Questions About the U.S. Executive Order on Outbound Foreign Investment? We Have (Some) Answers
President Biden has signed the long-expected “reverse CFIUS” executive order that will restrict outbound foreign investment into certain Chinese technology companies. The Executive Order on Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern (the Order or EO) was signed August 9, and outlines a new outbound foreign investment regime. The new regime will require notification for some transactions (notifiable transactions) while prohibiting others (prohibited transactions). Notably, the regime can affect transactions where neither party is based in the United States.
Actively considered by policymakers over the last few years, the EO has been influenced by both congressional action and ongoing deliberations within the Executive Branch. The issuance of the Order follows the Senate’s passage in July of the Outbound Investment Transparency Act as part of the National Defense Authorization Act of 2023 (NDAA). Like the Order, the Senate bill (which is not yet law) would also require U.S. investors to notify the Department of the Treasury of certain investments in “countries of concern,” but the Senate bill would cover a wider range of technologies. The release of the EO was delayed from an earlier anticipated announcement at the May G7 Leaders’ Summit in Hiroshima.
The new regime will be implemented through Treasury Department regulations, formulated in consultation with other agencies, most of which are already part of the Committee on Foreign Investment in the United States (CFIUS). The proposed rules will be subject to public notice and comment before they are implemented. In line with our prior blog post identifying questions around the regime, we have provided a summary of the key areas of interest, the specifics of which will be determined by the pending regulations.
What investments are covered?
On the investment side, the EO targets investments in certain sensitive technologies in China, with an emphasis on three categories: 1) semiconductors and microelectronics, 2) quantum information technology, and 3) artificial intelligence.
First, investments must involve “covered foreign persons” to be notifiable or prohibited. “Covered foreign person” means “a person of a country of concern who or that is engaged in activities, as identified in the regulations issued under this order, involving one or more covered national security technologies and products.” In a demonstration of the political focus on China, “country of concern” is defined to be China and its special administrative regions of Hong Kong and Macau. This is unlike the Senate’s provision in the NDAA, or last year’s CHIPS and Science Act and Inflation Reduction Act, which use a broader definition of “countries of concern” to place restrictions on parties from North Korea, Russia, and Iran.
Second, investments must involve “covered national security technologies and products”. Such technologies and products include “sensitive technologies and products in the semiconductors and microelectronics, quantum information technologies, and artificial intelligence sectors that are critical for the military, intelligence, surveillance, or cyber-enabled capabilities of a country of concern, as determined by the Secretary in consultation with the Secretary of Commerce and, as appropriate, the heads of other relevant agencies.” Specific examples of technologies under consideration include electronic design automation, semiconductor manufacturing equipment, advanced integrated circuits, supercomputers, quantum sensors, quantum networking, and quantum communications systems.
Whether a deal is a notifiable or prohibited transaction will depend on the pending regulations. Specifically, notifiable transactions will be those involving technologies that “may contribute to the threat to the national security of the United States identified in this order.” Prohibited transactions will involve technologies that “pose a particularly acute national security threat because of their potential to significantly advance the military, intelligence, surveillance, or cyber-enabled capabilities of countries of concern.”
The Treasury Department has indicated that it is considering whether indirect transactions should be within the scope of the regime to close a potentially large loophole. Our concern with including indirect transactions is the potential for collateral damage, particularly to companies in allied countries, if the rule is not tailored carefully.
Which investors are covered?
On the investor side, the Order indicates that nominally, the regime will apply to United States persons, defined as “any United States citizen, lawful permanent resident, entity organized under the laws of the United States or any jurisdiction within the United States, including any foreign branches of any such entity, and any person in the United States.”
That does not mean, however, that a U.S. person can sidestep the rules by working through an offshore intermediary. Under Section 8(d) of the Order, U.S. entities may be obliged to notify transactions by their controlled entities and take other steps to prevent prohibited transactions. Furthermore, the prohibition may affect non-U.S.-controlled entities that employ United States persons to make investments. Section 8(c) of the EO states that Treasury “may prohibit United States persons from knowingly directing transactions if such transactions would be prohibited transactions pursuant to this order if engaged in by a United States person.” This provision suggests that the regulations may ultimately include “facilitation” provisions often found in U.S. sanctions regulations, which prohibit United States persons from facilitating transactions by foreign persons when they would be prohibited if performed by a United States person. Violations of the new rules will come with both civil and criminal penalties.
Will there be any exceptions?
This is still being evaluated. In its fact sheet on the new regime, Treasury states that it is considering exceptions for certain types of passive and other investments that may pose a lower likelihood of conveying intangible benefits or in an effort to minimize unintended consequences. Treasury listed the following as possible examples:
- publicly traded securities;
- index funds;
- mutual funds;
- exchange-traded funds;
- certain investments made as a limited partner;
- committed but uncalled capital investments; and
- intracompany transfers of funds from a U.S. parent company to its subsidiary.
When will the regime take effect?
Probably not for a while. The Order does not set a deadline for the issuance of implementing regulations, but historically, regulatory processes take time, especially when coordination is required among multiple agencies.
CFIUS’s recent experience may prove illustrative. When Congress passed a law in August 2018 to augment CFIUS’s authority to review inbound foreign investments, Congress gave CFIUS 18 months to put implementing regulations into effect. Though CFIUS needed only 2 months to issue interim rules for its critical technology pilot program, it took until September 2019 for CFIUS to issue proposed rules for public comment. After a 30-day public comment period, CFIUS issued final rules in early 2020, and those rules took effect 30 days later, in February 2020.
In other words, it took CFIUS - a long-established interagency committee with a base of existing regulations it could use as a foundation - the entire 18 months allotted by law to put new implementing regulations into effect. In the case of the Order, the new Treasury-led interagency committee first needs to be staffed, and only then can the rulemaking process begin - this time from the ground up. Without a required deadline, the process is likely to take some time, despite the scope of the EO being far narrower than CFIUS’s mandate.
It is helpful that the rulemaking process is being led by Treasury’s Office of Investment Security, which manages CFIUS and has prior interagency regulatory experience. In fact, Treasury has jumpstarted the process by issuing an Advance Notice of Proposed Rulemaking asking for public inputs as to the types of investors, technologies, and transactions that will be within the scope of both notifiable and prohibited transactions. This initial public comment period will last 45 days (until September 28). Sometime later, Treasury will issue draft rules, submit them to the public for comment, reflect on the comments, and then issue final rules. Ultimately, we would be surprised if the new regime were to take effect before the fourth quarter of 2024.
How will the process work? Will it be more akin to CFIUS, export licenses, or sanctions regimes?
A lot of this will be determined by the pending regulations. However, the fact that the EO contemplates entirely prohibited categories of transactions suggests that there may be some similarities to U.S. sanctions regulations, rather than a transaction-specific interagency review process like that of CFIUS.
In addition, it does not appear that notifiable transactions will do much more than provide information to the government. However, this may be a prelude to more significant regulation down the line; notified transactions may inform Treasury’s decision as to whether to expand the scope of prohibited transactions under this regime, and a required annual report to the President may recommend the establishment or expansion of other regulatory programs. As the Order does not give clear guidance as to the confidentiality of the regime, it is theoretically possible (though unlikely) that Treasury could publish information from the notifications in an effort to “name and shame” parties involved in permitted, but still sensitive investments.
What is the policy impetus for this regime?
The outbound investment regime is intended to address gaps in U.S. trade and national security regulations that are not accounted for by CFIUS or the U.S. export controls regime. Greater attention to U.S. investment in dual-use technologies in China, particularly by private equity and venture capital funds, as well as concerns related to U.S.-China competition in these areas have burgeoned on a bipartisan basis in Washington. Washington is also working with other countries to ensure that the rules are implemented on a multilateral basis, with similar mechanisms under consideration among G7 countries. As we have previously noted, the European Union is only beginning what looks like a long path toward establishing its own potential process for handling outbound investments.
