by H. Christopher Boehning, Jessica S. Carey, Christopher D. Frey, Michael E. Gertzman, Roberto J. Gonzalez, Brad S. Karp, Xiaoyu Greg Liu, Richard S. Elliott, Rachel M. Fiorill, and Karen R. King
In response to the Trump administration’s CCMC sanctions (discussed in Part I of this post), the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”) has released additional guidance and its first two general licenses. The U.S. Department of Commerce also responded to the sanctions; it published on December 21, 2020 the first ever Military End User List pursuant to the Export Administration Regulations as well as a warning that exports to CCMCs will raise red flags and require due diligence.
OFAC Guidance and Implications
On January 14, 2021, OFAC published four additional FAQs regarding: securities exchanges operated by U.S. persons, U.S. person divestment of CCMCs required, a revision of the term “transaction” to track the amended Order, and activities permitted to effect divestment. We provide details regarding these additional FAQs below.
Permitted Activities for Securities Exchanges Operated by U.S. Persons (FAQ 871). OFAC clarified that General License No. 2 permits all transactions and activities by securities exchanges operated by U.S. persons related to CCMC securities (for CCMCs not identified on OFAC’s CCMC List as of 12:01 am January 14, 2021) through the applicable 365-day divestment period.[1] This appears to provide that for CCMCs other than the 35 on OFAC’s CCMC List (the 31 identified in the Order Annex and the four identified on December 3, 2020) as of January 14, 2021, U.S. person exchanges will be able to engage in transactions and activities involving the securities of CCMCs during the applicable 365-day wind down period.
S. Person Divestment of CCMC Securities Required (FAQ 872). OFAC made clear that, in light of the amended Order, U.S. persons must divest of any CCMC securities that they hold by the end of the 365-day wind down period and that, after the end of the wind down period, U.S. persons will be prohibited from holding or trading in CCMC securities.[2]
Amending the Definition of “Transaction” (FAQ 873). OFAC revised the definition of “transaction” for purposes of the CCMC sanctions to match the definition in the amended Order.[3] The definition of “transaction” for purposes of the CCMC sanctions program is now “the purchase for value, or sale, of any publicly traded security” [addition emphasized].
Amending the Definition of “Transaction” (FAQ 874). OFAC clarified that transaction (including purchases for value and sales) entered into on or before the end of the applicable 365-day divestment period, solely to divest, in whole or in part, from CCMC securities, is permitted.[4]OFAC also referred to a previously issued FAQ (FAQ 865, described below), which clarified the permissibility of market intermediaries and other participants engaging in ancillary or intermediary activities that are necessary to effectuate divestiture of CCMC securities during the relevant wind down periods.
January 6, 2020 FAQs:
On January 6, 2021, OFAC published three additional FAQs regarding: U.S. persons’ ability to offer for sale or service as transfer agent for trades in CCMC securities not involving U.S. persons; clarification that the prohibitions in the Order apply to subsidiaries of CCMC companies that have names that “closely match” a CCMC; and market intermediaries and other participants’ ability to facilitate divestment from publicly traded CCMC securities and U.S. person ability to continue to transact in investment funds in the process of divestment. We provide details regarding these additional FAQs below.
U.S. Persons’ Ability to Custody, Offer for Sale, Serve as a Transfer Agent, and Trade in Covered Securities (FAQ 863). OFAC made clear that U.S. person activities related to the following services with respect to CCMC securities are permitted under the Order (so long as such support services are not provided to U.S. persons in connection with transactions otherwise prohibited under the Order): clearing, execution, settlement, custody, transfer agency, back-end services, as well as “other such support services.”[5]
CCMC Subsidiaries with Names That “Closely Match” an Identified CCMC; Compliance Measured by Trade Date (FAQ 864). OFAC clarified that the prohibitions of the Order extend to subsidiaries of listed CCMCs “with a name that exactly or closely matches” the name of a listed CCMC, whether expressly listed or not. This FAQ specifically identified as within the scope of the Order three NYSE-listed subsidiaries of listed CCMCs as having names that “closely match” the name of a listed CCMC. The three companies identified in the FAQ are: China Telecom Corporation Limited (NYSE: CHA), China Mobile Limited (NYSE: CHL), and China Unicom (Hong Kong) Limited (NYSE: CHU). Two days after this guidance was issued, the three entities identified in the FAQ, along with CNOOC Limited, were identified on OFAC’s CCMC List in the “issuer name” column in connection with their CCMC parent companies. However, the FAQ did not provide any criteria to determine whether or not a given subsidiary name may “closely match” the name of an identified CCMC.[6]
Likely in recognition of the practical difficulties in implementing this “close match” criteria, on January 8, 2021, OFAC issued General License Number 1, which authorizes U.S. person transactions through January 28, 2021 that involve the publicly traded securities of entities “whose name closely matches” the name of a CCMC, but that have not themselves been listed on OFAC’s CCMC List.[7] This General License therefore does not apply to the four CCMC subsidiaries already identified on OFAC’s CCMC List. It remains to be seen how OFAC will address this issue in the longer-term.
FAQ 864 also clarifies that compliance with the Order is measured by trade date, not settlement date.
Activities of Market Intermediaries and Other Market Participants Related to Divestment of Publicly Traded Securities of CCMCs (FAQ 865). This FAQ permits divestment-related activities by market intermediaries and other participants that are necessary to effect divestiture during the relevant wind-down periods or that are otherwise not prohibited under the Order. Notably, this FAQ also clarifies that U.S. persons (including investors) may continue to transact in investment funds that are seeking to divest publicly traded CCMC securities during the relevant wind-down periods. While OFAC has not issued guidance as to how to ascertain whether a fund qualifies, it would be prudent for investors to receive some indication from the fund that it is divesting from any CCMC interest in accordance with the Order. The FAQ provides that such divestment must be completed by November 11, 2021.[8]
December 28, 2020 and January 4, 2020 FAQs:
As discussed in our prior memorandum,[9] on December 28, 2020, OFAC published five FAQs designed to answer some of the questions raised by the Order, including the application of the Order to CCMC subsidiaries, certain financial instruments, and investments in U.S. and non-U.S. funds holding CCMC securities, the definition of “publicly traded securities,” and discrepancies in the names of entities identified by DoD as CCMCs and the names of issuers of publicly traded securities. On January 4, 2021, OFAC published an additional FAQ addressing whether U.S. persons must divest from the securities of the CCMCs identified in the Order prior to the end of the initial grace period on January 11, 2021.
Publicly Traded Securities of CCMC Subsidiaries (FAQ 857). Because the Order itself suggests that its prohibitions will only apply to CCMC subsidiaries identified by DoD or the Treasury Department as CCMCs or publicly listed by the Treasury Department as a subsidiary of a listed CCMC, it was unclear whether OFAC would apply its 50 percent rule (providing that entities owned 50 percent or more, in the aggregate, by OFAC-sanctioned persons must themselves be treated as OFAC-sanctioned persons, whether or not such entities have been explicitly sanctioned by OFAC) in the context of the Order. OFAC’s guidance clarifies that the 50 percent rule will not automatically apply (e., that the Order’s prohibitions will apply to any subsidiary of a CCMC only after such subsidiary is publicly listed by OFAC); however, OFAC also states its intention to publicly list both CCMC subsidiaries that would fall under the scope of its 50 percent rule and entities it determines to be controlled by a CCMC.[10] This FAQ suggested that the private sector could rely on OFAC’s CCMC List to diligence which entities are subject to the Order’s prohibitions, but the subsequent OFAC guidance (FAQ 864) stating that entities with names that “closely match” a listed CCMC’s name are subject to the Order’s prohibitions reintroduces considerable uncertainty. As noted above, such uncertainty is mitigated in the short term by General License 1; however, that authorization is set to expire January 28, 2021.
Regardless, OFAC has put the public on notice that CCMC subsidiaries may well be subject to public listing (and therefore the Order’s prohibitions) in the future.
Scope of Covered Financial Instruments (FAQ 860). The Order’s prohibitions apply to any transaction in any securities that are derivative of, or are designed to provide investment exposure to publicly traded CCMC securities. While OFAC’s guidance does not define “designed,” it does provide that the financial instruments captured by this prohibition include, but are not limited to, derivatives (g., futures, options, swaps), warrants, ADRs, global depositary receipts (“GDRs”), exchange-traded funds (“ETFs”), index funds, and mutual funds, to the extent such instruments also meet the definition of “security” as defined in the Order.[11]
This is consistent with U.S. Secretary of State Mike Pompeo’s press statement that the Order’s prohibitions apply broadly to “all transactions by U.S. persons, including individuals, institutional investors, pension funds, university endowments, banks, bond issuers, venture capital firms, private equity firms, index firms, and other U.S. entities, including those operating overseas. This should allay concerns that U.S. investors might unknowingly support CCMCs via direct, indirect, or other passive investments including those linked to educational, ETFs, venture funds, private equity, Real Estate Investment Trusts, commodities, endowments, pensions, or any other investment funds tracking bonds, loans, lease lines, debt or equity indices that include securities of CCMCs or subsidiaries publicly listed by the U.S. government.”[12]
Investments in U.S. or non-U.S. Funds Holding CCMC Securities or Derivatives (FAQ 861). OFAC’s guidance states that the Order’s prohibitions apply to U.S. persons’ investments in U.S. and non-U.S. foreign funds, such as ETFs or other mutual funds that hold publicly traded securities of a CCMC, noting that any transaction in publicly traded securities, or any securities that are derivative of, or are designed to provide investment exposure to such publicly traded securities of, any CCMC is prohibited regardless of such securities’ share of the underlying index fund, ETF, or other derivative of a CCMC publicly traded security.[13] Accordingly, U.S. persons are prohibited from investing in any U.S. or non-U.S. fund that holds any CCMC security whatsoever; subject to the exception in FAQ 865, discussed above, that U.S. persons can invest in funds that hold CCMC securities and are in the process of divesting such securities. Given the prevalence of some of the CCMC securities in Asian markets, this interpretation presents significant due diligence challenges for investors, advisors, and funds seeking investment exposure in such markets.
Defining Publicly Traded Securities (FAQ 859). OFAC’s guidance states that, for the purposes of the Order, OFAC intends to interpret the term “publicly traded securities” to include securities (as defined in section 4(d) of E.O. 13959) denominated in any currency that trade on a securities exchange or through the method of trading that is commonly referred to as “over-the-counter,” in any jurisdiction.”[14] This FAQ removes the possibility that the Order would apply only to securities traded on a public exchange.
Discrepancies between the Names of CCMCs Identified by DoD and Names of Issuers (FAQ 858). In some cases, the names of the entities identified by DoD and CCMCs did not exactly match the names of issuers of publicly traded securities. OFAC’s guidance states that the Order applies with respect to publicly traded securities or any publicly traded securities that are derivative of, or are designed to provide investment exposure to, such securities) of an entity with a name that exactly or “closely matches” the name of an entity identified as a CCMC.[15] In other words, ambiguity in the DoD identification will not be a bar against the application of the Order. To assist the public in identifying the CCMC entities, OFAC updated the CCMC List on its website containing the names of the CCMCs identified by DoD along with other identifying information, such as aliases, issuer names, and equity tickers.[16] As noted above however, OFAC’s subsequent guidance extending the scope of the Order to subsidiaries, whether expressly listed or not, if the subsidiary’s name exactly or closely matches the name of a CMCC and related General License create considerable uncertainty regarding the application of the Order to CCMC subsidiaries not yet identified on the CCMC List.
Divestment From CCMC Securities by January 11, 2021 Not Required (FAQ 862). OFAC’s January 4, 2021 guidance clarifies that U.S. persons (including U.S. funds and related market intermediaries and participants) are not required to divest their holdings in publicly traded securities (and securities that are derivative of, or are designed to provide investment exposure to, such publicly traded securities) of the CCMCs identified in the Order by January 11, 2021. The guidance is silent as to whether U.S. persons will be permitted to continue to hold CCMC securities after the end of the divestment wind down period established by the Order (e.g., November 11, 2021 for the CCMCs identified in the Order).[17] However, as noted above, after this FAQ was published, President Trump amended the Order to require U.S. persons to divest from any CCMC securities that they possess at the end of the applicable one-year wind down period.
Significance of CCMC Identification to Exporters of U.S. Origin Goods
Finally, we note that on December 21, 2020, the U.S. Department of Commerce published the first ever Military End User List (the “MEU List”) pursuant to the Export Administration Regulations (the “EAR”).[18] The MEU List includes dozens of Chinese companies (many of which are also identified as CCMCs) and imposes restrictions on exports, reexports, and transfers of certain items that are subject to the EAR to these listed entities. As a part of its publication of the MEU List, the Department of Commerce also warned that any CCMC not currently included on the MEU List “would raise a Red Flag under the EAR and require additional due diligence by exporters, reexporters, or transferors.”[19] Accordingly, investors and others dealing in CCMC securities are not the only persons that need to be mindful of the universe of entities identified as CCMCs.
For Part I of this post, click here.
Footnotes
[1] OFAC, “Frequently Asked Question 871,” (Jan. 14, 2021), available here.
[2] OFAC, “Frequently Asked Question 872,” (Jan. 14, 2021), available here.
[3] OFAC, “Frequently Asked Question 873,” (Jan. 14, 2021), available here.
[4] OFAC, “Frequently Asked Question 874,” (Jan. 14, 2021), available here.
[5] OFAC, “Frequently Asked Question 863,” (Jan. 6, 2021), available here.
[6] OFAC, “Frequently Asked Question 864,” (Jan. 6, 2021), available here.
[7] OFAC, “General License No. 1 Authorizing Transactions Involving Securities of Certain Communist Chinese Military Companies” (Jan. 8, 2021), available here (PDF 175 KB).
[8] OFAC, “Frequently Asked Question 865,” (Jan. 6, 2021), available here.
[9] Paul, Weiss, “New Guidance Clarifies OFAC’s Broad Interpretation of Recent Sanctions Against Communist Chinese Military Companies,” (Jan. 4, 2021), available here.
[10] OFAC, “Frequently Asked Question 857,” (Dec. 28, 2020), available here.
[11] OFAC, “Frequently Asked Question 860,” (Dec. 28, 2020), available here.
[12] U.S. Dep’t of State, Press Statement, “Protecting U.S. Investors from Financing Communist Chinese Military Companies,” (Dec, 28, 2020), available here.
[13] OFAC, “Frequently Asked Question 861,” (Dec. 28, 2020), available here.
[14] OFAC, “Frequently Asked Question 859,” (Dec. 28, 2020), available here.
[15] OFAC, “Frequently Asked Question 858,” (Dec. 28, 2020), available here.
[16] OFAC, “Non-SDN Communist Chinese Military Companies List,” (Dec. 22, 2020), available here (PDF 116 KB)
[17] OFAC, “Frequently Asked Question 862,” (Jan. 4, 2021), available here.
[18] U.S. Dep’t of Commerce, Press Release, “Commerce Department Will Publish the First Military End User List Naming More Than 100 Chinese and Russian Companies,” (Dec. 21, 2020), available here.
[19] Id.
Brad S. Karp is chairman, H. Christopher Boehning, Jessica S. Carey, Christopher D. Frey, Michael E. Gertzman, Roberto J. Gonzalez, and Xiaoyu Greg Liu are partners, and Richard S. Elliott, Rachel M. Fiorill, and Karen R. King are counsel, at Paul, Weiss, Rifkind, Wharton & Garrison.
Disclaimer
The views, opinions and positions expressed within all posts are those of the authors alone and do not represent those of the Program on Corporate Compliance and Enforcement or of New York University School of Law. The accuracy, completeness and validity of any statements made within this article are not guaranteed. We accept no liability for any errors, omissions or representations. The copyright of this content belongs to the authors and any liability with regards to infringement of intellectual property rights remains with them.