U.S. Policy-makers Consider Alternatives for Outbound Investment Review

Key Points

• U.S. policy-makers are actively considering ways to limit outbound investment in countries of concern, including China and Russia. One of the most visible examples is the U.S. House of Representative’s passage of legislation to create a new government mechanism to review and prohibit a broad range of foreign investment by U.S. companies, as part of broader China competitiveness legislation.
• In recent weeks, as Congress enters conference negotiations to reconcile the House and Senate versions of the China competitiveness legislation, new proposals on outbound investment have emerged from key policy-makers in the administration and Congress. These proposals appear to recognize that the legislation passed by the House is unlikely to be included in the final conference report, and thus changes are needed to gain requisite congressional support.
• A U.S. Treasury Department draft bill that was recently made public entitled the “Sensitive Technologies Supply Chain Risk Management Act of 2022” would establish a pilot program requiring U.S. companies and individuals to submit notifications regarding certain outbound investments in China and Russia, among other designated countries, that involve sensitive technologies.
• The stated purpose of this pilot program is to better inform the U.S. government’s assessment of the national security concerns arising from those transactions and, based on those findings, identify what new authorities are needed to address those risks. Notably, while mandatory reporting applies to “notifiable transactions,” the pilot program would not authorize any actions to prohibit, suspend, mitigate or otherwise intervene in notified transactions.
• Sen. John Cornyn (R-TX), one of the original cosponsors of the legislation that passed the House, is also circulating a conference committee working paper that proposes narrowing the original bill in key ways.

Background

Over the past year, Congress and the Biden-Harris administration have been actively considering new ways to limit U.S. investment in China and (more recently) Russia. While some restrictions and penalties in this area have been imposed over the past few years (e.g., the Office of Foreign Assets Control (OFAC) investment prohibitions on Chinese-Military Industrial Complex Companies and the expected delisting of U.S.-listed Chinese companies pursuant to the Holding Foreign Companies Accountable Act), policy-makers from both parties have advocated for additional measures, particularly as it relates to investments in sensitive sectors and critical supply chains. Along those lines, the U.S.-China Economic and Security Review Commission’s (USCC) 2021 Annual Report recommended establishing authority to “screen the offshoring of critical supply chains and production capabilities to [China] to protect U.S. national and economic security interests.”

In this context, Sens. Casey and Cornyn last year introduced legislation to create a new mechanism through which the U.S. government would review outbound U.S. investments that result in the offshoring of critical supply chains and tech-industry resources to adversaries, particularly China and Russia. The legislation—titled the National Critical Capabilities Defense Act (NCCDA)—would create a new “reverse Committee on Foreign Investment in the United States (CFIUS)”-like interagency—the Committee on National Critical Capabilities to review-like interagency—the Committee on National Critical Capabilities to review certain outbound transactions. Led by the Office of the United States Trade Representative (USTR), the NCCDA would authorize the new committee to review and clear or recommend the president block, as warranted, transactions by U.S. businesses that would shift or relocate any “design, development, production, manufacture, fabrication, supply, servicing, testing, management, operation, investment, ownership or any other essential elements” involving one or more “national critical capabilities” to a “country of concern” (e.g., China or Russia). All covered transactions would be subject to mandatory filing, and any transaction identified by the committee as presenting an “unacceptable risk” to a national critical capability would be subject to potential blocking and other measures ordered by the President.

The Senate has not passed the NCCDA, either as part of last year’s U.S. Industrial Competitiveness Act (USICA) or the FY 2022 National Defense Authorization Act (NDAA). However, the House did pass this bill as part of the America COMPETES Act, which is its version of the China competition legislation, setting up the possibility of its inclusion in the reconciled version of the COMPETES-USICA legislation, referred to as the Bipartisan Innovation Act, which is currently being considered in conference. With that in mind, various business groups and numerous members of Congress have come out against the NCCDA given its breadth and significant concerns that the current proposal would not be implementable from a regulatory perspective without a substantial, near-term overhaul, and expansion of USTR and other federal agencies.

Meanwhile, the Biden-Harris administration has also vocalized support for some form of outbound investment screening. National Security Advisor Jake Sullivan has stated that the administration is concerned about the potential for outbound U.S. investments to enhance the Chinese military’s technological capacity, circumvent U.S. export controls and increase U.S. supply chain reliance on China in critical industries. Along those lines, Commerce and Treasury officials also have made statements in favor of some form of outbound investment review.

Overview of Treasury’s Draft Legislation

The Treasury draft legislation states that it is focused on “efforts of certain governments to control the supply chain of sensitive technologies [that] endanger the national security of the United States” and its allies while ensuring that the United States continue its open investment policy. With that in mind, the pilot program would impose a mandatory notification requirement in connection with certain transactions, as follows:

Who would need to submit? The reporting requirements would apply to “U.S. persons” that engage in a “notifiable transaction” (defined below). “U.S. person” is defined as any U.S. citizens and lawful permanent residents, as well as entities organized under U.S. law and “any subsidiary entity in which any such person or organization has a majority voting interest.” In other words, the requirement extends to foreign subsidiaries of U.S. companies.

Which countries and investment targets are captured? The pilot program generally would apply to certain investments in a “covered foreign person.” This term captures entities that (i) produce, design, test, manufacture, fabricate or develop “sensitive technologies” (or will as a result of the transaction) and (ii) either are (a) organized under the laws of a “covered state” if either their principal place of business is in such a state or their equity securities are primarily traded on an exchange in such a state; or (b) directly or indirectly owned, above a yet-to-be-determined threshold, by the government of a covered state. The draft defines “covered states” as those referenced in Section 126.1 of the International Traffic in Arms Regulations, which includes China and Russia, among other countries subject to arms embargoes or restrictions.

What types of transactions would be covered? The requirement would apply to “notifiable transactions,” which are investments by U.S. persons as follows: (i) direct or indirect “substantial investments” (i.e., above a yet-to-be-specified threshold) in a covered foreign person; (ii) direct or indirect investments of any value in a covered foreign person in which the investor has made or is making any “non-monetary contribution” (an undefined term); and (iii) a greenfield investment in a covered state when the investor is engaged in the production, design, testing, manufacturing, fabrication or development of a sensitive technology. The draft legislation defines “investment” to mean the acquisition of equity or contingent equity interests, monetary capital contributions or other payments.

Which technologies are targeted? The draft legislation is focused on “sensitive technologies” and defines that term as “those items for which dependence on supply from foreign persons of concern is likely to pose an unacceptable risk to the national security of the United States including technologies subject to export controls.” Notably, Treasury did not use the existing CFIUS term “critical technologies,” which captures most export-controlled items. In making this decision, Treasury may be signaling that it is focused on a wider range of technology, particularly related to emerging technologies (e.g., artificial intelligence), than what is currently controlled for export.

What are the penalties for noncompliance? The draft legislation contemplates the imposition of civil penalties up to $250,000 for failure to notify a covered transaction and for any material omissions or misstatements in submitted information. 

What is the timing and output of the pilot program? The draft legislation contemplates the pilot program becoming effective 180 days from enactment of the legislation for any transaction proposed or pending at that point. The program would run for approximately 18 months thereafter. At a yet-to-be-determined date at the end of that period, the responsible agency would prepare a report summarizing its findings and recommendations based on the pilot program and submit it to the appropriate congressional committees.

Key Contrasts with the NCCDA

Treasury’s draft does have similarities to the NCCDA in that it would impose a mandatory filing obligation related to certain investments related to critical supply chains. However, it diverges significantly from that legislation in a few fundamental ways, including:

• Narrowed/Targeted Scope – the NCCDA captures any transaction by a U.S. person that “shifts or relocates” the design, development, production, manufacture, fabrication, supply, servicing, testing, management, operation, investment, ownership or any other essential elements of “national critical capabilities” to a “country of concern.” Such capabilities would span from personal protective equipment to critical infrastructure to weapons systems, among others. In contrast, the Treasury draft is more narrowly focused on certain types of equity/financial investments involving sensitive technologies.
• Reporting Only – the NCCDA provides authority to mitigate, suspend and prohibit transactions. As noted above, however, the Treasury pilot program would be limited to a reporting requirement that will provide policy-makers with enough information and data to sufficiently assess the scope and character of national security concerns presented by the covered outbound investments and would result in a report to Congress with recommendations of the appropriate authorities to address risk in this area.
• No USTR Mandate – the NCCDA designates USTR as the lead agency in charge of the review process. Since USTR is a small agency (approximately 275 employees) that is focused on trade policy and trade agreement negotiation/litigation, it is unclear how it would be able to undertake this responsibility without a significant overhaul and expansion. Alternatively, the Treasury draft leaves open which agency would be charged with administering this pilot program, though it seems that Treasury (or perhaps Commerce) would be the leading contenders since they are larger agencies with similar existing mandates.

Cornyn Conference Proposal

In recent days, Sen. Cornyn has sought to generate more support for the NCCDA, including by floating potential revisions in a conference committee working paper that would limit the bill’s scope. In particular, the proposal offers to apply only to prospective investments and limit coverage to transactions involving (i) investors receiving certain types of government funding; (ii) investments involving critical supply chains identified in EO 14017; and (iii) investors that are ”beneficiaries” of U.S. government contracts, about a de minimis threshold, with national security agencies or for “a purpose to protect national security.” In addition, the working paper offers to exempt transactions below a minimum threshold or that do not include “know-how” transfers in certain specified sectors, as well as provide carve-outs for transactions subject to other government regimes, such as CFIUS, and a “trusted-participant” safe harbor option.

Outlook

Numerous policy-makers have strong interest in limiting outbound investment to countries of concern, such as China, but have expressed concerns about the specifics of the NCCDA. For that reason, it is unlikely that the House-passed version of the NCCDA will be included in any final version of the Bipartisan Innovation Act. The Treasury proposal and Cornyn modifications now under the discussion, however, help signal various ways in which the legislation could be refined in order to gain the needed support to address bipartisan concerns about certain types of outbound U.S. investment, either under the Bipartisan Innovation Act, or later this year through a different vehicle.

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