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US investment groups are urging the Biden administration to refine proposed limits on investment in China, with venture capitalists eager for changes to a White House executive order that they argue puts them at a disadvantage.
President Joe Biden in August signed an order restricting US investment in China’s quantum computing, advanced chips and artificial intelligence sectors in an effort to cut the flow of US capital and expertise to the Chinese military. It banned some investment and imposed government notification requirements on other areas.
In recent weeks American banks, manufacturers and industry groups have registered some concerns with the Treasury, which has the role of writing the rules that will implement Biden’s executive order. They have warned of uncertainty from how the restrictions have been laid out and the potential harm to domestic innovation, while lobbying to narrow some provisions or expand carve-outs for some types of investments.
“We no longer want to give an unlimited green light for investors to unwittingly threaten our national security,” Andy Barr, a Kentucky Republican who chairs the House financial institutions subcommittee, told the Financial Times. “At the same time we don’t need a clunky, bureaucratic process that freezes out cross-border capital flows in ways that undermine our commitment to a market-based economy.”
One of the parts of the proposed rules that has sparked much concern is a carve-out for US limited partners (LP) — the endowments, pension funds and charities that put money into venture funds. Lawyers say the rule will probably allow American LP capital to continue flowing into Chinese start-ups in all three sensitive sectors, provided that the venture capitalists directing the investment are Chinese or European and not American.
“The rules will potentially create disadvantages for US investors,” said George Grammas, a lawyer at Squire Patton Boggs.
The National Venture Capital Association, a group representing more than 400 American VC groups, warned that the measures would leave its members at a disadvantage against foreign rivals in the “fierce and global” fight to raise money from pension funds, endowments and other institutional investors.
The NVCA is pushing Washington to expand the exemption to include venture capital managers as well, provided they are not taking substantial or controlling stakes in Chinese start-ups that pose security risks.
“Without this change, much of the same LP capital will still reach many of the same Chinese companies (via foreign venture funds) without US funds being able to obtain a corresponding understanding of the state of the international market,” the association said in a filed comment with Treasury.
While US officials have said they do not intend to impose restrictions on LPs if their contributions are purely financial, the Treasury plans to set a threshold. The investment would have to be below that level to be allowed.
But the Institutional Limited Partners Association, representing investors with $3tn in assets, is pushing to do away with any threshold for its members’ passive investments to qualify for the exemption.
Uncertainty around the order has curtailed American LP interest in China. Venture capitalists expect US dollar backing for China-focused funds to remain tight until the final rules are released, which lawyers said could take up to a year.
Data from Preqin shows dollar investment in China venture and private equity groups has dried up. The $5.7bn raised this year is about a quarter of last year’s total and a fraction of the $48bn raised in 2021. Beijing’s crackdown on tech followed by Russia’s invasion of Ukraine had already unnerved foreign investors.
The comments in response to the proposed rules highlight the complexity of untangling US investment from sensitive areas of China’s tech sector.
One US venture capital manager said his fund was “caught in the middle” of US-China decoupling. “There’s this perception that US venture capital is funding breakthrough tech [in China]. But that’s wrong,” he said. “The companies that we’re funding are not in a position to advance China’s national interest. We’re investing in consumer start-ups and food delivery.”
But others say US companies must be more cognisant of national security. Some lawmakers, including House China Committee chair Mike Gallagher, have called for a ban on investment in Chinese capital markets. Illustrating the possible risks, the FT last week reported that Vanguard, the world’s second-largest asset manager, was channelling investment into 60 companies connected to China’s military-industrial complex.
Eric Sayers, an Asia security expert at Beacon Global Strategies consultancy, said administration officials and lawmakers arguing for an outbound investment tool viewed it as critical to tackling “existential national security issue” related to China.
“Even if a new regime at Treasury creates a new burdensome process for business, this is an acceptable cost for the hawks who believe limiting investment into key sectors in China is essential to containing the long-term military capacity of the People’s Liberation Army,” Sayers said.
Responses to the Treasury’s consultation from trade bodies and investment banks including Goldman Sachs also claimed that the rules too broadly define industries where technology has dual commercial and military uses, such as AI.
“I don’t think it’s the intention [of the order] to stop [all] investment, but it will be the outcome unless these definitions are tightened up,” said one person lobbying for clearer rules on behalf of investors.
