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In August, President Biden created the U.S. government’s newest national security tool: a regime that will regulate certain investments made outside of the United States. In response to concerns about the United States’ ability to maintain military and technological superiority critical to national security and beliefs that some U.S. investments undermine this edge, the Biden administration issued a long-anticipated executive order addressing U.S. investments in companies that engage with certain categories of technology and products located in the People’s Republic of China. Intended to fill a perceived regulatory gap, the program is designed to hinder the development of technologies that are regarded as supporting China’s military modernization, threaten U.S. national security, and—according to the Biden administration—benefit from U.S. investments and expertise. Conceptually, the new program prohibits certain investments and requires notifications for others.
The birth of a new regulatory regime is usually important, and this program is no exception. The announcement is also noteworthy because the program is not in its final form. Key terms are undefined, and necessary elements are incomplete. In their place are scores of questions posed to the public. Key constituencies in Congress, the administration, and the investment and technology sectors are sure to weigh in as the rulemaking process commences.
Below we describe the origins of the program, how it will work, key implications, and what will happen next.
A key tenet of U.S. national security and foreign policy is to establish controls over the next generation of advanced and critical technologies that will have significant military implications. At the center of this effort are several sectors of emerging technologies that have both commercial and military applications—most notably, semiconductors, artificial intelligence, biotechnology, and quantum computing. To that end, the Biden administration (and the Trump administration before it) levied a string of export and investment controls targeting the development of these technologies.
The U.S. government currently regulates practically all manner of commercial activity in the United States to protect and project its national security and foreign policy interests. It controls the import and export of goods, the provisions of goods and services from the United States, and investments from foreign companies in the United States. From excluding certain major technology companies from receiving U.S. exports, to banning the export of advanced computing chips, to increased scrutiny on investments into U.S. companies, to sanctions and prohibitions targeting foreign technology companies, the U.S. government has deployed nearly every tool available to it to confront and curtail development of certain advanced and critical technologies in China. Yet one gap technically exists in the U.S. national security toolbox—investments by U.S. companies and persons outside of the United States, through which U.S. capital is provided to foreign persons (and potentially adversaries).
Currently, the United States scrutinizes inbound investments by foreign persons into the United States via the Committee on Foreign Investment in the United States (CFIUS), an interagency committee chaired by the Department of the Treasury that reviews foreign investment in the United States for risks to U.S. national security. CFIUS has the authority to review transactions that give foreign persons control over a U.S. business and, in certain instances, investments by foreign persons into U.S. businesses engaged in sensitive activities even when the foreign investor does not gain control of the U.S. business. Depending on the level of threat posed by the foreign person and the vulnerability exposed through the U.S. business, CFIUS can impose burdensome conditions on transactions (namely, mitigation) or even recommend that the president prohibit or unwind a transaction altogether.
While CFIUS reviews inbound foreign direct investment into the United States, the new outbound investment program would flip the script; it would scrutinize investments by U.S. persons in companies outside the United States (hence the “reverse CFIUS” nickname for the new program).
The new outbound investment program thus represents the newest tool in the U.S. government’s whole-of-government toolbox to maintain its technological advantage in the next generation of critical and emerging technologies.
Overview of the Program
The Biden administration rolled out the outbound investment program in two parts. First, it issued an executive order that describes the broad contours of the screening program and the basis for implementing regulations. It then issued an advance notice of proposed rulemaking (ANPRM) that provides additional details about the program to be established in regulations and seeks public comment. The outbound investment program will not be effective until the rulemaking process is complete, and the Biden administration, in an effort to generate comments on the program, has included a long list of questions.
This level of public solicitation illustrates the novelty of this security control and the importance of striking the right balance between a free flow of capital and the protection of U.S. national security. The 45-day public comment period ends on Sept. 28. After reviewing comments, the Biden administration will roll out draft regulations that will also be open to public comment and ultimately a final rule formally establishing the outbound investment program.
As conceived, the outbound investment program will prohibit certain investments and require notification for others. Much like CFIUS, the outbound investment restrictions require three elements: a “U.S. person,” a transaction, and an entity located in or under the control of entities in China that is engaged in activities related to certain advanced technologies and products.
The outbound investment program broadly defines “U.S. person” to include any U.S. citizen; any lawful permanent resident; any 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 located in the United States. This broad definition could catch many possible connections to the United States and would create compliance obligations for many global investors.
Transactions subject to outbound investment review are called “covered transactions.” As currently drafted, the outbound investment program will cover the following activities:
- Acquisition of an equity interest or contingent equity interest in a covered foreign person.
- Provision of debt financing to a covered foreign person where such debt financing is convertible to an equity interest.
- Greenfield investments (namely, establishment of a new business entity) that result in the creation of a covered person.
- The 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 new program prohibits certain investments and requires notification for others. Only China-connected investments are currently covered, which include investments into entities in China (including the Hong Kong and Macau special administrative regions) or under the control of a Chinese entity or national. But the program could be expanded in the future to cover other countries or additional technologies.
The types of investments the Biden administration seeks to prohibit are investments into technologies related to comprehensive, long-term strategies by foreign adversaries that support advancements in sensitive technologies and products that are critical to such countries’ military, intelligence, surveillance, or cyber-enabled capabilities. China has, according to the Biden administration, eliminated certain barriers between commercial civilian sectors and military and defense industrial sectors by acquiring and diverting the world’s cutting-edge technologies for the purposes of achieving military dominance—and by exploiting investments from the United States. To address these concerns, the program seeks to prohibit certain transactions in three technology sectors: semiconductors and microelectronics, quantum information technologies, and certain artificial intelligence systems.
Specifically, the program would prohibit investments in entities engaged:
- in the development of electronic design automation software or semiconductor manufacturing equipment; the design, fabrication, or packaging of advanced integrated circuits; or the installation or sale of supercomputers; or
- in the production of quantum computers and certain components; the development of certain quantum sensors; or the development of quantum networking and quantum communication systems.
Details on prohibitions related to artificial intelligence systems are not provided. Rather, the administration requests comments on how to shape a prohibition on investments in entities engaged in a narrow set of activities related to software that incorporates artificial intelligence and is designed for national security end-uses, such as military surveillance.
The types of investments the Biden administration seeks notification on are U.S. investments in entities engaged in:
- the design, fabrication, and packaging of less-advanced integrated circuits; or
- activities related to software that incorporates an artificial intelligence system and is designed for certain end-uses that may have military or intelligence applications and pose a national security risk.
Transaction parties should expect to provide a detailed account of covered investments in filings, and the program allows the government to ask questions. Much like a CFIUS notice, an outbound investment filing would require the submission of detailed transaction-related information, such as of the identity of the transaction parties, the basis for determining that the transaction requires notice, transaction-related documents, description of the due diligence conducted, and previous transactions among the parties and plans for future transactions.
As currently constituted, the program will require submission of notifications within 30 days of consummating a transaction. The program also permits the U.S. government to investigate transactions and request additional information for transactions that have not been notified to the government. If the U.S. government determines that a notifiable transaction is a prohibited transaction, it can seek to nullify or void the transaction, compel divestment, or issue an exemption.
Although the factors that will be used to determine penalty amounts are not yet known, investors that fail to comply with the requirements of the outbound investment program could face civil—and possibly criminal—penalties.
The current language presents material issues that could have significant implications for investors.
Indirect Investments and Facilitation in the Crosshairs
Involvement by U.S. persons—even in foreign entities—can trigger reporting and other obligations. The program includes specific language related to coverage of investments by foreign entities controlled by U.S. persons or for which U.S. persons are involved in investment decisions. For example, the program contemplates requirements for U.S. persons who serve as the manager or general partner of an otherwise foreign fund when such funds undertake transactions that would otherwise be covered by the outbound investment program.
The program also includes the authority to prohibit U.S. persons from “knowingly directing transactions” that would be prohibited if engaged in by a U.S. person. Sanctions practitioners will recognize this language—it is similar to the “facilitation” provisions in many U.S. sanctions programs. But this could create affirmative compliance obligations for U.S. persons—wherever they are located—who work for foreign entities involved in investments that could implicate the outbound investment program. For example, a U.S. citizen who sits on the board of a foreign company or on the investment committee of a foreign fund may have affirmative compliance obligations if that foreign entity engages in covered transactions.
The administration intends to exclude certain types of passive investments, which could include investments in publicly traded securities, mutual funds, indirect investments by limited partners, and intracompany transfers. Ensuring that these carve-outs are clear and meaningful will be an important part of the rulemaking process and warrants careful consideration and comment by industry.
Subsidiaries Could Trigger Compliance Obligations
The outbound investment program applies to parent companies whose subsidiaries or branches engage in activities related to a covered technology, as well as entities located outside of China that are majority-owned by Chinese nationals. This definition could, for example, capture a subsidiary of a Chinese company operating in Europe, or even U.S.-organized entities operating in the United States, if owned 50 percent or more by a Chinese national. Given the potentially broad application of this rule, U.S. persons will need to undertake diligence and obtain potentially sensitive information from target companies to evaluate a transaction’s risk profile. Potentially innocuous, seemingly all-U.S. transactions could also trigger outbound investment compliance obligations (say, for example, when a U.S. investor invests in a U.S. subsidiary of a Chinese entity).
Comments on the outbound investment program are due by Sept. 28. Given the lengthy delay in issuing the executive order and ANPRM and voluminous questions, the Biden administration appears genuinely interested in and concerned about the implications and impact of this new rule. And given the likelihood of voluminous responses, it is likely to take many months to review these comments and release draft regulations. Those draft regulations will be followed by an additional comment period. Once these comments are reviewed, the final regulations will be published and become effective.
Although this program was developed by the Biden administration, Congress is still in the picture. In July, the Senate passed an amendment to its version of the National Defense Authorization Act (NDAA) that would create a mandatory notification regime for outbound investments to a broader set of countries of concern than the executive order. The legislation would not prohibit transactions but would include in the mandatory notification regime several technology sectors, including hypersonics and satellite-based communications. The House-passed version of the NDAA does not include a similar provision. The difference will need to be resolved in conference, so it is uncertain what, if any, provision regarding outbound investment will be included in the final legislation.
Even parties that are not directly affected have an interest in monitoring the development of this new tool, since once the U.S. government creates a national security tool, it rarely, if ever, puts it away. Here, the executive order underlying the program specifically contemplates the addition and removal of technologies or sectors after the program is finalized. Like other national security tools, such as export controls, sanctions, and CFIUS, the outbound investment program is here to stay and will likely grow.