US Should Expand Chinese Military Investment Restrictions, Harmonize With Entity List, Experts Say

U.S policymakers should further study the extent to which U.S. investors support China’s artificial intelligence industry and should revise the scope of a Treasury Department list that restricts investments in Chinese military companies, experts from Georgetown University’s Center for Security and Emerging Technology said in a new report. The report also said the U.S. should consider imposing investment restrictions on certain companies added to the Entity List.

The report, released last week, comes as the Biden administration reportedly crafts a new executive order that would establish an outbound investment review mechanism to block certain investments in China, including those linked to critical technology sectors (see 2301270034, 2301190024 and 2301120035). The center said its report aims to “better understand the scope and nature” of U.S. investment transactions in China’s AI sector, adding that U.S. investors participated in nearly 20% of all investments in Chinese artificial intelligence companies between 2015 to 2021. The report authors said those investments “merit additional attention and tracking.”

Part of that effort should include directing Treasury to expand the scope of Chinese companies subject to existing investment restrictions before the administration creates its widely expected outbound investment screening regime. Treasury’s Non-Specially Designated National Chinese Military-Industrial Complex Companies (CMIC) List (see 2106030067) should “at the minimum” include privately held Chinese companies that attract venture capital investments, the Georgetown center said.

“This tool should then be used in cases of U.S. outbound investment flowing to problematic actors in China,” the report said, “especially those working in the defense/military and surveillance industries, like iFlytek,” an AI company added to the Commerce Department’s Entity List in 2019 (see 1910070076). “This modified list could then be used in the most egregious cases … to gain a better perspective of the issues at play.”

Although companies on Treasury’s CMIC list are subject to certain investment restrictions, the center said the list has “several gaps” because it blocks only the “purchase for value, or sale” of publicly traded securities. “In other words, privately-held Chinese companies and nonstate-owned enterprises are not within the scope, despite some being on the list anyways,” the report said. “In addition, U.S. persons are still allowed to provide assistance and services that could allow Chinese firms to circumvent the essence of the CMIC List.” Chinese AI company Yitu Technology, for example, is on the CMIC List, but the report said it’s “unclear how much this listing has actually affected Yitu, if at all.”

To close these gaps, the administration should revise the CMIC List beyond its initial “defense materiel and surveillance” sector to include other Chinese AI companies operating in sectors critical to national security, the report said. These sectors could be determined by the administration or Congress.

The report also recommends the U.S. place similar investment restrictions on companies on Commerce’s Entity List. It can do this by “cross-listing” companies on the Entity List with those on the CMIC List but only in cases “where the underlying facts and risk assessment support a listing under each legal authority.” The center also stressed that the reasoning for adding entities to both lists should be “distinct to prevent jurisdictional overreach.”

“Moving forward, a Chinese company could be added to the Entity List for risk of potential diversion to a military end-user in China, while simultaneously [being] added to the CMIC List because of a connection to the Chinese defense sector,” the report said. “This ensures that both listings fall within the jurisdiction of their various agencies and regulations.”

Harmonizing the lists would help the U.S. better prevent companies on the Entity List from obtaining sensitive U.S. technology, the report said. “There is no element of the Entity List that requires any amount of divestiture from or limitations on investment into listed entities,” it said, adding that U.S. companies that invest in firms before they’re added to the Entity List aren’t “legally obligated” to divest. Qualcomm Ventures, for example, still lists Chinese AI surveillance company SenseTime as part of its portfolio, the report said, despite SenseTime’s addition to the Entity List in 2019 for its alleged involvement in human rights violations in China’s Xinjiang Province (see 2006030032).

The report also recommends creating a pilot program to collect data on U.S. outbound investments in China before introducing an outbound investment control regime. Through the pilot program, the U.S. can revise disclosure requirements for U.S.-based funds and firms investing in Chinese companies, including those “in sectors deemed critical to national security.”