Treasury to regulate U.S. semiconductor investments in China

What happened:

June 21, 2024 U.S. Department of the Treasury (Treasury) The Investment Security Office issued a notice of proposed regulatory position (Outward Investments NPRM) to implement Executive Order 14105 ( Outgoing investment order), which ordered the Treasury Department to regulate certain U.S. investments in China’s semiconductor and microelectronics, quantum information technology and artificial intelligence sectors. The NPRM for outbound investments relies on an advanced notice of proposed rulemaking (ANPRM) issued by the State Treasury in August 2023, which set out the full draft regulations and explained the intentions of the proposal, and invited the public to submit comments.

Conclusion:

The Outbound Investment NPRM further shapes the new national security program to be implemented and administered by the Treasury to regulate outbound U.S. investments. Companies that invest or plan to invest in China, particularly in the technology sector, should review the Outbound Investment NPRM to understand their evolving compliance obligations with respect to outbound U.S. investments and consider providing comments to the Treasury regarding implementation of the Outbound Investment Order.

The full story:

On August 9, 2023, President Biden issued an outward investment executive order directing the Treasury, in consultation with other federal agencies, to regulate certain U.S. investments in China’s semiconductor and microelectronics, quantum information technology, and artificial intelligence sectors. Treasury simultaneously published its ANPRM, seeking public comment on the implementation of the outward investment mandate. Our information on the Outward Investment Order and the ANPRM, including a summary of the proposed rules, is available here.

On June 21, 2024, Treasury issued the Outward Investment NPRM, which contains proposed regulations to implement the Outward Investment Order. In its press release accompanying the NPRM, Treasury noted that the NPRM provides further detail on key concepts and aspects of program implementation, including:

• obligations of a U.S. person with respect to a “covered transaction”;
• categories of covered transactions and “excluded transactions”;
• technical specifications defining the scope of transactions covered based on specific technologies and products in the areas of semiconductors and microelectronics, quantum information technology and artificial intelligence;
• information that a person in the United States is required to provide to the Department of the Treasury as part of the notification;
• the standard of knowledge and expectation for a U.S. person to make reasonable and diligent inquiries before engaging in a transaction; and
• behavior that would be treated as a violation of the proposed rule, and the penalties for such behavior.

As discussed in our earlier discussion of the emerging outbound investment regime, the Outbound Investment Order directs the Treasury Department to regulate two classes of covered transactions: (1) “reportable transactions,” of which U.S. persons must notify the Treasury Department, and (2) “prohibited transactions” , which US persons may not undertake. The regulations proposed in the Outbound Investment NPRM would not require a preliminary case-by-case review by the Treasury Department of covered transactions or any other transactions, nor would they establish a licensing or permitting process in which a U.S. person would seek prior authorization for a covered transaction. Instead, an appropriate U.S. person undertaking a transaction would be required to determine whether a transaction is prohibited, permissible but reportable, or not covered by the rule because it is an exempt transaction or falls outside the scope of the authority set forth in the proposed rule.

Key differences in the Outbound Investment NPRM compared to our earlier summary of the ANPRM include:

• Knowledge standard: In the ANPRM, the Treasury Department indicated that it is considering adopting a knowledge standard across the entire outward investment program, meaning that for a transaction to fall within the scope of the transaction, a U.S. person would have to know or, reasonably should know, based on publicly available information or information that is available through reasonable diligence, that he or she is engaging in a transaction involving a foreign covered person and that the transaction is a covered transaction. The Outward Investment NPRM specifies that for a transaction to be within scope, a U.S. person must have knowledge of the relevant facts or circumstances at the time of the transaction, including: actual knowledge that the fact or circumstance exists or is substantially certain to occur, knowledge of the high probability of the fact or circumstance existing or occurring, or reason to know of the existence of the fact or circumstance, with each statement stating that a covered foreign person (i.e., a person of the country to which the application relates who is engaged in activities related to one or more of the covered national security technologies and products identified in the Outward Investment NPRM) is involved in the transaction.
• Definitions: Adjusted a number of defined terms from the definitions originally proposed in the ANPRM, including the definition of “artificial intelligence systems”, which the NPRM proposes on outbound investments should be consistent with the definition in Executive Order 14110 (on Artificial Intelligence), but comment is expected on certain calculation systems, the thresholds and the “covered transaction” that the NPRM proposes for outbound investments will cover investments made by a U.S. Person as a limited partner in certain non-U.S. pooled funds, as long as the U.S. Person investor knows at the time investment that the pooling fund is likely to invest in a person from a given country involved in at least one of the three sectors covered by national security technology and products specified in the outward investment order.
• Controlled foreign entities: The “controlled foreign entity” obligations are expanded to require U.S. persons to apply the outward investment rules to non-U.S. entities under their control. The proposed rules also provide guidance on what constitutes “control.”
• Interaction with other regimes:The Outward Investment NPRM proposes that any covered transaction would be prohibited if it is with or involves a covered foreign person engaging in any covered activity—whether a prohibited transaction or a reportable transaction—if the covered foreign person is listed on one of several U.S. government lists, such as the Entity List maintained by the U.S. Department of Commerce, Bureau of Industry and Security.
• Exceptions: The Outbound Investment NPRM proposes and seeks comment on alternative proposed exceptions to establish the threshold below which an investment by a limited partner who is a U.S. person in a pooled fund that then invests in a covered foreign person would constitute an excluded transaction, as well as a proposal to exclude certain transactions with a person from a country or territory outside the United States, or with a person from a country or territory outside the United States designated by the Treasury in accordance with criteria (to be developed by the Treasury) that relate to that country’s or territory’s own resources to seize the national security risk associated with certain outbound trips.

The Treasury Department requests public comment on the NPRM for outbound investments by August 4, 2024.