On June 19, 2007, the Commerce Department’s Bureau of Industry and Security (BIS) issued its long-awaited final rule with regard to China titled, “Revisions and Clarification of Export and Reexport Controls for the People’s Republic of China; New Authorization Validated End-User; Revision of Import Certificate and PRC End-User Statement Requirements“ (72 Federal Register 33,646) (the “China Rule”). This rule will result in new compliance obligations for many U.S. companies doing business in China. The rule also applies to non-U.S. companies that reexport certain U.S.-origin products, software, and technology to China.
The China Rule imposes new licensing requirements on a specific set of items exported to China for a “military end-use,” requires exporters to obtain End-User Statements for all licensed transactions involving China, and establishes a general authorization for certain “validated” endusers in China. However, the final China Rule differs from the proposed rule released on July 6, 2006, in a number of significant ways. As highlighted by BIS Under Secretary Mario Mancuso at a June 18 event sponsored by the U.S.-China Business Council and hosted by Hogan & Hartson LLP, BIS worked with industry groups and those providing BIS with formal comments to make numerous changes to the final China Rule:
- Reduces the list of Export Control Classification Numbers (ECCNs) subject to military-end-use controls from 47 to 31. The list of 31 ECCNs now covers approximately 20 product groups and associated software and technology.
- Clarifies the Validated End-User Authorization (Authorization VEU) by specifying the criteria under which applicants will be reviewed and creates an inter-agency review committee to make determinations on VEU applications.
- Broadens the scope of items for which BIS may reject export license applications based on a determination that such items make a “direct and significant” contribution to China’s military capabilities.
- Raises the dollar threshold applicable to the requirements for U.S. exporters to obtain End-User Statements for China’s Ministry of Commerce (MOFCOM) from $5,000 to $50,000.
- Provides a revised definition of the term “military end-use.”
Military End-Use Controls
The China Rule implements a new licensing requirement on exports and reexports to China of certain items on the Commerce Control List (CCL) that would not otherwise require a license to China when an exporter knows or has reason to know that the items are destined for a “military end-use” in China or is informed that such items are destined for such an end-use. The knowledge standard applicable to this new licensing requirement is identical to the one provided in Section 772.1 of the Export Administration Regulations (EAR) and includes “not only positive knowledge that the circumstance exists or is substantially certain to occur, but also an awareness of a high probability of its existence or future occurrence.” As further noted in the EAR, “[s]uch awareness is inferred from evidence of the conscious disregard of facts known to a person and is also inferred from a person’s willful avoidance of facts.” As this definition of knowledge is broad, companies doing business with China will need to assess the appropriate level of due diligence and related documentation needed to confirm that an export or reexport will not be used for a “military end-use” or if a license may be required.
This new licensing requirement applies only when (1) the exporter has knowledge that the item is intended, entirely or in part, for a “military end-use” in China or has been informed by BIS that the item is or may be intended, entirely or in part, for a “military end-use” in China; and (2) the item to be exported is listed in new Supplement No. 2 to Part 744 of the EAR. The term “military end-use” is defined to mean: (1) incorporation into a military item on the United States Munitions List (USML) or the International Munitions List (IML); (2) incorporation into items listed under ECCNs ending in A018; (3) for the “use,” “development,” or “production” of items listed on the USML or IML or under ECCNs ending in A018; and (4) “deployment” of items classified under ECCN 9A991. BIS changed the definition of “military end-use” in response to comments that the definition in the proposed rule was overly broad and vague (see 71 Federal Register 38,313, 38,318 (July 6, 2006)).
The list of items and associated software and technology listed in new Supplement No. 2 to Part 744 of the EAR is shorter. The proposed rule included 47 ECCNs on this list but BIS reduced this list to 31 full or partial ECCNs by specifically analyzing the military applicability of each item, the relative foreign availability of each item, and the level of U.S. commercial exports of each item to China. For example, BIS excluded telecommunications test equipment classified under ECCN 5B991, encryption items classified under ECCNs 5A992, 5D992, and 5E992 and aircraft parts and components controlled under 9A991. Listed items include, for example, aircraft and aircraft engines, avionics and inertial navigation systems, lasers, depleted uranium, underwater cameras and propulsion systems, certain composite materials, and certain telecommunications equipment for space communications or air defense.
The China Rule specifies that license applications to export or reexport items subject to this license requirement will be reviewed on a case-by-case basis to determine whether “the export, reexport or transfer would make a material contribution to the military capabilities of China and would result in advancing the country’s military activities contrary to the national security interests of the United States.” If it is determined that the export, reexport, or transfer will make such a contribution, the license will be denied.
Licensing Review Policy for Other Highly Controlled Items
The China Rule also revises the licensing review policy for the export to China of certain other highly controlled items. Specifically, licenses to export to China items controlled for national security reasons will be reviewed under an overall policy of approval for exports to civil end-uses but under a general policy of denial for exports that will make a “direct and significant contribution” to the “military capabilities” of China. (In the proposed rule, BIS used the less stringent “material contribution” standard in this context.) Furthermore, BIS has included an illustrative list of the “military capabilities” of China in new Supplement No. 7 to Part 742 of the EAR. This illustrative list includes, but is not limited to, battle tanks, armored combat vehicles, combat aircraft, attack helicopters, and night vision equipment.
The export or reexport to China of items controlled for chemical and biological weapons proliferation, nuclear nonproliferation, and missile technology reasons will be reviewed under the licensing polices stated in Sections 742.2, 742.3, and 742.5 of the EAR respectively, as well as those described above in relation to items controlled for national security reasons.
Authorization Validated End-User
A key component of the China Rule is Authorization VEU. This authorization permits exports and reexports of items that would otherwise require a license to select end-users in China that have been scrutinized by the U.S. government. BIS has not yet identified any VEUs but Under Secretary Mancuso indicated that BIS hopes to publish an initial list of a “handful” of VEUs in the coming weeks.
Authorization VEU may only be used for exports, reexports, and transfers to end-users in China that have been verified by the U.S. government. Items controlled under the EAR for missile technology (MT) and crime control (CC) reasons may not be exported or reexported under this authorization.
1) Factors for Approval of Application for VEU Status
In reviewing a request to be listed as a “Validated End-User,” the U.S. government will review the following factors:
- Entity’s record of exclusive engagement in civil end-use activities;
- Entity’s compliance with U.S. export controls;
- Need for an on-site review prior to approval
- Entity’s capability to comply with the requirements of Authorization VEU;
- Entity’s agreement to on-site reviews to ensure adherence to the conditions of Authorization VEU by representatives of the U.S. government;
- Entity’s relationships with U.S. and foreign companies; and
- Status of export controls and the support and adherence to multilateral export control regimes by China.
It should be noted that while all VEUs must be located in China, the entities that apply for VEU status may be private Chinese entities or Chinese subsidiaries of companies headquartered in the United States or elsewhere. Deputy Assistant Secretary Matthew Borman indicated that ownership by the Chinese government does not necessarily disqualify a Chinese entity from consideration for Authorization VEU.
2) Application for Validated End-User Status
All applications for VEU status will be reviewed by the newly created End-User Review Committee (ERC) which will be composed of representatives of the U.S. Departments of State, Defense, Energy, and Commerce and other agencies as deemed appropriate by the U.S. government. Approval as a VEU requires a unanimous vote by the ERC. Applications for VEU status may be submitted by an exporter or reexporter who would like to have its customer identified as a VEU or by the end-user itself. All such applications must be submitted to BIS in the form of an advisory opinion request and must, for example, include the following information:
- Name of the proposed VEU candidate with full contact information;
- Overview of the structure, ownership, and business of the prospective VEU;
- List of all items, by ECCN, to be exported or reexported under Authorization VEU and a description of how the items will be used by the VEU;
- Destination to which the prospective VEU plans to reexport the items, if any; and
- Certification from an official of the prospective VEU that it will comply with all of the requirements of Authorization VEU.
Authorization VEU also contains several significant end-use restrictions. Significantly, items exported, reexported, or transferred to China under this authorization may not be used for “military end-uses” or for any other use described in Part 744 of the EAR, including nuclear and chemical and biological weapons end-uses. VEUs who receive items under Authorization VEU may only (1) use such items at the VEUs facility located in China or a facility in China over which the VEU demonstrates effective control; (2) consume such items during use; or (3) transfer or reexport such items after receiving authorization from BIS to do so.
Reporting, Recordkeeping and Audit Requirements
Authorization VEU also includes strict reporting and recordkeeping requirements, including the following:
- Exporters and reexporters must receive a certification from the VEU prior to the initial export or reexport to that VEU stating, among other things, that it will abide by the requirements of Authorization VEU.
- Exporters and reexporters who make use of Authorization VEU must submit annual reports to BIS including, among other things, the name and address of VEUs to whom the company exported or reexported eligible items and the quantity and value of items sent under this authorization.
- Exporters, reexporters, and VEUs must permit BIS to inspect their records and conduct on-site compliance reviews on a regular basis.
Deputy Assistant Secretary Borman indicated that on-site compliance reviews would not be conducted in the same manner as BIS’s end-use visits in China, and that compliance issues raised in such reviews would not necessarily result in enforcement actions, such as being listed on the Entity List.
End-User Statement Requirements
Under the China Rule exporters are required to obtain End-User Statements from MOFCOM for all exports to China of items on the CCL requiring a license to China when the total value of the transaction is over $50,000. (Under the proposed rule, the threshold value for this requirement was $5,000.) Prior to implementation of the China Rule, exporters were only required to obtain End- User Statements from MOFCOM for exports to China of goods and technology controlled for national security reasons. Under the China Rule, however, exporters must request the importers to obtain an End-User Statement for all exports of goods and technology to China that require a license provided that the $50,000 threshold is met. As is the current practice under the EAR, BIS will continue to require an End-User Statement for all exports of high performance computers to China that require a license, regardless of the value of the export. Exporters and reexporters will not be required to submit End-User Statements as part of a license application, but will be required to note the serial number of the End-User Statement on the license application and to maintain the End-User Statement in the company’s records.
As evidenced by questions fielded by Under Secretary Mancuso at the June 18 event, industry groups continue to express concern regarding how the China Rule will be implemented and its impact on U.S. business opportunities in China. In particular, there are continued concerns about MOFCOM’s capacity to handle an increase in the requests for End-User Statements, the broad definition of knowledge applicable to the “military end-use” controls, and the extent of the practical benefits of Authorization VEU. Mancuso responded to such comments by noting that BIS does not anticipate the China Rule to increase the number of End-User Statements processed by MOFCOM given the change to a $50,000 threshold and that discussions about the implementation of the rule with the Chinese government are ongoing. He also indicated that BIS has sought to streamline the application process for Authorization VEU and he expected that the new authorization would create new export opportunities for U.S. firms.