On November 12, 2020, President Trump issued an executive order (Order) that effectively prohibits US persons from transacting in publicly traded securities of Chinese firms determined by the US government to be owned or controlled by the Chinese military. The ban goes into effect January 11, 2021.
This action, which may foreshadow further tough measures against China in the waning days of the Trump Administration, is one of the first cases where Chinese access to capital markets has been limited for policy reasons. At this writing, the potential impact of this action on capital markets or US investors remains uncertain.
Authority and Rationale. The President issued the Order pursuant to his authority under the International Emergency Economic Powers Act (IEEPA) and the National Emergencies Act. Under IEEPA, upon the declaration of an international economic emergency, the President has the authority to regulate or prohibit a broad range of transactions subject to US jurisdiction.
The Order follows from a number of recent Trump Administration actions taken to effectively disengage from Chinese firms that support the Chinese military, including additional export control restrictions on Chinese end uses and end-users as well as Chinese firms assisting the Chinese military in its incursion into, and development and militarization of, artificial islands within the South China Sea. Notably, of direct relevance here, the Department of Defense, pursuant to Section 1237 of the National Defense Authorization Act for Fiscal Year 1999, recently designated 31 Chinese companies “engaged in providing commercial services, manufacturing, producing, or exporting” as “owned or controlled by, or affiliated with” the People’s Liberation Army (PLA) (DoD List). These companies are each considered to be a “Communist Chinese military company” according to the Order.
Building on these actions, the Order states that China is “increasingly exploiting United States capital to resource and to enable the development and modernization of its military, intelligence, and security apparatuses, which continues to allow the [China] to directly threaten the United States…” As Robert C. O’Brien, the national security adviser to President Trump, said, the action “serves to protect American investors from unintentionally providing capital that goes to enhancing the capabilities of the People’s Liberation Army and People’s Republic of China intelligence services.”
The Prohibition. Specifically, beginning on January 11, 2021, US persons are prohibited from transacting in the publically traded securities, or any securities that are derivative of, or are designed to provide investment exposure to such securities, of any Chinese military company designated on the DoD List now or in the future. Through November 11, 2021, trades that only divest in such securities that a US person held as of January 11, 2021 are permitted.
The prohibition also extends to subsidiaries of an entity already designated on the DoD List if the subsidiaries have also been so designated. US persons would be prohibited from such investment transactions 60 days after additional Chinese companies are designated and would have 365 days to divest of shares held on that date.
By its terms, the Order, which is broad in scope, appears to apply not only to direct purchases of publicly traded securities but purchases by US persons of shares in investment funds that hold public securities in such companies. In this regard, there is no exemption for such indirect purchases in the Order and it applies to purchases designed to “provide investment exposure to such securities” – the purchase of shares in a diversified fund which hold shares in such Chinese military companies might be considered to “provide investment exposure” to those securities. This conclusion also is supported by the anti-circumvention provision in the Order, which bars US persons from actions that evade or avoid the effect of the Order.
Similarly, the Order also appears to apply to transactions by US persons involving public securities in such Chinese military firms traded on foreign as well as US exchanges. Whether Treasury, which is charged with implementing the Order, later exempts or limits transactions through investment funds or held on foreign exchanges from the scope of the Order remains to be seen.
The Order does permit US persons to engage in transactions to divest from such securities by certain deadlines. Moreover, the Order also prohibits any transaction by a US person or within the United States that evades or avoids, has the purpose of evading or avoiding, causes a violation of, or attempts to violate the Order.
What Chinese Firms Securities are the Subject of the Rule? As noted above, the Order is directly applicable to transactions in publicly traded securities of Chinese companies on the DOD List. As such, if a company on the DOD List is not publically traded, it would apparently not be affected. During the summer of 2020, the DOD designated a total of 31 Chinese companies for the DOD List, including China Telecommunication Corp. and China Mobil Communications, both of which are listed on the New York Stock Exchange (NYSE), and China North Industries Group Corporation (Norinco Group), among others.
Why was this Order issued now? On one level, this Order is a continuation of and consistent with recent Administration actions with respect to Chinese military companies. Beyond that, with a change in administrations around the corner, it is possible the Trump Administration is trying to lock in a strong policy stance against China in this area. Of course, since the Order is administrative in nature, President-elect Biden, upon taking office, could rescind it or limit its scope. However, the Trump Administration may be taking the view that the incoming Administration would be reluctant to do that in the context of recent US-China relations and domestic politics.
This article originally appeared on the Eversheds Sutherland blog.