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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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.

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.