I have mentioned early on in the US-China trade dispute that China is not without its own levers with which to impact the bi-lateral trade in high-tech goods and technology. It seems after more than two years of some restraint in this regard, China is ready to initiate some of its own measures with more impact than simple tariffs. The impact on ByteDance and its rumoured sale of its US subsidiary have captured most of the attention. However, China’s regulatory change is likely to significantly impact not only multinational users of Chinese technology, but potentially even multinationals with research and design activities in China. The disruption and uncertainty to the trade in technology and high-tech dual-use goods has already begun mere days after its issuance and the worst may well be yet to come.
On 28 August Announcement No. 38 was jointly issued by China’s Ministry of Commerce (“MOFCOM”) and the Ministry of Science and Technology, revising the Catalogue of Technologies Prohibited and Restricted from Export pursuant to the Regulations of the People’s Republic of China on the Administration of technology Import and Export (Order 709, amended 2019) (“Order 709”). These technology export regulations, which were initially promulgated in 2001 and amended in 2008, have become a greater focus of the Central Government as China has developed higher value home-grown intellectual property. Last week’s amendment to the catalogue of restricted and prohibited technologies is the first in more than 10 years with the previous catalogue having been issued in 2008.
A lot has been made in recent months regarding amendments to US export control regulations and enforcement measures targeting China and Hong Kong. Notably, adding prominent Chinese technology companies to the US Bureau of Industry and Security’s Entities List effectively cutting them off from controlled US semiconductor technology as well as amending the foreign direct product rule applicable to certain items produced outside of the US although within US export control jurisdiction. In addition, certain technical changes to license exceptions applicable to China and Hong Kong have also been issued that have cooled substantially the trade in high-tech dual-use goods and technology with end-users in China and Hong Kong. These measures from the US are, arguably, incremental tightening of pre-existing rules. The regulatory update discussed here breaks some new ground and raises new questions which is discussed in brief here.
What do the Regulations Require?
Order 709 imposes control over the transfer of technology from within China to outside of China whether by trade, investment, or economic and technical cooperation. The regulation purports to control all transfers of technology regardless of the type of technology or whether the technology is permitted, restricted, or strictly prohibited. For permitted technology exports, a simple recordal process is required, which recordal is made with the local bureau of commerce under MOFCOM with jurisdiction over the location where the requesting entity is established. Restricted exports are subject to a license requirement, which will also be applied for and obtained from the same commercial bureau.
Who is Impacted?
The plain language of the regulation imposes these requirements regardless of the origin of the technology and regardless of the shareholding identity of the applicant. In other words, technology developed in China by foreign-invested enterprises are squarely subject to these controls. While this may not have been a significant issue up to this time, the amendments to the catalogue that have become effective on the date of issuance, 28 August 2020 will undoubtedly impact many multinationals.
What Technology is now covered?
In total, there are 17 industrial sectors impacted by China’s amended Prohibited and Restricted Technology Catalogue. Some of the more significant technologies in terms of strategic and commercial relevance include but are by no means limited to:
- Pharmaceutical and biotechnology manufacturing including technologies required for the development of vaccines;
- Technology relating to the development, testing, and maintenance of machine tools;
- ‘strategic’ new product design technology for heavy machinery;
- Unmanned aerial vehicle technology
- Speech synthesis technology;
- Artificial intelligence interaction and interface technology;
- Voice evaluation technology;
- Personalised information push service technology based on data analysis techniques;
- Cryptographic chip design and implementation technology; and
- Quantum encryption technology
It has been TikTok and the value of its algorithms that has captured much of the attention concerning this technology export restriction. However, many of the technologies covered by this list are used in common, not high-tech, manufacturing. For example, technology relating to the development, testing and maintenance of machine tools. These technologies are listed under an industry sector labelled as “General Equipment manufacturing”. Such restrictions could conceivably pose problems for multinationals that are contemplating the relocation out of China of certain manufacturing operations.
It is also worth noting that pharmaceutical and biotechnology technologies are impacted which apply directly to the development of vaccines. Further to this possible restriction is news this week that vaccine test samples developed in China by CanSino Biologics has been denied export clearance to Canada for phase 3 trials, while phase 3 trials are underway in Russia and Saudi Arabia for the companies vaccine.
What about Enforcement?
Order 709, under which the revised catalogue of technology export restrictions and prohibitions was issued, provides for extensive possibilities under which persons found in violation of its requirements could be punished. These measures include confiscation of illegal income gained through violation of the technology license restrictions or prohibitions and even criminal prosecution under State Secrecy Laws. What isn’t clear is how such enforcement may occur. MOFCOM, through its local bureaux are tasked with the administration of this regulatory obligation although MOFCOM may not have its own dedicated enforcement resources or a clearly established mechanism for supervision.
Beyond MOFCOM and local commercial bureaux, the international banks in China may also play a role. Under China’s existing foreign exchange regulatory scheme, banks are tasked with verifying the legitimate commercial agreements and transactions under which foreign currency may be received by an account holder. In this capacity, the banks may well verify that a technology license agreement has been registered with the commercial bureau in order to approve the receipt of such foreign currency and, where applicable, an export license has been obtained. Finally, China’s General Administration of Customs will continue to play its traditional role on export to the extent the technology export consists of tangible goods, which could potentially be the case in the CanSino situation described above. Otherwise, where technology may be contributed as a capital contribution for the establishment of a new foreign subsidiary, for which license fees are not received, the supervision and enforcement of Order 709 as well as the basic compliance with the restrictions may well prove challenging for all involved.
What About Extra-Territorial Reach
Because the provisions of Order 709 make no distinction regarding the origin of covered technology it remains possible that foreign technology utilised by a Chinese entity outside of China could well be subject to license requirements. Moreover, multinationals that utilise R&D centres in China may well be impacted by restrictions regardless of the domicile of the parent or the arrangements under which the technology was developed in China.
Possible Future Developments
This amendment to the catalogue of restricted and prohibit technologies for export comes at a time when many are imminently expecting the imposition of a new comprehensive export control law in China; it’s first. This draft law indeed contemplates extraterritorial reach. Thus, while Order 709 makes no such claim, its expansive language and the Standing Committee’s clear intention should lead to an affirmative conclusion with regard to extraterritoriality.
We will be looking for the export control law to perhaps formalise a method by which technologies may be classified in order to determine their regulatory treatment, a clearer insight into the enforcement and supervision of such controls, as well as more robust administrative procedures for compliance. In the meantime, the uncertainties created under this regulation may well further cool cross-border transactions and cooperation, including foreign investment, involving China.
William Marshall is an international trade lawyer qualified in New York and Hong Kong. William has more than 20 years of experience advising multinational clients on trade regulatory and supply chain matters in China, the US, and across the Asia Pacific region. He is currently a senior partner with Tiang & Partners in Hong Kong (in association with PwC Legal International Pte Ltd., a Singapore foreign law practice).