Narrow scope: The program contemplated by the Order and the ANPRM is not the sweeping “reverse CFIUS” that some policymakers have sought and many in industry have feared. The program is not a screening mechanism and is not retroactive. The Order focuses on technologies that are critical to China’s military, intelligence, and surveillance capabilities. Further, the Order does not capture many forms of purely passive investment, ordinary course commercial transactions, and intra-company transfers from U.S. parents to their Chinese subsidiaries. Investments are either subject to a prohibition or notification, with notification being only informational.

Numerous types of investors affected: Investors most likely to feel effects of the Order are U.S. venture capital firms, private equity firms, venture capital arms of strategic companies, and strategic companies contemplating a joint venture in China. However, it also applies to any U.S. person, and so will impact U.S. citizens and permanent residents that have material roles in many non-U.S. investor firms.

Deep impact on investments in semiconductors and quantum: The semiconductor and quantum/supercomputing sectors will feel the greatest impact from the Order. In particular, the Order amounts to a near shutdown of U.S. investment in Chinese firms creating semiconductor design software and manufacturing equipment, as well as Chinese firms fabricating and packaging advanced semiconductors. U.S. investments in other Chinese IC design, fabrication, and packaging entities will be notifiable, which is also likely to chill investment. Similarly, quantum and supercomputer investments are also now nearly entirely prohibited.

Less impact on investments in AI: Perhaps most surprisingly, the Order may have only limited impact in the artificial intelligence space. Here the prohibition is focused on military, intelligence, and mass-surveillance end uses. Treasury is considering whether covered AI technologies would need to be used “exclusively” or “primarily” for such sensitive purposes; the latter would likely have some degree of chilling effect on some commercial applications as well. Even the areas where notification is proposed are relatively limited.

Story still developing in the United States and elsewhere: As the Treasury will publish draft regulations which will be subject to public comment, the rules likely would not take effect before early next year, possibly well into the year. During that time, some contemplated elements could fall away, and additional limitations could be added. The narrow nature of the program is likely intended in part to increase the chances of broader international adoption of parallel restrictions. This is on the G7 agenda, and the EU has also confirmed that it is examining outbound investment controls.

Over the years, concern has been growing in the United States that both private investments by U.S. investors in China and the rendering of certain services to Chinese companies is enabling China to advance its capabilities in a way that would undermine U.S. national and economic security interests. This issue remained unaddressed following enactment of the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA). Focus initially was on using export controls and sanctions to begin to address this risk, and the Biden Administration issued new export controls on certain semiconductors and related manufacturing equipment in October 2022 and October 2023. Nevertheless, government stakeholders also agreed that more effort was necessary to directly address outbound investment.

A bill introduced in Congress in 2021 would have established a true “reverse CFIUS” screening mechanism covering investment in a broad range of technologies and activities in China. Though it may have addressed all the top issues – technology transfer, supply integrity, and U.S. domestic critical capability concerns – the legislation met opposition within Congress, the Biden Administration and the private sector, stalling its progress. More recently, the Senate passed a broader bill that contemplates only notification, not prohibition, of certain outbound investments. Neither of these bills has been enacted.

The Biden Administration publicly previewed an EO regarding narrowly-scoped restrictions on U.S. investments in China for over a year. Throughout a lengthy process, the Administration described the forthcoming order as narrowly tailored to protect emerging and foundational technologies critical to U.S. national security, using what Administration officials call a “small yard and high fence” approach. The Order indeed is far narrower than other recent proposals. Although many in Washington and beyond are relieved at the tailored approach, others are disappointed that the Order and regulations do not go far enough, and the issue will likely remain a potential subject of legislation.

The Order itself speaks in broad terms about how to deal with the threat presented by the advancement of countries of concern (i.e., China) in certain technological areas, but the program envisioned is relatively narrow. It specifies that transactions involving any “covered national security technologies or products” are subject to notification or prohibition when “critical for the military, intelligence, surveillance, or cyber-enabled capabilities of a country of concern.” The Order delegates to Treasury the decision of which transaction types should be prohibited.

Under the Order, going forward, outbound transactions can be categorized as one of three types:

1. Prohibited transactions: These are “covered transactions” that will be prohibited on the basis of the target company involvement in specified covered technologies. The Order does not provide for any generally applicable licensing or mitigation authority to allow these transactions to proceed.
2. Notifiable transactions:
   • These are covered transactions where the target company is involved in certain other covered technologies.
   • There is no case-by-case review for these transactions; assuming the investor has correctly categorized the transaction as notifiable rather than prohibited, Treasury would have no authority to take any action or mitigate any risk with respect to the transaction. 
3. All other transactions: If a transaction does not involve “covered national security technologies” or does not involve China or is not performed by a U.S. person or with a covered foreign person, there is no notification requirement and no prohibition.

The Order also specifies that the only “country of concern” is China (including Hong Kong and Macau), though this is subject to change by future executive order.

Our blog on the Order and ANPRM explores Treasury’s ANPRM in detail. Below are some of the key provisions of the ANPRM, which previews how Treasury plans to put the Order into practice:

1. Transaction forms: The ANPRM’s definition of “covered transaction” captures a range of transactions similar to those covered by the U.S. government’s inbound investment body, the Committee on Foreign Investment in the United States (CFIUS), except that greenfield investments would be covered.
   Notable exceptions to the coverage definition include: (i) purchases of publicly traded securities and publicly traded funds; (ii) intra-company transfers; (iii) acquisitions of a covered foreign person’s entire interest in an entity or assets outside China; and (iv) acquisitions of purely passive and de minimis LP interests in a private equity or venture capital fund.
2. Covered foreign persons include any entity organized or with principal place of business in a country of concern, an entity whose equity securities are principally traded in a country of concern, and any entity (regardless of location) more than 50 percent owned by either of the foregoing.
   Though there is some ambiguous language in the ANPRM, this definition would not appear to apply to a non-Chinese company with a Chinese subsidiary or office, unless its Chinese operations account for a majority of consolidated revenue, net income, capital expenditures or operating expenses.
3. Definitions of covered national security technologies are elaborated in the ANPRM table below this list. 
4. U.S. persons include U.S. citizens, legal permanent residents, and entities organized in the United States, as well as their foreign branches. A U.S. company would also be responsible for notifying transaction of its more than 50 percent foreign subsidiaries if they would have been notifiable if undertaken by a U.S. person. It would also be responsible for taking steps to prevent such subsidiaries for engaging in any transaction that would be prohibited if undertaken by a U.S. person.

Though official draft rules have not been published and a final rule will not be in place until next year, companies should take care to understand any impact of the Order on their business today.

• Companies should size up any investments that may not be closed until 2024 against the potential rules. The ANPRM is ambiguous as to whether a transaction that has been signed but not closed before the effective date of the regulations would be prohibited.
• Transactions completed as of August 9, 2023, could be subject in the future to a notification requirement, even if not prohibited. Therefore, investors should consider now whether future government scrutiny of current transactions would affect their interest in the transaction.
• Companies making investments now that may involve follow-on investments in the future should evaluate the potential for the rules to apply to those follow-on investments. If follow-on investments and capital calls can be declined without penalty, the investor may be obligated not to make the follow-on investment.
• U.S. investors in non-U.S. funds should consider whether they should include language that allows them to be excused from future fund investments in China that could conflict with the prohibitions under the rules. The ANPRM does not specify the de minimis threshold above which an investment as an LP would no longer be viewed as an exempt investment.