US Bans New Investments in China’s Sensitive High-Tech Industries
President Joe Biden issued a ban in August on new US investments in China targeting three high-tech sectors—AI, advanced semiconductors, and quantum information technologies. This includes any new indirect investments, private equity, venture capital, joint ventures, and greenfield investments. The latest US Executive Order mirrors export controls imposed on China in October 2022, which precipitated a decline in American technology investments in China.
Notification of Executive Order and ANPR
On August 9, 2023, US President Joe Biden issued an Executive Order, restricting specific US investments in Chinese enterprises operating in sensitive technological domains such as computer chips. The Executive Order also stipulates that it is necessary to notify the government when making such investments.
The US Treasury Department, on the same day, released an “Advanced Notice of Proposed Rulemaking” (“ANPR”), commencing the process of issuing regulations to impose the new investment restrictions.
Target sectors and types of investment
The Executive Order primarily targets three specific sectors in the Chinese economy: advanced semiconductors, quantum information technologies, and artificial intelligence.
The range of entities targeted by the Executive Order encompasses private equity, venture capital, joint ventures, and greenfield investments.
The Executive Order will only apply to prospective investments, leaving existing ones unaffected, while the US Treasury may request disclosure of prior transactions.
According to officials, the overarching objective of this order is to impede the flow of American capital and expertise towards the development of technologies that could potentially bolster China’s military advancements, posing a risk to US national security. They also referred the Executive Order as part of their effort to “de-risk” the US relationship with China but not to “decouple” from it.
The Executive Order and ANPR requirements are likely not to be effective for several months and potentially into the early 2023, given the time required to process multiple rounds of public comments, issue draft regulations, and publish the final rule. The ANPR solicits public comment till September 28, 2023.
Understanding the scope of Biden’s Executive Order
- What is covered: The Executive Order specifically applies to equity financing, convertible debt, greenfield investment, and joint ventures that could lead to a new Chinese entity in the stipulated sectors.
- What is exempt: Notably exempt are technology licensing, material transactions under export controls, and routine capital flows between parent and subsidiary companies in China, even within covered sectors.
The ANPR outlines two types of restrictions on affected investments:
- The first is a flat ban on US investments in covered national security technologies and products, relating to advanced semiconductor, microelectronic, quantum tech, and AI areas used for military, intelligence, surveillance, cybersecurity, and similar applications.
- The second involves notification requirements for transactions with fewer national security concerns.
The ANPR also lists activities excluded from “covered transactions,” such as research collaborations, raw material procurement, IP licensing, banking services, debt rating, and secondary services related to a transaction.
Who is a ‘covered foreign person’?
The US Treasury’s ANPR defines the term “covered foreign person” to include Chinese entities engaged in identified activities or subsidiaries comprising over 50 percent of financial metrics, which therefore extends the compliance obligations under the Executive Order to US parent companies for their foreign subsidiaries. Regarding subsidiaries of US companies, the Executive Order mandates US entities to inform the Treasury Department and ensure their controlled subsidiaries abstain from covered transactions.
The Treasury Department is considering “indirect” transactions within the scope of “covered transactions.” Such situations may include scenarios where an US individual knowingly invests in a third-country entity that intends to utilize the investment for conducting a transaction with a covered foreign person. This potential inclusion is intended to subject such transactions to the regulations as would apply if undertaken directly by a US person.
Responses from key stakeholders
China’s Ministry of Commerce expressed “grave concern” over the Executive Order, stating the severe impact on business operations and decisions, along with disruptions of international trade norms. MOFCOM called for adherence to market economy laws and fair competition principles and urged the US to avoid hindering global economic exchanges and cooperation or impeding world economic recovery. China’s Embassy to the US also mentioned that the restrictions will hurt both Chinese and American businesses, interfere with normal cooperation, and reduce investor confidence in the U.S.
As the Executive Order also includes Hong Kong and Macao, Hong Kong’s government issued a separate statement characterizing the US restrictions as “unreasonable measures” against the special administrative region. It criticized the hindrance of normal investment and trade activities and stressed that the measures disrupt the global economic and trade order. The Hong Kong government added that these actions introduced further uncertainty to global economic growth.
On the global stage, during the recent G7 summit meeting in Hiroshima, Japan, President Biden engaged in conversations with other country leaders about collaborative endeavors to curtail high-tech investments in China. Notably, US allies, such as the UK and the European Union, have openly suggested the possibility of adopting similar measures.
Impact on China’s technology sector and economy
Given its specific scope, the direct impact of the Executive Order is likely to be limited, but potential chilling effects could arise. China’s access to vast capital may also soften some of the impact. However, the ban comes at a moment of economic vulnerability for China: China’s National Bureau of Statistics reported a decline in consumer prices in July, marking the first such decrease in over two years. As many Chinese cities and businesses hope to stimulate local economies after the impact of COVID-19, this US ban may increase wariness among private sector investors despite coordinated government revival efforts.
Once a magnet for US venture capital, the Chinese tech sector has experienced a significant reduction in US investment due to escalating geopolitical tensions. Over the past two years, US investors have notably scaled back their involvement, leading to a broader impact on investment sentiment beyond the industries directly affected. Last year, direct US investment in China dropped to a 20-year low of US$8.2 billion, with US venture capital investment reaching a 10-year low of US$1.3 billion, as reported in the Wall Street Journal, indicating the substantial decline in investment activity.
While the Biden Administration framed the initiative solely within the context of national security concerns rather than economic advantage—the Executive Order demonstrates the difficulty of separating the two.
Despite export bans and apprehensions about Chinese investment in the U.S. being nothing new, this restriction on investment flow into China is unprecedented. Contrary to past decades when the US actively encouraged deeper investment in China as a means of fostering mutual interdependence and aligning with Western norms, this recent move marks a final departure from that approach.
Impact on US-China relations
The Executive Order represents the latest step in a series of measures aimed at limiting China’s access to advanced technology, aligned with the “small yard, high fence” strategy articulated by US national security adviser Jake Sullivan. The US has already imposed restrictions on certain technology exports to China, such as via the CHIPS and Science Act in October 2022, which aims to impede the country’s access to sophisticated chipmaking tools.
The tech sector stands as a focal point in the U.S.-China rivalry. China’s telecommunications leader, Huawei, has faced significant obstacles in the US market as well as those of its allies, such as Australia, with efforts to dismantle Huawei equipment from their networks.
The US Federal Communications Commission banned China Telecom, citing susceptibility to Chinese government influence and control. Simultaneously, the U.S., with assistance from countries like the Netherlands, Japan, and South Korea, has taken substantial measures to prevent China from independently developing high-end microelectronics manufacturing capabilities.
Such actions have prompted retaliation from China, including the recent export restriction of critical metals like gallium, which are vital to the Pentagon’s supply chain. New restrictions from the Executive Order may contribute to the escalating conflict between the world’s two largest economies.
Nevertheless, in recent months, Secretary of State Antony Blinken, Treasury Secretary Janet Yellen, and other American officials have engaged in renewed talks with Chinese officials. US Commerce Secretary Gina Raimondo is also expected to visit China soon. President Biden has stressed that he wants to stabilize relations with China rather than seeking conflict or a new “Cold War.” How these political visits get balanced by other regulatory actions targeting China is yet to be seen.
There may, however, be ramifications for businesses, as is often the spillover effect of political tensions. Given the interwoven nature of the U.S.-China economy, business professionals have displayed a range of sentiments concerning the heightened rivalry. A managing director at a consulting firm highlighted in a New York Times interview that “Politicians increasingly regard corporate investments in China as a form of collusion with a foreign enemy, even when there is no allegation of illegality.”
Are there still opportunities for US investors in China?
The targeting of specific sectors in the new EO could dissuade US investors from engaging with a wide spectrum of Chinese technology companies. But does it mean that US investors should simple remove China from their business landscape?
China continues to be a major revenue source for many investors. Over the past five years, China’s foreign direct investment has yielded a return rate of 9.1 percent. Notably, over 70,000 US companies have ventured into China, with nearly 90 percent of these endeavors proving profitable.
Even if China missed its annual economic targets of “around 5 percent” this year and grows at 3-4 percent per year, businesses will still have larger chance of earning more value here than in the US in the next five years. Thus, it’s too early and too costly to walk away from the biggest growth market in the world.
While it’s reasonable for US investors to be more cautious about committing money to the technology sector, opportunities remain in other areas, such as green industries, health relevant products, high-end lifestyle products, as well as elderly relevant products and services, to name a few.
Sectors that cater to the changing consumption patterns of the China market and are aligned with the government’s policy priorities could be the silver lining for general investors; these do not necessarily fall into the scope of Biden’s investment ban.
On the other hand, the Chinese government is acutely aware of the significance of foreign investment within its economy. As a result, it has been proactively intensifying its efforts to enhance the nation’s business environment, creating a level playing field for both domestic and foreign investors.
On August 13, 2023, the State Council released the Opinions on Further Optimizing the Environment for Foreign Investment and Increase Efforts to Attract Foreign Investment, a document detailing 24 policy measures divided into six major categories to boost foreign investment in the country. These measures entail a commitment to equitable treatment for both domestic and foreign enterprises, streamlining the process of cross-border data transfers, encouraging green energy usage, and the promise of fiscal and tax incentives.
This is definitely cause for cheer among foreign investors, provided these measures can be executed without delays and in a coordinated and consistent manner. We at China Briefing will continuously monitor news of the implementation guidelines and shall provide timely analysis.
China Briefing is written and produced by Dezan Shira & Associates. The practice assists foreign investors into China and has done so since 1992 through offices in Beijing, Tianjin, Dalian, Qingdao, Shanghai, Hangzhou, Ningbo, Suzhou, Guangzhou, Dongguan, Zhongshan, Shenzhen, and Hong Kong. Please contact the firm for assistance in China at email@example.com.
Dezan Shira & Associates has offices in Vietnam, Indonesia, Singapore, United States, Germany, Italy, India, Dubai (UAE), and Russia, in addition to our trade research facilities along the Belt & Road Initiative. We also have partner firms assisting foreign investors in The Philippines, Malaysia, Thailand, Bangladesh.
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