Congressional Oversight Intensifies on Military-Civil Fusion that Complicates US Export Licenses

Posted by on October 12, 2020


Leading US national security senators raisedgrave concerns” on October 5, 2020 to block the approval by US Department of Commerce (DOC) to “export over 227 tons of sensitive material critical to building missiles to China.”  These senators also stress the lack of detailed justification and alleged deviation from both the spirits and mandates concerning missiles and satellite exports under the Strom Thurmond National Defense Authorization Act for Fiscal Year 1999 enacted on October 17, 1998 (P.L. 105-261) (“Strom Thurmond NDAA for FY1999” or “1999 legislation on China”). The ongoing congressional oversight also concerns the military-civil fusion programs underlying the transaction in question, which complicates the prospect of both existing and prospective licensing under the US export control regime with broad FCPA/export control implications.

Key Requirements under Strom Thurmond NDAA for FY1999

Under the Strom Thurmond NDAA for FY 1999, “it is the sense of the Congress that US business interests must not be placed above US national security interests…. the United States should pursue policies that protect and enhance the US space launch industry.”  It further requires that:

  • U.S. government (USG) needs to ensure that the “missile equipment or technology” exports (including “any indirect technical benefit”) are “not detrimental” to the U.S. aerospace and military industries;
  • Nor should such exports “measurably improve” China’s missile or space launch capabilities, directly or indirectly. (Sections 1511-1522 of Strom Thurmond NDAA for FY1999)

Key Concerns of National Security Senators

The signing senators are: Robert Menendez (D-NJ), Senate Foreign Relations Committee Ranking Member, Charles Schumer (D-NY), Senate Minority Leader, Sherrod Brown (D-Ohio), Ranking Member of the Senate Committee on Banking, Housing, and Urban Affairs, Jack Reed (D-RI), Ranking Member of the Senate Armed Services Committee, and Richard Durbin (D-Ill), Senate Democratic Whip.  These national security senators urge that:

“With its potentially dangerous end-use as a component in these systems, there are serious questions regarding this decision, especially as your letter to Congress gave no mention of the exporter, the end-user, or end-use function—other than for the production of electronic discharge machines—for this sensitive material.”

The letter to Commerce Secretary Wilbur Ross also refer to Department of Defense report Military and Security Developments Involving the People’s Republic of China 2020 released on September 1, 2020 (“DOD China 2020 Report”).  DoD highlights 3 sectors where China has achieved or exceeded parity with US:

  • Shipbuilding
  • Land-based conventional ballistic and cruise missiles
  • Integrated air defense systems

Export Control Implications from Military-Civil Fusion

DOD has raised the concern that the military-civil fusion programs (MCF) designed for legitimate national rejuvenation goals – “there is not a clear line between the PRC’s civilian and military economies, raising due diligence costs for U.S. and global entities that do not desire to contribute to the PRC’s military modernization,” under the “legal framework for the Party’s national security concepts.”

In March, the State Department expressed its position not denying the entire MCF, but concerns its lack of transparency and potential misuse:

“Now, many countries, including the United States, leverage the talents of the civilian sector and academia for military modernization. However, there is a huge difference between our approach and the PRC’s approach. The United States and our partners around the world have made commitments to transparency and provided assurances through international agreements and norms that dual-use technologies will not be diverted to military end-use. But with MCF, the PRC flouts these norms and is in fact explicitly working to divert dual-use technology to military end-uses, and often without the knowledge of all the parties involved.”

In June, DOD identified 24 companies as “Communist Chinese military companies,” 20 years after the mandate of Strom Thurmond NDAA for FY1999, who are major SOEs (state-owned enterprises) in telecom, nuclear, shipbuilding, aero/aviation sectors, along with Huawei and HiVision.

Market Access Prongs under Strom Thurmond NDAA for FY1999

Currently, both the senators’ letter and DOD reports remain silent on the market-opening prong of the Strom Thurmond NDAA for FY1999, which arguably limits to “export of satellites” but nonetheless is its integral part indicative of solution and policy change:

“The impact of the proposed export on … opening up markets to US-made productsreducing trade barriers to US exports or foreign direct investment in China by US nationals ….the willingness of China to reduce formal and informal trade barriers and tariffs, duties, and other fees on US-made goods and services.” (Section 1515, Strom Thurmond NDAA for FY1999)

Sectors Impacted by Latest Military-Civil Fusion Programs

Military-civil fusion has been publicly announced as an elevated “state strategy” in China since 2016. Policy priorities include quantum computing, big data, semiconductors, 5G, advanced nuclear technology, aerospace technology, and AI but also new materials, strategic minerals, energy storage, such as new energy vehicles (NEVs).

On November 23, 2017, the State Council further issued the Guiding Opinion to Deepen Development of Military-civil Fusion in National Defense Technology Industries to ensure “state-driven” and “market orientation.” It seeks to reduce bureaucratic fragmentation, enhance removal of barriers to civilian participation in defense procurement, research and development, and build alliance to tackle “stranglehold” technologies, including:

  • Aerospace infrastructure: Heavy-duty launch vehicles, space nuclear power units, deep space exploration and space vehicle in-orbit services and maintenance systems, such as remote sensing satellites and data
  • Cyberspace: cyber security and electromagnetic spectrum resource management, integrated information network, e.g., satellite internet
  • Oceanic development: underwater detection, seaborne information transmission & security, nuclear-powered offshore platforms, specialized vessels, new materials and core parts

MCF Vulnerable to Discredits or Misinformed Reactions

Impacts of MCF also extended to traditional sectors with considerable breath. For example, MCF has also become a statutory pre-condition in investment project approvals in auto sector especially for NEVs, under the  Auto Industry Investment Regulation issued in late 2018 by National Development & Reform Commission (NDRC).

Local protectionism may reemerge in new forms through MCFs to stealthily eliminate internationally competitive participants, either at the outset or in the middle of significant projects, by simply labeling them as “less loyal” from acquisition process or core infrastructure construction.

Misuse as a result of lack of transparency may reward those who either wrote MCF into bidding rule or seek “implicit reciprocation” (as disguise from bribery) from those who would like to gain first-mover advantage and secure manufacturing licenses. Such licensing regime could constitute quantitative restriction in new form but not new in an ineffective market, to force joint venture with or technology transfer from late comers, competitors or suppliers/licensors.

Neither corruption nor protectionism is aligned with the Party’s state strategies – opening-up and to fight corruption stressed by China’s top leadership, however.

Existing & Prospective Export Licenses Jeopardized Beyond Graphite

Depending on specific grade and composition (undisclosed), graphite products in the present case may constitute dual-use items under US export control regime and will face more stringent scrutiny if not denial going forward.  Graphite has wide civil/military applications, from conductive / insulating materials, wear-resistant lubricants, to inputs/parts in the nuclear energy, military applications, as well as parts in aerospace sectors.

If the facts present impossibility to determine the eventual end use and end users of the sensitive exports (of not only emerging/foundational items but also traditional items), it would complicate the prospect of both existing and prospective licensing under the US export control regime.

Moreover, as a legacy from previous administration before China’s WTO accession, Section 1237 of the Strom Thurmond NDAA for FY1999 has broader implications to international businesses. It reserves the power within US presidential authority to investigate alleged violations by the DOD-identified companies under the presidential emergency power (unless exception applies). Such investigation may open the books and records and could lead to other fronts of enforcement, such as anti-fraud and anti-corruption. These scenarios are envisaged under the presidential emergency power (Section 203 of IEEPA) arising from “cooperation” to an “investigation,” with a lower evidential bar under the 1999 legislation on China.

Going forward, “annual congressional review” of “normal trade with China” (removed upon China’s WTO accession) could be restored, at least sector-specific, under the 1999 legislation on China or any further legislative reform in that direction. Also, precedents in non-China investigations involving countries like Iran and North Korea would be applied in such scenarios, and the current or future president may follow.

It’s critical to effectively engage with experienced compliance counsels to constantly examine and evaluate your vulnerabilities/deficiencies against pitfalls, while achieving inclusive, compliant business growth based on China’s self-driven reform.

We continue to closely monitor trade regulation/anti-corruption developments and the impacts to risk management functions of international businesses. Should you have any questions, please do not hesitate to contact us.