China Enacts New Export Control Law – Global Businesses Take Heed

Introduction

In a move that is certain to have broad impacts on cross-border trade, China is preparing to implement a comprehensive new Export Control Law (“ECL”).^[1] Many of the requirements, concepts, and mechanisms under the new law—which was announced on October 17, 2020 and is slated to come into effect on December 1, 2020—will be recognized by those familiar with the U.S. Export Administration Regulations (“EAR”).^[2] Indeed, a number of the key features of China’s law find direct parallels in the EAR. Among these are:

• China will be developing a new “Control List” comprised of civil-and-military “dual-use” items, military items, nuclear items, and other goods, technology control over which is deemed important to China’s national security and other policy interests.
• Persons seeking to export or re-export controlled items may need to obtain specific licenses from the Chinese government, depending on the level of control over the items, the intended destination of export, and the intended end user or end use.
• “Deemed exports” (transfers of controlled technology to a non-Chinese national, even wholly within China) will be covered and potentially subject to licensing or other restrictions.
• Chinese authorities will maintain a list of restricted importers and end users that, along with the recent publication of “Regulations on the Unreliable Entity List” by China’s Ministry of Commerce,^[3] establishes an analogue to the U.S. Entity List that will trigger a requirement for the Chinese government’s approval for transactions involving listed persons.
• Violation of the ECL will carry administrative and criminal penalties based in part of the value of the transactions at issue.

Some elements of the ECL, however, find no direct equivalent in the EAR, including the availability of preferential benefits, particularly certain blanket “general licenses,” for companies that establish effective internal compliance systems. The ECL also places an obligation on exporters to acquire approvals before engaging in any transaction where the exporter “knows or should have known” that the export of an item (even one not on any Control List) may “endanger China’s national security and interests”—a potentially unlimited discretionary control that is not found in U.S. law.

It also remains to be seen whether China will implement one of the most controversial features of U.S. export controls: the imposition of extraterritorial restrictions under the EAR on the export of foreign-made items that are comprised of, or are the “direct product” of, controlled U.S. content or technology. The United States has recently expanded these provisions to block foreign chipmakers from supplying semiconductors to leading Chinese companies. Notably, the first draft of the ECL released in June 2017 specified that it would apply to foreign products that “contain a certain proportion of China’s Controlled Items” exported from outside of China to other countries/regions. Later drafts and the final version of the ECL have removed this restriction, but it could still resurface in the form of regulations issued by one of the agencies that will be responsible for administering aspects of the law.

Several aspects of the new law, including the ability of the Chinese government to prohibit exports of entire categories of strategic goods to U.S. persons in China or elsewhere, could be a “game changer” in the U.S.-China trade relationship. One state-run publication went so far as to suggest that rare-earth metals and circuit boards—both of which U.S. technology companies overwhelmingly source from China—could come under government-sanctioned export bans, in a direct response to recent U.S. export control moves directed at China.^[4]

One thing is clear: the Chinese government is preparing to impose sweeping new requirements on transactions involving Chinese goods and technology. All companies doing business in or with China must take notice.

Background

Consisting of five chapters and 49 articles, the new ECL provides a comprehensive statutory framework for China to regulate exports. The new law governs the movement of controlled items (discussed below) from the Chinese territory to destinations outside of China (including re-exportation between foreign destinations), as well as the transfer or release of controlled technology by any Chinese individual, legal entity, or any other organization to any foreign individual or entity.^[5]

Prior to enactment of the ECL, exports were governed under China’s 2004 Foreign Trade Law for high-level export principles.^[6] Several State Council regulations also address transfers of specific controlled items.^[7] The ECL remakes China’s export control landscape by consolidating the applicable rules and providing general guidance for administration over the movement of all controlled items. It should be noted, however, that while laws enacted by the National People’s Congress and its Standing Committee, such as the ECL, are superior to State Council regulations, the ECL does not supersede the pre-ECL export control regulations in their entirety. These regulations remain effective unless they conflict with the ECL.

The ECL must be read in conjunction with other recent developments in China’s export control regime, in particular, the Regulations on the Unreliable Entity List issued by the Ministry of Commerce on September 19, 2020. As discussed below, application of aspects of the ECL and the Regulations on Unreliable Entity List intersect, creating similar but independent rules that may apply to transactions with specified foreign entities (see below Key Aspects of the ECL–End-User and End-Use Management).

The ECL has been characterized as China’s response to the increasing tensions over growing restrictions on U.S.-China technology transfers. Commentators note that, combined with the Regulations on the Unreliable Entity List and other relevant rules, the ECL will equip China to react to any U.S. trade measures targeted at its companies and economy. This is evidenced by ECL’s express language that China could take “reciprocal measures” against any country or region that “abuses export control measures to endanger China’s national security and interests.”^[8] As such, companies engaging in international trade—especially in both China and the U.S.—should be attuned to the evolving export control regimes of both countries in order to navigate through the political, strategic and regulatory challenges in today’s global trade environment.

Key Aspects of the ECL

Basic Requirements

The ECL regulates the export of certain items (“Controlled Items”), which include civil-and-military “dual-use” items, military items, nuclear items, and other goods, technology, and services identified as necessary to safeguarding China’s national security and interests, and fulfilling international obligations such as non-proliferation of nuclear, chemical, and biological weapons.^[9]Controlled Items will also include technology pertaining to controlled commodities, components and software.^[10]

The ECL authorizes certain national export control administration authorities, which comprise relevant departments within the State Council and the Central Military Commission (“Export Control Authorities”), to develop, adjust, and publish a control list (“Control List”)^[11] specifying the Controlled Items subject to export restrictions. These restrictions may include complete export bans or prohibitions on exports to specific destination countries, regions, organizations, or individuals.^[12] Companies seeking to export a Controlled Item must apply for a license from the competent Export Control Authority,^[13] which may grant or deny the application based on the following criteria: (i) national security and interests; (ii) international obligations and external commitments; (iii) type of export; (iv) sensitivity of the controlled item; (v) export destination country or region; (vi) end user and end use; (vii) relevant credit records of the export business operator; and (viii) other factors provided by laws and regulations.^[14]

The Control List has not yet been issued. On October 22, 2020, following the promulgation of the ECL, the Ministry of Commerce indicated that it would “actively promote the formulation of supporting regulations of the [ECL] to ensure the effective implementation of the various systems established thereby. At the same time, it will further improve and release in due course the [Control List].”^[15] While the ultimate Control List is not yet available, it is reasonable to expect that the Control List will encompass the substance of the recently updated Catalogue of Export-Prohibited and Export-Restricted Technologies of China.^[16]

Controlled Items Not on the Control List

In addition to items on the Control List, the ECL provides for “temporary controls” over the export of items that may be specified, from time to time. Specifically, in consultation with the State Council and/or Central Military Commission, the Export Control Authorities may impose and announce temporary export controls of no more than two years over certain goods, technology, and services that are not on the Control List.^[17] Towards the end of the restrictive period, the Export Control Authorities will evaluate the situation and determine whether to terminate or extend the temporary controls, or whether the Controlled Items concerned should be included on the Control List.^[18] Apart from their provisional nature, the temporary controls over the Controlled Items not on the Control List do not differ from those over the same on the Control List.^[19] This “temporary export controls” mechanism will provide the Chinese government with maximum flexibility to quickly impose restrictions, on a strategic basis, as warranted.

The ECL also requires exporters to apply for licenses prior to dealing with the export of certain goods, technology, and services, if the exporter “knows or should have known,” or is notified by the Export Control Authorities, that export of the items may: (i) endanger China’s national security and interests; (ii) be used for designing, developing, manufacturing, or utilizing weapons of mass destruction or the vehicles to transport the same; or (iii) be used for the purpose of terrorism.^[20] If an exporter is uncertain about whether the goods, technology, or services ^to be exported are considered Controlled Items under the ECL, it should inquire the competent Export Control Authority, which will respond promptly.^[21]

These rules extensively expand the ECL’s application. In addition to the Controlled Items that are clearly listed on the Control List, exporters will be well-advised to closely follow the Export Control Authorities’ ad hoc announcements on Controlled Items that are subject to temporary export restrictions. Furthermore, companies should develop adequate expertise to enable them to identify items that are “known or should have been known” to be Controlled Items, but are otherwise not listed on the Control List or subject to temporary export regulations.

Internal Compliance System for Export Controls

The ECL suggests that exporters with an effective internal compliance system for export control could benefit from certain “convenient measures,” such as being granted “general licenses” for the relevant Controlled Items.^[22] The Export Control Authorities will issue further guidance on the development of eligible comprehensive internal compliance systems,^[23] as well as the specific regulations regarding the granting of such convenient measures.^[24]

Logically, those without any export control compliance program would not be able to enjoy the benefit of any “convenient measures,” but that does not necessarily deprive them from the eligibility to obtain specific licenses. However, this does not obviate the need for devising effective internal compliance policies, which could be vital for ensuring compliance with the ECL and other trade regulations. As discussed above, an effective compliance program may also enable exporters to identify items that are subject to the ECL, but are not on the Control List or designated as under temporary export restrictions. Finally, just as U.S. authorities treat the existence of an effective compliance program, though not required under the regulations, as a mitigating factor in the case of alleged violations of the EAR, it is reasonable to expect that China’s Export Control Authorities will give considerable weight to the effectiveness of such compliance programs in similar circumstances.

End-User and End-Use Management

The ECL also requires exporters to provide Export Control Authorities with end-user and end-use certification documentation when exporting Controlled Items.^[25] Such documentation is to be issued by the end user, or the government of the country/region in which the end user is located.^[26] The timing of when the certification must be provided is not clear from the language of the law, but companies should expect that this documentation would be needed to obtain an export license. Once the certificate is provided for export of a Controlled Item, the end user will be restricted from unilaterally changing the stated end use or transferring the item to a previously undisclosed third party without additional authorization from the Export Control Authorities.^[27] If the exporter or importer has knowledge of a proposed change in the designated end user or end use of the Controlled Item concerned, it must immediately notify the competent Export Control Authority.^[28]

The Export Control Authorities will develop a risk management system to evaluate, examine, and strengthen oversight of the Controlled Items’ end users and end uses.^[29] While the specifics of this system are not available yet, the ECL previews that the Export Control Authorities will maintain a monitoring list of importers and end users that: (i) violate the administration requirements regarding end users and end uses; (ii) may harm China’s national security and interests; or (iii) use Controlled Items for the purpose of terrorism.^[30] Export Control Authorities may prohibit, restrict, or terminate the export of Controlled Items to those importers and end users on the monitoring list.^[31] Exporters will be restricted from transacting with importers or end users on the monitoring list in violation of regulations.^[32] Should any such transaction be necessary under special circumstances, the export business operator will be required to apply for an authorization to do so with the competent Export Control Authorities.^[33]

In this manner, the ECL appears to contemplate a “prohibited end user” list similar to the U.S. Entity List maintained under the EAR. However, as noted, the Chinese government has already announced Regulations for the creation of a separate Unreliable Entity List. The ECL does not explicitly refer to these regulations. At this time, it is unclear how the ECL’s monitoring list of importers and end users may relate to the Unreliable Entity List, but it is noteworthy that a shared factor for inclusion on both lists is the perceived harm caused to China’s national security, interests, and development.^[34] This indicates that the contents of the two lists might overlap to some degree, i.e., one entity could appear on both lists. Given that the consequences of being placed on these lists are similar but different (e.g., if transacting with an entity on both the Unreliable Entity List and the monitoring list under the ECL is essential, the company proposing the transaction may need to obtain approvals from the Office of the Working Mechanism pursuant to the Regulations on Unreliable Entity List^[35] as well as the competent Export Control Authorities^[36], companies should devise comprehensive due diligence procedures to identify export control red flags associated with their counterparties.

Investigative Power and Legal Liability

Export Control Authorities are authorized to undertake the following investigative measures against suspected violation of the ECL: (i) entering the business premises of the investigated entity or other relevant establishments for inspection; (ii) inquiring the investigated entity, interested parties, and other relevant organizations or individuals, and requesting the same to provide explanations to the issue under review; (iii) reviewing and copying relevant documents and information of the investigated entity, interested parties, and other relevant organizations or individuals such as order forms, agreements, books and records, business correspondence, etc.; (iv) inspecting the transportation vehicle for export, halting the loading of suspicious exports, and ordering the return of illegally exported items; (v) seizing the items at issue; and (vi) inspecting the investigated entity’s bank account.^[37]

Chapter 4 of the ECL contains 12 articles on legal liability, specifying the potential consequences for various violations of the ECL. The following chart provides an overview of these violations and associated legal liability:

As illustrated above, each of these violations could result in the disgorgement of illegal gains as well as an additional fine, which in certain situations may amount to up to 20 times the value of the illegal transaction. Severe violations may lead to suspension of operations and revocation of qualifications to export the relevant Controlled Items. Furthermore, the competent Export Control Authority may reject any application for an export license by an exporter who has previously been found to have violated the law, for up to five years after punishment.^[38] The principals in charge and other directly responsible personnel may also be prohibited from engaging in exporting activities for five years.^[39] Anyone who is criminally liable for violating export control regulations will be banned from export activities for life.^[40] Any violations of the ECL will also be noted in the exporter’s credit record.^[41]

Re-Exportation and Extraterritorial Reach

The ECL provides that the transit, transshipment, transportation (through China), and re-export of Controlled Items, as well as the export of Controlled Items from special customs supervision areas such bonded areas and export processing zones, and from bonded supervision sites such as export supervision warehouses and bonded logistics centers, are all subject to the ECL.^[42] This would suggest that parties can be held liable for engaging in unlicensed transactions involving movement of Controlled Items outside of China. The ECL states that any organization or individual outside China that violates the ECL, endangers China’s national security and interests, and hinders China’s fulfillment of its international obligations on non-proliferation, should be “dealt with in accordance with law and held legally accountable.”^[43] As discussed, importers and end users outside of China could be placed on the monitoring list. However, it remains unclear the extent to which the fines, penalties and other punishments will be applied to persons outside of China. Moreover, as discussed, specific language applying the “Controlled Items” designation to certain foreign-made products containing “a certain proportion of China’s Controlled Items” was deleted from the final language of the ECL. It is unclear whether the State Council or the Central Military Commission, which in earlier drafts had authority to apply this designation, might revive this approach when the ECL is implemented.

Key Takeaways

As discussed above, companies engaging in international trade must pay close attention to this significant shift in China’s export control landscape. Many aspects of implementation and enforcement of the ECL are yet to come. The heart of the entire system—the Control List—has not yet been released. Guidance on how the Export Control Authorities will monitor end users and end uses, the creation of the monitoring list, and what constitutes an effective internal compliance system, are all areas on which the Chinese government has yet to speak.

Other key concepts might remain undefined for some time. The ECL does not clearly define what constitutes an “exporter” under the law. A person can be an exporter not only when sending Controlled Items outside of China, but also when they release technology to non-Chinese persons within China (commonly known as “deemed exports”).^[44]

Regardless of whether and when these points are further clarified, now is the time for international businesses to take heed. In particular, potentially affected companies should act now to evaluate and reinforce their internal procedures to ensure compliance with China’s export control regulations. An effective compliance program under the ECL should accomplish the following at a minimum:

• There should be effective due diligence procedures in place to identify whether the company’s counterparties are Chinese or non-Chinese, and whether they are subject to specific trade restrictions, such as being listed on the monitoring list under the ECL or the Unreliable Entity List. Changes to these lists should be closely followed.
• There should be a system to inspect regularly the nature of the goods, technologies, and services, in which the company trades. In particular, the company should constantly monitor any updates on the Control List and any official announcements regarding temporary export restrictions. The company should also develop expertise to ascertain whether an item not otherwise covered could still be subject to ECL restrictions based on the “know or should have known” test.
• There should be standard operating procedures for applying for the requisite licenses to engage in the export of Controlled Items, as well as a mechanism to ensure that the export is strictly within the licensed scope as to the type of items exported, timing of the export, export destinations, end users, end uses, etc.
• The ECL requires that any deviation from the original end users and/or end uses of exported Controlled Items be promptly reported to the Export Control Authorities. Therefore, there should be a post-transaction monitoring system that reasonably traces the end-user and end-use status of exported Controlled Items. Any anomaly should be timely escalated for the company to make necessary disclosure to the authorities.