The U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”) has implemented new sanctions affecting China pursuant to Executive Order (“E.O.”) 13959, one of the Trump Administration’s final actions. The new sanctions program targets certain activities involving the securities of specifically identified Communist Chinese Military Companies (“CCMCs”).
As amended on January 13, 2021, by E.O. 13974, E.O. 13959 prohibits:
- Any transaction by a U.S. person, wherever located, or by any person within the United States, in publicly traded securities of a CCMC;
- Any transaction by a U.S. person, wherever located, or by any person within the United States, in any securities that are derivative of, or are designed to provide investment exposure to, publicly traded securities of a CCMC; and
- Possession of any such securities by a U.S. person, as of 11:59 pm EST on the date that is 365 days after the CCMC’s designation.
The sanctions apply to “securities” denominated in any currency that trades on any securities exchange or through over-the-counter (OTC) trading, such as stocks, bonds, derivatives (e.g., futures, options, swaps), warrants, American and global depositary receipts, exchange-traded funds, index funds, and mutual funds. Under the CCMC sanctions, the term “securities” is broader than in the Securities Exchange Act of 1934 and explicitly includes currency and notes, drafts, bills of exchange, and banker’s acceptances with a maturity of 9 months or less.
The affected Chinese entities are included on a so-called Non-SDN Communist Chinese Military Companies List (the “CCMC List”), which incorporates updates from the U.S. Department of Defense’s Section 1237 List. The restrictions are effective 60 days following the official designation of a CCMC by its inclusion on the CCMC List.
There is a grace period within which U.S. persons may divest securities held at the time of a CCMC’s designation. Transactions undertaken solely to divest from covered securities held by U.S. persons as of 9:30 am EST on the effective date (i.e., the date that is 60 days after the date of a CCMC’s designation) are authorized for 365 days following the date of the CCMC’s designation. For example, with respect to securities of a CCMC designated on November 12, 2020, that were held by U.S. persons as of 9:30 am EST on January 11, 2021, the divestment deadline is November 11, 2021.
OFAC has released a flurry of Frequently Asked Questions on the scope and application of the Chinese Military Companies Sanctions, clarifying that:
- The prohibitions do not apply to publicly traded securities of subsidiaries of CCMCs, except to the extent those subsidiaries are separately listed in the CCMC List;
- The prohibitions apply to publicly traded securities of an entity with a name that closely matches the name of a designated CCMC;
- The sanctions prohibit U.S. persons from investing in funds that themselves hold publicly traded securities of a CCMC, as such investments would be considered transactions in securities “designed to provide investment exposure” to restricted CCMC securities; and
- U.S. persons may lawfully provide support services in connection with CCMC securities trading (e.g., clearing, execution, settlement, custody, transfer agency, and back-end services), but only to non-U.S. persons.
To date, OFAC has issued two General Licenses authorizing specific types of transactions. General License No. 1A authorizes, through May 27, 2021, U.S. persons to engage in transactions in securities of an entity whose name closely, but not exactly, matches the name of a CCMC designated on November 12, 2020 (as listed in an Annex to E.O. 13959), or thereafter through updates to the Section 1237 List. OFAC’s General License No. 2 authorizes securities exchanges operated by U.S. persons to engage in otherwise prohibited transactions involving a CCMC for 365 days following the date of designation.
Those directly or indirectly holding publicly traded securities in Chinese entities should review the CCMC List, including recent updates to the Section 1237 List not yet incorporated into the CCMC List; examine whether their investments may be affected by the sanctions; and divest from CCMC or related securities, as required. Investors should also consider whether any funds in which they invest include publicly traded securities of CCMCs.
Although business dealings with CCMCs or their affiliates (not involving any transaction in their securities) are not prohibited by the new sanctions, being listed as a CCMC may indicate a red flag for purposes of U.S. export controls affecting military end-uses and/or military end-users in China, under the Export Administration Regulations, 15 C.F.R. Parts 730-774. Companies should accordingly review their compliance programs now to address potential sanctions and export controls risks indicated by the Chinese Military Companies Sanctions.