U.S. And China Export Control Regulations:
Implications For Global Tech Supply Chains
- The emergence of export control regulations from the U.S. and China could accelerate a trend of ‘decoupling’: the disintegration of high-tech components and reduced reliance on foreign suppliers by localizing assembly and production within global supply chains. These protectionist measures could have a more profound impact on global tech supply chains than tariffs themselves over the long-term, with the aim of preventing U.S. and Chinese companies and suppliers from selling advanced tech products and components to one another.
- Under the Trump administration, the U.S. has progressively ramped up its export control restrictions under the Export Control Reform Act (ECRA) in 2018, along with the relatively liberal use of its Entity List (an export blacklist targeting end users rather than products), aimed at keeping sensitive U.S. technology products away from Chinese entities and as a countermeasure against perceived ‘predatory’ industrial policies from Beijing.
- In response, China has drafted a raft of regulatory measures inhibiting foreign tech firms and suppliers through its proposed Export Control Law and Unreliable Entities List (UEL) that threatens to target foreign entities and introduce new licensing requirements mirroring that of the U.S. Entity List. Beijing has repeatedly made veiled threats that “concrete measures” will be taken, but has yet to clarify which foreign entities will be targeted.
- Chinese firms may be forced to “de-Americanize” and localize their supply chains in a move that also holds serious implications for foreign firms keen to continue working with China and avoid the long-arm of Washington’s new measures that provide it with more control over the resale of U.S. hi-tech products internationally.
- For non-U.S. and Chinese tech manufacturers, they may face an uncomfortable conundrum: in order to retain access to U.S. equipment, they could be required to give up on sales to Chinese firms; or, conversely, they may choose to turn away from U.S.-made equipment but would be required to switch to substitute equipment from non-U.S. suppliers.
- Supply chain professionals will need to continue to take precautions in preparing for additional regulatory uncertainty. This includes taking measures to closely monitor revisions to export control lists, reassessing internal compliance and third-party due diligence measures, realigning inventory strategies, and re-evaluating supplier and distribution networks to mitigate potential further supply chain disruptions.
Amid the backdrop of the COVID-19 global pandemic, the U.S. and China are continuing to tighten export control regulations (ECRs) that threaten to seriously further disrupt an already volatile market for global tech supply chains. These developments are continuing to fuel growing fears of an accelerated ‘decoupling’ – the concept of reducing technological reliance on foreign suppliers by localizing the production and assembly of high-tech components – that are posing serious risks for companies caught in the middle of an escalating U.S.-China ‘techno-nationalism’.
Over the course of the U.S.-China trade war, Washington and Beijing have both frequently cited national security or foreign policy concerns to justify targeting rival key tech supply chain entities through their respective export control regimes. The Trump administration has sought to shore up its export control regime that – while not explicitly targeting Chinese entities – is widely being viewed as making it easier to reject license applications for U.S. exports of advanced tech products to China. In retaliation, Beijing has also introduced its own updated draft of a proposed Export Control Law and repeatedly threatened to enact an Unreliable Entities List (UEL) targeting U.S. and foreign companies, organizations and individuals that do not comply with market rules and “block off, disrupt supplies, and damage the legitimate interests of Chinese enterprises.”
In recent weeks, the U.S. amended its ‘direct product rule’ by requiring foreign manufacturers to obtain an export license before sales to Chinese telecommunications giant Huawei Technologies for certain semiconductor products made abroad with U.S. technology. This follows reports of Washington’s successful campaign to have Taiwan Semiconductor Manufacturing Company (TSMC) build a new U.S.-based semiconductor fabrication plant and another new final rule tightening export controls on certain semiconductor and aircraft components to China that requires any products that can be used to support the Chinese military to obtain an export license and undergo a review before shipping. In response, Chinese state media sources report that Beijing is threatening to impose restrictions on leading U.S. companies (such as Apple Inc., Cisco Systems, and Qualcomm Inc., and Boeing Co.) under its UEL. Beijing is also set to impose tougher cybersecurity regulations that will toughen procurement rules for hi-tech equipment and require foreign companies to assess risks of supply chain disruption due to “politics, diplomacy, and trade.”
China’s Technological Ambitions
In 2015, the Chinese government launched a state-led ten-year industrial policy initiative known as ‘Made in China 2025’ (MIC 2025) that outlined Beijing’s ambitions to transform itself as a global technological leader in 10 key sectors: next-generation IT, aerospace and aeronautical equipment, automated machine tools and robotics, new materials, maritime equipment and high-tech shipping, advanced railway equipment, power equipment, new energy vehicles, biopharma and advanced medical products, and agricultural equipment (see Figure 1 below). China has set out a target to achieve 70 percent self-sufficiency in high-tech manufacturing industries with the aim of catching up and surpassing Western and other advanced economies by 2025.
All of the key priority areas identified under MIC 2025 are heavily dependent on advanced semiconductor manufacturing capabilities, where Beijing remains reliant on U.S. firms that hold around 45 percent of the global market share for semiconductors. China is the world’s largest importer of foreign integrated circuits and microchip technology, making up around more than 40 percent of global imports but only producing around 13 percent of global supply. While semiconductor technology is considered crucial for China’s top manufacturing exports (including higher-end electronics such as smartphones and personal computers), Chinese domestic production accounted for only 9 percent of consumption and only USD 4.7 billion (EUR 4.34 billion) out of USD 23.8 billion (EUR 22 billion) worth of local production in 2018.
Beijing’s desire to reduce its dependence on foreign technologies and create its own indigenous champions has come through an aggressive industrial campaign fueled by state-backed subsidies, attracting foreign direct investment (FDI), and acquisition of strategic foreign technologies. However, despite these concerted efforts to improve self-sufficiency in key flagship industries, Chinese companies still largely focus on manufacturing lower-to-mid range integrated circuit units and are viewed as being two or three generations behind those produced by leading global manufacturers such as Samsung (South Korea), Intel (U.S.), Micron Technology (U.S.), and TSMC (Taiwan).
U.S. Export Controls on “Emerging And Foundational Technologies”
The U.S. contends that Beijing’s MIC 2025 initiative has created unfair advantages for Chinese companies and that counter-measures are necessary due to alleged infringements on intellectual property rights, illegal state subsidies, forced technology transfers, and other regulatory barriers placed on U.S. companies operating in the China market. In response to what it perceives as ‘predatory’ industrial practices from China, Washington has increasingly turned to export controls and other protectionist mechanisms on grounds of national security and foreign policy interests.
Export Control Reform Act (ECRA)
Enacted in August 2018, the ECRA was initiated to bring about an expansion of U.S. export controls that mandates the executive branch to identify, and the Commerce Department to control, exports of “emerging and foundational technologies” that are essential to U.S. national security and not already subject to ECRs. The Commerce Department’s Bureau of Industry and Security (BIS) is responsible for enforcing export controls on all entities identified under the Commerce Control List (CCL). A key feature of the CCL are “dual-use technologies” for U.S. exports of products that could have both military and commercial applications. U.S. companies are required to obtain a license before exporting, re-exporting, or transferring a controlled technology depending on its destination, identity of the actual buyer, and intended use of the item.
Under the ECRA, the BIS is currently seeking public input on an Advanced Notice of Proposed Rulemaking (ANPRM) on criteria for identifying “emerging and foundational technologies” essential for U.S. national security. The ANPRM listed 14 categories including biotechnology; artificial intelligence and machine learning technology; Position, Navigation, and Timing (PNT) technology; microprocessor technology; advanced computing technology; data analytics technology; quantum information and sensing technology; logistics technology; additive manufacturing (e.g., 3D printing); robotics; brain-computer interfaces; advanced materials; and advanced surveillance technologies. Most, if not all, of Beijing’s 10 strategic MIC 2025 categories are already identified as dual-use technologies or likely to be covered by the CCL.
Prior to the ECRA, the BIS focused on promoting high-tech civilian trade with China but restricting the military end-use of such exported items. As China’s civil-military integration efforts have become more sophisticated though, the ECRA has switched the focus of the BIS to expanding the scope of controls relating to military end-uses in China. In recent years, Washington has rejected more licenses and slowed down the approval process for export licenses to U.S. technology companies exporting to Chinese entities. For example, the Commerce Department granted 350 export licenses to U.S. technology companies with 350 licenses being granted in 2018 compared to 771 licenses in 2017.
Over the past few weeks, the U.S. has taken major steps towards tightening export controls on U.S. high-tech products bound for China. On May 15, 2020, the Trump administration expanded U.S. authority to require foreign manufacturers to acquire licenses for the sale of certain semiconductor products made abroad with U.S. technology to a specific Chinese telecommunications firm Huawei Technologies. Earlier on April 28, 2020, the BIS had announced that U.S. companies will be required to apply for licenses to sell certain items in China that support the military even if the products were sold for commercial purposes. These items included semiconductor equipment, aircraft parts and components, sensors, vessels, gas turbine engines, nuclear handling materials, chemicals, and marine systems or equipment. The rule changes also do away with a civilian exception that allows certain U.S. technology to be exported without a license and requires U.S. companies to file declarations of all exports to China, Russia, and Venezuela regardless of value.
Restricted entity lists
Under the Trump administration, there has been a sharp uptick of Chinese tech entities targeted most notably through the Entity List and Unverified List under the BIS’ Export Administration Regulations (EAR). The Entity List – a restricted export blacklist targeting end users rather than products – identifies foreign entities that are subject to specific license requirements for the export of specified items but the majority of these license requests are usually denied.
While not as restrictive as the Entity List, the Unverified List (UVL) differs in that U.S. companies are not legally embargoed or prohibited from interacting with these entities, but are required to “to conduct additional due diligence before exporting, re-exporting, or transferring to listed entities commodities, software, or technology subject to U.S. jurisdiction that do not normally require a license.” Although short of an outright ban, the UVL creates additional responsibilities for any U.S. exporter that intends to conduct business with a listed entity and has seen an increasing number of Chinese entities being listed under the Trump administration.
From a supply chain perspective, restricted entity lists are already impacting global tech manufacturers and suppliers with significant trade involving U.S.-origin goods as U.S. firms are required to apply for new licenses to sell products or services to red-flagged companies. In October 2018, the BIS restricted U.S. companies from selling crucial software and technology to Chinese semiconductor firm Fujian Jinhua Integrated Circuit Company – which produces DRAM memory chips – over alleged intellectual property theft and national security concerns. Other notable Chinese technology entities targeted by the Trump administration on the Entity Lists include semiconductor suppliers San’an Optoelectronics, Chengdu Haiguang Integrated Circuit, and Beijing Bayi Space LCD Materials Technology; video surveillance manufacturers Hikvision and Dahua Technology; and artificial intelligence firms Sensetime, iFlytek, and Alibaba-backed Megvii.
De minimis thresholds
U.S. and Chinese tech manufacturers have resorted to instructing suppliers to reduce the overall de minimis value of U.S. technology within its supply chain as a means of legally circumventing U.S. export controls. Under the current regulation, the U.S. can require a license or block the export of many high-tech products shipped to China from other countries if U.S. made components make up more than 25 percent of the value.
Over recent months, the U.S. Commerce Department has reportedly been considering lowering the threshold to 10 percent for the de minimis rule, which determines the amount of U.S. content in a foreign-made product and provides the U.S. government the authority to regulate an export. If adopted, the new rule change would increase the scope of items that would be subject to the EAR on grounds of national security. In addition, the Commerce Department has also drafted a Foreign Direct Product Rule that could potentially further prohibit any foreign-made goods using U.S. technology or software from being exported to specific Chinese entities.
Blocking of mergers and acquisitions for critical technologies
In addition to ECRs, the Trump administration has proactively blocked the mergers and acquisitions involving U.S. and Chinese technology companies amid a substantial increase in foreign investment reviews by the Committee on Foreign Investment in the United States (CFIUS). The number of high-profile acquisitions of U.S. technology companies by Chinese entities have therefore subsequently been significantly limited since the passage of the Foreign Investment Risk Review Modernization Act (FIRRMA). Notable attempted acquisition deals involving Chinese technology entities that have been blocked by CFIUS include Fairchild Semiconductor International, Lattice Semiconductor, Aixtron, and GSR Ventures.
Chinese Export Controls
In response to the Trump administration, Beijing has taken a harder retaliatory line through its own ECR mechanisms that threaten to target U.S. and foreign technology firms. Likewise citing matters of national security, China has introduced a raft of new proposed export controls and other various regulations that will make it harder to export and import foreign tech products.
Export Control Law
On December 28, 2019, China’s Ministry of Commerce (MOFCOM) released its second draft of its Export Control Law that, if enacted, would be Beijing’s first law specifically addressing export controls and to counter U.S. export control measures. The latest draft marks its first revision since 2017 and would enable China to blacklist foreign importers through new and consolidated export control lists. These lists would likely include sensitive and emerging indigenous technologies that would result in a similar tit-for-tat response to similar ECR measures adopted by the U.S. It may also include strategic resources where the U.S. remains highly dependent on China for rare earth elements that are essential for various technological products such as high-end consumer electronics, electric car motors, satellites, fiber optics, superconductors, and lasers.
Unreliable Entities List (UEL)
On May 15, 2020, Chinese state media outlets reported that Beijing was ready to place specific U.S. companies on its UEL as part of its countermeasures against Washington’s ruling to block shipments of semiconductors to Huawei Technologies. The measures include potential investigations and restrictions on leading U.S. companies such as Apple Inc., Cisco Systems Inc., Qualcomm Inc., as well as the suspension of purchases of Boeing Co. planes. The developments follow earlier Chinese reports from last year claiming that Beijing was preparing its first batch of entities to be named on the UEL are likely to target well-known U.S. technology companies that “are strong enough to pose actual or potential threats to China’s national security.”
In May 2019, MOFCOM previously announced that it would establish an UEL aimed at “targeting foreign enterprises, organizations and individuals that do not comply with market rules and block off, disrupt supplies, and damage the legitimate interests of Chinese enterprises.” The criteria includes whether the entity (1) has blocked, cut supply of, or conducted discriminatory measures against China; (2) is based on non-commercial purposes, or contrary to market rules and the spirit of the contract; (3) has adopted actions that cause substantial damage to Chinese enterprises or related industries; and (4) has adopted actions that pose a threat or potential threat to national security. If enacted, the UEL would provide China a potential equivalent law mirroring that of the U.S. Entity List.
Authorities are also surveying the supply chain structure of domestic technology companies – which include smartphone makers Xiaomi Corporation, Oppo and Vivo – and their reliance on U.S. suppliers for its semiconductors, modems, and jet engines. In addition, several Chinese state ministries are in the process of enacting their own national technological security management list aimed at “preventing and resolving risks to [China’s] national security more efficiently.”
Set to come into effect on June 1, 2020, the Cyberspace Administration of China (CAC) announced new procurement rules that will require operators of “critical information infrastructure” to go through a cybersecurity review process when ordering goods and services that may affect national security. The measures will place foreign tech products at a disadvantage as companies will need, before signing a contract, to submit procurement documents, purchase agreements, and an analysis of the deal’s national security impact for government review. The prospect of lengthy reviews that could wind up within 45 working days or possibly longer for more complicated cases could incentivize Chinese companies to turn away from foreign tech products and services as well as being used as a justification for switching to domestic alternatives.
The measures place specific focus on supply chain security and a direct reference to concerns regarding potential disruptions from foreign governments. In particular, it identifies two risk factors that are highly relevant to foreign suppliers: first, it cites concerns about whether foreign-sourced products could gain leverage within China’s networks; and second, the risk of supply disruptions due to “political, diplomatic, and trade factors” at a time when the U.S. government has deployed various mechanisms to restrict the supply of key technology components to Chinese companies.
Export controls and other protectionist measures are seriously complicating how U.S. and Chinese tech manufacturers and suppliers will be able to interact going forward. Everstream Analytics outlines recommendations on what this could mean for U.S. and Chinese tech firms and suppliers and how global supply chains will need to adapt amid ongoing regulatory uncertainty.
- Closely monitor exclusions and waivers from export controls: At least in the near term, supply chain managers should closely monitor any potential waivers or exclusions that may be granted to U.S. and Chinese tech firms from the U.S. Entity List and China’s proposed UEL as foreign entities and suppliers may be removed through different rounds of revisions.
- Re-assess compliance and third-party due diligence strategies: U.S. and Chinese firms that import technology products from both countries are advised to conduct a more comprehensive review of their supply chain security through their compliance and third-party due diligence procedures when engaging with foreign suppliers. In short, global tech manufacturers will have to work more collaboratively to avoid any immediate impact to their production as working in silos in this ever-changing risk landscape no longer works.
- Evaluate supplier and distribution networks: Supply chain professionals will need to determine whether revisions to their operational and logistical planning is feasible and assess if alternative suppliers and distributors are necessary should companies determine that their suppliers may be vulnerable to export control restrictions. Clear visualization of critical supplier and shipping locations would enable more accurate assessments of risks at sub-tier supplier levels, both from a product and geographical flow perspective.
- Re-align inventory strategies: While the strategy may initially place cash flow strains and incur additional warehousing or storage costs, supply chain managers could consider ‘buying forward’ inventory from critical suppliers to avoid potential disruptions that may be deployed in the future due to export controls or other regulatory-type restrictions.
The rapid deployment of export controls from Washington and Beijing may accelerate further ‘decoupling’ of global tech supply chains that could have serious worldwide repercussions. Export controls have already inflicted immediate costs on U.S. companies due to being cut off from Chinese buyers, while Chinese firms may be forced to “de-Americanize” and localize their supply chains – a move that also holds serious implications for foreign firms keen to continue working with China and avoid the long-arm of Washington’s new measures that provide it with more control over the resale of advanced U.S. tech products internationally. For non- U.S. and Chinese tech manufacturers, they may face a conundrum: in order to retain access to U.S. equipment, they could be required to give up on sales to Chinese firms; or, conversely, they may choose to turn away from U.S.-made equipment but would be required to switch to substitute equipment from non-U.S. suppliers.
On top of the COVID-19 pandemic, the volatile nature of U.S.-China trade tensions suggest that the flurry of protectionist policies will likely continue as tech manufacturers and suppliers cope with further disruptions to their global supply chains. As many companies attempt to mitigate risk and maintain their businesses, global tech manufacturing firms have been hit with higher supply chain traceability costs, lost sales to restricted entities, and revoked export privileges due to non-compliance. Companies importing and exporting U.S. and Chinese high-tech products will therefore need to be prepared to carry out sufficient due diligence and evaluate whether potential alternative suppliers are needed to protect their supply chain networks.