On Tuesday, May 19, the U.S. Commerce Department published a regulation (effective May 15, 2020) that prohibits sale to Huawei of a microchip made to a Huawei specification, made outside the United States with non-U.S. materials, sent from a foreign country, by a foreign person.

To quote the philosopher, hol’ up.

How is that even possible?

The Changes

Well, the U.S. Government now asserts control of an export to Huawei of a product with no other U.S. nexus than if the machine that used to fabricate that item originated in the United States.

Take a hypothetical example: a Korean chip manufacturer gets an order from Huawei for a specific semiconductor for telecommunications equipment. The Korean manufacturer sources materials from Japan and Taiwan and orders the chip made in a Singaporean foundry. That is now a U.S.-controlled export.

The Context

As we discussed here last December, the U.S. Government views China as a strategic adversary in a struggle for global technological dominance. One important front in that struggle is the semiconductor industry. A primary target in that fight is the Chinese tech giant, Huawei. In May, 2019, the U.S. Government designated Huawei and dozens of affiliated companies to the U.S. Entity List, generally prohibiting U.S.-origin products from export to Huawei.

Since that time, the U.S. Government, with the Commerce Department leading the charge, has been aiming to crack down on non-U.S. exports to Huawei where U.S. technology is even minimally involved. Different ideas have been floated among regulatory agencies, including changes to the de minimis rule governing U.S. content in foreign made items, and changes to the “direct product rule” regulating items that are the direct product of U.S. technology.

“Despite the Entity List actions the Department took last year, Huawei and its foreign affiliates have stepped-up efforts to undermine these national security-based restrictions through an indigenization effort.  However, that effort is still dependent on U.S. technologies,” said Secretary of Commerce Wilbur Ross.  “This is not how a responsible global corporate citizen behaves.  We must amend our rules exploited by Huawei and HiSilicon and prevent U.S. technologies from enabling malign activities contrary to U.S. national security and foreign policy interests.”

In the end, U.S. regulators decided that a change to the Direct Product Rule, imposing U.S. controls on items made by U.S.-origin machines, would be a good way to cut off Huawei and its affiliates (including HiSilicon) from semiconductor supplies.

The Specifics

The rule change makes the following foreign-produced items subject to the U.S. Export Administration Regulations (EAR):

(i) Items, such as semiconductor designs, when produced by Huawei and its affiliates on the Entity List (e.g., HiSilicon), that are the direct product of certain U.S. Commerce Control List (CCL) software and technology; and

(ii) Items, such as chipsets, when produced from the design specifications of Huawei or an affiliate on the Entity List (e.g., HiSilicon), that are the direct product of certain CCL semiconductor manufacturing equipment, software or technology of U.S. origin located outside the United States. Such foreign-produced items will only require a license when there is knowledge that they are destined for reexport, export from abroad, or transfer (in-country) to Huawei or any of its affiliates on the Entity List.  But beware of the very broad Commerce Department definition of “knowledge” that includes “awareness of a high probability.”

The rule is immediately effective, although it does provide limited grandfathering by allowing foreign foundries using U.S. semiconductor manufacturing equipment to complete shipments before September 14, 2020 provided they had already initiated production steps prior to May 15, 2020.

The Effects

Across the semiconductor industry, U.S. and non-U.S. manufacturers that produce chips overseas for sale to Huawei are being forced to reconsider their business models. For decades, the machinery for fabricating chips has largely been designed or produced in the United States. Those machines are now the jurisdictional hook by which the U.S. Government will control non-U.S. exports to Huawei.

Given the U.S. Government’s war footing with China in the technology realm, the Department of Commerce has articulated a “presumption of denial” for any applications for export licenses for exports that are caught by the new rules. Moreover, we fully expect that the Office of Export Enforcement will be actively seeking to enforce the new regulations.

Sophisticated manufacturers, designers, fabricators and others in the semiconductor industry are already planning paths to compliance. Like all of us in this technology space, they are looking for a safe passage to successful business in the United States and China. A place they can thrive – before the hammer of U.S. enforcement finds even more range, and comes down again.