After over a year of anticipation, on August 9, 2023, President Biden issued an Executive Order (“EO”) outlining a new regulatory regime for outbound investments from the United States. The EO targets certain U.S. investments in China and Chinese-owned companies. The EO directs the U.S. Department of the Treasury to propose regulations and develop a new program to impose prohibitions on certain transactions and notification requirements on others concerning U.S. investments in China, involving (1) semiconductors and microelectronics, (2) quantum information technologies, and (3) artificial intelligence. On the same day the President issued the EO, Treasury issued an advance notice of proposed rulemaking (“Notice”) setting forth its thinking on a regulatory framework for outbound investments and seeking comment on 83 separate questions by September 28, 2023.

Significantly for U.S. and non-U.S. investors alike, the current Notice does not contemplate retroactive application of either the notification or the prohibition requirement. Nor does the Notice consider a transaction-by-transaction review of outbound investments. While the scope and breadth of the new outbound investment regime is far from clear, Treasury has provided companies with both the opportunity to influence the final regulations and ample time to prepare for its implementation. That said, although the Biden Administration has stated that the scope of the EO is intended to be narrow (“small yard, high fence”), the text of the EO and the issues Treasury identified in the Notice are broad and may have a broader impact than investors and companies currently anticipate.

The EO, entitled “Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern,” directs the Treasury Secretary, in consultations with the Secretary of Commerce, to 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)” that may contribute to the threat to the national security of the United States. The EO states that “countries of concern” are engaged in strategies to use advances in sensitive technologies to pose a threat to the United States and its allies, and that U.S. investments may accelerate those advances. At this time, China is the only country identified as a “country of concern,” which, for purposes of the EO, China includes Hong Kong and Macau. When the EO was signed, Treasury’s Office of Investment Security issued an advance notice of proposed rulemaking corresponding to the EO. The proposed rulemaking seeks to protect the United States’ military, intelligence, surveillance, and cyber-enabled capability advantage. The Notice contemplates (1) prohibitions of “certain types of investment by a United States person in a covered foreign person whose business involves certain categories of advanced technologies and products”; and (2) notification of “certain types of investments by a United States person in a covered foreign person whose business involves other categories of technologies and products.”

Treasury did not issue a set of proposed rules but issued a proposed regulatory framework. The Notice does not implement the EO and is not a draft regulatory text. Treasury will issue draft regulations later. Consistent with the EO, Treasury’s framework identified the following three areas that would be subject to the new outbound investment regulatory regime:

• Semiconductors and microelectronics,

• Quantum information technologies, and

• AI systems

In all three sectors, transactions will likely be either notifiable or prohibited based on the underlying technology of the target.

In the semiconductor and microelectronics sectors, Treasury is considering prohibitions on transactions involving companies that develop electronic design automation software or semiconductor manufacturing equipment and companies engaged in the design, fabrication, or packaging of advanced integrated circuits, and companies involved in the installation or sale of supercomputers. Investments in companies involved in designing, fabricating, or packaging of less advanced integrated circuits would require notification.

Treasury is considering prohibitions on investments in companies producing quantum computers and certain components, developing certain quantum sensors designed for military, intelligence, or mass surveillance uses, and developing quantum networking and quantum communications systems. Treasury is not currently considering any investments in the quantum information systems sector that would require notification.

Treasury is considering prohibitions on investments in companies developing software incorporating AI designed exclusively for military, government, intelligence, or surveillance. Treasury is considering notification requirements for developing software incorporating AI for other civilian uses, including cybersecurity, digital forensics, penetration testing, control of robotic systems, surreptitious listening, non-cooperative location tracking, and facial recognition. Given the rapid pace at which AI is being developed and adopted, the final regulations for AI investment prohibitions and notifications will most likely evolve during the comment and implementation period.

The Notice seeks comments on how to define the industry sectors and products that will fall into each category and how best to regulate transactions in each sector. Notably, the Notice makes clear that the policy behind outbound investment restrictions is not solely to prevent China from accessing U.S. capital but to prevent China from accessing the U.S. know-how that often accompanies U.S. venture capital and private equity investment. Identifying and defining these so-called “intangible” advantages will be an important part of the rulemaking process. The Notice anticipates that the new regime would cover only certain types of transactions, including “mergers and acquisitions, private equity, and venture capital[], greenfield, joint ventures, and certain debt financing transactions by United States persons.” The Notice also anticipates that certain transactions will likely be excepted under the new regulations, including:

• Investments into publicly traded securities, index funds, mutual funds, and ETFs;

• Certain (yet to be defined) investments made as a limited partner in a private equity, venture capital, or other fund;

• Committed but uncalled capital investments; and

• Intracompany transfers of funds from a U.S. parent to a subsidiary.

As mentioned, Treasury has clarified that it is not proposing retroactive application of the new rulemaking. But the Notice states that Treasury may request information about transactions completed before implementing of the new outbound investment regulatory regime to “better inform the development and implementation of the program.” The contemplated rulemaking would also be limited to only cover transactions with “a person of a country of concern,” as defined by Executive Order, which is subject to change at the discretion of the President.

Finally, the Notice contemplates that the final rules will apply to any U.S. person, regardless of whether they reside in the United States.

As noted earlier, the topics identified above are just some of the topics Treasury seeks comment. The 83 topics identified in the Notice for comment include (1) the definition and breadth of companies and individuals that will be considered “U.S. persons,” (2) covered foreign person; person of a country of concern; (3) covered transactions; (4) excepted transactions; (5) covered national security technologies and products; (6) covered national security technology or product: semiconductors and microelectronics; (7) covered national security technology or product: quantum information technologies; (8) covered national security technology and product: AI systems; (9) knowledge standard; (10) notification requirements; form, content, and timing; (11) controlled foreign entities – obligations of U.S. persons; (12) national interest exemption; (13) compliance; record-keeping; (14) penalties; and (15) overarching and additional inquiries.

Key Takeaways

• The EO and the Notice represent the first step in what looks to be a lengthy rulemaking process. There are no draft outbound investment regulations, and there is no certainty as to what those regulations will look like one year from now when they become effective. But the Biden Administration has sent strong signals that, absent Congressional action expanding the scope of outbound investment restrictions, regulations will be limited to (1) future transactions, (2) covering only a handful of countries, and (3) a discrete, identifiable set of advanced technologies determined to have an outsized impact on U.S. national security.

• U.S. investors, including private equity and venture capital funds, as well as family offices, individual investors, and multinational companies, particularly those that invest or operate in the semiconductor, quantum computing, and AI sectors, whether as general partners with direct investments in Chinese companies or as limited partners that invest across sectors should:

• Familiarize themselves with the EO and the Notice and decide whether to file comments by September 28.
• Consider conducting a portfolio risk assessment to determine whether and how the EO and the Notice will impact portfolio companies and long-term strategy.

• Non-U.S. investors, especially private equity and venture capital funds that operate in any of the three covered sectors, should:

• Get clarity on the scope of excepted limited partner investments will have outsized importance for capital planning purposes. Although far from certain, Treasury’s regulations may draw from the regulations covering inbound non-controlling minority investments into technology, infrastructure, and data businesses under the Foreign Investment Risk Review Modernization Act (FIRRMA). If general partners can demonstrate that LP investments are truly passive and that U.S. knowledge or other intangible benefits will not be passed along to companies in countries of concern, Treasury may determine that such investments are “excepted” under the new regime.
• Consider conducting a portfolio risk assessment to determine whether and how the EO and the Notice will impact portfolio companies.
• Assess their past and future reliance on U.S. investors (and especially with U.S. limited partners) and review the documents governing U.S. investor rights to assess whether the new regulations could trigger any obligations on the part of the fund or the investor. The U.S. government is engaged in ongoing dialogue with its international allies, so non-U.S. funds should also consider engagement with their respective governments.
• Consider whether and how these new regulations could impact their current employees, directors, and advisors.

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