Big changes in outbound foreign investment to China

Key details for private equity sponsors to consider in response to President Biden’s executive order.

By Jonathan Gafni, Anna Gooding and Ray Hou, Linklaters

By now you have likely heard about Executive Order 14105 – President Biden’s August 9 executive order that will eventually restrict outbound US investment in Chinese companies “engaged in activities involving” semiconductors and microelectronics, quantum information technologies or artificial intelligence that are deemed critical for China’s military, intelligence, surveillance or cyber-related capabilities. Some of these investments will be prohibited outright, while others will require notification to the US government.

Jonathan Gafni, Linklaters

Implementation of the order will not come for several months. Multiple US government agencies, led by the Treasury Department’s Office of Investment Security (OIS), will draft rules putting the order into effect. As a first step, however, Treasury has issued an Advance Notice of Proposed Rulemaking (ANPRM) identifying some of the current thinking as to how the order might work. Issuance of the ANPRM just minutes after the order was released shows that Treasury has already put a good deal of thought into the regulations. However, a lot of details are still up for discussion; Treasury has asked for public input – due by September 28 – on 83 separate issues that remain unresolved.

The new prohibitions and notifications will not apply to transactions predating the effective date of the regulations, but Treasury has issued a warning in the ANPRM that it may ask parties about any transactions that took place between the August 9 date of the Order and the effective date of the regulations.

Which investors will be covered?

At its core, the order applies to transactions undertaken by “United States persons,” defined generally in the order as US citizens, permanent residents, entities, as well as anyone located in the United States. In practice, however, the regulations are expected to cover transactions directed by United States persons or undertaken by non-US entities controlled by United States persons.

Anna Gooding, Linklaters

In the context of PE investments, the eventual rules could have broad implications. For instance, the regulations may cover a situation in which an investment vehicle is established offshore but the sponsor (or others acting on its behalf such as general partners and investment managers) are in the United States or are led by US nationals.

A similar issue could apply to limited partners, though Treasury could be offering LPs a few ways out. The regulations may except limited partners who invest below certain thresholds based on parameters such as the amount invested or the size of the investment relative to the LP’s total capital. In addition, Treasury is considering an exception for LPs whose rights are consistent with “standard minority investor protections.” Treasury calls out material governance rights with respect to the target, such as board representation, as likely to be excessive. Another concern is that when OIS wrote regulations concerning the Committee on Foreign Investment in the United States (CFIUS), which reviews inbound foreign investments, the list of minority investor protections not deemed “controlling” in the CFIUS rules fell far short of the “standard” protections found in many limited partnership agreements.

Which targets will be covered, and how can an investor tell?

The order defines three broad technology categories but leaves it to Treasury to identify which technologies within those categories will be prohibited and which will be notifiable. When faced with this challenge in 2018 when the law governing CFIUS created a new category of “critical technologies,” CFIUS decided to rely on the various US export control regimes to benchmark the technologies deemed “critical.” In the context of the order, benchmarking Chinese technologies against US export controls is likely to leave a number of gaps. These are rapidly developing technologies, and US export controls may not apply to them, or may not keep up with the pace of innovation.

Ray Hou, Linklaters

Moreover, under the “fundamental research exception,” many types of basic or applied research in science or engineering – if not restricted from publication – are exempt from US export controls. If there are not controls on fundamental research in the United States, there will be no benchmark to apply to comparable research in China. The rules will therefore have to include precise technical definitions of at least some technologies to close this gap.

Another challenge for PE sponsors (and LPs concerned with application of the order to their indirect investments) will be conducting due diligence confirming whether a prospective target is in scope. For companies based in China, this has been made much harder under China’s expanded Anti-Espionage Law, which restricts foreign transfers – even to nongovernmental entities – of information “related to the national security and interest.” The three technology categories in the order are likely to be considered by China as just as sensitive as they are viewed in the Order, so information shared with outside entities during diligence could violate Chinese law.

Jonathan Gafni ( is head of US foreign investment at Linklaters LLP;  and is former US intelligence community representative to the Committee on Foreign Investment in the United States. Anna Gooding (, is an associate, Antitrust & Foreign Investment Group, Linklaters LLP. Ray Hou (, is an associate, Antitrust & Foreign Investment Group, Linklaters LLP.