Outbound Investment Review: Little Immediate Effect, but More Is Coming

The US government’s multibranch effort to implement a new regulatory regime designed to regulate outbound investments based on national security concerns moved forward with the White House’s August 9, 2023 Executive Order, EO 14105, Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern (the EO or Order). While the long-anticipated Order provides a roadmap for how such a regime would work, many details remain open for discussion, and to a large extent the Order’s true impact remains to be seen.

INTRODUCTION

Highly anticipated and preceded by vigorous discussion and debate on the scope of such a program, the EO lays out the Executive Branch’s vision for an outbound investment regime. The Order, as well as the accompanying advance notice of proposed rulemaking (the ANPRM) simultaneously issued by the US Department of Treasury, acknowledges that the development of an outbound investment regime is a complex and time-intensive undertaking.

The EO is not self-executing, and the Order directs Treasury to draft regulations. As such, neither the Order nor the ANPRM has any immediate ramifications for affected parties beyond the opportunity to comment on the ANPRM. However, the eventual regulations will likely have significant consequences for investors and will involve continued intense debate surrounding the establishment of this review mechanism. Based on the benefits of preparing for a likely regime, we provide a review of the initial proposal and some insights into where this effort might be headed.

BACKGROUND

Similar to the “maximum advantage” adage that informed the US Department of Commerce’s October 7, 2022 rule regarding additional restrictions on advanced semiconductors and supercomputers, the EO and ANPRM propose limits on the funding of indigenous development of certain technologies in “countries of concern”—currently, the People’s Republic of China (the PRC).[1]

As described in the EO, identified countries of concern are ones “engaged in comprehensive, long-term strategies that direct, facilitate, or otherwise support advancements in sensitive technologies and products that are critical to such countries’ military, intelligence, surveillance, or cyber-enabled capabilities” (emphasis added). Although only one country is currently included in the Annex to the EO, there is no limitation in the Order that precludes the addition of other countries that meet the criteria for designation.

The EO also identifies three types of “sensitive technologies” that may be prohibited or subject to a notification requirement under this program:

• Semiconductors and microelectronics
• Quantum information technologies
• Artificial intelligence (AI)

The ANPRM expounds on these in some detail, indicating that certain investments in semiconductor and microelectronics companies in China may invite both prohibitions and notification requirements. Certain quantum information technology investments will likely be prohibited, while certain investments in AI sector companies may only require notice. In some circumstances, no notices will be required. The EO also instructs the Secretary of the Treasury to further define additional technologies that should be subject to investment prohibitions or notification requirements.

Importantly, the ANPRM indicates that Treasury may inquire about any investment made after the date of the EO, even if those investments were made prior to the implementing regulations. This appears consistent with a “look-back” process used in the foreign direct investment context under the Committee on Foreign Investment in the United States (CFIUS).

However, the inclusion of a “look-back” authority undercuts the stability that comes with a designated start date for when the regulations will apply. Thus, while existing transactions will not be covered, any transactions completed after August 9, 2023 may be subject to these new rules—though exactly what is covered and how such transactions will be treated remains to be seen.

Treasury, in connection with other relevant agencies, is also required to report annually to the president on the effectiveness of the measures in place, advancements in countries of concern, and aggregate sector trends in notifiable transactions and related capital flows, among other relevant information.

The reports will also include recommendations regarding modification of the Order, including the addition or removal of relevant sectors or countries of concern and the establishment or expansion of other federal programs to address the national security threats identified in the EO. The EO also authorizes Treasury to submit recurring and final reports to Congress on the declared national emergency.

TREASURY’S ADVANCE NOTICE OF PROPOSED RULEMAKING

The EO directs Treasury to issue regulations implementing the requirements of the outbound investment program. Concurrent with the EO, Treasury issued an ANPRM (to be published on August 14) to set forth an overview of its intended outbound investment program and solicit comments from the public to inform its future rulemaking.

The ANPRM, which poses 83 questions where feedback is specifically sought, also provides a window into the government’s views on how an outbound investment regime will or, in certain areas, could operate.

Overview of the Intended Program

The ANPRM outlines a program that would either prohibit or require notification to Treasury of specified investments by US persons into foreign entities that are engaged in activities related to technologies or products of national security concern. Unlike the inbound investment review program conducted through CFIUS, Treasury states that it does not intend to conduct a case-by-case review of US outbound investments. Rather, the ANPRM places the onus on the transaction parties—primarily the US investor—to determine whether a given transaction is prohibited, subject to notification, or permissible without notification.

While Treasury states that it does not intend the program to apply retroactively, it may, after the effective date of the regulations, request information about transactions by US persons that were completed or agreed to after the date of the EO “to better inform the development and implementation of the program.”

The ANPRM does not go so far as to mention a non-notified process such as that employed by CFIUS, however, the agency may adopt something similar to monitor compliance and enforce the requirements of the outbound investment program.

Issues for Public Comment

The ANPRM seeks public input on a number of issues, including the subsets of sensitive technologies and products enumerated in the EO that would be subject to the proposed rules. Key items where public input is sought include the following:

• Semiconductors and microelectronics: Treasury is considering prohibiting certain advanced semiconductor and microelectronics investments, while allowing other investments into these technologies contingent on the parties’ notification. Specifically, Treasury may prohibit US persons from investing in activities involving software for electronic design automation for integrated circuit (IC) design, front-end semiconductor fabrication equipment used for volume fabrication of ICs, advanced IC design and fabrication for ICs that meet specified criteria, advanced IC packaging, and supercomputers. Additionally, Treasury is considering a notification requirement for investments involving IC design, fabrication, or packaging that do not fall within the scope of prohibited transactions.
• Quantum information technologies: Treasury intends to prohibit investments related to quantum computers and components; quantum sensors designed to be used for military, intelligence, or surveillance end uses; and quantum networking and communications systems designed for secure communications.
• AI systems: Treasury is considering prohibiting investments in AI software designed to be exclusively used for military, government intelligence, or mass-surveillance end uses, while imposing a notification requirement for investments in AI software designed to be exclusively used for cybersecurity, digital forensics, penetration testing, control of robotic systems, surreptitious listening, non-cooperative location tracking, or facial recognition purposes.

Exceptions

The ANPRM also seeks comment on certain proposed exceptions to the new prohibitions and notification requirements. In particular, Treasury identifies certain transactions that would be carved out from the definition of “covered transaction” because the nature of the investments present a perceived lesser national security concern.

The proposed exceptions include different categories of transactions, including certain types of excepted investments such as:

• investments into publicly traded securities;
• investments into index funds, mutual funds, exchange-traded funds, or similar instruments; and
• investments made as a limited partner (LP) into a venture capital fund, private equity fund, fund of funds, or other pooled investment funds where the LP’s contribution is passive and below a specified de minimis threshold; this exception, as written, could allow for massive capital flow through pooled funds, unless it is cabined appropriately.

Notably, any such investments that include membership, observer, or nomination rights or other involvement in substantive decision-making of the covered foreign person would not qualify for the exception.

Additional proposed exceptions include:

• certain equity acquisitions;
• intracompany funds transfers by a US parent to a covered subsidiary; or
• a binding uncalled capital commitment, where the commitment was entered into before the date of the EO.

Other points on which Treasury has asked for public comment include:

• the definitions of “US person,” “covered foreign person,” and “person of a country of concern”;
• the form, content, and timing of notifications for applicable covered transactions;
• obligations of US persons related to knowledge of a prohibited transaction and controlled foreign entities;
• the availability of a national interest exemption;
• compliance and recordkeeping controls; and
• potential penalties.

Comments on and Treasury’s responses to these points will be instructive on the anticipated compliance burdens on US persons, as well as Treasury’s assessment of the trade-offs involved with implementation.

Implications of ANPRM Process

The use of an ANPRM with its associated notice and comment process versus issuance of regulations as final (or interim final, which often occurs in the national security sphere) suggests that the government is interested in obtaining stakeholder input before drafting the final regulations, and that there will be time for investors to adjust their operations as needed to conform to the new restrictions.

As such, affected parties should consider submitting comments, either individually or as members of a group, to maximize the chances of the final regulations reflecting a program that considers the specific experiences, investment flows, and views of industry. Written comments on the ANPRM may be submitted electronically or by mail, but in any case must be submitted by September 28, 2023.

LEGISLATIVE IMPLICATIONS

As discussed in our August 2 LawFlash, on July 25, 2023 the US Senate approved an amendment to the National Defense Authorization Act (NDAA) that added mandatory notification requirements to certain outbound investments into the PRC. The Outbound Investment Transparency Act (OITA) requires US companies to notify the US government of investments in certain Chinese sectors but, unlike the EO, does not authorize blanket investment bans.

More specifically, the OITA would require notifications to Treasury of investments in semiconductors, batteries with dual-use applications, quantum technologies, microelectronics, AI, satellite-based communications, hypersonics, network laser scanning systems with dual-use applications, and any other export-controlled technology deemed relevant to US national security interests.

It would also require notification of the establishment of any subsidiary or joint venture in China, the purpose of which includes production, design, testing, manufacturing, fabrication, or research involving one or more national critical capabilities sectors. By contrast, and as discussed above, the EO covers only (1) semiconductors and microelectronics, (2) quantum information technologies, and (3) AI.

Within the first day, the limited scope of the EO was the subject of congressional commentary. Representative Mike Gallagher, Chairman of the Select Committee on the Chinese Communist Party, characterized the EO as including “loopholes” that are “wide enough to sail the PLA Navy fleet through.” Representative Gallagher also stated that the EO “[d]oesn’t address the passive flows of US money into malign CCP-affiliated companies.” Meanwhile, Representative Gallagher’s Democratic colleague Ranking Member Raja Krishnamoorthi noted that the EO was “an essential step forward” but that it “cannot be the final step.”  

House Foreign Affairs Committee Chairman Michael McCaul, whose committee shares jurisdiction over many of these matters, was more specific, raising concerns that the EO failed to cover existing technology investments as well as biotechnology and energy.

Meanwhile, Representative Patrick McHenry, Chairman of the House Financial Services Committee, and Representative Blaine Luetkemeyer, Chairman of the Subcommittee on National Security, Illicit Finance, and International Financial Institutions, expressed satisfaction with the EO, especially the “targeted scope,” but signaled that it should be Congress making laws rather than the president through executive order.

This congressional commentary suggests that the EO is not the last word on the development of an outbound investment regime. In the short term, Congress will have an opportunity to weigh in during upcoming reconciliation negotiations over the NDAA and FY2024 appropriations packages.

On a longer timeline, it is clear that there are many well-positioned members who remain convinced that a broader, more restrictive regime, similar to the National Critical Capabilities Defense Act (currently pending in the House of Representatives), should be implemented, leaving open the possibility that the outbound investment regime established by the EO could be strengthened by future congresses and administrations. Impacted parties will want to monitor developments going forward as Congress searches for consensus on these matters.

CONCLUSION AND TAKEAWAYS

The EO and ANPRM preview the proposed rules, outline the objectives and scope of the review regime, and propose 83 questions that are being considered to help finalize any outbound investment review regime. Despite the implementation of a novel legal authority, there is little immediate effect on parties considering investments in the PRC.

The ANPRM is scheduled to be published on August 14, and Treasury may also issue a subsequent NPRM with proposed regulations and seek further public comment. Clearly, there is much still to do to stand up an outbound investment program in terms of soliciting public feedback and crafting a regulatory regime that meets the US government’s policy objectives. 

Notwithstanding the delayed effect, there are at least some initial conclusions that can be drawn to help inform an analysis of the effects that any resulting regime may have on investment opportunities:

• This is a complex proposal that will require a significant amount of time and energy to develop and implement. Based on the expectation that Treasury will receive extensive comments in response to the ANPRM, all of which must be addressed, it will take several months or more before any interim final or final rules are issued. While there may be a notice and comment period for the actual proposed rules, those may also include some sort of delayed effective date.
• The EO includes both prohibited transactions and a notification process for certain classes of transactions, but the ANPRM indicates that regulations will leave the determination of whether investments are prohibited or require notification—as well as the risk of getting that determination wrong—to the investor. Treasury will define what is prohibited and what requires notification, but investors remain the focal point of deciding whether to submit a notice, pursue a transaction, or consider themselves outside the scope of a “covered transaction.” An investor must analyze whether a contemplated investment involves a party from a country of concern, a sensitive technology, or an activity that is covered, including for transactions consummated after August 9, 2023 but before regulations come into effect. Should Treasury finalize this approach, documenting a detailed and robust evaluation of investments in the countries of concern and the technology sectors highlighted may be essential to ensure that investors demonstrate objective, contemporaneous decision-making should Treasury question a failure to submit a notice or proceed with what the agency decides is a prohibited transaction.

If so, then even within the covered transaction determination, an investor will need to decide whether the investment qualifies as an excepted transaction. The possibility of analytical missteps could be significant, and, if left as proposed, the likelihood of overcompliance will be great.

• The language of the EO opens the door to the possible expansion of the list of covered technologies that could be subject to reporting requirements and additional restrictions. Non-identified industries should not assume they will be exempt, despite the current tailored scope of covered technologies. Moreover, non-identified industries that have involvement in one of the identified industries (e.g., a life sciences company that uses AI) might still be covered.
• This is not a “reverse CFIUS” process and indeed there is little resemblance to CFIUS overall. While the outbound and CFIUS reviews use some common terminology—such as “covered transactions” and the concept of “sensitive technologies” (which could be viewed as comparable to critical technologies)—the similarities end relatively quickly, despite the fact that both programs would be led by Treasury.
• As Congress moves forward to reconcile the Senate and House versions of an outbound investment review process written into the NDAA, assessing the differences between the legislation and the EO/Treasury regulations will provide additional insight into how impactful the program may be and whether Congress will act as a supporter of or impediment to the review process. The Senate and House versions vary, and Congress will control Treasury’s budgets for any program under the EO and through the Treasury regulations. If Congress and the administration’s focuses align, then Congress’s budget process may not impede Treasury’s progress in operationalizing its program. If they do not align, there could be further delays or parallel processes that would need to be reconciled between Congress and the Executive Branch. 
• Treasury’s use of an ANPRM indicates that the government recognizes the complexity of this issue and is willing to pursue a longer rulemaking process to benefit from stakeholder input before finalizing the regulations. Affected industries and investors should consider the benefits of engaging with the agency to ensure that their voices are heard—whether through the submission of individual comments, the coordination of comments through related trade associations, or through the submission of comments without specific attribution such as through counsel. In any circumstance, engagement could be essential to ensuring that affected parties’ equities can be addressed. As highlighted, comments are due to Treasury by September 28, 2023.
• On the same day the EO issued, China’s Ministry of Commerce reacted with a statement voicing “serious concerns” about the EO and reserving the right to take countermeasures. In recent years, China promulgated its own Blocking Statutes and Anti-Foreign Sanctions Law, which authorize certain retaliations (such as investment bans, travel restrictions, asset seizures, and private claims of damages by private Chinese parties) against foreign companies and their executives for complying with “unjustified” foreign sanctions. It remains to be seen whether the Chinese government will take any specific countermeasures aimed at either deterring US investors from complying with the EO and/or incentivizing new US investment in China despite the investment restrictions under the EO. 
• The US government has confirmed that the EO was developed in consultation with international partners, and, given how the United States pursued multilateral engagement for previous semiconductor and supercomputer export rules, it would not be unusual for the US government to urge its partners and allies to pursue a similar path. In some instances, other governments, such as South Korea and Taiwan, already have some outbound investment review process. But, even with multilateral engagement, the Biden administration has moved forward with unilateral action, again as reflected through the October 7, 2022 export regulation, while partners and allies contemplate their own positions and approaches.

Our lawyers will discuss these issues in further detail in our presentation Impact of New Executive Order On US Outbound Investment. For further information, contact Erin Buday.