On June 3, 2021, President Biden issued an Executive Order to modify sanctions initially imposed by former President Trump regarding investments in Chinese companies with alleged ties to the Chinese military. The new sanctions provide clarity on a number of issues and demonstrate the U.S. Government’s continued focus on China.
Key changes include:
- Expanded set of investment services that U.S. persons can provide when acting for non-U.S. funds, investors or companies;
- Divestment of securities of Chinese companies that become listed is no longer required;
- Only explicitly listed entities will be subject to the sanctions;
- The U.S. Government’s criteria for sanctions designation are refined; and
- These sanctions are now decoupled from defense spending legislation that authorized lists.
What are the New Restrictions?
Executive Order 14032 (“E.O. 14032”) restricts the ability of U.S. persons to invest in specified companies involved in the defense (or related materiel) and surveillance technology sectors of the Chinese economy, which now are referred to by the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) as Chinese Military-Industrial Complex Companies (“CMICfs”). E.O. 14032 replaces and supersedes Executive Order 13959 (“E.O. 13959”), which was issued by former President Trump in November 2020 and imposed similar restrictions on investment activities involving securities of Communist Chinese military companies” (“CCMCs”). As a result of new superseding EO, all prior CCMC restrictions have been lifted and replaced, including prohibitions on purchases of previously targeted CCMC securities as well as requirements to divest affected securities by relevant CMCC deadlines.1
Subject to various deadlines, U.S. persons now are prohibited from purchasing or selling any publicly-traded securities of CMICs as well as any other securities that are derivative of, or designed to provide investment exposure to, such securities. Purchasing restrictions start on August 2, 2021 for the 59 companies currently identified as CMICs. U.S. persons are permitted to divest any affected securities until June 2, 2022. Importantly and as discussed in more detail below, E.O. 14032 makes clear that these restrictions only apply to activities involving U.S. investors – U.S. persons acting on behalf of non-U.S. funds or other non-U.S. investors generally are not subject to these prohibitions.
The U.S. Government released several resources to assist in compliance efforts:
- OFAC issued a new “Non-SDN Chinese Military-Industrial Complex Companies” List (“NS-CMIC List”) that identifies the 59 companies targeted under the new measures. OFAC also identified nearly 600 International Securities Identification Numbers (ISINs) associated with publicly-traded securities of such companies.
- Of these 59 companies, approximately half previously were listed as CCMCs and half are listed for the first time (though most of the newly listed companies are corporate affiliates of companies that were previously identified as CCMCs that remain listed as CMICs).
- Regardless of whether a company was previously listed as a CCMC, the restrictions on purchasing securities related to companies on the NS-CMIC List do not apply until August 2, 2021.
- 19 companies that previously were identified as CCMCs are not included on the NS-CMIC List. There are no restrictions on investments involving securities of these companies unless and until they are added to the new NS-CMIC List, and restrictions would not take effect until 60 days after they are listed.
- OFAC issued several new and amended FAQs describing the scope of the CMIC sanctions. Notably, several FAQs, such as those stating that divestment of affected securities was required, have been revised or deleted entirely. Other key differences are summarized below.
- The White House also issued a fact sheet providing further background on the intent and scope of the sanctions.
E.O. 14032 retains many aspects of the prior CCMC sanctions. As before, the Order restricts purchases of publicly-traded securities of listed companies as well as any securities that are “derivative of” or “designed to provide exposure to” such publicly-traded securities. These terms remain defined broadly – for example, any fund that holds any amount of CMIC securities is considered to “provide investment exposure” to that prohibited security. OFAC also retained guidance stating that U.S. investors can invest in funds that hold CMIC securities as long as such funds are seeking to divest such securities during the relevant wind-down period.
What Changed from the Prior CCMC Sanctions?
While the new CMIC sanctions are similar in many ways to the prior CMCC sanctions, there are several key differences. As an initial matter, the new sanctions authority was deemed necessary as several companies that had been identified as CCMCs under the Trump administration had successfully challenged or were in the process of challenging their designations. The U.S. Government was unable to demonstrate that such companies had a sufficient nexus to the Chinese military to be appropriately considered as CCMCs as defined under U.S. law.
The new order is intended to provide a firmer legal basis for imposing investment restrictions as it allows the Treasury Department to impose sanctions on any company that: (i) operates in the defense (and related materiel) sector or the surveillance technology sector of the Chinese economy; or (ii) is owned or controlled by, or owns or controls, any such company. This refines the criteria from before, which allowed a CCMC to be designated on the basis that it allegedly was “affiliated with” the Chinese military, per Section 1237 of the National Defense Authorization Act for Fiscal Year 1999, as amended. The U.S. District Court for the District of Columbia issued preliminary injunctions in two cases challenging the “affiliated with” criteria, where ownership or control criteria could not be met, and DOD had applied the affiliation criteria broadly.2 The new criteria for the CMIC list closely tracks the language set forth in the National Defense Authorization Act for Fiscal Year 2021, at Section 1260H, which also requires DOD to maintain a list of Chinese companies involved in the military industrial complex. DOD has now issued such a list, however, it is not linked to OFAC’s CMIC list.3
With respect to the surveillance technology sector, OFAC has indicated through its publication of FAQ 900 that it “intends to use its discretion to target [companies supporting] (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.” This guidance adds a new human rights dimension that aligns with other recent actions at OFAC with respect to China, but that is an apparent expansion of the criteria from the prior listings of CCMCs carried out by the Trump Administration.
The most significant change is the expansion of the ability of U.S. persons to engage in a much broader scope of activities when acting on behalf of a non-U.S. fund or other non-U.S. persons. Under prior OFAC guidance for CCMC sanctions, U.S. persons were authorized only to engage in certain non-discretionary, ancillary activities involving CCMC securities such as clearance, settlement, and custody. Now, under OFAC FAQs 901 and 902, U.S. persons also are permitted to provide investment advisory and management services involving CMICs securities to non-U.S. funds or other non-U.S. investors. As a result, portfolio managers and other decision makers who are considered “U.S. persons” because they are located in the United States or are U.S. citizens or permanent residents now can advise non-U.S. funds or investors to purchase CMIC securities after August 2.
Another important change is that under the prior CCMC sanctions (following the issuance of clarifying Executive Order 13974 in January 2021), U.S. persons were required to divest affected securities within one year of the CCMC being listed. Possession of affected securities after that time was affirmatively prohibited. E.O. 14032 revoked Executive Order 13974 entirely, including the divestment requirement. As a result, U.S. persons are permitted to engage in activities to divest CMIC holdings until June 2022, but are not affirmatively required to do so. It is unclear at this time how securities held past that time should be treated (e.g., whether they need to be blocked and reported to OFAC).
The chart below summarizes key differences between the now-revoked CCMC sanctions and the new CMIC sanctions:
||New CMIC Sanctions
||Prior CCMC Sanctions
|Terminology for targeted companies
||Chinese Military-Industrial Complex Companies (CMICs)
||Communist Chinese Military Companies (CCMCs)
|Number of targeted companies
companies (with the potential for additional unlisted subsidiaries with a
closely matching name)
|Agency responsible for listing sanctioned companies
||Department of Defense or OFAC
|Permitted activities of U.S. persons acting for non-U.S. funds, investors, or companies
||All prior support services plus investment advisory, investment management, or similar services (including advising on, authorizing, directing, or approving otherwise-prohibited purchases or sales of CMIC securities)
||Clearing, execution, settlement, custody, transfer agency, back-end services, as well as other such support services
||Divestment permitted within one year of listing, but not required
||Divestment required one year after CCMC listing; possession post-deadline prohibited
|Application to subsidiaries with “closely matching” name to listed company
||Sanctions only apply to companies whose name exactly matches listed companies
||Sanctions applied to companies with similar, but not exact, names (though these restrictions never applied due to general licenses
|Required level of diligence to ensure compliance
||U.S. persons can rely “upon the information available to them in the ordinary course of business
||No standard provided
When President Biden first assumed office, there was some speculation in the financial industry that he would simply lift the CCMC sanctions. E.O. 14032 demonstrates that these restrictions will be in place for the foreseeable future. The new measures provide welcome clarity, however, regarding the specific companies and instruments that are affected. Investment managers and other financial industry participants will need to continue to ensure that activities involving exchange-traded or other funds that might hold CMIC securities are in compliance with the new measures.
1) The U.S. Department of Defense will continue to maintain a list of “Communist Chinese military companies,” but this list will no longer be linked to investment restrictions implemented by OFAC.
2) Xiaomi Corp. et al v. U.S. DOD et al, Case No. 1:21-cv-00280-RC (Dist. D.C.), Memorandum Opinion Granting Plaintiffs’ Motion for Preliminary Injunction (March 12, 2021); Luokung Technology Corp. et al v. U.S. DOJ et al, Case No. 1:21-cv-00583-RC (Dist. D.C.), Memorandum Opinion Granting Plaintiffs’ Motion for Preliminary Injunction (May 5, 2021).
3) DOD’s new Section 1260H list is available here: https://www.defense.gov/Newsroom/Releases/Release/Article/2645126/dod-releases-list-of-chinese-military-companies-in-accordance-with-section-1260/. As of the time of this publication the legacy Section 1237 list is still published on DOD’s website. DOD has not yet clarified its intent with respect to that list (although it no longer triggers OFAC sanctions).