On May 21, 2020, the U.S. Department of the Treasury released a proposed rule in the Federal Register related to the regulations of the Committee on Foreign Investment in the United States (CFIUS) which implement Section 721 of the Defense Production Act of 1950, as amended by the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA). The proposed rule would modify the criteria for requiring a mandatory declaration to be filed with CFIUS, which is applicable to U.S. businesses that produce, design, test, manufacture, fabricate, or develop a critical technology, critical infrastructure, or critical data (TID U.S. Businesses) and that are parties to certain foreign investment transactions. The regulations initially implemented under FIRRMA currently require TID U.S. Businesses to file a mandatory declaration with CFIUS if the U.S. business "produces, designs, tests, manufactures, fabricates, or develops a critical technology utilized in connection with the U.S. business' activity in, or designed by the U.S. business for use in" one or more of 27 industries identified by their North American Industry Classification System code (NAICS code).
The proposed rule would remove the NAICS code criteria altogether. Instead, a mandatory declaration would be required for foreign investment transactions involving a TID U.S. Business that produces, designs, tests, manufactures, fabricates, or develops one or more critical technologies for which a "U.S. regulatory authorization" would be required to export, re-export, transfer (in country), or retransfer the critical technology or technologies to a foreign person that is a party to the foreign investment transaction. The mandatory declaration requirement would apply only if the foreign person meets at least one of certain criteria established by the proposed rule, including if the foreign person:
- Could directly control the TID U.S. Business as a result of the transaction;
- Is directly acquiring an interest that is a covered investment in the TID U.S. Business;
- Has a direct investment in the TID U.S. Business, the rights of the foreign person with respect to the TID U.S. Business are changing, and the change in rights could result in a covered control transaction or covered investment;
- Is a party to an agreement or arrangement with respect to the TID U.S. Business that is designed to circumvent Section 721 of the Defense Production Act; or
- Individually holds or is part of a group of foreign persons that, in the aggregate, holds a "voting interest for purposes of critical technology mandatory declarations."
A "U.S. regulatory authorization" that would trigger the declaration requirement includes licenses granted by the State Department under the International Traffic in Arms Regulations (ITAR); licenses granted by the Commerce Department under the Export Administration Regulations (EAR); authorizations from the Energy Department granted pursuant to regulations on assistance to foreign atomic energy activities; and licenses issued by the Nuclear Regulatory Commission (NRC) for exporting or importing nuclear equipment. The proposed rule also would create exceptions to the mandatory declaration requirement for transactions involving certain types of encryption technology.
The proposed rule would define a "voting interest for purposes of critical technology mandatory declarations" as a right belonging to a foreign person with a direct or indirect voting interest of 25 percent or more. For the purpose of determining this voting interest, the proposed rule states that "any interest of a parent will be deemed to be a 100 percent interest in any entity of which it is a parent." The proposed rule would also instruct that "foreign persons who are related, have formal or informal arrangements to act in concert, or are agencies or instrumentalities of, or controlled by, the national or subnational governments of a single foreign state are considered part of a group of foreign persons and their individual holdings are aggregated."
The rule also proposes a change to the declaration requirement under FIRRMA for certain covered transactions where a foreign government has a substantial interest in a foreign person that will acquire a substantial interest in certain types of U.S. businesses. The proposed rule would modify the definition of "substantial interest" to narrow its scope for certain types of entities and to clarify how an interest, whether it is a voting or other type of interest, is calculated.
In addition to the release of this proposed rule, the May 27, 2020 statement by U.S. Secretary of State Mike Pompeo that the Hong Kong Special Administration Region (HKSAR or Hong Kong) does not continue to warrant treatment under U.S. law as was applied to Hong Kong before July 1997 has potential implications for CFIUS-related considerations, including the mandatory disclosure requirement. The statement stemmed from the Secretary's obligation under the Hong Kong Human Rights and Democracy Act of 2019 to provide an annual determination as to whether the United States should continue to treat Hong Kong as autonomous from the People's Republic of China (China) for various trade and national security regulations. It will be critical to follow whether or how the White House alters Hong Kong's trading or diplomatic status. One possibility is that a change in status could impose more restrictions on foreign investment from Hong Kong if, for example, the United States were to treat Hong Kong and China similarly for export controls or national security purposes.
The Treasury Department is accepting comments on the proposed rule until June 22, 2020, and we are available to submit or monitor comments. Moreover, please contact Venable's International Trade Group to discuss the potential changes in Hong Kong's status and for guidance as to how it may affect your business.