Key Takeaways

• In brief. On August 9, 2023, President Biden signed a highly anticipated Executive Order (the “Outbound E.O.”) to establish a U.S. outbound investment regime. The U.S. Department of Treasury (“Treasury”) concurrently published an Advance Notice of Proposed Rulemaking (the “ANPRM”) (as well as a related fact sheet) to initiate a rulemaking process to develop and implement an outbound investment regime that addresses the national security threat posed by “countries of concern” seeking to exploit advanced technologies to enhance their military, intelligence, surveillance, or cyber-enabled capabilities. Under the current proposed outbound investment proposal, the U.S. Government is focusing on certain investments by U.S. persons in companies located in the People’s Republic of China, Hong Kong, or Macau that engage in activities involving certain advanced technologies described in more detail below. The ANPRM also invites public comment on the intended outbound investment regulations. Public comments can be submitted for 45 days after the ANPRM’s publication in the Federal Register (which is currently scheduled for August 14, 2023, which would result in comments due by September 28, 2023).

• The U.S. Outbound Investment Regime will include certain prohibitions and certain notification obligations for U.S. persons. The outbound investment regime will either prohibit or require notification of participation by a U.S. person in one or more “covered transactions” that involve certain advanced technologies pertaining to semiconductors, microelectronics, quantum information technology, and artificial intelligence or “AI” with persons from “countries of concern” (currently including China and the Special Administrative Regions of Hong Kong and Macau). “Covered transactions” include transactions involving U.S. persons who acquire an equity investment in, provide convertible debt financing to, make a greenfield investment involving, or establish a joint venture that could result in, a company engaged in activities involving the targeted Chinese advanced technology sectors. U.S. persons that make a prohibited investment or fail to file a required notification related to a covered transaction are subject to potential monetary penalties and also could be required to divest the investment.

• The Biden Administration articulated a goal of balancing U.S. economic policy and U.S. national security. In establishing the outbound investment regime, the Biden Administration expressed a goal of balancing the United States’ commitment to open investment with the desire to disrupt strategic military, intelligence, surveillance, and cyber advancements in countries of concern. How Treasury will strike this balance in the outbound investment regime’s implementing regulations is still to be seen.

• The ANPRM does not implement the outbound investment regime; the relevant prohibitions and notification obligations do not become effective until the regime is implemented. Although the ANPRM does not implement the outbound investment regime, it provides helpful insight into what to expect (as well as what not to expect) from the implementing regulations, invites comments to key aspects of the outbound investment regimeand indicates how much work is still to be done. Even though the regime is not yet effective, the investment community should evaluate the forthcoming measures in connection with their China investment strategy.

• U.S. Persons are on notice – Treasury can inquire about covered transactions that occur during the interim period between the publication of the Outbound E.O. and the eventual publication of the outbound investment regime’s implementing regulations. The Outbound E.O. requires Treasury to implement regulations within one year. While it is not yet clear when the implementing regulations will be promulgated, the ANPRM provides that Treasury can begin inquiring about covered transactions (as we describe in the section below) that occur after the ANPRM is published in the Federal Register. In essence, the U.S. Government is already seeking to shape behavior with respect to investments in “countries of concern” (i.e., China). While covered transactions conducted before the implementation of the outbound investment regime regulations will not retroactively become subject to the prohibitions or reporting requirements of the regulations (and thus will not be subject to potential penalties), such activity could pose potential reputational exposure if information becomes public through this request process.

• The outbound investment regime is not a “reverse CFIUS” process. After much speculation about the proposed scope and nature of the initial outbound investment regime, it is clear from the ANPRM that Treasury is not contemplating a CFIUS-like process. Notably, Treasury does not foresee that the Outbound Investment Program will involve a review and approval mechanism akin to the U.S. Committee on Foreign Investment in the United States (“CFIUS”). Instead, covered transactions will either be prohibited or require a notification to the U.S. Government. Treasury does not (currently) intend to require affirmative approval by any U.S. agency for outbound investment transactions of concern. As a result, there would be no case-by-case consideration of whether prohibited covered transactions may proceed on a specific basis (for example, after the implementation of mitigation measures meant to reduce any identified risk to national security). For the investment community, this restraint may come as a welcome respite from perceived regulatory overreach and recent trends in the U.S. Government to exercise greater discretion and oversight with respect to private market activities that may impact U.S. national security.

• It is not yet known if Congress and other lawmakers will pressure the Biden Administration to expand the outbound investment regime beyond this initial proposal. Given the focus in Congress on the U.S. response to China, and the fact that there are several current Congressional proposals for U.S. outbound investment legislation (which we cover here) that are broader in scope than the Biden Administration’s proposal, the road ahead remains unclear. The initial reactions have been lukewarm. Chairman of the House Financial Services Committee, Rep. Patrick McHenry (R-NC), released a statement applauding the White House for listening to Congress’ concerns regarding China, but also cautioned that Congress must look past “feel good but inadequate policies and take stronger action to confront the Chinese Communist Party” and address such threat through “legislation rather than executive fiat.” Republican presidential candidate, Nikki Haley (who has previously called for an aggressive approach to U.S. outbound investment to China, up to and including a ban) stated that the outbound investment regime proposal was “not even a half measure.” We will continue to follow developments in this space to see if (and how) legislation may progress and if it impacts the future implementation of the outbound investment regime.

• The ANPRM contains exceptions, and more clarity will be required. The ANPRM notes that certain investments that otherwise would be considered “covered transactions” will be excepted from the prohibitions and notification obligations of the outbound investment regime. In particular, investments by U.S. persons in publicly traded securities of covered foreign entities are not subject to the program’s requirements, which should provide a significant relief to U.S. asset managers and their clients. However, it remains unclear whether the ANPRM’s reference to “publicly traded” securities is designed to cover only listed securities, securities acquired solely on a secondary market, or securities otherwise acquired in a public transaction. In addition, there are carveouts for passive investments of U.S. limited partners. As long as the limited partner (i) does not have the ability to influence or participate in the decision-making or operations of one or both of the investment fund and investment, and (ii) invests below a de minimis threshold that has not yet been established in the ANPRM (but could include consideration of the limited partner itself or the size of the limited partner’s investment), U.S. persons generally are permitted to make passive investments in index funds, mutual funds, exchange-traded funds, and similar investments that have engaged in covered transactions, though these funds would themselves be subject to the investment restrictions going forward. It will be important to monitor what Treasury considers passive. These exceptions also contrast with U.S. sanctions measures that prohibit U.S. persons from investing in publicly-traded securities of certain “Chinese Military Industrial Complex Companies” or funds that provide investment exposure to such securities. Under the current ANPRM, however, many questions remain about how effective these exceptions will be for the U.S. financial services industry. For example, while bank lending is included among the exceptions in the ANPRM, the investment community will need to evaluate whether and to what extent other types of non-bank lending may be impacted if it qualifies as a covered transaction.

• China has signaled that it will take action in response to the Outbound E.O. Chinese officials were quick to criticize the Outbound E.O., claiming that it “politicize[s] and weaponize[s] trade” with “blatant economic coercion and technological bullying.” Chinese officials made clear that China “reserves the right” to respond, though there have been no further details on what such countermeasures would entail at this time.

• U.S. allies assemble? We have written for months about the Biden Administration meeting with allied countries (including G7 members and others) to encourage the development of parallel outbound investment restrictions. Treasury’s outbound investment regime and Fact Sheet clearly state that the Outbound E.O. and ANPRM reflect discussions with allied countries and relevant private industry stakeholders. Nevertheless, there have not yet been any corresponding announcements or moves made by U.S. allies to establish a complementary outbound investment program other than general statements of support for the development of an equivalent European Union (“EU”) regime by senior EU officials. If similar outbound investment programs are not established by U.S. allies, the Biden Administration will need to consider whether the outbound investment regime will put U.S. investors at a competitive disadvantage in the global market, and whether the impact of the regime is worth the cost to the U.S. economy. It will be important to monitor if the timing of formal implementation of the U.S. outbound regime is delayed to provide additional time for coordination among the United States and its allies.

• Below, we provide an overview of the Biden Administration’s current outbound investment regime proposal, as articulated by the ANPRM.

Background

Currently, the U.S. Government reviews inbound foreign investments in, and acquisitions of, U.S. businesses to determine the impact on U.S. national security via CFIUS, which has the authority to impose mitigation measures, suspend transactions, and, where appropriate, recommend that the President block or unwind transactions.

However, the Biden Administration describes U.S outbound investments as also being particularly valuable to persons from countries of concern because they often include the transfer of “intangible benefits” in addition to capital. Such intangible benefits include enhanced standing, managerial assistance, access to investment and talent networks, access to markets, and access to additional financing.

The concept of a U.S. outbound investment review mechanism is not new and has been considered previously by Congress. For example, early drafts of what eventually became the Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”), which updated and expanded the statutory authorization for CFIUS, also contained a U.S. outbound investment review mechanism, but the proposal did not make it into the enacted legislation. Congress renewed the discussion of a U.S. outbound investment review mechanism in 2021. At the time, the U.S. supply chain crisis motivated Congress, as did the desire to prevent U.S. supply chain components from benefitting certain countries of concern, such as China.

Currently, the primary motivating concern is the desire to prevent capital flows, technical know-how, and other intangible benefits into sectors of the Chinese economy that support the Chinese government’s “military-civil fusion” regime, which seeks to develop the most technologically advanced military by removing barriers between civilian and defense sectors. Although other countries (including China, Taiwan, and South Korea) already employ some form of an outbound investment review mechanism, the outbound investment regime will be the first of its kind in a major Western economy. Moreover, given the Biden Administration’s coordination with U.S. allies, we can speculate that although it may be the first, the United States will not likely be the last Western economy to establish such a program and mechanism.

U.S. Outbound Review Proposal

Overview

The Outbound E.O. directs Treasury, in consultation with the U.S. Department of Commerce (and other federal agencies, as appropriate), to administer and implement the outbound investment regime. In brief, the regime will include prohibitions and notification obligations for U.S. persons.

• Prohibitions. Prohibit U.S. persons from engaging in certain transactions involving (i) entities located in or subject to the jurisdiction of a country of concern or entities owned by persons of a country of concern, and (ii) technologies and products that pose a particularly acute threat to U.S. national security; and

• Notification Obligations. Require U.S. persons to notify Treasury of certain other transactions involving (i) entities located in or subject to the jurisdiction of a country of concern or entities owned by persons of a country of concern, and (ii) technologies and products that may contribute to the threat to U.S. national security.

The details and terms set forth in the ANPRM are subject to review following the close of the public comment period, especially in light of Treasury’s requests for further input and comment from stakeholders. Nevertheless, the ANPRM currently defines “countries of concern” as China and the Special Administrative Regions of Hong Kong and Macau. However, the ANPRM states that the list of countries of concern may be modified by the President in the future if necessary.

Scope

As provided in the ANPRM, the outbound investment regime is not intended to broadly impede U.S. investment in a country of concern or impose sector-wide restrictions on certain U.S. investment activity. Rather, the proposed scope of the regime is intended to be narrowly tailored to restrict and monitor U.S. investment (and related capital flows) into specific areas of advanced technologies that countries of concern can use to undermine U.S. national security.

Accordingly, the proposed scope of the U.S. Outbound Investment Review Program is focused on U.S. persons’ participation in covered transactions that could aid in the advancement of the following advanced technologies that pose a risk to U.S. national security (“national security technologies”, which the specific areas of concern are identified later in this update):

• Semiconductors and microelectronics;
• Quantum information technologies; and
• AI systems with specific end uses.

U.S. Persons

The ANPRM defines “U.S. person” as any U.S. citizen, lawful permanent resident, entity organized under the laws of the United States or any jurisdiction within the United States, including any foreign branches of any such entity, and any person in the United States. The implementing regulations for the regime will apply to U.S. persons wherever they are located.

Interestingly, the definition of U.S. person does not extend to non-U.S. subsidiaries, but the ANPRM’s proposed requirement that a U.S. person “take all reasonable steps to prohibit and prevent any transaction by a foreign entity controlled by such United States person that would be a prohibited transaction if engaged by a United States person” creates an obligation for U.S. parents that control non-U.S. entities. “All reasonable steps” is a broad concept, but the ANPRM defines it to include implementing relevant policies, procedures, training, and internal controls (including a testing and audit function) to govern the U.S. parent’s compliance with the obligations under the implementing regulations in respect of its controlled foreign entities. U.S. persons also can be subject to the Program’s prohibitions and notification requirements if they “knowingly direct” activities by a non-U.S. person that are covered by the Program. This reach raises issues for general partners or portfolio managers who are “U.S. persons” and are involved in activities of non-U.S. funds that invest in Chinese companies of concern.

Covered Transactions

The ANPRM defines a “covered transaction” to include:

• Acquisitions of equity interests or contingent equity interests (such as options-like investments) in a covered foreign person;

• Provision of debt financing to a covered foreign person where such debt financing is convertible to an equity interest;

• Greenfield investment that could result in the establishment of a covered foreign person; and

• The 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 definition of covered transaction will also include indirect transactions via intermediary entities. For example, a U.S. person cannot knowingly invest in a foreign entity that will engage in a covered transaction that that would be subject to the jurisdiction of the outbound investment regime if engaged in by a U.S. person directly.

In contrast, the definition of “covered transaction” will not include certain categories of activities such as university to university research collaborations, intellectual property licensing arrangements, bank lending and payment services, and underwriting services. Certain passive investments (such as passive investments in publicly traded securities and investment funds), equity interest buyouts, intercompany transfers, and transactions involving committed but uncalled capital, will also be exempted from the definition of covered transaction. However, as discussed more thoroughly below regarding covered foreign persons, the extent of the exemption for passive investments may be limited and we should expect a vibrant comment period as interested stakeholders seek to provide input.

In addition, transactions that provide an “extraordinary benefit to U.S. national security” or provide an “extraordinary benefit to the U.S. national interest that overwhelmingly outweighs relevant U.S. national security concerns” (such as transactions with U.S. Government contractors) are also excepted from the scope of the outbound investment regime (the “National Interest Exception”). Treasury will not except prohibited transactions under this exception on a case-by-case basis (for example, through a CFIUS-like case review process); rather, determinations will be made in consultation with the relevant U.S. Government agencies and departments.

Although the ANPRM provides that Treasury may request information about transactions by U.S. persons that are or will be completed or agreed to after August 9, 2023 (i.e., the date of issuance of the Outbound E.O.) to better inform the program’s development and implementation, there will be no retroactive look-back period for covered transactions completed before the regime’s implementing regulations are promulgated.

National Security Technologies

The ANPRM provides a high-level overview of the three categories of “national security technologies” and the proposed prohibitions and notice requirements for each such category. If a Chinese/Hong Kong/Macau company engages in activities involving these categories, an investment involving U.S. persons could be prohibited or trigger a notification requirement. Although it is clear from the ANPRM that Treasury seeks to capture only those national security technologies that pose significant U.S. national security risks and not national security technologies and products intended for consumer/civilian end uses, the success of Treasury’s goals remains to be seen.

PROPOSED NATIONAL SECURITY TECHNOLOGIES AND PRODUCTS

The ANPRM solicits public comment on further categories of consideration for national security technologies. Public comments can be submitted for 45 days after the ANPRM’s publication in the Federal Register (which is currently scheduled for August 14, 2023, which would result in comments due by September 28, 2023).

Covered Foreign Persons

The ANPRM defines “covered foreign person” as:

• 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; and

• A person whose direct or indirect subsidiaries or branches are engaged in the above and which, individually or in the aggregate, comprise more than 50 percent of that person’s consolidated revenue, net income, capital expenditure, or operating expenses.

The “knowledge” standard will include actual or constructive knowledge as well as “reason to know” or “reason to believe” (similar to the definition of knowledge in the Export Administration Regulations). Treasury will also restrict U.S. persons from “knowingly directing transactions” covered by the implementing regulations. “Directing” will include ordering, deciding, approving, or otherwise causing to be performed a transaction prohibited under the implementing regulations if engaged in by a U.S. person. The ANPRM includes the following examples of activities covered by the “knowingly direct” standard

• Example 1: A U.S. person General Partner manages a foreign fund that undertakes a transaction that would be prohibited if performed by a U.S. person.

• Example 2: A U.S. person is an officer, senior manager, or equivalent senior-level employee at a foreign fund that undertakes a transaction at that U.S. person’s direction when the transaction would be prohibited if performed by a U.S. person.

• Example 3: Several U.S. person venture partners launch a non-U.S. fund focused on undertaking transactions that would be prohibited if performed by a U.S. person.

As flagged above, even though some passive investments are expected to be excepted from the outbound investment regime, the examples above (each from the ANPRM) signal that a broader exception may be needed for certain members of the U.S. investment community (such as U.S. asset managers acting on behalf of non-U.S. person investors or funds).

Notice Process

The ANPRM provides that any required notice regarding a covered transaction will be submitted to Treasury electronically (via a future e-portal) and must be filed no later than 30 days following the closing of a covered transaction. The ANPRM sets forth at least ten specific areas of information the notice must provide including beneficial ownership information for all transaction parties (including key personnel), a description of the rights or other involvement afforded to the U.S. persons’ participating in the transaction, a description of the due diligence conducted regarding the transaction, and information about previous transactions made/future transactions contemplated by the U.S. person into the covered foreign person.

Penalties

Similar to CFIUS, the ANPRM provides that Treasury will have the power to “nullify, void, or otherwise compel the divestment” of any prohibited transaction entered into after the effective date of the implementing regulations. The ANPRM also contemplates the imposition of civil penalties (up to the maximum permitted under the International Emergency Economic Powers Act) for material misstatements and omissions in filings, entry into prohibited transactions, and failure to timely notify (when required). This would mean that penalties for violations under the implementing regulations could be the greater of approximately $360,000 or an amount that is twice the amount of the transaction that is the basis of the violation.

Conclusion

While it is clear that the Biden Administration’s outbound investment proposal shows restraint and an effort to “narrowly tailor” the approach to governing such activities, there remains a tremendous amount of work to finalize and implement the regime. Treasury’s approach to the ANPRM is organized in a manner that enables collaboration from stakeholders during the comment period. In terms of what is next, interested parties should consider whether there are specific issues applicable to their U.S. outbound investment strategy and whether engaging with Treasury via comment submission (as part of the rulemaking process) for the outbound investment regime is worthwhile. Given the potential magnitude of the regime, we expect significant interest and commentary from U.S. and non-U.S. persons alike.