This text is based on presentations on this subject made recently by Mr. Burke to the American Chamber of Commerce in Beijing and the American Chamber of Commerce in Shanghai.
Export Controls And The China-U.S. Trade Relationship
One of the leading Chinese complaints about the trade relationship between China and the United States is that U.S. export controls, according to China, unnecessarily limit what China can buy from the United States. The Obama Administration, apparently seeing some merit in China’s complaint, is seeking substantial reform of U.S. export controls as part of the President’s initiative to double U.S. exports in five years. This blog will report on those reform efforts in a future article. This article discusses the impact those export controls have on foreign investment in the United States, including Chinese, and the current state of U.S. export controls.
Export Controls Impact Investment
Export controls impact foreign investment in the United States both directly and indirectly. They impact investment directly because export control considerations are incorporated into national security reviews of foreign investment by the Committee on Foreign Investment in the United States. This issue is discussed in greater detail in National Security And Chinese Investment In The United States, which we published on this blog in May 2011.
Export controls indirectly affect foreign investment because they may limit the ability of the foreign parent to manage and obtain the full economic benefit from its newly acquired U.S. business. If the to–be-acquired U.S. company is registered with the State Department as a manufacturer or exporter of defense articles or supplier of defense services, that company must notify the State Department 60 days before ownership of the company can be transferred to a foreign person. The State Department could revoke the company’s registration and outstanding export licenses should it disapprove of the new foreign owner. Also, depending upon the company’s technology, export licenses may be needed from either the State Department or the Commerce Department in order for the company to disclose that technology to non-U.S. persons, even non-U.S. management personnel installed by the new owners. Similarly, export licenses may be needed to export the company’s products and technology to its new foreign affiliates, reducing the economic value of the deal to the new parent.
None of these requirements is peculiar to Chinese buyers of a registered American company. They apply to all foreign persons, regardless of nationality.
The U.S. Export Control Regime
The primary export control agencies are the State Department’s Directorate of Defense Trade Controls (“DDTC”) and the Commerce Department’s Bureau of Industry and Security (“BIS”). DDTC is responsible for the International Traffic in Arms Regulations (“ITAR”), which control exports of military items and satellites. BIS is responsible for the Export Administration Regulations (“EAR”), which control exports of civilian items.
The ITAR covers items specifically designed, developed, configured, adapted, or modified for a military application. It also covers firearms and commercial satellites. Many items, originally designed for military purposes, now have widespread commercial uses, but remain subject to the ITAR even when they will be used in commercial applications. Such items remain subject to the ITAR until such time as DDTC makes a commodity jurisdiction determination that they can be released from the ITAR.
Companies that manufacture or export items subject to the ITAR must be registered with DDTC and the export of such items almost always requires a license or other written authorization from DDTC. These requirements impair U.S. export trade with China, in particular, because the United States has an arms embargo against China. As a result, items controlled under the ITAR may not be exported to China and ITAR-controlled technical data may not be disclosed to Chinese nationals even in the United States. This restriction is one of the most contentious in Chinese-U.S. relations.
The EAR, in contrast to the ITAR, has a much more limited impact on U.S. exports to China. The EAR covers exports and re-exports of almost all civilian items. However, no licenses are required for most products to most destinations, including China. Although licenses are needed for some products to some destinations or for certain end-uses or end-users, these requirements cover an extremely small percentage of U.S. exports.
EAR Export Licensing Steps
There are four basic questions to ask in determining whether an export license from BIS is needed for a particular transaction. Those questions are:
1. Is the transaction subject to the EAR?
2. How is the product classified?
3. Is the product controlled to the planned destination?
4. Can a license exception be used?
Transactions are subject to the EAR when they involve products or technical data not controlled by other U.S. agencies, such as DDTC, that are being exported from the United States, or are U.S.-origin products or technology being re-exported from one foreign country to another. The EAR also covers deemed exports and re-exports, which occur when technical data controlled by the EAR is disclosed to a foreign national in the United States or a third country national in the original country of export. The EAR does not cover the transfer or disclosure of information in the public domain.
Companies classify their products for export control purposes by determining which entry on the Commerce Control List matches their product. The Commerce Control List contains several hundred Export Commodity Classification Numbers (“ECCN”). Each ECCN contains detailed technical parameters describing the items covered. When the product does not fit within any of the ECCNs listed, it is classified as “EAR99.”
Products classified as EAR99 require export licenses only when the destination is a comprehensively embargoed country, such as Iran, or the specific end-use or end-user is prohibited for purposes of non-proliferation of chemical, biological or nuclear weapons. For other products, the exporter must match the destination and the reason for control on the Commerce Country Chart to determine whether the product is controlled to the planned destination. The following is an illustrative excerpt from the Commerce Country Chart:
The ECCN that covers the product will state the reason or reasons for control. When the only reason listed is National Security 2 (NS2), then, by looking at the Commerce Country Chart, the exporter can determine that the product is not controlled for export to Australia, but is to China and Sudan. In most cases the answer to the third question, as determined from the Commerce Country Chart, is “no” (the item is not controlled to the destination) and the transaction can go forward without an export license.
When the answer to the third question is “yes,” the exporter must move on to the fourth question and determine whether it can use an exception to the license requirements. There are 16 license exceptions listed in the EAR – were any to apply, the product could be exported to that destination without a license. One of the most popular exceptions used for exports to China is License Exception CIV, which allows exports to civilian end-users in China where the ECCN listing for product contains the legend “CIV – Yes.”
When the answer to the fourth question is “no” (no license exceptions are available), the company must apply to BIS for an export license. In most cases, BIS issues a license. Out of the 21,660 applications in Fiscal 2010, BIS approved 18,020, returned 3,513 without action (usually when the application was incomplete or no license was needed) and denied only 127. The average processing time was 29 days.
The export controls under the EAR have not been a major impediment to U.S. exports, including exports to China. By contrast, the export controls under the ITAR are a significant impediment to increasing U.S. exports to China. It is unlikely that the arms embargo against China would be lifted soon. However, there are numerous products currently subject to the ITAR that could be exported for commercial end-uses in China with no negative impact on U.S. national security. Reforms of the export control regime that move as many of these products as possible from control under the ITAR to control under the EAR, could pave the way for substantially increasing U.S. exports to China.