Biden Administration Launches New Regulatory Regime Governing Outbound Investment

The Biden Administration has launched a much-anticipated regulatory regime governing outbound investments from the United States. President Biden has issued an Executive Order on Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern (“Executive Order”), directing the Treasury Secretary, in consultation with the Commerce Secretary, to establish regulations that will prohibit or require notification of certain types of outbound investments by US persons in entities in, or owned by entities, in China (including Hong Kong and Macau) involved in three specific categories of advanced technologies and products: semiconductors and microelectronics, quantum information technologies, and artificial intelligence. The Executive Order does not have immediate effect on pending transactions, and interested parties will have the opportunity to weigh in on the regulations as they are being developed.

Concurrent with the issuance of the Executive Order, the Treasury Department published an Advanced Notice of Proposed Rulemaking, which reflects Treasury’s current thinking on the scope of the implementing regulations, and solicits public comment on an extensive list of questions. Comments are due by September 28, 2023. Notably, Treasury’s initial proposal does not plan for retroactive application of either the notification or prohibition rules. Further, while sometimes referred to in the press as “reverse CFIUS,” Treasury does not expect the outbound investment program to entail a case-by-case review of transactions. As the shape of the regulations develop over the coming months, there will be greater clarity as to the breadth and impact of this new outbound investment program.

The Executive Order

The US national security concern prompting the launch of a regulatory regime governing outbound investment is that “countries of concern” are engaged in strategies to support advancement in sensitive technologies and products critical for military, intelligence, surveillance, and cyber-enabled capabilities that pose a threat to the United States and its allies, and that certain US investments “may accelerate and increase the success of the development” of those technologies. The Executive Order identifies only one “country of concern” — China (including Hong Kong and Macau). The sensitive technologies and products described in the Executive Order, referred to as “covered national security technologies and products,” are defined to mean sensitive technologies and products in the semiconductors and microelectronics, quantum information technologies, and artificial intelligence sectors.

To address this threat, the Executive Order authorizes the Treasury Department to issue regulations that: (1) require US persons to provide information to the US Government regarding certain types of transactions with specified foreign persons (the “Notification Requirement”); or (2) prohibit US persons from engaging in other types of transactions involving specified foreign persons (the “Prohibition Requirement”).

The details regarding the scope of the Notification Requirement and Prohibition Requirement, including the types of products and technologies of concern, and the types of investments subject to notice or prohibition, will be determined through a regulatory process administered by the Treasury Department over the coming months.

The Advanced Notice of Proposed Rulemaking (“ANPRM”)

The ANPRM outlines Treasury’s current preliminary view of the appropriate scope of transactions and technologies that will be covered by the regulations concerning the Notification and Prohibition Requirements. The ANPRM notes that the aim of the outbound investment program is not solely on restricting the investment of capital in Chinese companies. Indeed, a senior administration official acknowledged “China doesn’t need our money.” Rather, the focus is on the “intangible benefits” that accompany US investments, including “enhanced standing and prominence, managerial assistance, access to investment and talent networks, market access, and enhanced access to additional financing.” The national security concern is that US investor support could extend to Chinese entities that are developing technology with military end uses.

The outbound investment program is not intended to impede all US investments in China or impose sector-wide restrictions on US person activities. Instead, consistent with the Biden Administration’s approach in other national security areas related to China of “small yard, high fence,” the outbound investment program is intended to be a narrowly targeted action aimed at complementing existing US export controls and CFIUS’s inbound investment screening tools.

Within that broader context, the proposed scope of the outbound investment regulations includes the following key elements:

Transaction Scope

Treasury is considering including the following elements to “covered transactions” subject to the Notification and Prohibition Requirements of the outbound investment program.

• US Persons: US persons, wherever located, will be subject to the rules, including US citizens, lawful permanent residents, entities organized under the laws of the United States, including foreign branches, and any person in the United States. Foreign entities controlled by US persons and situations where US persons knowingly direct transactions by non- US persons may also be subject to the Notification and Prohibition Requirements.
• Foreign Persons: Foreign persons will include PRC citizens who are not also US citizens or lawful permanent residents, entities organized under the laws of the PRC, entities with a principal place of business in the PRC, and entities outside of the PRC that are majority owned by PRC individuals or entities. To fall within scope of the applicable requirements, the foreign person would have to be engaged in, or the US person knows or should know will be engaged in, the relevant activities within scope of the applicable requirements, or a foreign person’s direct and indirect subsidiaries are engaged in the activities and they, individually or in aggregate, comprise more than 50% of the foreign person’s consolidated revenue, net income, capital expenditure, or operating expenses.
• Covered Transactions: The ANPRM is considering the following types of transactions to be covered by the regulations: (1) acquisitions equity interests or contingent equity interests; (2) convertible debt financing; (3) greenfield investments; and (4) joint ventures. Treasury, however, does not intend covered transactions to include the following, provided they are not intended to evade the regulations: university-to-university research collaborations; contracts for procuring material inputs for covered national security technologies or products, intellectual property licensing arrangements, bank lending, bank payment settlements, underwriting services, debt rating services, prime brokerage, global custody, and equity research or analysis.
• Excepted Transactions: Treasury is also considering excepting the following types of transactions that would otherwise fall within scope of covered transactions: (1) investments into publicly-traded securities, index funds, mutual funds, exchange-traded funds; (2) certain investments, to be determined, made as a limited partner in a private equity, venture capital, or other investment fund; (3) committed but uncalled capital investments; and (4) intracompany transfers of funds from a US parent company to its subsidiary.

Technology Scope

Treasury is considering the following Prohibition and Notification Requirements for covered transactions related to products and technologies in the semiconductor and microelectronics, quantum information system, and artificial intelligence sectors:

• Semiconductors and Microelectronics:
  • Prohibition: (1) Development of electronic design automation software or semiconductor manufacturing equipment; (2) the design, fabrication, or packaging of advanced integrated circuits; and (3) the installation or sale of supercomputers.
  • Notification: Design, fabrication, and packaging of less advanced integrated circuits.

• Quantum Information Systems:
  • Prohibition: (1) Production of quantum computers and certain components; (2) the development of certain quantum sensors designed for exclusive use for military, government intelligence or mass-surveillance end-uses; and (3) the development of quantum networking and quantum communication systems.
  • Notification: Not under consideration at this time.

• Artificial Intelligence:
  • Prohibition: Development of software incorporating AI designed exclusively for military, government intelligence or mass-surveillance end-uses.
  • Notification: Development of software incorporating AI exclusively for use for cybersecurity, digital forensics, penetration testing, control of robotic systems, surreptitious listening, non-cooperative location tracking and facial recognition.

Timing Considerations

In light of the ANPRM and public notice and comment approach taken by the Biden Administration, final regulations are not anticipated until some point in 2024. The transaction scope for the outbound investment program will not be retroactive to transactions completed prior to the effective date of the Executive Order. However, Treasury indicates in the ANPRM that it may request information from parties to transactions completed or agreed to after the Executive Order was issued but prior to the effective date of the regulations to “better inform the development and implementation of the program.”

Implications

The announcement and implementation of an outbound investment regulatory regime is yet another national security tool aimed primarily at countering perceived threats to the United States posed by China. While the Biden Administration has emphasized that “this is a national security action, not an economic one,” it will nevertheless have a financial impact on US investors and Chinese recipients of those funds. The extent of that impact will be determined by the ultimate scope of the outbound investment program regulations once they are developed and published next year.

In the interim, US investors seeking to invest in Chinese companies involved in covered national security technologies and products should be aware that even if not prohibited or notifiable at this time, future transactions of that nature may ultimately come within the scope of the new regulations. Parties can also expect US Government monitoring of outbound investments in China in the interim. Potentially affected investors may find it worthwhile to follow (and potentially influence through comments) the regulatory process. As well, US allies including the EU and UK have stated that they are each considering their own outbound screening regimes, which may further chill investment in Chinese companies involved in semiconductors, quantum information systems and artificial intelligence.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Greta L. Nightingale, an O’Melveny partner licensed to practice law in the District of Columbia, David J. Ribner, an O’Melveny counsel licensed to practice law in the District of Columbia and New York, and Damilola G. Arowolaju, an O’Melveny associate licensed to practice law in the District of Columbia, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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