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China’s Export Control Regulation and Its Impact on MNCs By Ron CAI, Guoxun ZHANG, Sherry Zhang, Doris Li    2020-09-15

 

In early August, U.S. President Donald Trump issued several executive orders banning a popular short-form video app T from operating in the U.S., by citing “national security” concerns.  The executive orders require Company B, the Chinese parent of the app T, to find a U.S. purchaser for the app T’s U.S. operation by September 15.  If they fail to secure a purchaser, Trump said he would shut down the app in the U.S. effective September 20.  After the executive orders, the Company B started talks with potential buyers, such as Microsoft and Oracle, on a potential purchase.

 

On August 28, 2020, the Chinese government published the 2020 Amendment to the Catalogue of China's Technologies Subject to Export Prohibition or Restriction (the “2020 Export Catalogue”).  The 2020 Export Catalogue deleted, revised, and added 53 items of technologies from the existing Catalogue. Those items include certain AI and cybersecurity technologies.  Some media and commentators speculate that primary intent for the publication of the 2020 Export Catalogue is directed to the app T’s situation to make the Chinese government a stakeholder in the matter.  But the publication of the 2020 Export Catalogue also highlights the increased focus on export control of AI, big data, and cybersecurity related technologies. 

 

A.

History of the China’s Export Control Law and the Technology Catalogue

 

1. The Legislative History

 

The current legislative basis for the technology export control is the PRC Foreign Trade Law.  Article 16 of that law gives the government the power to prohibit or restrict certain technology’s import or export for the reasons listed in Article 16, including “national security”.  However, for several years, neither implementation rules nor enforcement measures were in place, until the 911 terrorist attack in 2001. 

 

Following 911 incident, to cooperate with other countries in the global anti-terrorist efforts, Chinese government quickly enacted several export control laws in late 2001, including:

 

  • (i) Regulations on the Administration of Import and Export of Technologies (the “Import and Export Regulations”), issued by the State Council on December 10, 2001, and amended twice in 2011 and 2019 respectively. These regulations were formulated based on the PRC Foreign Trade Law, and provide founding guidelines for technology import and export administration in China.

     

  • (ii) On the same day and along with the Import and Export Regulations, the State Council also published, for the first time, catalogues of technologies that are prohibited and restricted from import and export, i.e., the Catalogue of China's Technologies Subject to Import Prohibition or Restriction and the Catalogue of China's Technologies Subject to Export Prohibition or Restriction (collectively the “Catalogues”). 

     

  • (iii) Measures for the Administration of Technologies Prohibited or Restricted from Export (the “Restricted Technology Export Measures”), issued on December 12, 2001 by the Ministry of Science and Technology and the Ministry of Foreign Trade and Economic Cooperation, based on the PRC Foreign Trade Law and the Import and Export Regulations, and was amended in 2009.  These measures aim to specifically regulate the export of the prohibited and restricted technologies, and provide detailed guidelines with respect to technology export license.

 

2. Amendment to the Export Catalogue

 

Over the past 20 years, the Export Catalogue has been amended twice, once in 2008 and the other on August 28, 2020.  The 2008 amendment was substantial, reflecting the growth of its economy and technologies. 

 

In the 2020 Export Catalogue, a total of 53 items of technologies that are deleted, revised, or added.  For example, among those added in the restricted computer technology (Class 15) and software (Class 16) categories include many technologies relating to AI, such as speech synthesis, voice recognition, interactive understanding, print scanning recognition, handwriting scanning recognition, photo recognition, Chineseand English composition, and more particularly, “personalized information push service technology based on data analysis”.

 

The newly added technologies in the 2020 Export Catalogue also include many technologies relating to cybersecurity, such as cryptographic chip design, quantum cryptography, and database security.

 

3. The Upcoming Export Control Law

 

In addition to the amendment to the Export Catalogue, the Chinese government is also in the process of finalizing the drafting of the PRC Export Control Law (the draft “ECL”).

 

The Ministry of Commerce of China (“MOFCOM”) issued the first draft of the ECL in June 2017, followed by the release of a second version by NPC in December 2019.  On July 3, 2020, the National People’s Congress (“NPC”) issued the third draft of the ECL for public comments.  It is anticipated that the draft ECL will likely be finalized and become effective soon.

 

When enacted, the ECL will become the first comprehensive national export control legislation (and the first one at the level of “law”, which is only lower than the Constitution in terms of level of legislative importance) that regulates export control enforcement in China.

 

The highlights of the draft ECL are summarized below:

 

  • (i) Scope of items subject to export control.  Under the draft ECL[1], (i) dual-use items, (ii) military arms & goods, (iii) nuclear materials, and (iv) other items concerning the performance of non-proliferation and other international obligations and the safeguarding of national security such as goods, technologies and services are subject to export control.  Controlled items cover not only tangible goods, but also technologies and services.

     

  • (ii) Application of export control.  According to the draft ECL[2], “export control” applies to both (i) the cross-border transfer of controlled items from the territory of China to outside China, and (ii) provision of controlled items (including technologies) by any PRC citizen or incorporated or non-incorporated entity of China to any foreign entity or individual.  Methods of cross board transfer shall not be limited to export in the form of purchase and sale, but also include transfers conducted in the form of outbound investment, foreign donation, overseas exhibition, scientific and technological cooperation, foreign aid, and technology services.  In addition to physical transfer, it may also include sending e-mail, uploading to foreign websites, instant message and other transfer methods.

     

  • (iii) The blacklist management system. The draft ECL provides that[3] the Chinese authorities may prohibit the export of certain controlled items to any specific destination country or region, or to any specific entities or individuals, for the purpose of “fulfilling non-proliferation and other international obligations or protecting national security”.

     

  • (iv) Extraterritorial jurisdiction enforcement.  It is also worth noting that the draft ECL stipulates[4] that China has the right to pursue legal liabilities against entities and individuals outside the territory of China that violate the export control law, hinder the performance of non-proliferation and other international obligations, or endanger China’s national security and interests, and shows the Chinese government’s determination to enforce the export control law in extraterritorial jurisdictions.

 

B.

The Jurisdiction, Procedures and Penalties

 

1. Jurisdictions on Export Control

 

(a) Territorial Jurisdiction

 

According to Article 2 of  Import and Export Regulations, technology export refers to the transfer of technology from the territory of China to any territory outside of China. through trade, investment or economic and technological cooperation.  

 

Currently, the Chinese government adopts territorial jurisdiction over the control of import and export of technologies occurring across the border of China, covering land, airspace and territorial sea.  Export of technology from China across the border is subject to China’s export control laws and regulations. The nationality or incorporation location of the technology owner is not a factor to decide if PRC law applies. For example, the transfer of a patented technology within China by a U.S. patent owner to a Japanese buyer is still subject to the jurisdiction of the PRC laws.

 

(b) Definition of Technology Transfer Activities

 

Technology transfer is defined broadly under the Import and Export Regulations.  The Import and Export Regulations specify that technology transfer includes patent right transfer, patent application right transfer, patent implementation license, technology secret transfer and technical service. But it also indicates that technology transfer is not necessarily restricted to these forms. Theoretically, technology transfer may include disclosing and disseminating technical information to other individuals or organizations in any form, including sending emails or others.  

 

2. Export Control Procedures

 

Under the Import and Export Regulations, technologies are classified into three categories: i.e., the free export technologies, restricted technologies for export and the prohibited technologies for export.  Each category is subject to different level of scrutiny.

 

(a) Free Export Technology

 

Free export technology is subject to contract registration[5].  Within 60 days after a technology export contract becomes effective, the exporters are required to register the contract and other supporting documents with the provincial level commerce bureau[6], and the provincial level commerce bureau must register the technology export contract and issue the registration certificate within 3 working days from the date of application[7].  The exporter may then go through the relevant foreign exchange, banking, taxation, customs and other related procedures, if necessary, to complete the technology export process via the registration certificate[8]

 

It is worth noting that registration does not affect the validity of the technology export contract.  To our knowledge so far, the registration requirement is not strictly implemented in practice.

 

(b) Restricted Technology

 

Technology restricted from export is subject to license administration[9]. Exporters who export technology restricted by China must go through the licensing procedures in accordance with the Restricted Technology Export Measures. [10]

 

Before conducting any substantive negotiation with a foreign party regarding a technology export transaction, the exporter must submit an application to the provincial commerce bureau. The commerce bureau must, together with the provincial science and technology bureau, conduct trade review and technical review on the technology export projects, and decide whether to approve the application within 30 working days after receiving the application[11]. In the process of technical review, the provincial science and technology bureau may organize experts to review the technology for export[12].

 

If the application is approved, the provincial commerce bureau will issue a Letter of Intent for The Technology Export License (the “License LOI”), which is valid for three (3) years, to the exporter[13]. The exporter may then conduct substantive negotiations with the foreign party and enter into a technology export contract. Before obtaining the License LOI, no entity or individual is permitted to conduct any substantive negotiation with a foreign party or make legally binding commitments on technology export.

 

After a technology export contract is signed, the exporter must then submit a copy of the contract, the License LOI and other documents to provincial commerce bureau. The commerce bureau will, within 15 working days after receiving the documents, decide whether to grant a license to the technology export, and issue a technology export license to the exporter, if it approves[14]. Unlike free-export technology, the technology export contract will only take effect upon the date of issuance of the technology export license[15].

 

(c) Prohibited Technology

 

Prohibited technology is prohibited from export any way, and thus, there is no approval process to go through.

 

3. Liabilities for Violation

 

Article 44 of the Import and Export Regulations[16] stipulates the legal liabilities for illegal import and export of the prohibited or restricted technologies, including administrative liabilities and criminal liabilities.  If the circumstance is not serious enough for criminal punishment, the business operator who violates the law may be subject to a warning, confiscation of illegal gains, monetary fines from one time to five times of the illegal gains, and up to revocation of the registration of the technology export contract or even the foreign trade operation license. If the circumstance is serious, the business operator who violates the law may be subject to criminal liabilities in accordance with relevant provisions of the PRC Criminal Law on smuggling, illegal business operation, divulging state secrets or other crimes.

 

Additionally, the relevant authorities may refuse to accept import or export license application from the business operator who violate the export control laws for a period of three years or less, or prohibit the business operator from engaging in technology import and export related activities for a period of one to three years.

 

C.

Potential Impact on Multinational Companies in China

 

1. Intercompany arrangements between multinational companies may be subject to PRC export control laws.

 

Theoretically, according to the Import and Export Regulations, if a Chinese subsidiary of a multinational company (“MNCs”), for example, an R&D center of an MNC, enters into an agreement with its parent or affiliate outside China that specifies the ownership of technologies developed by Chinese subsidiary, the Chinese subsidiary may be interpreted as conducting technology transfer through technical services, and thus is subject to the regulation of China’s export control laws and regulations.  

 

2. Historically, China’s export control law has posed remote risks on MNCs.

 

So far, the export control law was not strictly enforced.  In practice, except for the need to obtain Customs clearance or receive foreign exchange payments, most companies have not applied for the export license. There are few public reports about a company being punished for not obtaining the export license. Additionally, China has encouraged, for a long time, MNCs to set up R&D centers in China.  Most R&D centers in China are generally supported through cost plus financial arrangements with their overseas parent companies. The overseas parent companies own the IP rights of the technology based on the “work for hire” legal principle and the technology service contracts. So far there is no indication that the Chinese government would change the long-held policy of encouraging MNCs to conduct R&D in China.

 

3. The 2020 Amendment and the increasing tension between the United States and China have increased the risks. 

 

On September 1, the Beijing Commerce Bureau made a public announcement on the national media that it would strictly enforce the 2020 Export Catalogue, and demand that if the technology falls into the restricted category, the business operators must file for approvals before they enter into any substantive negotiations for the technology export, as the rules and regulations require.  Additionally, the ECL, which is expected to be rolled out soon, will likely add the Chinese government’s momentum to safeguard its top technologies and control their export.

 

4. The extent of such risks has yet to be further observed and evaluated.

 

However, the extent of such risks has yet to be further observed and evaluated as the time goes by, for the following two reasons:

 

  • (i) There is still uncertainty with respect to the enforcement of the 2020 Export Catalogue. The government still lacks the resources and organizational structures to broadly enforce export control and to review every export license application. Therefore, there may be selective enforcement of the export control law, unless, and until the Chinese government can ramp up its enforcement mechanism across board, which will require additional investment in terms of human resources and fiscal resources.

     

  • (ii) The Chinese government would also need to balance between the need to control the technology export, and its need to encourage foreign investment and technology import in key industries, such as AI and quantum computing. 

 

D.

Recommended Actions

 

Given the above, we would recommend MNCs consider the following actions:

 

(1) closely monitor the new legislative and law enforcement trends of the Chinese government in the field of export control, especially the issuance of any follow-up implementation rules, guidelines or cases;

 

(2) seek clarity by the Chinese government regarding technology ownership and sharing by the MNCs and their overseas parents;

 

(3) strengthen internal reviews and approvals of any projects that may involve technology under the 2020 Amendment;

 

(4) consider (if not yet) setting up a review committee for any project that is questionable from the export control point of view, or adding the export control compliance in the review criteria if a review committee and process are already in place; and

 

(5) regularly conduct internal trainings to educate employees about the export control law, and add relevant clauses in related contracts, user terms, and other legal documents (if needed).   

 

[Note] 

[1] Article 2 of the PRC Export Control Law (the draft for second reading) 《中华人民共和国出口管制法(草案第二次审议稿)》第二条

[2] Article 2 of the PRC Export Control Law (the draft for second reading)《中华人民共和国出口管制法(草案第二次审议稿)》第二条

[3] Article 10 of the PRC Export Control Law (the draft for second reading).《中华人民共和国出口管制法(草案第二次审议稿)》第十条

[4] Article 44 of the PRC Export Control Law (the draft for second reading). 《中华人民共和国出口管制法(草案第二次审议稿)》第四十四条

[5] Article 37 of the Regulations of the People's Republic of China on the Administration of Import and Export of Technologies《中华人民共和国技术进出口管理条例》第三十七条  

[6] Article 6 of the Administrative Measures for the Registration of Technology Import and Export Contracts《技术进出口合同登记管理办法》第六条  

[7] Article 39 of the Regulations of the People's Republic of China on the Administration of Import and Export of Technologies.《中华人民共和国技术进出口管理条例》第三十九条  

[8] Article 40 of the Regulations of the People's Republic of China on the Administration of Import and Export of Technologies 《中华人民共和国技术进出口管理条例》第四十条  

[9] Article 31 of the Regulations of the People's Republic of China on the Administration of Import and Export of Technologies 《中华人民共和国技术进出口管理条例》第三十一条 

[10] Article 3 of the Measures for the Administration of Technologies Prohibited or Restricted from Export 《禁止出口限制出口技术管理办法》第三条  

[11] Article 6 of the Measures for the Administration of Technologies Prohibited or Restricted from Export 《禁止出口限制出口技术管理办法》第六条  

[12] Article 7 of the Measures for the Administration of Technologies Prohibited or Restricted from Export《禁止出口限制出口技术管理办法》第七条  

[13] Article 10 of the Measures for the Administration of Technologies Prohibited or Restricted from Export 《禁止出口限制出口技术管理办法》第十条  

[14] Article 14 of the Measures for the Administration of Technologies Prohibited or Restricted from Export《禁止出口限制出口技术管理办法》第十四条  

[15] Article 15 of the Measures for the Administration of Technologies Prohibited or Restricted from Export《禁止出口限制出口技术管理办法》第十五条  

[16] Article 44 of the Regulations of the People's Republic of China on the Administration of Import and Export of Technologies《中华人民共和国技术进出口管理条例》第四十四条