There is a tendency in industry to conflate the trade war with the imposition of targeted export controls on various Chinese entities. The common view, at times encouraged by the President’s own pronouncements, is that Huawei’s inclusion on the Entity List is temporary, i.e., a bargaining chip in the overall trade negotiations. Nothing in the legislative or regulatory landscape supports that conclusion.
Our view is contrary: (1) Huawei is unlikely to be removed from the Entity List anytime soon; (2) Huawei and ZTE are not outliers; (3) the coming year will see far more scrutiny of previously unreported Chinese and Russian investment into critical industries; and (4) there will be more expansive controls over previously uncontrolled industry sectors as the Bureau of Industry and Security (BIS) identifies and sets forth controls over emerging and foundational technologies. Plan and execute accordingly.
The Paradigm Shift(ed)
The default U.S. position, for over a century, has been that open markets foster democracy and stability and vice versa. In that sense, U.S. trade policy has been an instrument of both foreign policy and our national security, much like the U.S. export controls framework. The “Bipartisan Trade Promotion Authority Act of 2002” synthesizes this aptly:
“Trade Agreements today serve the same purposes that security pacts played during the Cold War, binding nations together through a series of mutual rights and obligations. Leadership by the United States in international trade fosters open markets, democracy, and peace throughout the world… Trade agreements maximize opportunities for the critical sectors and building blocks of the economy of the United States, such as information technology, telecommunications and other leading technologies…” [Emphasis added.]
We appear to have lost faith in the belief that open markets beget security. In the past year, the U.S. government enacted several measures to exclude certain Chinese and Russian telecommunications and information technology from the entire federal supply chain. One example, the Federal Acquisition Supply Chain Security Act of 2018 (FASCA), allows for the exclusion of information, communications technology or related service companies from government contracting (prime contractor, subcontractor, or otherwise) if said company’s presence in the supply chain creates a risk of hacking, surveillance, or other cybersecurity risks.
Increasingly, there is less that separates civilian from military technologies. Our adversaries, often through theft and subterfuge, are deploying technological advances in the former for use in the latter. The legal landscape taking shape is a harbinger of an ever-more-guarded and insular United States. Specifically, our foreign direct investment and export controls policy are being designed, primarily, to preserve any remaining U.S. technological primacy. This May, the Under Secretary of Defense for Acquisition and Sustainment announced that the Department of Defense (DoD) is helping create a Trusted Capital Marketplace to introduce small (read start-up) firms with trusted sources of capital. We believe this program aims to offer an alternative to foreign investment in the industries of the future.
Important Dates and Upcoming Regulations
As of August 2019, U.S. government agencies are prohibited from procuring or obtaining, or entering into, extending, or renewing a contract with any entity that uses “any equipment, system, or service that uses covered telecommunications equipment or services as a substantial or essential component of any system, or as critical technology as part of any system.” Covered “telecommunications equipment and services” includes telecommunications equipment and services produced or provided by many high-profile Chinese companies, including Huawei, ZTE, Hytera Communications Corp., Hangzhou Hikvision Digital Technology Co. and Dahua Technology Co. As of August 2020, the ban is effective for contractors. Expect the vendor blacklist to grow.
As of May 9, 2020, and pursuant to §1759 of the Export Control Reform Act of 2018, new export licensing requirements (and, presumably, tighter controls) will be implemented on countries subject to a U.S. arms embargo, including China. There are several other key regulations that will roll out later this year. For example, immediately prior to Huawei’s inclusion on the Entity List, the President issued “Executive Order on Securing the Information and Communications Technology and Services Supply Chain” (“the Order”) authorizing a potentially expansive framework for U.S. government review of transactions involving foreign information and communications technology (ICT) or services by foreign adversaries. This is, in effect, an extension of FASCA into the private sector. The Department of Commerce is required to issue implementing regulations by October 12, 2019 that ought to:
- Identify countries or persons to be considered foreign adversaries;
- Provide criteria for determining whether a person is owned by, controlled by, or subject to the jurisdiction or direction of a foreign adversary;
- Identify particular technologies or countries warranting scrutiny:
- Establish procedures for licensing; and
- Identify mechanisms and relevant factors for the negotiation of agreements to mitigate concerns relating to U.S. acquisition and use of ICT provided by foreign adversaries.
The foregoing mirror the review process of the Committee on Foreign Investment in the United States (CFIUS), which evaluates the national security risks arising from foreign investments in U.S. businesses. Given how ubiquitous Chinese ICT equipment has become, industry ought to keep a close watch on the development of these regulations to see whether they’ll impact U.S. ICT manufacturers based in China or equipment made by U.S. subsidiaries of Chinese entities. The potential creep of these regulations extends far beyond the currently blacklisted entities.
While on the subject of CFIUS, BIS is working alongside Treasury to fully implement the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) Pilot Program, including guidelines pertinent to Emerging and Foundational Technologies. CFIUS must fully implement FIRRMA by February 13, 2020. The government has already indicated that CFIUS investigations will rise in order to address previously undisclosed investments in U.S. technology companies that pose national security risks. Indications are that the government is presently reviewing trends in foreign investments to determine threats to nascent technology sectors.
This May, BIS issued a 90-day Temporary General License (TGL) permitting companies to continue supplying Huawei and its listed affiliates with certain commodities subject to the EAR. As a reminder, the TGL is valid only through August 19, 2019, and only for a limited number of activities. Following his meeting with China at the G-20 last month, the President directed the National Security Council to examine ways of narrowing the restrictions on Huawei so they focus on sales of U.S. technology used in “chokepoints,” where Huawei technology could control wireless networks.
We expect that BIS will shortly offer some guide as to what type of transactions with Huawei are licensable, i.e., not a threat to U.S. national security. This is supported by the July 9, 2019 statements of Secretary Ross at the BIS Annual Conference on Export Controls:
To implement the President’s G-20 Summit directive two weeks ago, Commerce will issue licenses where there is no threat to U.S. national security. Within those confines we will try to make sure that we don’t just transfer revenue from the U.S. to foreign firms. Huawei itself remains on the Entity List, and the announcement does not change the scope of items requiring licenses from the Commerce Department, nor the presumption of denial.
What to Pay Attention to in the Near Term
In addition to the key dates mentioned above, pay attention to the any Advance Notice of Proposed Rulemaking by the Commerce Department to identify “foundational technologies” within the next few months. In addition, Commerce will issue a Notice of Proposed Rulemaking for emerging technologies sometime this summer. Review the identified foundational and emerging technologies against your current offerings and contact your export controls counsel to determine a path forward.
We expect that CFIUS will review far more declarations as part of the FIRRMA Pilot Program mandatory filing requirements. The focus will be not only on China, but also on previously sanctioned Russian-owned businesses investing in U.S. companies that serve as major suppliers in the U.S. defense supply chain. The fiscal year 2020 Financial Services and General Government Appropriations bill includes a “CFIUS fund” with a $20 million war chest in discretionary appropriations offset by up to $10 million in user fee revenue. Involve your export controls counsel early in the due diligence process. Allow for a deep dive into any potential nexus to critical technologies in CFIUS Pilot Program industries. These steps are crucial, as the penalties for failure to file a declaration fall jointly on both parties.
BIS workload, in supporting both CFIUS and enforcement, is expected to quadruple, according to the Commerce, Justice, Science, and Related Agencies Appropriations Bill, 2020. To ensure sufficient resources, BIS may see $127 million in FY 2020 funding, which is nearly a $10 million increase over FY 2019. A full $69 million is dedicated to export administration, while an additional $52 million is dedicated solely to enforcement. Since the start of 2017, BIS has initiated 2,284 export control investigations, a 21 percent increase in the number of cases opened from the previous two and a half years. All indications are that this trend will continue. Work with export controls counsel to ensure compliance throughout your supply chain.
If you are a start-up or small entity in the critical, emerging, or foundational technology realm, monitor developments in the DoD’s brainchild Trusted Capital Marketplace, which was envisioned as a matchmaking service to connect smaller government suppliers with trusted investors. Presumably, the Trusted Capital Marketplace would steer start-ups away from foreign investors and toward “trusted” investors, thereby allowing the former to avoid being disqualified from government contracting by virtue of accepting certain foreign investments.
Section 1711 of the National Defense Authorization Act for Fiscal Year 2018 provides the statutory basis for the Trusted Capital Marketplace. Specifically, it directs the Secretary of Defense to carry out a pilot program whose authorities include:
Giving awards to third-party entities to support investments in small- and medium-sized manufacturers working in areas of national security interest, including debt and equity investments that would benefit missions of the Department of Defense.
On May 17, 2019, the Trusted Capital Marketplace was to have completed the selection of one or more entities to assume the functional management responsibility of a nonprofit Trusted Capital Marketplace manager. This is a promising development for entities that cannot withstand funding cycle oscillations common in government procurement. If you are thinking of accepting foreign investments and are in the government supply chain or hope to be, we recommend that you speak with your export controls and CFIUS counsel to identify and vet potential investors prior to making commitments.