In a new Executive Order, President Donald J. Trump prohibited U.S. persons, including financial institutions, from engaging in transactions in the securities of Chinese companies that the U.S. Secretary of Defense and/or the Secretary of the Treasury determines supply or otherwise support China's military, intelligence and security services. The Executive Order, which becomes effective on January 11, 2021, will preclude investment in any company specified as a "Communist Chinese military company" as defined in Section 1237 ("National Defense Authorization Act") of Public Law 105-261.

There are currently 31 companies that have been designated as Communist Chinese military companies, including two with New York Stock Exchange-traded American depositary receipts, China Mobile Limited ("CHL") and China Telecom Corporation Limited ("CHA").

The Executive Order prohibits not only "any transaction in publicly traded securities," but also "any securities that are derivative of, or are designed to provide investment exposure to such securities." The Executive Order grants the Secretary of the Treasury the ability to establish procedures to license transactions that would otherwise be prohibited, although any such procedures would also require consultation with the Secretary of State, the Secretary of Defense and the Director of National Intelligence.

For U.S. persons holding securities in a Communist Chinese military company as of January 11, 2021, the Executive Order authorizes divestiture of such securities by November 11, 2021 - even if divestiture requires the purchase of a Communist Chinese military company security by a U.S. person. Similarly, for U.S. persons holding securities in an entity subsequently determined to be a Communist Chinese military company, the Executive Order permits divestiture transactions no later than 365 days from the date of such determination.

Commentary

This Executive Order follows a series of other China-related executive actions and proposed legislation, including Xinjiang- and Hong Kong-related sanctions, significant export controls targeting an increasing number of Chinese companies, efforts to protect against access by the Chinese government to the data of U.S. customers of TikTok and WeChat, and proposals that U.S.-listed foreign companies be required to comply with U.S. auditing requirements. While the application of sanctions and other national security-related economic measures against China has certainly increased under President Trump, there is no clear indication at this time whether a Biden administration would chart a markedly different course.

Commentary

This Executive Order is likely to impact all classes of U.S. investors and an assortment of financial products, including investment companies and exchange-traded funds, derivatives, structured notes and equity indices. More guidance is needed to assess the full impact of this Executive Order and should be forthcoming from the Treasury during the 60-day delay implementation period and the ensuing divestment window. For example, what is the meaning and scope of “investment exposure” (e.g., is there a de minimis exception for funds; will this necessitate delisting of affected U.S.-listed securities like CHL and CHA; and under what conditions, if any, exemptions will be permitted).