President Biden Orders Treasury Department To Implement New Outbound Investment Regime That Will Target Certain US Investments In China’s Tech Sector

What Happened

On August 9, 2023, President Biden issued a new Executive Order (Outbound Investment Order) directing the US Department of Treasury (Treasury), in consultation with other federal agencies, to regulate certain US investments into China’s semiconductors and microelectronics, quantum information technologies, and artificial intelligence sectors.  Treasury simultaneously released an Advanced Notice of Proposed Rulemaking (Notice) seeking public comment related to the implementation of the Outbound Investment Order.

The White House announced the Outbound Investment Order as an effort to prevent “foreign countries of concern” from exploiting US investment in a narrow set of technologies that are critical to support the development of military, intelligence, surveillance, and cyber-enabled capabilities of foreign countries that pose risks to US national security.  Although both the Outbound Investment Order and the Notice use the concept of foreign countries of concern, the former specifically identifies only one country – China – as a country of concern.  In the future, the president could extend the outbound investment limitations to other adversarial countries by amending the original order or by issuing a new order.  However, the order is presently directed only at China and we similarly focus on China in our discussions below.

The Bottom Line:

The Outbound Investment Order provides for the establishment of a new national security program to be implemented and administered by Treasury to regulate US outbound investment.  Companies with investments, or planning to invest, in China, particularly in the tech sector, should monitor this development, and Treasury’s forthcoming rulemaking to understand changing compliance obligations with respect to US outbound investment.

The Full Story:

US outbound investment in China and other countries has been a subject of concern and discussion for the last few years.  In 2022 and 2023, the US Congress debated several bills regulating such outbound investment (sometimes referred to as “reverse CFIUS” given the conceptual similarity to the current regime regulating foreign investment inbound to the United States that is administered by the Committee on Foreign Investment in the United States (CFIUS)).  Although there appears to be bi-partisan support for limitations of some kind on US outbound investment, to date there has been no legislative consensus on the exact form those limitations should take.  In the absence of new legislation, there has been speculation for several months that President Biden would issue an executive order exercising his authority under existing law (including the International Emergency Economic Powers Act and the National Emergencies Act) to limit US investment in certain sectors of the Chinese economy.  President Biden issued the Outbound Investment Order on August 9, 2023.

Outbound Investment Order

The Outbound Investment Order identifies as a threat to the national security of the United States the comprehensive, long-term strategies of China (including the special administrative regions of Hong Kong and Macao) that direct, facilitate, or otherwise support advancements in sensitive technologies and products that are critical to China’s military, intelligence, surveillance, or cyber-enabled capabilities.  The Outbound Investment Order further notes that China is exploiting or has the ability to exploit certain US outbound investments and that certain US investments may accelerate and increase the success of the development of sensitive technologies and products to counter US and allied national security capabilities.

To counter this threat, the Outbound Investment Order directs Treasury, in consultation with the US Department of Commerce (Commerce) and US Department of State, to develop and establish a new national security program for outbound investment.  The new program will include: (1) requirements for US persons to notify Treasury of certain transactions involving covered foreign persons (i.e., “notifiable transactions”); and (2) prohibitions on engaging in certain other transactions involving covered foreign persons (i.e., “prohibited transactions”).  The Outbound Investment Order defines a US person as “any United States 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 regulations to be developed by Treasury under the Outbound Investment Order will identify categories of notifiable transactions that involve “covered national security technologies and products” as such technologies and products are determined by Treasury (in consultation with other relevant agencies).  Treasury will also identify categories of prohibited transaction that involve technologies and products that pose a particularly acute national security threat because of their potential to significantly advance the military, intelligence, surveillance, or cyber-enabled capabilities of countries of concern.  The Outbound Investment Order also authorizes Treasury to require US persons to take “reasonable steps” to prohibit and prevent any transaction by a foreign entity controlled by such US person that would be a prohibited transaction if engaged in by a US person.

The White House has stated that the new program “will complement existing export control and inbound screening tools with a ‘small yard, high fence’ approach to address the national security threat posed by countries of concern advancing such sensitive technologies.”  Indeed, Treasury has observed that current export controls already prohibit or restrict the export to China of many of the technologies and products under consideration for the new program and that the new program aims to “prevent US investments from helping accelerate the indigenization of these technologies in [China], which undermines the effectiveness of our existing export controls and inbound investment screening programs….”  The Outbound Investment Order’s targeting of investments in China’s semiconductor sector, for example, follows export control rules for China issued by Commerce’s Bureau of Industry and Security in October 2022, which restrict the export of advanced computing chips and advanced semiconductor technology to China.

Treasury’s Advance Notice of Proposed Rulemaking

In implementing the Outbound Investment Order, Treasury took the step of issuing the Notice on August 9, 2023 to encourage stakeholder participation early in the rulemaking process.  The Notice provides initial details on what the key terms and aspects of what the new outbound investment program may look like.

For notifiable transactions, Treasury intends to require submission of a notification to Treasury but does not contemplate that the program will entail a case-by-case review of US outbound investments (as exists for inbound foreign investment in the US for transactions notified to CFIUS). Rather, Treasury intends to impose obligations on the parties to the US transaction to determine whether a given transaction is prohibited, subject to notification, or permissible without notification.  This indicates that the new outbound investment regime will likely entail significant new regulatory compliance obligations for investors.

Treasury currently anticipates that the transactions covered by the program will include certain acquisitions of equity interests (e.g., mergers and acquisitions, private equity, and venture capital), greenfield, joint ventures, and certain debt financing transactions by US persons, and expects to create a carveout or exception for specific types of transactions deemed not to pose a threat to national security, such as certain investments in publicly-traded securities or exchange traded funds.  Other exceptions under consideration include certain investments made as a limited partner, committed but uncalled capital investments, and intracompany transfers of funds from a US parent company to a foreign subsidiary.

Treasury does not intend that the program will be retroactive but has indicated that it may request information about transactions by US persons that were completed or agreed to after the date of the issuance of the Outbound Investment Order and prior to the effective date of the forthcoming regulations.

The Notice includes a number of key draft definitions that preview how Treasury will implement the Outbound Investment Order, including:

• “covered foreign person” which is defined to capture parent companies whose subsidiaries and branches engage in activities related to a covered national security technology or product, as well as subsidiaries and branches themselves;
• “person of a country of concern” which is defined to capture entities, citizens or permanent residents of a country of concern, as well as entities located outside of a country of concern that are majority-owned (50% or more individually or in the aggregate) by persons of a country of concern; and
• “covered transaction” which is defined as “a US person’s direct or indirect (1) acquisition of an equity interest or contingent equity interest in a covered foreign person; (2) provision of debt financing to a covered foreign person where such debt financing is convertible to an equity interest; (3) greenfield investment that could result in the establishment of a covered foreign person; or (4) 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 Notice also includes Treasury’s initial views with respect to the high-level categories of the technologies and products identified in the Outbound Investment Order, and indicates where Treasury may draw the line between a prohibited transaction and a notifiable transaction with respect to the three categories of national security technologies (transactions involving other technologies will neither be prohibited nor notifiable under the new program):

Advanced Semiconductors and Microelectronics

Treasury is considering that the prohibition for advanced semiconductor and microelectronic technologies will extend to investments into covered foreign persons engaged in:

• the development or production of electronic design automation software designed to be exclusively used for integrated circuit design;
• the development or production of front-end semiconductor fabrication equipment designed to be exclusively used for the volume fabrication of integrated circuits;
• the design of integrated circuits that exceed export control thresholds or integrated circuits designed for operation at or below 4.5 Kelvin;
• the fabrication of integrated circuits that meet certain specifications with respect to circuit density and operating temperature;
• the packaging of integrated circuits that support the three-dimensional integration of integrated circuits, using silicon vias or through mold vias; or
• the installation or sale to third-party customers of a supercomputer, which are enabled by advanced integrated circuits, that can provide a theoretical compute capacity of 100 or more double-precision (64-bit) petaflops or 200 or more single-precision (32-bit) petaflops of processing power within a 41,600 cubic foot or smaller envelope.

Treasury is considering that investments in a covered foreign person engaged in integrated circuit design, integrated circuit fabrication, or integrated circuit packaging that are not otherwise prohibited above will require notification.

Quantum Information Technologies

Treasury is considering a prohibition for quantum information technologies that will extend to investments into covered foreign persons engaged in:

• the production of a quantum computer, dilution refrigerator, or two-stage pulse tube cryocooler;
• the development of a quantum sensing platform designed to be exclusively used for military end uses, government intelligence, or mass surveillance end uses; or
• the development of a quantum network or quantum communication system designed to be exclusively used for secure communications, such as quantum key distribution.

The Notice does not indicate that Treasury intends to make any quantum information technology investments subject to notice requirements (that are not otherwise prohibited above).

AI Systems

As a fast-evolving field, Treasury is considering defining “AI system” as “an engineered or machine based system that can, for a given set of objectives, generate outputs such as predictions, recommendations, or decisions influencing real or virtual environments.”  The Notice request comment on whether Treasury should focus the prohibition in this area on US investments into covered foreign persons engaged in the development of software that incorporates an AI system and is designed to be exclusively used for military, government intelligence, or mass-surveillance end uses.

Treasury is considering that permitted notifiable transactions in this area would include investments into covered foreign persons engaged in “the development of software that incorporates an artificial intelligence system and is designed to be exclusively used for: cybersecurity applications, digital forensics tools, and penetration testing tools; the control of robotic systems; surreptitious listening devices that can intercept live conversations without the consent of the parties involved; non-cooperative location tracking (including international mobile subscriber identity (IMSI) catchers and automatic license plate readers); or facial recognition.” 

In addition to requesting public comment on the above definitions and restrictions, Treasury requests comment on regulations that condition a person’s obligations on that person’s knowledge of relevant circumstances and the scope of compliance obligations with respect to prohibited transactions, as well as the mechanics of providing Treasury of notice of notifiable transactions. 

Treasury will issue draft regulations at a later date.  The public is invited to submit comments on the Notice by October 2, 2023.

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The national security, mergers and acquisitions, private equity and competition practices at Hunton Andrews Kurth LLP will continue to monitor the development of the outbound investment regime and other cross-border investment matters. Please contact us if you have any questions or would like further information regarding these developments.