As noted in our previous post, Executive Order 13959 (“Addressing the Threat from Securities Investments that Finance Communist Chinese Military Companies”) (EO 13959 or Order), dated November 12, 2020, targets “Communist Chinese military compan[ies]” (CCMCs) by blocking “any transaction in publicly traded securities, or any securities that are derivative of, or are designed to provide investment exposure to such securities, of any [CCMC] . . . by any United States person.” The Order takes effect on January 11, 2021. The Order’s stated purpose includes preventing CCMCs from “rais[ing] capital by selling securities to United States investors that trade on public exchanges both here and abroad, lobbying United States index providers and funds to include these securities in market offerings, and engaging in other acts to ensure access to United States capital.”
On December 28, 2020, the Office of Foreign Assets Control (OFAC) of the US Department of the Treasury published significant guidance on EO 13959 in the form of five Frequently Asked Questions (FAQs), as well as an updated list of CCMCs. This is the first guidance published in connection with EO 13959. The new guidance from OFAC suggests that OFAC has adopted a broad interpretation of the Order. The following are the key takeaways from the new FAQs:
- EO 13959 will apply to subsidiaries of CCMCs as and when OFAC publicly names such subsidiaries. Thus, the Order does not apply automatically to subsidiaries if not designated. The basis for the designation of subsidiaries will be consistent with OFAC’s 50 percent rule, i.e., if the subsidiary is owned 50 percent or more or determined to be controlled by one or more CCMCs.
- EO 13959 applies to the “publicly traded securities” of the designated CCMCs, which the new guidance defines broadly to include securities (including debt and equity securities) which are traded on exchanges, as well as “over-the-counter” securities. “Securities” are defined consistently with the meaning of this term in Section 3(a)(10) of the Exchange Act of 1934, 15 U.S.C. 78c(a)(10). Additionally, the term “security” as defined under EO 13959 includes “currency or any note, draft, bill of exchange, or banker’s acceptance which has a maturity at the time of issuance of not exceeding 9 months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited . . . .”
- The term “derivative” as used in EO 13959 encompasses a wide range of financial products, including “derivatives (e.g., futures, options, swaps), warrants, American depositary receipts (ADRs), global depositary receipts (GDRs), exchange-traded funds (ETFs), index funds, and mutual funds,” provided in each case that the product meets the definition of a “security” under EO 13959.
- No matter how small the percentage of a fund that is comprised of shares in designated CCMCs, “transactions” in the fund may be prohibited under the Order. As a practical matter, this means that funds that seek to maintain access to the US market will likely divest from the designated CCMCs.
Finally, we expect OFAC to publish a list of subsidiaries of CCMCs that will be covered by EO 13959 in the coming weeks. The list of current designated CCMCs is available here.
We summarize each of the five FAQs in turn below.
FAQ 857 responds to the following question: “Do the prohibitions in E.O. 13959 apply to transactions in publicly traded securities of subsidiaries of Communist Chinese military companies?”
The answer provided by OFAC is a qualified “yes.” Under OFAC’s long-standing 50 percent rule, subsidiaries owned or controlled by blocked persons will also be deemed to be blocked under US sanctions. Under EO 13959, an additional step is required for subsidiaries to be subject to the Order’s restrictions: the subsidiary must be publicly listed by OFAC. FAQ 857 indicates that the criteria for a subsidiary to be listed are consistent with the 50 percent rule: (i) the subsidiary is 50 percent or more owned by one or more CCMCs; or (ii) the subsidiary is “determined to be controlled by one or more” CCMCs.
Further action by OFAC is expected to publicly list any affected subsidiaries.
FAQ 858 responds to the following question: “In certain cases, the names of the entities published in the Annex to E.O. 13959 or subsequently identified pursuant to E.O. 13959 as Communist Chinese military companies do not match the names of issuers of publicly traded securities. How do I know which entity is subject to the prohibitions under E.O. 13959?”
OFAC states in response that the restrictions of EO 13959 will apply to any entity “with a name that exactly or closely matches the name of an entity” designated as a CCMC pursuant to EO 13959. OFAC has provided an updated list of CCMCs with additional identifying information here. The list may be updated and revised, as indicated in the Order.
FAQ 859 responds to the following question: “How does OFAC interpret the term “publicly traded securities” for purposes of Executive Order (E.O.) 13959?” EO 13959 applies to the “publicly traded securities” of the designated CCMCs.
In response, OFAC clarifies that the term “publicly traded securities” will be construed to mean “securities . . . denominated in any currency that trade on a securities exchange or through the method of trading that is commonly referred to as ‘over-the-counter’, in any jurisdiction.”
As a practical matter, EO 13959 will therefore not be limited to securities traded on public exchanges; it applies to OTC trades.
FAQ 860 responds to the following question: “For purposes of Executive Order (E.O.) 13959, what financial instruments are covered by the provision stating the prohibitions apply to ‘any transaction in … any securities that are derivative of, or are designed to provide investment exposure to such’ publicly traded securities?”
In response, OFAC indicates that a wide range of financial products may be covered under EO 13959, specifically, “derivatives (e.g., futures, options, swaps), warrants, American depositary receipts (ADRs), global depositary receipts (GDRs), exchange-traded funds (ETFs), index funds, and mutual funds,” provided in each case that the product meets the definition of a “security” under EO 13959.
As a practical matter, OFAC guidance in FAQ 860 clarifies the scope of the term “derivative” in the Order. The application of the Order to ETFs and mutual funds suggests that the Order may have a broader impact on US investors than originally believed.
FAQ 861 responds to the following question: “Does Executive Order (E.O.) 13959 prohibit U.S. persons from investing in U.S. or foreign funds, such as exchange-traded funds (ETFs) or other mutual funds, that hold publicly traded securities of a Communist Chinese military company?”
In response, OFAC indicates that the prohibitions under EO 13959 apply to financial products such as ETFs and mutual funds, regardless of the percentage of the fund that is made up of shares in the designated securities.
As a practical matter, this means that funds that seek to maintain access to the US market will likely divest from the designated CCMCs. MSCI and other funds have already begun divesting in CCMCs, according to public reports.
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We will continue to monitor developments, which are expected in the coming weeks. Please reach out to your usual HSF NY contacts with any questions.