FI Monitor Issue 5, 2022

Biden administration pushes forward strategy to protect US technology edge

The Biden administration continues to build out the US regulatory infrastructure to manage evolving national security risks and to maintain the US edge in technology, particularly in relation to China.

These steps – reinforcing the focus and enforcement of inbound investment screening (CFIUS) rules, developing a potential outbound investment screening process, and promulgation of significant new export control measures – are likely to have long-lasting and significant effects on the competitive environment for both US and non-US companies, even in cases without a direct China nexus.

Furthermore, the US appears to be having success in persuading allies and partners to act, or at least strongly consider acting, in similar fashion.

China at the core of the Biden administration’s technology protection objectives and strategy

The Biden administration’s October 2022 National Security Strategy (NSS) identified geopolitical competition as one of the principal challenges that the United States faces, with China being “the only competitor with both the intent to reshape the international order and, increasingly, the economic, diplomatic, military, and technological power to do it.” A key strategy to address the geopolitical challenge, according to the NSS, is to ensure that “strategic competitors cannot exploit foundational American and allied technologies, know-how, or data to undermine American and allied security.”

President Biden’s National Security Advisor, Jake Sullivan, identified these foundational technologies in a September speech. Three “families of technologies,” he argued, will be force multipliers — the twenty percent of technologies that will determine 80 percent of success: (1) computing-related technologies, including microelectronics, quantum information systems, and artificial intelligence; (2) biotechnologies and biomanufacturing; and (3) clean energy technologies. These areas cover a range of sub-technologies, many of which were identified in a February list of “critical and emerging technologies” published by the White House.

To protect these technologies, Sullivan stated, and the NSS reiterated, the specific intent of the US government to modernize and strengthen export control and investment screening mechanisms and to pursue “targeted new approaches,” such as screening of outbound investment.

Since September 2022, the Biden administration has taken a deliberate series of steps to reinforce or lean into its strategy to address concerns related to technology, particularly as it relates to China.

Inbound investment screening (CFIUS)

While the Trump administration substantially revamped the infrastructure of CFIUS by pushing for the enactment of the Foreign Investment Risk Review Modernization Act of 2018 and significantly growing the CFIUS staff, the Biden administration has taken a number of steps in the last few months to further develop CFIUS as a means of effecting its policy objectives.

In September 2022, President Biden issued Executive Order 14083 (EO), the first executive order on CFIUS since President Bush issued an executive order in 2008 revising the operating rules for CFIUS. (See our blog post on the EO.) While the EO more reflects current trends than establishes a new direction for CFIUS, it is still notable as confirmation that an increasingly broader range of US targets and foreign investors will face tougher CFIUS scrutiny. It provides greater transparency into key policy considerations that drive CFIUS reviews, provides more definitive direction to CFIUS agencies to align the review process around Biden administration priorities, and places the administration’s stamp on the CFIUS process.

The key policy considerations include that:

• Economic security is a key driver of national security.
• Non-Chinese investor ties to China will draw scrutiny.
• Transactions are to be reviewed in context of broader investment and industry trends, not in isolation.
• Supply chain risks are not limited to the defense industry but include areas important to economic security.
• Technological leadership considerations are within the scope of CFIUS’s definition of national security.
• Cybersecurity risk, including third party risk, and sensitive personal data will continue to be key areas of focus.

Then, in October 2022, the US Department of the Treasury, as chair of CFIUS, released the first-ever CFIUS Enforcement and Penalty Guidelines. CFIUS received penalty authority in 2008 but did not issue its first penalty until 2018 and since then has only issued one additional penalty, both being $1 million or less, so very small. While the guidelines are a listing of common-sense factors that CFIUS will consider to be aggravating or mitigating as it assesses what action to take in response to a violation of the CFIUS regulations and agreements, they are clearly part of an effort by CFIUS to create an expectation of increased enforcement. Indeed, it is widely expected that the issuance of these guidelines is a prelude to CFIUS issuing a first-time penalty within the next year for failure to comply with the mandatory filing requirement and to levy a more substantial fine for non-compliance with a mitigation agreement.

Export controls

In October 2022, the Bureau of Industry and Security, the US dual-use export control agency, issued a major rule targeting the export of semiconductor manufacturing equipment, advanced computing integrated circuits, and other emerging technologies. The rule targets not just Chinese acquisition of technology and products produced in the United States, but goes significantly beyond prior rules in restricting the use of US technology in third countries to produce certain products that would not be exportable to China if produced in the United States. Furthermore, it imposes restrictions on US persons supporting the development of production of certain semiconductors in China. The issuance of this rule has created significant challenges in the context of M&A transactions, as companies struggle to understand the impact on target companies and investments for in-progress deals and adjust to a new reality of more robust diligence exercises to ensure compliance with the rule going forward.

The rule reflects the balance that the Biden administration is seeking to achieve to advance its China technology competition strategy. On the one hand, it is adopting carefully targeted policies after significant internal deliberation and scrutiny and alongside active engagement with foreign allies and partners. On the other hand, it has proven willing, at least as it relates to competition with China, to upend existing assumptions about US regulatory policy and to disrupt commercial activity. In addition to being a significant expansion of existing tools, it reflects a major shift in long-standing technology policy as related to China, portending a more aggressive technology control policy. Sullivan noted in his September speech that the United States can no longer just aim to stay a couple steps ahead of China but must maintain as much of its current advantage as it can.

Outbound investment screening (reverse CFIUS?)

At the same time as the US government works to strengthen the existing inbound investment and export control regimes, there is broad agreement in Washington that these tools do not fully address the technology competition risk from China. There is an emerging view in Washington that some form of outbound investment control is necessary.

The theory is that investors, including financial sponsors, are particularly skilled at driving organizational effectiveness and technological innovation. Furthermore, their participation in a project lends it a degree of credibility that will itself better position the Chinese business to succeed. The net result, or so is the concern, is that the investment of capital and business acumen could be used by China to facilitate the indigenous development of technologies that it cannot otherwise acquire from the United States.

The Biden administration has not yet settled on whether it will seek to establish a mechanism initially intended just to collect information about investment in China or to establish a screening mechanism that requires investments in specific technologies to first be notified to a US government body for review and approval. It has emphasized that any such mechanisms will be targeted to tightly scoped categories of investment.

An effort in Congress to establish a much broader form of outbound investment control, extending not just to investment in Chinese technological capabilities but also to offshoring of critical supply chains to China, has not yet received sufficient support to pass and has been met with opposition from some members of Congress and from the business community.

Some outbound investment restrictions were included in the recently enacted CHIPS Act, which is legislation designed to support semiconductor production in the United States. The Act provides for “guardrails” for funding recipients, including a requirement that recipients and their affiliated entities agree not to engage in significant transactions involving the material expansion of semiconductor manufacturing capacity in China for 10 years (other than certain legacy chips).

At present, it is not clear whether Congress will pass some narrowed form of outbound investment screening legislation. However, given the now repeated statements by the Biden administration that it sees outbound investment as an important element of its China strategy, it remains likely that it will issue an Executive Order within the next year. This is clearly an area of trans-Atlantic discussion as well, as the European Commission recently stated that it will be examining a potential outbound investment mechanism as part of its 2023 agenda.

Implications for international investment

There are several key takeaways that investors can derive from these developments in the United States:

• The concept of economic security is firmly established as a pillar of US national security strategy. Moreover, because economic security appeals to both China hawks and economic protectionists, it will likely be less susceptible to shifts in the partisan balance of power. The flavor of policies pursued as part of an economic security agenda may vary slightly from administration to administration, with more or less emphasis being placed on domestic spending initiatives, but the general concept appears to be here to stay. 
• National security analysis is a necessary part of diligence in just about every significant cross-border transaction. With the proliferation of economic security concerns under the rubric of national security, deals that several years ago would have had no apparent national security nexus might now end up on CFIUS’s radar and, possibly, called in for review. 
• Investors should take a proactive approach to managing their exposure to national security risk. This means developing an effective messaging strategy that communicates how the commercial goals of a transaction align with the national and economic security goals of the United States. It also means understanding how an investor or target’s global operations, relationships, and investments portfolio – particularly in China and Russia – might be viewed by US regulatory authorities or affected by new regulations in these areas. 

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