The Impact of Modern Economic Statecraft on Cross-Border Trade and Investment: Sanctions, Export Controls, Investment Screening, and Supply Chain Rules
Geopolitical risk is top of mind for companies these days, and it seems that every week brings a new proposed sanction, trade control, or investment restriction. Increasingly, companies and investors are discovering that their cross-border movement of goods, technology, and capital implicates regulatory restrictions of some kind and is subject to governmental scrutiny.
In modern parlance, such measures fall under the rubric of “economic statecraft.” The pace of change is dizzying, and the stakes are high, with each new economic statecraft tool holding the power to cut off business with targeted markets, trigger regulatory scrutiny of transactions, and impact business planning.
Economic statecraft is not new. The earliest recorded example dates back to the 5th century BC, when the Athenian Empire banned the people of Megara, a town allied with Sparta, from trading in harbors and marketplaces controlled by the empire. Another notable example is Napoleon’s Continental System, in which the French emperor sought to prohibit trade between the European continent and Great Britain. A further historical instance, with modern-day implications, is the U.S. embargo of Cuba, which dates back to the early 1960s.
While economic statecraft is not new, what is new is the power of the U.S. government and, increasingly, other governments, to respond swiftly to geopolitical events with economic countermeasures. In the modern landscape, such measures are often multilateral and reinforced through governmental bodies and market gatekeepers such as financial institutions.
Given the prevalence of economic statecraft tools and the geopolitical trends prompting their promulgation, it is important for economic operators engaged in cross-border trade and investment, and those advising them, to understand the nature and scope of the tools at governments’ disposal.
Economic sanctions are measures that a jurisdiction imposes, with binding effect within its territory and (often) to its nationals around the world, that restrict dealings with specified countries, economic operators, and malign actors.
Economic sanctions are perhaps the oldest form of economic statecraft, with a history spanning 2,500 years, as noted above. Sanctions remain the preferred tool for policymakers responding to geopolitical crises, with the U.S.-led sanctions against Russia following the invasion of Ukraine standing out as conceivably the best-known and most consequential set of sanctions measures in history.
The U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) administers various types of sanctions, including:
- Embargo: Complete prohibition of exports, imports, and investments involving the sanctioned country.
- Government-wide sanctions: Freezing of the assets of a country’s government and prohibition of all dealings with that government and state-owned entities.
- Sectoral sanctions: Prohibition of certain dealings with certain sectors of a country’s economy.
- Targeted sanctions: Freezing of the assets of specified bad actors (e.g., regime members, terrorists, human rights abusers, cyber-hacking groups, narcotraffickers, etc.) and prohibition of all dealings with the designated person and entities owned 50% or more by the person.
- Secondary sanctions: Asset freezes and denial of privileges of doing business with the United States directed at non-U.S. persons that engage in dealings with sanctioned persons.
Most U.S. sanctions programs apply to “U.S. persons,” defined as (1) persons located in the United States; (2) U.S. citizens and lawful permanent residents, wherever located; and (3) U.S.-incorporated entities and their non-U.S. branches.
Violations of most U.S. sanctions programs are punishable by civil penalties of up to the greater of ~$356,000 per violation (annually adjusted for inflation) or twice the value of the transaction at issue, and criminal penalties of up to $1 million and/or twenty years’ imprisonment.
Further, non-U.S. persons can face risk to the extent they engage in activity with a U.S. nexus (such as U.S. dollar denomination of transactions), cause U.S. persons to violate sanctions, or provide support to sanctioned persons.
Many U.S. partners around the world maintain their own sanctions programs, with increasingly mature institutions in place to administer and enforce the sanctions, especially following Russia’s invasion of Ukraine. Such jurisdictions include the European Union, the United Kingdom, Canada, Australia, and Japan.
Furthermore, many individual U.S. states maintain their own sanctions, typically in the form of restrictions on state government contracts with parties that do certain business with sanctioned countries and on state pension fund investments in sanctioned countries.
Export controls regulate the export, re-export, and transfer of goods, equipment, software, and technology (together referred to as “items”), based on the destination, end-use, and end-user of the item. Although export controls can be linked with sanctions, they are a wholly distinct regulatory regime focused on the movement of items, particularly more sensitive items.
There are two main types of export controls: (1) “dual-use” export controls applicable to items that can be used either for a military or civilian purpose; and (2) military export controls applicable to defense articles and defense services. This article will focus on dual-use export controls.
Arguably, export controls are the most cutting-edge tool in the economic statecraft toolbox today, featuring prominently in the Western response to Russia’s invasion of Ukraine and in the U.S.-China strategic competition. In the United States, this recently has crystallized in the formation of a U.S. government “Disruptive Technology Strike Force” intended to prevent the unlawful export of sensitive technologies.
Dual-use export controls rest on a solid foundation of multilateralism, with many countries agreeing to impose the same baseline level of controls pursuant to participation in multilateral export control regimes. The most prominent example of this is the Wassenaar Arrangement, consisting of forty-two participating member countries, including the United States, all EU member states, the United Kingdom, India, and others.
The core Wassenaar controls apply to ten categories of items that are set out in a control list:
- Category 1: Special materials and related equipment
- Category 2: Materials processing
- Category 3: Electronics
- Category 4: Computers
- Category 5:
- Part 1: Telecommunications
- Part 2: Information security
- Category 6: Sensors and lasers
- Category 7: Navigation and avionics
- Category 8: Marine
- Category 9: Aerospace and propulsion
Within each of the nine categories, there are five subcategories (lettered A-E) for (a) systems, equipment, and components; (b) test and production equipment; (c) materials; (d) software; and (e) technology. Across these categories and subcategories, there is a long list of controlled items, with many entries setting out detailed technical descriptions of the items at issue.
Where an item is listed on the Wassenaar list, a license from a governmental authority is required to export the item out of a participating country’s territory, subject to exceptions that the country may promulgate.
While the Wassenaar regime sets out the baseline, it is the local implementation of the controls that makes all the difference, and in this, the United States is a world leader. The United States, through the U.S. Department of Commerce’s Bureau of Industry and Security (BIS), has expanded significantly on the Wassenaar controls in the Export Administration Regulations (EAR), including by:
- Extensively expanding the control list, as set out in the EAR’s Commerce Control List (CCL);
- Establishing export control jurisdiction over all U.S.-origin items worldwide;
- Establishing export control jurisdiction over non-U.S. items outside the United States that (a) incorporate more than a “de minimis” level of controlled U.S. content (the “de minimis rule”) or (b) are the “direct product” of certain U.S. technology or software (the “foreign direct product” rule); and
- Imposing controls over the release of technology and source code to non-U.S. nationals within the United States, which are considered “deemed exports” to such person’s country of nationality.
The EAR establish export licensing requirements based on the destination, end-use, and end-user of an item, so it is important to know those details as well as the item’s Export Control Classification Number (ECCN) as set out on the CCL when seeking to make an export.
As with OFAC sanctions, EAR violations are punishable by civil penalties of up to the greater of ~$356,000 per violation (annually adjusted for inflation) or twice the value of the transaction at issue, and criminal penalties of up to $1 million and/or twenty years’ imprisonment.
U.S. export controls relating to China warrant special mention, as export controls are now arguably the tip of the spear for policymakers in the context of the U.S.-China strategic competition.
The best-known example of this is BIS’s imposition of sweeping export controls directed at China’s semiconductor industry in October 2022. The measure was intended as a paradigm-shifting, and potentially generationally significant, development in the ongoing technological “decoupling” between the two powers.
Generally, the United States has advanced its export control objectives vis-à-vis China in recent years by expanding the list of items controlled for export to China; designating a significant number of Chinese companies (such as Huawei) on the BIS “Entity List,” thereby cutting them off from exports of all items subject to the EAR; and, in certain instances (such as in the semiconductor export controls noted above), significantly expanding the scope of the “foreign direct product” rule to sweep in a range of non-U.S. items based on U.S. technology and software. The consequence of these measures is that any company exporting semiconductors or advanced technologies to China should proceed with caution.
Another pillar in the economic statecraft superstructure is governmental authorities’ review of inbound foreign investment for national security risks.
In the United States, the U.S. government conducts such reviews under authority of the Committee on Foreign Investment in the United States (CFIUS), an interagency body chaired by the U.S. Department of the Treasury. Although the term CFIUS is now a well-known buzzword in the M&A field, for decades, CFIUS was a little-known body that rarely impacted transactions. That changed in a big way with the 2018 passage of the Foreign Investment Risk Review Modernization Act (FIRRMA), which significantly expanded the scope of CFIUS review.
Under FIRRMA and its implementing regulations, CFIUS has jurisdiction to review the following types of foreign investments in U.S. businesses:
- Investments that result in control of a U.S. business by a foreign investor.
- Investments in U.S. businesses with a nexus to “critical technology,” “critical infrastructure,” or “sensitive personal data” (known as “TID businesses”) that afford a foreign investor board or observer rights or certain other specified rights.
Critically (pun intended), CFIUS review and export controls are closely intertwined in the context of “critical technology” companies. Specifically, assessment of whether a company is a “critical technology” company (and thus a TID business) depends on a determination of the ECCN(s) of the item(s) that the company designs, develops, produces, manufactures, fabricates, or tests.
Notably, certain transactions are subject to mandatory CFIUS review as follows:
- Investment in a “critical technology” company where an export license would be required to export the company’s technology to the foreign investor.
- Certain investments involving foreign government investors.
It is important to note that even where CFIUS review is not mandatory and thus is voluntary on the part of the parties, often such review may be warranted, and CFIUS in fact retains broad discretion to review “non-notified” transactions, even years after closing.
Parties can elect to make a filing to CFIUS either via a short-form declaration or a long-form joint voluntary notice (JVN), which can impact processing times, although CFIUS retains discretion to require filing of a JVN.
In conducting its review, CFIUS will assess the national security implications of a transaction—taking into account the sensitivity of the target and the national security profile of the investor—and has broad discretion to order mitigation of national security risks and even block the transaction. Notably, the assessment of the investor focuses not only on the specifics of the investor and the investor’s domicile but also the investor’s third-party relationships. For example, a German investor with a purely European business will have a national security profile that is different from a German investor with extensive ties to China.
It is important to note that many other jurisdictions maintain foreign investment review regimes of varying rigor. One particularly robust regime is the UK National Security and Investment Act, which is similar to the CFIUS regime in certain key respects. In one notable recent example under this authority, the UK government blocked the acquisition of a UK semiconductor foundry by a Chinese investor.
An economic statecraft tool of more recent vintage is regulation of the supply chain to counteract the supply of items that present a national security threat or are inconsistent with U.S. values.
One example of this is the U.S. Department of Commerce’s rules on Securing the Information and Communications Technology and Services (ICTS) Supply Chain (known as the “ICTS Rules”). Under the ICTS Rules, the Commerce Department has CFIUS-like authority to review ICTS transactions on national security grounds and is empowered to mitigate or block transactions as appropriate. The rules are focused on the supply of ICTS with a nexus to designated “foreign adversaries,” currently consisting of China, Russia, Iran, Cuba, Venezuela, and North Korea. While the Commerce Department has not yet implemented a formal CFIUS-type review process for ICTS, which is expected in due course, it has issued subpoenas to companies under authority of the ICTS Rules. These rules are especially relevant for companies involved in telecommunications, connected applications, software development, and emerging technologies, or with a nexus to critical infrastructure.
Another example is the Uyghur Forced Labor Prevention Act (UFLPA), pursuant to which the United States has established a rebuttable presumption that all goods originating in China’s Xinjiang Uyghur Autonomous Region (XUAR), or that incorporate XUAR-origin content, are the production of forced labor and thus ineligible for importation into the United States. Enactment of the law followed extensive reporting regarding human rights abuses in the XUAR, which produces more 20% of the world’s cotton and also is a source of electronics, computer parts, polysilicon and silica-based products, and touchscreens for devices. The UFLPA, which empowers U.S. Customs and Border Protection to detain cargo with an XUAR nexus, is reflective of the U.S. position that goods produced through means inconsistent with U.S. values should be barred from entering the United States.
Notably, other jurisdictions, such as the European Union, are considering their own versions of rules regarding the ICTS supply chain and forced labor. Furthermore, along those lines, the European Commission has proposed legislation requiring companies to conduct sustainability due diligence following implementation of a similar law in Germany at the beginning of this year.
It is unmistakable that we are entering a new geopolitical era, with the Biden Administration declaring in its most recent National Security Strategy that “the post-Cold War era is definitively over.” This will bring new applications of time-tested economic statecraft tools along with adoption of new tools.
In a changing world, it is more important than ever for companies engaged in the cross-border movement of goods, technology, and capital to keep apprised of such economic statecraft measures.
For more information, register now for Anthony’s upcoming One Hour Briefing, Modern Economic Statecraft Tools and Geopolitical Risk: Sanctions, Export Controls, Investment Screening, and Supply Chain Security, scheduled for April 17, 2023.
“The Impact of Modern Economic Statecraft on Cross-Border Trade and Investment: Sanctions, Export Controls, Investment Screening, and Supply Chain Rules,” by Anthony Rapa was published in the PLI Chronicle: Insights and Perspectives for the Legal Community (March 2023) on March 10, 2023. Reprinted with permission.