'Reverse CFIUS' Moves Closer to Reality: Highlights for Investors, Companies From Outbound Investment Actions
In this article in The National Law Journal, partners Mario Mancuso and Luci Hague discuss seven highlights of Biden’s executive order (EO) imposing outbound investment controls on certain types of investments by U.S. persons in China and Chinese-owned companies in the semiconductor, quantum computing, and artificial intelligence sectors, as well as the Advance Notice of Proposed Rulemaking (ANPRM) from the U.S. Department of the Treasury (Treasury), which outlines how Treasury is considering implementing the EO’s requirements.
The U.S. government sees what U.S. market participants consider ordinary course relationship-building with Chinese investors and companies as a significant vector of national security risk.
On Aug. 9, President Joe Biden issued the long-awaited executive order (EO) imposing outbound investment controls on certain types of investments by U.S. persons in China and Chinese-owned companies in the semiconductor, quantum computing and artificial intelligence sectors. The EO was released alongside an advance notice of proposed rulemaking (ANPRM) from the U.S. Department of the Treasury (Treasury), which outlines how the Treasury is considering implementing the EO’s requirements, and poses 83 questions for public comment relating to the key concepts and definitions that will be refined in regulations.
Taken together, the EO and ANPRM highlight the U.S. government’s focus on how U.S. capital flows, expertise, and networks can bolster the development and production of technologies by Chinese companies to the detriment of U.S. national security. Put simply, the U.S. government sees what U.S. market participants consider ordinary course relationship-building with Chinese investors and companies as a significant vector of national security risk.
Here are some highlights about the EO and ANPRM.
1. The EO’s requirements are limited to investments in three key sectors: semiconductors, quantum computing, and artificial intelligence.
The EO notes that rapid progress in these areas “significantly advances [China’s] ability to conduct activities that threaten” U.S. national security. The Treasury’s ANPRM further states that regulations will target U.S. persons’ investments in these sectors because their technologies and products pose particularly acute national security challenges.
2. Certain transactions will be prohibited …
The Treasury is considering prohibiting U.S. persons’ investments in companies located in China, Hong Kong, or Macau (as well as third country companies that are 50% or greater owned by one or more persons located in one or more of these countries), that are engaged in activities relating to advanced semiconductors (e.g., technologies that enable advanced integrated circuits), quantum computing, and software incorporating AI that is designed to be exclusively, or primarily, used for military, government intelligence, or mass surveillance end-uses.
3. … while others will require notifications to the U.S. government.
The Treasury is considering requiring notifications for U.S. persons’ investments in companies located in China, Hong Kong, or Macau (as well as third country companies that are 50% or greater owned by one or more persons located in one or more of these countries), that are engaged in activities relating to less-advanced semiconductors (e.g., integrated circuit design, fabrication, and packaging that are not sufficiently advanced to trigger a prohibition), and (ii) software incorporating AI that is designed exclusively, or primarily, for certain end-uses (e.g., cybersecurity, digital forensics tools, robotic systems, facial recognition). Notably, the Treasury is not considering implementing any notification requirements for in-scope transactions relating to quantum computing; all such transactions would be subject to a flat prohibition.
4. Some transactions will be exempt.
The ANPRM notes that Treasury is considering exempting certain types of transactions from the prohibition and notification requirements because, based on the nature of the transactions, they are less likely to threaten U.S. national security. These may include, for example, investments in publicly traded securities or index or mutual funds, or strictly passive limited partnership investments by U.S. persons. With respect to, the Treasury notes that the limited partnership investment could not confer on the U.S. person any formal or informal ability to influence or participate in the foreign person’s decision-making or operations and would need to be below a certain unspecified de minimis threshold.
Importantly, the de minimis threshold could potentially apply not only to the size of the U.S. person’s limited partnership interest in the fund, but also apply to what the Treasury calls “the size of the limited partners itself.” Even small investments from well-known, blue-chip sponsors may have outsized impacts on the Chinese target’s ability to raise additional funding and enjoy “enhanced standing and prominence.”
5. Final regulations will almost certainly capture transactions undertaken by U.S. sponsors’ offshore funds.
The EO specifically authorizes the Treasury to require U.S. persons to notify transactions undertaken by foreign entities controlled by U.S. persons (e.g., Cayman limited partnerships) if the transactions would be notifiable when undertaken by a U.S. person, and further states that the Treasury may require U.S. persons to “take all reasonable steps to prohibit and prevent” transactions by their controlled foreign entities if such transactions would be prohibited for U.S. persons. The ANPRM builds on this point, suggesting that the Treasury intends for regulations to apply to, among other things, activities of non-U.S. funds that are managed by U.S. person general partners.
6. The disclosure required in notifications will likely closely mirror the content of filings made to the Committee on Foreign Investment in the United States (CFIUS).
The ANPRM borrows heavily from CFIUS definitions and concepts, including the concept of a “covered transaction” as one within the regime’s legal jurisdiction, as well as the concept of “evasion.” In outlining the potential contents of required notifications, the Treasury similarly drew on the required content for CFIUS notifications: among other things, a U.S. person would need to provide basic business information about itself and details about the transaction being notified, as well as all relevant transaction documents (e.g., partnership agreements, side letters). While not explicitly covered in the ANPRM, we anticipate that, following submission of a notification, the Treasury may pose questions to the notifying party regarding the submission, akin to how the Treasury engages with parties in the CFIUS review process.
Closing Thoughts
The EO and ANPRM are a floor—not a ceiling. The EO requires the Treasury to make annual recommendations regarding sectors and countries that may be added or removed from the scope of the EO’s requirements, as well as changes to deter evasion. Moreover, the Treasury makes clear in the ANPRM that it will use the content of notifications to inform future policy decisions.
U.S. investors and companies should start accounting for potential new prohibitions and requirements in transaction planning now. While there is no deadline by which the Treasury must promulgate regulations, we anticipate that the Treasury will seek to finalize regulations sooner rather than later following the 45-day period of public comment on the ANPRM.
These actions send an important signal for market participants as to how the U.S. government views partnerships with Chinese investors, even outside of the identified sectors. For example, U.S. sponsors investing in software companies should not assume that the U.S. government would take a positive—or even a neutral—view of such sponsors’ strategic partnerships and anchor investments from Chinese limited partners.
Other countries may join the United States in implementing similar outbound investment controls. The United States’ taking a first step toward an outbound investment screening regime is an invitation to allies and partners to consider adopting similar mechanisms. We anticipate that the Biden administration will encourage allied and partner countries, especially those with close commercial ties to China’s semiconductor, quantum and AI industries, to do so.
