On January 14, 2021, the White House issued an Executive Order (EO) to amend EO 13959 of November 12, 2020, which prohibits US persons from transacting in securities related to so-called “Communist Chinese military companies” (CCMCs).
The amended EO 13959 makes clear that US persons must divest their holdings in such securities within designated wind-down periods, after which possessing the securities will also be prohibited. For CCMCs identified in the Annex to EO 13959, on November 12, 2020, the wind-down period will end on November 11, 2021. The amended EO also clarifies that prohibited transactions include both “purchase for value” and “sales” of covered securities.
Meanwhile, the US Department of Defense (DoD) identified an additional nine entities as CCMCs, bringing the total number to 44. Restrictions under EO 13959 will take effect with respect to the newly named CCMCs after 60 days, on March 15, 2021.
Shortly thereafter, the US Treasury Department’s Office of Foreign Assets Control (OFAC) published four new Frequently Asked Questions (FAQs) and General License No. 2 (GL-2) authorizing securities exchanges operated by US persons to engage in transactions involving covered securities through the relevant wind-down periods.
On January 8, 2021, OFAC published General License No. 1 (GL-1) authorizing transactions, until January 28, 2021, involving securities of any subsidiary of a CCMC that has not specifically been named by OFAC but whose name “closely matches the name” of an entity on the CCMC List.
(For more information on the earlier version of Executive Order 13959, see our blog post of November 13, 2020, “Executive Order Prohibits US Persons from Buying Securities of Chinese Military Companies as of January 11, 2021.”)
Amendments to EO 13959
The EO of January 14, 2021 amending EO 13959 replaces Sections 1(b) and 1(c) to expand the EO’s wind-down authorization to cover “any transaction” that is “solely to divest, in whole or in part, from securities” held by a US person. The earlier version of the EO authorized only “purchase for value and sales.” A new sentence in each section states that “possession of any such securities by a United States person is prohibited” after the wind-down period. The earlier version of the EO was ambiguous as to whether US persons must divest their holdings.
This means that US persons holding covered securities of CCMCs identified in the Annex of EO 13959 must sell or otherwise dispose of those securities by November 11, 2021.
The EO also amended the definition of “transaction,” as used in Section 1(a) of EO 13959 to include both the “purchase for value” and “sale” of publicly traded securities. The earlier EO only referred to the “purchase for value” of publicly traded securities.
The amended EO also contains certain technical changes to the designation criteria contained in the definition of a CCMC in Section 4. These changes do not appear to have a material effect on US persons’ compliance with the EO.
Key Points from OFAC’s FAQs
As of January 14, 2021, OFAC has issued a total of 13 FAQs on EO 13959.
The FAQs, which respond to questions and concerns raised by members of the securities industry since the EO’s issuance on November 12, 2020, are accompanied by a “Non-SDN Communist Chinese Military Companies List” (the CCMC List) providing additional identifying information about CCMCs previously named by the Department of Defense, as well as three subsidiaries identified in FAQ 864 that are issuers of US-listed securities.
- FAQ 857 clarifies that OFAC intends to identify subsidiaries of CCMCs using its authority under Section 4(a)(iii) of EO 13959. Such entities will be issuers of publicly traded securities that are (i) 50 percent or more owned by one or more CCMCs, or (ii) determined to be controlled by one or more CCMCs. The restrictions under EO 13959 would take effect 60 days after their identification.
- FAQ 858 notes that some names of CCMCs previously identified by the Department of Defense (DoD) do not match the names of issuers of publicly traded securities. The FAQ states that the EO applies to securities of CCMCs “with a name that exactly or closely matches the name of an entity” identified in the Annex to EO 13959 or subsequently identified by the DoD or Treasury Department. The newly issued Non-SDN Communist Chinese Military Companies List provides additional identifying information.
- FAQ 859 states that the term “publicly traded securities” includes both exchange-listed and over-the-counter securities in any jurisdiction, for the purposes of EO 13959.
- FAQ 860 provides examples of financial instruments that are “securities that are derivative of, or are designed to provide investment exposure to” publicly traded securities of CCMCs. Examples given include “derivatives (e.g., futures, options, swaps), warrants, American depositary receipts (ADRs), global depositary receipts (GDRs), exchange-traded funds (ETFs), index funds, and mutual funds, to the extent such instruments also meet the definition of ‘security’ as defined” in EO 13959 (which refers to the definition of “security” at Section 3(a)(10) of the Securities Exchange Act of 1934).
- FAQ 861 clarifies the EO’s application to both US and foreign funds, including ETFs or mutual funds, that hold publicly traded securities of CCMCs. According to the FAQ, the EO’s restrictions apply “regardless of such securities’ share of the underlying index fund, ETF, or derivative thereof.”
- FAQ 862 confirms that the EO does not require US persons (including US funds and related market intermediaries and participants) to divest holdings in covered securities by January 11, 2021, the effective date of the EO’s prohibition on purchases by US persons.
- FAQ 863 states that US persons may engage in activity related to “clearing, execution, settlement, custody, transfer agency, back-end services, as well as other such support services” “to the extent that such support services are not provided to US persons in connection with prohibited transactions.” The FAQ appears to exclude activity such as trading and offering for sale covered securities (e.g., by US broker-dealers).
- FAQ 864 clarifies that US-listed ADRs of three particular subsidiaries of CCMCs are subject to the EO because, according to OFAC, their names “exactly or closely matches the name of an entity identified in the Annex to EO 13959.” The FAQ states that subsidiaries of CCMCs need not be separately listed if their names exactly or closely match the name of a previously listed CCMC. OFAC “will continue to update a list on its website to aid in the implementation of E.O. 13959.”
- FAQ 865 states that “ancillary or intermediary activities that are necessary to effect divestiture [of CCMC securities] during the relevant wind-down periods or that are otherwise not prohibited” are permitted, including by US persons. FAQ 865 notes that certain divestment activity “must be completed by November 11, 2021,” which appears referring to transactions carried out pursuant to Section 1(b)..
- FAQ 871 explains the scope of GL-2 stating that “[i]n general, all transactions and activities by securities exchanges operated by US persons . . . are authorized” through the relevant wind-down periods.
- FAQ 872 affirms that the amended EO 13959 requires US persons to divest securities within the relevant wind-down period (e.g., by November 11, 2021 for CCMCs identified in the Annex to EO 13959).
- FAQ 873 restates the amended definition of “transaction” in Section 4(e) of the EO.
- FAQ 874 states that “[a]ny transaction (including purchases for value and sales) entered into” within the relevant wind-down period that are “solely to divest, in whole or in part, from securities” held by a US person are permitted.
GL-1 authorizes all transactions and activities otherwise prohibited under Section 1(a)(i) of EO 13959 related to publicly traded securities “of an entity whose name closely matches the name of a” previously listed CCMC “but that has not been listed” on the CCMC List, until January 28, 2021.
Given the language of FAQ 857, which suggests that the prohibition under EO 13959 does not apply until OFAC adds an entity to the CCMC List, it is unclear to what extent a US person could be held liable for failing to identify an unlisted entity whose name “closely matches the name” of an entity on the CCMC List, with the exception of the subsidiaries named in FAQ 864.
OFAC could attempt to resolve this issue by publishing further guidance or adding names to the CCMC List before GL-1 expires on January 28, 2021.
GL-2 clarifies that US securities exchanges are permitted to continue listing securities of CCMCs through the relevant wind-down periods specified in Sections 1(b) and 1(c) of EO 13959. Specifically, GL-2 authorizes “activities by securities exchanges operated by US persons prohibited by section 1(a)(ii)” of EO 13959. Notably, GL-2 does not authorize transactions prohibited under Section 1(a)(i) of the EO (i.e., those prohibited as of January 11, 2021), which may have been intended to enforce the delisting of ADRs referred to in FAQ 864.
More to Come?
As noted in our earlier blog post, the EO’s plain language appears to exclude many activities and, as confirmed in FAQ 862, does not require US persons to divest holdings of CCMC securities by January 11, 2021 (for CCMCs identified in the Annex to EO 13959). However, the amended EO 13959 now makes clear that divestment is ultimately required of US persons by the end of the 365-day wind-down period following the identification of a CCMC.
OFAC has not provided specific guidance on other much-asked-about topics such as derivatives products that are excluded from US securities regulations or the liability of non-US persons providing investment services to US persons. Financial institutions outside the United States may also need to consider the “suitability” of investment products that may have exposure to CCMC securities, if offered to investors who are US persons.
As some industry concerns remain outstanding, it is possible that OFAC could continue to issue additional guidance on EO 13959, including guidance reflecting the views of the incoming administration following the presidential transition on January 20, 2021. Previously issued FAQs may be revised to conform to the amended EO.
In the interim, investors and financial institutions should evaluate whether divestment of securities or additional compliance controls are warranted prior to the EO’s effective date of January 11, 2021 (February 1, 2021, for four CCMCs identified by the DoD on December 3, 2020; and March 15, 2021, for nine CCMCs identified by the DoD on January 14, 2021).