The U.S. Department of the Treasury (“Treasury”) recently issued a Notice of Proposed Rulemaking (“NPRM”), setting the stage for the regulation of certain U.S. foreign investments in China and China-related companies. The NPRM is the latest step in Treasury rulemaking on foreign investments following Executive Order (“EO”) 14105 and the Advance Notice of Proposed Rulemaking (“ANPRM”) that was the subject of a previous Blank Rome client alert. The NPRM presents the first proposed regulations on this topic. The public comment period on the NPRM closes on August 4, 2024.
The Treasury Department’s June 21, 2024 NPRM seeks to restrict certain U.S. investments in China and China-related companies based on concerns that U.S. capital and the associated “intangible benefits” (such as management assistance, status enhancements, and access to talent networks) could aid China in developing technologies that threaten U.S. national security. The NPRM applies to “covered transactions.” In other wordsInvestments in which a U.S. person or U.S.-owned investor “knows” that a China or China-related investment has a particular nexus with semiconductors, artificial intelligence (“AI”), or quantum technology and is subject to notification obligations or prohibited outright. For more information, see the Treasury Department fact sheet.
It is important to note that the NPRM is still in the proposed stage and final regulations have not yet been released. It may be several months, perhaps even into next year, before the Treasury Department issues final regulations, and it is also important to keep in mind that a change in presidential administration (if one occurs) could delay the final regulations and their implementation.
The NPRM contains the following key elements:
- Applications for US persons/US-owned entities: The NPRM applies to U.S. persons (defined as U.S. citizens, U.S. permanent residents, U.S. residents, and U.S. corporations and their foreign branches) as well as to foreign corporations that are “parented” by U.S. persons (referred to as “controlled foreign corporations”).
- Knowledge Standards/Work Expectations: The NPRM applies to transactions in which an investor knows, or reasonably should know through “reasonable and diligent investigation,” that the investment target is a “covered foreign person.”
- Specific categories of transactions covered: A “covered transaction” is one that a U.S. person knows involves a “covered foreign person,” and includes the following:
- Acquisition of shares or conditional shares.
- Certain debt financings that are convertible into equity or that give specific rights to lenders.
- Conversion of conditional equity interests.
- Greenfield investments or other corporate expansions.
- Joint ventures, and
- Certain investments as limited partners (“LPs”) or equivalent in non-U.S. pooled investment funds.
- Eligible activities: The NPRM defines “covered activity” to mean any activity that is defined as a “notifiable transaction” or a “prohibited transaction.”
- Transactions subject to notification: Transactions involving technologies that “may contribute to threats to the national security of the United States,” as described in more detail below.
- Prohibited Transactions: Transactions involving technologies that “pose particularly significant national security threats,” as described in more detail below.
- Countries of concern: As set forth in the Annex to Executive Order 14105, the President designated the People’s Republic of China, along with Hong Kong and Macau, as “Countries of Concern.”
- Persons of concern: The NPRM defines “countries of concern” broadly to include Chinese nationals and China-related entities outside of China, including:
- Individuals who are nationals or permanent residents of a “Country of Concern.”
- Entities that have their principal place of business, headquarters or organisation in a Country of Concern.
- governments of “concern” including state-owned enterprises;
- Any legal entity, regardless of location, that is 50% or more owned by one or more of the persons listed above.
- Going a step further, any entity, regardless of location, that is more than 50% owned by any of the majority-owned entities listed above.
- Eligible foreigners: A “covered foreign national” is defined as follows:
- “Countries of Concern” persons engaged in targeted activities.
- Anyone who is not from a Countries of Concern or engaged in covered activities, including those who:
- Holds voting rights, directorships or equity interests in persons from a Country of Concern who are engaged in covered activities;
- Derives 50 percent or more of its revenues or net income from, or incurs 50 percent or more of its capital expenditures or operating expenses through, persons in a Country of Concern engaged in covered activities.
- Exceptions to this rule: According to a Treasury fact sheet, the NPRM proposes to exclude several types of transactions from the rule, including:
- Investments in publicly listed securities;
- A certain amount of LP investment.
- Complete acquisition of ownership of the entity by the country concerned.
- Intercompany transactions between a U.S. parent and a majority-controlled subsidiary in support of ongoing operations or other uncovered activities.
- Transactions pursuant to binding uncalled capital commitments entered into before August 9, 2023.
- A transaction in which a U.S. person, as a member of a loan syndicate, acquires the voting power of a foreign target in the event of default, cannot take any action against the debtor, and does not play a leading role in the syndicate.
- Certain transactions outside the United States where the Treasury Department has determined that the countries involved have adequately addressed the national security concerns posed by the foreign investment.
- National Interest Exemption: Under the proposed regulations, Americans may seek a “national interest” waiver determination for transactions that are “in the national interest of the United States.” The Treasury Department plans to publish details on the waiver procedures and required information at a later date.
- Notifiable and Prohibited Transactions:
- As mentioned above, certain covered transactions are subject to notification (In other wordswhich would trigger notification requirements, while certain other things that pose particularly serious national security threats are banned outright.
- A U.S. person subject to the notification requirements under the proposed regulations would be required to submit notice to the Treasury Department within 30 days after (1) the transaction is consummated or (2) the U.S. person knows (or should reasonably have known through appropriate due diligence) that the transaction was a covered transaction.
Specifically, the NPRM states that the rule “It does not involve individual review of covered transactions or any other transactions by the Department of the Treasury, and does not establish a licensing process for U.S. persons to seek prior approval of covered transactions.Rather, the NPRM requires U.S. persons to determine whether a particular transaction is “prohibited, permitted but subject to notice, or exempt from the regulations.”
Target Technology
As previously mentioned, the NPRM pertains to three types of technologies that are subject to investment prohibitions or notices. Specifically, they include:
Semiconductors/Microelectronics
- BanElectronic design and operation software, certain front-end semiconductor manufacturing equipment, certain mass production advanced packaging equipment, the design, manufacture and packaging of certain advanced integrated circuits, and supercomputers incorporating certain advanced integrated circuits
- notificationThe design, manufacture, and packaging of integrated circuits not included in the definition of prohibited transactions
Quantum Information Technology
- BanThe development or manufacture of certain quantum sensing platforms; the development or manufacture of certain quantum networks or quantum communication systems.
- notification: none
artificial intelligence
- BanCertain AI systems that are designed to be used exclusively for military, government intelligence, or mass surveillance end uses, or that are intended for use by relevant covered foreign persons for those purposes
- notification: The development of AI systems not included in the definition of prohibited transactions that are designed for (i) military, government intelligence, or mass surveillance end users, (ii) end users who intend to use the system in a specific application, and (iii) users who have been trained using a specific amount of computing power.
Execution
Violations of the NPRM are subject to civil and criminal penalties under the International Economic Emergency Powers Act (IEEPA). Violations of the IEEPA are subject to civil penalties of up to approximately $368,000 (adjusted annually for inflation) or twice the amount of the transaction at issue, whichever is greater, and criminal penalties of up to $1 million and/or 20 years in prison. In addition, the Treasury Department can also enforce the divestment of prohibited investments. Notably, the NPRM allows any person who violates the rules to voluntarily self-disclose to the Treasury Department.
summary
The NPRM is an important step in regulating U.S. foreign investment related to China’s technological developments, a proposal that has been proposed in various forms for many years. Here are some points of particular note about the NPRM:
- The focus is on three technologies — integrated circuits, AI and quantum — that are at the top of national security concerns for the U.S. The NPRM does not target all investments with ties to China.
- If the investment is related to the technologies listed above, the scope of the NPRM is quite broad and applies to:
- Investments by U.S. persons and non-U.S. entities owned or controlled by U.S. persons.
- Direct or indirect investments in Chinese enterprises, Chinese-owned enterprises outside China, and enterprises owned by Chinese-owned enterprises outside China.
- Investments in targets that are engaged in activities related to the above technologies or that are invested in other companies engaged in such activities.
- As a result, where an investment may indirectly relate to one of the technologies at issue, U.S. and U.S.-owned investors may need to conduct extensive due diligence covering multiple degrees of separation to assess whether a transaction is prohibited or notifiable.
- The NPRM reinforces this through a knowledge standard that imputes to investors what they should know through a “reasonable and diligent investigation.”
- Violation of the NPRM could result in significant penalties under IEEPA and, for prohibited transactions, could result in the dissolution of the transaction.
- The NPRM is currently still in the proposed stage, and industry comments and Presidential policy may affect the content and timing of the final rule.
