Compliance, compliance, compliance: A primer for Canadian companies

In recent years, the United States (U.S) has added a growing number of Chinese firms to various sanctions and export control-related entity lists, and expanded its military end-users interpretation. In turn, China has accelerated the introduction of multiple laws and regulations that can be viewed as countermeasures. Overall, there is a heightening of multi-jurisdictional compliance risks for international companies and stakeholders doing business with Chinese entities across a number of sectors.

U.S. sanctions and export controls

The Bureau of Industry and Security (BIS), a part of the U.S. Department of Commerce, deals with national security and high technology issues. BIS' Entity List and Military-End User (MEU) List inform exporters, re-exporters, and transferors of heightened export controls applied to the listed entities.

The Entity list

• Contains names of Chinese and other foreign entities reasonably believed to be involved, or pose a significant risk of becoming involved, in activities contrary to the U.S.'s national security or foreign policy interests
• Export licenses are required for controlled and typically non-controlled commercial goods and technologies; the review policy is generally on the presumption-of-denial basis
• As of February 22, 2021, the list includes over 340 Chinese entities for a range of violations:
  • engaging in the theft of US trade secrets
  • acquiring U.S.-origin items in support of the People's Liberation Army's programs
  • enabling human rights abuses
  • supporting the militarization and unlawful maritime claims in the South China Sea, etc.

The MEU list

• Contains names of Chinese and other foreign entities representing an unacceptable risk of use in or diversion to a 'military end use' or 'military end-user'
• The license applications for items on BIS' "List of items subject to the military end-use or end-user license requirement of 744.21" are reviewed on the presumption-of-denial basis, and no exceptions are available
• As of February 22, 2021, the MEU list includes 58 Chinese entities (mainly state-owned enterprises and research institutes)

The Department of Defense's Communist Chinese military companies list (the DoD List)

In 2020, the Department of Defense began compiling a list of Chinese entities referred to as "Communist Chinese military companies" operating directly or indirectly in the U.S., under the statutory requirement of Section 1237 of the National Defense Authorization Act for the fiscal year 1999.

Once an entity is placed on the DOD list, the U.S. may impose wide-ranging sanctions against it, generally via a presidential executive order. Sanctions may include:

• restrictions on U.S. person's activities with listed individuals
• exports to designated parties or geographies
• financial dealings
• travel ban to the US.

As of January 14, 2021 44 Chinese companies were on the DoD list.

The only executive order (EO) in relation to the entities on the DoD list was EO13959 issued on November 12, 2020 (an EO13974 was issued on January 13, 2021 amending certain elements of the EO13959). The EO prohibits U.S. persons from making purchases of publically traded securities of the entities on the DoD List.

On December 28, 2020, the United States Department of the Treasury's Office of Foreign Assets Control (OFAC) published additional information on the implementation of the EO 13959. The Biden Administration has placed a number of executive orders issued by the Trump Administration, including this one, under review.

Chinese sanctions and export controls

China is developing comprehensive sanctions and export control toolkits, ostensibly to safeguard national security, and likely to respond to measures by the U.S. government seen by China to contain its development.

The three most relevant tools are:

• the Unreliable Entity List
• the Export Control law
• the Blocking Rules

The Unreliable Entity List

Published on September 19, 2020, the Chinese Ministry of Commerce (MOFCOM)'s Provisions on the Unreliable Entity List (the Provisions) provide the legal framework and mechanism for the Unreliable Entity List, a listing of foreign entities that China views as having impinged on its national security or interest.

Key articles of the Provisions are:

• article 10 – Listed entities that fail to address deficiencies may be restricted or prohibited from participating in China-related import or export activities, investments, travel, eligibility for work permits, as well as risk fines, asset freezes, and physical detention
• article 11 - For each listed entity, MOFCOM will assign a correction date in a public announcement
• article 12 - Chinese entities will require MOFCOM's Working Mechanism Office's approval to transact with the listed entities

Detailed rules on the operation of the Provisions, including enforcement guidelines, are yet to be released.

The Export Controls Law

On October 17, 2020, China's much-anticipated Export Control Law (ECL) was promulgated, coming into force on December 1, 2020. Before the new law, China's export control regime was comprised of various disparate laws, administrative regulations, and guidelines (e.g., Foreign Trade Law, Customs Law, etc.).

Key provisions include:

• article 2 - Deemed-exports: An in-country transfer of information or data related to controlled technology from a Chinese entity to a non-Chinese entity will require a Chinese export permit
• article 9 – Export control list & Temporary Control List: In addition to the standard list of controlled goods and technologies, China may also control other items deemed critical for national security and interest via the "temporary control list"
• article 12 – Catch-all provisions: China may also control certain less-sensitive or commercial items based on end-use or end-user for national security or interest reasons
• article 18 – Restricted List: If it is necessary to transact with the foreign entities on the "blacklist," the Chinese entities will require the relevant State Export Control Administration Department's approval
• article 44 – Extraterritoriality: Foreign entities that violate the ECL are legally liable even if they are outside of China's territories

China's new export control law can negatively impact the sourcing of strategic intermediate goods and technologies from China, as well as research and development collaborations between Chinese and foreign entities.

The Blocking Rules

On January 9, 2021, MOFCOM issued the Rules on Counteracting Unjustified Extraterritorial Application of Foreign Legislation and Other Measures (the Blocking Rules), effective immediately. The Rules create a system to block the extraterritorial application of foreign laws and measures on Chinese citizens, companies, and organizations by third-country entities. For example, the rules would apply if a Canadian company was perceived to harm Chinese entities' interests through actions in compliance with U.S. sanctions.

Key provisions include:

• article 2 - The Rules are introduced to address the extraterritorial application of foreign laws and measures that unjustifiably prohibits or restricts Chinese entities from engaging in normal economic and trade activities with third-state entities
• article 5 - Chinese entities have obligations to report violations to MOFCOM within 30 days
• article 6- A MOFCOM-led Working Mechanism will assess if the reported foreign laws and measures are unjustifiably applied extraterritorially based on international laws, basic principles of international relations, and potential impact on China's national interest, the legitimate rights of Chinese persons, etc.
• article 7 - When the Working Mechanism concludes the existence of the unjustified extraterritorial application of the foreign laws and measures, they may issue a prohibition order that the foreign laws and measures are not to be accepted, executed, or observed
• article 8 - If Chinese entities choose to apply for an exemption from the prohibition order, MOFCOM must review and decide whether to approve the exemption application within 30 days
• article 9 - After MOFCOM rules the prohibition order, Chinese entities can sue for compensations in Chinese courts from the third country entity's local operations

Anti-Foreign Sanctions Law

With the adoption of the Anti-Foreign Sanctions Law, China added to its evolving toolkit of measures designed to counter the effect of foreign measures restricting activities of Chinese persons. With the Blocking Rules adopted in January 2021 covering the so-called secondary sanctions, the Anti-Foreign Sanctions Law plugs the gap by addressing the primary sanctions; and provides an underlying legislative basis for the disparate measures currently in effect (Unreliable Entities List, the Blocking Rules and the Export Controls Law) and ones that are yet to come.

The Anti-Foreign Sanctions Law does not fundamentally change capacity of the Chinese government to sanction foreign entities. In fact, China has already done so before in relation to three U.S. military suppliers (in an unspecified way), as well as against EU and US individuals and organisations. The new law does bring a common legislative denominator under China's various sanctions tools. It also leaves a considerable discretion – largely through lack of clarity in the provisions and the absence of implementing regulations – in how these tools will be deployed.

With the increased geopolitical tensions, many foreign businesses operating in China may find themselves in the compliance vise of Chinese and home-country sanctions. This is likely to contribute to a continued bifurcation between supply chains and business operations in China and the rest of the world for many international firms. This bifurcation, however, is not to be confused with decoupling in the sense that the former Trump Administration used the term, since successive business sentiment surveys indicate that foreign companies have no intention to leave China – on the contrary, many increase their investments and efforts to onshore the Chinese supply chains.

For more information on the Anti-Foreign Sanctions Law, please see additional background information.

COMPLIANCE, COMPLIANCE, COMPLIANCE.

Canadian companies should stay informed of the US and Chinese sanctions and export control-related developments and seek counsel/compliance professionals' advice to evaluate the risk of exposure and compliance requirements to minimize business operational risks and supply-chain disruptions.