Sweeping US Export Controls on Semiconductor, Supercomputer Manufacturing in China Raise Compliance Questions – Morgan Lewis

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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.
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:
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.
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:
Questions include:
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.
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.
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.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following:
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