The US is tightening the ratchet on China again — by restricting access to its capital, and the intangible benefits that come with it.
Inferences from Minerva Technology Policy Advisors. Vol.20 - 2 July, 2024
The United States has taken another significant step towards stifling China’s access to advanced military, intelligence, surveillance, and cyber-enabled technologies. It could have a chilling effect on entangled investment networks in deep tech.
What’s happened? Last week, the US Treasury Department published details of a forthcoming rule that will restrict US investors’ ability to fund Chinese companies working on advanced technology, through a proposed Outbound Investment Security Program (OISP).
Under the rule, US investors will be prohibited from making investments in Chinese (or China-connected) companies that they know — or ought to know — are working on certain technologies that could harm national security interests. Some other investments will also have to be reported to the US government.
So what? It’s the latest turn of the ratchet in the US campaign to restrict Chinese capabilities in advanced technologies that have military, intelligence, or cyber applications. It follows earlier moves aimed at preventing the flow of advanced semiconductors and semiconductor manufacturing equipment to China, and intensifying scrutiny of acquisitions by Chinese companies of strategic US technology or data, among others. Now, the US government is beginning to block China from accessing one of America’s most distinctive assets: its massive pools of investable capital.
How? The forthcoming rule will regulate investment coming from the US into China or Chinese companies in three critical domains; semiconductors, artificial intelligence and quantum technologies. Specifically, it will restrict certain transactions between US investors and “covered foreign persons” involved in the aforementioned industries.
The draft rules have been drawn up in excruciating detail, partly to limit their scope to specific subcategories of the technologies where the US sees the most serious national security risks, but also to close off loopholes. Public comments on the near-final rules are open until 4 August, with final publication expected later this year. As things stand, US investors will face direct restrictions, but overseas pooled funds that take capital from US investors will also be affected.
Why? Technological capabilities in semiconductors, artificial intelligence and quantum computing are at the heart of the intensifying confrontation between Washington and Beijing, and the US is pressing its advantage.
Not only is the US home to the world’s leading tech companies, it is also home to the biggest pool of investable capital on the planet. The rules will curb the benefits that China can derive from the home of global capitalism; not just from the money itself, but also from intangible benefits, like the prestige granted by investments from high-profile venture capital firms, or access to the entrepreneurial knowhow and professional networks that only Silicon Valley can provide.
Who’ll be affected? The extraterritorial reach of the rule means its effects will be felt well outside the US. Critically, pooled funds based in third-party countries (think: the UAE, or Saudi Arabia) may no longer be able to accept capital from US contributors, if they intend to invest in Chinese companies that are working on capabilities in AI, quantum and semiconductors. The restrictions will also affect any entity a) with a principal place of business, headquarters, or incorporated in China, b) an entity organized under Chinese law or c) that is directly or indirectly majority-owned by any person or entity in the aforementioned categories.
Does it matter? On the one hand, investment by US actors into Chinese companies working on sensitive technologies was already seen as politically risky in the current environment of heightened tensions and focus on national security risks posed by China. The new rules are likely to shut down remaining linkages where more exploratory US investors may be pursuing deals in China in these key areas. On the other hand, lots of Chinese companies received investment from joint funds with non-US and US-based contributors. The US government now appears determined to divorce US funds from these sorts of relationships; after over 20 years of integration, it is trying to sever ties between the Western and Chinese deep tech ecosystems.
What does it mean for China? In a recent speech, the Chinese leader Xi Jinping acknowledged the relative weakness of China’s “original innovation” ecosystem; precisely the system of companies and scientists that requires huge amounts of capital to make strides. Just how much the new rule will hold China back in this regard remains to be seen.
The prohibitions place a significant burden of due diligence on US investors to know where their capital is going. Where the Treasury draws the line on whether a given investor ought to know the intended use of investment funds will be important. There is, in the current ruling, no provision for reviewing each case individually for approval, and investors assume the responsibility for assessing whether their activities would be prohibited, at their own risk. That is likely to have a chilling effect beyond the letter of the rule itself. It will also spark some hard thinking about the limits of reasonable knowledge; where the rules line up with the Department of Commerce’s Export Administration Regulations definition (page 22).
What’s next? For the time being, the list of strategic sectors is small, and the list of “countries of concern” begins and ends with China. But if a potential new administration wanted to widen the aperture on its confrontation with Beijing, the new rule leaves the door open to doing so. Adding other technologies — related to nuclear energy or biological or genetic engineering, say — could be relatively trivial once the main framework is in place. It is also plausible that other countries, besides China, could be added to the list over time.
The program is a serious signal to venture capitalists in the US; that national security trumps financial acuity at the frontiers of the deepening technology contest with China.
What we’re reading:
Ryan Campbell and Stacey Gray’s brief on The Role of Chevron Deference in Federal Privacy Regulation for The Future of Privacy Forum.
Recent analysis on how the US Department of Defense is collaborating when it comes to research.
Former Assistant Director of CIA, Dave Pitts, on whether the first Presidential Debate addressed any national security concerns at all.
What we’re looking ahead to:
15 - 18 July: IEEE International Conference on Artificial Intelligence Testing in Shanghai, China.
22 July: Priorities for AI policy and regulation in the UK Forum.
22 - 23 September: UN Summit of the Future.
10 - 11 February 2025 : AI Action Summit in Paris, France.