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FI Monitor Issue 4, 2022

Outbound investment controls: the US looks to expand its regulatory arsenal

Notwithstanding the immediate focus on the risk posed by Russia, China continues to be viewed by much of the US government as the principal long-term national security threat, both economically and militarily. This consensus has resulted in continued bi-partisan efforts to develop tools and resources to deny China certain capabilities and to protect and reinforce critical US capabilities. Here, we explore one of the emerging areas of US government interest: risks related to outbound investment into China.

Key takeaways

  • The policy discussion surrounding outbound investment relates to concerns about technology transfer (sharing of advanced technologies with military/intelligence applications), technological competitiveness (ability to compete more generally as it relates to technology development), supply chain security (ensuring that the United States is not reliant on any adversary country for critical inputs), and human rights (ensuring US persons are not supporting foreign development of tools used to commit human rights violations).
  • The more aggressive versions of proposed outbound restrictions, reflected in legislation currently pending in Congress, would establish mandatory screening of transactions involving foreign investment in, or offshoring of, a broadly defined set of critical capabilities. Even the least ambitious proposals are likely to at minimum require the monitoring, and potentially CFIUS-like review, of financial sponsor investments in certain technology areas in China.
  • While there are very different views about the nature and objectives of any outbound investment rules, there appears to be enough bi-partisan interest that some are likely to be established.
  • The Biden administration may be looking to establish these rules through an executive order, which may reduce the pressure for passage of any legislation, but to the extent the administration might prefer a notification regime without remedial authority, political pressure may push towards a review process with remedial authority, though likely focused on a defined set of technologies.
  • If the United States were to adopt such a policy, it would likely seek to influence European governments to consider similar controls. This would follow now established precedent in the inbound investment review space.

How did we get here?

The US government has established a number of tools over the past several years to fill some perceived gaps in its ability to address China-related risks, including around the transfer of sensitive technologies to China and introduction of Chinese-origin goods and services into the United States that could be exploited by the PRC government.

  • In 2018, through the Foreign Investment Risk Review Modernization Act (FIRRMA), Congress expanded the authority of CFIUS to enable it to review certain non-controlling investments in US companies.
  • In 2018, through the Export Control Reform Act, Congress directed the review and expansion of export controls to cover “emerging and foundational technologies” that might otherwise only be subject to minimal controls.
  • In 2020, President Trump issued an Executive Order under the International Emergency Economic Powers Act (IEEPA), reaffirmed in 2021 by President Biden, that served as the basis for a new regulation allowing the Department of Commerce to review certain transactions involving the sale or use in the United States of information and communications technology and services from adversary countries, including China.
  • In 2020 President Trump also issued an Executive Order under IEEPA that, as subsequently revised by President Biden, prohibits US persons from transacting in publicly traded securities of Chinese companies designated by the government as being part of the Chinese military-industrial complex or as producing surveillance technology to facilitate repression or serious human rights abuses.

Though some of these measures are intended to address the risks of US companies sharing technology or otherwise bolstering Chinese capabilities, there continues to be dissatisfaction in some parts of the government with the authority to address technology transfer risks resulting from US companies in strategically important sectors investing in China. With the pandemic and resulting supply chain disruptions, there has also been increasing focus on China’s control over critical supply chains (such as semiconductor fabrication, rare earth minerals, and active pharmaceutical ingredients) and how those could be used offensively to apply pressure or deny vital inputs. Most recently, concern has focused on financial sponsor investment in Chinese companies, where such investment reinforces Chinese technological competitiveness with the United States and potentially also China’s military capabilities via the PRC’s policy of Military-Civil Fusion.

Increasing support within government for outbound investment review

As a result, there is increasing support in the US government for the establishment of outbound investment review authority, at least in relation to investment in China and other countries of concern. The most visible effort thus far is legislation drafted by Senators Casey and Cornyn, the National Critical Capabilities Defense Act of 2021 (NCCDA). The NCCDA would create an interagency body, chaired by the US trade representative, to review transactions that would shift to a country of concern (or entity of concern) any business activities, investment, or ownership of certain critical capabilities, including medical supplies and services, articles or services essential to critical infrastructure, and critical components of military/intelligence systems. It would be mandatory to file transactions with the body, which could then recommend to the President that they take action to address or mitigate a risk to these critical capabilities.

As drafted, therefore, the NCCDA actually goes beyond review of investment in third-party companies in countries of concern to cover companies investing in their own subsidiaries in China and even outsourcing on a contract basis. Though consensus over China as a threat has only hardened in Congress since the business community successfully pushed back efforts to give CFIUS authority to review outbound joint ventures as part of FIRRMA in 2018, the scope of the NCCDA is so sweeping as to make it unlikely that it will be enacted in its current form. The NCCDA will be considered by the committee formed by the House of Representatives and the Senate to reconcile the House’s America COMPETES Act (to which the NCCDA was attached) with the Senate’s US Innovation and Competition Act (which omitted the NCCDA due to business community concern) – counterpart legislation intended to build US resiliency against competition from China.

White House focused on more targeted authority

The Biden administration has agreed that outbound investment into China is a concern, but it has not put out a statement of support for the NCCDA. Instead, it appears that the White House is focused on developing more targeted authority, perhaps focusing on technology transfer and technological competitiveness, as opposed to supply chain vulnerabilities. In July of 2021, national security advisor Jake Sullivan stated that the administration is “looking at the impact of outbound US investment flows that could circumvent the spirit of export controls or otherwise enhance the technological capacity of [US] competitors in ways that harm our national security.” In March 2022, at the Berkeley Forum on M&A and the Boardroom, hosted by Berkeley Law and Freshfields, special assistant to the President Peter Harrell noted that the administration is focused on “pretty narrow and tightly scoped categories of US investment … in competitor nations … where there are national security risks that need to be evaluated.” Mr. Harrell went on to note, as an example, specific concern with US and international investment in the creation of high-end semiconductor capabilities in China, and stressed that Taiwan and South Korea already regulate such outbound investment. Though the administration has not publicly discussed a list of technologies beyond semiconductors that may be subject to such controls, it would be reasonable to assume it would be a subset of the list the White House National Science and Technology Council identified in February 2022 as “critical and emerging” technologies.

New rules likely to be established through executive order

Given the difference in focus of the NCCDA and the White House approach, and that there is now established precedent for using executive orders under IEEPA to address trade and investment concerns related to China, the greater likelihood is that the White House will seek to establish any outbound investment rules through executive order, which will give it the ability to craft a more targeted program. More recently, however, Bloomberg has reported that the US Treasury Department, which would be involved in any executive branch discussion, raised the possibility with legislators of a notification program without any remedial authority. That proposal, not surprisingly, received a cool reception from advocates of outbound screening in Congress. To the extent that the administration had been considering implementation of such a notification process, the negative reaction may make it more difficult to adopt a process that does not include some remedial authority.

Mr. Harrell noted concern not just with US investment in Chinese capabilities, but international investment in advanced Chinese capabilities. Just as the US government sought to influence European governments to adopt CFIUS-like inbound investment regimes, there is every reason to believe that once the United States adopts an outbound investment regime, it will seek to influence allied nations, in particular Canada, Japan, and across Europe, to consider similar measures.