The US Department of Commerce’s Bureau of Industry and Security (BIS) released an interim final rule (IFR) on October 7, 2022, imposing additional export controls on certain advanced computing and semiconductor manufacturing items destined for the People’s Republic of China (China), with the goal of limiting China’s access to key US technologies.
Through the Export Administration Regulations (EAR), BIS has long imposed controls on exports to China to address national security and foreign policy concerns and to restrict access to technologies that can be used for military and weapons proliferation applications. The newly issued IFR reflects an expanded approach by the US government to address growing concerns that China's military-civil fusion strategy seeks to eliminate barriers between military and civilian research and trade, thereby enhancing China’s military and defense-related posture.
New and Expanded Export Controls
The IFR imposes complex new controls in a number of areas impacting advanced computing integrated circuits (ICs), computer commodities, semiconductor items and related manufacturing equipment, and supercomputers. It also adopts controls for items associated with targeted end uses and end users and imposes heightened knowledge standards and diligence requirements on parties that are subject to US jurisdiction.
Finally, the IFR imposes extremely broad and vague restrictions on the support by US persons of certain foreign semiconductor fabrication facilities, even if the US person is engaged in activities that do not involve EAR-controlled items and even if the US person lacks knowledge as to whether the fabrication facility produces ICs meeting the relevant criteria.
At a high level, the IFR:
- Amends the Commerce Control List (CCL) to include new Export Control Classification Number (ECCNs) for advanced computing ICs, computer commodities that contain such circuits, and certain semiconductor manufacturing items.
- Expands existing ECCNs to encompass software and technology associated with the new ECCNs.
- Expands controls for transactions involving items for supercomputer and semiconductor manufacturing end uses by adding new CCL-based Regional Stability (RS) controls for China.
- Limits the availability of most license exceptions for certain exports, reexports, or transfers (in-country) to or within China.
- Creates two new Foreign Direct Product Rules that apply to advanced computing and supercomputers.
- Designates 28 Chinese entities (that are already on the Entity List) as Footnote 4 Entities to ensure any items incorporated into, or used in the production or development of, any part, component, or equipment produced, purchased, or ordered by any of these entities (including when there is “knowledge” that the end users are these entities) are subject to the new license requirements.
- Restricts the ability of US persons to support the development or production of ICs at certain semiconductor fabrication facilities (fabs) in China, even if the US person is engaged in activities that do not involve EAR-controlled items and even if the US person lacks knowledge as to whether the fab produces ICs meeting the relevant criteria
- Establishes a Temporary General License in effect from October 21, 2022, through April 7, 2023, to permit companies not headquartered in Country Group D:1, D:5, or E to allow for continued engagement in supply chain–related activities that implicate the newly controlled items where the ultimate destination is outside of China.
The overall impact of the rules results in licensing requirements for a broad swath of items destined for China, and greatly limits license exceptions that previously could have been used for transactions involving China or Chinese entities. License applications considered under the new policies will have a presumption of denial, and heightened due diligence is needed in order to comply.
While the new regulations follow a pattern by the Biden-Harris administration (and previously the Trump administration) to tighten engagements with China or Chinese parties, this rule extends beyond prior BIS and executive branch actions by adopting a “sanctions-like” effect to imposing restrictions, including new restrictions on support similar to what Office of Foreign Assets Control (OFAC) has imposed in the sanctions context under its facilitation rules.
The IFR is being implemented in phases, with certain aspects of the rule already taking effect on the date of publication (October 7), other aspects taking effect on October 12, and the remainder becoming effective October 21. Although issued as an interim final rule, BIS is accepting comments on the IFR through December 12, 2022.
BIS Public Briefing and Open Issues
The October 7 regulation introduces expanded controls and broader interpretations than generally imposed by BIS. The rule leaves some terms undefined, addresses other terms, and focuses on areas that have been of longstanding interest to the US government, raising a question regarding the timing of the regulation’s issuance.
The complexity and breadth have companies and counsel grappling with possible interpretations, and it is clear that the IFR raises more questions than it answers. Although BIS has presented the IFR as “narrowly” tailored to address the chips, equipment, activities, and entities of greatest national security concern to the US government, the IFR language belies this statement as the regulation is broadly drafted, with sweeping effects across the supply chain and customer base, and ambiguities that leave companies with a lack of critical guidance. The IFR lacks several key definitions that may affect the scope of the rules and the ability for companies to timely and appropriately update their compliance measures.
Perhaps in anticipation of these issues, BIS held a public briefing on October 13, 2022, led by Assistant Secretary for Export Administration Thea Kendler, to discuss the proposed controls and answer select questions from the public. Although certain information conveyed to the audience provided some baseline information—including that BIS will take “foreign availability” of controlled items and “risk of diversion” for military end users or end uses into account in determining whether to grant a license for a newly controlled item—BIS answered few questions of interest to the industry and has provided little clarification to date on how the IFR controls apply in practice or how broadly they will be enforced.
And, while BIS has promised to release frequently asked questions on its website on a rolling basis, the agency has not indicated when additional guidance will be forthcoming. Thus, companies face a lack of clarity on key issues that require resolution to enable compliance in good faith.
In particular, the regulations appear to create new obligations for transactions or activities that were neither subject to licensing nor potentially subject to the EAR (such as the extension of certain licensing to foreign-origin items that do not meet de minimis or foreign-produced direct product rules). When assessing the potential impact, and the attendant need to adjust any company compliance measures, clarification regarding the following issues appears foundational to determine what steps may be needed to manage the new EAR requirements:
- Diligence efforts
- Definitions of facilitation and support
- US person activities
- Will companies need to update their current diligence and vetting processes?
- If so, what types of information will need to be collected from suppliers and downstream customers to satisfy due diligence obligations?
- Although the regulation provides some guidance regarding consultations with BIS should an end use or end user information remain obscure, can parties proceed without outreach to BIS when this information is incomplete?
- Is BIS planning to take the OFAC approach to facilitation or support—in essence, a sanctions-like approach that heightens the responsibility and analyses for parties that engage with Chinese parties in China and potentially outside of China?
- If not, what standards will BIS apply to determine whether a US person is “facilitating the shipment, transmission, or transfer (in-country) to or within” China?
- Does BIS consider a party to have “knowledge” or “reason to know” in circumstances where information provided by a Chinese party is incomplete or unclear?
- How broadly will BIS interpret and enforce the restrictions for US persons? For example, does a software program for digitally twinning equipment for which IC manufacturing will be used in the “development” or “production” process at a targeted fab fall within the scope of the new controls?
- What processes may a US person or company subject to the EAR utilize to determine whether China’s civil-military fusion approach applies to specific manufacturing? For example, how will BIS approach a situation where an IC fab uses a common production line to manufacture both civil and military ICs?
Companies may use the comment process to convey particular concerns to BIS regarding the regulatory implementation, but compliance efforts will need to move forward in the interim to manage the new obligations even without needed clarity on key issues. There are no certainties in the process, and although BIS invited engagement to clarify any questions, the agency is currently resource challenged to the point that responsiveness remains an issue of concern. Thus, contacting BIS may elicit a response, but the question of timing is unclear.
Although BIS estimates the changes effected by the IFR will result in an additional 1,600 license applications being submitted annually, the actual numbers look to be much higher in the absence of clear guidance as to the scope of the new controls. Even with clear guidance, it is unclear that this number reflects the likely impact of the regulation.
Courses of Action to Consider
Given the additional obligations that attach by the IFR’s implementation and the unclear regulatory landscape, parties are confronting challenges, not only as to what may be exported to China, but how their business must adapt to meet the new requirements on activities of US persons.
Against this landscape, affected persons may wish to consider whether to implement any (or all) of the following actions to help coordinate their response to the new rulemaking. None of these suggestions provides a “silver bullet” to compliance obligations, as every activity with China discussed in this rule requires a fact-specific analysis. Regardless, these suggestions outline some initial steps for experienced compliance officials or business leaders to consider, and can allow for some interim compliance actions to be implemented until BIS offers further clarification.
- Verify export classifications. Fundamentally, a company’s compliance obligations begin with an assessment of the export classifications of its products. Incomplete or inaccurate classifications can lead to inadvertent errors, which can compound an honest mistake into potential harm to US national security. As the new rule describes, and as intimated by Assistant Secretary Kendler, products and technology should be reevaluated against the new and expanded classifications to verify whether or to what extent any item may now be included within the prescribed list. If so, then a party is obligated to comply with the new controls.
- Identify other business touchpoints that may come into contact with the rule. Beyond the new or expanded ECCNs, parties should review whether or to what extent their employees may be engaging in prohibited “support” activities. The rule indicates that representative activities that constitute “support” include, but are not limited to, shipping, transmitting, or transferring (in-country) items not subject to the EAR; facilitating such shipment, transmission, or transfer (in-country); or servicing items not subject to the EAR. Listing representative examples of activities alludes to the fact that other activities may also be covered but not named. In light of the unarticulated standards noted above, companies should review their own business activities to identify those areas that both directly and indirectly touch on the proscribed activities. Once the universe of those issues has been identified, decisionmakers can engage in a reasoned, risk-based analysis to determine where the compliance exposure exists, and how to develop clear messages regarding changes to the business processes.
- Enhance existing end user and end use diligence processes. Parties should reevaluate their diligence (i.e., know your customer) practices to identify restricted end users and end uses to ensure that sufficient information is both collected to evaluate these new prohibitions and contemporaneously documented to demonstrate their compliance practices. Simply asking about the intended end use is insufficient. Including stock contractual representations on compliance with laws may be equally inadequate to satisfy any new diligence requirements or support business decisions. Companies should confirm that they have processes in place to reliably verify the types of fabrication, development, and production activities that are completed by their customers, as well as have their customers specify the products that they produce. If customer responses contain insufficient details, BIS may consider these inadequacies as red flags that merit additional diligence, formal consultation with the agency, suspension of the business, or consideration of other options for pursuing the business.
- Develop a clear message and communicate it to internal and external stakeholders. Once a path forward is identified, company leadership and compliance teams should prepare appropriate messages for internal and external stakeholders that provide guidance in several areas: (1) identification of the specific compliance challenge(s) facing the company; (2) what changes, if any, will be made to how business may or may not continue; (3) what approach will be used for conducting new business under the regulations; and (4) where any gaps in understanding exist or remain under development. Without such a messaging strategy, a company’s employees can (and often will be) left to their own devices to address any issues that arise because of the IRF’s implementation. At the same time, companies with operations in China will need to be mindful of triggering any potential countersanctions by the Chinese government when issuing messages to employees in China.
- Consider whether to submit license applications. Given the lack of clarity in the final rule, particularly with respect to the scope of US person support, it would be beneficial to consider the submission of license applications to BIS (where the transaction timeline permits) for transactions where there is no clear answer as to whether a particular action is controlled and to address planned future business activities. Even if BIS returns the application “Without Action,” it will provide further guidance as to the agency’s views that can potentially be extrapolated for other similar transactions. Press reports suggest that certain major semiconductor manufacturers may have already obtained temporary licenses, perhaps based on advance information of the rule’s issuance.
Although BIS had the option of initially implementing these new controls through the 0Y521 ECCN series (which is a temporary holding classification for new controls before they are permanently added to the CCL), it opted instead to proceed directly to create new permanent ECCNs on the CCL.
Moreover, Assistant Secretary Kendler indicated during the October 13 briefing that BIS will seek multilateral enforcement of the new controls through the Wassenaar Arrangement process. This indicates that, although the rule issued as an interim final rule with a call for public comment, the agency may be taking a long-term view of these controls, and companies should anticipate a sustained impact to their business operations.