Proposed Rulemaking by the Ministry of Finance Regarding Outbound Investments
2024-08-18 09:28:46
On June 21, 2024, the U.S. Department of the Treasury ("Treasury") issued a Notice of Proposed Rulemaking ("NPRM") to implement the Executive Order ("Outbound Investment Order") issued by President Biden in August 2023 regarding "Addressing United States Investments in Certain National Security Technologies and Products." The notice aims to address potential threats to U.S. national security posed by advancements in sensitive technologies by certain foreign countries.
Background and Purpose
Under the Outbound Investment Order, advancements in sensitive technologies and products by certain "countries of concern" (primarily the People's Republic of China, including its Special Administrative Regions of Hong Kong and Macau) constitute a threat to U.S. national security. These advancements focus on critical areas such as semiconductor and microelectronics technologies, quantum information technologies, and artificial intelligence systems, which could enhance the military, intelligence, surveillance, or cyber capabilities of these countries, thereby posing significant risks to the United States. In particular, artificial intelligence systems are broadly defined as machine-based systems that, after receiving human-defined objectives, perceive real and virtual environments through data inputs, use automated or algorithmic statistical analysis to abstract these perceptions into models, and utilize these models for classification, prediction, recommendation, or decision-making. Additionally, any data systems, software, hardware, applications, tools, or utilities that use these functionalities in whole or in part are also included.
Definition of Covered Foreign Persons and Covered Transactions
In the NPRM, "covered foreign persons" include the following categories:
Persons from countries of concern engaged in covered activities.
Persons who directly or indirectly hold any voting rights, board seats, or equity interests in entities engaged in covered activities, or who have control over such entities. This includes variable interest entities.
Persons who derive more than 50% of their revenue, net income, capital expenditures, or operating expenses from entities engaged in covered activities, based on the most recent annual financial statements.
Transactions involving the following activities with covered foreign persons will be considered "covered transactions":
Acquisition of equity or contingent equity interests in covered foreign persons.
Provision of convertible loans or similar debt financing arrangements to covered foreign persons.
Conversion of contingent equity or debt into equity in covered foreign persons.
Acquisition, leasing, or development of assets in countries of concern that result in covered foreign persons engaging in new covered activities.
Establishment of joint ventures with persons from countries of concern engaged in covered activities.
Investment in non-U.S. mutual funds that may invest in covered foreign persons in targeted industries.
Under the proposed rules, covered activities refer to any activities mentioned in the definitions of notifiable transactions or prohibited transactions (see below). A transaction is considered covered only if the transacting party has knowledge of the relevant facts or circumstances at the time of the transaction. The NPRM defines "knowledge" to include a "reason to know" standard, meaning that if a transacting party fails to conduct a reasonable and diligent investigation when facts or circumstances indicating a covered transaction arise, they may be presumed to have knowledge. The Treasury may assess whether the transacting party obtained necessary information and contractual assurances through reasonable due diligence procedures. If a transacting party later discovers that a transaction is covered, they must file a notice explaining why such information was not obtained at the time and detailing the due diligence conducted prior to the transaction.
Prohibited Transactions
Prohibited transactions are those explicitly banned by the NPRM to protect national security. These transactions include the development or production of advanced technologies such as electronic design automation software for integrated circuits; certain semiconductor manufacturing equipment; advanced integrated circuits; supercomputers; quantum computers; and artificial intelligence systems intended for military or surveillance applications.
Notifiable Transactions
Notifiable transactions are those that are not prohibited but require detailed reporting to the Treasury. These transactions typically involve the design, manufacture, or packaging of integrated circuits, as well as the development of certain artificial intelligence systems. Notifications must include comprehensive information about the transaction, including the business rationale, structure, and financial details, the completion date, and a description of the covered activities and end uses. Reports must be filed within 30 days of the transaction's completion.
Who Must Comply?
The NPRM applies to "U.S. persons," which is broadly defined to include U.S. citizens, lawful permanent residents, entities organized under U.S. law, and individuals within the United States. Additionally, U.S. entities with foreign branches or non-U.S. parent companies are also included. Furthermore, U.S. executives of non-U.S. companies must recuse themselves from making investment decisions that would be prohibited if made directly by a U.S. person. U.S. persons must also ensure that foreign entities they control do not engage in prohibited transactions, and if these entities engage in notifiable transactions, they must promptly report them to the Treasury.
Exceptions and Exemptions
To balance national security and economic interests, the NPRM exempts certain transactions. These exceptions include:
Investments in publicly traded securities, index funds, mutual funds, and exchange-traded funds.
Certain limited partnership investments based on committed capital thresholds.
Intra-company transactions supporting non-covered activities.
Binding contracts or commitments entered into before the effective date of the Outbound Investment Order.
Certain joint loan financings.
Compliance and Penalties
Violations of the NPRM include engaging in prohibited transactions, failing to notify the Treasury of notifiable transactions, and providing false information. Penalties for violations include civil fines of up to 1,000,000 or imprisonment for up to 20 years. Voluntary disclosure may mitigate penalties.
Divestment and Voluntary Disclosure
The NPRM authorizes the Treasury to rescind, void, or mandate divestment of prohibited transactions conducted after the effective date of the final rules. U.S. persons may voluntarily disclose actual or potential violations, which may be considered a mitigating factor in assessing penalties.
Conclusion and Next Steps
The Treasury is currently evaluating public comments on the NPRM and will issue final rules in the future. For assistance with specific foreign investment issues, please contact our team.