Introduction

On 15 May 2020 the Department of Commerce and the Bureau of Industry and Security (BIS) revised an arcane export control rule that imposes US export controls on foreign-origin products (hardware, software and technology) that are a direct product of certain US technologies.

Prior to its revision, this foreign direct product rule imposed export controls on foreign-origin items that would fall under national security controls, but only if they were the direct product of a small set of highly controlled technologies. Further, those controlled items required a licence only when they were exported, re-exported or transferred to a few countries.

What does the new rule do?

The recent rule change creates two new categories of foreign direct product. These categories are far broader than the old one, but new foreign direct products require a licence only when they are exported or re-exported to entities on a new special subset of the Entity List, which includes Huawei, HiSilicon and many other Huawei affiliates.(1)

The key takeaway for companies that are fulfilling orders of foreign-origin items that must meet a Huawei specification or design requirement (as opposed to standard catalogue items sold as-is to many customers) is to evaluate whether those items are made using US-origin technology, software or production equipment that falls under one of the export control classification numbers (ECCNs) listed in the regulation (and noted below).

Put another way, the new control applies to foreign-produced items that are:

  • the brainchild of Huawei or one of the listed entities – namely, the foreign direct product is either designed or produced by a designated entity listed on the Entity List under Supplement 4 to Part 744 or is the product of software or technology from one of those entities; and
  • the brainchild of certain US-sourced technology or software or equipment that is the brainchild of certain US-sourced technology or software – namely, the foreign direct product is also the direct product of technology or software that is subject to the Export Administration Regulations (EARs) and falls under one of the ECCNs or is the direct product of a plant or a major component of a plant that is the direct product of US-origin technology or software that falls into a list of specific ECCNs.

The US ECCNs in scope represent a large swathe of US semiconductor, computing and telecoms technology and software at both a high level of control (ie, ECCN 3E001, 3E002, 3E003, 4E001, 5E001, 3D001, 4D001 and 5D001) but also a low level of control (anti-terrorism) (ie, ECCN 3E991, 4E992, 4E993, 3E991, 4E992, 4E993, 5E991, 3D991, 4D993, 4D994 and 5D991). EAR 99 technology in the semiconductor, computing and telecoms categories is omitted.

When is the new rule effective and when are comments due?

The new rule took effect on 15 May 2020, which is the date on which it appeared for public inspection in the Federal Register. Comments must be submitted on or before 14 July 2020.

However, the rule does have a savings clause. Foreign origin items are not subject to the new rule if they:

  • were on the dock for loading, on lighter, laden aboard an exporting or transferring carrier or en route aboard a carrier to a port of export to the consignee or end user on 15 May 2020, pursuant to actual orders (foreign direct product provision); or
  • started production before 15 May 2020 (foreign direct plant provision only).

What is the new rule's purpose?

The new rule aims to further cut off the supply of semiconductors and other items made outside the United States to Huawei and other companies on the Entity List that were not previously subject to the EARs.

What effect will the new rule have?

This rule will force non-US semiconductor development and manufacturing companies to choose between using US semiconductor technology and equipment or serving Huawei, HiSilicon and other listed Chinese entities as customers. However, it remains to be seen what choice those non-US companies will make. They could stop producing chips for Huawei and HiSilicon. But where US engineering has non-US competitors, what is to stop them from eliminating US semiconductor design, engineering and test equipment in at least some if not all offshore facilities? And what if China retaliates by putting US companies on its unreliable entity list? If these scenarios come to pass, will putting more pressure on Huawei be worth it?

Are there any positives?

This rule could have been a lot worse for US engineering. The new rule does not capture all of the foreign products that are designed with US technology or software where Huawei, HiSilicon and other listed entities are not in the design, development, or production picture. As an example, design engineers come up with a great design (3E991) for a Taiwanese origin chip (3A991) that is made in Taiwan and is not subject to the EARs. Huawei and HiSilicon are not part of that design and the chip is not modified to meet their specifications. Huawei and HiSilicon then want to buy the design. The chip is not subject to the EARs and is not prohibited by the EARs from being exported from Taiwan to Huawei or HiSilicon.

Ultimately, if a company is not collaborating with Huawei, HiSilicon or another designated company on the Entity List in the design or modification of its products, it need not redesign its compliance programme or foreign factory floors.

How does the new rule work?

The key part of the rule is contained in Footnote 1 of Supplement 4 to Part 744 of the rule (Pages 38 and 39).(2)

The new rule applies to foreign-produced items destined to entities with a Footnote 1 designation on the Entity List. Especially targeted are Huawei Technologies Co, Ltd (Huawei) and its non-US affiliates.

Items that fall under of the following categories cannot be re-exported, exported from abroad or transferred to companies with a Footnote 1 designation on the Entity List.

Category 1: foreign direct product provision (Section A of Note 1)

The foreign produced item is:

  • produced or developed by a company with a Footnote 1 designation on the Entity List; and
  • the direct product of technology or software; that
    • is subject to the EARs; and
    • falls under ECCN 3E001, 3E002, 3E003, 4E001, 5E001, 3D001, 4D001, 5D001, 3E991, 4E992, 4E993, 3E991, 4E992, 4E993, 5E991, 3D991, 4D993, 4D994 or 5D991.

Example

Company A is located in Hong Kong and often collaborates with Huawei on developing new integrated circuit (IC) designs that Company A manufactures for Huawei. In conjunction with this process, Company A uses US-origin 3D991 software to create the design layout for the Huawei IC. The products that Company A manufacturers for Huawei are now subject to the EARs under the rule and require authorisation to be sent to Huawei or any other company on the Entity List that is noted as having the new extra restriction.

Category 2: foreign direct product plant (Section B of Note 1)

The foreign produced item is:

  • the direct product of software or technology produced or developed by an entity with a Footnote 1 designation on the Entity List; and
  • the direct product of a plant or major component of a plant located outside the United States.

'Major component' of a plant located outside the United States means equipment that is essential for the production of an item, including testing equipment, to meet the specifications of a design specified in point two above.

The plant or major component of a plant itself must be:

  • a direct product of US-origin technology or software (the technology or software must be 'US' not 'subject to the EARs'); and
  • the US-origin technology or software must fall under ECCN 3E001, 3E002, 3E003, 4E001, 5E001, 3D001, 4D001, 5D001, 3E991, 4E992, 4E993, 5E991, 3D991, 4D993, 4D994 or 5D991 of the Commerce Control List in Supplement 1 to Part 774 of the EARs.

Example

An entity on the Entity List designs an IC that it asks Fab A in Taiwan to manufacture (ie, the IC is the direct product of the entity's technology). Fab A uses Chinese recrystallising equipment that was produced using US-origin 3E991 technology. This crystallising process is essential to the production of the IC. The ICs manufactured by Fab A using that equipment are now subject to the EARs under the rule and require authorisation to be sent to Hi-Silicon or any other company on the Entity List that is noted as having the new extra restriction.

What about existing Huawei licences?

Some companies may have obtained a BIS licence to share US technology with Huawei and are wondering what this means. The new regulation does not explicitly answer this question; if a licence covered technology exports but the foreign product being sold to Huawei is a foreign direct product as a result of the new rule, the licence might be a technology licence, not a hardware licence.

However, BIS and the US agencies which reviewed an existing licence application will have already determined that it should be granted. Therefore, BIS will hopefully fill this gap by stating that an existing Huawei licence covers both the technology and software and the hardware that is the foreign direct product of that technology and software.

Next steps

Companies should ask their engineering and plant operations teams whether:

  • they design anything with Huawei or HiSilicon (including adapting their product designs to Huawei's products);
  • they produce anything that Huawei has designed; or
  • Huawei has provided them with technology or software to design or produce.

If the answer is yes, the company will need to map out each Huawei-related project based on the products and the facilities producing those products and further ask the following questions:

  • Are the products that they are making or designing for or with Huawei direct products of technology or software that is subject to the EARs and falls under ECCN 3E001, 3E002, 3E003, 4E001, 5E001, 3D001, 4D001, 5D001, 3E991, 4E992, 4E993, 3E991, 4E992, 4E993, 5E991, 3D991, 4D993, 4D994 or 5D991?
  • Are the products that they are making or designing for or with Huawei a direct product made in a plant where:
    • the whole plant or any major component is a direct product of US-origin technology or software (the technology or software must be 'US' not 'subject to the EARs'); and
    • the US-origin technology or software falls under ECCN 3E001, 3E002, 3E003, 4E001, 5E001, 3D001, 4D001, 5D001, 3E991, 4E992, 4E993, 5E991, 3D991, 4D993, 4D994 or 5D991 of the Commerce Control List in Supplement 1 to Part 774 of the EARs?

The second question will require companies to map out their production steps and the equipment and software used at each step to determine whether it is a major component and the direct product of US technology or software that falls into one of the above ECCNs.

Endnotes

(1) The Entity List is available here.

(2) Footnote 1 of Supplement 4 to Part 744 reads as follows:

Items subject to the EAR that are controlled for NS reasons or specified in certain ECCNs when destined to designated entities. You may not re-export, export from abroad, or transfer (in-country) without a license or license exception any foreign-produced item specified in paragraph (a) or (b) of this footnote when there is "knowledge" that the foreign-produced item is destined to any entity with a footnote 1 designation in the license requirement column of this Supplement.

1. Direct product of "technology" or "software" subject to the EAR and specified in certain Category 3, 4, or 5 ECCNs. The foreign-produced item is produced or developed by any entity with a footnote 1 designation in the license requirement column of this Supplement and is a direct product of "technology" or "software" subject to the EAR and specified in Export Control Classification Number (ECCN) 3E001, 3E002, 3E003, 4E001, 5E001, 3D001, 4D001, or 5D001; of "technology" subject to the EAR and specified in ECCN 3E991, 4E992, 4E993, or 5E991; or of "software" subject to the EAR and specified in ECCN 3D991, 4D993, 4D994, or 5D991 of the Commerce Control List in Supplement No. 1 to part 774 of the EAR.

2. Direct product of a plant or major component of a plant. The foreign-produced item is:

1. Produced by any plant or major component of a plant that is located outside the United States, when the plant or major component of a plant itself is a direct product of US- origin "technology" or "software" that is specified in Export Control Classification Number (ECCN) 3E001, 3E002, 3E003, 4E001, 5E001, 3D001, 4D001, or 5D001; of US-origin "technology" that is specified in ECCN 3E991, 4E992, 4E993, or 5E991; or of US-origin "software" that is specified in ECCN 3D991, 4D993, 4D994, or 5D991 of the Commerce Control List in Supplement No. 1 to part 774 of the EAR; and

Note to paragraph (b)(1) of footnote 1: 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 specified in (b)(2).

2. A direct product of "software" or "technology" produced or developed by an entity with a footnote 1 designation in the license requirement column of the Entity List.