Letters from Cathay, No. 100
Matthew S. McKay MA MCIL AITI
I translate Chinese, French & (Swiss) German into English | ???? Arts & Humanities | ???? International Cooperation
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Trump’s Election Victory: What Impact Will the US ‘Outbound Order’ Have on China?
Original article published on November 6, 2024. Translated by Matthew McKay and published to LinkedIn Pulse on November 18, 2024.
By the Internet Law Review
On Oct. 28, 2024, the U.S. Department of the Treasury issued a “Final Rule ” restricting U.S. investment in “countries of concern” in areas such as artificial intelligence, semiconductors and microelectronics, and quantum computing that may threaten national security. This completes the implementation of the China-focused foreign investment plan proposed by outgoing President Biden in Executive Order No. 14105 (hereinafter referred to as the “Outbound Order ”) on Aug. 9, 2023. The rule will take effect on Jan. 2, 2025.
While China is not the only country to which this investment review mechanism applies, it is the first and currently the only country to be listed as a country of concern in the executive order. The Outbound Order is also unprecedented on the part of the U.S. government, in that it restricts personnel, products, and capital at the same time.
This may not have taken China’s government and industry entirely by surprise, because the U.S. government has been communicating with its allies via diplomatic channels and rehearsing just such an operation for quite some time. In contrast, on Nov. 1, 2024, the Chinese government significantly relaxed the requirements for foreign institutions and companies to invest in Chinese-listed companies as strategic investors, including the range of foreign entities that can make strategic investments, the methods of investment, and asset requirements. This regulation will be implemented on Dec. 2, 2024.
However, at time of writing, Trump has just won the election, so: Will the U.S. ban on investments in key technologies like Chinese AI continue to be enforced and effective? Will U.S. allies be able to follow in the new administration’s footsteps while still fulfilling their commitments to the Biden administration? Below, the Internet Law Review provides a preliminary analysis of this policy.
Completion of the Biden administration’s strategy transformation towards China
For decades, U.S. policy towards China has largely been one of achieving greater development through trade. Going by the logic of comparative advantage, developing countries absorbing investments from industrialized countries and developing their economies and technologies is a good thing for the U.S., in terms of both ideology and economic benefits. This is why the U.S. government is happy for the development and production of technologies now considered “vital to national security” (such as semiconductors) to be transferred to China—and American companies have indeed long benefitted from investing and selling in China, the world’s largest market.
But differences and conflicts have arisen between the U.S.’ economic and national security agencies, starting with the ban on supplying chips and software to Huawei. Over a long period of time and after numerous discussions on policy towards China, a dynamic consensus has gradually emerged: Although some investment in China is inevitable and even beneficial, the government should still err on the side of caution and take security considerations into account.
Where the Trump administration adopted a “whack-a-mole” approach to China due to its internal rifts, the Biden administration’s national security team has been more conscious and strategic about participating in and promoting consensus on its industrial policy—that the U.S. should not only compete with China but also curb its growth—and has brought about a strategic shift in its China policy in a more logical manner.
First, it rekindled partnerships between the U.S. and its allies, aiming to build a market-oriented digital economic alliance, and guiding other countries to make policy decisions that align with the U.S. through the use of ideological and economic interests.
Second, to eliminate its dependence on Chinese companies, it passed a series of new industrial policies, of which the CHIPS and Science Act and the Inflation Reduction Act are the main representatives.
Third, it cracked down on China’s technological development using the “small courtyard, high wall” approach. In theory, in concept and in policy, U.S. export controls on high-end chips represent a radical transformation of its China strategy—and they are only the beginning. We can see that this crackdown policy has gradually opened up new areas and battlefields: Data, software and network devices, but also strategies to curb financial support for China that have been percolating since 2022.
The policy logic of restricting AI investment in China
Under the general trend of expanding national security regulations mentioned above, U.S. lawmakers are increasingly concerned about the potential impact investing in China could have on their economy and national security, and proposals to establish a foreign investment review mechanism are receiving growing bipartisan support. The 118th Congress is considering legislation to strengthen foreign investment review agencies and restrict some U.S. investments in “countries of concern” such as China. These ongoing legislative proposals include:
However, during [the U.S. Congress’] so-called “China Week” last month, the House of Representatives did not pass any relevant bills, which shows that the legislative process still faces many doubts and obstacles, even if some lawmakers in both parties support the new measures. With the legislative agenda on hold, the U.S. Treasury has taken the lead in introducing specific regulatory measures to implement the Outbound Order:
1) Policy goals: Containing China’s independent innovation
The biggest similarity between the U.S. foreign investment mechanism and its rules on chips is that they both share the same goal, namely that the U.S. should not help China to innovate independently. But as a measure to supplement the U.S.’ existing export controls and inbound investment screening tools, the mechanism for restricting outbound investment must face a question of necessity: Can U.S. concerns about its supply chain dominance be addressed through existing structures?
As Inu Manak of the Council on Foreign Relations has said , “The United States has a robust export control regime, and it is not clear that an outbound investment screening mechanism would capture any additional national security concerns that the export control regime cannot address.”
In 2023, the Center for Security and Emerging Technology (CSET) at Georgetown University’s Walsh School of Foreign Service also released a report , “U.S. Outbound Investment into Chinese AI Companies,” aimed at providing data support for the new U.S. policy.
The report admits that American investors have little influence over China in terms of its artificial intelligence development, and that regulating outbound investment in China’s AI ecosystem is unlikely to hinder China’s progress in that sector, because most of its funding comes from domestic Chinese entities.
Therefore, the implementation of the Outbound Order and its specifics is actually aimed at achieving a secondary goal: Collecting and controlling factual information on U.S. companies’ investments in China. That is, the U.S. government needs to identify the major American investors active in the Chinese AI market, as well as Chinese AI companies that benefit from American capital. This is why, in addition to prohibiting certain transactions, part of the Final Rule requires U.S. businesses to provide “notifications” of certain transactions. This information will provide the groundwork for further U.S. measures and related legislation against China.
2) Regulatory key points: Curbing the transfer of intangible benefits
Even though U.S. outbound investment in Chinese AI companies is limited, American legislators and law enforcement officials are more concerned about the “intangible benefits” generated behind the capital, including “enhanced standing, managerial assistance, [access to] investment and talent networks, access to markets, and access to additional financing.” Legislators who support the investment review mechanism argue that these intangible benefits are the real loopholes in export controls.
Under the Final Rule, the penalties for failing to comply with the prohibition or notification requirements are therefore quite severe . In addition to civil liabilities of up to a maximum limit (currently $368,136 adjusted for inflation) or twice the value of the transaction, willful violations of the Rule carry criminal liabilities of up to $1 million in fines, up to 20 years in prison, or both.?
In addition, the U.S. Treasury does not have an explicit “due diligence safe harbor”; that is, for investment targets or non-U.S. collective investment vehicles, the Final Rule does not clearly explain what level of pre-investment due diligence or contractual protections will meet U.S. individuals’ obligations.
Furthermore, the Rule extends to both the applicable entities and to foreign persons subject to the regulations. In other words, U.S. entities must not only ensure that “covered foreign entities” comply with the rules in their investments, but to avoid engaging in regulated transactions, they must also ensure that their investment due diligence is sufficient to identify enterprises outside China.
?In summary, the Final Rule could bring on a “chilling effect,” which could force companies into excessive regulatory over-compliance so as not to get trapped in a web of complexity and ambiguity, or it could even stop them investing in China entirely. This is also an area that Chinese companies should pay close attention to.
3) Exempt transactions: Leaving the country’s capital flows and economic interests as unaffected as possible
However, an overly broad foreign investment review system could create too much uncertainty for the business community, reduce the willingness and ability of American companies to maintain operations in China, and even lead to additional domestic supply chain problems for the U.S., potentially reducing their companies’ competitive advantage. The U.S. Chamber of Commerce has raised similar questions and objections during its legislative process.
As such, the Outbound Order purports to target only a small portion of potential “active” investment into China (totaling less than $10 billion in 2022), thereby avoiding restrictions on large “passive” investments in publicly traded Chinese stocks and bonds. The Final Rule features a number of “excepted transactions ” that are exempt:
Can the U.S.’ allies follow its lead?
Prior to issuing the Outbound Order, the Biden administration had been pushing its allies to adopt similar regulations to restrict investment in China’s technology industry. It is fair to say that any unilateral action on the part of the U.S. would appear weak without the help of its allies, so it is doing its best to ensure that other countries do not step in to fill any investment gaps left by American companies. The U.S. Treasury has noted that the European Commission and the United Kingdom have started deliberations on whether and how to respond to foreign investment risks.
1) The European Union: Acknowledging the loopholes but not immediately following suit
On Jan. 24, 2024, the European Commission published a “White Paper on Outbound Investments” (hereinafter referred to as the “White Paper ”) aimed at strengthening the EU's economic security interests. This marked the first time in its history that the EU reviewed the debate on whether and how to restrict EU foreign investment.
The White Paper acknowledges that the EU currently has a double regulatory loophole: Neither the EU’s dual-use export control system nor its introduction of regulations to review its foreign direct investment framework currently govern outbound investments, thus potentially risking a leakage of “emerging and sensitive technologies.”
But as to whether and how to implement this type of policy, the EU clearly believes that it needs to make assessments and decisions independently, as, while such policies may have a huge impact on EU business, the differences between the U.S. and EU economies also require different approaches. The European Commission acknowledges that, due to the lack of any systematic review and assessment of outbound investment from EU member states, it does not have detailed data on foreign investment flows.
The White Paper sets out a timetable for relevant discussions and consultations aimed at defining the scope of its decision-making, and it is expected that the European Commission will assess the need for a policy response in this area—and its possible contents—in the autumn of 2025. In other words, the EU is “not immediately following suit” on U.S. policies.
2) The United Kingdom: Increasing restrictions, but with circumspection
In April 2024, the British government stated that it would tighten restrictions on trade and investment with China, which to some extent fulfilled then Prime Minister Rishi Sunak’s promise to President Biden. Prior to the formal announcement, officials from the U.K.’s Department for Business and Trade had informally notified British companies that the U.K. would be restricting investment in Chinese semiconductors, AI, and quantum computing technology.
But because major British companies had advised officials in related government-sponsored surveys not to follow the U.S.’ example, the move appeared particularly hesitant and cautious.
In announcing this move, the British government had to take into account the commercial interests of its companies. As former Deputy Prime Minister Oliver Dowden said , “The U.K. has roughly ￡13 trillion [$16.4 trillion] worth of external investment stocks, generating hundreds of billions of pounds worth of income,” and the U.K. will not surrender those interests too readily.
Additionally, the British government is unlikely to establish a new system; instead, it will use the National Security and Investment Act to review foreign direct investment in the U.K. and curb the flow of funds from strategic competitors like China into sensitive technologies. Dowden himself has specifically stated that for him, there is a high bar for the imposition of any form of restrictions.
The future of China’s AI development
Given the importance of AI in the digital economy and in geopolitics, China’s AI companies will need to face and solve some thorny issues in the near future: Obtaining long-term and reliable computing resources; working out how to utilize Western open-source models; competing for talent; and fighting for more stable and long-term investment support, in a global environment of tightening investment toward China.
The good news is that our government’s actions have sent a strong signal that it will continue to support emerging technologies, and that it believes that AI will become a major driver of future economic growth. China’s 2024 “Report on the Work of the Government,” delivered at the National People’s Congress in March 2024, hinted that China is about to launch a new policy initiative aimed at improving the competitiveness of Chinese companies in the field of AI, which may make it an “AI+ ” plan similar to the “Internet Plus ” initiative launched in 2015.
According to the latest regulations issued on November 1 by six government departments and agencies, among which China’s Ministry of Commerce and the China Securities Regulatory Commission, China will significantly relax restrictions on foreign investments in listed companies from December 2, including for investors with personal assets of not less than $50 million or with assets under management of no less than $300 million; such investors will be eligible to make strategic investments in companies listed on mainland Chinese stock exchanges. To a certain extent, this move may serve as a hedge against a current investment environment that is not exactly friendly towards Chinese companies.
In addition, with the U.S. elections just concluding and Trump emerging victorious again, this will be the biggest variable in U.S. science and technology policy. The U.S. foreign investment plan will remain in effect under the next administration, but the focus and execution style of its implementation may change significantly. Moreover, given Trump’s previous manner of interacting with his “allies,” there is still a question mark over whether the latter will follow U.S. policies and create synergies with them. If U.S. allies and the Trump administration do not see eye to eye, then U.S. investment restrictions on China will not do any substantial harm.
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Disclaimer: Views and opinions expressed herein are those of the author or authors, and do not necessarily reflect those of the translator. All efforts are made to ensure accuracy with respect to tone, register, and lexical choice, but for the avoidance of doubt, only the original version shall be considered definitive.