The Outbound Shadow War: How the United States’ Aim to Tighten Its Grip on China’s Technological and Military Capabilities Will Affect Foreign Investment Considerations in 2023.

As tensions between the United States and China continue to escalate, both sides have elected to make stronger geopolitical shifts in anticipation of a technological arms race and possible military conflict. Foreign investment restrictions in the United States are typically handled through legislation; more specifically, an interagency committee called The Committee on Foreign Investments in the United States (CFIUS). CFIUS’ role is to protect against foreign access to critical technology, personal data, infrastructure, and other potential national security risks. However, as U.S. investors continue to seek more promising returns abroad, they might be attracted to lucrative opportunities that simultaneously serve Chinese interests at the expense of U.S. (and its allies) national security. In fact, a Georgetown University think tank recently showed that “U.S. investors . . . accounted for nearly a fifth of investments in Chinese artificial intelligence companies from 2015-2021”. These transactions, which included investments from chipmakers Intel Corp and Qualcomm Inc, were valued at $40.2 billion. Consequently, the need to restrict U.S. outbound Chinese investments has become increasingly apparent. While lawmakers quickly got to work proposing solutions back in July, congressional leaders appear to be content with the Biden Administration taking the first swing .

As a result, the Administration is tailoring an Executive Order aimed at restricting outbound investments in certain industries. The Executive Order – which was originally thought to include a more expansive list of industries such as biometrics and batteries – will now more narrowly focus on quantum computing, artificial intelligence (AI), and semiconductors with the aim of limiting China’s ambitious goals of using these technologies to advance their military capabilities. The anticipation of this executive order has seen some delays as the Biden administration seeks to consolidate support from its European allies and solicit feedback from key financial stakeholders and lawmakers. There were also further delays in the hopes of Secretary of State Antony Blinken’s trip to China easing relations between the two nations. However, the recent Chinese spy balloon fiasco has made tensions between the two countries increasingly fragile.

So why are AI chips and semiconductors so valuable to China? For starters, it is important to consider mainland China’s ongoing conflict with Taiwan and the United States role within it. While the U.S. government’s stance has been historically ambiguous, the Biden administration has increasingly showed its support for Taiwan. This culminated in the Taiwan Policy Act of 2022 which notably includes roughly $4.5 billion in security aid over the next four years that was evidently followed by Chinese countermeasures. Nevertheless, this perceived growing threat to Chinese national security has put pressure on its military to gain access to critical AI and semiconductor technology which has the potential for “commercial and military innovations including, AI, robotics, [and] autonomous vehicles.”

There is a clear gap between countries that design chips “suitable to train and run cutting-edge neural networks,” and those that are capable of manufacturing them. This aperture is created by a need for critical design knowledge which inhibits countries like China, South Korea, and Taiwan from posing a legitimate threat to the U.S despite possessing highly specialized equipment capable of manufacturing the chips in mass. However, China’s success in developing this technology is dependent on its continued access to a certain class of semiconductors capable of training advanced machine learning systems. This access has been traced to products produced by U.S.-based semiconductor companies who may be unaware that their technology is falling in the hands of the Chines military.

While the details of the proposed executive order have yet to be finalized, recent escalations have resulted in the U.S. and some of its close allies taking measures to begin tightening its control on China’s access to this coveted technology. This February, the U.S. government issued even further restrictions on the Chinese multinational tech corporation, Huawei, which now prevents its access to even low-tech products that fall under the Foreign Direct Product Rule (FDPR). Additionally, the Netherlands and Japan have now reached an agreement to impose restrictions on semiconductor exports to China that reflect current U.S. policy.

Amongst the many concerns that U.S. investors, companies, and private equity firms interested in outbound investments within these industries need to be mindful of, it is clear that the coming months promise to bring further competition between the two nations and with it, further restrictions. Issuers ­– and the lawyers that represent them ­– should make sure that there is adequate disclosure reflecting this uncertainty, while also considering a multitude of outbound investment risks including (but not limited to): China’s reopening of the economy resulting from relaxed COVID-19 restrictions; potential military conflict between Mainland China and Taiwan (which could lead to further restrictions); compliance with export control on certain technologies; potential sanctions associated with doing business with Chinese companies; conflict of law risks created by the conflict between compliance with U.S. obligations and Chinese countermeasures or sanctions; and the various levels of support from both U.S. and Chinese allies. While the Biden administration states that it aims to be fully transparent, they are making it clear to private equity firms and other U.S. based investors that, “ there's plenty of other ways for you to make money than investing in things that enable China's military capability.”

Sam Biermann is a second-year law student at Wake Forest University School of Law. He holds a Bachelor of Arts in Economics with a minor in Entrepreneurship from Wake Forest University. Prior to attending Wake Forest Law, Sam spent several years working in Charlotte, NC for the global investment firm Dimensional Fund Advisors as an Associate in its Global Client Group. Upon graduation, Sam intends to work in cross-border corporate securities and investment management. 

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