• The Biden Administration made clear in its recently released National Security Strategy (the “National Security Strategy”) that it intends to take new and aggressive approaches to protect U.S. national security.
• The U.S. Government considers the People’s Republic of China (“PRC”) to present “the most consequential geopolitical challenge” to U.S. interests and to be “the only competitor” with both the intent and the ability to reshape the international order.
• The U.S. Congress (“Congress”) and the Biden Administration have steadily moved to establish measures responsive to perceived threats from the PRC, including enhanced export controls, investments in domestic capabilities in sensitive industries, and an outbound investment review mechanism. U.S. Government officials have signaled that additional regulatory measures should be expected.

Introduction

The Biden Administration has taken and is considering multiple steps in furtherance of its multi-faceted National Security Strategy to preserve American technological advantages, even if this comes at the expense of trade with China. Some of these measures are in effect already. The U.S. Department of Commerce (“Commerce”) recently announced enhanced export control measures to thwart Chinese access to many types of semiconductors and related technologies. President Biden also signed the CHIPS and Science Act (the “CHIPS Act”) into law in August 2022; among other measures, the CHIPS Act imposes limitations on the ability of semiconductor companies that receive federal assistance to invest in China. And the Biden Administration has been working with Congress on the potential establishment of an outbound investment review mechanism. We provide updates below on U.S.-China trade relations by reference to the National Security Strategy, the current environment for technology and trade, and what further developments might be anticipated.

The National Security Strategy

The U.S. Government’s national security concerns regarding trade with China in particular stem from the PRC’s so-called “military-civil fusion” regime. According to the U.S. State Department, the PRC intends to develop the most technologically advanced military in the world by (i) removing barriers between China's civilian research and commercial sectors and its military and defense industrial sectors, (ii) promoting Chinese research and development capabilities, and (iii) acquiring (or stealing) and then diverting leading non-Chinese technologies. Moreover, earlier this year the Office of the Director of National Intelligence (“ODNI”) identified in its 2022 Annual Threat Assessment that the leading national security threats currently are presented by certain countries, with China at the top of the list.¹ ODNI warned that “China will remain the top threat to U.S. technological competitiveness as Beijing targets key sectors and proprietary commercial and military technology from U.S. and allied companies and institutions. Beijing uses a variety of tools, from public investment to espionage to advance its technological capabilities. Beijing’s willingness to use espionage, subsidies, and trade policy to give its firms a competitive advantage represents not just an ongoing challenge for the U.S. economy and its workers, but also advances Beijing's ability to assume leadership of the world's technological advancement and standards.”

In response to this threat, the Biden Administration’s National Security Strategy calls for the United States to take steps to “out-compete” China, including investments in domestic competitiveness, innovation and resilience, and initiatives to manage strategic, global competition and remain the world’s leading economy.

Senior U.S. Government officials recently have offered perspective on the National Security Strategy. In a speech earlier this fall, National Security Advisor Jake Sullivan recounted the Biden Administration’s steps to “bolster [the Committee on Foreign Investment in the United States’ (“CFIUS”)] ability to defend against evolving risks by directing the Committee to consider, in connection with countries of concern, a new set of specific risk factors, such as whether a transaction impacts U.S. leadership in technologies relevant to national security…” Sullivan also stated that there is a “national security imperative” to “[strengthen] the resilience and security of the supply chains that underpin” certain computing-related technologies (e.g., those relating to semiconductors, artificial intelligence, quantum information, and microelectronics) that are considered military “force multipliers.” Undersecretary Alan Estevez of the Commerce Department’s Bureau of Industry and Security (“BIS”) recently stated that his bureau’s priorities “are purely about national security. . .we do not balance trade with national security.”

Measures Effectuating the National Security Strategy

In October, BIS announced an export overhaul that includes new export restrictions and a possible review process for certain technology exports to China. These changes have already and will continue to have a major impact on the Chinese semiconductor industry. The new export controls apply to a range of high technology items (e.g., advanced integrated circuits, semiconductor production equipment, and related components and technologies), including certain non-U.S.-made items as well as certain activities of U.S. persons. The new export controls seek to limit development and production of advanced computing and semiconductor capabilities in China.

The Biden Administration also is targeting PRC access to sensitive technologies through broader use of the Foreign Direct Product Rule (“FDP Rule”) to counteract reexports and transfers of non-U.S. technology products that occur outside of the United States but involve U.S. technology components. Earlier this year, the Biden Administration foreshadowed its plan to enhance the FDP Rule by reorganizing and rephrasing regulations to ultimately clarify their extraterritorial application.

The new controls expand the restrictions on specific activities of “U.S. persons” (i.e., U.S. citizens and lawful permanent residents as well as U.S. entities and their non-U.S. branches) to prohibit unlicensed activities that support semiconductor manufacturing in China.² The U.S. Government previously applied export control restrictions (which typically apply to U.S.-origin items, rather than U.S. persons) to the activities of U.S. persons only in limited circumstances, including the proliferation of weapons of mass destruction and missile technologies and certain military end uses and end users. The extension of this type of restriction to semiconductor manufacturing in China reinforces that the U.S. Government believes it poses a meaningful threat to U.S. national security.

Taken together, the enhanced FDP Rule and related export controls effectively put an end to exports to several Chinese high technology companies and likely will impede China’s ability to manufacture advanced chips domestically.

BIS also introduced a new rule concerning the United States’ growing inability to conduct physical end use checks in China to confirm whether an exported item is being put to its intended civilian use or has been diverted for military end use. The rule places the onus on the Chinese company (and the Chinese Government) to comply with end use check requirements. Chinese companies that do not comply will be listed initially on the BIS “Unverified List,” which will impose certain additional restrictions and certification requirements on exports of U.S. items to the entity. If end use checks cannot be completed for another 60 days thereafter, then BIS may move the Chinese company to the BIS “Entity List,” which would impose even broader restrictions on exports of U.S. items to the entity.

What is Next for the National Security Strategy

The Biden Administration, with bipartisan support in Congress,³ is steadily moving toward an outbound investment review mechanism, a process similar to the inbound investment review process administered by CFIUS. In support of this goal, the U.S.-China Economic and Security Review Commission (the “Commission”) in its November 2022 Report called upon Congress to “create an authority under which the president can require specific U.S. entities or U.S. entities operating in specific sectors to divest in a timely manner from their operations, assets, and investment in China.” The Commission also recommended that Congress “direct the Office of the U.S. Trade Representative to create an updateable list of Chinese firms operating in critical sectors and found to have benefited from coercive intellectual property transfer, including theft,” and that the U.S. Department of Treasury be empowered to ban investment in, and Commerce deny export licenses to, Chinese firms placed on the hypothetical list. It has been reported that the Biden Administration is in active discussions with allies and industry representatives to design an appropriately tailored approach to review of outbound investments in sensitive technologies. An executive order establishing this review mechanism may be forthcoming.

Congress has already introduced a limited mechanism for outbound investment review in the CHIPS Act. The Act incentivizes companies to manufacture domestically, but with a few strings attached: recipients of federal funding under the Act must submit a formal notice and undergo a review process for certain “significant transactions” and investments involving China.⁴ Commerce is authorized to review such notices and determine whether the proposed activities comply with the funding agreements, qualify for waivers or exemptions (e.g., for legacy investments), or otherwise raise U.S. national security risks that require mitigation.⁵ The limited outbound review mechanism in the CHIPS Act likely will serve as a pilot program for a broader outbound review mechanism.

Analogous to federal funding programs like the one in the CHIPS Act, we can expect to see the Biden Administration provide additional incentives to U.S. companies to partner with the U.S. Government in innovative ways. For example, on December 1, 2022, the U.S. Department of Defense (the “DoD”) announced the establishment of the Office of Strategic Capital (“OSC”), which will “connect companies developing critical technologies vital to national security with capital.” Unlike most federal programs that support companies through federal grants, OSC is exploring the use of loans, loan guarantees, and other non-acquisition-based tools to help supply capital to certain companies operating in areas of critical technology (e.g., next-gen biotech, advanced materials, and quantum science). This new program is distinguishable from the DoD’s Trusted Capital Digital Marketplace program (“TCDM”), which provides a government platform for small and medium-sized businesses operating in the defense industrial space to find funding opportunities through trusted financial institutions. By contrast, it appears OSC will provide funding directly to companies operating in the critical technology space. The Biden Administration believes OSC will help preserve the United States’ technological advantage.

BIS continues to review a variety of items pertaining to semiconductors, chipmaking equipment and related technologies to assess the need for new export controls, and Under Secretary Estevez has made clear that BIS will not be completing its “China assessment” any time soon. BIS officials have signaled that there are multiple other technology areas that the U.S. Government has on its radar. When asked recently whether BIS is likely to impose export controls on additional categories of technologies, Under Secretary Estevez stated: “if I was a betting person, I would put money on that.” Moreover, BIS expects to clarify some of its recently issued rules to remedy unintended supply chain disruptions.

Going forward, U.S. companies and foreign investors should remain mindful of likely aggressive enforcement of the Biden Administration’s national security objectives. As discussed in our prior article, President Biden issued an executive order (“Order”) this fall to reinvigorate CFIUS’s authority to review foreign investments posing threats to U.S. national security within specific technology and data-driven industries, including microelectronics. Shortly thereafter, CFIUS released a memorandum detailing its enforcement and penalty guidelines, reminding foreign investors of CFIUS’s increasingly aggressive enforcement agenda, as discussed in another one of our articles. BIS Under Secretary Estevez recently echoed this sentiment in an interview in which he stated that BIS will “use [its] full gamut of capability of both civil and criminal [penalties]” with respect to violators of new and existing export control rules and regulations.

Finally, the new U.S. export controls likely will become multilateral in scope. Currently, the new controls regarding China are strictly unilateral and apply only to items (and, in certain circumstances, persons) subject to U.S. jurisdiction. However, the National Security Strategy and U.S. Government officials call for a multilateral approach to the threats posed by China, and a multilateral “deal” may be forthcoming.

Conclusion

U.S. companies should look for the Biden Administration to release additional export control and investment review regulations and restrictions, and to enforce them aggressively, in support of its National Security Strategy. Dechert will continue to monitor and report on these developments.

Footnotes

1) In recent years, ODNI focused first on other types of threat (e.g., international terrorism, weapons of mass destruction); now the focus is on a short list of nation-state actors.

2) Licenses for this type of activity are subject to a presumption of denial. Since establishing the regulations, however, Commerce has worked with certain foreign companies to overcome unintended consequences resulting from the regulations. For example, Commerce has issued waivers to certain South Korean companies allowing them to engage in certain semiconductor production activities in China to avoid supply chain disruption.

3) Republican and Democratic senators have written President Biden, urging him to issue an executive order to curtail China’s “egregious track record of promoting intellectual property theft,” citing to CFIUS’ inception, which was initially established through executive order.

4) Specifically, each federal funding recipient under the CHIPS Act must enter into a 10-year agreement with Commerce in which it commits, among other things and with certain exceptions, that it and its affiliated group will not engage in any “significant transaction, as defined in the agreement, involving the material expansion of semiconductor manufacturing capacity in [China] or any other foreign country of concern.” The Act does not forbid “material investment” in China and other foreign Countries of Concern if such investment is for “existing facilities or equipment of a covered entity for manufacturing legacy semiconductors” and “significant transactions involving the material expansion of semiconductor manufacturing capacity that produces legacy semiconductors and predominantly serves the market of a foreign country of concern.”

5) Upon identification of a national security risk, Commerce is authorized to determine, in consultation with certain government officials, whether the transaction requires mitigation or, in an extreme case, must be abandoned entirely. If mitigation measures are unavailable and/or the federal funding recipient is unable to abandon the transaction, then Commerce shall recover all U.S. federal funding.