End-of-Year Sanctions Target Chinese Supply Chains and AI, Quantum Computing, and Biotechnology
Several US executive branch agencies and the US Congress have adopted wide-ranging end-of-year sanctions, export control and supply-chain restrictions targeting the Chinese national security complex, high-technology entities and firms enabling human rights abuses in Xinjiang. Collectively, these measures reflect growing bipartisan concern about US investment in, export to and commercial support of certain Chinese military and industrial activities that have been determined to undermine US national security interests—as well as China’s human rights violations. The new measures will prompt US and global firms to further examine legal, political and reputational risks associated with China-related trade and investment as the United States continues to enhance restrictions targeting sensitive aspects of the bilateral economic relationship.1
New Capital Markets Sanctions and Audit Rules Targeting Chinese Issuers
Since December 10, the Treasury Department’s Office of Foreign Assets Control (OFAC) has added nine Chinese technology firms to its list of Non-SDN Chinese Military-Industrial Complex (NS-CMIC) entities under Executive Order (EO) 13959, as amended by EO 14032.2 (All nine companies had already been on the Commerce Department’s Entity List, which prevents companies from exporting products and technology subject to US jurisdiction to them without a license.) As a result of the designations, US persons may no longer purchase or sell any publicly traded securities of the listed entities, or any publicly traded securities derivative of, or designed to provide investment exposure to, such securities.
The targeted entities are principally Chinese firms that have allegedly developed or contributed to high technology to assist in the surveillance and suppression of the Uyghur and other minority populations in Xinjiang, including firms that have developed artificial intelligence (AI)-based facial recognition software to identify members of ethnic minority groups and alert authorities upon positive identification; “big data systems” for surveillance applications, such as scanning mobile devices for “criminal” content; and surveillance drone technology. This includes SenseTime, which was added to the NS-CMIC list on December 10, International Human Rights Day. In doing so, the Biden Administration specifically highlighted the “Serious Human Rights Abuse” perpetrated by SenseTime. The designation resulted in a temporary delay of SenseTime’s Hong Kong initial public offering, which was originally planned for December 17 and is currently planned for December 30.
In addition, on December 16, the US Public Company Accounting Oversight Board (PCAOB) issued a report determining that it is unable to “inspect or investigate completely” PCAOB-registered public accounting firms headquartered in China and Hong Kong. This brings the United States one step closer to prohibiting trading in securities of Mainland Chinese and Hong Kong firms on US exchanges, pursuant to the 2020 Holding Foreign Companies Accountable Act (HFCAA). Under the HFCAA and related rules, the trading prohibitions would begin in 2024 absent any changes in Chinese companies’ auditing practices—a significant additional step toward financial decoupling that is on the horizon. The US Senate has passed legislation that would accelerate the timeline for trading prohibitions by one year, although the House of Representatives has not yet passed companion legislation.
Export Controls Against Chinese AI, Quantum Computing and Biotechnology
The Commerce Department’s Bureau of Industry and Security (BIS) has also issued a series of new China-related Entity List designations and export control reforms to restrict exports to China in the fields of AI, quantum computing, biotechnology and drones. These actions are consistent with recent US intelligence assessments that have focused on the national security dimensions of certain critical technologies, including AI, the bioeconomy, autonomous systems, quantum computing and semiconductors.
On December 16, BIS amended by final rule the Export Administration Regulations (EAR) to add 37 Chinese and third-country entities to the Entity List. The designations focus principally on the Chinese Academy of Military Medical Sciences and its research institutes in response to their use of “biotechnology processes to support Chinese military end uses and end users,” including the development of “brain-control weaponry” and Chinese military modernization. The US intelligence community has identified the technologies of the “bioeconomy” as creating “national security and economic vulnerabilities” for the United States. BIS generally imposes a license requirement for exports, reexports and transfers (in-country) to entities on the Entity List of all items subject to the EAR with a presumption of denial.
These Entity List designations followed other significant BIS actions in recent weeks to augment restrictions on the export of sensitive technology to China and other countries. On November 24, BIS issued a final rule adding 27 Chinese and third-country entities to the Entity List for their role in support of Chinese “quantum computing efforts that support military applications, such as counter-stealth and counter-submarine applications, and the ability to break encryption or develop unbreakable encryption,” among other activities. Furthermore, on October 5, 2021, BIS issued a final rule to control certain life sciences technology as part of an ongoing BIS process to identify and control emerging technologies. Specifically, the final rule expands the Commerce Control List (CCL) to include certain software (and related technology) designed for nucleic acid assemblers and synthesizers that is capable of designing and building functional genetic elements from digital sequence data given its possible use in biological weapons programs. As such, the final rule creates new export control requirements affecting the life sciences and biotechnology industry, as well as further expands authority of the Committee on Foreign Investment in the United States (CFIUS) to scrutinize and potentially restrict foreign acquisitions and investments of businesses developing such software.
Moreover, the Biden Administration is reportedly considering tightening existing restrictions on the export of certain semiconductor technology to the Chinese semiconductor giant Semiconductor Manufacturing International Corp. (SMIC), which BIS added to the Entity List in 2020 but under a presumption of denial only for items “uniquely required” for production of semiconductors at advanced technology nodes. The amended rules would eliminate the “uniquely required” caveat and thereby restrict exports of a larger range of production technology to SMIC.
Legislation Targeting Chinese Forced Labor and Supply Chain Vulnerabilities
On December 23, President Biden signed into law the Uyghur Forced Labor Prevention Act, which strengthens a prohibition against the importation of goods made with forced labor in China. In particular, the legislation requires US Customs and Border Protection (CBP) to apply a rebuttable presumption that “any goods, wares, articles, and merchandise mined, produced, or manufactured wholly or in part in the Xinjiang Uyghur Autonomous Region of the People’s Republic of China” or produced by an entity on a list of entities operating in the region will be prohibited from entry into the United States. The presumption may be overcome when CBP determines that the importer has undertaken due diligence and responded to inquiries and that “by clear and convincing evidence” the product was not produced with forced labor.
In addition, Section 855 of the National Defense Authorization Act, which President Biden signed into law on December 27, creates a new disclosure requirement for firms performing work in China on US Defense Department contracts in excess of $5 million. This measure reflects concern that firms performing work for both the US and Chinese governments could disclose sensitive US national security information or work product to China.
The executive and legislative branch actions outlined above reflect an emerging US policy to reduce US technological, commercial and financial links to certain sensitive, high-technology sectors of the Chinese economy, based on both national security and human rights concerns.
The recent restrictions also indicate that the US government appears inclined, at least for now, to use list-based sanctions and export controls to target specific Chinese entities of concern, rather than technology controls of general application, such as blanket restrictions on the exports of technologies associated with AI, semiconductors, quantum computing and biotechnology (although there are examples of limited measures in this regard, as noted above). In contrast to restrictions of general application, which would affect broad categories of technology and could have uncertain implications for US domestic investment in, and commercialization of, that technology, list-based sanctions could potentially have a more predictable effect and fewer unintended consequences. List-based sanctions are also relatively easy for US businesses to administer. The US government has to date aimed to avoid overcontrolling certain technologies so that the United States continues to facilitate investment in, and commercialization of, these technologies.
For many companies, the policy measures described above underscore the continuing challenges of doing business in the current geopolitical environment—which require not only compliance with current law but also, in many cases, anticipation of the likely direction of future changes to US law—as well as new Chinese laws designed to counter the effect of US restrictions.
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WilmerHale is prepared to assist US and global firms to manage the rapidly changing US-China regulatory environment and identify competitive opportunities amid these changes.