The United States is trudging forward on its own long march toward a cold war with China. In the near term, there is little doubt that this path creates complications for U.S. companies involved with business in China. The question is how to position your business to adapt to these changes, given the economic and political headwinds. And COVID-19 is not helping.
COVID-19 and its stunning impact of death and economic hardship dominates the front pages of U.S. papers. But buried inside a recent Sunday edition of the Washington Post was an article quoting China's foreign minister, Wang Yi, saying that President Trump and Secretary of State Mike Pompeo, "are taking China-U.S. relations hostage and pushing our two countries to the brink of a new Cold War."1 This "pushing" (or "pushing back," as the U.S. would have it) has major implications for U.S. businesses, trade, and supply chain management—not just with China, but also in other parts of the world.
The already complicated relationship between the U.S. and China has become particularly prickly recently, given any number of Trump-era U.S. initiatives. Here are some examples:
- Trade War. In March 2018, the Office of the U.S. Trade Representative (USTR) issued a report finding that China actively seeks to acquire U.S. technologies through unreasonable or discriminatory practices.2 The resulting Section 301 investigation led to the imposition of additional duties on roughly all U.S.-China trade, valued at $550 billion. This has prompted many businesses to move manufacturing out of China, at least for items destined for the U.S.
- Restricting Chinese Investment in the U.S. In August 2018, the president signed the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA).3 FIRRMA broadened the authority of the Committee on Foreign Investment in the United States (CFIUS). Part of the U.S. Department of the Treasury, CFIUS reviews and takes action to address national security concerns arising from "covered transactions," which includes noncontrolling investments and real estate transactions involving foreign persons. Shortly thereafter, CFIUS forced Chinese investors to divest from two companies: PatientsLikeMe (a healthcare startup) and Grindr (the LGBTQ dating app).4 It is no wonder that industry is abuzz over the expanded CFIUS jurisdiction regarding critical technologies, which may seriously impact Chinese investment in U.S. tech firms.5
- Restricting Chinese Company Huawei's Operations in the U.S. In May 2019, the Bureau of Industry and Security (BIS) of the U.S. Department of Commerce implemented measures against Huawei, a major Chinese technology company, after determining that Huawei was reasonably believed to be involved, or to pose a significant risk of being or becoming involved, in activities contrary to the national security or foreign policy interests of the U.S.6 In January 2019, the U.S. charged Huawei and its CFO, Wanzhou Meng (the daughter of Huawei's founder), with financial fraud—and in February 2020, among other things, followed up with charges of racketeering and conspiracy to steal trade secrets.7
- Expanded Export Controls. In April 2020, BIS published three notices in the Federal Register.8 BIS administers the U.S. Export Administration Regulations (EAR), which govern the export,9 reexport,10 and transfer (in country)11 of most commercial and some military items (known as "dual-use" items). The Notices are aimed at China, and expand end user rules to China, a move that will have a large impact on the semiconductor industry and equipment manufacturers. BIS followed the Notices recently with a new interim final rule that implements an export license requirement for manufacturers of wafers that is reportedly targeted at Huawei's HiSilicon.12 This is expected to result in additional license requirements for U.S. suppliers of Chinese foundries providing integrated circuits to the Chinese People's Liberation Army (PLA). And on Friday, May 22, BIS announced that it will add some two dozen Chinese companies with military ties to the Entity List, restricting their ability to conduct business with the U.S.13
- FCC. In April 2020, citing national security concerns, the Federal Communications Commission (FCC or Commission) issued Orders to Show Cause14 against four Chinese companies that are indirectly owned and controlled by the Chinese government. The Orders directed each company to show cause why the Commission should not revoke its domestic and international authorizations15 that allow each company to operate in the U.S. If the licenses are revoked in whole or part, doing business with China-based businesses will become much more complicated. At worst, an FCC decision could cut off internet use between the U.S. and much of China. The companies' responses are due June 1 (China Unicom, Pacific Networks, and ComNet) and June 8 (China Telecom).
- Hong Kong. In May 2020, Secretary of State Pompeo informed Congress that, "[n]o reasonable person can assert today that Hong Kong maintains a high degree of autonomy from China."16 He stated, "[a]fter careful study of developments over the reporting period, I certified to Congress today that Hong Kong does not continue to warrant treatment under United States laws in the same manner as U.S. laws were applied to Hong Kong before July 1997."17 If President Trump determines that Hong Kong is not sufficiently autonomous such that it justifies treatment different from that of China, he may issue an executive order suspending any different treatment of Hong Kong. This has wide implications, from export controls and visas to trade.
- Attack on the WHO. In April and May, 2020, the president repeatedly attacked the World Health Organization as a proxy for China, while accusing China of "unleashing" the "Wuhan Virus" and hoarding personal protective equipment. This resulted, in late May, in the president announcing that the U.S. is withdrawing from the WHO.
- Delisting Chinese Companies from the NYSE. A bill passed by the Senate and now before the House could force Chinese companies to give up U.S. stock exchange listings unless their audits are inspected by U.S. regulators.18
A number of broad implications flow from these—and other—recent U.S. policy decisions concerning China:
- Pressure on Chinese Supply Chains. Manufacturing in China as a U.S. company will become more complex and expensive because of U.S. regulations and tariffs, regardless of what China does. This trend will continue if, as seems likely, the U.S. administration proceeds along its current path.
- Pressure on U.S. High Tech. U.S. technology-based businesses engaged in China will be subject to increased pressures from both China, which will continue to view U.S. companies as conduits to U.S.-based intelligence (economic and national security), and the U.S., which sees Chinese operations of U.S. companies as doors for China spying.
- Pressure on Hong Kong. U.S. financial companies using Hong Kong as a platform for operations in China and the Pacific rim will encounter increased costs as China's laws take over from Hong Kong's, the U.S. levies additional restrictions on trade with China, and, potentially, currency and exchange, visa, and other restrictions are imposed. (The impact of China's and the U.S.' decisions concerning Hong Kong will be raised at a U.S. Senate Banking Committee hearing on June 4, 2020.)
- Pressure on Foreign Investment in the U.S. U.S. restrictions on foreign investment in the U.S. impact not just China but all foreign investors, placing an additional "entry tax" on investing in real estate, tech companies, and national security businesses in the U.S.—that is, anything that may constitute a "covered investment."
- Pressure on U.S. Partners. With the exception of the U.S. withdrawal from the WHO, there are examples of other countries, for better or worse, following the U.S. lead regarding increased investment controls. For example, in the area of foreign investment, the UK, Italy, and a number of other European countries are imposing new foreign ownership restrictions on their domestic companies. Left unchecked, these restrictions have the potential to lead to economic balkanization and higher investment, manufacturing, and consumer costs.
- Pressure to Seek Stability. There are also two tangential results worth considering that follow from the ratcheting up of Sino-U.S. tensions—issues laid bare in large part by the pandemic. The first is a drive to reduce reliance on foreign suppliers for critical inputs to essential goods, including pharmaceutical products. As China is currently a major foreign supplier, U.S. businesses are seeking other sources less likely to be threatened by a change in U.S. policy. The second is a move by U.S. businesses to locate new supplies of critical raw materials that are either in the U.S. or free from Chinese or Russian control.
Chairman Mao once quipped, "In waking a tiger, use a long stick." Without doubt, recent U.S. pokes at China—as acknowledged by Chinese foreign minister Wang Yi—are being felt. The question is whether the U.S. stick is long enough. As U.S. businesses pivot to deal with the pressures imposed by COVID-19, they would be well served to consider the implications of the current relationship between the U.S. and China and reach out to our team with any questions regarding these recent actions and the impact they may have on your business.
1 Anna Fifield, "Chinese foreign minister warns U.S. against taking the countries 'to the brink of a new Cold War," Washington Post (May 24, 2020), available at https://www.washingtonpost.com/world/asia_pacific/china-tells-us-to-stop-taking-them-to-the-brink-of-a-new-cold-war/2020/05/24/4eda6ffc-9da9-11ea-9d96-c3f7c755fd6e_story.html.
2 See, e.g., Findings of the Investigation into China's Acts, Policies, and Practices Related to Technology Transfer, Intellectual Property, and Innovation Under Section 301 of the Trade Act of 1974 (March 22, 2018) at 17. ("A key part of China's technology drive involves the acquisition of foreign technologies through acts, policies, and practices by the Chinese government that are unreasonable or discriminatory and burden or restrict U.S. commerce. These acts, policies, and practices work collectively as part of a multi-faceted strategy to advance China's industrial policy objectives. They are applied across a broad range of sectors, overlap in their use of policy tools (e.g., the issuance of planning documents and guidance catalogues), and are implemented through a diverse set of state and state-backed actors, including state-owned enterprises.")
3 FIRRMA amends section 721 of the Defense Production Act of 1950, as amended (DPA), which provides the authority for CFIUS.
4 Jeff Farrah, Another Day, another US company forced to divest of Chinese investors: CFIUS continues to exercise its power over tech companies, TechCrunch.com (April 15, 2019), available at https://techcrunch.com/2019/04/15/another-day-another-u-s-company-forced-to-divest-of-chinese-investors/).
5 See, e.g., https://fortune.com/2020/01/20/cfius-rules-regulations-china-investment/. See also Provisions Pertaining to Certain Investments in the United States by Foreign Persons, 85 Fed. Reg. 30893 (May 21, 2020) (CFIUS proposed new rule for foreign transactions involving critical technologies focused on export control test).
6 On May 16, 2019, BIS amended the Export Administration Regulations (EAR) by adding Huawei Technologies Co. Ltd. and certain non-U.S. affiliates of Huawei (collectively, Huawei) to the Entity List (Supplement No. 4 to Part 744). The Entity List identifies entities and other persons reasonably believed to be involved, or to pose a significant risk of being or becoming involved, in activities contrary to the national security or foreign policy interests of the United States. 84 Fed. Reg. 22961 (May 21, 2019). On May 20, 2019, BIS provided a temporary general license (TGL) that partially restored the EAR privileges of Huawei. 84 Fed. Reg. 23468 (May 22, 2019). The TGL has been extended since that time, most recently on May 18, 2020. See Temporary General License: Extension of Validity, 85 Fed. Reg. 29610 (May 18, 2020) (extending the TGL through August 13, 2020).
7 Chinese Telecommunications Conglomerate Huawei and Huawei CFO Wanzhou Meng Charged with Financial Fraud, U.S. Department of Justice Press Release (January 28, 2019), available at https://www.justice.gov/opa/pr/chinese-telecommunications-conglomerate-huawei-and-huawei-cfo-wanzhou-meng-charged-financial (13-count indictment, which is available at https://www.justice.gov/opa/press-release/file/1125021/download); see also Chinese Telecommunications Conglomerate Huawei and Subsidiaries Charged in Racketeering Conspiracy and Conspiracy to Steal Trade Secrets, U.S. Department of Justice Press Release (February 13, 2020), available at https://www.justice.gov/opa/pr/chinese-telecommunications-conglomerate-huawei-and-subsidiaries-charged-racketeering.
8 Expansion of Export, Reexport, and Transfer (in-Country) Controls for Military End Use or Military End Users in the People's Republic of China, Russia, or Venezuela, 85 Fed. Reg. 23459 (April 28, 2020) ("Expansion of License Requirements"); Elimination of License Exception Civil End Users (CIV), 85 Fed. Reg. 23470 (April 28, 2020) ("Removing License Exception CIV"); and Modification of License Exception Additional Permissive Reexports (APR), 85 Fed. Reg. 23496 (April 28, 2020) ("Modify License Exception APR") (collectively, the "Notices").
9 15 C.F.R. § 734.13 (listing activities defining an export, e.g., an actual shipment or transmission out of the United States, including the sending or taking of an item out of the United States, in any manner, or a deemed export of "technology" or source code to a foreign person). See also 15 C.F.R. §§ 734.17 or 734.18 (regarding export of encryption source code and object code and listing activities that are not exports, respectively).
10 15 C.F.R. § 734.14(b). A reexport is the shipment or transmission of an item subject to the EAR from one foreign country (i.e., a country other than the United States) to another foreign country. A reexport also occurs when there is release of technology or software (source code) subject to the EAR in one foreign country to a national of another foreign country. See also 15 C.F.R. § 734.20 (listing activities that are not deemed reexports).
11 15 C.F.R. § 734.16. In-country transfer or transfer (in-country) is a shipment, transmission, or release of items subject to the EAR from one person to another person that occurs outside the United States within a single foreign country. See also 15 15 C.F.R. § 734.18(a)(3) (listing activity that is not deemed a transfer, i.e., transmitting or otherwise making a transfer (in country) within the same foreign country of "technology" or "software" between or among only persons who are not "foreign persons," as long as the transmission or transfer does not result in a release to a foreign person or to a person prohibited from receiving the "technology" or "software").
12 Export Administration Regulations: Amendments to General Prohibition Three (Foreign-Produced Direct Product Rule) and the Entity List, 85 Fed. Reg. 29849 (May 19, 2020). See also Commerce Addresses Huawei's Efforts to Undermine Entity List, Restricts Products Designed and Produced with U.S. Technologies, U.S. Department of Commerce Press Release (May 15, 2020), available at https://www.commerce.gov/news/press-releases/2020/05/commerce-addresses-huaweis-efforts-undermine-entity-list-restricts.
13 Commerce Department to Add Two Dozen Chinese Companies with Ties to WMD and Military Activities to the Entity List, U.S. Department of Commerce Press Release (May 22, 2020), available at https://www.commerce.gov/news/press-releases/2020/05/commerce-department-add-two-dozen-chinese-companies-ties-wmd-and.
14 FCC Scrutinizes Four Chinese Government-Controlled Telecom Entities, Federal Communications Commission Press Release (April 24, 2020), available at https://www.fcc.gov/document/fcc-scrutinizes-four-chinese-government-controlled-telecom-entities.
15 See, e.g., FCC Scrutinizes Four Chinese Government-Controlled Entities Providing Telecommunications Services in the U.S., FCC News from the Federal Communications Commission Press Release (April 24, 2020), available at https://docs.fcc.gov/public/attachments/DOC-363976A1.pdf (raising national security concerns over the Chinese ownership of the companies, stating that the Orders reflected a "deep concern" about their "vulnerability to the exploitation, influence, and control" of the Chinese Government). See also In the Matter of China Mobile International (USA) Inc., Memorandum Opinion and Order of the Federal Communications Commission (adopted May 9, 2019) (the Orders highlight the Commission's 2019 rejection—on national security grounds—of China Mobile USA's application to provide international telecommunications services as a basis for the current Orders to Show Cause).
16 Michael R. Pompeo, U.S. Secretary of State, PRC National People's Congress Proposal on Hong Kong National Security Legislation, U.S. Department of State Press Statement (May 27, 2020).
18 Dave Michaels and Akane Otani, U.S. Moves to Audit Chinese Firms. Market Frets over What Comes Next, Wall Street Journal (May 26, 2020), available at https://www.wsj.com/articles/u-s-moves-to-audit-chinese-firms-market-frets-over-what-comes-next-11590485401.