By Pete Schroeder, Michelle Price and Carolina Mandl
WASHINGTON/NEW YORK (Reuters) – U.S. financial firms are pushing for more clarity on proposed new rules restricting U.S. investments in some Chinese technology sectors that they say are too vague and impose a burden on investors to comply.
To protect national security and prevent U.S. capital from supporting the Chinese military, President Joe Biden issued an executive order last month restricting new U.S. investments in sensitive Chinese technologies. The Treasury Department then initiated a rulemaking process to implement the order, and financial firms rushed to hold a meeting on September 28 to provide input. The rules are expected to be implemented sometime next year.
The proposed rule applies to U.S. persons – including U.S. citizens, residents, corporations, and U.S. entities of foreign corporations. They must notify the Treasury when making certain investments in China in semiconductors and microelectronics, artificial intelligence and quantum information technologies, and prohibit other such investments altogether.
In addition to venture capital and private equity firms, hedge funds, banks and possibly index-tracking funds are also likely to be affected by the proposal, which financial industry executives and lawyers criticize as broad and ambiguous.
Among their main concerns: How would the rules apply to U.S. citizens? which specific Chinese companies would be subject to the restrictions; and a better definition of a proposed exemption for publicly traded securities.
“The scope is pretty broad,” said Timothy Keeler, a partner at law firm Mayer Brown, noting that this applies to Chinese companies operating outside of China. “It could apply to companies that are based outside China but are subsidiaries of Chinese companies or controlled by a Chinese person.”
While the U.S. already has restrictions on some Chinese investments in the U.S. and U.S. investments in China, the order creates a new program. Unlike a process conducted by the Committee on Foreign Investment in the United States, a panel of U.S. government agencies, the new program will not involve case-by-case reviews of investments. And unlike sanctions, there is no list of restricted entities or companies.
This means investors will have to figure out which investments fall within the scope of the new regime and how to comply, leading to significant compliance costs and legal risks.
“This represents a significant burden for an investor,” said a former Treasury official.
They may also prohibit U.S. residents from “knowingly controlling” covered transactions of non-U.S. residents. But the threshold of knowledge or what directing means is unclear.
“We hear a lot about the issue of a U.S. person directing the activities of a non-U.S. person,” said Jen Fernandez, a partner at law firm Sidley Austin.
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“At what level does ‘directorship’ apply and what does that mean for these non-U.S. private equity funds that may have a dual national as a partner?”
The program proposes to exempt publicly traded securities and index and mutual funds from the tax, but financial companies want these securities to be more strictly defined. A key question is whether shares allocated before trading would be separated out in IPOs.
To address these and other issues, some companies plan to push for a list of restricted companies and investments, similar to a sanctions regime. Former Securities and Exchange Commission Chairman Jay Clayton, now a consultant at the law firm Sullivan & Cromwell, expressed this idea when he told a House China committee this month that “Wall Street responds very quickly” to lists of blocked companies.
But some sources said they doubt the Treasury would take that route, which would reduce the program’s flexibility and, since it involves cutting-edge technology, would quickly become outdated. “That just doesn’t seem to be the direction this process is going,” Keeler said.
A Treasury spokesman did not respond to a request for comment but said in the proposal that it welcomes input. The rules are necessary because US investments could be used to accelerate the development of sensitive technologies that threaten US national security, the Treasury Department and the government said.
Financial firms say they support the government’s national security goals but fear increased liability and the economic costs of restricting capital flows. US-China tensions have already caused takeovers of Chinese companies by US firms to fall by almost 60% from January this year to early August compared to the same period last year.
“Protecting U.S. national security is a primary obligation of the federal government, but as the Treasury Department notes, maintaining global capital flows does not have to be at odds with that,” said Peter Matheson, executive director of the Securities Industry and Financial Markets Association, a financial institution lobbying group Industry.
But lobbying to curb the rules is politically sensitive, especially as China hawks in Congress are pushing bills to tighten restrictions. Given the uncertainty, companies may start avoiding the covered sectors altogether, Fernandez said.
“I do think we’re going to see a lot of de-risking,” she added.