“Red Scare” Reload: Commerce Tightens Controls on Exports/Reexports

Commerce Tightens Controls on Exports/Reexports to China, Russia, and Other Countries of Concern

Key Takeaways

• On April 28, 2020, the U.S. Department of Commerce, Bureau of Industry and Security (BIS), published two final rules and one proposed rule intended to keep certain technologies out of the hands of countries (and their nationals) deemed to be of national security concern to the U.S.
• The two final rules take effect on June 29, 2020 and include:
  • Expansion of Military End Use/User Controls for China, Russia, and Venezuela (the targeted countries”)
  • Removal of License Exception Civil End Users (CIV)
• The proposed rule would narrow the scope of License Exception Additional Permissive Reexports (APR) to enable U.S. government review of reexports of certain items to, among others, the targeted countries. Comments must be submitted by June 29, 2020.
• Any entity that transfers items subject to the EAR to the targeted countries or their nationals, or that regularly relies on License Exceptions CIV and/or APR, should consider whether the rules may impact operations.
• The changing regulations reflect continuing dynamic tension in the U.S. trade and strategic relationship with the targeted countries, which interested companies and parties will need to watch closely.

Overview

On April 28, 2020, the BIS published two final rules and one proposed rule with amendments to the Export Administration Regulations (EAR) intended to further curtail exports, reexports, and in-country transfers of certain technologies to countries the U.S. feels are blurring the lines between civil and military technology development. Forefront in the minds of the regulators are countries such as China, Russia, and Venezuela, with histories of using civilian entities as a cover to obtain sensitive products and technologies destined for use by their militaries.

This heightened concern around civil-military integration and BIS’s actions to address it will mean: increased due diligence on the part of exporters, reexporters, and in-country transferors of EAR-controlled items in more sensitive dual-use technology areas such as materials processing, electronics, telecommunications, information security, sensors and lasers, and aerospace and propulsion when the targeted countries and other countries of national security concern are involved; as well as more stringent licensing requirements, and in some cases a presumption of license denial. The two final rules take effect on June 29, 2020, and public comments on the proposed rule are due to BIS by the same day.

What is at Stake for U.S. Exporters?

China was the third-most popular destination for U.S. exports in 2018 and 2019.[1] According to the most recent data available from BIS (for 2018), the vast majority of those exports did not require a BIS license, and for those that did, License Exception CIV was the second-most-utilized exception.[2] Additionally, of the “no license required” (NLR) exports, seven of the top 10  Export Control Classification Numbers (ECCNs) by value are ECCNs that will be subject to the expansion of the Military End Use/User Controls. Data available for exports to Russia and Venezuela in 2017 indicate a similar trend, where the majority of exports (over 95% for Russia and over 99% for Venezuela) did not require a license.[3] For both NLR exports to Russia and Venezuela, five of the top 10 ECCNs by value will soon be subject to the revised Military End Use/User Controls rule as well. As described further below, the two final rules will broaden the scope of items, end uses, and end users triggering a license requirement for export or reexport to the Targeted Countries. In some cases, such license requests will be denied.

Companies who export, reexport, or transfer (in-country) the named EAR-controlled items and technologies to the targeted countries and other countries of national security concern to the U.S. should assess their exposure under the changed rules. Specifically, entities that export, reexport, or transfer (in-country) the following types of items may be significantly affected by these regulatory changes: semiconductors and semiconductor manufacturing equipment and materials, mass market encryption commodities and software, telecommunications equipment, computers and other electronics products, aerospace-related products, materials/chemicals and software for the production of composites, and synthetic fibers and filaments.

The following sections outline the most significant changes associated with each rule and how they might affect companies who do business with the targeted countries and other countries deemed to present a national security threat to the U.S. For a full account of the changes, please refer to the associated Federal Register Notices cited in each section.

Expansion of Military End Use/User Controls (MEU Rule; 06/03/2020 Correction[4])

Since June 2007, BIS has imposed a licensing requirement on exports, reexports, and in-country transfers of certain items intended for military end use in China. In 2014, BIS expanded the licensing requirement to include military end uses and end users in Russia and Venezuela. The list of items subject to these requirements is set forth in Supplement No. 2 to Part 744 of the EAR and currently spans nine of the 10 Commerce Control List (CCL) categories, including items from certain equipment and machine tools to electronic devices, telecommunications equipment, cameras, lasers, navigation and avionics equipment, aircraft, gas turbine engines, as well as certain software and technology.

Effective June 29, 2020, the MEU Rule will implement the following significant changes to the controls set forth in EAR §744.21:

• Broaden the definition of “military end use” to include operation, installation, maintenance, repair, overhaul, refurbishing, as well as “development” or “production” of the relevant CCL hardware, software or technology (items)
• Add “military end users” to the licensing requirement for China, aligning with restrictions already in place for Russia and Venezuela
• Add 18 ECCNs to the list of items subject to the licensing requirements, including materials processing, electronics, telecommunications, information security, sensors and lasers, aerospace and propulsion, and additional categories of information security and software
• Expand the scope of existing ECCNs on the list of items subject to the licensing requirements in the categories of electronics, marine, and aerospace and propulsion
• Implement a licensing policy presumption of denial for licenses submitted pursuant to the MEU requirements

Exporters, reexporters, and in-country transferors of EAR-controlled items to the targeted countries should closely review their business with those countries and determine (1) whether they include any items, end uses, or end users that will be covered by the military end use/user controls as of June 29, 2020, and (2) if so, what they must do to comply. Frequently, significant due diligence may be needed to reliably determine whether a military end use or end user is implicated.

Removal of License Exception Civil End Users (CIV; EAR §740.5)

License Exception CIV currently authorizes the export, reexport, and in-country transfer without a license of 28 ECCNs subject to national security controls to most civil end users for civil end uses in Country Group D:1 countries[5] (which include the Targeted Countries, along with 20 additional countries of national security concern). Effective June 29, 2020, the CIV Rule will remove License Exception CIV from the EAR, thus requiring licenses for export of those 28 types of national security-controlled items to any country (or national) in Country Group D:1.

Similar to the rationale behind the expansion of military end use/end user controls, the removal of License Exception CIV is a result of “the increasing integration of civilian and military technology development in these countries of concern.”  The removal of this license exception will give the U.S. government control and visibility into the transfer to these countries of the covered items, including certain semiconductor manufacturing equipment, telecommunications systems, lasers and optical devices, and gas turbine engine equipment. (A summary table of the affected ECCNs can be found at the end of this alert.) License applications submitted for such items and end users will be subject to a case-by-case review, with a general policy of approval when items are for civilian use.

Exporters, reexporters, and in-country transferors who use License Exception CIV on a regular basis should prepare to obtain the necessary information and documentation to support the preparation and submission of license applications to BIS as of June 29, 2020.

Proposed Changes to License Exception Additional Permissive Reexports (APR; EAR §740.16)

Paragraph (a)(3)(ii) of License Exception APR currently authorizes certain reexports of specified items from countries in Country Group A:1[6] (i.e., Wassenaar Arrangement Participating States, except for Malta, Russia, and Ukraine) or Hong Kong to Country Group D:1 countries, provided that the reexport is consistent with an export authorization from the reexporting country. Due to BIS concerns regarding less stringent licensing review standards for national security-controlled items in Country Group A:1 countries and Hong Kong, the proposed rule (APR Proposed Rule) would remove Country Group D:1 (i.e., countries of national security concern) from the list of eligible destinations.

Companies using subsidiaries or supply chain partners in the A:1 countries or Hong Kong as part of their export strategy for ultimate export to the D:1 countries should consider the loss of exception APR closely. Interested parties should submit comments to BIS by June 29, 2020.

How Ankura Can Help

These final rules and proposed rules are part of a continuing trend from the U.S. government of restricting Chinese, Russian, and Venezuelan access to U.S. markets and technology through the use of export controls, supply chain controls, and more stringent foreign direct investment regulations. These actions reflect a trend of generally-tightening developments that U.S. and international companies, investors, and counsel will continue to face in this evolving regulatory environment. The special trading status of Hong Kong under U.S. regulations is another pending fault line. Conversely, BIS’s loosening of restrictions with regard to sharing certain 5G-related U.S. technologies with Huawei points to the dynamic complexity of these evolving relationships.

Ankura’s unique experience and expertise as former in-house compliance executives and counsel with global technology companies, technical experts and solution providers, and trusted external advisors allows our team to rapidly and efficiently help our clients and their counsel grapple with and stay ahead of emerging developments.

Ankura’s experts can help companies and their counsel, with:

• Distribution, Supply Chain, and Customer Diligence – Ankura integrates our world-class trade compliance expertise with sophisticated geopolitical intelligence and foreign entity diligence capabilities. We regularly assist clients with conducting deep-dives into their supply chain and end-users to identify issues that may implicate U.S. trade restrictions.
• Jurisdiction and Classification Assessments – Our team has deep subject matter expertise in conducting export jurisdiction, classification, de minimis and foreign direct product rule analyses, and can assist companies and counsel in quickly determining the degree to which their products and technologies are subject to U.S. export restrictions. We can assist clients in creating an internal program to make such assessments as controls and technologies evolve in the future.
• Export Licensing Analysis and Application Preparation, Submission, and Management – Ankura currently assists a wide range of clients in determining whether export authorizations are required to engage in various business transactions. Our team has also developed a turnkey solution around the authorization application, tracking, and management process.
• S. Regulator Engagement – Ankura regularly advises and assists clients in engaging with U.S. regulators to obtain jurisdiction and classification determinations, advisory opinions, and export/reexport/transfer licenses. Our experts have decades of collective experience engaging with U.S. government agencies on sensitive trade matters and have helped our clients successfully navigate complex, business critical scenarios through strategic engagement with U.S. regulators.
• Compliance Risk Mitigation – Ankura has deep experience assisting companies to adapt to changing regulatory environments with smart, managed application of business-integrated controls. Our team includes team members who have designed and built industry-proven corporate compliance programs in-house, and understand how to design, deliver, and execute rigorous compliance programs and solutions that operate at the speed of business and provide a competitive advantage.

Table: ECCNs Affected by the Removal of License Exception CIV

[1] Ref. International Trade Administration, “Top U.S. Trade Partners,” available at: https://legacy.trade.gov/mas/ian/build/groups/public/@tg_ian/documents/webcontent/tg_ian_003364.pdf.
[2] Ref. Bureau of Industry and Security, “2018 Statistical Analysis of US Trade with China,” available at: https://www.bis.doc.gov/index.php/component/docman/?task=doc_download&gid=2441.
[3] Ref. Bureau of Industry and Security, “2017 Statistical Analysis of US Trade with Russia,” available at: https://www.bis.doc.gov/index.php/documents/technology-evaluation/ote-data-portal/country-analysis/2277-2017-statistical-analysis-of-u-s-trade-with-russia-pdf; and “2017 Statistical Analysis of US Trade with Venezuela,” available at: https://www.bis.doc.gov/index.php/documents/technology-evaluation/ote-data-portal/country-analysis/2281-2017-statistical-analysis-of-u-s-trade-with-venezuela-pdf.
[4] On June 3, 2020, BIS published a correction to the MEU Rule, which included only the revised portions of the ECCNs affected by the rule. The correction publishes each revised ECCN in full. No other corrections or changes were made to the final rule.
[5] Per Supplement No. 1 to Part 740 of the EAR, the current list of Country Group D:1 countries includes: Armenia; Azerbaijan; Belarus; Cambodia; China; Georgia; Iraq; Kazakhstan; Korea, North; Kyrgyzstan; Laos; Libya; Macau; Moldova; Mongolia; Russia; Tajikistan; Turkmenistan; Ukraine; Uzbekistan; Venezuela; Vietnam; and Yemen.
[6] Per Supplement No. 1 to Part 740 of the EAR, the current list of Country Group A:1 countries includes: Argentina; Australia; Austria; Belgium; Bulgaria; Canada; Croatia; Czech Republic; Denmark; Estonia; Finland; France; Germany; Greece; Hungary; Iceland; India; Ireland; Italy; Japan; Korea, South; Latvia; Lithuania; Luxembourg; Mexico; Netherlands; New Zealand; Norway; Poland; Portugal; Romania; Slovakia; Slovenia; South Africa; Spain; Sweden; Switzerland; Turkey; United Kingdom; and United States.

© Copyright 2020. The views expressed herein are those of the author(s) and not necessarily the views of Ankura Consulting Group, LLC., its management, its subsidiaries, its affiliates, or its other professionals. Ankura is not a law firm and cannot provide legal advice.