On June 3, 2021, the Biden Administration issued a new executive order (EO) 14032 in response to the threat posed by the military-industrial complex of the People’s Republic of China (the “PRC” or “China”). EO 14032 prohibits U.S. persons from engaging in the purchase or sale of securities in 59 Chinese companies that are listed in an Annex to the executive order, as well as any person that is determined to operate or have operated in the defense and related materiel sector or the surveillance technology sector of the PRC. EO 14032 aims to prevent U.S. investment from benefiting the Chinese defense and surveillance technology sectors and is intended to cut off the PRC’s military-industrial complex from access to U.S. capital markets. It revamps and clarifies EO 13959, which was issued by Trump Administration in November 2020 and targeted Chinese Communist Military Companies (“CCMCs”).1 That executive order came under criticism for being unclear and difficult to implement.
- EO 14032, “Addressing the Threat from Securities Investments that Finance Certain Companies of the People’s Republic of China,”2 provides authority to target Chinese companies that operate in the defense and related materiel sector or the surveillance technology sector of the PRC’s economy. EO 14032 amends and expands the scope of EO 13959, which sought to prohibit U.S. investors from purchasing publicly traded securities in certain Chinese military companies. EO 14032 now also targets companies in the surveillance technology sector of the PRC.
- EO 14032 prohibits U.S. persons from purchasing or selling publicly traded securities of any of the 59 companies listed in the Annex to the EO, as well as any companies that may be designated in the future (“covered securities”). The prohibitions against the companies in the Annex take effect on August 2, 2021, and the prohibitions against any other companies targeted under the order take effect 60 days after the date of determination. These prohibitions apply to derivatives of publicly traded securities and any securities that are designed to provide investment exposure to such securities, regardless of the amount of shares held by underlying funds. U.S. persons are not generally prohibited from transacting with the companies themselves beyond the scope of these prohibitions.
- EO 14032 provides greater clarity to the investment community regarding the entities that may be targeted and transactions in which U.S. persons are prohibited from engaging. As discussed in previous3 alerts4, EO 13959 imposed a securities trading ban for any entity listed by the Department of Defense (DOD) as a Chinese military company. Substantial confusion resulted from the failure of DOD to identify either the official names of listed companies or their stock ticker symbol. EO 13959 created further confusion by extending the trading ban to any company with a name that “closely matched” a listed entity, but without providing any additional guidance. This confusion led to difficulty in implementation of the order. In addition, DOD also failed to develop a sufficient factual record to establish a linkage between listed company and the Chinese military. Two Chinese companies, Luokung Technology Corporation5 and Xiaomi Corporation,6 successfully challenged their designation in U.S. court. Both companies were able to prove that DOD did not provide sufficient evidence to justify the companies’ designations under EO 13959, and OFAC delisted them shortly thereafter.
- EO 14032 has already drawn China’s ire and will likely drive further economic decoupling between the U.S. and China, particularly in the military and surveillance technology sectors. EO 14032 comes amid reportedly constructive trade talks between China’s Vice Premier, Liu He, and U.S. Trade Representative Katherine Tai and U.S. Secretary of the Treasury Janet Yellen.7 In addition, President Biden is preparing to visit the United Kingdom on June 11 for his first overseas trip to attend the G7 Summit, where China is expected to be a topic of discussion.8 China may respond with retaliatory countersanctions, which it has used more frequently, such as when China sanctioned 28 former Trump officials,9 or when it sanctioned members of Parliament in the United Kingdom (“UK”) in response to the UK’s sanctioning of Chinese individuals in relation to ongoing human rights abuses in Xinjiang.10
Executive Order 14032 and Related Guidance
- EO 14032 amends EO 13959 to prohibit the purchase or sale by U.S. persons of any publicly traded securities of 59 Chinese companies listed in the Annex to the EO, as well as any person determined by the Secretary of the Treasury to operate in the defense and related materiel sector or the surveillance sector of the PRC. Treasury has the authority to designate additional companies that own or control, or are owned or controlled by, the companies listed in the Annex or by companies operating in the defense or related materiel sector or the surveillance sector. Such entities would only become sanctioned if Treasury designated them. OFAC has placed the companies that are subject to these prohibitions on a newly created list, the Non-SDN Chinese Military-Industrial Complex Companies List (“NS-CMIC List”).
- The NS-CMIC list, which includes the 59 major technology, defense, and telecommunications companies in the EO Annex, supersedes the list imposed by the Trump Administration. The three largest telecommunications companies, China Mobile Communications Group Co., China Unicom Ltd., and China Telecommunications Corp., that were targeted by the Trump Administration remain on the new list. In addition, among the defense companies listed, giants in the aviation and maritime sector were targeted, such as Aviation Industry Corp., China Aerospace Science and Industry Corporation Ltd., and China Shipbuilding Industry Co. A number of companies were not included on the new list however, such as Luokung Technology and Xiaomi Corporation.
- EO 14032 is more targeted in scope than EO 13959, and only applies to companies that are specifically listed by the Treasury Department on the NS-CMIC List. As noted in our previous alert11 on the topic, when EO 13959 was issued, it caused considerable confusion in the markets due to ambiguity surrounding the application of the prohibitions to targeted companies and their subsidiaries. In particular, the prohibitions under the original EO applied to entities with a name that exactly matched the name of an entity identified under the EO, as well as entities with a “closely matching” name. EO 14032 leaves no room for ambiguity by removing the “closely matching” prohibition. In addition, EO 14032 includes the full English names of the targeted companies rather than the shorthand English names that caused confusion following the issuance of EO 13959.
- EO 14032 provides a delayed effective date for listed companies. The prohibitions against purchasing or selling covered securities will take effect on August 2, 2021 for companies that are listed in the Annex to the EO, and 60 days after the date of designation for any other person designated under EO 14032.
- EO 14032 provides a 365-day “wind-down” period solely to allow U.S. persons to divest from the targeted companies. For the companies identified in the Annex to the EO as subject to the prohibitions, the deadline for such transactions is June 3, 2022. For any other company that is listed on the NS-CMIC List, the deadline for such transactions is 365 days following a company’s listing on the NS-CMIC List. FAQ 865 further clarifies that market intermediaries and other participants may facilitate transactions by U.S. persons involving the targeted securities that are necessary to effect divestiture of the securities within the one-year wind-down timeframe.
- U.S. persons who are employed by foreign companies are not prohibited from facilitating purchases or sales related to a covered security of NS-CMICs. FAQ 902 clarifies that U.S. persons employed by foreign companies facilitating such transactions are not violating the prohibitions as long as the purchase or sale of the covered security is not for the ultimate benefit of a U.S. person (e.g., a U.S. person is the ultimate buyer).
- OFAC’s 50 percent rule does not apply to entities that are listed solely pursuant to EO 14032. FAQ 857 clarifies that the subsidiaries of NS-CMIC companies are not subject to the prohibitions in EO 14032 unless they are specifically listed on the NS-CMIC List, which is a departure from OFAC’s prior guidance under the NS-CCMC program. Under the previous sanctions program, OFAC said that it needed to publicly list subsidiaries on the NS-CMIC List for the prohibitions to apply, unless a subsidiary had an exact or “closely matching” name, in which case the prohibitions automatically applied. The new OFAC FAQ significantly clarifies this matter.
- The prohibitions apply to a wide variety of financial products, including investment funds. EO 14032 prohibits transactions in publicly traded securities of NS-CMIC companies, including derivatives of these securities such as futures, options, and swaps, as well as American depository receipts, global depository receipts, exchange-traded funds, index funds, and mutual funds. The prohibitions against purchasing or selling covered securities also apply to any fund that holds any amount of NS-CMIC securities, regardless of the securities’ share of the underlying fund. This means that a fund that holds even one share of a NS-CMIC company may be covered by the prohibitions.
- Under EO 14032, the entities placed on the NS-CMIC List are not considered SDNs. As FAQ 905 clarifies, EO 14032 only prohibits certain purchases or sales of publicly traded securities of entities on the NS-CMIC List, and not to any other activities that are unrelated to such securities, such as the purchase or sale of goods or services from NS-CMIC entities.
- OFAC has provided guidance regarding what it means to “operate” or “have operated” in the surveillance technology sector of the PRC. FAQ 900 states that OFAC expects to use its discretion under this new authority to target persons whose operations include or support or, have included or supported: (1) surveillance of persons by Chinese technology companies that occurs outside of the PRC; or (2) the development, marketing, sale, or export of Chinese surveillance technology that is, was, or can be used for surveillance of religious or ethnic minorities or to otherwise facilitate repression or serious human rights abuse. The scope of this authority appears designed to address a significant concern related to China’s Belt and Road Initiative, through which countries receive infrastructure development support from China that includes surveillance equipment, such as facial recognition cameras.12 This crackdown on China’s surveillance technology sector is a continuation of a Trump Administration policy barring U.S. firms from providing technology to several Chinese surveillance technology companies.13
Implications for the Private Sector
- EO 14032 signals that the Biden Administration is continuing to take a firm stand against China’s repression and serious human rights abuses by targeting the companies that enable China’s surveillance activities and prohibiting certain U.S. investments that support the Chinese defense, military, and surveillance technology sectors. EO 14032 is another tool in the whole-of-government approach used by the Biden Administration to address China’s malign activities, including sanctions targeting human rights abuses in Xinjiang, rigorous foreign investment screening mechanisms to address malicious investment in U.S. businesses, and export controls preventing China from accessing important U.S. technologies.
- The prohibitions under EO 14032 highlight a fractious U.S.-China relationship and the potential for additional sanctions targeting companies operating in China’s defense and technology sectors. In light of President Biden’s willingness to put additional pressure on China to counter the threats posed by the PRC military-industrial complex to facilitate repression or serious human rights abuses, U.S. companies should evaluate their exposure to Chinese companies that may be seen as operating in its military, intelligence, security research and development, and weapons production sectors of the Chinese economy. Senior White House officials have publicly indicated that they expect to continue adding companies to the CMIC list.14 The amended sanctions authorities provide a deterrent to investing and facilitating business with Chinese counterparties in such sectors.
- The global investment community should evaluate its holdings to determine potential exposure to NS-CMIC companies as well as companies that own or control, or are owned or controlled by, companies involved in the defense and surveillance technology sectors, which may be subject to future designations. The scope of these investment restrictions is broad, and the restrictions apply to publicly traded securities of NS-CMIC companies traded on exchanges in any jurisdiction. In addition, U.S. market participants should evaluate their exposure to covered securities and conduct appropriate due diligence regarding their investment holdings because any funds that include any amount of prohibited securities are included in the investment prohibition. Similar to the previous NS-CCMC List program, there is no de minimis threshold under which transactions involving funds that hold underlying prohibited securities is permitted. In addition, it is possible that the European Union and other U.S. partners may decide to supplement this action with additional sanctions targeting individuals and entities in China engaged in human rights abuses in Xinjiang, which would further increase sanctions risks.
- OFAC has provided clarity on the level of due diligence that is required to assess whether an underlying sale or purchase of a security is prohibited under EO 14032. FAQ 901 states that U.S. persons, including U.S. exchanges, market intermediaries, and participants, may rely on information available to them in the ordinary course of business. U.S. persons can also rely on extensive information provided by OFAC in the NS-CMIC List, which contains a number of useful identifiers, including equity tickers, International Securities Identification Numbers, and United Social Credit Codes.
1 K2 Integrity. “United States Prohibits Investment in Chinese Companies with Military Ties,” (November 19, 2020), available at https://www.k2integrity.com/en/knowledge/policy-alerts/united-states-prohibits-investment-in-chinese-companies-with-military-ties.
2 “Addressing the Threat from Securities Investments that Finance Certain Companies of the People’s Republic of China,” (June 3, 2021), available at https://home.treasury.gov/system/files/126/eo_cmic.pdf.
3 K2 Integrity. “United States Prohibits Investment in Chinese Companies with Military Ties,” (November 19, 2020), available at https://www.k2integrity.com/en/knowledge/policy-alerts/united-states-prohibits-investment-in-chinese-companies-with-military-ties.
4 K2 Integrity. “OFAC Issues Clarifying Guidance on Communist Chinese Military Companies Sanctions,” (January 7, 2021), available at https://www.k2integrity.com/en/knowledge/policy-alerts/ofac-issues-clarifying-guidance-on-communist-chinese-military-companies-sanctions.
5 United States District Court for the District of Columbia. Memorandum Opinion. Luokung Technology Corp. v. Department of Defense, available at https://ecf.dcd.uscourts.gov/cgi-bin/show_public_doc?2021cv0583-33.
6 United States District Court for the District of Columbia. Memorandum Opinion. Xiaomi Corporation v. Department of Defense, available at https://cdn.vox-cdn.com/uploads/chorus_asset/file/22367849/xiaomi_v_us_dept_of_defense.pdf.
7 “China upbeat on trade talks with U.S., says both 'seek common ground.’” Reuters, (June 3, 2021), available at https://www.reuters.com/business/china-us-will-work-issues-producers-consumers-next-step-ministry-2021-06-03/
8 Tensions between the G7 and China have risen recently, with a May 2021 G7 communique criticizing a range of China’s activities, including “concern regarding [China’s] practices that undermine such free and fair economic systems, including on trade, investment and development finance.” G7 Foreign and Development Ministers’ Meeting: Communique, London, May 5, 20201. Available at https://www.gov.uk/government/publications/g7-foreign-and-development-ministers-meeting-may-2021-communique/g7-foreign-and-development-ministers-meeting-communique-london-5-may-2021.
9 Cate Cadell, Tony Munroe. “China imposes sanctions on 28 Trump-era officials including Pompeo,” Reuters, (January 20, 2021), available at https://www.reuters.com/article/us-usa-china-pompeo-blinken/china-imposes-sanctions-on-28-trump-era-officials-including-pompeo-idUSKBN29P14K
10 James Griffiths, “China sanctions UK lawmakers and entities in retaliation for Xinjiang measures,” CNN, (March 26, 2021), available at https://www.cnn.com/2021/03/25/china/china-uk-sanctions-xinjiang-intl-hnk/index.html
11 K2 Integrity. “OFAC Issues Clarifying Guidance on Communist Chinese Military Companies Sanctions,” (January 7, 2021), available at https://www.k2integrity.com/en/knowledge/policy-alerts/ofac-issues-clarifying-guidance-on-communist-chinese-military-companies-sanctions.
12 “Chinese facial recognition tech installed in nations vulnerable to abuse.” CBS News, (October 16, 2019), available at https://www.cbsnews.com/news/china-huawei-face-recognition-cameras-serbia-other-countries-questionable-human-rights-2019-10-16/.
13 Josh Zumbrun, Kate O’Keefe, and William Mauldin. “U.S. Adds Chinese Firms to Blacklist Citing Repression of Muslim Minorities.” The Wall Street Journal, (October 8, 2019), available at https://www.wsj.com/articles/u-s-adds-chinese-firms-to-blacklist-citing-repression-of-muslim-minorities-11570488642?mod=article_inline.
14 “Biden sanctions Chinese companies as Beijing says ‘normal communication’ resumed’ The Guardian (June 3, 2021), available at https://www.theguardian.com/us-news/2021/jun/03/biden-bans-us-investment-chinese-military-tech-surveillance