US-China Economic and Security Review Commission Releases … – Morgan Lewis

The US-China Economic and Security Review Commission released on November 14 its annual report for 2023—2023 Report to Congress: US-China Economic and Security Review Commission—issuing recommendations to track the Biden administration’s focus on export controls, foreign direct investment, trade, the supply chain, and economic risks. 

After a year of hearings involving 67 witnesses, engagements with subject matter experts and government personnel, as well as interactions with partners and allies, the Commission[1] outlined its findings in several key areas:

• Military and diplomatic engagements
• Training the workforce of the future
• Pursuit of defense technologies
• Export controls and foreign investment screening
• Understand the rule of law when dealing with China
• How Europe and the US view China
• Supply chain
• Implications for investors

The Commission unanimously issued the 2023 Report to Congress: US-China Economic and Security Review Commission (the Report) and provided 30 recommendations for congressional actions, 10 of which the Commission viewed as priorities for congressional action. The Report highlights the ongoing tensions between the US and China, the rebalancing of the global environment, and the impact of US and Chinese laws and policies on the business community.

At a high level, the Report notes that the continuation of the tense engagement between the US and China has failed to produce any concrete advancements in lessening tensions. The Report indicates that partners, allies, industries, and others have experienced the need to reassess existing relationships within China or with Chinese parties, as well as to plan for broader outreach to jurisdictions other than China to manage the de-risking that is occurring.

Among its findings, the Report includes insight into the impact of various regulatory changes— such as the US Export Administration Regulation (EAR) updates to export controls for semiconductors and supercomputers or China’s restrictions on access to certain business-related information used by non-Chinese parties to evaluate business opportunities—on management of business, research and development (R&D), outsourcing, and financial investments with Chinese parties.

In that vein, the Report concludes the following:

• Neither the United States nor Europe, allies, and partners are decoupling from China. Governments and parties are taking steps to lessen their risk of unexpected actions within China and making investment or other related business decisions on the basis of the new risk profile.
• The United States and its allies and partners are moving toward resource diversification—whether raw materials, manufacturing and assembly services, production, personnel, R&D, and distribution channels.
• Foreign policy positions matter in the global environment, and China’s continuing engagement with Russia forms one of the foundational pillars for US, European, other Far East and Near East countries’ relationships with China. The Commission highlighted concerns for diversions of controlled technology or items, the use of dual-use items for military, defense or intelligence applications, and the prevalent impact of artificial intelligence within this environment.
• Investments in China have slowed based on a confluence of circumstances ranging from economic uncertainty within China to diversification of portfolio holdings to manage the de-risking approach parties have taken. At the same time, China’s outbound investments have shifted as well, with a focus on establishing a foothold from a power projection standpoint in jurisdictions outside of China’s regional sphere. The Report identifies China’s outreach to Cuba as well as the establishment of its base in Djibouti, as indications of a more outward-facing, power projection stance.
• Export controls and foreign direct investment screening (FDI) remain key tools used by the United States and other governments to address national security and economic considerations when dealing with China. The US Department of Commerce’s recent October 2023 semiconductor and supercomputer regulations and the president’s Executive Order 14105 on outbound investment identify key sectors of interest where national security concerns arise. Several witnesses testified that, while US export laws provide some options for delaying access to certain technologies, those laws benefit from a more multilateral approach and speedier implementation. This finding is not new but further emphasized by the concern of the last four or five years regarding advancements in essential technologies such as semiconductors, quantum computing and communication, quantum encryption, and artificial intelligence.

Against this backdrop, the Commission considered “10 of its 30 recommendations to Congress to be of particular significance”[2] and thus important for Congress to address with a higher degree of urgency. These 10 recommendations revolve around changes to export controls, FDI enhancements, supply chain tracking, foreign influence in the educational sector, threats by counterfeit electronics, and lack of transparency.

Each of these areas has the potential to impact cross-border investments, the establishment of commercial operations abroad that either conduct business in China or rely on Chinese companies for parts, components, or technology, and the flexibility or seamlessness when exporting or importing to or from China.

If Congress moves forward with the recommendations summarized below, companies and others should evaluate and reconsider how they manage their diligence processes, what factors should be considered in greater detail when assessing business opportunities in China, and how to address significant investments by China in and through the US educational system.

COMMISSION RECOMMENDATIONS TO CONGRESS MOST RELEVANT TO COMPANIES AND INSTITUTIONS DOING BUSINESS WITH CHINA

1. Congress should consider establishing additional corporate disclosure requirements that increase transparency for investors. The Biden Administration has focused on investor transparency through new proposed regulations related to ultimate beneficial ownership disclosures, which, if finalized, would align in part with the Commission’s recommendations for the sharing of more information regarding who is invested in what entity and at what level.
2. Congress should direct that the US government establish a risk matrix to be shared with industry that allows parties to assess the risk of importing electronics from China. This recommendation aligns with the administration’s approach to product integrity used in military or defense platforms and the various regulatory efforts underway to increase the ability to identify and track, for example, counterfeit electronics.
3. Congress should address the requirements of the Higher Education Act of 1965 (HEA), Section 117, and the obligations that universities, colleges, and research institutions have to report foreign gifts, foreign contracts, and foreign donations. This recommendation includes multilayered updates to the HEA and how it is enforced. Among the sub-recommendations are the following:
   1. a. Calls upon the Office of the Director of National Intelligence (ODNI) to identify the risks posed by these monies with a focus on Chinese and Hong-Kong-origin funds
   2. b. Requires that this assessment be shared with Congress and used to determine whether suspension of federal funds should be considered and implemented to mitigate the risks of the foreign monies
   3. c. Requires the Department of Education to share the HEA Section 117 reports with the Federal Bureau of Investigation and ODNI
   4. d. Requires that HEA Section 117 reports be extended to cover a 10-year period rather than the current five period
   5. e. Embeds a recommendation that the Department of Education require universities, colleges, and other entities subject to HEA Section 117 to report when they are adding donations, contracts, or gifts retroactively—in essence, a requirement to “disclose” past noncompliance with the Section 117 requirements

   Relatedly, the Commission recommends that Congress amend the Foreign Investment Review Modernization Act (FIRRMA) to expand the definition of “covered transaction” to include “research contracts.”

4. Congress should task the Government Accountability Office to complete an evaluation of the effectiveness of US export controls on semiconductors recently imposed by the Department of Commerce. The report should be completed within 180 days and focus on an assessment of where allies and partners multilaterally support US restrictions. Notably, the Commission also recommends holding hearings to evaluate the potential for establishing a unified export licensing system, which would integrate the Commerce Control List and the US Munitions List. Key considerations include whether such a system could enhance export control enforcement, especially in regions like China with limited corporate transparency, while minimizing the compliance burden on industry without compromising national security. Other considerations include which technologies to include, where to house the system within the government, and how to facilitate effective coordination among various agencies.
5. Congress should update the authority of the Committee on Foreign Investment in the United States (CFIUS) to include the ability “to review investments in US companies that could support foreign acquisition capabilities”[3] in certain areas where China could then surpass US technological capabilities. The Commission highlighted three specific areas for jurisdictional enhancement:
   1. Investments which specific adversary industrial policies prioritize
   2. Investments in US firms that receive funding from the Departments of Defense, Energy, Commerce, or other agencies that involve projects critical to US national security or economic security
   3. Other investments that provide “privileged”[4] access to expertise or business networks, as well as certain production methods that allow the US to maintain an economic or economically competitive position

   Interestingly, CFIUS already has the authority to review the first two areas noted above and could, in select circumstances, review the third area.

6. Congress should establish an interagency group, led by ODNI, to create a public database accessible to US companies, universities, and other parties that can be used as part of the diligence process. The hearings highlighted that the lack of information or opacity makes it difficult to determine the risks of engaging with parties in China or affiliates of Chinese parties. The database could include information regarding how the Chinese military or intelligence agencies may be linked to Chinese companies or where research institutions or financial firms have ties to the Chinese government.

As with past reports, Congress considers the recommendations and decides whether to move forward with specific legislative initiatives. While the recommendations are not self-effectuating, they reflect consistent issues raised by both Congress and the executive branch over the last five years.

At the same time, the Biden administration has moved forward assertively to expand restrictions on technology transfers to China, scrutinized cross-border investments closely for national security concerns, and created new tools (such as an outbound investment review framework) to manage the relationship. One or all of these changes will require a more detailed focus on how industry, the academic community, and investors factor the risks and benefits of conducting business with China.

From a pragmatic perspective, the Report provides a roadmap of concerns and proposed solutions that outline where congressional action is required—such as legislation—or where congressional direction is all that is needed. Congress appears to have bipartisan support for addressing publicly stated concerns with actions by the Chinese government, and the potential for legislative action is not insignificant.