On November 12, 2020, President Trump issued an Executive Order (E.O.) prohibiting U.S. persons from engaging in any transaction (defined as a “purchase for value”) of publicly traded securities, or transacting in financial products that are derivative of, or provide investment exposure to, securities of designated Communist Chinese military companies (“Chinese Military Companies”).
The prohibition will enter into effect on January 11, 2021 at 9:30 a.m. Eastern time and currently applies to 31 entities that have been identified on a list of Chinese Military Companies published by the U.S. Department of Defense (DoD). U.S. investors will have until November 11, 2021 at 11:59 p.m. Eastern time to fully divest from any shares or funds involving these 31 companies.
The E.O.’s prohibitions apply to companies that have been identified by the DoD as supporting the Chinese military. The DoD issued an initial list in June 2020 (available here) and a supplemental list in August 2020 (available here) pursuant to its reporting obligation under Section 1237 of the 1999 National Defense Authorization Act (“1999 NDAA”). Section 1237 of the 1999 NDAA requires the Secretary of Defense to compile a list of Chinese Military Companies (i.e., any person owned or controlled by the People’s Liberation Army and engaged in providing commercial services, manufacturing, producing, or exporting) that are operating directly or indirectly in the United States or its territories and possessions. The 31 listed Chinese Military Companies cover a broad range of sectors, including telecommunications, aviation, aerospace, shipping, and construction.
Importantly, the E.O. also will apply prospectively to newly designated companies, which can occur in one of two ways. First, the DoD can issue further designations pursuant to Section 1237(b)(2) of the 1999 NDAA. Second, the E.O. also authorizes the Treasury Department to publicly list any person meeting the criteria in Section 1237(b)(4)(B) of the 1999 NDAA as “(i) owned or controlled by the People’s Liberation Army; and (ii) is engaged in providing commercial services, manufacturing, producing, or exporting,” without specifying the need for finding a U.S. operating nexus. The Treasury Department also may designate persons identified as a subsidiary of a person already determined to be a Chinese Military Company. For newly designated companies, U.S. persons are prohibited from the activities identified above 60 days after designation. When designated, the E.O. provides U.S. investors with a 365-day wind-down period to complete divestment.
Of the 31 companies currently listed by the DoD, approximately two-thirds have publicly traded shares or have subsidiaries with publicly traded shares. As noted above, the E.O. prohibits U.S. investors from having either a direct investment in publicly traded securities as well as indirect investments via derivatives or other instruments providing exposure to company securities. The definition of “securities” in the E.O. includes the definition in section 3(a)(10) of the Securities Exchange Act of 1934, which covers swaps of securities (i.e., security-based swaps). In practice, the prohibitions may impact investment vehicles like pension funds and retirement plans, as well as emerging-markets index funds, exchange traded funds and other investment vehicles with exposure to Chinese Military Companies.
The E.O. is the latest in a series of actions the Trump Administration has taken against China, including the addition of Chinese companies and institutions to the U.S. Department of Commerce’s Bureau of Industry and Security’s (BIS) Entity List for alleged ties to the Chinese military or human rights violations (discussed here), new export control rules targeting commercial companies within China that do business with military agencies (discussed here), and the expanded reach of U.S. export controls to suppliers of semiconductors to Huawei and its affiliates (discussed here).