In the final year of the Trump administration, the U.S. government issued a flurry of actions related to China, utilizing a diverse basket of economic statecraft tools in furtherance of national security objectives. These ranged from targeted asset freezes of individuals undermining Hong Kong’s autonomy to restrictions on the importation of goods suspected of being produced with forced labor in Xinjiang. The two most high-profile actions were Commerce Department restrictions on the provision by businesses of certain services to the social media platform TikTok and the messaging app WeChat in August and September of 2020, followed by November 2020 sanctions prohibiting the purchase of the stock or bonds of Chinese military-linked companies.
Both the Commerce restrictions and the investment sanctions quickly ran into trouble in the courts. In its haste to push through tough-on-China accomplishments before its term expired, the Trump administration left those policies, and the underlying administrative edifice supporting them, legally vulnerable. It is significant, then, that the Biden administration has so far chosen not to back away from a strategic posture that views Chinese military and technological development as a potential threat to be combatted using the full suite of economic tools at the government’s disposal.
President Joe Biden in early June issued two executive orders revoking both the Tiktok/WeChat restrictions and the Chinese military-related investment sanctions, replacing them with new authorities. In effect, the Biden administration’s retreat was purely tactical. It revoked the earlier orders to shore up the legal basis of the Trump administration policies while attempting to close the “credibility gap” that had opened up in the face of uncorroborated claims about the Chinese targets. The underlying analysis and policy framework that drove these actions, however, remain in place.
The Trump administration’s investment sanctions on Chinese military-linked companies revealed serious tactical errors. These mistakes culminated in a March 2020 injunction enjoining the Treasury Department from enforcing the sanctions against Xiaomi Corporation, a Chinese manufacturer of cellular handsets and other consumer electronics.
First, the Trump administration sanctions linked restrictions implemented by the Treasury Department to determinations made by the Defense Department. Treasury—not Defense—should write designation packages, as it has the requisite experience. Second, the U.S. government picked some targets, such as Xiaomi, with extensive U.S. operations, which guaranteed that the courts would accord less deference than to sanctions targeting a company without a U.S. presence. Third, the sanctions did not grandfather existing equity or debt. Unlike the 2014 Russia investment sanctions, which only targeted new purchases prospectively, the November 2020 order would have forced U.S. owners of Chinese securities to sell off their assets at a loss. This cast doubt on the feasibility of investing in any Chinese company, as it became uncertain whether such companies could become the subject of future sanctions. That may have been precisely the point, but it backfired.
The courts found that the Defense Department, in its perfunctory two-page evidentiary record, had not established an adequate factual basis to link Xiaomi to the Chinese military. The Pentagon’s linkage was based on flimsy evidence: first, because the CEO received an award from a government ministry involved in civil-military fusion; and second, because the company works on 5G telecommunications technology. As the judges wrote in the injunction, “The Court is somewhat skeptical that weighty national security interests are actually implicated here.” The U.S. government agreed to lift the Xiaomi sanctions in May 2021.
Then, this month the Biden administration reversed the Trump administration’s summer 2020 TikTok and WeChat restrictions, which would have forced Google and Apple to remove the services from their app stores, among other requirements. TikTok and WeChat had also won preliminary injunctions staying those Commerce Department orders in September 2020. The restrictions rested on shaky ground. Targeting social media and communications companies with extensive U.S. operations raised significant First Amendment and due process concerns. Commerce rushed the order, moreover, releasing it before it had finalized an underlying import control regulatory framework, which it only published in January of this year as an interim final rule.
The Biden administration was wise to back down, especially on Xiaomi. If the government had lost at trial—which seemed likely—there was a low-probability but high-impact possibility that a negative precedent could be set, with far-reaching implications for all sanctions programs. For example, courts could require additional and even prior notice to targets, more consultation with the public, more regulatory impact analysis, or other regulatory requirements that could make sanctions more challenging. While a radically negative ruling was unlikely given strong sanctions case law (the force of prior cases being difficult although not impossible to overcome), Xiaomi is not the type of case that the Treasury or Justice Departments want to use to set precedent.
The risk posed by Xiaomi was compounded by the fact that the TikTok and WeChat orders imposed by the Commerce Department also relied on the main sanctions law, the International Emergency Economic Powers Act (IEEPA). Presumably, policymakers saw the use of an existing law as more expedient than seeking dedicated import-control legislation. But this introduced the risk of spillover from a Commerce action to Treasury sanctions, should there have been an adverse ruling on TikTok. Notably, TikTok was represented by the same law firm as Xiaomi.
After a Quick Step Back, a Larger Step Forward
What the reversals on Xiaomi, TikTok, and WeChat elide at first blush is the Biden administration’s acceptance of the premise of the Trump administration’s policy. That premise seems to be that the U.S. government should seek to limit both financial flows to China’s military-industrial base and the operations of Chinese technology companies that could gather large amounts of data on American citizens.
The new investment sanctions authority returns the responsibility for designations from Defense to Treasury and applies only to new transactions, meaning existing holdings of securities are grandfathered. But it actually expands targeting from military-linked firms to the surveillance technology sector. The new Biden communications technology import controls order concurs with the Trump order that China is a “foreign adversary” state whose access to American citizens’ “sensitive data” poses a national security threat. Rather than rush to judgment regarding any particular software, the new approach holds targeting in abeyance until a regulatory framework is in place. On the matter of 5G and telecom infrastructure, Biden has left Trump’s January 2021 interim final rule in place.
There is more continuity between the Biden and Trump policies in these areas than meets the eye. In fact, there is more continuity than change.
The Obvious Next Step: Investment Screening
What should interested observers expect next? For one, more activity under the new authorities. The Biden administration may move to prohibit formally the participation of the Chinese telecom giants Huawei and ZTE in U.S. telecom infrastructure projects. It may restrict the access of Chinese software and communications companies, potentially including messaging and social media companies, although not until it has had a chance to formalize a regulatory framework. It may also consider going to Congress for standalone legislation, which would serve to separate any communications import controls from IEEPA. One might also expect further tightening of controls on exports of dual-use goods to Chinese defense, technology, and telecom companies, building on Trump administration actions.
The most obvious and compelling area for action, though, is on Chinese investment in the U.S. defense, technology, and communications sectors. U.S. foreign investment screening, conducted by the Treasury-led interagency body known as the Committee on Foreign Investment in the United States (CFIUS), was overhauled in 2018. That reform was in large part a policy response to growing concern about China. It included what is slated to become a seven-fold budget boost for CFIUS, brought a far broader range of transactions under review, and required mandatory disclosure of certain acquisitions to CFIUS prior to completion. Both the Trump and Biden administrations have started looking aggressively at the record of Chinese investments in U.S. technology for transactions to scrutinize, including those completed months or even years ago.
However, even the enhanced CFIUS process has two major gaps. CFIUS still generally cannot review investment in a new company, known as a “greenfield” transaction. It can only review acquisitions of existing companies or assets. CFIUS also may only review transactions by foreign buyers, generally exempting acquisitions by foreign investors routed through a U.S. private equity or venture capital fund. This exemption may have the unintended consequence of pushing more Chinese investment from direct acquisitions by Chinese companies to layered purchases made via Chinese investment in U.S. funds that in turn acquire U.S. target companies.
The Credibility Gap
The message to national security policymakers from the courts is to slow down and exercise greater caution. The Trump administration exposed the U.S. sanctions apparatus to real legal risk with the Xiaomi, TikTok, and WeChat actions. Leading sanctions practitioners and scholars, including former senior Treasury officials, have also expressed concern that the overuse of sanctions—particularly secondary sanctions that go after third-country actors’ interactions with sanctions targets—may ultimately spur a global shift away from the U.S. economy and financial system. Former Treasury Secretary Jack Lew said in March 2016, “We must be conscious of the risk that overuse of sanctions could undermine our leadership position within the global economy, and the effectiveness of the sanctions themselves.”
Just as important as legal and economic considerations, though, is the basic question of trustworthiness. Allies’ trust in the reliability of U.S. intelligence and the earnestness of U.S. intentions—a critical element for global cooperation and compliance with U.S. sanctions—is difficult to build and easy to squander. Maintaining credibility in the competition with the authoritarian government of China will demand American excellence and American leadership.