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San Juan Puerto Rico
26 May 202010 minute read

Commerce Department targets Huawei with additional export control restrictions

International Trade Alert

On May 19, 2020, the US Department of Commerce’s Bureau of Industry and Security (BIS) published an interim final rule that imposes additional restrictions on the provision of certain foreign-made products to Huawei Technologies Co., Ltd and most of its non-US affiliates (collectively, Huawei).  These restrictions are another step in a series of US government measures to limit Huawei’s access to US technology.  The US government has long considered Huawei to present a national security risk based on its suspected association with, and potential to conduct espionage on behalf of, the Communist Party of China.  In addition to these perceived national security risks, Huawei is under investigation for violations of economic sanctions for business in North Korea, assisting the government of Iran with domestic surveillance, and was recently indicted for conspiracy to violate the Racketeer Influenced and Corrupt Organizations Act and conspiracy to steal trade secrets, further exacerbating US government concerns with the company.

On May 16, 2019, BIS added Huawei to the Entity List[1] – a list of individuals and entities that are restricted from receiving items subject to the Export Administration Regulations (EAR).  Since that date, all items “subject to the EAR” require a license from BIS to provide to Huawei, but such license applications are subject to a policy of denial.[2]  After many months of consideration on how to further restrict trade with Huawei, BIS has proposed a relatively narrow expansion of these export restrictions by revising the “foreign direct product rule” and its applicability to designated entities on the Entity List, currently limited to Huawei and its affiliates.

China may respond to these actions by imposing restrictions on large US companies doing business in or with China.  It has been reported that China is considering suspending significant purchases from several prominent US companies on an “unreliable entity list.”  China first floated the creation of this “unreliable entity list” in 2019 but has yet to implement any such restrictions.

The foreign direct product rule

BIS imposes export controls in the form of licensing requirements on items (including goods, software and technology) that are considered “subject to the EAR.”  These controls apply to the export of items from the US and the subsequent reexport to other jurisdictions or transfer (in country) to other end users of those items.  In limited circumstances, items that are manufactured or developed outside the US are also considered “subject to the EAR” and must comply with the applicable licensing requirements.  Specifically, foreign-produced items that are subject to the EAR include:

  1. Items that incorporate more than a de minimis amount (typically 25 percent but sometimes lower) of controlled US-origin content

  2. Items that are the “direct product” of technology or software controlled for “national security” (NS) reasons on the Commerce Control List (CCL), and the foreign-produced item also is classified in CCL entries controlled for NS reasons and

  3. Items that are the direct product of a complete plant or any major component of a plant, when that plant or component is the direct product of US-origin technology or software that is controlled for NS reasons on the CCL and the resulting items are also controlled for NS reasons.

These last two controls are known as the foreign direct product rule (FDPR) and are the rules that the interim final rule amends.  Under the FDPR, the “direct product” means the immediate product (including processes and services) produced directly using technology or software.  BIS has clarified that a “major component of a plant located outside the United States means equipment that is essential to the production of an item, including testing equipment, to meet the specifications of a design.”

The most significant limitation on the FDPR has been the requirement that the foreign-produced items are the direct product of NS-controlled software or technology that is subject to the EAR and the resulting foreign-made item is also NS-controlled based on its Export Control Classification Number (ECCN) on the CCL.  As NS controls apply to a limited subset of items on the CCL, this requirement significantly reduces the scope of the FDPR and thus the jurisdiction of the US to control foreign-made items under this rule.

Expansion of the FDPR

The interim final rule extends the FDPR beyond items controlled for NS reasons to include items subject to lesser controls manufactured for entities specially designated in a footnote on the Entity List (currently only including Huawei).[3]  This expansion of the FDPR broadens the scope of items “subject to the EAR,” and can be divided into two parts, as described below.  There is now a license requirement on the export from abroad, re-export or in-country transfer of such items when there is “knowledge”[4] that the items are destined for an entity with this footnote designation.

The rule became effective May 15, 2020 but includes a delayed implementation of 120 days (on September 14, 2020) for products currently in production or in shipment that are now subject to these licensing requirements.  BIS is also accepting public comments on the effects of this new control until July 14, 2020.

(a)  Foreign-made items produced using Huawei designs that are the direct product of “technology” or “software” subject to the EAR

The first category of items that are now subject to the EAR are foreign-produced items that are (i) “produced or developed”[5] by Huawei or to Huawei’s specifications and (ii) are the direct product of certain software or technology subject to the EAR which are found in Category 3, 4 or 5 of the CCL.[6]  Categories 3, 4, and 5 of the CCL include most technology or software pertaining to integrated circuits and microprocessors, digital computers and telecommunications equipment.

BIS provided an example to illustrate the application of this new rule.  Specifically, BIS explained that “if an entity with a footnote 1 designation on the Entity List, [i.e., Huawei,] produces or develops an integrated circuit design utilizing specified Category 3, 4 or 5 ‘technology’ or ‘software’ such as Electronic Design Automation software, whether the ‘technology’ or ‘software’ is U.S.-origin or foreign-produced and made subject to the EAR pursuant to the de minimis or foreign-produced direct product rule, that foreign-produced integrated circuit design is subject to the EAR.”  This integrated circuit would require a license from BIS to provide to Huawei.  However, this rule does not apply to integrated circuits manufactured using US-origin technology and/or software without any design or production input from Huawei.

(b)  Foreign-made items produced or developed for Huawei or to Huawei’s specifications using manufacturing and test equipment that is subject to the EAR

The second category of items subject to the EAR under the expanded FDPR includes foreign-produced items that are (i) the direct products of a foreign plant ormajor component of a plant that is itself the direct product of specified CCL Category 3, 4 or 5 technology or software subject to the EAR, and (ii) the direct product of software or technology produced or developed by Huawei.

This rule is directed at non-US semiconductor foundries that supply Huawei with chips based on Huawei’s specifications and use US-origin capital equipment for production and testing.  As BIS explained:

…if a foreign company produces integrated circuits outside the United States in a foundry containing U.S.-origin or foreign-produced equipment (which itself is a direct product of U.S.-origin ‘technology’ or ‘software’ in specified Category 3, 4, or 5 ECCNs) that is essential to the ‘production’ of the integrated circuit to meet the specifications of their design, including testing equipment (i.e., a major component of a plant), and the design for the integrated circuit was produced or developed from ‘software’ or ‘technology’ by an entity specified in footnote 1 to the Entity List, [i.e., Huawei,] whether or not such design is subject to the EAR, then that foreign-produced integrated circuit is subject to the EAR.

After receiving significant pushback from the industry on earlier proposals to expand the FDPR more broadly, this interim final rule is much more limited in scope – only applying to foreign-produced items using US capital equipment where the item is designed to Huawei’s specifications.  However, the application of this rule may be extended to other entities identified on the Entity List currently or added in the future.

Companies dealing with Huawei should ensure that they are not exporting, re-exporting or transferring items captured by the expanded FDPR.

[1] BIS initially added Huawei Technologies Co., Ltd. and 68 of its non-U.S. affiliates to the Entity List. In August 2019, BIS added an additional 46 non-U.S. Huawei affiliates to the Entity List.

[2] Concurrently with listing Huawei on the Entity List in May 2019, BIS issued a 90-day temporary general license (TGL) that authorized limited transactions with Huawei that otherwise would be prohibited. The TGL permits certain activities, including those necessary for the continued operation of existing networks and equipment and the support of existing mobile services.  BIS has repeatedly extended the validity of the TGL, including most recently on May 15, 2020.  BIS has announced that the TGL, which is now effective through August 13, 2020, is unlikely to be extended again.

[3] The interim final rule adds a “footnote 1” designation to the Entity List in Supplement No. 1 to Part 744 of the EAR.

[4] Under the EAR, “knowledge” means “positive knowledge that the circumstance exists or is substantially certain to occur,” but also “an awareness of a high probability of its existence or future occurrence,” which may be “inferred from evidence of the conscious disregard of facts known to a person and is also inferred from a person’s willful avoidance of facts.”

[5] Although the new rule does not specifically link “produced or developed” to the definitions of production and development in the EAR, the EAR defines these terms as follows: “Production” includes all production stages, such as product engineering, manufacture, integration, assembly (mounting), inspection, testing, and quality assurance. “Development” is related to all stages prior to serial production, such as design, design research, design analyses, design concepts, assembly and testing of prototypes, pilot production schemes, design data, process of transforming design data into a product, configuration design, integration design, and layouts.

[6]That “technology” and “software” include ECCNs 3E001, 3E002, 3E003, 4E001, 5E001, 3D001, 4D001, 5D001, ECCN 3E991, 4E992, 4E993, 5E991, 3D991, 4D993, 4D994, and 5D991.