UNPACKING US-CHINA SANCTIONS AND EXPORT CONTROL REGULATIONS: OUTLOOK FOR 2021

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UNPACKING US-CHINA SANCTIONS AND EXPORT CONTROL REGULATIONS: OUTLOOK FOR 2021

January 27th, 2021 Ginger T. Faulk and Jeffrey P. Bialos Leave a comment

This is the fifth in a series of articles by Eversheds Sutherland partners Jeff Bialos and Ginger Faulk explaining the legal and regulatory impacts of certain recent US sanctions and export control actions targeting various Chinese entities. Each article explains the regulatory context of the recent rules and intends to be explanatory in nature.

During a seemingly interminable and challenging transition period, the Trump administration has layered on an array of additional China sanctions. What are the impacts of these actions? What approach is the Biden administration likely to adopt and what changes can we expect? These are the topics that are addressed in this article, the last in this five-part series.

China-related Sanctions since November 6, 2020

Specifically, since November 6, 2020, the Trump administration has:

1. issued an Executive Order banning US persons from trading in the publicly traded securities of more than 35 “Communist Chinese Military Companies;”

2. named no less than 60 Chinese entities to the US Commerce Department Entity List, which establishes a license requirement for nearly all exports to such firms and general presumption of denial for such exports;

3. designated 58 entities as China “Military End Users” under the Export Administration Regulations (EAR), which also results in restrictions on a wide range of high-tech exports; and

4. removed Hong Kong as a separate destination from China under the Export Administration Regulations, which removes its preferential treatment for export licensing.

Moreover, during the same period, President Trump signed an executive order blocking transactions with companies that “develop or control” certain Chinese connected mobile and desktop applications and related software – namely Alipay, CamScanner, QQ Wallet, SHAREit, Tencent QQ, VMate, WeChat Pay, and WPS Office. At the same time, earlier executive orders banning transactions with the owners of TikTok and WeChat were halted by federal courts and the effective date of these orders has been suspended pending the outcome of ongoing litigation.

In particular, compliance with the recent securities trading ban has proven challenging for the financial community, forcing banks and investment companies to divest or restructure hundreds of products containing publicly traded securities of the named “Communist Chinese Military Companies” and other companies whose names “closely match” the names of the listed companies. The term “securities” is broadly defined under US law, and OFAC has interpreted the ban to apply to any security that “designed to provide investment exposure” to the securities of a named entity. Thus, the ban includes, for example, a mutual fund which includes in its portfolio one or more of the subject securities or an insurance policy that has a mutual fund option for insureds holding the securities of such named entities. The ban also applies to securities held on a US or foreign exchange if the investor is a US person. The NYSE has announced the delisting of these companies, and both the NASDAQ and MCSI have announced they will remove the listed companies from their indices.

In short, while other lame duck presidents have taken actions that make things easier for their successors, the Trump administration has taken the opposite tack in an apparent effort to lock in a hard-line China policy. It will be more challenging for the Biden administration to easily unwind. In response, China has adopted its own regulations prohibiting Chinese companies and individuals from complying with “punitive measures mandated by foreign governments.”

Outlook under President Biden

Whether and to what degree the Biden administration will implement, unwind or limit the scope or applicability of these and other pre-existing Trump administration restrictions against China remain to be seen. As a threshold matter, we expect an initial waiting period as the Biden administration gets its new team in place, evaluates its overall strategic approach toward China, and considers these particular restrictive measures in the context of its overall strategy.

Generally, based on public statements to date, we believe that the Biden administration will in all probability share the basic view that China is a strategic competitor and potential adversary. However, how to deal with China, a major power whose cooperation the United States needs on some important issues, is another matter – there are a range of possible approaches. In this regard, at this early juncture, we believe that US policy toward China under President Biden is likely to reflect a number of elements:

-selective disengagement with China in certain areas viewed as more central to national security and cooperative in other areas where national security risks are considered less significant;

-more cooperation with allies to shape shared approaches to addressing areas of concern with respect to China;

-stronger views on human rights violations by China; and

-more direct engagement with China on areas of concern with a view toward seeking sensible solutions.

It is within this overall policy framework that the Biden administration will evaluate and approach the new and existing China restrictions imposed by the Trump administration. Certainly, the Biden administration has the legal authority to undo or roll back nearly all of the Trump Administration’s actions.

At the same time, the new administration undoubtedly will recognize that any major actions to roll back China sanctions will be controversial and raise questions among policy hard-liners who believe stringent dual-use export control sanctions are strongly justified in light of China’s “military-civil fusion” strategy (i.e., whereby any dual-use exports to commercial firms could wind up in China’s military sector). Indeed, even small actions to curtail or limit China sanctions (e.g., removing companies from lists, creating new licenses or issuing new interpretations) will send political signals both at home and abroad. Meanwhile, the business community will monitor and interpret such measures in Talmudic fashion to divine if there is a new wind blowing in this area.

For these and other reasons, we do not foresee an imminent reversal of most of the Trump administration’s actions. Rather, we expect a more balanced and incremental approach than we have seen in the last four years, with more careful sculpting of existing sanctions to ameliorate the effects (with FAQs, licenses and the like) while taking a strong line against China in other areas in coordination with close allies.

Previous installments can be found here.

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Jeffrey P. Bialos, partner at Eversheds Sutherland, assists clients in making multi-faceted business decisions, structuring transactions and complying with complex regulatory requirements. A former Deputy Under Secretary of Defense for Industrial Affairs, he brings deep experience in defense, homeland security and national security matters, including antitrust, export controls, foreign investment, industrial security, the Foreign Corrupt Practices Act, and mergers and acquisitions, and procurement.

Ginger T. Faulk, partner at Eversheds Sutherland, represents multinational companies in matters involving US government regulation of foreign trade and investment. She has extensive experience advising and representing global companies, counseling clients in matters arising under US sanctions, export controls, import and other national security and foreign policy trade-related regulations.

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UNPACKING US-CHINA SANCTIONS AND EXPORT CONTROL REGULATIONS: PRACTICAL COMPLIANCE STRATEGIES

December 22nd, 2020 Ginger T. Faulk and Jeffrey P. Bialos Leave a comment

This is the fourth in a series of articles by Eversheds Sutherland partners Jeff Bialos and Ginger Faulk explaining the legal and regulatory impacts of certain recent US sanctions and export control actions targeting various Chinese entities. Each article explains the regulatory context of the recent rules.

Our previous articles have discussed recent developments in US sanctions and export controls affecting trade with China, including US export controls on software and semiconductor technology, the Department of Defense list of Chinese military companies, the Commerce Department’s “Military End User” rule, and the use of the US “Entity List” to target various concerns from export control to human rights to Iran sanctions. The last month has also seen efforts to restrict foreign investments in publicly traded securities of companies associated with the Chinese military.

The purpose of this article is to provide a framework and practical guidance for complying with existing and emerging US-China export controls and sanctions. In other words, how does a company establish an effective compliance program that appropriately manages risk, limits potential liability exposure, and, at the same time, if things go wrong, confirms to regulators and prosecutors that the company took compliance seriously, thereby mitigating penalties and avoiding a criminal referral?

The best approach to trade compliance is a multidisciplinary approach

As a starting point, if recent developments in US-China trade policies have taught us anything, it’s that US trade restrictions can apply to everything from technical exchanges (internal and external) and product shipments to intracompany shipments and financial transactions and investments. As such, a company’s approach to compliance with US-China trade rules and well as the broader range of other sanctions regimes should be multidisciplinary and capable of responding to emerging requirements in any and all of these areas.

Recent US-China trade policies have targeted certain products, technology, and software; third parties; financial flows and financial institutions; inbound foreign investment; imports and tariffs; and even access to capital market financing. As a result, in considering your multinational company’s compliance obligations and risk exposure, you should consider the implications across business units and functions, including:

-Research and Development

-Sales and Marketing

-Procurement

-Shipping and Logistics

-Finance and Accounting

-Banking and Insurance

-Customer Service

-IT Systems, and others.

These rules can apply to intra-company, as well as external, activities. Even if one segment of your business has a particular type of heightened risk exposure, it does not mean that is the only segment of your business that may be exposed.

Ensure accountability and support for trade compliance

Overall, an effective compliance program requires a number of core elements: 1) leadership commitment and the allocation of resources to the compliance function; 2) robust procedures and processes integrated into the company’s business; 3) internal controls that can test the efficacy of the procedures on an ongoing basis; and 4) training that ensures that the company’s personnel understand their compliance obligations and internalize them in their work routines.

US regulatory agencies expect a company to assign responsibility to a person or function within a company for ensuring trade compliance and to provide that function sufficient access to, and support from, senior management. Often, this means designating a compliance officer who reports to the board of directors. Regulators will look not only at a company’s “culture of compliance,” but also assess whether the company provided adequate compliance resources commensurate with the size and nature of its operations. Recognizing that a corporate parent may be held liable for its subsidiaries’ trade control violations resulting from inadequate supervision, companies are advised to establish centralized policies and procedures for ensuring and monitoring compliance by each of their subsidiaries. Compliance integration under these policies should be part of every post-acquisition integration effort.

Know Thyself: Assessing your own business risks

A centerpiece of modern regulatory compliance is prudent risk management. In many regulatory areas, including sanctions, it is challenging for firms to achieve 100% compliance at all times. Rather, the goal is to establish a program to appropriately manage and mitigate compliance risk.

US foreign trade and investment regulatory and enforcement agencies emphasize the importance of conducting a risk assessment in order to identify compliance risks that are particular to your business. OFAC’s Framework for Compliance Commitments advises companies in developing compliance measures to consider the risk profiles of the company’s “customers, supply chain, intermediaries, and counter-parties; (ii) the products and services it offers, including how and where such items fit into other financial or commercial products, services, networks, or systems; and (iii) the geographic locations of the organization, as well as its customers, supply chain, intermediaries, and counter-parties.” [1]

You should also understand how sanctions laws may apply in the context of your company’s multinational structure and operations. It is a mistake to believe that companies operating outside of the US cannot be touched by US sanctions and export controls. Many times violations arise from US person “facilitation” of sanctioned activities and interactions by non-US companies with the US financial system, e.g., through US dollar-denominated financial transactions. For this reason, some US-based multinationals have elected to apply sanctions and export control compliance throughout not only their US, but also foreign, operations – even in areas where the controls are not fully extraterritorial. The application of corporate liability rules in a multinational enterprise where US persons have some level of involvement around the globe otherwise makes compliance more challenging than it needs to be.

In assessing its exposure to US trade controls, a company must look not only at the location of management and administrative support personnel, but also the geographic footprint of its entire product and R&D supply chains, i.e., the location of internal technology and software development and the location of manufacturing of products, parts, components and materials and the development of software and technology on which they are based. Consider not only software and technology shared with third parties but also internal (intracompany) cross-border or domestic transfers of software and technology and establish effective internal controls.

Implement a program to manage identified risks effectively, including Know Your Counterparty (KYC) controls

As impressive as a compliance program may appear on paper, the only worthwhile compliance program is one that is effective. To be effective, a compliance program should work with company’s existing structures and information flows and be integrated with day to day internal work instructions. It needs to be able to incorporate and screen in real-time existing third-party information and implement stop-hold procedures for transactions that trigger risk. This usually calls for a customized screening and software solution.

In developing a trade compliance program, US regulators and enforcement agencies encourage companies to build around certain basic core elements.

Management Commitment – As discussed above, demonstrate and document senior management approval of the compliance program and foster a “culture of compliance” with a positive “tone from the top.”

(2) Risk Assessment – Again, a compliance program must be responsive to identified risks, and there is no “one-size-fits-all” approach.

(3) Internal Controls – Per OFAC, this refers to “policies and procedures, in order to identify, interdict, escalate, report (as appropriate), and keep records pertaining to activity that may be prohibited by the regulations and laws.” These internal policies should be clearly set out in writing and consistently implemented and enforced. Heightened review is recommended for transfers of dual-use and military items and dealings with high-risk destinations or counter-parties.

Beyond day-to-day KYC screening, numerous companies have recognized that their foreign collaborative engagements can involve significant risk, which can vary depending on the country, industry, and the particular party involved. Thus, firms often establish a special committee to vet engagements with third parties, whether agents, distributors, or joint venture partners. Individual business units may propose these engagements, and the company will evaluate them on an enterprise-wide basis after due diligence and the assessment of risks, advising also on the structuring of legal arrangements to mitigate such risks.

(4) Testing and Auditing – Regular monitoring of trade compliance is encouraged and, in some cases, expected. Regular auditing can occur at a global level or may rotate to focus on certain business units, functions, or procedures. Testing and auditing may be conducted by internal audit or external subject matter experts.

(5) Compliance training – Much of trade compliance depends on employees knowing how to spot and address “red flags” of sanctions and export control issues. Compliance training should provide information that is readily useable and easily accessible, risk-focused, and tailored to the duties and responsibilities of the participants.

To summarize, in today’s global business, complying with US-China trade policies requires a holistic review of a company’s external and internal operations. The best compliance programs are developed on the basis of a realistic review of a company’s compliance risk exposure; designed to be able to respond to ever-changing targets and regulations; and implemented effectively to work with a company’s existing systems and structures.

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[1] OFAC Framework for Compliance Commitments, at https://home.treasury.gov/system/files/126/framework_ofac_cc.pdf; see also BIS Elements of an Effective Compliance Program, available at at https://www.bis.doc.gov/index.php/documents/pdfs/1641-ecp/file; see also US Department of Justice, National Security Division, “Export Control and Sanctions Enforcement Policy for Business Organizations,” Dec. 14, 2019, available at https://us.eversheds-sutherland.com/portalresource/ces_vsd_policy_2019.pdf.

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UNPACKING US-CHINA SANCTIONS AND EXPORT CONTROL REGULATIONS: THE US “ENTITY LIST”

November 24th, 2020 Ginger T. Faulk and Jeffrey P. Bialos Leave a comment

This is the third in a series of articles by Eversheds Sutherland partners Ginger Faulk and Jeff Bialos explaining the legal and regulatory impacts of certain recent US sanctions and export control actions targeting various Chinese entities. Each article explains the regulatory context of the recent rules. Recognizing that this is a highly charged political topic, the article does not condone or promote any governmental actions discussed here but is only explanatory in nature.

If the first time you ever heard of the US “Entity List” was in March 2016, when subsidiaries of mobile telecommunications equipment manufacturer ZTE Corporation were listed, or in March 2017, when ZTE agreed to an $892,360,064 penalty and settlement agreement in order to secure its removal from the list, you are probably not alone. That 2016 listing had to do with allegations of evasion of US sanctions against North Korea and Iran. More recent Entity List designations have derived not only from US economic sanctions but also cite to various other types of US allegations or policy concerns.

In the first article of this series, we discussed US export controls applicable to Huawei as a result of its designation on the Entity List in May 2019. In this article, we delve into the background and regulatory context of the list itself, as compared to other US sanctions lists, and discuss ways it has been used in the last four years under the Trump Administration.

1. What is the Entity List and What are Its Origins?

The Bureau of Industry and Security (“BIS”) at the US Department of Commerce administers US export controls pursuant to the Export Administration Regulations (“EAR”). The EAR generally controls, and in some cases, requires licenses for, exports on the basis of the type of product, the country of export and the reasons for control, e.g. Anti-Terrorism, Nonproliferation, National Security, etc. In contrast, the Entity List imposes comprehensive export controls applicable to particular foreign entities due to specific policy concerns.

The US Entity List was established in 1997. It initially focused on identifying the public entities at risk of causing the diversion of exported items in support of the proliferation of weapons of mass destruction. Since its initial publication, however, the purpose of the Entity List has been considerably expanded to encompass the identification and designation of foreign entities and other persons “reasonably believed to be involved, or to pose a significant risk of being or becoming involved, in activities contrary to the national security or foreign policy interests of the United States.” A committee (known as the “ERC”) composed of the US Departments of Commerce (Chair), State, Defense, Energy and Treasury adds persons to the Entity List by majority vote.

Once an entity is added to the list, it generally follows that exports or re-exports of goods, technology or software (“items”) that are “subject to the EAR” require an export license issued by BIS. As a result, the export and re-export of not only military or dual-use items but all categories of items are subject to a licensing requirement (of course, to the extent that they are deemed to be subject to the jurisdiction of US export controls). Notably, the Commerce Department’s policy is generally one of “presumption of denial” for these types of license applications unless indicated otherwise in the company’s listing.

Jurisdictionally, the ban applies also to non-US persons to the extent that those persons deal in subject US items. Significantly, items “subject to the EAR” includes not only US-origin items and items exported from the US but also non-US-origin items that contain more than a minimal (“de minimis”) level of controlled US-origin content. Since a licensing requirement generally applies to exports or re-exports of any item to an Entity List entity, this means that any type of US content or component whatsoever, provided it is of sufficient value as compared to the overall fair-market value of the finished item (25% for non-embargoed countries, including China), could cause an item manufactured outside of the US item to be “subject to the EAR” and therefore requiring a license for export or re-export to an Entity List entity.

2. The Entity List and China

Until 2012, there were fewer than 30 Chinese entities on the Entity List. Before President Trump’s 2017 Inauguration, fewer than 100 Chinese entities had ever been listed on the Entity List over its 23-year history. Since then, however, more than 200 Chinese companies have been added to the Entity List, making export controls one of many contentious issues in recent US-China relations. Perhaps most notable was the May 2019 listing of Huawei and its 114 non-US affiliates – an enterprise which recently took the place of Samsung as the world’s largest mobile phone manufacturer (as addressed in our earlier article). More recently, the US added a number of Chinese state-owned enterprises to the Entity List on the basis of their alleged support in advancing Beijing’s territorial claims in the South China Sea. Further, over the last year, more than 38 individuals and entities were added for reasons related to their alleged use of forced labor in the Xinjiang province of China.

One might ask why the US Commerce Department would use the same export control list to address so many varied types of issues. And does it make sense to designate under export controls companies that are the producers of raw materials such as cotton and textile producers in Xinjiang?

The answer lies both in the designation process and in the intended impacts of an Entity List designation. As noted, the ERC is an interagency committee represented by multiple US government departments. Fundamentally, it affords the ERC, the interagency charged with adding companies to the list, the flexibility to address certain conduct by such entities in a more targeted and flexible fashion – as it did with respect to Huawei. In this regard, an Entity List designation does not impose the same outright ban on all commercial and financial dealings as a designation on the US Treasury Department’s Specially Designated Nationals List. It also is intended to signal to industry to use care when doing business with these entities.

In addition to the Entity List, BIS also maintains a Denied Persons List of persons or entities that are the subject of an export denial order. For example, after deciding that ZTE failed to fulfill its commitments under the 2017 settlement by which it secured its removal from the Entity List, BIS issued a denial order in June 2018 that exceeded the terms of the original Entity Listing by also preventing ZTE from directly or indirectly participating in any way in any transaction involving an item subject to the EAR. That denial order was removed following discussions between the Trump Administration and the Chinese government in July 2018.

3. Can a party seek removal from the Entity List?

The ERC also reviews requests for removal from the Entity List. To be removed, the person or entity must submit a request to the chairman of the ERC. In making a determination, the ERC will look favorably upon an entity’s cooperation with the US government and future compliance assurances. The ERC’s decision is final and cannot be appealed as an administrative matter.

4. Conclusion

Recently, the US has made frequent use of the Entity List to target Chinese companies over varied national security concerns. In response, China has introduced its own “Unreliable Entity List” regime, under which foreign entities or individuals that boycott supplies to Chinese companies for non-commercial reasons may be listed. It remains to be seen whether the US Commerce Department will continue to make such an expansive use of the Entity List under the Biden Administration.

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Eversheds Sutherland associate Vedia Biton Eidelman was a contributing author to this article.

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Unpacking U.S.-China Sanctions and Export Control Regulations: The China “Military End Use” and “Military End User” Rule and the Department of Defense List

October 26th, 2020 Ginger T. Faulk and Jeffrey P. Bialos Leave a comment

This is the second in a series of articles by Eversheds Sutherland partners Jeff Bialos and Ginger Faulk explaining the legal and regulatory impacts of certain recent US sanctions and export control actions targeting various Chinese entities. Each article explains the regulatory context of the recent rules. Recognizing that this is a highly charged political topic, the article does not condone or promote any governmental actions discussed here but is only explanatory in nature.

As part of the overall realignment of US national security strategy toward China, the US government has taken a series of actions this year to target the Chinese military sector through sanctions and export controls imposed against a range of Chinese companies. The recent promulgation of the expanded China “military end-use” and “military end user” rule mark an expansion of a longstanding US policy to bar certain exports of US “dual-use” goods and technologies that can contribute to China’s military capability. This, combined with the recent release by the Department of Defense of a list of companies considered to be “owned or controlled” by the Chinese military – pursuant to a 20-year-old law – signals increased US government pressure on China and its firms that are viewed as instruments of the Chinese government. These rules together threaten to limit significantly the availability of “dual-use” US goods and technology to Chinese companies on the list.

Unpacking the China “Military End User” Rule

A recent amendment to the Export Administration Regulations (EAR) targeting a broader range of “military end-uses” and “military end-users” in China is designed to curtail exports and re-exports of a range of US origin “dual-use” technology, software, and goods to China’s private sector but only where the private sector end-user is determined to support the Chinese military. Per the US Commerce Department, the new rule “will require increased diligence with respect to the evaluation of end-users in China, particularly in view of China’s widespread civil-military integration.”

Previously, the rule applied only when the item was intended for military end-use, e.g., incorporation into a military end-item. The new rule now expands this approach beyond exports for military end-use, and now requires an export license for exports or transfers of listed items to China if the item is intended entirely OR in part for a “military end-user” in these countries. Under this expanded control, the rule potentially proscribes exports and re-exports not only to the military (e.g., the Peoples Liberation Army (“PLA”)) but also to police, national guard, intelligence organizations and “any person or entity whose actions or functions are intended to support ‘military end-uses.’” In other words, an export of a subject item to a private sector company which also contracts with the Chinese government could be prohibited even if the item itself is neither destined for the military (defined in a traditional sense) nor for a military application.

In addition, the new rule expands the definition of “military end-use” by no longer just restricting exports for “the use, development, production of, or incorporation into” military items, but now also extending to an export that “supports or contributes to the operation, installation, maintenance, repair, overhaul, refurbishing, ‘development,’ or ‘production’ of military items.” A subject item that supports even one of these functions triggers the “military end-use” rule.

The rule also adds products to the scope of the rule under the categories of materials processing, electronics, telecommunications, information security, sensors and lasers, and propulsion. Importantly, now subject to the rule are 5G-capable microprocessors, devices, and components. Finally, the new rule subjects certain exports to China to new country-based licensing controls under a “regional stability” control.

Heightened Due Diligence Obligations for Exporters of Goods, Software and Technologies

Significantly, the new “military end user” rule imposes a broader obligation on US exporters to identify potential military links of Chinese counterparts and assure against diversion of technology to the Chinese military. It places the burden on US exporters to not only (i) determine the end-user of subject items, even if those items are transferred to a third country, but also to (ii) evaluate and determine whether the identified end-user would be considered a “military end user” by virtue of potential links with Chinese military agencies. This applies to exports of all subject items (e.g., 5G devices and certain electrical components, among others) regardless of how the export in question will ultimately be used.

In practical terms, this means enhanced due diligence to identify potential military affiliations of Chinese and third-country customers, distributors, procurement agents, and other intermediaries with respect to all dual-use exports to China. It also means re-evaluating technology sharing arrangements between US companies and Chinese joint venture partners such as commercial partners, research institutes, and academic institutions.

Note, the EAR controls apply not just to US goods and equipment but also foreign manufactured goods and equipment that incorporate US-origin content. The “dual-use” items that are subject to the military end-user rule are listed by category at Supplement No. 2 to the EAR 15 CFR Part 744 and include certain controlled materials and materials processing equipment, telecommunications equipment and software (e.g., 5G technologies), sensors and laser technology, and marine and space vessels. So, technology and software companies in any country whose products rely on these US technologies face a binary choice: either to police China business partners for even tangential connections to the military sector or divorce their China supply chains and technology/software flows from the US.

The PLA/DoD List

Similarly, on June 25^th, 2020, the US Department of Defense (DoD) issued a list of 20 “communist Chinese military companies” operating in the US that meet the criteria of section 1237 of the National Defense Authorization Act (“NDAA”) for FY 1999. Eleven new additions to the list were issued on August 28, 2020. [1] Companies on these lists include massive Chinese state-owned companies in the aerospace, construction and engineering, chemical, electronics, nuclear, telecommunications, and other sectors. The issuance of this list and the Commerce Department’s new end-user” rules are connected in that this list of companies is likely to guide determinations under the EAR “military end user” rule and the direction of future US-China sanctions actions. The DoD List may be a natural place for the US government to start in identifying Chinese “military end-users” subject to further restriction. Thus the implications for US technology partnerships with Chinese companies in these are potentially quite significant.

In 1999, Congress enacted a provision authorizing the DoD to issue a list of “communist Chinese military companies” operating in the US that are “owned or controlled by the People’s Liberation Army” and are “engaged in providing commercial services, manufacturing, production or exporting.”

On June 24, 2020, nearly 22 years later, DoD finally issued the list. This was in response to a letter sent by a bipartisan group of Senators to Secretary of Defense Mark Esper requesting that DoD issue the list as a tool to confront China and its stated strategy of “military-civilian fusion” to achieve its national objectives. The DoD compiled the list of companies that support the Chinese military as the basis for subsequent US policy actions to address the competitive Chinese threat. The specific risks under consideration included: 1) the transfer of “dual-use” technology to these companies that could, in turn, be used for military purposes given their relationships with the PLA; and 2) the supply chain risks associated with the participation of these companies in US supply chains (e.g., through providing equipment such as semiconductors). Such supply chain risks include the risks that such Chinese firms could introduce malevolent software into US products or use its equipment as a basis for surveillance (i.e., espionage).

It should be recognized that the companies on the DoD List by no means encompass the universe of Chinese government-owned or controlled companies, as there are numerous such state-owned or controlled companies not on the DoD List. Rather, the focus is on companies considered to be owned or controlled by the PLA itself. Further, the term “control,” as used in this context, appears to be broad in scope and seems to be utilized by DoD to reach companies that have some significant engagement with the PLA (i.e., where it might be the case that the PLA supervises or directs some functional activity or area at the company). In this regard, there are at least several companies on the DoD list not generally considered to be government-owned or controlled, let alone PLA owned or controlled in a traditional sense—a small number of which are publicly traded. Thus, in these circumstances, the “control” must relate to some functional areas of engagement. For example, in the case of Huawei, the control might arguably relate to the idea that the PLA can direct Huawei to utilize its platforms and equipment for surveillance or other activities.

Notably, being listed on the DoD list has no direct and immediate legal consequences for the listed companies. However, the law does make it easier for the president to impose sanctions. Once a company is on the section 1237 list, the president can impose the full array of economic sanctions without any additional finding, including prohibitions on US persons doing business with that company, export restrictions, and the like. Note also that the president can also impose an import ban on companies on the DoD list upon declaring an international economic emergency – an action that, if undertaken, is not subject to challenge in federal courts.

Further, as noted above, the recent listings of Chinese companies on the DoD List are likely to lead to additional export control restrictions on the named parties under the new Commerce rule that requires licenses, and establishes a “presumption of denial” policy, for exports, re-exports, or transfers (in-country) of certain products and technologies to Chinese “military end-users.” Since this new rule defines “military end-users” to include any “person or entity whose actions or functions are intended to support ‘military end uses,” it is reasonably likely that Commerce will find that parties listed on the DoD list would be considered a military “end-user,” and as such, any license applications for covered products and technologies will be subject to a presumption of denial.

Finally, the list is a tool that can generally build pressure on China. In releasing the list, DoD officials observed that “As the People’s Republic of China attempts to blur the lines between civil and military sectors, ‘knowing your supplier’ is critical … We envision this list will be used as a tool for the US government, companies, investors, academic institutions and like-minded parties to conduct due diligence with regard to partnerships with these entities….”

In conclusion, while the DoD/PLA list itself has no direct legal effect, in combination with the EAR’s military end-user rule, it signals a US desire to limit the availability of “dual-use” American technologies to these companies. To comply with the rule exporters and re-exporters of the listed US technologies must conduct heightened diligence of Chinese SOE end-users and will require a US export license where an end-user also uses, develops or produces items for the Chinese military. This places the impetus on the Chinese companies to demonstrate to US exporters and to the US government that, as applicable: 1) there is sufficient separation between subsidiaries with defense-related operations and those engaged in purely commercial activities; or 2) for those with purely commercial operations, they are not providing US-based dual-use products or technologies to support China’s military.

In some circumstances, it also means that Chinese companies on the list may be forced to look elsewhere (outside of the United States) for the equivalent non-US technologies and products and restructure their supply chains accordingly. Notably, the US position places it as an outlier among allied Western governments. If the US has a new President in 2021, we would expect to see a more multilateral approach on these and other China-related trade issues.

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[1] Both lists are available here.

Jeffrey P. Bialos, partner at Eversheds Sutherland, assists clients in making multi-faceted business decisions, structuring transactions and complying with complex regulatory requirements. As former Deputy Under Secretary of Defense for Industrial Affairs, he brings deep experience in defense, homeland security and national security matters, including antitrust, procurement, export controls, industrial security and the Foreign Corrupt Practices Act.

Archives, Global Trade Daily, Imports/Exports, International Trade, Software

UNPACKING US-CHINA SANCTIONS AND EXPORT CONTROL REGULATIONS: HUAWEI

September 10th, 2020 Ginger T. Faulk and Jeffrey P. Bialos Leave a comment

This is the first in a series of articles by Eversheds Sutherland partners Ginger Faulk and Jeff Bialos explaining the legal and regulatory impacts of certain recent US sanctions and export control actions targeting various Chinese entities. Each article focuses on a different aspect of a recent US sanctions or export control regulatory action targeting China and explains in-depth the regulatory context. Recognizing that this is a highly charged political topic, the article does not condone or promote any governmental actions discussed here but is only explanatory in nature.

You undoubtedly will have heard by now that the United States has effectively blocked Huawei’s access to US exports of goods, software and technology, handicapping a giant in the global battle for 5G dominance, upsetting telecom supply chains and setting off a telecom cybersecurity crisis of conscience among many of the world’s developed and developing nations. As a result of Huawei’s designation on the US Department of Commerce’s “Entity List” in May 2019, all companies – no matter where they are – are prohibited under US law from exporting, re-exporting or transferring items that are “subject to the [US] Export Administration Regulations (EAR)” to 152 non-US Huawei affiliates. As a result, hundreds of telecommunication and software companies in third world countries are faced with the binary choice of whether to source technology and software from the United States or to transact business with Huawei.

The US government apparently concluded that this move alone did not work to prevent Huawei from benefiting from US-origin 5G semiconductor technology. Thus, more than a year later, recent rules have expanded the definition of what is “subject to the EAR,” with respect to Huawei specifically, to include offshore semiconductor production based on US technology. The changes to the rule demonstrate how US export controls are evolving to address perceived national security threats in the telecom sector writ large.

All of this is occurring against the backdrop of the US seeking to encourage friends and allies in Europe and beyond to eliminate or at least restrict the role of Huawei in their domestic telecom network infrastructure. This effort is based on concerns over the risk that Huawei theoretically could, at the behest of the Chinese government, either disrupt such infrastructure during periods of exigency or use their access to these platforms to conduct surveillance. In this regard, the new and more restrictive US regulatory approach to Huawei’s access to offshore semiconductor chips appears to have been effective. The UK has reportedly restricted its engagement with Huawei in 5G, apparently as a consequence of supply chain risks resulting from the new US rules, in other words, out of concern that Huawei might not have sufficient access to necessary semiconductor chips to meet the UK’s telecom needs. Whether other US friends and allies will do likewise remains to be seen.

1. The initial Huawei ban

Since May 2019, the Export Administration Regulations have prohibited US and non-US persons and companies from exporting, re-exporting or transferring in the country, or causing, aiding, abetting or soliciting the export, re-export or transfer of, any item that is “subject to the EAR” to the designated Huawei affiliates.

Items that are “subject to the EAR”[1] include all commodities, software and technology, regardless of their sensitivity, that are:

1. a) in the US (even temporarily);

2. b) produced in the US, or

3. c) exported from the US.

The EAR state further that “items subject to the EAR” include all hardware, software and technology that meet the definition of that term, whether or not the items are listed on the Commerce Control List (CCL) in Part 774 of the EAR. Items subject to the EAR that are not listed in the CCL are designated as “EAR99,” which serves as a catchall category.

Non-US-origin items produced and sold from outside the US also may be subject to the EAR in the following ways:

(a) Under the “De minimis Rule,” non-US items subject to the EAR include items anywhere in the world that contain more than a certain percentage (25% in most cases) US-origin content by value based on fair market price.

(b) Under the “Direct Product Rule,” foreign items that:

(i) are the direct product of certain “National Security”-controlled US technology, software, or

(ii) are the direct product of a factory or major component of a factory (such as, chip manufacturing equipment) that is itself the direct product of specified controlled technology or software that may be subject to the EAR.

The Entity List designation created challenges for numerous US companies that are suppliers to Huawei or that afford it access to their technology platforms, such as Google’s Android operating system. Following the BIS designation, some of these US technology companies – including Google, Intel, Qualcomm and Broadcom – announced they would cease doing business with Huawei, effective immediately. Specifically, Google announced it would cut off Huawei’s access to the Google Play Store and to the core components of the Android ecosystem that are built by Google (i.e., not those distributed under the Android Open Source Project (AOSP)). Given that many third-party apps rely on Google Maps, this restricted the offerings of Huawei handsets, especially in the European markets. The chips manufacturers also were forced to shift outside of the US manufacturing and processing of silicon wafers that would ultimately be sold to Huawei.

Shortly after Huawei’s designation, in response to clamoring by industry, a Temporary General License (TGL) was issued to authorize the continued operation of existing networks and equipment, continued support to existing Huawei personal devices and equipment and cybersecurity research and vulnerability disclosures. It also authorized engagement with Huawei companies for the development of 5G standards. The goal of the TGL was to allow time in which to phase in the application of the designation for US firms with pre-existing arrangements with Huawei and allow them time to plan for an appropriate transition.

2. What was the perceived “loophole” in the rule?

Meanwhile, chipmaking factories outside of the United States, including Taiwan-based manufacturers, apparently continued to fabricate cutting-edge chips for Huawei using certain equipment that was designed, in part, based on US-origin technology.

This is because, for the first year of the rule (until May 16, 2020), whether intentionally or not, chips manufactured outside of the United States – even those designed or produced using US technology – appeared to fall outside of the EAR’s jurisdiction. Indeed, for purposes of determining US content value, the value of technology incorporated into a software or hardware component or used to design chip manufacturing equipment is not valued. As such, the “direct product rule” (prior to May 15, 2020) applied only to certain types of controlled technology to certain countries and did not extend to reexports to China of non-US-manufactured semiconductors not containing US-manufactured components.

3. How did US regulators fill in the loophole?

On May 15, 2020, almost exactly a year after the Entity List ban came into place, a new “footnote 1” was added to the Entity List banning the unlicensed export specifically to listed Huawei entities (but not to others on the Entity List) of a broad spectrum of foreign-produced telecom and computer components and equipment that are (i) the “direct product” of US technology or US software, or (ii) are the “direct product of manufacturing equipment that itself is a direct product of US technology or software. This extended the ban to, for example, semiconductor designs – and chipsets produced from those designs – that are developed on the basis of US software or technology. It also extended the ban to chipsets produced using semiconductor manufacturing equipment, even in Taiwan, if that equipment was designed on the basis of US-origin technology. According to industry experts, this seems to cover almost any chip currently in production. “To prevent immediate adverse economic impacts on foreign foundries utilizing US semiconductor manufacturing equipment that have initiated any production step,” the US provided a 120-day grace period for exports to Huawei of items based on (US-derived) Huawei design specifications as of May 15, 2020.

Under this revised rule, foreign-produced chips are prohibited for export or re-export when there is “knowledge [including awareness of a high probability] that they are destined for re-export, export from abroad, or transfer (in-country) to Huawei or any of its affiliates on the Entity List.” This change threatens to impact Huawei’s access to 5G microprocessors and appears to have caused the UK to rethink the role of Huawei in its developing 5G network. The US work to close the loophole was not yet complete, however…

4. The grip tightens…

The most recent rule change on August 20 ended the Temporary General License and also further tightened the screws on Huawei by clarifying that the ban applies (1) not only when a listed Huawei affiliate is the destination for or receives an item but also whenever it is an indirect party to a transaction involving a subject item, e.g., as a “purchaser,” “intermediate consignee,” “ultimate consignee” or “end-user,” and (2) when the foreign-produced item will be incorporated into or used in the production or development of any part, component or equipment produced, purchased or ordered by a listed Huawei entity. These changes were principally designed to address concerns raised by public commenters that Huawei could continue to procure US manufactured items through third-parties who incorporate the subject US-controlled component into a system that is ultimately sold to Huawei.

Critics of the rule have commented that the new rule will encourage China to develop its own computer and telecom system chips and technologies in order to support Huawei and other Chinese companies that rely on such chips for their products. Others have voiced concerns that – without US security patches and software updates permitted under the TGL – overseas consumers and operators will be vulnerable to severe disruptions and cyber-security risks.

Meanwhile, the global telecom sector is carefully watching countries like Germany, which is deciding the role that Huawei will play in domestic telecoms infrastructure. These decisions will signal whether continental Europe and other US friends and allies in Asia and elsewhere will fall in line behind US efforts to exclude Huawei from global networks – thereby decoupling US-China telecom supply chains. Or alternatively, whether these countries will assert their own “digital sovereignty” and allow Huawei a continued role – with attendant repercussions on their security relationships with the United States.

Meanwhile, the Department of Commerce enjoys the latitude to issue specific export licenses to firms that request to keep supplying Huawei with software or components. The stage is set for the battle to continue as China is reportedly considering retaliatory measures of its own, possibly to include its own export controls.

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Jeffrey P. Bialos, partner at Eversheds Sutherland, assists clients in making multi-faceted business decisions, structuring transactions and complying with complex regulatory requirements. As former Deputy Under Secretary of Defense for Industrial Affairs, he brings deep experience in defense, homeland security and national security matters, including antitrust, procurement, export controls, industrial security and the Foreign Corrupt Practices Act.

[1] See generally 15 CFR Parts 732 and 734.

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