The witnesses asserted that supplier audits conducted in the XUAR are unreliable, as the Chinese government obfuscates forced labor practices and criminalizes the investigation of such practices as a matter of policy. The discussion touched on the illustrative example of an audit conducted by Loening GmbH on a Volkswagen joint venture in the XUAR, which found no indication of forced labor at the site, despite the region’s widely-acknowledged state-sponsored forced labor programs. Although several senior staff at Loening disavowed the audit results and resigned, American index provider MSCI Inc. removed Volkswagen’s “red flag” status based on the audit. This underscores the broader concern beyond the unreliable nature of social compliance audits conducted in XUAR and highlights the sustainable sourcing certification agencies and indexing organizations that rely on and legitimize those audits, notwithstanding these deficiencies.

The witnesses emphasized, however, that social compliance audits elsewhere in the PRC – even outside of the XUAR – are still inherently unreliable. They noted the challenges in tracking the destinations of labor transfers outside of the XUAR and that the labor transfer program is expanding. The Uyghur Forced Labor Prevention Act (“UFLPA”) prohibits the importation of goods manufactured wholly or in part with forced labor in the PRC. This includes not only goods manufactured in the XUAR, but also goods manufactured in the PRC outside the XUAR with forced labor, including forced labor facilitated by means of labor transfer programs. Witnesses noted that the lack of independent worker organizations in the PRC makes properly assessing labor conditions more difficult, and that it is typical for managers to prepare facilities for an audit by creating fake time sheets and pressuring workers to provide inaccurate information. The witnesses stressed that off-site worker interviews are essential in reliable social compliance audits, but noted that this is rarely possible in the PRC.

General critiques of social compliance audits are not new, but any attempt to utilize such audits in an environment of state-sponsored forced labor exacerbates the approach’s deficiencies. The International Labor Organization (“ILO”) – along with much of the international community – seems to have acknowledged as much. In the ILO’s February 2024 update to their “Hard to see, harder to count” handbook on identifying forced labor, the organization includes for the first time an entire section on state-sponsored forced labor. In this context, the ILO’s pre-eminent handbook on identifying forced labor now formally recognizes that “large-scale labour transfers frequently involve elements of compulsory labour ‘as a means of political coercion and education’ and compulsory labour ‘as a means of racial, national, social or religious discrimination.’ Much like the evidence gathering that a reliable social compliance audit would seek to incorporate, the ILO notes that “[u]ndertaking research on state-imposed forced labour poses a number of unique practical challenges. As the State itself imposes this category of forced labour, States may have little incentive to collaborate with or facilitate the work of researchers wishing to shed light on it. Information access can be problematic.”

In short, companies that rely on social compliance audits conducted in the PRC – including, but not limited to, the XUAR – should not presume the accuracy of such audits as a factual matter, much less that they accurately identify forced labor trade enforcement risks under the UFLPA and related laws. There is certainly a role for both social compliance audits and certifications to help verify supply chains are free of forced labor, but companies should consider a more holistic approach and be cognizant of the challenges posed by state-sponsored forced labor, in particular. Please reach out to a Kelley Drye attorney if you have concerns about your supply chain and how your company could be impacted.

[1] The expert witnesses included: Thea Lee (Undersecretary for International Affairs at the U.S. Department of Labor), Scott Nova (Executive Director of the Worker Rights Consortium), Dr. Adrian Zenz (Senior Fellow and Director in China Studies at the Victims of Communism Memorial Foundation), and Jim Wormington (Senior Research and Advocate on Corporate Accountability at Human Rights Watch).

The Report and its findings herald a notable shift away from a “free trade” oriented U.S. export policy toward more hardline oversight and regulation of U.S. exports to the PRC and adversaries. According to the House Committee, the Chinese Communist Party’s (CCP) Military-Civil fusion strategy blurs the line between commercial and military items in such a way that requires the United States to abandon the “post-Cold War” distinction between economic and national security. In doing so, the Report calls on licensing officials to act less as the “voice of business” and more as U.S. regulators that are more “willing to deny licenses to export technology” to U.S. adversaries. It remains to be seen whether Congress or BIS will implement any of the recommendations, but it is clear the House Committee has serious concerns about the current state of play.

The Report makes several recommendations to address key areas of weakness in the United States’ approach to U.S. export controls, including the following:

1. Implement a majority vote system for the BIS’s Operating Committee, especially for exports to China. For the fiscal years of 2017–2019, there has been a 60 percent increase in non-consensus decisions of the Operating Committee, which adjudicates escalations from licensing decisions where reviewing agencies are not in agreement. According to the House Committee, these statistics raise concerns that the Operating Committee too often overrides the objections of other agencies by abusing Commerce’s role as both a Chair and a member. Implementation of this recommendation from the House Committee would likely make it more difficult for U.S. industry to obtain favorable licensing decisions through the escalation process.
2. BIS should impose a policy of denial for all exports of national security-controlled items to China to reduce the rate of approval. In 2020, nearly all exports to China of items listed on the Commerce Control List (CCL) were unlicensed. Even where required, BIS granted an overwhelming majority of requests to export or release U.S. software or technology to the PRC. The House Committee concluded that denying the value of these exports, which in 2021 reflected around 1 percent of U.S. exports to China, would hardly effect U.S.-China trade relations, while blunting CCP military ambitions. If implemented, U.S.-regulated firms involved in dual-use transactions with China would face stronger headwinds in obtaining licenses that historically have been granted.
3. BIS (or Congress) should apply a “presumption of denial” for all items subject to the EAR for companies on the Entity List and clearly define the term to mean that a license, no matter the item, will be denied in essentially every instance. BIS’s licensing regime is not strict enough in preventing the proliferation of U.S. technology to prohibited end users and end uses, according to the Report. The Report submits that too many license applications for companies appearing on the Entity List are approved despite being subject to a “presumption of denial,” with BIS approving $60 billion worth of licenses to Huawei during a six-month period between November 2020 and April 2021. Defining the term to limit BIS’s discretion, while also expanding the scope of items subject to the “presumption of denial” standard, would make it much more difficult if not impossible to engage in controlled transactions with Entity Listed PRC companies.
4. BIS should broaden the scope of Entity List requirements to subsidiaries and affiliates, and invest in enhanced, commercially-available mapping tools. The Report cites the effectiveness of the “50 percent rule,” a mechanism that the Treasury Department’s Office of Foreign Assets Control employs when administering economic sanctions against Specially Designated Nationals (SDNs) to “flow-down” U.S. sanctions requirements to certain entities majority owned by SDNs. The Report recommends that BIS similarly adopt, at the very least, a mechanism that would automatically apply Entity List licensing requirements to related PRC-entities in order to mitigate circumvention of U.S. export controls. In addition, the House Committee calls for investment in enhanced tools for screening and identifying linkages of PRC companies to CCP military. This measure, if implemented, could result in more entities being subject to Entity List restrictions, cutting off sales to unlisted subsidiaries.
5. The Department of Commerce must renegotiate its end-use agreement with the PRC or impose greater restrictions on exports to China considering the inability to conduct meaningful end-use checks. Unlike other countries, where U.S. export control officers have a good deal of discretion to conduct end-use checks for up to 5 years after shipment, end-use checks involving PRC shipments must occur within 180 days. Moreover, end-use checks on PRC shipments require PRC approval. According to the Report, this severely hinders BIS’s ability to monitor and ensure compliance with license terms. Should the Department of Commerce successfully re-negotiate these terms, U.S. exporters can expect greater and longer lasting U.S. official involvement in commercial relationships with PRC firms overseas, including more auditing of end users and end uses.

In addition to the above, the Report makes numerous other recommendations, including limitations on standard-setting loopholes, fees for certain export licensing requests, requirements to refer certain licensing decisions or CCL determinations to interested U.S. agencies, intensive review and transfer of EAR99 technologies to the CCL, and a continued push for bilateral and plurilateral export control agreements covering, at a minimum, AI, quantum, and biotechnology.

Key Takeaways:

In the run up to the election, neither Party will want to be regarded as “weak on China” or U.S. national security issues. And it is unlikely that the Commerce Department and BIS will push back against these recommendations in any public way.

So, while the administration and BIS may not implement every recommendation, the Report marks for the new year a movement toward a stricter policy position with respect to China, if not additional “tough on China” measures and rulemaking. As pressure on U.S. regulatory bodies continues to mount, U.S. industry should anticipate increased regulation and greater difficulty in obtaining licenses for export transactions involving China, even where those transactions involve EAR99 designated items.

Please contact our sanctions and export controls team if you require any assistance navigating this development.

To the extent the recommendations are accepted, industry could see even further restrictions on dealings with China. In particular, the proposals could result in more export controls enforcement and the granting of fewer licenses. Industry could also see additional scrutiny for Chinese investment into the United States.

A select summary of the report’s key findings and recommendations is below.

Export Controls. The Commission found that, even where coordinated with allies, current U.S. export controls are “insufficient” to stem the flow of knowhow and capital into China’s defense sector. The effectiveness of export controls is diluted by China’s MCF strategy, which combines the capabilities and innovation of civilian sectors “to drive military development through . . . policies and government-supported mechanisms.” This MCF strategy necessitates a “renewed focus on dual-use technologies, particularly in current multilateral regimes, which focus mainly on preventing the spread of military technologies that currently exist rather than preventing the development of new ones.”

The Commission recommended that Congress evaluate the possibility of establishing a single export licensing system. This system would integrate the Commerce Control List and the U.S. Munitions List, which refer to dual-use technology and armament licensing systems managed by the Commerce Department’s Bureau of Industry and Security (BIS) and the State Department’s Directorate of Defense Trade Controls, respectively. In evaluating the feasibility of a single export licensing system, the Commission advised that Congress evaluate, among other factors, (1) the commercial impact of combining the licensing systems, (2) which technologies to include in a combined system, and (3) which U.S. government agency should be in charge of the new system.

Additionally, the Commission recommended that Congress direct the General Accountability Office to evaluate the effectiveness of the recently imposed semiconductor export controls. These controls are designed to prevent China from acquiring or developing the capacity to manufacture certain advanced semiconductors. Last month BIS published interim final rules seeking to address certain gaps BIS found in its existing controls on advanced computing items, semiconductor manufacturing equipment, and items that support supercomputing applications and end-uses.

The Commission found that, following the implementation of BIS’s controls on the semiconductors that go into artificial intelligence (AI), MCF allowed China to expand its circumvention of U.S. restrictions by “scaling up thousands of intermediaries to [procure high]-end chips, including from U.S.-based NVIDIA.” This allowed the Chinese military to make rapid advances in AI for defense applications through its partnerships with civilian entities, and that “investment and procurement patterns suggest the [China] aims to use AI-enabled weapons systems to counter specific U.S. advantages and target U.S. vulnerabilities.”

Committee on Foreign Investment in the United States (CFIUS). The Commission recommended that CFIUS, an inter-agency committee that screens U.S.-bound investments, be granted the authority to “review investments in U.S. companies that could support foreign acquisition of capabilities to attain technological self-sufficiency or otherwise impair the economic competitiveness of the United States.” These “capabilities” would include investments in technology that are prioritized in the industrial policies of adversarial countries and investments in U.S. firms that have received funding from the U.S. government for projects critical to national security.

This recommendation from the Commission, if enacted, would complement an Executive Order issued by the Biden Administration last year directing CFIUS to consider additional national security risks in its evaluations of transactions. Importantly, the U.S. Treasury Department, which chairs CFIUS, is also in the process of drafting regulations to restrict U.S. outbound investment to countries that pose a risk to U.S. national security. CFIUS itself, as well as this forthcoming outbound investment screening mechanism, would have the effect of limiting China’s ability to procure technology that could go into the development of AI.

China’s Influence Over Foreign Militaries. China is keen to advance its technological prowess, partly through the acquisition of U.S. technologies. Because of this, there is a risk that U.S.-controlled technology could be supplied to the foreign militaries that China partners with. The Commission found that China seeks to deepen its influence over foreign militaries to undermine U.S. interests and “pursue relevant combat support capabilities in communications, logistics, survival skills, military medicine, and other basic military skills. Further, in addition to being a major exporter of small arms, “China has both improved the quality of its exports and expanded the range of equipment it provides, with the most notable advances in aircraft and ships.”

To that end, the Commission recommended that the U.S. Department of Defense (DOD) submit a report to Congress “detailing measures DOD is taking to mitigate the risk of the [Chinese military] gaining indirect knowledge of U.S. Armed Forces’ equipment and operational tactics, techniques, and procedures through interactions with the militaries of U.S. allies and partners.” The Commission also recommended that the report identify the steps necessary for end-use monitoring to ensure compliance.

In summary, U.S.-based firms should take the above issues raised by the Commission into account when considering sales to China or investments involving Chinese entities. Opportunities being pursued with China now may come under additional scrutiny or restrictions later as the Commission’s proposals are reviewed and potentially implemented.

Please contact our sanctions and export team if you need assistance navigating these developments in the course of certain sales to China.

The new E.O. resets the U.S. government’s approach to ICTS by ordering a review of the national security threats posed by software applications that collect Americans’ sensitive personal and business data and by foreign adversaries’ access to large repositories of U.S. person data. New restrictions are likely following that review, and companies that rely on software applications owned or managed by companies linked to China or other potential foreign adversaries, should closely watch developments in this space.

New reports on “unacceptable or undue risks” posed by foreign adversary-connected applications

The E.O. directs the Directors of National Intelligence and Homeland Security to provide threat and vulnerability assessments to the Secretary of Commerce. In turn, the Commerce Department will draft two reports on foreign adversary-connected software, defined as software that has the ability to collect, process, or transmit data over the internet. The reports will recommend actions to protect against harm from the sale of, transfer of, or access to U.S. persons’ sensitive data, including personally identifiable information, personal health information, and genetic information. In addition, the Commerce Department will recommend additional actions to address risks associated with software applications that are designed, developed, manufactured, or supplied by persons owned or controlled by, or subject to the jurisdiction or direction of, a foreign adversary.

Several criteria indicate national security risk of ICTS applications

Building on the criteria to assess national security threats listed in E.O. 13873, the new E.O. lists several factors that will be considered when evaluating the risks posed by foreign adversary-connected software, including:

• ownership, control, or management by persons that support a foreign adversary’s military, intelligence, or proliferation activities;
• use of the connected software applications to conduct surveillance that enables espionage, including through a foreign adversary’s access to sensitive or confidential government or business information, or sensitive personal data;
• ownership, control, or management of connected software applications by persons subject to coercion or cooption by a foreign adversary;
• ownership, control, or management of connected software applications by persons involved in malicious cyber activities;
• a lack of thorough and reliable third-party auditing of connected software applications;
• the scope and sensitivity of the data collected; the number and sensitivity of the users of the connected software application; and
• the extent to which identified risks have been or can be addressed by independently verifiable measures.

These criteria will inform the U.S. government’s decision-making framework to adopt a “rigorous, evidence-based” analysis to address risks posed by ICTS transactions involving foreign adversary-connected software.

Further action on ICTS applications likely

Although yesterday’s E.O. rescinds the previous E.O.s dealing with Chinese mobile applications, new restrictions on Chinese and other software that collect large amounts of sensitive U.S. person data are likely to flow from the Commerce Department’s forthcoming report and recommendations, which are expected within 180 days. Furthermore, the E.O. provides the Commerce Department with authority to restrict transactions and business activities that may:

• Pose a risk of sabotage or subversion of the design, integrity, manufacturing, production, distribution, installation, operation, or maintenance of ICTS in the United States;
• Pose a risk of catastrophic effects on the security or resiliency of the critical infrastructure or digital economy of the United States; or
• Otherwise pose an unacceptable risk to the national security of the United States or the security and safety of United States persons.

The amended order reflects a growing emphasis on human rights and “democratic values” in U.S. sanctions policy related to China. The White House fact sheet announcing today’s amendment indicated that the Order is intended to prevent the flow of U.S. capital to companies that develop or use surveillance technology to facilitate repression or serious human rights abuse in and outside of China, including technology used to surveil religious or ethnic minorities. Other recent moves, including those in response to Chinese government policies in the Xinjiang region and Hong Kong, have similar human rights policy motivations. The administration may cite to security and adherence to democratic values in imposing future sanctions.

Below, we summarize the key features of the new restrictions and guidance issued by the Office of Foreign Assets Control (“OFAC”).

Companies targeted

The Biden administration indicated that it expects to add additional parties to the NS-CIMC List in the future.

Relevant securities

Wind-down period

Guidance for U.S. financial service companies and investors

• U.S. financial service companies that provide clearing, execution, settlement, and related services can continue to deal in CMIC securities so long as they do not facilitate prohibited transactions by U.S. persons.
• Securities exchanges operated by U.S. persons, along with market makers, market intermediaries and other participants, are not prohibited from effecting U.S. persons’ divesture of publicly traded securities in the listed CMICs during the wind-down period.
• U.S. persons employed by non-U.S. entities are not prohibited from facilitating purchases or sales related to a CMIC security on behalf of their non-U.S. employer or providing investment management or similar services to a non-U.S. person.
• U.S. financial service companies can rely on “information available to them in the ordinary course of business” in conducting due diligence on whether an underlying purchase or sale is prohibited under the amended E.O

* * * * *

Additions to NS-CMIC List

“Delisted” Companies

AEROSPACE CH UAV CO., LTD AEROSPACE COMMUNICATIONS HOLDINGS GROUP COMPANY LIMITED AEROSUN CORPORATION ANHUI GREATWALL MILITARY INDUSTRY COMPANY LIMITED AVIATION INDUSTRY CORPORATION OF CHINA, LTD. AVIC AVIATION HIGH-TECHNOLOGY COMPANY LIMITED AVIC HEAVY MACHINERY COMPANY LIMITED AVIC JONHON OPTRONIC TECHNOLOGY CO., LTD. AVIC SHENYANG AIRCRAFT COMPANY LIMITED AVIC XI’AN AIRCRAFT INDUSTRY GROUP COMPANY LTD. CHANGSHA JINGJIA MICROELECTRONICS COMPANY LIMITED CHINA AEROSPACE TIMES ELECTRONICS CO., LTD CHINA AVIONICS SYSTEMS COMPANY LIMITED CHINA MARINE INFORMATION ELECTRONICS COMPANY LIMITED CHINA COMMUNICATIONS CONSTRUCTION GROUP (LIMITED) CHINA MOBILE LIMITED CHINA NUCLEAR ENGINEERING CORPORATION LIMITED CHINA SHIPBUILDING INDUSTRY COMPANY LIMITED CHINA SHIPBUILDING INDUSTRY GROUP POWER COMPANY LIMITED CHINA STATE SHIPBUILDING CORPORATION LIMITED CHINA TELECOM CORPORATION LIMITED CNOOC LIMITED COSTAR GROUP CO., LTD. CSSC OFFSHORE & MARINE ENGINEERING (GROUP) COMPANY LIMITED FUJIAN TORCH ELECTRON TECHNOLOGY CO., LTD. GUIZHOU SPACE APPLIANCE CO., LTD HUAWEI TECHNOLOGIES CO., LTD. INNER MONGOLIA FIRST MACHINERY GROUP CO., LTD. JIANGXI HONGDU AVIATION INDUSTRY CO., LTD. NANJING PANDA ELECTRONICS COMPANY LIMITED NORTH NAVIGATION CONTROL TECHNOLOGY CO., LTD. PROVEN GLORY CAPITAL LIMITED PROVEN HONOUR CAPITAL LIMITED SHAANXI ZHONGTIAN ROCKET TECHNOLOGY COMPANY LIMITED ZHONGHANG ELECTRONIC MEASURING INSTRUMENTS COMPANY LIMITED

CHINA INTERNATIONAL ENGINEERING CONSULTING CORP. CHINA NATIONAL CHEMICAL CORPORATION (CHEMCHINA) CHINA NATIONAL CHEMICAL ENGINEERING GROUP CO., LTD. (CNCEC) CHINA NUCLEAR ENGINEERING & CONSTRUCTION CORPORATION (CNECC) CHINA SHIPBUILDING INDUSTRY CORPORATION (CSIC) CHINA THREE GORGES CORPORATION LIMITED CRRC CORP. DAWNING INFORMATION INDUSTRY CO (SUGON) INSPUR GROUP SINOCHEM GROUP CO LTD

Certain exports of crude oil, condensates, aromatics, natural gas liquids, hydrocarbon gas liquids, natural gas plant liquids, refined petroleum products, liquefied natural gas, natural gas, synthetic natural gas, and compressed natural gas to CNOOC are excluded from the license requirement, as are exports of items to joint ventures with persons from Country Group A:1 countries that operate outside of the South China Sea.

In the notice, the Commerce Department indicated that CNOOC was added to the Entity List due to the company’s involvement in the South China sea dispute. Suppliers and other companies doing business with CNOOC should carefully review whether these rules apply to their operations and implement controls to prevent exports, re-exports, or transfers of items to CNOOC, unless licensed by BIS.

As of the date of designation, U.S. persons are prohibited from conducting business with CEIEC and its over 200 subsidiaries without authorization from OFAC and all property and interests in property of the company are blocked (i.e., frozen) under U.S. law. Because of the wide potential reach of the sanctions, OFAC issued General License 38 to allow U.S. persons to wind-down pre-existing business with the company and its subsidiaries over a 45-day period.

Please contact our economic sanctions team if you have any questions about the designation or your sanctions risk profile.

What companies are targeted by the Order?

The Order applies to the securities of any company designated as a “Communist Chinese military company” (CCMC) by the U.S. Department of Defense (DoD) or Treasury’s Office of Foreign Assets Control (OFAC). The Order initially applies to 31 companies previously designated as CCMCs by DoD earlier this year. The Order will also apply to newly listed CCMCs 60 days after they are designated by the U.S. government.

As written, the Order does not appear to apply to subsidiaries of CCMCs that are not explicitly designated by DoD or OFAC. Further guidance from OFAC on that point would be helpful, however.

What securities are subject to the Order?

The Order applies to all publicly traded securities of CCMCs, including securities that are derivative of or are designed to provide investment exposure to CCMC securities. The Order defines “securities” to include those specified in Section 3(a)(10) of the Securities Exchange Act of 1934.

Are there any exceptions?

The Order allows U.S. persons to divest from existing holdings in the currently listed CCMCs until November 21, 2021, provided that the securities are sold to non-U.S. persons. The Order provides for a 365-day divestment period for CCMCs that are designated in the future. Similar divestment periods are available under various OFAC sanctions programs that target securities.

What’s next?

We expect OFAC to issue guidance clarifying the scope of the Order before it becomes effective, as the agency has done for similar sanctions programs in the past. There are a number of questions that could be addressed by the agency, including how the Order will apply to U.S. broker dealers who facilitate divestment activities by U.S. persons and transactions by non-U.S. persons, U.S. and non-U.S. funds that are backed by CCMC securities, and to what extent the Order will apply to subsidiaries of listed CCMCs.

Notably, the Order takes effect only nine days before the inauguration of the Biden administration. The next administration could suspend or modify the Order, although immediate action on the Order may not be a top priority given other challenges the administration is expected to face upon taking office.

This action is the most recent in a series of confrontational U.S. trade control measures targeting China. An unnamed senior U.S. official described CCCC as “the Huawei of infrastructure.”

BIS added 36 other companies to the list, including parties in France, Hong Kong, Indonesia, Malaysia, Oman, Pakistan, Switzerland, and the UAE for activities deemed contrary to U.S. national security or foreign policy interests.

At a high level, the new rule prohibits the export, re-export, or transfer of certain items produced outside the United States if you know that the foreign-made item will be incorporated into or used in the “production” or “development” of an item intended for a designated Huawei entity or if the foreign-made item will be provided to a designated Huawei entity. The rule also applies to shipments involving certain foreign-made items where Huawei plays any role, including as a purchaser, intermediate consignee, ultimate consignee, or end-user.

The following foreign-made items are subject to the new rule:

• Foreign-made items that are direct products of technology or software subject to the EAR and that are classified under Export Control Classification Numbers (ECCNs) 3D001, 3D991, 3E001, 3E002, 3E003, 3E991, 4D001, 4D993, 4D994, 4E001, 4E992, 4E993, 5D001, 5D991, 5E001, or 5E991; or
• Foreign-made items that are produced by a non-U.S. plant or major component of a non-U.S. plant if that plant or major component is itself a direct product of U.S.-origin technology or software classified under those ECCNs.[1]

The August 20 rule also adds 38 additional Huawei companies to the Entity List and replaces a temporary general license with an authorization that allows parties to provide limited security cybersecurity research to designated Huawei entities. Other transactions involving Huawei that are subject to the new rule require a license from BIS. Such license requests will generally be reviewed pursuant to a “policy of denial,” unless the transaction involves items that are only capable of supporting equipment at below the 5G level (e.g., 4G and 3G technology).

[1] The new rule contains a savings clause excluding from control certain foreign-made items that were in production prior to August 17, 2020 until September 14, 2020. The savings clause is narrow in scope and should be reviewed carefully.

OFAC added 11 current and former Hong Kong government officials, including Carrie Lam, Hong Kong’s Chief Executive, to its List of Specially Designated Nationals (SDN List). As a result, all property and interests in property of the designated officials in the United States or within the possession or control of U.S. persons must be blocked and reported to OFAC. U.S. persons, companies, and financial institutions are also broadly prohibited from conducting business dealings with the designated officials.

U.S. companies that do business with Hong Kong’s government should ensure that they do not engage in direct or indirect business dealings with the sanctioned officials, which OFAC is likely to view as a violation of the E.O. Foreign financial institutions that provide services to the officials should also examine their institutions’ potential exposure under U.S. secondary sanctions authorized under the Hong Kong Autonomy Act of 2020 (HKAA).

“Provided a full and complete accounting to any COVID-19 investigation led by the United States, its allies, or United Nations affiliates, such as the World Health Organization (WHO);

• Closed all wet markets that have the potential to expose humans to health risks; and
• Released all pro-democracy advocates in Hong Kong that were arrested in the post COVID-19 crackdowns.”

The legislation has additional requirements, most notably for exporters requires Buy America for procurements related to the Strategic National Stockpile with standard waiver authority for the Health and Human Services Secretary.

We are closely monitoring this draft legislation and related developments. We are happy to help answer any questions your company may have regarding this Act or other export and sanctions related matters, particularly in light of COVID-19.

These changes, which are largely effective on June 29, 2020, will create additional hurdles in transactions with China, Russia, and Venezuela. Many transactions that were previously authorized under a general license will now require a specific license from BIS. Even transactions that may still be completed without a specific authorization may require significant additional due diligence steps, particularly to ascertain end-users and end-use in China. If your company is currently doing business in these markets, it is important to determine whether these rule changes affect your business and, if so, how to comply with the new regulations.

Final rule increasing restrictions on transactions involving products for military end-use and end-users in China, Russia, and Venezuela

Second, the final rule expands the scope of the military end-use restriction, which will apply to all three of China, Russia, and Venezuela. Currently, end-use restrictions apply to transactions in which the item is for the use, development, or production of military items. The final rule expands the scope of this restriction to include an item that “supports or contributes to the operation, maintenance, repair, overhaul, refurbishing, development, or production” of military items. This is designed to capture items that may have a relatively limited supporting role for a military item, where the current restriction can be interpreted to require a more robust relationship between the item involved in a transaction and a military item.

Last, this final rule adds nearly twenty additional Export Control Classification Numbers (“ECCNs”) to Supplement 2, and expands the coverage related to some ECCNs already covered, which currently includes approximate 30 ECCNs, adding ECCNs covering materials processing, telecommunications, and information security, among others.[2]

This rule becomes effective on June 29, 2020.

Final Rule Removing License Exception CIV

BIS stated in the final rule that additional guidance regarding the rule is forthcoming. This rule also becomes effective on June 29, 2020.

Proposed Rule Modifying License Exception APR

BIS requests comments regarding how the proposed rule would potentially impact companies and other stakeholders who currently use or plan to use the License Exception APR. BIS is particularly interested in the volume of transactions and time necessary to complete to future transactions affected by the proposed change, as well as other potential business impact. Comments must be submitted to BIS by June 29, 2020.

These significant new restrictions are primarily aimed at and will especially impact trade with China.[6] At a minimum, these new rules will significantly increase due diligence burdens on transactions with China, as the U.S. responds to “civil-military integration” in that market. Parties engaged in transactions with China may be required to seek additional certification from their business partners that items exported will violate the expanded end-use and end-user restrictions.

Further, many exports that would have previously been permissible without specific authorization from BIS will now be subject to BIS licensing requirements. This change may create delays as parties go through the licensing process, and BIS is likely to refuse to authorize transactions where there is insufficient clarity on the national security and foreign policy implications of the proposed transaction. Companies exporting covered items to China, or using License Exceptions CIV and/or APR should immediately begin preparation to comply with these rules to minimize disruption.

Please contact us if you have questions regarding this rule making or if you would like to discuss compliance strategies.

[1] 15 C.F.R. § 744.21. A military end-user is “the national armed services (army, navy, marine, air force, or coast guard), as well as the national guard and national police, government intelligence or reconnaissance organizations, or any person or entity whose actions or functions are intended to support 'military end uses'.” 15 C.F.R. § 744.21(g).

[2] The complete list of ECCNs added to the supplement as part of the rule is 2A290, 2A291, 2B999, 2D290, 3A991, 3A992, 3A999, 3B991, 3B992, 3C992, 3D991, 5B991, 5A992, 5D992, 6A991, 6A996, and 9B990.

[3] See 15 C.F.R. Part 740, Supp. No. 1 (Countries include: Armenia, Azerbaijan, Belarus, Cambodia, China, Georgia, Iraq, Kazakhstan, Kyrgyzstan, Laos, Libya, Macau, Moldova, Mongolia, Russia, Tajikistan, Turkmenistan, Ukraine, Uzbekistan, and Vietnam. The exception specifically excludes North Korea.

[4] License Exception CIV authorized exports for approximately 30 ECCNs. These are identified by “CIV: Yes” under the ECCNs heading on the Commerce Control List.

[5] See 15 C.F.R. Part 740, Supp. No. 1.

[6] Venezuela is already subject to significant economic sanctions administered by the U.S. Office of Foreign Assets Control (“OFAC”), and OFAC recently increased those restrictions.

In July 2016, Commerce issued AD and CVD orders on CORE from China and an AD order on CORE from Taiwan (along with AD and CVD orders on U.S. imports of CORE from India, Italy, and South Korea). CORE subject to the orders is generally defined as a steel sheet that has been coated or plated with a corrosion‐ or heat‐resistant metal (such as zinc, zinc-iron alloy, aluminum, or zinc-aluminum alloy) to prevent corrosion and thereby extend the service life of products produced from the steel. According to Commerce, shipments of CORE from Costa Rica, Guatemala, Malaysia, South Africa, and the UAE to the United States increased in value by 29,210 percent, 35,944 percent, 151,216 percent, 629 percent, and 5,571 percent, respectively, in the 45 months before and after the 2015 initiation of the AD and CVD investigations on CORE from China and Taiwan. If Commerce preliminarily determines that circumvention of these orders is occurring, Commerce will instruct Customs and Border Protection to suspend liquidation and begin collecting cash deposits on imports of CORE from Costa Rica, Guatemala, Malaysia, South Africa, and the UAE using Chinese-origin substrate, and CORE completed in Malaysia using Taiwanese-origin substrate.

Commerce has previously investigated and found circumvention of the AD and CVD orders on imports of CORE from China and Taiwan. In November 2016, in response to requests from domestic CORE producers, Commerce initiated an anti-circumvention inquiry into whether imports of CORE from Vietnam using hot-rolled and cold-rolled steel substrates from China were circumventing the AD and CVD orders on CORE from China. In May 2018, Commerce reached an affirmative final determination in that anti-circumvention proceeding, applying cash deposit rates of 39-199 percent to imports of CORE from Vietnam unless use of non-Chinese origin substrate is documented. In August 2018, Commerce initiated two additional anti-circumvention inquiries – again, at the domestic industry’s request – into whether imports of Vietnamese CORE using substrate from Taiwan and Korea circumvented the duties on CORE from those two countries. In July 2019, Commerce reached preliminary affirmative circumvention determinations with respect to the orders on CORE from both Taiwan and Korea.

Kelley Drye & Warren LLP represented domestic CORE producer ArcelorMittal USA LLC in the original CORE AD and CVD investigations and in the 2016 and 2018 anti-circumvention proceedings.

According to the Office of the U.S. Trade Representative (USTR), the trade policy agenda underscores three main points. First, the agenda notes that this Administration inherited a “deeply flawed global trading system” that it is striving to improve. The agenda calls out the primary targets of the Administration’s trade efforts to date: overhauling the North American Free Trade Agreement (NAFTA) into the United States-Mexico-Canada Agreement (USMCA), the overreach of the World Trade Organization’s (WTO) Appellate Body, and unfair trade practices from U.S. trading partners, such as China’s non-market policies.

Second, the Administration continues efforts to improve domestic trade policies to better serve U.S. workers. While the agenda reviews a number of the Administration’s recent achievements, it highlights that a primary goal of 2019 is to obtain Congressional approval of the USMCA, which the President has touted as better serving the interests of U.S. workers, farmers, and businesses than NAFTA. Trade issues with China are unsurprisingly a significant focus, with USTR highlighting its negotiations with China to eliminate a range of unfair trade policies and practices. The Administration’s concern that the WTO Appellate Body’s decisions are overreaching is well-known, and the agenda promises a commitment to WTO reform efforts.

Third, the Administration intends to pursue new trade deals and to continue its enforcement of current trade laws. Here, the Administration highlights its focus on efforts to preserve U.S. national security and national defense, a nod to its current use of Sections 232 and 301 to impose tariffs on a broad range of global imports. The agenda also notes USTR’s intent to pursue new trade deals with Japan, the European Union, and the United Kingdom, as well as to concentrate on trade and investment with Kenya.

In sum, the 2019 agenda focuses on the ongoing goals of the Administration to improve conditions for American workers, to strictly enforce U.S. trade laws, and to encourage U.S. economic growth. We continue to monitor the Administration’s efforts and initiatives as they unfold in 2019. Please contact the international trade group with any questions.

This development is the latest in a series of steps taken by the Trump administration to curtail Chinese investment in the U.S. The recently proposed Foreign Investment Review Modernization Act (“FIRRMA”) would expand the jurisdiction of the Committee on Foreign Investment in the United States (“CFIUS”) to include investments in “critical technology” and “critical infrastructure”, and would also make it easier for regulatory agencies to review investments made by state-owned enterprises. This legislative proposal is largely viewed as focused on regulating Chinese investment. The Trump administration already exercised existing CFIUS-related authority to block the acquisition of Lattice Semiconductor Corp. by Canyon Bridge Capital Partners, a Chinese firm.

Capella did not participate in U.S. Department of Commerce’s (“Commerce”) 2011-2012 administrative review of aluminum extrusions from China. As a result, its entries were subject to the 374.15% “all others” rate under the countervailing duty order. In connection with other litigation, the 374.15% “all others” rate was reduced to 7.37% in October 2015 based on challenges brought by several other importers of aluminum extrusions.

Capella, however, challenged the countervailing duty margin applied to its entries and filed two complaints at the U.S. Court of International Trade (“CIT”) challenging Commerce’s liquidation instructions that incorporated that rate. In its complaints, Capella asserted that Commerce could not lawfully apply the 374.15% rate to Cappella’s entries because the disparity between that rate and the litigated 7.37% rate was too great. The CIT dismissed Capella’s complaints for failure to state a claim. In its decisions, the CIT found that the statute contemplates that the CVD rate Commerce established in its final determination is the rate that applies to pre-Timken notice entries when liquidation is not 1) enjoined by a court decision, or 2) the subject of administrative review. Further, because Capella’s imports were entered before publication of the Timken notice, the company did not request administrative review of its entries, and it did not participate in the rate-lowering litigation – it could not claim the benefit of the lower all-others rate.

In its decision, the Federal Circuit upheld the CIT’s two decisions dismissing Capella’s complaints. The Federal Circuit found that, based on the facts of the case, the statute and legislative history supported the CIT’s findings. Specifically, like the CIT, the CAFC determined that because Capella did not participate in the litigation challenging the 374.15% all others rate, and because Capella’s pre-Timken notice entries were not enjoined by a court order, its entries were properly liquidated “as entered” at the “all others” rate of 374.15% identified in the final determination

Low-priced Chinese steel has long been the target of antidumping and countervailing duty trade actions in numerous countries that have seen their domestic steel industries hammered by surging imports, including the United States, the European Union, Canada, Mexico, Australia, and several of China’s neighboring Asian countries. According to the OECD, global steel capacity reached 2.38 billion metric tons in 2016, with China alone accounting for more than half of that capacity. Another nearly 40 million metric tons of worldwide capacity additions are under way and expected to come online by 2019. An estimated 53 million metric tons of capacity expansions are also in the planning stages over the next few years. The modest improvements in global steel demand in 2017 and 2018 are insufficient to combat the overcapacity crisis. As the Chairman of the OECD Steel Committee stated in September 2017, “Forecasts by external experts suggest that steel demand could reach only 1.87 billion metric tonnes in 2035, which would be 0.49 billion metric tonnes or 20.1% below the latest steelmaking capacity level expected for 2017.”

In the past year or so, a groundswell for collective, international action in response to the glut of Chinese steel has resulted in important statements made at the G-20 (establishing a Global Forum on Steel Excess Capacity), the OECD, and the WTO, but with little more than non-binding commitments from China. Ironically, China announced that it was relieving taxes on Chinese steel exporters just days after the United States, the European Union, and Japan issued a statement on global trade crises in the wings of the WTO’s ministerial summit in Buenos Aires. The members agreed to “enhance trilateral cooperation in the WTO and other forums” to address, among other things, “severe excess capacity in key sectors exacerbated by government-financed and supported capacity expansion, {and} unfair competitive conditions caused by large market-distorting subsidies and state owned enterprises.” The mention of “excess capacity in key sectors” did not need to directly mention China or steel to reach the right audience, but will likely continue to fall on deaf ears.