On October 7, 2022, the Department of Commerce’s Bureau of Industry and Security (“BIS”) took two significant actions with major implications for companies and persons dealing with the Chinese semiconductor and electronics sectors:
- BIS issued an interim final rule (the “IFR”) targeting exports to the People’s Republic of China that, among other things, imposes sweeping new controls on advanced computing integrated circuits (“ICs”), commodities that contain ICs, and certain items related to the manufacture of semiconductors; tightens end-use restrictions for semiconductor manufacturing by adding “Regional Stability” controls for China; expands the so-called Foreign-Produced Direct Product Rule (the “FDP Rule”); and introduces sui generis restrictions on US person “support” for semiconductor manufacturing.
- BIS simultaneously issued a final rule revising the so-called Unverified List (“the Unverified List Rule,” and together with the IFR, the “New Rules”) by adding 31 persons (and removing nine others) in China. More importantly, the Unverified List Rule and the accompanying memorandum entitled “Addressing Foreign Government Prevention Of End-Use Checks” from Matthew S. Axelrod, Assistant Secretary for BIS’s enforcement arm, introduced novel procedures governing the addition of companies to the so-called Entity List based upon a foreign party’s failure to comply with BIS-initiated “end-use checks.”
The New Rules impose a complex set of novel controls while leaving certain key terms and concepts undefined. According to a press release, the New Rules will restrict China’s “ability to both purchase and manufacture certain high-end chips used in military applications and build on prior policies, company-specific actions, and less public regulatory, legal, and enforcement actions taken by BIS.”
Below is a summary of the key aspects of the New Rules that may have the greatest immediate impact on companies dealing with covered items in supply chains that implicate China or Chinese end users:
- For the first time, the IFR prohibits U.S. persons from engaging in certain “support” activities even where there is no nexus to an item, software or technology subject to the Export Administration Regulations (“EAR”). The “support” restrictions are in some ways more similar to prohibitions on “facilitation” under U.S. Treasury Department financial sanctions, than to the traditional restrictions imposed under U.S. Commerce Department export controls. The prohibition applies to “support” for the “development” or “production” of covered ICs for “WMD- and military-intelligence-related end uses and end users” identified in Section 744.6(b)(1)-(5), even where, for example, the transaction involves the shipment, transmission, or transfer (in-country) of an item not subject to the EAR; “facilitation” of the same; or “servicing” such items where it would “assist” development or production of covered ICs. This prohibition will likely have broad impacts on Chinese companies that rely on U.S., and/or dual-citizen, employees and managers.
- The IFR imposes broad end-user and end-use restrictions applicable to “supercomputer” and semiconductor end uses that may significantly impact the scope of due diligence companies are required to perform. The end use scope under Section 744.23 includes, for example, the design, development, production, operation, installation, maintenance, repair, overhaul, or refurbishing of a “supercomputer” located in or destined for China, or the incorporation of certain items into any “component” or “equipment” that will be used in a “supercomputer” located in or destined for China. As these restrictions implicate multiple stages of supply chains, companies should be aware of the potentially expanded scope of diligence required.
- The IFR revises the scope of the Entity List FDP Rule to add 28 Chinese entities that were previously designated on the Entity List, but are now listed with a “footnote 4” designation. The “footnote 4” designation is similar to the “footnote 1” designation applicable to Huawei, but applies to additional Export Control Classification Numbers and may be triggered even when a “footnote 4” entity is not a party to the transaction, provided the item in question will be used in the “development” or “production” of any “part,” “component,” or “equipment” that is produced, purchased, or ordered by a “footnote 4” entity. The IFR also creates two new FDP Rules, e., the Advanced Computing FDP Rule and the Supercomputer End-Use FDP Rule.
- The IFR prohibits the export of advanced chipmaking equipment to China, which essentially bars exports of U.S.-made tools needed for advanced chip production in China. This restriction also prohibits exports of U.S. tools or components to Chinese factories capable of making chips above or below a certain threshold.
- Through the Unverified List Rule and accompanying memorandum, BIS has imposed specific procedures that may lead to a company’s designation on the Entity List where BIS is unable to complete “end-use checks.” The “Unverified List” is a list of non-U.S. companies for which BIS is unable to verify the bona fides (e., legitimacy and reliability relating to the end use and end user of items subject to the EAR) because an end-use check, such as a pre-license check or a post-shipment verification, cannot be completed satisfactorily for reasons outside of the U.S. Government’s control. The Unverified List Rule and accompanying memorandum have the effect that any party that does not complete an end-use check within 60 days of a request will be added to the Unverified List. If the end-use check still cannot be conducted, BIS will commence the inter-agency process for the designation of the company on the Entity List. In practice, this means that a lack of cooperation from a company and/or a host government, e.g., China, in providing information related to end-use checks could lead to a company’s designation on the Entity List.
While the Unverified List Rule became effective upon publication as of October 7, 2022, various provisions in the IFR will take effect in three stages on October 7, October 12, and October 21, 2022. As an interim final rule, the IFR is also subject to a public comment period, which closes on December 12, 2022. However, citing the “urgent need for [the IFR] to counter China’s actions,” BIS has not published the IFR as a Section 1758 technology rule under the Export Control Reform Act of 2018.
Computer chips are an essential component of most technology, including military equipment. According to media reports, “China still lags behind Taiwan, South Korea and the United States” with respect to producing specialized chips, such as AI chips and the processors used in supercomputer. However, China has begun to build a domestic advanced chip industry.
White House officials explained that the New Rules are “designed to help the [U.S.] maintain as large a lead in technology as possible over rivals,” and also address “national security concerns such as China’s efforts to develop artificial intelligence that has military uses.”
President Biden previously signed into law the bipartisan CHIPS and Science Act of 2022, which was intended to “boost American semiconductor research, development, and production, ensuring U.S. leadership in the technology that forms the foundation of everything from automobiles to household appliances to defense systems.”
The IFR focuses on two central objectives: (i) imposing restrictive export controls on certain advanced computing semiconductor chips, transactions for supercomputer end-uses, and transactions involving certain entities on the Entity List; and (ii) imposing new controls on certain semiconductor manufacturing items and on transactions for certain IC end uses. As discussed above, these restrictions are intended to prevent the flow of the U.S.’s technological expertise to China’s military and surveillance systems.
To accomplish these objectives, the IFR:
- Adds certain advanced and high-performance computing chips and computer commodities that contain such chips to the Commerce Control List (“CCL”);
- Adds new license requirements for items destined for a supercomputer or semiconductor development or production end use in China;
- Expands the scope of the EAR over certain foreign-produced advanced computing items and foreign-produced items for supercomputer end uses;
- Expands the scope of foreign-produced items subject to license requirements to twenty-eight existing entities on the Entity List that are located in China;
- Adds certain semiconductor manufacturing equipment and related items to the CCL;
- Adds new license requirements for items destined to a semiconductor fabrication “facility” in China that fabricates ICs meeting specified criteria (note that licenses for facilities owned by Chinese entities will face a “presumption of denial,” and facilities owned by multinationals will be decided on a case-by-case basis);
- Adds new license requirements to export items to develop or produce semiconductor manufacturing equipment and related items; and
- Establishes a Temporary General License (“TGL”) to minimize the short-term impact on the semiconductor supply chain by allowing specific, limited manufacturing activities related to items destined for use outside of China.
In addition, the IFR restricts the ability of U.S. persons to support the development or production of ICs at certain semiconductor fabrication “facilities” located in China without a license. More specifically, the IFR provides that activities by a “U.S. person” (including U.S. citizens, residents, “green card” holders, persons present in the United States, and U.S. incorporated entities) related to the “development” or “production” of ICs that could involve “support” to the following weapons-of-mass-destruction-related (“WMD”) and/or military-intelligence-related end uses and end users are subject to a BIS license requirement:
- The design, development, production, operation, installation (including on-site installation), maintenance (checking), repair, overhaul, or refurbishing of nuclear explosive devices in or by any country not listed in supplement no. 3 of the EAR;
- The design, development, production, operation, installation (including on-site installation), maintenance (checking), repair, overhaul, or refurbishing of missiles in or by a country listed in Country Groups D:4 or E:2;
- The design, development, production, operation, installation (including on-site installation), maintenance (checking), repair, overhaul, or refurbishing of chemical or biological weapons in or by any country or destination worldwide;
- The design, development, production, operation, installation (including on-site installation), maintenance (checking), repair, overhaul, refurbishing, shipment, or transfer (in-country) of a whole plant to make chemical weapons precursors identified in ECCN 1C350, in or by countries other than those listed in Country Group A:3 (Australia Group); or
- A “military-intelligence end use” or a “military-intelligence end user,” as defined in § 744.22(f), in Belarus, Burma, Cambodia, China, Russia, or Venezuela; or a country listed in Country Groups E:1 or E:2.
See 15 CFR § 744.6(b)(1)-(b)(5). The IFR emphasizes that “semiconductor manufacturing items enable the ‘development’ or ‘production’ of advanced ICs that may contribute to the WMD-related end uses set forth in § 744.6(b).”
Note that the term “support” encompasses a number of activities, including, but not limited to, shipping, transmitting, or transferring (in-country) items not subject to the EAR; facilitating such shipment, transmission, or transfer (in-country); and/or servicing items not subject to the EAR. See 15 CFR § 744.6(b)(6).
The IFR will become effective as follows: (i) the semiconductor manufacturing items restrictions will become effective on October 7, 2022; (ii) the restrictions on U.S. persons’ ability to support the development, production, or use of ICs at certain semiconductor fabrication “facilities” located in China will become effective on October 12, 2022; and (iii) the other aspects of the IFR will become effective on October 21, 2022.
The Unverified List Rule
Unverified List Rule revises BIS’s policy with respect to the “Unverified List,” which acts as a precursor to the “Entity List.” The Entity List is a trade restriction list, maintained by BIS, which bans exports of U.S. designs and technology to specified entities.
More specifically, the Unverified List Rule provides that “sustained lack of cooperation by a foreign government that prevents BIS from verifying the bona fides of companies on the Unverified List can result in those parties being moved to the Entity List, if an end-use check is not timely scheduled and completed.” BIS noted that, “[a]ll additions, removals, or revisions to the Entity List are still subject to the approval of the End-User Review Committee, which is made up of the Departments of Commerce, State, Defense, and Energy pursuant to existing rules.”
The Unverified List Rule also adds 31 new entities to the Unverified List and removes 9 entities that have met relevant requirements.
As noted above, the memorandum accompanying the Unverified List Rule calls for adding parties to the Unverified List 60 days after checks are requested but host government inaction prevents their completion, and an additional 60-day process for adding Unverified List parties to the Entity List when there is a sustained lack of cooperation by a host government to facilitate completion of the checks.
We will continue to monitor developments in this area and encourage you to subscribe to be kept informed of latest developments. Please contact the authors or your usual Herbert Smith Freehills contacts for more information.