On November 12, 2020, President Trump issued a new executive order: the “Executive Order on Addressing the Threat from Securities Investments that Finance Communist Chinese Military Companies” (the EO). In an apparent aim to escalate the US-China trade war in the Administration’s final months, the EO prohibits US transactions in securities of 31 targeted Chinese companies. The EO’s restrictions will take effect from January 11, 2021, which is 60 days from the date of the EO’s issuance and nine days before the inauguration of President-elect Joe Biden.
Our key takeaways follow:
Which Chinese companies does the EO target?
The EO currently targets 31 Chinese companies that are purportedly owned or controlled by the Chinese military, including many major companies in the energy, technology, telecommunications, and manufacturing sectors. All of these companies were included on lists previously released in June and August 2020 by the US Department of Defense (the DOD) following the DOD’s determination that the companies were owned or controlled by the Chinese military. Because the lists were released under the authority of Section 1237 of the National Defense Authorization Act for Fiscal Year 1999, the lists are commonly referred to as the Section 1237 List (and sometimes also as the “DOD List” or the “Pentagon List”).
Prior to the EO, the Section 1237 List did not impose any restrictions on the 31 companies. The EO references the Section 1237 List now, however, to identify those Chinese companies whose securities are targeted by these new sanctions. This sequencing is similar to how the US government approached the 2018 sanctioning of Russian oligarchs. First, in January 2018, the US Treasury Department published a list identifying Russian oligarchs; thereafter, in April 2018, the Treasury Department’s Office of Foreign Assets Control (OFAC) added several of those individuals to the US list of Specially Designated Nationals (SDN List).
Any additional Chinese companies that the DOD designates on the Section 1237 List at a later date will have their securities targeted by the same sanctions restrictions. A Chinese company’s securities may also be targeted by the EO’s restrictions if the Treasury Secretary publicly lists the Chinese company as meeting the criteria of the Section 1237 List.
At this time, it does not appear that the EO targets subsidiaries of companies on the Section 1237 List, although the EO provides that if the Treasury Secretary “publicly lists” such a subsidiary, it too will be targeted by these new sanctions.
If a Chinese company is removed from the Section 1237 List (or Treasury’s Section 1237-related list), the sanctions on that entity are automatically lifted.
What do the sanctions on targeted Chinese companies prohibit?
US persons are prohibited from engaging in any “transaction” in publicly traded securities – or any securities that are derivative of, or designed to provide investment exposure to securities – of any company on the Section 1237 List.
The EO defines prohibited “transactions” as only “the purchase for value of any publicly traded security,” which at first glance appears to suggest that US persons are prohibited only from purchasing targeted securities but not from selling such securities. Notably, however, the EO’s 60-day grace and 365-day wind-down periods permit “purchases for value or sales” of targeted securities. It is therefore not clear whether the intention of the EO is also to prohibit US persons from selling targeted securities or if the terms of the grace and wind-down are overbroad and purport to authorize an activity that is not prohibited by the EO. Forthcoming guidance may clarify this point.
The scope of “securities” targeted by the EO is based on a relatively broad definition from the US Securities Exchange Act of 1934 and includes, among other things, publicly-traded shares and American depositary receipts (ADRs) of the targeted companies. As noted above, the EO also targets derivates of such securities, including investments that are indexed to the value of the targeted securities, as well as options, puts and calls on the targeted companies’ shares.
The EO restricts US transactions in targeted securities around the world, regardless of where the securities are issued or traded.
When do the sanctions take effect, and is there a wind-down period?
“Transactions” by US persons in targeted securities will be prohibited starting 60 days from the date of the EO, at 9:30am EST on January 11, 2021. Similarly, restrictions on securities of entities later added to the Section 1237 List will begin 60 days after such designation.
The EO provides a one-year wind-down period for US persons to divest from targeted securities. As such, US persons are authorized to engage in purchases or sales of targeted securities until November 11, 2021, provided that the overarching purpose of any such transactions is “solely to divest.”
The EO does not appear to prohibit US persons from continuing to hold targeted securities even after the wind-down period has expired, as long as US persons do not engage in any “transactions” in those securities.
Are these sanctions similar to “blocking” sanctions?
The EO’s sanctions prohibit US purchases of targeted securities, so these sanctions are more limited than the “blocking” sanctions that typically apply to persons on OFAC’s SDN List. Under OFAC blocking sanctions for SDNs, US persons are generally required to block (i.e., freeze) all property or interests in property of designated persons, whereas the EO targets only the targeted companies’ securities.
These new sanctions are closer in scope to the US and EU sectoral sanctions on Russian companies. Under the relevant sectoral sanctions, US and EU persons are prohibited from dealings in certain new equity of targeted Russian companies. The EO, by comparison, is broader in certain respects because these new sanctions cover both new and existing securities as well as derivatives, but the EO is also more limited in other respects because the EO targets only publicly-traded instruments.
Will these sanctions change under the Biden Administration?
It is possible that President-elect Biden could, when he becomes President on January 20, 2021, rescind or amend the EO. Short of that, a Biden Administration could also issue regulations or guidance on the Section 1237 List sanctions that significantly blunt the potential impact of the EO. It remains to be seen whether President-elect Biden or his policy team will comment directly on the EO or signal an intent as to how the next Administration will treat these sanctions.
The restrictions take effect nine days before Inauguration, however, so there will likely be at least some period of time where these sanctions will be in effect.
Potential impact and conclusion
Until the current or incoming Administration provides further guidance, the potential long-term scope of these new sanctions is not clear. It is also not clear what practical business or market operation challenges these new sanctions will present.
Helpfully, however, the EO provides 60 days for Section 1237 Listed companies, and parties dealing with Section 1237 Listed companies, to assess the implications of these new sanctions on their investments, business arrangements, and agreements. Companies should use this time to ensure that they are prepared for the sanctions taking effect on January 11, 2021 and continue to monitor developments with the Section 1237 List sanctions.