. 

6. What questions does the rulemaking notice raise about implementation and compliance?

The notice includes potential defined terms that are complicated and could create uncertainty for companies trying to comply. It also raises questions about what diligence the U.S. government will expect of U.S. persons contemplating investments in Chinese companies and how they can verify compliance should the Treasury Department investigate a potential violation. 

7. What Happens Next?

The Treasury Department requests public comment on more than 80 issues regarding the new program.  Written comments may be submitted until September 28, 2023.