New Executive Order prohibits investments in Chinese Military Companies

Amidst escalating tensions in US-China trade relations, President Trump last week issued an Executive Order ("the EO") on Addressing the Threat from Securities Investments that Finance Communist Chinese Military Companies.

The EO, issued 12 November 2020, will prohibit US persons (individuals and entities) from engaging in "any transaction in publicly traded securities, or any securities that are derivative of, or are designed to provide investment exposure to such securities, of any Communist Chinese military company" as further defined in the EO. The prohibition takes effect on 11 January 2021. According to a statement from National Security Advisor Robert C. O'Brien, the EO takes aim at preventing US investors from "unknowingly provid[ing] funds" to publically traded companies the US considers to have close links to the Chinese military, and that "directly threaten the critical infrastructure, economy, and military of America and its allies and partners around the world."

The EO defines such "Communist Chinese Military Companies" ("Military Companies") by way of Section 1237 as amended, of the National Defense Authorization Act ("Section 1237") for fiscal year 1999. This provision allows the Secretary of Defense to produce and maintain a list of such companies (the "DoD-list"), and provides the President discretionary power to impose sanctions on such listed companies, pursuant to the International Emergency Economic Powers Act ("IEEPA"). After several years of dormancy, the Department of Defence made use of Section 1237 this summer, when it identified and listed 31 such companies considered by the US to be Military Companies by listings released in June 2020 and in August 2020. The DoD-list included several prominent companies within a broad array of industries, including technology, communications, shipping, chemicals and electronics.

The EO defines a "transaction" as "the purchase for value of any publicly traded security". The term "Security" is defined with reference to the broad definition of the term in the Securities Exchange Act, cf. 15 USC 78c(a)(10). The definition covers a host of financial instruments, including inter alia notes, stock, bonds, security futures, transferable shares or in general, any instrument commonly known as a "security". Note that the definition of "US person" includes entities incorporated in the US, including foreign branches. Foreign subsidiaries of American companies are not comprised by the definition.

In addition to the 31 companies listed already, the prohibition extends to investments in any companies that may be added to the DoD-list in the future. Furthermore, the prohibition also encompasses entities the Secretary of the Treasury publicly lists as meeting the criteria in Section 1237, or "publicly lists as a subsidiary of a person already determined" to be a Military Company. The wording suggests that for an entity that is itself not included on the DoD-list to be comprised of the prohibition, the Treasury Department would have to publicly identify it under one of these two conditions. Note in this connection that the EO does not contain blocking sanctions, and no companies currently on the DoD-list are listed as Specially Designated Nationals.

Note also that further guidance on the EO may be released by US sanctioning authorities during the coming weeks, that may clarify the intended scope of the prohibition as well as how the EO will be implemented.

US persons have been given a grace period until 11 November 2021 to divest from already listed companies. For entities identified by the US as Military Companies after 12 November 2020, the prohibition is triggered 60 days after the determination is made.

The EO adds another string to the US' bow in its targeting of the Chinese economy, towards the end of a presidential term overlapping with a tumultuous period in US-China trade relations. Although the scope of the prohibition appears to be relatively limited, and only applies to US persons, businesses involved in and with China would be well advised to follow developments closely.

The move also marks President Trump's first major foreign policy action since losing the election. Some commentators and experts have expected Mr. Trump to take an even more confrontational stance towards China if he lost the election, hoping that Mr. Biden will hesitate to rescind Mr. Trump's executive actions, in fear of appearing too soft on an American adversary. No doubt, investors and others will be following the incoming administration's trade policies towards China with keen interest.