On 9 August, the Biden Administration released a long-awaited Executive Order (“EO”) that tasks the U.S. Treasury Department with establishing a program to prohibit or require notification of certain outbound investments by U.S. persons into certain entities subject to the jurisdiction of identified “countries of concern.” In an Annex to the EO, the People’s Republic of China (“PRC”) (including Hong Kong and Macau) is the sole country of concern designated—indicating clearly that this EO is explicitly targeted only at China, and not countries like Russia or Iran that are already subject to broad U.S. economic sanctions or embargoes. The EO was accompanied by a U.S. Department of the Treasury (“Treasury”) Fact Sheet and Advanced Notice of Proposed Rulemaking (“ANPRM”) that aim to provide transparency and clarity about Treasury’s intended scope of an “outbound investment notification and restriction program” (the “Program”) and to solicit public comments on the EO’s implementation and the appropriate scope of the Program before its launch.

Broad Observations about the EO and ANPRM

Implementation and administration of the Program are delegated by the EO squarely to Treasury, granting Treasury leadership of, and wide discretion in setting up, the Program. The ANPRM contemplates the Program bearing many characteristics of existing Treasury-administered economic sanctions programs—for example, the definition of “U.S. persons” subjected to the investment prohibition and reporting requirements mirrors that of Treasury’s existing sanctions programs, as does the proposed investigation and enforcement regime, which could result in civil and criminal penalties for those who violate the Program’s restrictions. In addition, the ANPRM proposes a potential regime to permit what would otherwise be prohibited.

In other words, the Program is clearly not the outbound transactions screening construct, or “reverse CFIUS,” for which some have advocated; transaction-by-transaction reviews are not contemplated. Instead, the scope and impact of the Program’s investment restrictions will be primarily limited by many key, yet-to-be-defined terms, and by highly technical technological parameters that parallel those usually only found in U.S. Department of Commerce (“Commerce”) export controls. Presumably because of this latter design feature, Treasury is directed to consult with Commerce when exercising its broad discretion to administer the Program.

As telegraphed by the Biden Administration for some time, the ANPRM signals an intent to narrowly focus (at least at the outset) only on certain types of investments in PRC entities related to the development of “sensitive or advanced technologies and products critical for military, intelligence, surveillance, or cyber-enabled capabilities.” For the Program’s initial phase, the ANPRM only contemplates investment prohibitions that target the production of advanced semiconductors, quantum information technologies, and activities related to software that incorporates AI and is designed for military or intelligence end uses. The ANPRM also contemplates requiring notification to Treasury of certain types of investments in less advanced semiconductors and AI systems with potential military or intelligence end-uses. In theory, the authority granted under the EO could allow the Program to expand to prohibit U.S. outbound investments across a wide range of Chinese firms engaged in activities related to specific technologies being developed in the AI, quantum information technologies, and semiconductor sectors. But importantly, the EO makes clear that the Program will not expand outside of these sectors unless a new EO is issued to amend or modify the existing EO.

The scope of the Program will also be limited by Treasury’s discretion to exempt a wide range of transactions from the Program’s restrictions and notification requirements. The ANPRM contemplates carving out all public market investments, many types of private market investments, and investments in large Chinese companies that are not directly involved in technologies targeted by the Program but that might have subsidiaries involved in such activities. These significant proposed carve-outs will surely come under heavy scrutiny by proponents of stricter outbound investment limitations. Further, the Program’s investment prohibitions and reporting requirements will not apply retroactively, although Treasury may request information on certain past transactions involving Chinese technology firms in order to inform the development and implementation of the Program.

Importantly, many key terms and contours of the Program that will ultimately determine its true scope remain undefined or unclear. Accordingly, industry and congressional engagement during the notice and comment period regarding these issues will likely be robust, particularly regarding the range of potential investment types and foreign persons to which the Program could apply. Treasury seems likely to proceed cautiously, with the ANPRM being the first component of a lengthy engagement, deliberation, and drafting process regarding the Program’s final particulars, lasting well into 2024.

The EO signals the real start of what will likely be a long and loud debate in Washington, other G7 country capitals, and international fora over both this new type of capital control, more broadly, as well as the ultimate contours of not only Treasury’s outbound investment restrictions, but those of U.S. allies, which in some instances could soon follow. Once implemented, the Program will afford the U.S. government a new tool of economic statecraft with few current international parallels in market economies.

Important Questions for Foreign Firms and U.S. Investors Over the Applicability of the Outbound Investment Program

Some of the most important—and unresolved—questions regarding the contemplated Program relate to the types of “U.S. persons” and kinds of investments that would be reportable or restricted.

What constitutes a “United States person”?

The EO instructs the Treasury Secretary, in consultation with the Commerce Secretary, to issue implementing regulations applicable to “United States persons,” which is defined to include U.S. citizens, permanent residents, “any person in the United States,” and any “entity organized under the laws of the United States,” including “any foreign branches of any such entity.” The ANPRM states that Treasury is considering adopting the EO’s definition of “United States person” without modification and seeks feedback from stakeholders as to what unintended consequences could result from this definition.

The definition currently contemplated, which mirrors the definition of U.S. person that is frequently used in U.S. economic sanctions programs, will likely have significant implications for the foreign affiliates of U.S. private equity and venture capital funds, as well as for U.S. citizens who may serve in key leadership or decision-making roles in foreign firms. The definition also appears potentially to impact the activities of U.S.-incorporated affiliates of foreign entities, including foreign private equity and venture funds.

The Program’s potential applicability to foreign financial firms and U.S. persons “directing” restricted transactions

While the investment activities of a U.S. subsidiary of a foreign firm could be captured by the Program, investment activities by the foreign parent of a U.S. company might not. However, the EO authorizes Treasury to prohibit U.S. persons from “knowingly directing transactions” that are barred by the EO.

Treasury’s contemplated definitions of “knowingly” and “directing” could except banks, U.S. subsidiaries of foreign companies, and professional services firms from being subject to the Program’s restrictions. However, the ANPRM makes clear that Treasury intends to enforce the EO’s requirements against any U.S. person who “causes to be performed a transaction that would be prohibited under these regulations if engaged in by a U.S. person,” despite the potential exclusion of a range of advisory and financial services from the Program’s reach.

Indeed, the ANPRM indicates that Treasury will likely prohibit U.S. persons working at foreign firms from directing business dealings that would be prohibited under the Program. Several hypotheticals described in the ANPRM show how U.S. persons working at foreign funds might be impacted. For example, in one hypothetical the ANPRM contemplates that a U.S. person on the management committee of a foreign fund would need to be recused from any decision by the fund to engage in a prohibited transaction.  Depending on the particular facts and circumstances, could the act of recusal itself, and knowingly not taking action to prevent a particular transaction, be construed as violating the EO?

Which investment types will be captured?

The EO directs the promulgation of regulations that pertain to “prohibited transactions” and “notifiable transactions.” Treasury’s proposed construct would capture both under the term “covered transaction,” for which it contemplates the following types of investments into a “covered foreign person”: equity interests, greenfield investments that may result in the creation of a covered foreign person, joint ventures, and certain convertible debt investments.

Consistent with the EO, the ANPRM contemplates the following definition for “covered foreign person”:

(1) a person of a country of concern that is engaged in, or a person of a country of concern that a U.S. person knows or should know will be engaged in, an identified activity with respect to a covered national security technology or product; or (2) a person whose direct or indirect subsidiaries or branches are referenced in item (1) and which, individually or in the aggregate, comprise more than 50 percent of that person’s consolidated revenue, net income, capital expenditure, or operating expenses.

It should be anticipated that considerable public comment and interagency deliberation and debate will be focused on the final scope of the terms “covered national security technology or product” and “person of a country of concern.” One major issue likely to be debated is whether the 50 percent carve-out is appropriate – this seems to potentially enable continued U.S. institutional investment in Chinese conglomerates not directly engaged in activities covered by the Program, but with subsidiaries involved in activities related to covered national security technology or products in support of the Chinese military. Notably, Treasury is seeking feedback on whether the contemplated 50 percent threshold is appropriate, or whether another approach should be considered to address Chinese companies whose subsidiaries and branches engage in the identified activity with respect to a covered national security technology or product.

Uncertainty remains over the technology types to be captured by the Program

The EO directs the Treasury Secretary to define “covered national security technology or product” by specifically identifying sensitive technologies and products within the semiconductors/microelectronics, quantum, and AI sectors that “are critical for the military, intelligence, surveillance, or cyber-enabled capabilities of a country of concern.” A large share of the ANPRM is devoted to setting forth and seeking feedback on highly technical definitions of what would be considered a “covered national security technology or product.”

The potential unintended costs, and loopholes, precipitated by top-down definitions related to such dynamic technologies will likely be a source of significant pushback as stakeholders engage in the ANPRM process. Interestingly, and noteworthy both for the apparent intent to target only very specific technologies and for the potential complexity of the final implementing regulations, the ANPRM also seeks public comment regarding how investments in AI, quantum information technology, and semiconductor companies affiliated with the PRC could “benefit, and not impair, U.S. national security.”

What type of Chinese nexus will result in a firm being considered a “person of a country of concern”?

The proposed “person of a country of concern” definition is also likely to create significant debate and feedback. The ANPRM posits a scope that aligns with the EO’s definition, and thus would not only include entities incorporated or having a principal place of business in a country of concern, but also entities “controlled, or directed by, or acting for or on behalf of governments of a country of concern” (emphasis added), as well as any entity directly or indirectly owned 50 percent or more by such entities.

Due diligence under the scope of such a definition could be highly challenging, uncertain, and subjective. The ANPRM proposal ostensibly intends to avoid loopholes, presumably regarding companies that are founded by PRC persons and influenced by the Chinese Communist Party but incorporated outside China. The ANPRM requests stakeholder comment on the potential unintended consequences of this construct and how best to define “covered foreign person” and “person of a country of concern” to both eliminate loopholes and minimize the burden on transaction parties.

Expect extensive debate over the range of “excepted transactions” contemplated in the ANPRM

The ANPRM contemplates a wide range of transactions that would be exempt from the Program. Treasury has suggested excepting investments into i) publicly-traded securities, and ii) index funds, exchange traded funds, or similar instruments; as well as those made as a limited partner (“LP”) in a private fund, where the LP i) “cannot make managerial decisions, is not responsible for any debts beyond its investments, and does not have the ability (formally or informally) to influence or participate in the fund’s or a covered foreign person’s decision making or operations,” and ii) is below an as yet undefined de minimis threshold. Investments that a reasonable person would consider to extend rights beyond those reasonably considered to be standard minority investor protections would not be considered “exempt.” Buyouts of country of concern ownership are also potentially exempt.

The ANPRM’s rationale for this broad set of “excepted transactions” is in part driven by a focus on preventing transactions that convey “intangible benefits” such as managerial assistance, enhanced standing and prominence, and further access to financing. (Notably, the singular mention of “intangible benefits” in the EO notes that “countries of concern are exploiting or have the ability to exploit certain United States outbound investments, including certain intangible benefits that often accompany United States investments.”) Treasury’s Fact Sheet accompanying the EO and ANPRM, as well as recent anonymous comments by Biden Administration officials, indicate a purported goal to limit the Program’s reach to so-called “smart” venture capital and private equity investments.

Ultimately, whether this outcome is achieved will hinge on the scope of “excepted transactions” and the de minimis threshold that is established. Treasury has indicated that it “is considering defining such a threshold with respect to one or more factors such as the size of the U.S. limited partner’s transaction, and/or the total assets under management of the U.S. limited partner.”

What to Expect in the United States and Abroad as the Debate Over Outbound Investment Notifications and Restrictions Evolve

Responses to the 83 questions posed to stakeholders by the Treasury ANPRM are due on 28 September 2023, only 45 days after its official publication in the Federal Register. It is certainly possible that the response from various stakeholders will precipitate an extension of the comment period. Initial reaction to the EO is mixed, and some influential policy makers and some stakeholders are likely to push for more far-reaching restrictions.

Indeed, certain Republicans and Democrats – particularly proponents of outbound investment “screening” (which this EO is not) – have welcomed the EO but are indicating that the proposed Program falls short. On the other hand, Republicans generally critical of these types of outbound investment restrictions are encouraged by the EO’s relatively modest approach.

It remains to be seen whether this year’s National Defense Authorization Act (“NDAA”) will ultimately incorporate a Treasury-administered outbound investment reporting mechanism included as part of the Senate’s NDAA bill. The enactment of such bipartisan legislation (which passed the Senate 91-6) could significantly influence the implementation of the Program under the current EO. Importantly, this legislation contemplates a reporting mechanism that is applicable to investments in a broader range of technology sectors than is contemplated in the EO.

Against this backdrop, Treasury’s regulatory implementation process will progress deliberately, and relatively slowly, for the duration of the year. After ANPRM comments are received, Treasury will have to publish and reasonably consider all comments received, conduct further due diligence on issues that might not have been considered, and engage in what is likely to be extensive interagency debate and consensus-building in order to craft regulations establishing the Program. A range of operational and staffing issues will require resolution—from securing appropriated funds, to hiring and allocating the necessary human capital, to establishing the IT infrastructure to facilitate the required notifications under the Program, to establishing an enforcement regime, among others. Proposed rules, which will bring about another period of prolonged stakeholder engagement, will likely not be released until 2024.

Yet unresolved and unclear is how political leadership in G7 countries will respond to the Program and whether any will follow the United States’ lead to establish similar restrictions. On 20 May 2023, White House National Security Advisor Jake Sullivan indicated his expectation that G7 leaders will ultimately adopt a “common set” of “economic security tools” that includes “outbound investment measures.” These measures were briefly mentioned in a G7 leaders’ statement on economic resilience and economic security that failed to endorse “outbound investment measures” but noted such policies “could be important to complement existing tools of targeted controls on exports and inbound investments” (emphasis added).

Ultimately, the Biden Administration is likely to exert diplomatic pressure on U.S. allies to adopt an outbound investment reporting and restriction regime similar to what has been set forth by the EO. As outbound investment measures are implemented by the U.S. government and some of its allies, the PRC government can be expected to respond in kind—which might include new export controls, economic sanctions against firms that comply with the Program’s requirements, and new restrictions on access to the Chinese market, and no doubt efforts to evade the new restrictions.

Notably, initial official responses from the PRC government and Chinese state media were quite critical of the EO but did not indicate any firm policy responses. Interestingly, recent press reporting indicates an expectation that venture capital investment to Chinese tech sectors targeted by the EO will be reasonably undampened by new restrictions.

In the end, the Biden Administration’s outbound investment EO marks a new and uncertain phase in national security-related “economic statecraft” that brings additional impediments to global capital flows and will likely precipitate similar investment and capital restrictions in other major economies. These regulatory regimes and policies will in turn add to an ongoing escalatory policy trend that culminates in both increased geopolitical risk and due diligence obligations for global companies and financial firms with sizable business dealings in both the U.S. and China.