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Proposed Outbound Investment Regs Expound on Transaction Scope, Knowledge Standard

The Treasury Department last week issued a set of proposed regulations that could introduce new prohibitions and notification requirements on U.S. investments in China, Hong Kong and Macau as the Biden administration works toward finalizing the new rules before year-end (see 2405080039). The proposed rule, which builds on an advance notice of proposed rulemaking Treasury issued in August (see 2308090066), outlines how the agency would implement new bans on certain types of outbound American investments in China’s semiconductor, quantum and artificial intelligence industries, as well as notification requirements for other, broader investments in China’s chip and AI sectors.

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The new rules are designed to be “narrow and targeted,” Treasury said in a June 21 news release, and are aimed at stopping U.S. investments “that contribute capital as well as intangible benefits” to people and companies working on sensitive technologies “that could pose risks to U.S. national security.”

The agency said it’s accepting public comments on the proposed rule until Aug. 4. It plans to issue final regulations soon after, which will “set an effective date for the program.”

The 165-page proposed rule includes "detailed" definitions and descriptions to "appropriately scope coverage and facilitate compliance" by U.S. people and companies, the agency said. It also outlines the “knowledge standard” that sets obligations on U.S. persons who know their transaction may be prohibited, the government's due diligence expectations for the private sector, possible penalties, excepted transactions, and more.

The outbound investment regime “will not be a case-by-case review of transactions,” Treasury said in a fact sheet issued alongside the proposed rule. The U.S. person making the investment “would have the obligation to determine whether the given transaction is prohibited, permissible but subject to notification, or not covered by the rule.”

The technology sectors that would be covered by the proposed prohibitions are:

  • Semiconductor and microelectronics: transactions related to electronic design automation software; fabrication and advanced packaging tools; the design, fabrication or packaging of certain advanced integrated circuits; and supercomputers
  • Quantum information technologies: transactions related to the development of quantum computers and production of critical components; the development or production of certain quantum sensing platforms; and the development or production of quantum networking and quantum communication systems
  • AI: transactions related to the development of any AI system designed for certain end uses, and transactions related to the development of any AI system trained "using a specified quantity of computing power, and trained using a specified quantity of computing power using primarily biological sequence data."

The agency’s proposed notification requirements would cover a broader range of transactions. For China’s chip industry, they would cover transactions related to the “design, fabrication, or packaging of integrated circuits not otherwise covered by the prohibited transaction definition.” For China’s AI Industry, they would cover transactions involving development of any AI system “not otherwise covered by the prohibited transaction definition, where such AI system is designed or intended to be used for certain end uses or is trained using a specified quantity of computing power (set below the levels in the prohibited transaction definition).”

Under the proposed rule, companies will be required to submit a notification to Treasury within 30 days after the transaction is completed, or within 30 days after they realize the deal was a covered transaction. The notification form must include a range of transaction details, including information about the U.S. person, the covered transaction, “relevant national security technologies and products, and the covered foreign person.”

Treasury used a portion of the rule to outline some due diligence expectations. Law firms and industry associations asked the agency last year to clarify the due-diligence steps that will be required of deal-makers, warning that the government risked chilling a broad range of U.S. ventures in China and incentivizing foreign companies to seek funds elsewhere (see 2310050035).

In the rule, Treasury said it “anticipates that U.S. persons should be able to comply with the proposed rule through a reasonable transactional due diligence process.”

The agency said U.S. people and companies could be blocked from making certain investments in China if they have certain “knowledge of relevant facts or circumstances” that makes the deal a covered transaction. That “knowledge” may include an “awareness of a high probability of a fact or circumstance’s existence or future occurrence,” or if a person or company “could have possessed such information through a reasonable and diligent inquiry.”

The proposed rule lists some of the factors Treasury will consider when deciding whether a U.S. person or company “undertook such an inquiry,” including if they made efforts to “obtain information and contractual assurances” to show that the deal wasn't subject to the rules.

If Treasury determines that a U.S. person or company conducted reasonable due diligence and still didn’t meet the rule’s knowledge standard, the agency will “ordinarily” not “attribute knowledge of that fact or circumstance to such U.S. person even if the transaction has all of the other attributes of a covered transaction,” the rule said.

Violators of the outbound investment rules could be subject to civil and criminal penalties under the International Emergency Economic Powers Act, Treasury said, adding that it may also order a divestment of the transaction. The agency also plans to set up a voluntary disclosure process where companies can self-report possible violations.

Treasury stressed it's not looking to “prohibit all investment activity in countries of concern,” such as China. “The approach in Treasury’s NPRM is focused on discrete categories of transactions involving sub-sets of technologies and products in an effort to protect national security, maximize compliance, and minimize unintended consequences."

The rule lists a set of transactions that would be exempt from investment prohibitions, similar to the list Treasury included in its advance notice of proposed rulemaking last year, including investments in publicly traded securities, investments in index funds, and an “intracompany” transaction between a U.S. parent business and its subsidiary to “support ongoing operations.” The agency also added an exception that would apply to transactions involving people or companies from third countries that have “similar” outbound investment restrictions to those of the U.S.

The rule also proposes exempting certain investments if the deal is in the "national interest" of the U.S. The agency said it expects to grant this exemption only in "exceptional circumstances."

The rule received some praise from Rep. Patrick McHenry, R-N.C., chair of the House Financial Services Committee, who said in an emailed statement that it "appears to be a step in the right direction." It's "promising" that Treasury is trying to make the prohibitions "more targeted," and the Biden administration "should continue working to ensure this can be appropriately implemented," McHenry said.

But he also stressed that he favors existing sanctions and export control authorities over creating a "new bureaucracy" to regulate outbound investments (see 2311300023).

"We have an existing, time-tested sanctions regime that can have an immediate impact," McHenry said. "Any effort to block global funding for the Chinese military-industrial complex must include the full blocking sanctions in Congressman Andy Barr’s Chinese Military and Surveillance Company Sanctions Act," he said, referring to a bill that would require the administration to make annual determinations on whether sanctions should be applied to companies subject to existing U.S. investment restrictions, among other measures (see 2309200052).

Sen. Bob Casey, D-Pa., one of the sponsors of a bill that would require U.S. firms to report outbound investments that could threaten American national security (see 2312110063), called Treasury's proposed rule an "important step" to protect sensitive U.S. technology and expertise.

"The administration’s proposed rule is a good start," Casey said, "but I will keep pushing to pass my bipartisan legislation to make permanent an outbound investment screening program.”

The U.S.-China Business Council on June 21 said it's still analyzing the rule, but stressed that the U.S. should be careful not to target investments that don't impact national security.

“We will continue to advocate for U.S. companies and the need for clear guidelines, a targeted approach and rules that can be implemented across many countries to ensure U.S. companies are not disadvantaged," President Craig Allen said.