How US-China Tensions Impact Issuer Risk Disclosure

As geopolitical, trade, and investment tensions continue between the United States and China, US issuers should review their current exposure to the China market and adjust their risk factor disclosures on a quarterly basis, taking recent developments into account.

Beginning with the Trump administration in 2017 and largely continuing with the Biden administration, the United States has taken a series of trade, international treaty, tax, and sanctions actions against China. These actions have in many cases triggered, or are expected to trigger, countersanctions or countermeasures from the Chinese government.

Additionally, in recent years, tensions between mainland China and Taiwan have further escalated. The newly passed Taiwan Policy Act of 2022, among other things, provides almost $4.5 billion in security assistance over the next four years. As countermeasures, China has significantly increased its air patrol and military exercises near the Taiwan Strait and imposed sanctions on US officials visiting Taiwan and US defense companies selling arms to Taiwan.

Military leadership and civilian think tanks in various countries are openly contemplating the outbreak of hostilities with varying but specific timetables. In case of a military conflict between China and Taiwan, global manufacturers would likely lose access to advanced semiconductor chips and other products that are sourced from Taiwan. Such a conflict would also likely limit access to key Chinese ports and exporters due to both military actions and potential international sanctions, which would create significant disruption for industries that rely on supply chain in China.

RISK FACTOR DISCLOSURE KEY TAKEAWAYS

• Carefully tailor risk factors to address specific risks facing businesses related to China; these should be benchmarked against what their peers are disclosing.
• While the risk factors of Chinese-based companies publicly traded in the United States offer a catalogue of China-related risks to consider, many of these will not be relevant to US issuers doing business in China.
• Reliance on generic risk factors related to the risks of doing business internationally may fall short of properly informing investors of the specific risks an issuer may face when engaging in certain China-related activities, and the SEC discourages such boilerplate disclosure.
• While the SEC has not to date provided any tailored guidance on how US companies should consider disclosing risks related to doing business in China, previous guidance pertaining to COVID-19 disclosure considerations[1] and, in particular, the sample letter in response to Russia’s invasion of Ukraine and related supply chain issues provide a useful analytical framework for considering the disclosure of China-related trade risk.
• Companies should consider detailed risk factor disclosure, to the extent material or otherwise required, relating to direct and indirect exposure to China through operations, employee base, investments in China, securities traded in China, sanctions against China or Chinese individuals or entities, or legal or regulatory uncertainty associated with operating in or exiting China, to name a few.
• Since US-China trade tensions have increased, many companies have experienced heightened cybersecurity risks, increased or ongoing supply chain challenges, and volatility related to the trading prices of commodities, regardless of whether they have operations in China that likely warrant disclosure.

FINANCIAL DISCLOSURE

Financial statements may also need to reflect and disclose the impairment of assets, changes in inventory valuation, deferred tax asset valuation allowance, disposal or exiting of a business, deconsolidation, changes in exchange rates, and changes in contracts with customers or the ability to collect contract considerations.

Companies with significant and material exposure to these risks also should consider how these matters may affect management’s evaluation of disclosure controls and procedures, management’s assessment of the effectiveness of internal controls over financial reporting, and the role of the board of directors in risk oversight of any action or inaction related to increased US-China trade and investment tensions, including consideration of whether to continue or halt operations or investments in China.

NEXT STEPS

Further action on China is expected from the Biden administration and Congress this year. Legislation relating to China—from supply chain security, unfair trade practices, intellectual property protection, data privacy, and defense and national security to China’s inbound investments into the US and US outbound investment flows to China, Taiwan, human rights, and higher education—is one of the few areas of potential consensus between Republicans and Democrats.

US issuers with China exposure and US-listed Chinese companies should review comprehensively their risk factors to ensure their filings adequately reflect the risks they face from heightened US-China tensions with specific, tailored disclosures in order to satisfy applicable disclosure requirements, mitigate private civil litigation risks, and withstand potential regulatory scrutiny.

For more information, see Your Checklist for Risk Factor Disclosures Amid US-China Tensions, part of our 2023 series, Continuing Evolution of US-China Relations: 2023 and Beyond, which examines the interrelated issues affecting global business with a focus on intellectual property, sanctions, export controls, and the potential for an outbound investment regime.